Misconceptions About Tacit Collusion

The Netherlands Authority for Consumers and Markets recently released the final version of its study on the Dutch savings market, following an earlier draft open for public consultation. The three major Dutch banks responded strongly, asserting that the savings market is competitive, denying any oligopoly or tacit collusion.

In a previous blog (June 5), I introduced the concept of tacit collusion, providing context alongside the draft report, which identified an oligopolistic market structure with three dominant players and significant switching costs for savers. In this blog, I’ll clarify the concept of tacit collusion and address common misunderstandings around it.

Concrete Example

Economic and game theory describe tacit collusion as an equilibrium that can arise from repeated interactions between firms. In this equilibrium, companies implicitly coordinate their behavior without explicit agreements or communication, leading to reduced competition and disadvantageous outcomes for consumers.

Here’s how it works: Imagine two ice cream vendors on a beach. Each morning, they independently set their prices for a scoop of ice cream:

1. In a competitive scenario, consumers pay the lowest prices while both vendors earn reasonable profits.
2. If both vendors set higher prices, ice cream becomes more expensive, and profits increase beyond normal levels (“supra-normal” profits).
3. However, if one vendor undercuts the other, they can attract more customers and boost profits temporarily. The competitor, noticing this, may lower their price the next day, erasing the initial profit advantage.

These ice cream vendors, who observe each other’s pricing daily, not only consider current prices but also anticipate how the other will respond to price changes. If the risk of returning to fierce competition is real, they may be reluctant to jeopardize their supra-normal profits by lowering prices. As a result, prices can stabilize above competitive levels in a tacitly collusive equilibrium.

This theory relies on a repeated game with an indefinite time horizon, where prices are set, observed, and adjusted in successive rounds. The implicit threat of future price cuts discourages aggressive competition without any explicit retaliatory actions…

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