collusion complete for students

1. In economics, collusion occurs when rival firms agree to
work together, e.g. setting higher prices in order to
make higher profits.
• Collusion is a secretive agreement between
two or more organizations, formed with the
aim of gaining illegal mutual benefits.

2. • In the above example, a competitive industry will have price P1 and Q
competitive. If firms collude, they can restrict output to Q2 and increase price to
P2.

3. Collusion usually involves some form of agreement to seek
higher prices. This may involve:
 Agreeing to increase prices faced by consumers.
 controlling production.

4. Types of collusion
Formal collusion – when firms make formal agreement to stick to
high prices. This can involve the creation of a cartel.
Example: OPEC
Tacit collusion – where firms make informal agreements or collude
without actually speaking to their rivals.
This maybe to avoid detection by government regulators.
Price leadership. It is possible firms may try to unofficially collude by
following the prices set by a market leader. This enables them to
keep prices high, without ever meeting with rival firms. This kind of
collusion is hard to prove whether it is unfair competition or just the
natural operation of markets.

5. Profits are allocated on basis
of:
(1)Individual outputs,
(2) Historical market shares,
(3) Production capacity of firms and
(4) Bargaining power of individual firms.

6. Problems of collusion
Collusion is seen as bad for consumers and economic welfare, and
therefore collusion is mostly regulated by governments. Collusion can
lead to:
High prices for consumers. This leads to a decline in consumer
surplus and allocative inefficiency (Price pushed up above marginal
cost)
New firms can be discouraged from entering the market by types of
collusion which act as a barrier to entry.
Easy profits from collusion can make firms lazy and avoid innovation
and efforts to increase productivity.
Industry gets the disadvantages monopoly (higher price) but none of
the advantages (e.g. economies of scale)

7. However, cartel arrangements do not
last for long due to:
(1)Changing products,
(2) Entry of new firms into the
industry
(3) Disagreement among the
members.
(4) Cheating