Impossibility of Collusion under Imperfect Monitoring with.pdf

Impossibility of Collusion under Imperfect Monitoring with Flexible Production * Yuliy Sannikov and Andrzej Skrzypacz October 2006 We show that it is impossible to achieve collusion in a duopoly when (1) goods are homogenous and firms compete in quantities, (2) new, noisy information arrives continuously, without sudden events and (3) firms are able to respond to new information quickly. The result holds even if we allow for asymmetric equilibria or monetary transfers. The intuition is that the flexibility to respond quickly to new information unravels any collusive scheme. Our result applies to both a simple stationary model and a more complicated one with prices following a mean-reverting Markov process, as well as to models of dynamic cooperation in many other settings. (JEL C73, D43, L13, L14) Collusion is a major problem in many markets and has been an important topic of study in both applied and theoretical economics. From exposed collusive cases we know how numerous real-life cartels have been organized and what kinds of agreements (either implicit or explicit) are likely to be successful in obtaining collusive profits.1 At least since George J. Stigler (1964), economists have recognized that imperfect monitoring may destabilize cartels. Nevertheless, the seminal paper of Edward J. Green and Robert H. Porter (1984) has shown that even with imperfect monitoring firms can create collusive incentives by allowing price wars to break out with positive probability. We study the scope of collusion in a quantity-setting duopoly with homogenous goods and flexible