What policies can be used to stop firms in an oligopoly from colluding? To see more of our products visit our website at Ruth Tarrant, Head of Economics, Bedales School

It can be simply looked at as a ‘non-competitive’ market outcome, where prices are higher than they would be under competition and closer to those charged by a monopolist. This could result from explicit or deliberate collusion such as a cartel, or tacit collusion, where prices converge on a price above the competitive equilibrium in a non-cooperative way. Horizontal collusion is where there is agreement between firms at the same stage of the production process to charge prices above the competitive level. Vertical collusion, between firms at different stages in the production process, is usually viewed with tolerance by competition authorities as being ‘self-policing’. What is collusion? Procurement collusion or bid-rigging is where companies illegally bid for large contracts by rigging bids to decide which one of them gets the contract in advance.

Collusion usually occurs in an oligopolistic market structure, where there are a small number of firms operating interdependently. The Prisoners’ Dilemma game illustrates how the dominant strategy of each firm is to choose a low price, but if firms manage to collude and set a high price, both firms will earn more profits. This interdependence can lead to uncertainty and much lower profits than could be achieved if firms worked together. Why does collusion happen? Such collusion is more likely if firms sell very similar goods, and if demand is relatively price inelastic so that revenue will rise when price rises.

Collusion has a negative impact on consumer welfare so competition authorities try to detect and punish such activity. But, collusive agreements often break down without government intervention. For example, if barriers to entry are low, new entrants may be able to undercut collusive firms and gain market share. Or, demand for the product made by the colluders may fall due to changing tastes or new substitutes. Do we need to tackle collusion? And, the larger the number of firms that are colluding, the more likely it is that one firm will ‘defect’ on the agreement. However, there is no guarantee that collusive agreements will break down which is why the UK Competition Commission investigates collusive activity.

Competition authorities may try to reduce barriers to entry into an industry. This could be done by reducing administrative burdens making it easier for rival firms to enter an industry, although this is easier to introduce into a relatively new industry such as the building of wind farms. Deregulation can reduce entry barriers deliberately as has happened in the airline industry and the local bus industry in the UK. However, there may be natural barriers to entry which remain if economies of scale are necessary for profitability. Reducing costs for new and/or small businesses will also reduce barriers to entry by offering small businesses lower borrowing rates, easier access to finance and helping support new business entrepreneurs. Methods for tackling Collusion 1: Making markets more competitive

Competition authorities now offer a leniency policy to companies who report price-fixing behaviour in which they have been involved so that ‘whistleblowers’ will not face fines. Authorities are also increasing fines for those found guilty of colluding to fix prices. This acts as a deterrent to collusive behaviour as it reduces the potential payoff for colluding. One downside to this, is that heavy fines by the competition authorities in certain situations has caused collusive firms to go bust, which has reduced market concentration as a result. Methods for tackling collusion 2: Increasing the chance of a breakdown in collusive agreements

Firms choose to collude rather than compete in order to increase their profitability at the expense of consumers. Whilst the market itself can be self-correcting and self-policing there remains a role for competition authorities to act on behalf of consumers. Their role must be multi-dimensional to be effective, by reducing the risk that collusive agreements may form in the first place, and by encouraging a faster breakdown in those agreements. Conclusions