Oligopoly - Collusion

When a few large firms dominate a market there is always the potential for businesses to seek to reduce uncertainty and engage in some form of collusive behaviour

In an oligopoly, collusion refers to an agreement, either explicit or tacit, between competing firms to coordinate their actions to reduce competition and maximize joint profits. Through collusion, firms act collectively as if they were a single monopoly, often to the detriment of consumers and market efficiency.

Evaluating the Costs and Benefits of Collusion - Revision Video

Types of Collusion

1. Explicit Collusion:
   • Firms openly communicate and agree on strategies such as setting prices, limiting production, or dividing markets.
   • This type of collusion often involves formal agreements, such as a cartel.
   • Example: OPEC (Organization of the Petroleum Exporting Countries) acts as a cartel, coordinating oil production to influence prices.
2. Tacit Collusion:
   • Firms indirectly coordinate their actions without explicit communication or agreements.
   • This is often achieved by observing competitors' behavior and aligning strategies, such as following price changes by a dominant firm (price leadership).
   • Example: Airlines often match price increases initiated by competitors without direct negotiation.

Forms of Collusion

1. Price Fixing:
   • Firms agree to charge a uniform price for their products, avoiding price competition.
   • This leads to higher prices for consumers.
2. Output Restriction:
   • Firms agree to limit production to create artificial scarcity, driving up prices.
3. Market Sharing:
   • Firms divide the market geographically or by customer type to avoid competition.
   • Example: One firm might serve only certain regions, leaving others for competitors.
4. Bid Rigging:
   • Firms collude in auctions or procurement processes by agreeing in advance on who will submit the winning bid.

Reasons for Collusion

1. Maximizing Joint Profits:
   • Firms can achieve monopoly-like profits by eliminating competitive pressures.
2. Reducing Uncertainty:
   • In an oligopoly, firms are interdependent, and collusion provides stability in pricing and output decisions.
3. Avoiding Price Wars:
   • Collusion helps firms avoid destructive price competition that erodes profitability.

Challenges to Collusion

1. Cheating Among Firms:
   • Collusion is inherently unstable because firms have an incentive to cheat by secretly lowering prices or increasing output to capture a larger market share.
   • Example: In a price-fixing agreement, one firm may undercut the agreed-upon price to gain more customers.
2. Market Entry:
   • High prices resulting from collusion may attract new entrants, increasing competition and undermining the collusive agreement.
3. Legal and Regulatory Enforcement:
   • Collusion is often illegal and subject to heavy fines and penalties in many jurisdictions.
   • Example: Antitrust laws in the U.S., EU, and other countries aim to detect and penalize collusive behavior.

Effects of Collusion

1. On Firms:
   • Positive: Firms earn higher profits and avoid uncertainty.
   • Negative: Collusion is risky due to potential fines, loss of reputation, and enforcement actions.
2. On Consumers:
   • Negative: Consumers face higher prices, limited choices, and reduced innovation due to lack of competition.
   • Positive: In rare cases, collusion might lead to price stability in markets where fluctuating prices harm consumers.
3. On the Market:
   • Collusion reduces market efficiency, leading to allocative inefficiency where prices exceed marginal costs.

Examples of Real-World Collusion

1. Airlines (Price Fixing):
   • Several airlines have been fined for colluding on fuel surcharges.
2. Automobile Manufacturers (Emissions):
   • In 2019, European carmakers faced scrutiny for colluding on delaying emission-reducing technology.
3. Tech Companies:
   • Technology firms have been penalized for colluding on employee hiring practices (e.g., "no-poach" agreements).

Conclusion

Collusion in an oligopoly allows firms to behave like a monopoly, maximizing joint profits but at the cost of consumer welfare and market efficiency. While collusion can be explicit or tacit, it is often illegal due to its negative impact on competition and consumers. Regulatory authorities play a crucial role in identifying and preventing collusion to maintain fair market practices.