ChainWhat it assumes · how to break it
Start
The few large firms in an oligopoly secretly agree to fix prices and share out the market instead of competing.
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
Therefore, each firm earns a share of the joint supernormal profit that is larger than it would make by competing on price.
joint profit maximisation · supernormal profit
joint profit maximisation · supernormal profit
Assumes: Every firm keeps to its quota.
But: Each firm can earn even more by cheating, so the agreement may collapse into a price war.
4
Since the agreement is secret, the firms keep these profits for as long as it goes undetected.
covert collusion
covert collusion
Best link to attack
Assumes: The competition authority does not uncover the cartel.
Assumes: The competition authority does not uncover the cartel.
But: The CMA can fine firms up to 10% of their worldwide turnover, and leniency for the first firm to report the cartel makes a confession likely.
End
Each firm's profit rises above the competitive level for as long as the cartel holds and is not caught.
Evaluation chain
- E1However, the profit gain depends on the risk and cost of being caught.
- E2If a cartel is uncovered, then fines of up to 10% of worldwide turnover can wipe out years of extra profit, and directors can be disqualified.
- E3As a result, the expected profit from colluding, allowing for the chance of a fine, may be far lower than the gain from the higher price.
- E4So collusion raises profits in the short run, but where detection is likely and fines are large, it may reduce profits over time.
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Questions this answers
- Explain why firms in an oligopoly may collude.
- Assess whether collusion is likely to raise firms' profits in the long run.
- Discuss the factors that determine whether a cartel is successful.
Diagram
Cartel diagram: industry MC = MR sets joint output and price, with the joint supernormal profit area shared between members by quota. A game theory payoff matrix shows that each firm's profit is higher still if it cheats.
Reverse and related
Breakdown of collusion → price competition drives profits down towards normal profit.