Collusion with Capacity Constraints over the Business Cycle

Abstract

This paper investigates the e®ect of capacity constraints on the sustainability of collusion in markets subject to cyclical demand °uctuations. In the absence of capacity constraints (i.e. a limiting case of our model), Haltiwanger and Harrington (1991) show that ¯rms ¯nd it more di±cult to collude during periods of decreasing demand. We ¯nd that this prediction can be overturned if ¯rms' capacities are su±ciently small. Capacity constraints imply that punishment pro¯ts move procyclically, so that periods of increasing demand may lead to lower losses from cheating even if collusive pro¯ts are rising. Haltiwanger and Harrington's main prediction remains valid for su±ciently large capacities.