Collusive Behaviour in an Oligopoly A2 Economics

Key Issues The meaning of collusion Different forms of collusion Cartels Joint product developments Horizontal and vertical collusion Overt and covert collusion The benefits of collusion for businesses Impact of collusion for consumers – possible market failure Is collusions always against the public interest? The instability of cartels in an oligopoly How competition policy seeks to attack collusion Recent examples of anti-competitive practices and cases Possible risk of government failure

Collusion and Cartels under Oligopoly Collusion represents an attempt by firms to recognize their interdependence and act together rather than compete Collusion – can seen as a move towards joint-profit maximization Collusion normally requires control over the market supply of a commodity Overt collusion This is the creation of a price fixing arrangement with a producer cartel responsible for allocating output / supply within the market

Collusion and Cartels under Oligopoly Tacit collusion Dominant firm ‘price leadership’ One firm’s price changes are matched by the other firms Price leadership often happens in segments of a market E.g. the market for mortgage lending The market for breakfast cereals Barometric-firm leadership The price leader is the one judged to have best knowledge of prevailing market conditions

Price Fixing Agreements OPEC cartel (still in existence but periodic tensions / breakdown of cartel agreement) ‘Over the counter’ pharmaceuticals (ended May 2001) Cement price fixing (cartel collapsed in 1987) European steel producers (cartel fined heavily in 1996) Electrical goods retailers and computer games producers – investigated by the Competition Commission in 2000 Alleged price fixing by the main art auction houses EU vitamin producers fined 750 million Euro in 2001

Horizontal Collusion Most collusive activity takes place between firms in the same industry. Recent examples: Bus service operators in some cities Car body parts suppliers Steel producers within the European Union Coffee producers (coffee export retention scheme) Independent schools West Midlands roofing contractors cartel! But not all horizontal agreements are bad or illegal! Strategic Alliances to share R and D, for example, if registered, can be exempted from EU competition law

Vertical Collusion Vertical restraints refer to the methods used by manufacturers to restrict the ways in which retailers can market their product Examples include Franchising and Distribution channels Examples in the UK in recent years include: Car manufacturers and agreements with distributors Football Kit Manufacturers Net Book Agreement (ended in 1995) Over the Counter Pharmaceutical products (ended in May 2001)

Price fixing and the law Competition law prohibits almost any attempt to fix prices - for example, you cannot Agree prices with your competitors, e.g. you can't agree to work from a shared minimum price list Share markets or limit production to raise prices Impose minimum prices on different distributors such as shops Agree with your competitors what purchase price you will offer your suppliers Cut prices below cost in order to force a smaller or weaker competitor out of the market The law doesn't just cover formal agreements. It also includes other activities with a price-fixing effect. For example, you shouldn't discuss your pricing plans with your competitors. If you then all "happen" to raise your prices, you are fixing prices.

Football shirt price fixing The OFT ruled in August 2003 that businesses had entered into anti-competitive agreements to fix the price of top-selling shirts. The 10 businesses – which included Manchester United and the Football Association – were fined a total of £18.6 million. Two of the other companies involved were All Sports, fined £1.35 million, and JJB Sports, fined £8.373 million. Before the OFT’s investigation into price-fixing began, it was difficult to buy an adult short-sleeved England shirt for less than £39.99. By Euro 2004, he says they were widely available for as little as £25

Toys price fixing Argos and Littlewoods were fined a record £22.65 million by the OFT for fixing the price of toys and games together with Hasbro in breach of the Competition Act 1998. Argos, Littlewoods and Hasbro entered into agreements to fix the prices of Hasbro toys and games between 1999 and May 2001, breaching Chapter I of the Competition Act from 1 March 2000 when it came into force. Argos was fined £17.28 million, reflecting its high turnover, and Littlewoods was fined £5.37 million. Hasbro was granted full leniency, and so its potential penalty of £15.59 million was reduced to zero, because it provided crucial evidence that initiated the investigation and co-operated fully. In November 2002 Hasbro was however fined £4.95 million for entering into price-fixing agreements with 10 distributors

Price Fixing with a Cartel Individual Firm Industry MC (industry) Demand MR Firms Output Industry Output

Price Fixing with a Cartel Individual Firm Industry MC (industry) P(cartel) Demand MR Industry Output Firms Output Industry Output

Price Fixing with a Cartel Individual Firm Industry MC (industry) P(cartel) Demand MR Industry Output Firms Output Industry Output

Price Fixing with a Cartel Individual Firm Industry MC MC (industry) P(cartel) AC Demand MR Industry Output Firms Output Industry Output

Price Fixing with a Cartel Individual Firm Industry MC MC (industry) AC P(cartel) Demand MR Quota Industry Output Firms Output Industry Output

Collusion is easier when …….. There is only a small number of firms in the industry The industry has substantial entry barriers A large number of customers Total market demand not too variable Low income elasticity of demand Demand fairly inelastic with respect to price, interest rates etc Firm’s output can be easily monitored Easier to control total supply and identify firms who are cheating on output quotas Price discounts are hard to deliver Hard for firms to under-cut their rivals and break the cartel

Why are Cartels unstable? Most cartel arrangements experience difficulties Falling demand creates excess capacity in the industry e.g. during an economic downturn Entry of non-cartel firms into the industry Exposure of price fixing by Government agencies Over-production which breaks the price fixing OPEC one of the best examples – but other international commodity agreements have suffered from similar problems Prisoners’ Dilemma suggests that collusion breaks down Incentive to cheat because joint-profit maximization does not mean each firm is maximising profits on their own

Are Cartels Against the Consumer Interest? “Cartels take money off their customers by rigging markets against them. The OFT will not hesitate to use its powers to unearth, stop and punish cartels Firms that operate a cartel can now be fined up to 10% of their UK turnover for up to three years” John Vickers Director General Office of Fair Trading

Are Cartels in the Public Interest? Consumers may gain from Period of relative price stability A reduction of some of the wasteful costs of advertising and marketing if producers co-operate rather than compete with each-other Guaranteed supply from the producer cartel Producer cartels may be successful in raising the price of exported commodities May help to fund higher levels of capital investment Boost to export revenues for countries with a high dependency on exports of primary commodities