A revision presentation of business collusion in an oligopoly

1. Collusion in an Oligopoly
Topic 3.3.9

2. 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. 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

4. Basic Analysis of Price Fixing in Oligopoly
Cost & 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)

5. Basic Analysis of Price Fixing in Oligopoly
Cost & Price
Output (Q)
Cost & Price
Output (Q)
Industry Demand and Costs Cartel Price and the Individual Member
MC
MR AR
Q1
P1
P1 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)

6. 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 A
P1 becomes cartel price
P1

7. 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 A
P1 becomes cartel price
P1
Output
quota for
firm

8. 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 A
P1 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

9. 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 A
P1 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

10. 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 A
P1 becomes cartel price
P1
Output
quota for
firm
C2
Cheating –
exceeding
the quota
RISK!
Over-supply
threatens
stability of
cartel

11. Price Fixing (Collusion) is easier when….
1. Industry regulators are weak / ineffective
2. Penalties for collusion are low relative to the
potential gains in revenues / operating profits
3. 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 objectives
5. Industry products are standardised and output is
easily measurable
6. Brands are strong so that consumers will not
switch demand when collusion raises price

12. 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

13. OPEC's share of global crude oil output
42% 41.9% 42.8%
44.5%
43.3%
41.8%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
2009 2010 2011 2012 2013 2014
Percentageofglobalproduction

14. 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

15. Quebec is the dominant supply source
0
2000
4000
6000
8000
10000
12000
2008 2009 2010 2011 2012 2013 2014
Productioninthousandgallons
Quebec New Brunswick Ontario Nova Scotia

16. 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.

17. 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

18. 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 efficiency
Reinforces monopoly power
• Harder for new businesses to enter the market
– reduces contestability

19. 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

20. Collusion in an Oligopoly
Topic 3.3.9