Regulating Discriminatory Pricing in the Presence of Tacit Collusion

49 Pages Posted: 30 Nov 2023 Last revised: 7 Dec 2023

See all articles by Zongsen Yang

Zongsen Yang

The Chinese University of Hong Kong, Shenzhen

Xiao Lei

HKU Business School, The University of Hong Kong

Pin Gao

School of Data Science, The Chinese University of Hong Kong, Shenzhen

Date Written: November 15, 2023

Abstract

Price-setting algorithms have facilitated widespread awareness-based price discrimination, in which firms charge high prices to customers unaware of alternative choices and low prices to those in competitive markets. This unethical behavior has increased customer complaints and prompted policymakers to enact fairness regulations in response. However, while limiting price discrimination may improve consumer welfare under genuine competition, it also affects firms' incentives to form tacit collusion, another regulatory concern arising from the proliferation of pricing algorithms. We develop an analytical model to examine the interplay between fairness regulation and tacit collusion, and discuss its impact on consumer welfare and policymaking. Firms utilize customers' product unawareness to implement price discrimination and decide whether to collude by comparing profits from collusion and deviation. We then explore the consequences of price fairness regulation on the sustainability of algorithmic collusion. For homogeneous products, fairness regulation can substantially weaken collusion, potentially rendering it unattainable. However, for differentiated products, strict fairness inadvertently supports collusive behavior, harming consumer welfare. In this case, mild fairness permitting moderate price differentiation can prevent market collusion and optimize welfare. We conduct a numerical experiment using simple Q-learning algorithms to demonstrate the realism of our analytical findings. To address fairness-induced collusion, we propose a novel approach that randomizes over the fairness levels, achieving the desired fairness in expectation. Our randomized policy is effective in both obstructing collusion and improving consumer surplus. Overall, our study emphasizes the importance of a nuanced approach to regulating discriminatory pricing in the presence of tacit collusion.

Keywords: price discrimination, algorithmic collusion, dynamic competition, fairness

JEL Classification: D63, L13, L40, L51

Suggested Citation

Yang, Zongsen and Lei, Xiao and Gao, Pin, Regulating Discriminatory Pricing in the Presence of Tacit Collusion (November 15, 2023). Available at SSRN: https://ssrn.com/abstract=4633784 or http://dx.doi.org/10.2139/ssrn.4633784

Zongsen Yang (Contact Author)

The Chinese University of Hong Kong, Shenzhen ( email )

Xiao Lei

HKU Business School, The University of Hong Kong ( email )

Hong Kong
China

HOME PAGE: http://www.xiao-lei.org

Pin Gao

School of Data Science, The Chinese University of Hong Kong, Shenzhen ( email )

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