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Abstract
This paper uses a duopoly model with horizontally differentiated products to analyse how price collusion in the presence of a uniform tax affects market equilibrium. Moreover, this paper investigates the effect of price collusion on social welfare and the government's decision in setting the optimal tax. We show that in the presence of a uniform tax, instead of bringing social welfare down as is traditionally believed, price collusion affects government policy implication. We further show that firms still prefer colluding rather than competing, for which the government's policy decision becomes the key point. By allowing the optimal tax to be negative, we find that under Bertrand competition the government can impose a positive, zero or negative tax on firms depending on the level of the product differentiation. There is a tendency that the more heterogeneous the products, the more subsidies will be given. Under price collusion, the government always subsidises firms regardless of the degree of product differentiation. Finally, we show that when the products are sufficiently differentiated, the government will subsidise firms more under collusion than they will under Bertrand. In short, firms can use price collusion to induce the government to subsidise them.
Highlights
Collusion practices in industries have been proven to be socially undesirable
We show that despite identical equilibrium price and quantity, firms still prefer to collude rather than compete. Do they benefit from the competition missing from the market, but they benefit from the policy undertaken by a government under a collusion regime. This result is confirmed by our third finding, which is that under the Bertrand regime a government can impose a positive, zero or negative tax on firms depending on the level of product differentiation
We find that in the presence of a uniform tax, the equilibrium price and quantities and the consumer surplus under price collusion can be identical to those under pure price competition (Bertrand competition)
Summary
Collusion practices in industries have been proven to be socially undesirable. Collusion gives firms an incentive to gain more profit while eliminating fair competition from the market. This paper discusses price collusion in the presence of a uniform tax, which is allowed to be negative and further considers the welfare implication of price collusion itself This will definitely affect the trade policy, namely tax and in this case, undertaken by the domestic government. We show that despite identical equilibrium price and quantity, firms still prefer to collude rather than compete Do they benefit from the competition missing from the market, but they benefit from the policy undertaken by a government under a collusion regime. This result is confirmed by our third finding, which is that under the Bertrand regime a government can impose a positive, zero or negative tax on firms depending on the level of product differentiation. The remainder of this paper is as follows: the second section previews the related literature, which supports this paper; the third section provides the basic model used in this paper; section four discusses the main results and section five concludes the paper
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