L3+4 - Cartels Flashcards
What is tacit and explicit collusion?
Tacit collusion - a collusive outcome that requires no formal agreement and no direct communication
Explicit collusion - verbal and written agreements
Why might companies want to collude?
Collusion - a way of easing competitive pressure
Eliminates the uncertainties of independent action and reduces interdependence
What are cartels and what is the overall objective of a cartel?
Cartels - an association of companies that take action to
coordinate their prices, contract tender, split the market, fix
market shares
Associations of independent firms that restrain competition and exploit market power
Overall objective: ease competitive pressure through collective agreements that enable members to increase prices and profits above competitive level
Cartel formation may be described by a cooperative game
What might cartel agreements be?
Agreements to:
Impede entry or the development of new products that might threaten the profitability or survival of incumbent firms (most important)
Sales conditions; costs, prices and profit margins; allocation of territories or customers; productive capacity allocation
What are trade associations?
Provide members with industry data information on
industry sales, productive capacity, creditworthiness of
customers, etc
Promote activities to reduce inefficiency
Promote better relations with customers
What is a joint venture?
Join venture - an association between two or more otherwise competing firms. Might take the form of a consortium or syndicate
Firms may enter joint ventures to:
combine firm resource to increase efficiency
overcome entry barriers and enter new markets
develop joint research and development undertakings
What is semi-collusion?
Occurs in cases where it is difficult to formulate specific agreements covering all aspects of the firms’ behaviour.
Firms may opt to collude in some activities and compete in others.
What is state-sponsored collusion?
State-sponsored collusion -government imposes cartel conditions on firms
What are the assumptions for profit-maximization for cartels (when all firms in the industry are in the cartel)?
All firms in an industry are in a centralised cartel with complete control over price and output
Identical products
Produce under different cost structure
No threat of entry
When is profit maximized (when all firms in the industry are in the cartel)?
Maximization of combined profit of boils down to joint profit
maximization as if a multi-plant monopolist
Output level at which marginal revenue (derived from industry
average revenue function) equals industry’s marginal cost function
The total cost of producing QM is minimised by allocating
quotas in such a way that the marginal costs of each firm, when producing its own quota, are the same
What are four motives for collusion?
Risk management and the enhancement of security
Exchange of information
Unsatisfactory performance
Profit-maximization
How can risk management and exchange of info be motives for collusion?
Risk management and the enhancement of security:
Risk arises from changes in consumer tastes and risk results directly from competition between producers
Firms can choose to take independent actions (product differentiation, advertising and marketing) or collude and act jointly
Exchange of information: It lowers firms’ vulnerability, encourages cooperative behaviour and increases industry stability
How can unsatisfactory performance and profit-maximization be motives for collusion?
Unsatisfactory performance:
Low profitability due to industry conditions such as intense competition and demand decline can encourage firms to collude
Firms in a declining industry are perhaps more likely to collude in an attempt to restore profitability to some historical level.
Profit-maximization:
Higher profit by exercising (near monopoly) market power
What are five factors conducive to cartel formation?
Structural characteristics for formation and stability of cartels
- Seller concentration and number of firms
- Cost functions
- Size and product differentiation
- Vertical integration
- Transaction costs of collusion: costs of ensuring compliance and punishing non-compliant members
How can seller concentration and the number of firms be conducive to cartel formation?
Small number of firms or high concentration facilitates collusion.
As the number of firms increases, the contribution of each firm to total output decreases, and the firms become more likely to ignore their interdependence.
As the number of firms increases, there is more temptation for a rogue firm to undercut the agreed price, as it perceives a low risk of detection.
Since firms often have different views as to the optimal cartel policy, communication and negotiation between firms is required to reconcile differences. Coordination becomes more difficult as numbers increase
A more explicit form of collusion is needed as the numbers increase
How can cost functions be conducive to cartel formation?
Firms with similar cost structures enhances collusive behaviour
A firm faced with an average cost function that
decreases as output increases may be reluctant to restrict its output as a condition of cartel membership.
How can size and product differentiation be conducive to cartel formation?
It is easier to collude when most firms are similar in their market share, size, product ranges, production technology and capacity
Small firms may be reluctant to adopt quotas based on existing market shares, while large firms may collude with each other to enhance their (collective) dominance.
Difficult to agree on price if products are very different
Demand that is relatively inelastic at the pre-cartel price ensures that revenues can be increased significantly by reducing output levels and raising price.
How can vertical integration be conducive to cartel formation?
It renders effective monitoring of cartel members difficult and thus may impede collusion
How can transaction costs of collusion (costs of ensuring compliance and punishing non-compliant members) be conducive to cartel formation?
Ability to specify contractual relations correctly
Extent to which agreement can be reached over joint gains (might require the reduction of some firms’ output and the expansion of others)
Uncertainty associated with change in the economic environment
Monitoring especially when there are non-price forms of competition
Penalties particularly important in the absence of legal protection. Successful collusion must rest on the availability of effective sanctions against firms that fail to comply with the agreement
Are cartels inherently unstable?
Coordination/Collusion/cartel outcome: behave like a monopolist and split market
However, both have an incentive to deviate
Hence, cartel outcome is not a Nash equilibrium and therefore inherently unstable!
What are the assumptions in the joint profit-maximization model where some firms are outside the cartel?
Two groups of firms, one forms a cartel and one does not
Number of firms N
Number of firms that form a cartel K
Large number of small firms in both groups
Identical product
Identical cost function
Entry is successfully deterred
Price-taking behaviour on the part of non-cartel firms
Where do cartel firms maximize profits (when not all firms in the industry are in the cartel)?
Cartel firms maximize profits where residual marginal revenue equals collective marginal cost, MR = C
Market demand left for the cartel is reduced by the free rider’s supply
The resulting demand curve relevant
for the cartel is D_cartel which cartel takes as given when deciding on the price
What is the freerider problem?
The freeriding non-cartel firms (N-K) earn higher profits than the cartel firms, thanks entirely to the sacrifices made by the latter.
The N - K firms behave as price takers and sell everything they can until their marginal costs are equal to the price
The cartel members are allowed to produce q1 only, according to the cartel rules, while free riders can offer q2, thus earning a higher profit (The free riders also gets additional producer surplus in form of the little triangle in the figure on the left)
How does increased transparency affect cartel stability?
If transparency is increased, less likely firms will deviate from cartel
With increased market transparency,
Cartel members will find it easier to detect deviators
At the same time, expected gain from deviation and loss after break-up becomes larger
Deviations from cartels become less attractive (under certain assumptions):
o more transparency
o conventional view: A increases less than B increases
o expected net gain from deviation shrinks
o better to stay in cartel (get cartel profit in all periods)
