Collusion

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Collusion is a deceitful agreement or secret cooperation between two or more parties to limit open competition by deceiving, misleading or defrauding others of their legal right. Collusion is not always considered illegal. It can be used to attain objectives forbidden by law; for example, by defrauding or gaining an unfair market advantage. It is an agreement among firms or individuals to divide a market, set prices, limit production or limit opportunities. [1] It can involve "unions, wage fixing, kickbacks, or misrepresenting the independence of the relationship between the colluding parties". [2] In legal terms, all acts effected by collusion are considered void. [3]

Contents

Definition

In the study of economics and market competition, collusion takes place within an industry when rival companies cooperate for their mutual benefit. Collusion often takes place within an oligopoly market structure, where there are few firms and agreements have significant impacts on the entire market or industry. To differentiate from a cartel, collusive agreements between parties may not be explicit; however, the implications of cartels and collusion are the same. [4]

Collusion which is covert is known as tacit collusion, and is considered legal. Adam Smith in the Wealth of Nations explains that since the masters (business owners) are fewer in numbers, it is easier to collude to serve common interests among those involved, such as maintaining low wages, whilst it is difficult for the labour to coordinate to protect their own interests due to their vast numbers. Hence, business owners have a bigger advantage over the working class. Nevertheless, according to Adam Smith, the public rarely hear about coordination and collaborations that occur between business owners as it takes place under informal settings. [5]

Variations

According to neoclassical price-determination theory and game theory, the independence of suppliers forces prices to their minimum, increasing efficiency and decreasing the price-determining ability of each individual firm. [6] However if all firms collude to increase prices, loss of sales will be minimized, as consumers lack alternative choices at lower prices and must decide between what is available. This benefits the colluding firms, as they generate more sales, at the cost of efficiency to society. [7]

One variation of this traditional theory is the theory of kinked demand. Firms face a kinked demand curve if, when one firm decreases its price, other firms are expected to follow suit in order to maintain sales. When one firm increases its price, its rivals are unlikely to follow, as they would lose the sales' gains that they would otherwise receive by holding prices at the previous level. Kinked demand potentially fosters supra-competitive prices because any one firm would receive a reduced benefit from cutting price, as opposed to the benefits accruing under neoclassical theory and certain game-theoretic models such as Bertrand competition. [8]

Collusion may also occur in auction markets, where independent firms coordinate their bids (bid rigging). [9]

Antecedents

Scholars in economics and management have tried to identify factors explaining why some firms are more or less likely to be involved in collusion. Some have noted the role of the regulatory environment [10] and the existence of leniency programs. [11] Others, drawing upon the literature in criminology and misconduct, have suggested that firms conduct a costs/benefits analysis to assess their participation in collusion. [12]

Indicators

Practices that suggest possible collusion may include one or more actions such as:

Examples

Collusion is illegal in the United States, Canada and most of the EU due to antitrust laws, but implicit collusion in the form of price leadership and tacit understandings still takes place. Several examples of collusion in the United States include:

In the EU:

There are many ways that implicit collusion tends to develop:

Barriers

There can be significant barriers to collusion. In any given industry, these may include:

See also

Related Research Articles

Microeconomics Branch of economics that studies the behavior of individual households and firms in making decisions on the allocation of limited resources

Microeconomics is a branch of economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms.

An oligopoly (ολιγοπώλιο) is a market form wherein a market or industry is dominated by a small group of large sellers (oligopolists). Oligopolies can result from various forms of collusion that reduce market competition which then typically leads to higher prices for consumers. Oligopolies have their own market structure.

In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In theoretical models where conditions of perfect competition hold, it has been demonstrated that a market will reach an equilibrium in which the quantity supplied for every product or service, including labor, equals the quantity demanded at the current price. This equilibrium would be a Pareto optimum.

Cartel Mutually beneficial collusion among competing corporations

A cartel is a group of independent market participants who collude with each other in order to improve their profits and dominate the market. Cartels are usually associations in the same sphere of business, and thus an alliance of rivals. Most jurisdictions consider it anti-competitive behavior. Cartel behavior includes price fixing, bid rigging, and reductions in output. The doctrine in economics that analyzes cartels is cartel theory. Cartels are distinguished from other forms of collusion or anti-competitive organization such as corporate mergers.

Price fixing Agreement over prices between participants on the same side in a market

Price fixing is an agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand.

A subsidy or government incentive is a form of financial aid or support extended to an economic sector generally with the aim of promoting economic and social policy. Although commonly extended from government, the term subsidy can relate to any type of support – for example from NGOs or as implicit subsidies. Subsidies come in various forms including: direct and indirect.

Price

A price is the quantity of payment or compensation given by one party to another in return for one unit of goods or services. A price is influenced by production costs, supply of the desired item, and demand for the product. A price may be determined by a monopolist or may be imposed on the firm by market conditions.

Anti-competitive practices are business or government practices that unlawfully prevent or reduce competition in a market .The debate about the morality of certain business practices termed as being anti-competitive has continued both in the study of the history of economics and in the popular culture. Anti-trust laws differ among state and federal laws to ensure businesses do not engage in competitive practices that harm other, usually smaller, businesses or consumers. These laws are formed to promote healthy competition within a free market by limiting the abuse of monopoly power. Competition allows companies to compete in order for products and services to improve; promote innovation ; and provide a more choices for consumers to preference. Some business practices may be pro-competitive, economic methodological tests and empirical legal cases are used to test whether business activity constitutes as anti-competitive behavior.

In theories of competition in economics, a barrier to entry, or an economic barrier to entry, is a fixed cost that must be incurred by a new entrant, regardless of production or sales activities, into a market that incumbents do not have or have not had to incur. Because barriers to entry protect incumbent firms and restrict competition in a market, they can contribute to distortionary prices and are therefore most important when discussing antitrust policy. Barriers to entry often cause or aid the existence of monopolies and oligopolies, or give companies market power.

Decartelization is the transition of a national economy from monopoly control by groups of large businesses, known as cartels, to a free market economy. This change rarely arises naturally, and is generally the result of regulation by a governing body with monopoly of power to decide what structures it likes.

In economics and particularly in industrial organization, market power is the ability of a firm to profitably raise the market price of a good or service over marginal cost. In perfectly competitive markets, market participants have no market power. A firm with total market power can raise prices without losing any customers to competitors. Market participants that have market power are therefore sometimes referred to as "price makers" or "price setters", while those without are sometimes called "price takers". Significant market power occurs when prices exceed marginal cost and long run average cost, so the firm makes economic profit.

Non-price competition

Non-price competition is a marketing strategy "in which one firm tries to distinguish its product or service from competing products on the basis of attributes like design and workmanship". It often occurs in imperfectly competitive markets because it exists between two or more producers that sell goods and services at the same prices but compete to increase their respective market shares through non-price measures such as marketing schemes and greater quality. It is a form of competition that requires firms to focus on product differentiation instead of pricing strategies among competitors. Such differentiation measures allowing for firms to distinguish themselves, and their products from competitors, may include, offering superb quality of service, extensive distribution, customer focus, or any sustainable competitive advantage other than price. When price controls are not present, the set of competitive equilibria naturally correspond to the state of natural outcomes in Hatfield and Milgrom's two-sided matching with contracts model.

Bid rigging is a fraudulent scheme in procurement auctions resulting in non-competitive bids and can be performed by corrupt officials, by firms in an orchestrated act of collusion, or between officials and firms. This form of collusion is illegal in most countries. It is a form of price fixing and market allocation, often practiced where contracts are determined by a call for bids, for example in the case of government construction contracts. The typical objective of bid rigging is to enable the "winning" party to obtain contracts at uncompetitive prices. The other parties are compensated in various ways, for example, by cash payments, or by being designated to be the "winning" bidder on other contracts, or by an arrangement where some parts of the successful bidder's contract will be subcontracted to them. In this way, they "share the spoils" among themselves. Bid rigging almost always results in economic harm to the agency which is seeking the bids, and to the public, who ultimately bear the costs as taxpayers or consumers.

An Edgeworth price cycle is cyclical pattern in prices characterized by an initial jump, which is then followed by a slower decline back towards the initial level. The term was introduced by Maskin and Tirole (1988) in a theoretical setting featuring two firms bidding sequentially and where the winner captures the full market.

Competition (economics)

In economics, competition is a scenario where different economic firms are in contention to obtain goods that are limited by varying the elements of the marketing mix: price, product, promotion and place. In classical economic thought, competition causes commercial firms to develop new products, services and technologies, which would give consumers greater selection and better products. The greater the selection of a good is in the market, prices are typically lower for the products, compared to what the price would be if there was no competition (monopoly) or little competition (oligopoly). This is because there is now no rivalry between firms to obtain the product as there is enough for everyone. The level of competition that exists within the market is dependant on a variety of factors both on the firm/ seller side; the number of firms, barriers to entry, information availability, availability/ accessibility of resources. The number of buyers within the market also factors into competition with each buyer having a willingness to pay, influencing overall demand for the product in the market.

A two-sided market, also called a two-sided network, is an intermediary economic platform having two distinct user groups that provide each other with network benefits. The organization that creates value primarily by enabling direct interactions between two distinct types of affiliated customers is called a multi-sided platform. This concept of two-sided markets has been mainly theorised by the French economists Jean Tirole and Jean-Charles Rochet.

Tacit collusion occurs where firms choose actions that are likely to minimize a response from another firm, e.g. avoiding the opportunity to price cut an opposition because it would cause the opposition to retaliate. Put another way, two firms agree to play a certain strategy without explicitly saying so. Oligopolists usually try not to engage in price cutting, excessive advertising or other forms of competition. Thus, there may be unwritten rules of collusive behavior such as price leadership. A price leader will then emerge and it sets the general industry price, with other firms following suit. For example, see the case of British Salt Limited and New Cheshire Salt Works Limited.

Kinked demand economic theory regarding oligopoly and monopolistic competition

The Kinked-Demand curve theory is an economic theory regarding oligopoly and monopolistic competition. Kinked demand was an initial attempt to explain sticky prices.

An economic profit is the difference between the revenue a business has received from its outputs and the opportunity costs of its inputs. An economic profit differs from an accounting profit as it considers both the firms implicit and explicit costs, where as an accounting profit only considers the explicit costs which appear on a firms financial statements. Due to the additional implicit costs being considered, the economic profit usually differs from the accounting profit.

A Markov perfect equilibrium is an equilibrium concept in game theory. It has been used in analyses of industrial organization, macroeconomics, and political economy. It is a refinement of the concept of subgame perfect equilibrium to extensive form games for which a pay-off relevant state space can be identified. The term appeared in publications starting about 1988 in the work of economists Jean Tirole and Eric Maskin.

References

General references

Inline citations

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