2019 Paper 1 (Micro) Flashcards
25 MARKER
With reference to an industry of your choice, evaluate why some firms engage in collusive behaviour. (25)
Def. - Collusion is a non-competitive, secret, and sometimes illegal agreement between rivals which attempts to disrupt the market’s equilibrium. It involves two people/firms who would usually compete against one another, conspiring with one another to gain an unfair competitive advantage
UK Modelling Agency’s. In 2016, group of UK modelling agencys (Storm, Viva, FM Models) found guilty of price-fixing and fined £1.5m.
MA said these firms fixed minimum prices and common approaches were agreed. Benefit of this collusion is that consumers (fashion retailers online and high-street) must pay higher prices to modelling agencies, as they are all charging the same price ,’, Agencies see increased revenue and profit. This was an example of overt collusion, where firms formally agree to set prices in which they will benefit from.
2013 -> rise of social media -> lowered barriers to entry for new firms -> market share of these agencies decrease. Collusion could have helped maintain market share -> maintain price maker status -> SNP distributed to shareholders or reinvested for dynamic efficiency.
However, effectiveness of the collusion relies on the PED of the product, chance of whistleblower activity. Also is the risk of fines
Market was an oligopoly, so SNP can be made, however in worst case could have become near monopolistic, in which only normal profit could be made, bad for existing firms.
However, not all firms engage in collusion, and there is also an incentive to break the cartel (GAME THEORY DIAGRAM). Lowering price further than agreed -> increased sales, rev and profit -> other competitors market share decreases. As this incentive to break is so high, cartels are often difficult to sustain over time
Additionally, collusion allows firms to avoid costly price wars, especially in an oligopoly, due to high strategic interdependence. Oligopoly diagram. Firms may hold out at extremely low prices, maybe even subnormal, to drive competitors out of the market once they reach short run shutdown point (AR=AVC).
One example is the 1992 US Airline price wars, resulting in increased air travel but huge losses. Estimated that industry losses that year exceeded entire combined profits since the industry began.
However, collusion can be negative -> Easy profits from collusion can make firms lazy and avoid innovation and efforts to increase productivity. -> X-Inefficiency
In conclusion -> clear why they colluded -> increased revenue and market share -> exert market dominance in changing market.
That said, non-collusive behaviour likely more profitable if firms can sustain low prices below competitors, or non-price strategies like advertising and improved quality
