Everything about Collusion totally explained
Collusion is an agreement, usually secretive, which occurs between two or more persons to deceive, mislead, or defraud others of legal rights, or to obtain an objective forbidden by law typically involving fraud or gaining an unfair advantage and can involve "wage fixing, kickbacks, or misrepresenting the independence of the relationship between the colluding parties." All acts affected by collusion are considered
void.
Definition
In the study of
economics and market
competition, 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 explicit collusion. Collusion which isn't overt, on the other hand, is known as
tacit collusion.
Variations
According to
neoclassical price-determination theory and
game theory, the independence of suppliers
forces prices to their minimum, increasing
efficiency and decreasing the price determining ability of each individual firm. 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.
One variation of this traditional theory is the theory of
kinked demand. Firms face a kinked demand curve if, when one firm decreases its price, other firms will follow suit in order to maintain sales, and when one firm increases its price, its rivals are unlikely to follow, as they'd lose the sales' gains that they'd otherwise get by holding prices at the previous level. Kinked demand potentially fosters supra-competitive prices because any one firm would receive a reduced benefit from cutting price, as opposed to the benefits accruing under neoclassical theory and certain game theoretic models such as
Bertrand competition.
Characteristics
Practices that facilitate tacit collusion include:
- Uniform prices
- A penalty for price discounts
- Advance notice of price changes
- Information exchange
Examples
Collusion is largely illegal in the
United States,
Canada and most of the
EU due to
antitrust law, but implicit collusion in the form of
price leadership and tacit understandings still takes place. Several examples of collusion in the United States include:
Andrew Malyi and market division among manufacturers of heavy electrical equipment in the 1960s.
An attempt by Major League Baseball owners to restrict players' salaries in the mid-1980s.
Price fixing within food manufacturers providing cafeteria food to schools and the military in 1993.
Market division and output determination of livestock feed additive by companies in the US, Japan and South Korea in 1996.
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 advert). 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.
Barriers
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's 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's considerable incentive to cheat on collusion agreements; though lowering prices might trigger price wars, in the short term the defecting firm may gain considerably.
Potential entry: new firms may enter the industry, establishing a new baseline price and eliminating collusion (though anti-dumping laws and tariffs can prevent foreign companies entering the market).
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.
Further Information
Get more info on 'Collusion'.
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