Collusive oligopoly

Question 1

Define collusive oligopoly

Answer 1

• firms agree informally/formally
• cooperate and limit competition
• reduce uncertainty
• maximise firms’ joint profits
• act collectively like a monopoly
• avoid price wars – might make firms worse off
• fix prices, allocate output quotas

Question 2

Collusive oligopoly example

Answer 2

• OPEC+ agree to meet at beginning of each month
• discuss adjustments of pdtn vol
• avoid price war % Saudi Arabia (biggest member) and Russia

Question 3

Factors that facilitate collusion

Answer 3

• small no. of firms
• similar product
• high barriers to entry
• clear leader (e.g. Saudi Arabia)
• stable market

Question 4

Small no. of firms

Answer 4

easier to arrive at a consensus

Question 5

Similar product

Answer 5

similar COP

Question 6

High barriers to entry

Answer 6

• harder for non-member firms to join and lower px

Question 7

Stable mkt

Answer 7

• dd and pdtn cost fluctuate wildly
• difficult to predict and make agreements (have to be frequently amended)
• declining mkt – tempted to defect and lower px

Question 8

Types of collusive oligopoly

Answer 8

• Cartel (formal/open)
• Price leadership model (informal/tacit)

Question 9

Define cartel

Answer 9

• formal collusive agreement
• made by number of firms
• maximise joint profits, limit comp
• behave like a monopoly
• agree on common px that is profitable for all
• cannot sell below agreed px

Question 10

Profit-maximization by price-fixing cartel

Answer 10

• draw diagram
• MC curve = sum of all MC curves
• profit-maximising output = 0Q1
• need to divide industry outpt
• based on historical mkt shares
• or agree to compete (pdt differentiation, advertising)

Question 11

-ve of cartels

Answer 11

• inherently unstable
• strong incentive to produce beyond quota, take advantage of high px
• causes px to fall; lower profits
• illegal in most countries due to anti-competitive behavior
• harm consumers’ interests (pay higher px)

Question 12

Factors that make cartels difficult to establish and mantain

Answer 12

• incentive to cheat
• possibility of px war
• cost diff % firms
• diff dd curves

Question 13

Incentive to cheat (Establishment and maintenance of cartels)

Answer 13

• secretly lower px for some buyers
• cheat – increase mkt share and profit
• at expense of other firms
• discovered – likely to collapse

Question 14

Possibility of px war (Establishment and maintenance of cartels)

Answer 14

• possible outcome of cheating
• one firm’s px cut matched by retaliatory price cuts frm other forms
• make firms collectively worse off
• lower px, lower profits
• e.g. 2020 price war (OPEC)

Question 15

Cost diff % firms (Establishing and maintenance of cartels)

Answer 15

• ideal: MC=MR – max profit
• each firm has diff cost curves
• those with higher average cost – lower profits (vice versa)
• difficult to agree on px and output quota

Question 16

Diff dd curve (Establishment and maintenance of cartels)

Answer 16

• diff mkt shares
• pdt differentiation
• more differentiated – greater diff btwn dd curves
• difficult to agree on px

Question 17

Price leadership model (informal collusion)

Answer 17

• co-operation that is implicit/understood % firms
• coordinate px behavior w/o formal agreement
• one dominant firm (most cost-efficient) act as leader, set px, others are price-takers

Question 18

Tactics in price leadership model

Answer 18

• infrequent px changes
• limit pricing

Question 19

Infrequent px changes (Px leadership model tactics)

Answer 19

• px increases – risky, no guarantee that others will follow
• leaders might lose substantial share
• px changes only initiated if whole industry faces sig changes in cost/dd conditions

Question 20

Limit pricing (Px leadership model tactics)

Answer 20

• leader choose to set a px that doesnt max SR profits for industry
• below firms’ SR profit-maximizing px
• limit px to protect LR profits frm damage frm comp