Collusion in an Oligopoly

Topic 3.3.9

Oligopoly and Collusion

• Collusion is a form of anti-competitive behaviour • Collusion can be• Horizontal• Vertical• Explicit v Tacit collusion• Some collusion between businesses is legal

3 Key Aim of Business Collusion

Businesses in a cartel recognise their mutual interdependence and act together – the main aim is to maximise joint profits

Collusion lowers the costs of competition e.g. wasteful marketing wars which can run into millions of pounds

Collusion reduces uncertainty in a market – and higher profits increases producer surplus / shareholder value – leading to higher share prices

Basic Analysis of Price Fixing in OligopolyCost & Price

Output (Q)

Cost & Price

Output (Q)

Industry Demand and Costs Cartel Price and the Individual Member

MC

MR AR

When there are only a few dominant firms in a market, they can engage in RESTRICTIVE PRACTICES (such as cooperation to restrict output or fix higher prices)

Basic Analysis of Price Fixing in OligopolyCost & Price

Output (Q)

Cost & Price

Output (Q)

Industry Demand and Costs Cartel Price and the Individual Member

MC

MR AR

Q1

P1P1 becomes cartel price

When there are only a few dominant firms in a market, they can engage in RESTRICTIVE PRACTICES (such as cooperation to restrict output or fix higher prices)

Basic Analysis of Price Fixing in Oligopoly

P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)

Industry Demand and Costs Cartel Price and the Individual Member

MC

MR AR

MC Firm A

AC Firm AP1 becomes cartel price

P1

Basic Analysis of Price Fixing in Oligopoly

P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)

Industry Demand and Costs Cartel Price and the Individual Member

MC

MR AR

MC Firm A

AC Firm AP1 becomes cartel price

P1

Output quota for

firm

Basic Analysis of Price Fixing in Oligopoly

P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)

Industry Demand and Costs Cartel Price and the Individual Member

MC

MR AR

MC Firm A

AC Firm AP1 becomes cartel price

P1

Output quota for

firm

C1

Super-normal profit for this firm in the cartel

Profit at cartel price and staying within the

quota

Basic Analysis of Price Fixing in Oligopoly

P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)

Industry Demand and Costs Cartel Price and the Individual Member

MC

MR AR

MC Firm A

AC Firm AP1 becomes cartel price

P1

Output quota for

firm

C2

Cheating – exceeding the quota

Higher profit from producing in excess of the output quota

Increasing output to achieve higher profits

Basic Analysis of Price Fixing in Oligopoly

P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)

Industry Demand and Costs Cartel Price and the Individual Member

MC

MR AR

MC Firm A

AC Firm AP1 becomes cartel price

P1

Output quota for

firm

C2

Cheating – exceeding the quota

RISK!Over-supply

threatens stability of

cartel

Price Fixing (Collusion) is easier when….

1. Industry regulators are weak / ineffective2. Penalties for collusion are low relative to the

potential gains in revenues / operating profits3. Participating firms have a high percentage of total

sales – this allows them to control market supply 4. Firms can communicate well and trust each other

and they have similar strategic objectives5. Industry products are standardised and output is

easily measurable6. Brands are strong so that consumers will not switch

demand when collusion raises price

Background on the OPEC cartel

• The Organization of the Petroleum Exporting Countries (OPEC) is a cartel of oil-producing countries which was established in Baghdad, Iraq, in 1961.

• OPEC generates approximately 45 percent of the world’s total crude oil production, and more than 20 percent of the world’s natural gas production.

• OPEC owns more than four fifths of total global crude oil reserves, and around 48 percent of global natural gas reserves

OPEC's share of global crude oil output

2009 2010 2011 2012 2013 20140.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

42% 41.9% 42.8%44.5% 43.3%

41.8%

Perc

enta

ge o

f glo

bal p

rodu

ction

Canadian Maple Syrup Cartel Threatened• Quebec has 7,500 mostly family-run farms – who produce 70% of

world supply• Since 1990 producers have been required to hand over the bulk of

what they produce to the Federation of Quebec Maple Syrup Producers (FPAQ) which has a monopoly control over the market

• The cartel sets output quotas. • Farmers who produce in excess of the quota must send excess

output to a strategic reserve• FPAQ sets the price for how much it pays producers• The Quebec maple syrup cartel is being challenged by

independent producers who argue that it penalizes producers who want to expand

• One key threat for the Quebec cartel is the rapid growth of maple syrup production in the United States

Quebec is the dominant supply source

2008 2009 2010 2011 2012 2013 20140

2000

4000

6000

8000

10000

12000

Quebec New Brunswick Ontario Nova Scotia

Prod

uctio

n in

thou

sand

gal

lons

Why do many cartels break down?• Enforcement problems:

1. The cartel aims to restrict production to maximize total profits. 2. But each individual seller finds it profitable to expand their

production. 3. Other firms who are not members of the cartel may opt to take a

free ride by selling just under the cartel price• Falling market demand creates excess capacity in the industry and puts

pressure on profits and cash-flow• The successful entry of non-cartel firms into the industry undermines a

cartel’s control of the market• The exposure of price-fixing by whistle-blowing firms – these are firms

previously engaged in a cartel that pass on information to the competition authorities

• When trust breaks down within a cartel it is highly likely to come under pressure and many eventually collapse.

Why do many cartels break down?

Falling market demand in a recession Over-production by some members

Exposure by competition authorities Entry of non-cartel firms into industry

Costs of Collusive Behaviour

Damages consumer welfare• Higher prices / lost consumer surplus• Hits lower income families – regressive

impact

Absence of competition hits efficiency • X-inefficiencies / higher unit costs• Less incentive to innovate / dynamic

efficiencyReinforces monopoly power• Harder for new businesses to enter the

market – reduces contestability

Potential Benefits from Collusion

Industry standards bring social benefits• Pharmaceutical research• Car safety technology

Fair Prices for producer cooperatives• Competing with monopsonistic corporations• May help to reducing extreme income poverty

Profits have value – how are they used?• Capital investment• Research and development• Higher wages for employees

Collusion in an Oligopoly

Topic 3.3.9