Competition versus collusion: The impact of consumer inertia

• Author: Erik Pot,Iwan Bos,Ronald Peeters
• Date: 01 December 2017
• Published date: 01 December 2017
• DOI: http://doi.org/10.1111/ijet.12136

doi: 10.1111/ijet.12136

Competition versus collusion:

The impact of consumer inertia

Iwan Bos,∗Ronald Peeters†and Erik Pot‡

A model of dynamic price competition is analyzedto assess how consumer inertia may impact the

ability of firms to sustain high prices. Three main consequences are identified: maintaining high

prices does not require punishment strategies when firms are sufficiently myopic; for sufficiently

high levels of inertia, high prices can be sustained at all discount factors; and the ability to

maintain high prices may depend non-monotonically on the level of the discount factor. Our

findings offer implications for strategic firm behavior and public policy. For example, measures

aiming to reduce the degree of consumer inertia are unambiguously effective in traditional

markets, but may facilitate collusion in network industries.

Key wor ds collusion, consumer inertia, dynamic competition

JEL classification C73; D43; L13; L41

Accepted 9 May2016

1 Introduction

Collusion theory commonly presumes that firms face a prisoner’s dilemma when attempting to

coordinate prices. By slightly undercutting the collusive price, each firm is assumed to generate an

instant and substantial increase in its sales and profits. While there might be instances in which

consumers respond quickly to price changes, it is often more common that they do not switch

suppliers instantaneously. For example, buyers may exhibit brand loyalty, switching costs or a lack

of information on the price or quality of competing products. They also may have signed long-term

contracts with their suppliers or simply not switch even when it would be beneficial to do so.1

The presence of these types of consumer inertia fundamentally alters the incentive compatibility

constraint for colluding oligopolists. Absent inertia, firms have an incentive to abide by a collusive

agreement when short-run gains from defecting fall short of future losses. Given that demand is

∗Department of Organization & Strategy, Maastricht University,Maastricht, The Netherlands.

†Department of Economics, Maastricht University,Maastricht, The Netherlands. Email: r.peeters@maastrichtuniversity.nl

‡Department of Quantitative Economics, Maastricht University,Maastricht, The Netherlands.

The content of this paper has been presented at ACLE (Amsterdam), Tilburg University, NAKE (Utrecht), SING-6

(Palermo), the Netherlands Competition Authority( The Hague),University of Groningen (Groningen), IIOC (Boston),

Erasmus University Rotterdam, DICE (D¨

usseldorf). We thank the respective audiences as well as an anonymous referee

for their helpful comments and suggestions. R. Peeters gratefully acknowledges financial support of the Netherlands

Organization for Scientific Research (NWO).

1That consumersmay stick to defaults and achieve suboptimal outcomes is confirmed experimentally by Sitzia et al. (2012).

The opposite may also occur.Wilson and Waddams Price (2010) analyze consumerbehavior in the UK electr icity market

and find that a significant number of customers lost surplus by switching supplier.

International Journal of Economic Theory 13 (2017) 387–400 © IAET 387