Collusion in Oligopolistic Markets
Economics: Edexcel A A Level, topic 6.1.7
Preventing Collusion
Firms who collude or form cartels make the market less competitive and exploit their customers. Collusion is outlawed in most countries. Governments can reduce collusion by:
Increasing punishments
- If there is a very significant fine for collusion then firms are less likely to collude.
- British Airways was fined £270m in 2007 for colluding on price with another airline, Virgin Atlantic.
Whistleblowing
- Encouraging firms to come clean about collusion, without them being punished, makes it more likely that collusion will be revealed.
Keeping markets competitive
- By keeping the number of firms in the market high they make it harder for firms to agree on colluding, reduce the payoff and increasing the chance of a whistleblower.
Outcomes in Oligopolies
Whether an industry is collusive or competitive industries has a big impact on consumers in that market.
Collusive oligopoly
- Firms colluding can result in outcomes similar to a monopoly.
- Because of this, consumers are likely to have lower consumer surplus and producers will have higher producer surplus.
- Firms colluding on price will restrict their output and raise their prices closer to the profit maximising level (marginal cost equals marginal revenue).
- This creates a deadweight welfare loss to society and is statically inefficient.
- But firms will still compete in non-price competition, particularly through marketing.
Non-collusive oligopoly
- A non-collusive oligopoly will still have a deadweight welfare loss, because output will not be at the statically efficient level of product that would be created under perfect competition.
- However, output is likely to be higher and prices are likely to be lower than in a collusive oligopoly.
Kinked Demand Curve
Price stability in oligopolistic competition could be explained by a kinked demand curve. The kinked demand curve shows the level of demand faced by one firm in the oligopoly.
Why is there a kink?
- The 'kink' is at the current market price, which other small numbers of firms in the market have already set. Initially, the firm also chooses to produce at that price.
- Demand above the current market price is elastic, and below the current market price is inelastic.
The firm's choices
- If the firm chooses to raise its price, rivals stick at the original price and steal their customers.
- If the firm chooses to lower its price, rivals will follow and cut their own prices in order to maintain their market share.
- As a result of the market price falling there is a small increase in quantity demanded but it's shared among all the firms in the market.
- Prices remain stable at the kink point because each firm knows if they increase or decrease their prices they'll lose profit.
Test yourself on Collusion in Oligopolistic Markets
Why would keeping markets competitive NOT reduce the likelihood of collusion?
Which of these are methods of reducing the incentive to collude?
What is this table showing?
What is this diagram showing?
For a kinked demand curve, which of the following are true?