Collusion with Capacity Constraints over the Business Cycle

This paper investigates the effect of capacity constraints on the sustainability of collusion in markets subject to cyclical demand fluctuations. In the absence of capacity constraints (i.e. a limiting case of our model), Haltiwanger and Harrington (1991) show that firms find it more difficult to collude during periods of decreasing demand. We find that this prediction can be overturned if firms’ capacities are sufficiently small. Capacity constraints imply that punishment profits move procyclically, so that periods of increasing demand may lead to lower losses from cheating even if collusive profits are rising. Haltiwanger and Harrington’s main prediction remains valid for sufficiently large capacities.