Tricky Dicky, the Colluder-in-Chief

Noting that up to a certain point, higher output is accompanied by per unit cost falls, a firm will have the incentive to increase profit by cheating on a collusive agreement.

Assume that Visy convinces Amcor that demand for boxes has collapsed and that it, Visy, will lower its price in response. Silly Amcor takes Dicky at his word and cuts its price while maintaining the agreed production volumes.

In fact demand didn’t budge one iota. Visy plans to raise its output beyond the agreed volumes, but is aware that such actions will depress the price. Visy is most keen to ensure that Amcor does not raise its output beyond the agreed level.

Case 2 illustrates what happens when Visy cheats.

The industry output (of 4 million boxes) exceeds the production levels (of 3.1 million) had the two firms colluded, as shown in Case 1. At 4 million boxes, the price per unit is 140c, somewhat lower than what could be achieved in Case 1 (175c).

There are several reasons why Visy would behave in this manner. It may be after higher market share. It may seek the industry profits to be shared differently among the colluders. It may be trying to send Amcor broke. It may want to show the market that Amcor is an unreliable provider of boxes in terms of price or volumes offered.

In Case 2 Visy has secured more sales. We can infer that its market share has moved from 60 per cent to 67 per cent, and Amcor’s has dipped from 33 per cent to 26 per cent.

Note, that the industry wide economic profit in this case ($0.76 million) is smaller than in the case where the two firms colluded ($0.775 million). Repudiating the illicit agreement is clearly in the interests of the Colluder-in-Chief, Visy, whose revenues and economic profit are much improved when it alone cheats.

Notes to table:

1. We begin in Case 1, relying on Visy’s media estimates (however suspect) that the market is divided between Visy (60 per cent) and Amcor (33 per cent).
2. Economic profit is “profit” after allowing for all expenses, one of which is the opportunity cost of the capital (also includes “normal” profit).

Both Visy and Amcor cheat