How to spot a cartel
ONE WAY to identify dodgy prices is to use a splendidly counterintuitive phenomenon known as Benford’s law. In a 1938 paper Frank Benford, a physicist working for General Electric, pointed out a pattern that occurs in large data sets. Across thousands of metrics, including 3,259 different population distributions and 741 sources of data on firms’ costs, he found that leading digits (for example, the numbers “3” and “7” in 3,259 and 741, respectively) are not distributed evenly, as you might expect. They follow a pattern: “1” is the most common and “9” the rarest. Benford’s law holds across a wide range of measures, including naturally occurring data like populations (see left-hand chart). Such patterns can be used to "price screen": a test that can help spot markets where pricing patterns are odd and warrant further investigation. In a competitive market, theory suggests prices should track firms' costs over time, and because costs differ between firms, prices should as well. Firms’ selling prices should vary over time, too. Cartels change things: prices rise far above costs, so small cost increases can simply be absorbed. And colluders tend to smooth prices, too. In a 2006 paper the authors looked at the price of fish sold to American military bases in the late 1980s to backtest the theory. A cartel had stitched up the market for cod, flounder, haddock and perch. When the cartel reigned, the prices of perch were oddly stable. But when providers began to compete, prices dropped by 16% and also became choppier, reflecting fluctuations in wholesale fish prices (see right-hand chart). This suggests that one way to direct scarce antitrust resources is to set up automatic scans of market prices, looking for excess price stability. Read more in this week's free exchange.