Regulating Discriminatory Pricing in the Presence of Tacit Collusion
49 Pages Posted: 30 Nov 2023 Last revised: 7 Dec 2023
Date Written: November 15, 2023
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
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