Licensing and Collusive Behavior : A Duopoly Game

We examine the role of licensing agreements in facilitating collusive behavior. The focus is on how technology transfer is used to influence product market behavior, market prices and quantities and the welfare effects thereof. Although collusion often leads to less production, technology sharing of nondrastic, but sufficiently large, innovations can increase welfare in an industry characterized by diseconomies of scale. We identify licensing agreements that will lead to an aggregate industry quantity output under collusion equal to or higher than that achieved under Cournot competition, making consumers indifferent to whether firms cooperate or better off, as well as to an increased producer surplus because of improved production efficiency. Most important, we show how licensing fees can be constructed so that no parties would like to deviate from a collusive equilibrium. Stability of collusion has policy implications for competition authorities as it provides an explanation for why licensing agreements are often observed in highly concentrated industries characterized by significant diseconomies of scale relative to demand