Collusion

From Academic Kids

In the study of economics, collusion takes place within an industry when rival companies cooperate for their mutual benefit. Collusion most often takes place within the market form of oligopoly, where the decision of a few firms to collude can significantly impact the market as a whole. Cartels are a special case of overt collusion.

According to game theory, the independence of suppliers forces prices to their minimum, increasing efficiency and decreasing the price determining ability of each individual firm. If one firm decreases its price, other firms will follow suit in order to maintain sales, and if one firm increases its price, its rivals are unlikely to follow, as their sales would only decrease. These rules are used as the basis of kinked-demand theory. If firms collude to increase prices as a cooperative, however, loss of sales is minimized as consumers lack alternative choices at lower prices. This benefits the colluding firms at the cost of efficiency to society.

Collusion is largely illegal in the United States due to antitrust law, but implicit collusion in the form of price leadership and tacit understandings still takes place. Several recent examples of collusion in the United States include:

There are many ways that implicit collusion tends to develop:

  • The practice of stock analyst conference calls and meetings of industry almost necessarily cause tremendous amounts of strategic and price transparency. This allows each firm to see how and why every other firm is pricing their products.
  • If the practice of the industry causes more complicated pricing, which is hard for the consumer to understand (such as risk based pricing, hidden taxes and fees in the wireless industry, negotiable pricing), this can cause competition based on price to be meaningless (because it would be too complicated to explain to the customer in a short ad). This causes industries to have essentially the same prices and compete on advertising and image, something theoretically as damaging to a consumer as normal price fixing.

There are significant barriers to collusion, however, under most circumstances. These include:

  • The number of firms: as the number of firms in an industry increases, it is more difficult to successfully organize and communicate.
  • Cost and demand differences between firms: if costs vary significantly between firms, it may be impossible to establish a price at which to fix output.
  • Cheating: there is considerable incentive to cheat on collusion agreements, as lowering prices would create price wars and provide considerable profits to the cheating firm.
  • Potential entry: new firms may enter the industry, establishing a new baseline price and eliminating collusion.
  • Economic recession: an increase in average total cost or a decrease in revenue provides incentive to compete with rival firms in order to secure a larger market share and increased demand.
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