Collusive Behaviour in an Oligopoly A2 EconomicsCollusion represents an attempt by firms to recognize their interdependence and act together rather than compete Collusion — can seen as a move towards joint-profit maximization Collusion normally requires control over the market supply of a commodity Overt collusion + This is the creation of a price fixing arrangement with a producer cartel responsible for allocating output / supply within the market* Tacit collusion — Dominant firm ‘price leadership’ * One firm's price changes are matched by the other firms * Price leadership often happens in segments of a market — E.g. the market for mortgage lending — The market for breakfast cereals — Barometric-firm leadership * The price leader is the one judged to have best knowledge of prevailing market conditions+ OPEC cartel (periodic tensions / breakdown of cartel agreement) + ‘Over the counter’ pharmaceuticals (ended May 2001) + Electrical goods retailers and computer games producers — investigated by the Competition Commission in 2000+ Most collusive activity takes place between firms in the same industry. + Recent examples: Bus service operators in some cities Car body parts suppliers Steel producers within the European Union Coffee producers (coffee export retention scheme) Independent schools West Midlands roofing contractors cartel! * But not all horizontal agreements are bad or illegal! Strategic Alliances to share R and D, for example, if registered, can be exempted from EU competition law+ Vertical restraints refer to the methods used by manufacturers to restrict the ways in which retailers can market their product + Examples include Franchising and Distribution channels + Examples in the UK in recent years include: — Car manufacturers and agreements with distributors — Football Kit Manufacturers — Net Book Agreement (ended in 1995) — Over the Counter Pharmaceutical products (ended in May 2001)Competition law prohibits almost any attempt to fix prices - for example, you cannot — Agree prices with your competitors, e.g. you can’t agree to work from a shared minimum price list — Share markets or limit production to raise prices = Impose minimum prices on different distributors such as shops — Agree with your competitors what purchase price you will offer your suppliers — Cut prices below cost in order to force a smaller or weaker competitor out of the market The law doesn't just cover formal agreements. It also includes other activities with a price-fixing effect. For example, you shouldn't discuss your pricing plans with your competitors. If you then all "happen" to raise your prices, you are fixing prices,There is only a small number of firms in the industry The industry has substantial entry barriers A large number of customers. Total market demand not too variable — Low income elasticity of demand — Demand fairly inelastic with respect to price, interest rates etc Firm's output can be easily monitored — Easier to control total supply and identify firms who are cheating on output quotas Price discounts are hard to deliver — Hard for firms to under-cut their rivals and break the cartelMost cartel arrangements experience difficulties Falling demand creates excess capacity in the industry e.g. during an economic downturn Entry of non-cartel firms into the industry Exposure of price fixing by Government agencies Over-production which breaks the price fixing — OPEC one of the best examples — but other international commodity agreements have suffered from similar problems Prisoners’ Dilemma suggests that collusion breaks down — Incentive to cheat because joint-profit maximization does not mean each firm is maximising profits on their own* Consumers may gain from — Period of relative price stability — Areduction of some of the wasteful costs of advertising and marketing if producers co-operate rather than compete with each-other — Guaranteed supply from the producer cartel + Producer cartels may be successful in raising the price of exported commodities — May help to fund higher levels of capital investment — Boost to export revenues for countries with a high dependency on exports of primary commodities