Collusion in Bertrand vs. Cournot Competition: A Virtual Bargaining Approach

How do firms manage to collude without communicating? Why do we find more collusion in price competition than in quantity competition? Why is collusion so hard to detect? We examine strategic behavior in competitive interactions by developing and applying the concept of virtual bargaining. When decision makers virtually bargain, they mentally simulate, and choose among, agreements that they could reach if they were able to explicitly negotiate with each other. Virtual bargainers focus on agreements that offer some protection against the possibility that their counterparts may deviate and best respond to these agreements. We develop a formal account of virtual bargaining and demonstrate that it leads to collusion in Bertrand, but not in Cournot, competition. In this framework, collusion is a result of virtual bargaining as a mode of reasoning and requires neither communication nor dynamic considerations, such as rewards and punishments, between the players. This paper was accepted by Manel Baucells, decision analysis.