ChainWhat it assumes · how to break it
Start
The few large firms in an oligopoly agree to fix prices, or follow a price leader, instead of competing on price.
1
As a result, the firms act together like a single monopolist, setting joint output where industry MC = MR.
cartel · joint profit maximisation
cartel · joint profit maximisation
Assumes: All the main firms take part.
But: Firms outside the agreement, or new entrants, can undercut the agreed price and win customers.
2
This means industry output is restricted, with each firm given a quota, so the price rises towards the level a monopoly would charge.
output quotas · collusive price
output quotas · collusive price
Assumes: Firms have similar costs, so they can agree on one price.
But: If costs differ, low-cost firms want a lower price and more output than high-cost firms, so agreement is hard.
3
Consequently, consumers pay more and buy less, so consumer surplus falls, with part transferred to the firms as profit and part lost as deadweight loss.
consumer surplus · deadweight loss
consumer surplus · deadweight loss
Assumes: Consumers cannot switch to firms outside the agreement.
But: If imports or smaller firms outside the cartel offer close substitutes, consumers switch and the cartel cannot hold the price up.
4
In addition, with price competition removed, firms compete through advertising and branding, so consumers lose the choice of a cheaper option.
non-price competition · consumer choice
non-price competition · consumer choice
Best link to attack
Assumes: Non-price competition gives consumers little of real value.
Assumes: Non-price competition gives consumers little of real value.
But: Firms may compete hard on quality, service and new product features, which can bring real gains to consumers.
End
Consumers pay higher prices, lose consumer surplus and lose the choice of cheaper options.
Evaluation chain
- E1However, the harm to consumers depends on whether non-price competition gives them something of value.
- E2Because colluding firms still compete for market share through quality, service and new product features, consumers may receive better products even though prices are fixed.
- E3As a result, part of the loss of consumer surplus from higher prices may be offset by gains in quality.
- E4So collusion harms consumers through higher prices, but the overall harm is smaller where firms compete hard on quality and larger where non-price competition is mainly advertising.
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Questions this answers
- Assess the impact of collusion between oligopolists on consumers.
- Explain how price fixing reduces consumer surplus.
- Discuss whether non-price competition in an oligopoly benefits consumers.
Diagram
Cartel diagram: compare the competitive price and output with the collusive price and output, shading the lost consumer surplus and deadweight loss.
Reverse and related
Breakdown of collusion → price war, lower prices and more consumer surplus.