Number Effects and Tacit Collusion in Oligopolistic Markets
60 Pages Posted: 30 Mar 2017 Last revised: 9 Aug 2017
Date Written: August 15, 2017
Concerns about market power and coordinated behavior frequently confront competition and regulatory authorities with the question: How many competitors are enough to ensure competition? For example, several high-profile merger control proceedings in the European Union as well as in the US have dealt with cases that would reduce the remaining number of competitors from four to three major mobile telecommunications operators. In the US airline industry, the Department of Justice had initially filed a lawsuit to block the merger between American Airlines and US Airways that reduced the number of legacy carriers from four to three, explicitly referring to the low number of competitors as a critical threat to effective competition. Even in a high-tech commodity industry like the hard disk drive industry, consolidation among manufacturers raises the question whether there is a magical number to reconcile scale synergies and pro-competitive effects.
In general, the number of firms in a specific market is determined endogenously by the competitive process and particularly by firms’ entry and exit decisions. However, in merger cases and regulatory proceedings, authorities are often required to determine a specific number of competitors exogenously. This makes it necessary to estimate the impact of number effects on the competitiveness of a market. It is well known that equilibrium predictions for market prices are generally decreasing with a higher number of competitors. However, the impact on the degree of tacit collusion, i.e., the ability of firms to sustain a supra-competitive price above the equilibrium price, is not as clear.
In this article, we investigate the research hypothesis that tacit collusion in oligopolistic markets with two, three, and four competitors decreases strictly monotonically with the number of competing firms. From a methodological point of view, experimental laboratory experiments are well suited to address this question, because they allow to observe out-of-equilibrium behavior while controlling for environmental conditions. Whereas, a meta-analysis of the extant literature supports the notion that duopolies are significantly more prone to tacit collusion than quadropolies, i.e., that “two are few and four are many”, there is no empirical support for a significant effect when moving from four to three firms. However, the lack of statistical power across and within existing studies precludes a conclusive evaluation. Moreover, the review of the literature reveals a lack of systematic evaluation of number effects under different competition models with symmetric and asymmetric firms, and under consideration of different theoretical equilibrium predictions. Therefore, we conduct two laboratory experiments, which are explicitly designed to test for number effects on tacit collusion under price and quantity competition, as well as with symmetric and asymmetric firms. We do find a significant increase in tacit collusion from four to three firms as well as from three to two firms. In fact, the empirically observed increase of tacit collusion is almost identical from four to three as from three to two, suggesting a linear number effect for highly concentrated oligopolies with regard to the (in)ability to coordinate on a price level above the theoretical Nash prediction.
Keywords: Number of competitors, Mobile telecommunications markets, Merger control, Oligopolies, Tacit collusion, Experimental economics
JEL Classification: L13, D21, D43, C92
Suggested Citation: Suggested Citation