Collusion is the practice of companies agreeing on the price and quantity of goods in an oligopolistic market to gain unfair profits, and the Korean government has introduced a self-reporting system to prevent it. However, there is also a risk of abuse by large companies.
Among the many economic news and stories, there are some that pop up every once in a while that are worth forgetting, making their presence felt and annoying busy modern people. One of the most common economic offenses is collusion. Collusion is most common in oligopolistic markets, where a few giant companies control most of the market. Unlike other market structures, firms in oligopolies interact like a game to determine corporate strategy. In this interactive process, firms know that a small number of competitors dominate the market and that they cannot make much profit by competing with each other by undercutting each other’s prices, and they formulate strategies by predicting the attitudes and reactions of other firms to their actions.
At this point, firms in an oligopolistic market are highly tempted to negotiate and determine the price and quantity of goods to avoid fierce price competition, and there is a great risk of falling into the temptation of “collusion,” which is an act of restricting effective competition in the field and gaining unfair advantage by setting prices or restricting the number of business partners through contracts or agreements. It’s a clear disruption of market order and unfair advantage, which is why many people are outraged when they hear of companies colluding, and why the Korean government has laws that prohibit and punish collusion.
So, what are the ways to eliminate collusion? First, let’s take a look at a fun example before giving an answer. Two people, A and B, have committed a crime and are arrested as suspects. They are separated into different interrogation rooms for questioning. They can’t communicate with each other, and A and B can choose one of two strategies: confess or remain silent. The police offer to sentence them both to five years in prison if they both confess and one year each if they remain silent, and also offer to release the confessing person and sentence the silent person to nine years in prison if one of A and B confesses and the other remains silent.
The above example is a game theory developed by Princeton University professor Albert Tucker, and is commonly referred to as the “prisoner’s dilemma. The answer to this problem can be easily analyzed using common sense reasoning rather than a difficult theoretical approach. Let’s go back to the situation and put ourselves in A’s shoes. A cannot easily predict what strategy B will take, but A’s strategy is self-evident. Assuming B confesses, if A remains silent, A will be sentenced to 9 years in prison, but B will be released; if A confesses, both A and B will be sentenced to 5 years in prison. Furthermore, even assuming B remains silent, A would prefer to be released if he confesses than to be sentenced to 1 year in prison if he remains silent. In other words, regardless of B’s choice, A will choose the strategy of confessing that is favorable to him. Similarly, we can infer that B will eventually choose the strategy of confessing. The upshot is that both A and B will confess for their own gain, even though they know that the best strategy for both of them is silence, and both will end up with the worst of all possible worlds: a sentence of 5 years each, and 10 years in total.
We would like to focus on a real-world application of this interesting Prisoner’s Dilemma phenomenon, specifically the “Reward System,” which was created to break collusion between companies. The system is designed to encourage companies that engage in collusive behavior that harms the market economy to voluntarily report it, and it exempts or reduces sanctions such as fines for the first company to report collusion between companies, thus reducing attempts at collusion that are very difficult to detect due to their sophistication, as they may report the other company. The Korean government introduced the program in 1997 and activated it in 2005, and the benefits of self-reporting include a 100% exemption from fines for the first self-reporters and a 50% reduction in fines for the second self-reporters. This is a classic prisoner’s dilemma situation.
Using the above methodology, we can see that it is in the best interest of both Company A and Company B to self-report. This gives them a good incentive to avoid fines and encourages the colluding firms to defect. However, as with most schemes, there is a major downside to the linearity system. Large, well-informed companies are often the first to engage in collusion and are often the first to be exempted from fines, leading to repeated collusion. In addition, the system is fundamentally flawed because the company that leads the collusion has an advantage when it comes time to provide crucial evidence in a self-report, which is often the company with the largest market share. In response to the criticism, the government announced a revised version of the system that does not provide immunity for repeated collusion within a certain period of time and does not benefit secondary filers. Prosecutors have also made it clear that they will investigate companies that have used the linearity system if the offense is serious enough.
The above is a real-world example of game theory applied to the Renewal System. However, today, game theory has become a mathematically integrated theory that can be applied in all areas of society to analyze human behavior, decision-making, and the formulation and implementation of all kinds of strategies, and it has great potential. In today’s uncertain and always curious about the future, game theory deserves more attention and effort because it provides us with tools that allow us to make insightful and rational decisions.
