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Oligopoly: Formal and Informal Collusion

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Rene Zou

on 24 October 2013

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Transcript of Oligopoly: Formal and Informal Collusion

Notes
Antitrust Laws
More firms
Cheating
Oligopoly: Formal and Informal Collusion
Oligopoly Behavior
Oligopoly: a market system that consists of a few large sellers of products either differentiated or standardized, with entry and exit in the market being restricted due to barriers of entry.

The sellers have some control over price, but they are
interdependent
on their rivals, that is to say, their profits are affected by the pricing decisions that their rivals make. Thus an Oligopoly’s
strategic behavior
shows its self-interested actions that take into account the reactions of its competitors.
Collusion
Collusion: a usually secretive cooperation of oligopoly firms with rivals in attempt to dominate the market, and control market price (incentive to cheat instead of compete)
U.S. Airways & American Airline Merger
In response to the bankruptcy of American Airlines’s parent company, AMR, American Airlines and US Airways have been considering a merger. Before they are able to do this, the two companies would have to go before the U.S. Supreme Court and stand trial against the Anti-trust laws present in the country, which discourages monopoly behavior. The merger would create the largest U.S. airline by revenue.
Cooperating is more beneficial for firms than competing. Thus, the two airlines have decided to join legally, together they will gain greater market share and control over price. The government has an obligation to protect consumers and promote competition, thus it is against the merger, which predicts higher fares and lower competition. The Airline industry is already a concentrated oligopoly business, and can charge high prices thanks to its inelastic demand. However, cost saving and the economies of scale involved is a bonus that the companies are advocating.
How Connected?






There are also situations in which collusion may not work due to real world obstacles. Consider the following three instances:
Works Cited
Greenberg, Chris. "Dwight Freeney: NFL Owners' Collusion Kept Free Agent Contracts Low." The Huffington Post. TheHuffingtonPost.com, 02 June 2013. Web. 5 Oct. 2013.
Melendez, Eleazar David. "American Airlines, US Airways Merger Likely A Bad Deal For Customers: Consumer Advocates." The Huffington Post. TheHuffingtonPost.com, 08 Feb. 2013. Web. 1 Oct. 2013.
"Implicit Collusion." AmosWEB Encyclonomic WEB*pedia. AmosWEB LLC, 2000-2013. Web. 1 Oct. 2013.
"Collusion." AmosWEB Encyclonomic WEB*pedia. AmosWEB LLC, 2000-2013. Web. 1 Oct. 2013.
"Imperfect Competition: Monopolistic Competition and Oligopoly." Imperfect Competition: Monopolistic Competition and Oligopoly. Harper College, n.d. Web. 23 Oct. 2013.
"Oligopoly [A Levels]." Dineshbakshi.com. N.p., n.d. Web. 8 Oct. 2013.
"Price Leadership." Investopedia. ValueClick, Inc., n.d. Web. 6 Oct. 2013.
Conclusion
Oligopolies have a tendency to collude, and the interdependency characteristic of the market makes this possible. When Oligopoly firms become tired of competing, they collude to gain higher profits and greater market control. While formal and informal collusion may be utilized differently depending on the situation of the market, collusion ultimately hurts consumers as they are charged higher prices, or lower income. Hence, the government tries to prevent this with anti-trust laws that limit monopoly behavior, and promote competition.
Collusion can be
formal
and
informal
:

Formal

– overt collusion in which two or more firms formally agree to control the market

Ex.: The forming of cartels, which is the association of producers with the purpose of controlling price and supply, like OPEC, or company mergers combining firms in similar industries.

Informal

– tacit collusion in which two or more firms informally agree to control the market

Ex.: Gentleman's agreement that may often happen during meetings of industry participants, or begin with price leadership of a certain firm, usually the dominant one
NFL Owners' Gentleman's agreement
After recently being signed during off-season, NFL player Dwight Freeney accused the owners of colluding. He suggests that by agreeing not to "spend money" and sign each others’ players after terminated contracts, clubs gain control of the price and lower the income of the players, thus acting as a monopoly which dominates the market.
The Gentleman’s agreement is the kind of collusion that sports club owners may employ to drive down the pays of free agents. However, tacit collusion is hard to confirm, as competing firms may carry out independent, but parallel actions, otherwise known as price leadership. The leading firm will first announce a change in price, then other firms will soon declare similar changes. Ultimately, price leadership as means of collusion is difficult to pin down and nonpunishable.
Collusion is illegal under antitrust laws in U.S., Canada and most of the EU. A major incentive to collude is greater total profit for cooperating firms. While price wars drive prices low and put consumers in a position of power, collusion gives firms access to monopoly power. In the case of United Airways and American Airlines, collusion may be blocked by the U.S. Supreme Court to appease consumers. On the other hand, formal collusion between governments such as OPEC is allowed.
Firms avoid both price-competition, and non-price competition by colluding. However collusion is made difficult with more firms in the industry, as competition becomes higher and market share is spread out, it is hard for a few firms to collaborate and gain significant market power.

Within colluding firms, one firm may decide not to honor a pricing decision, thus earning themselves more profit during a certain market period. Trust is key in collusion. And Collusion may be prevented or dissolved due to trust issues.


The END
Colluding Oligopoly firms may be depicted through a monopoly graph. Moreover, the shaded square shows the new profit in which oligopolies are able to obtain after gaining significant market control.
Colluding Oligopoly Firms
( "Imperfect Competition: Monopolistic Competition and Oligopoly." )
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