Do Price Increases While Demand Is Falling Indicate Collusion?

Because of difficulties in identifying direct evidence of collusive activity on the part of suspected firms under antitrust law, the courts in the past have been forced to rely heavily on indirect evidence, such as pricing behavior, in rendering their decisions. Recently, with the smoking-induced health costs and related class-action litigation against the tobacco industry, the courts have become an important forum for regulating tobacco products. The purpose of this article is to investigate theoretically the pricing behavior of a cartel (or price leader) under conditions of decreasing demand and falling costs with a formal proof and numerical simulations. In particular, this article generalizes and examines both the normal case and unusual case under these circumstances. The model thus derived can be used as a more general theoretical basis for antitrust enforcement. It applies directly to the tobacco industry in which promotional activities, rather than prices, are regulated.