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Pricing Algorithms and Implications for Competition | Competition Policy International

Welcome to our first new issue of CPI’s Cartels column.  It’s been about two years since our last column, and much has happened in the area of collusion in that time.  We will be compiling interesting areas of discussion on cartels every month, most often with invited contributors, hoping to gather your interest and reaction.  In addition, please feel free to send us your thoughts on areas you would like us to cover.  For now, are starting with pricing algorithms and collusion.

Pricing algorithms are an increasingly integral topic of policy discussion.  Last November, as part of the Federal Trade Commission’s (“FTC”) Hearings on Consumer Protection and Competition, I had the privilege of participating in a distinguished panel on pricing algorithms and collusion.  The panelists were Ai Deng, Joe Harrington, Kai-Uwe Kühn, Sonia Kuester Pfaffenroth, Maurice E. Stucke, and myself, with Ellen Connelly and James Rhilinger2 as moderators.  The video for this panel clearly illustrates the divergence of opinions on this topic.3

What are pricing algorithms?  Put simply, pricing algorithms are computer models which predict the optimal (generally “profit maximizing”) price given various inputs.  These inputs would include signals of prevailing market demand and supply conditions, and could include the prices charged by competitors for similar (substitutable) or complimentary goods.

Pricing Algorithms and Benefits to Competition

In principle any business could develop and use a pricing algorithm.  Usually, however,  there is a connotation that pricing algorithms can quickly change prices given quickly changing information.  It is not practical for a brick-and-mortar retailer to retag all their products during the day, even if a pricing algorithm would suggest that the market would support a higher price during the lunch hour rush.  It is also not practical to send an employee to other brick-and-mortar stores and survey what their prices are throughout the day.  While these traditional retailers could use programs and econometric models to help them set prices over time, and while these models could fairly be called “pricing algorithms,” they are not the sort of application most people have in mind when they use the term.

Instead, when we talk about “pricing algorithms,” we usually have in mind an internet application of some sort.  An internet retailer, for example, could alter prices moment to moment as their algorithms consider (i) how many customers have been recently browsing those items and (ii) how many browsing customers decided to make a purchase at the old prices.  They could deploy “bots” – AI programs which continuously scour the websites of their competitors to see what prices they are charging.

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Pricing Algorithms and Implications for Competition | Competition Policy International.

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