Collusion

In the study of economics, collusion takes place within an industry when rival companies cooperate for their mutual benefit. Collusion most often takes place within the market form of oligopoly, where the decision of a few firms to collude can significantly impact the market as a whole. Cartels are a special case of overt collusion.

According to game theory, the independence of suppliers forces prices to their minimum, increasing efficiency and decreasing the price determining ability of each individual firm. If one firm decreases its price, other firms will follow suit in order to maintain sales, and if one firm increases its price, its rivals are unlikely to follow, as their sales would only decrease. These rules are used as the basis of kinked-demand theory. If firms collude to increase prices as a cooperative, however, loss of sales is minimized as consumers lack alternative choices at lower prices. This benefits the colluding firms at the cost of efficiency to society.

Collusion is largely illegal in the United States due to antitrust law, but implicit collusion in the form of price leadership and tacit understandings still takes place. Several recent examples of collusion in the United States include:

• Price-fixing and market division among manufacturers of heavy electrical equipment in the 1960s
• Price fixing within food manufacturers providing cafeteria food to schools and the military in 1993
• Market division and output determination of livestock feed additive by companies in the US, Japan and South Korea in 1996

There are significant barriers to collusion, however, under most circumstances. These include:

• The number of firms: as the amount of firms in an industry increases, it is more difficult to successfully organize and communicate
• Cost and demand differences between firms: if costs vary significantly between firms, it may be impossible to establish a price at which to fix output
• Cheating: there is considerable incentive to cheat on collusion agreements, as lowering prices would create price wars and provide considerable profits to the cheating firm
• Potential entry: new firms may enter the industry, establishing a new baseline price and eliminating collusion
• Economic recession: an increase in average total cost or a decrease in revenue provides incentive to compete with rival firms in order to secure a larger market share and increased demand