Tacit Collusion with Consumer Preference Costs

When consumers have preference costs, two opposing effects need to be assessed to analyze firms' incentives to set collusive prices. On the one hand, preference costs make a deviation from collusion less attractive, as the deviating firm must offer a steeper discount to cover these preference costs. On the other hand, preference costs lock in consumers and make punishment from rivals less effective. When preference costs are low, the second effect dominates and collusion is harder to sustain than in a situation with no preference costs. The contrary happens with high enough preference costs.