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Collusion and Market Structure

Explain what economists mean by collusion and consider the view that collusion will occur only in a certain type of market structure.

Category:

Market Structures and Competition

CIE A Level October/November 2022

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Answer

Tips on How to Answer Economics Essay

1. ⏩Know Your Concepts⏩⬅: Familiarize yourself with all relevant economic concepts. In this case, understand what collusion means and the characteristics of different market structures.

2. ⏩Define Your Terms⏩⬅: Start the essay by defining the main terms. This sets the stage for your discussion and shows that you understand what you're talking about.

3. ⏩Analyse⏩⬅: Discuss how the main concepts relate to each other and the essay question. Here, analyze how collusion fits into different market structures.

4. ⏩Draw from Real Life⏩⬅: Use examples to illustrate your points. These can be drawn from case studies, news reports, or your own observations.

5. ⏩Critique⏩⬅: Discuss the strengths and weaknesses of the different views or theories you're discussing. In this case, discuss the limitations of collusion and its viability in different market structures.

6. ⏩Conclude⏩⬅: Wrap up by restating your main points and answering the essay question directly.

7. ⏩Review⏩⬅: Go through your essay for any grammar or spelling mistakes, and to make sure your argument is clear and logical.

ESSAY:


⏩Introduction⏩

Collusion, in the context of economics, refers to an agreement among firms within an industry to coordinate their activities to secure mutual benefits. It often involves price-fixing, output control or both. This essay aims to explore the nature of collusion and consider the view that it primarily occurs in specific market structures.

⏩Understanding Collusion⏩

Collusion can manifest in two forms⬅: formal and tacit. Formal collusion, known as a cartel, involves an explicit agreement among firms, usually to control prices or output, often deemed illegal. Tacit collusion, on the other hand, involves an implicit understanding where a dominant firm sets the trend, and others follow suit.

Certain conditions favor collusion⬅: firms producing similar products using alike methods, large firms often with a dominant entity, significant entry barriers, stable market conditions, and minimal government interference.

⏩Collusion in Different Market Structures⏩

Not all market structures lend themselves to collusion. Perfect competition, characterized by numerous small firms and no entry barriers, leaves firms as price-takers with no scope for collusion. Monopolistic competition, with small firms selling differentiated products and no entry barriers, similarly precludes collusion. Monopoly, by its nature, involves one large firm controlling the market, making collusion irrelevant.

Perfect Competition and collusion:

Perfect competition is a market structure characterized by a large number of small firms producing identical products, with no entry barriers and perfect information. In such a market, individual firms have no market power and are considered price-takers. Due to the presence of numerous firms and intense competition, collusion is highly unlikely and ineffective. Each firm's actions have a negligible impact on the overall market, making coordination and agreement on prices or output impractical. Any attempt at collusion would quickly unravel as firms compete to offer lower prices or better products to attract customers.

Monopolistic Competition and collusion:

Monopolistic competition shares some similarities with perfect competition, such as a large number of firms and no entry barriers. However, in monopolistic competition, firms sell differentiated products, meaning they have some control over their prices and can engage in limited product differentiation strategies. While collusion is technically possible in this market structure, it is unlikely to be successful or sustainable. Firms differentiate their products to capture market share and create brand loyalty, making it difficult to coordinate on prices or output. Additionally, the presence of product differentiation creates a degree of competition among firms, reducing the incentive to collude.

Monopoly and collusion:

In a monopoly market structure, a single firm controls the entire market for a particular product or service. As the sole provider, the monopolistic firm faces no competition, eliminating the need or possibility for collusion. Collusion requires multiple firms to cooperate and coordinate their actions, but in a monopoly, there are no other firms to collude with. The monopolistic firm has full control over pricing and output decisions, allowing it to maximize its profits without the need for collusion.

In summary, collusion is unlikely or irrelevant in market structures such as perfect competition and monopolistic competition due to the presence of numerous firms, intense competition, and product differentiation. In a monopoly, collusion is not possible as there is only one firm in the market. The effectiveness and sustainability of collusion heavily depend on the market structure and the ability of firms to coordinate their actions, which vary significantly across different market structures.

⏩Emphasis on Oligopoly⏩

The oligopoly market structure, characterized by a handful of large firms often producing similar goods and employing entry barriers, presents ideal conditions for collusion. However, it's essential to note that the existence of such conditions does not automatically lead to collusion. Firms within an oligopoly still compete using strategies like advertising and product differentiation. Furthermore, cartels often face challenges due to cheating or non-compliance with agreed rules.


Collusion is an anti-competitive action by producers. Informal or tacit collusion, however, is not illegal and usually takes the form of price leadership, where firms automatically follow the lead of one of the group. Th e objective is to maximise the profits of the whole group by acting as a single monopolist. Th e price leader is invariably the dominant firm and has sufficient market power to determine a price change that other fi rms follow. On the other hand, a cartel is a formal price or output agreement between fi rms in an industry to restrict competition. This is illegal.

Collusion is more likely to be tacit where the behaviour of each fi rm is the result of an unwritten rather than
formal agreement. As noted above, one of the simplest forms is a follow-the-leader agreement, where each fi rm will only adjust its price following a move by the dominant firm. There are other price leadership models, such as using a typical firm as the yardstick for price. This will only change if a rise in costs aff ects the profit margin. The principle is the same: each firm will act in the same way in the interests of the group as a whole.

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The figure above shows what happens when fi rms join a cartel and agree prices. By doing this, they are operating as a monopoly and maximising their profits. A profi t-maximising monopolist would
choose the output where MC = MR. Th is output will be somewhere over the price range where demand is price elastic and will be sold at the price consumers will pay. If the total revenue is higher than the production costs, it will make abnormal profi t. Th is will be a permanent feature. In monopoly, there is no distinction between the short run and the long run because of the barriers that prevent the entry of competitors. Th ere is no economic incentive for the monopolist to move away from the profi t-maximising
output Q.

⏩Conclusion⏩

In conclusion, while collusion can theoretically occur in various market structures, the conditions under an oligopoly make it the most likely contender. However, the occurrence of collusion is not guaranteed, and firms in an oligopoly engage in non-price competitive practices. Thus, it's accurate to say collusion is more prevalent in certain market structures, but it is not confined solely to them.


OUTLINE



⏩I. Introduction⏩
- Definition of collusion.
- Initial consideration of the view that collusion occurs only in certain market structures.

⏩II. Understanding Collusion⏩
- Further explanation of collusion.
- Different forms of collusion⬅: formal and tacit.
- Conditions that favor collusion.

⏩III. Collusion in Different Market Structures⏩
- Analysis of the occurrence of collusion in different market structures⬅: Perfect competition, monopolistic competition, monopoly, and oligopoly.

⏩IV. Emphasis on Oligopoly⏩
- Discussion on why oligopoly market structure is most likely to promote collusion.
- Limitations and competition within oligopoly.

⏩V. Conclusion⏩
- Recap of the argument and response to the view that collusion occurs only in certain market structures.











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