Firms in an oligopoly can increase their profits by agreeing with other firms in the industry on what prices to charge. Explicit price fixing violates the antitrust laws and can subject the firms involved to fines of up to $100 million and executives at the firms to fines of up to $1 million and prison terms of up to 10 years. Despite these penalties, the rewards to avoiding price competition are often so great that firms look for ways to implicitly collude—that is, to arrange ways to coordinate their prices without violating the law by explicitly agreeing on the prices to charge. (We discuss the antitrust laws in Microeconomics and Economics, Chapter 15, Section 15.6.)
One way for firms to implicitly collude is through price leadership. With price leadership, one firm in the industry takes the lead in announcing a price change that other firms in the industry then match. (We briefly discuss price leadership in Microeconomics and Economics, Chapter 14, Section 14.2.)
In their classic industrial organization textbook, F.M. Scherer of Harvard’s Kennedy School and David Ross of Bryn Mawr College summarize the legal status of price leadership, given court opinions from antitrust cases: “[P]rice leadership is not apt to be found contrary to the antitrust laws unless the leader attempts to coerce other producers into following its lead, or unless there is evidence of an agreement among members of the industry to use the leadership device as the basis of a price-fixing scheme.” As the Federal Trade Commission notes on its website: “A uniform, simultaneous price change could be the result of price fixing, but it could also be the result of independent business responses to the same market conditions.”
Scherer and Ross describe price leadership in a number of oligopolistic industries during the twentieth century, including cigarettes, steel, automobiles, breakfast cereals, turbogenerators, and gasoline.
Recently, Nathan Miller of Georgetown University, Gloria Sheu of the Federal Reserve, and Matthew Weinberg of Ohio State University published an article in the American Economic Review analyzing price leadership in the beer industry. They focus on the period from 2001 to 2011, although they believe that conditions in the beer industry are similar today. From 2001 to 2007, three large U.S.-based firms—Anheuser-Busch, SABMiller, and Molson Coors—accounted for about two-thirds of beer sales in the United States. Two importers—Heineken and Grupo Modelo—accounted for about 14 percent of sales. In 2008, SABMiller and Molson Coors combined to form MillerCoors and InBev—which had a small market share—bought Anheuser Busch. In 2011, MillerCoors and InBev together accounted for 63 percent of beer sales.
ABI has acted as the price leader, announcing prices in the late summer that MillerCoors typically matches. ABI’s Bud Light had the largest market share among beers in the United States in 2011, well ahead of Coors Light, which had the second largest share. They find that industry profits were 17 percent above the competitive level in 2007—just before the Miller-Coors merger—and 22 percent above the competitive level in 2010—after the merger. The U.S. Department of Justice (DOJ) had decided not to contest the Miller-Coors merger because “cost savings in distribution likely would offset any loss of competition.” As it turned out, the cost savings occurred but their value was smaller than the losses in consumer surplus resulting from reduced competition.
The authors estimate that, compared with the competitive outcome, the reduction in consumer surplus in the beer market due to price leadership equaled 154 of the increase in producer surplus before the Miller-Coors merger and 170 percent after it. Figure 15.5 from Chapter 15 of Microeconomics (reproduced below) illustrates why the loss of consumer surplus is larger than the increase in producer surplus: The increase in price and decline in quantity compared with the competitive level results in a deadweight loss that reduces the total economic surplus in the market. (Note that the figure is comparing the situation when a market is monopoly with the situation when the market is perfectly competitive. For simplicity, we are assuming that price leadership in an oligopolistic industry, such as beer, results in the monopoly outcome. But note that whenever collusive behavior, like price leadership, occurs in an industry, we would expect an increase in deadweight loss that will make the gains to firms larger than the losses to consumers.)
Sources: Federal Trade Commission, “Price Fixing,” ftc.gov; U.S. Department of Justice, Antitrust Division, “Price Fixing, Bid Rigging, and Market Allocation Schemes: What They Are and What to Look for,” justice.gov; Nathan H. Miller, Gloria Sheu, and Matthew C. Weinberg, “Oligopolistic Price Leadership and Mergers: The United States Beer Industry,” American Economic Review, Vol. 111, No. 10, pp. 3123-3159; and F.M Scherer and David Ross, Industrial Market Structure and Economic Performance, Third edition, Boston: Houghton Mifflin, 1990.