oligopoly and collusion
TRANSCRIPT
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