Demand forecasting, signal precision, and collusion with hidden actions

Abstract

We analyze how higher demand-forecasting precision affects firms' chances of sustaining supracompetitive profits, depending on whether actions are observable or hidden. We identify a dual role of improving forecasting ability for situations in which actions are hidden. Improved forecasting ability increases the temptation for firms to deviate, reducing profits; at the same time, such ability reduces and eventually eliminates the uncertainty over whether deviations are occurring. Our framework, in which firms decide on prices and promotional activities, reveals a U-shaped relationship between profits and predictive ability. Generally, collusive profits may increase or decrease in signal precision, depending on action observability, highlighting the importance of industry-specific considerations for regulatory interventions and competition policy.