Collusion happens when businesses in an oligopoly (a market dominated by a few large firms) secretly work together. Their goal is to limit competition and increase their total profits by acting like a single monopoly.
Types of Collusion:
- Tacit Collusion: Firms follow the actions of a “price leader” without making any formal or written agreements.
- Overt Collusion: Firms make formal, explicit agreements to control prices, output levels, or divide up market territory. This is illegal in most countries because it is anti-competitive.
Why Firms Collude:
- To earn maximum joint profits.
- To avoid price wars and reduce business uncertainty.
- To make it difficult for new companies to enter the market.
When is Collusion Likely?
- When there are only a few large companies.
- When products are very similar (homogeneous).
- When the market is stable and has high barriers to entry.
What Stops Collusion?
- When there are many competing firms or products are different (differentiated).
- When businesses are tempted to “cheat” on the agreement to make more money for themselves.
- Strict laws and government regulations.
Consequences for the Market:
- Consumers pay higher prices.
- There is less variety and lower levels of innovation.
- The overall economic welfare of society declines.