Price collusion in oligopolies

legal injury collusion in oligopoliesAn oligopoly trade exists when a a couple of(prenominal) gravid pie-eyeds dominate the industry. This form of grocery store organise lies in between the realms of the unattainable social system of Perfect Competition to the structure of Monopoly. Each sozzled deals in evidence to maximise its foodstuff sh be. Oligopolies be defined as per their behavioural aspects rather than their grocery structure. As a result oligopolies argon characterised upon two fundamentals high barriers to entry and interdependence. n unitarytheless though each firm competes with one a nonher, each firm is comfort tied with each opposite, in the sense that each firm is interdependent. When confront upon decisions, the firm must take into consideration the likely reaction of ch each(prenominal)enger firms, as one wrong move nominate end with a devastating consequence the loss of market sh ar. Incumbent firms are saved by barriers to entry however each in dustry varies in basis of contestability. The goods and services that firms produce within an oligopoly are differentiated, in the sense that uniform goods vary in terms of its branding, quality and after-sales services etc. A few good examples of firms competing in oligopolistic markets are the car industry, supermarket chains and banks etc.Oligopolies tend to behave either agonisticly or collusively. In compliance with the kinked engage bend theory, homogeneous oligopolies are fairly restrict in terms of charge competition, as sh feature by the spare-time activity diagram. Each firm must take into account the reactions of rivals hence if a firm discrete to raise equipment casualtys, with the hope of gaining extra benefits, from point P1 to P2. Other firms hollo this yield, accordingly keep their costs untouched. Quantity sold would plunge from point Q1 to Q2. This authorise in sales is greater than the increase in scathe, and so leads to an overall fall in taxa tion hence the elastic require curve (curve A). fifty-fifty if this firm chose as an alternative, to lower its sets from point P1 to P3, other firms would follow suit, with the intentions of not losing market share to its rival. Consequently quantity sold would only increase from point Q1 to Q3.The fall in cost would have to be large for it to accommodate the increase in sales, hence the inelastic pauperism curve (curve B). Again this decision would result in a reduction in revenue, bearing in mind a fall in market share. Thus firms are reluctant to change prices due to the cause mentioned. Therefore, price stability is imposed under oligopoly markets in turn firms focus on aspects of non-price competition. such practices whitethorn include extra after-sales services, longer broadcasting times, broaden warranties and extensive advertising campaigns etc. Non-price competition would at that placefore shift the demand curve or the firm successfully makes the price elastici ty of demand for the product less elastic, and so developing brand loyalty amongst consumers.Price/non-price competition involves firms behaving interdependently. Seeking to eliminate market uncertainty is a fundamental desire for a market dominated by a few large firms. Thus businesses are keen to collude with competitors to reduce the effects of interdependence, either collude openly (formal accordances), or tacitly (informally under the radar). statuesque collusive capital of impertinently Hampshires bring forth the formation of a compact. The advantages of such trustfulnesss, is that firms are able to achieve joint profit maximisation. Each extremity of the cartel is given an startput quota usually depending upon each firms market share, which as a unscathed will maximise the cartels profits at the profit maximising price. Cartels therefore act as if they were a monopoly, taking start of the whole industry, whereby it is able to restrict output and raise prices (di sadvantages of a monopoly structure). Consumer surplus is restricted and producer sovereignty exploited.As an assumption, there are a heart of five firms in the industry, each agreed to be a member of the cartel. For the members to achieve joint profit maximisation, the cartel thus has to produce at its profit maximising level at point where marginal cost (MC) make ups marginal revenue (MR). Thus the cartel, therefore the industry produces 4000 units which are whence sold at the price of 6. Assuming that each firm shares an equal amount of the market, for that reason each firm is given an output quota of 800 units. By analysing each firm independently (figure 3), the quota of 800 units does not lie at their profit maximising level. For this reason, the firm is likely to cheat, maybe undercut the cartel price or increase output to maximise its utility. Assuming the firm agrees not to change the price, for the firm to maximise its profits, it would have to increase output to 2400 u nits at the point where the cartels price (MR) equals the firms MC curve. At the cartel output, it would achieve revenue of 4800. By increasing output to 2400 units it post boost revenue to 14400 a good 200% increase in revenue. This would only occur if the firm can control total market share, taking the other members out of the equation. In turn if the firm wished to profit maximise using its own curves, it would therefore sell 1600 units at a price of 4 at where MC=MR. By undercutting the cartel price the firm can get out extra customers, therefore increase supernormal profits. Interestingly, other member firms are as well likely to lower their prices in the midst of cheating, which could lead to a price war, eventually leading to the breakdown of the cartel.For the reasons mentioned above, i.e. cartels behaving as a monopoly and the breakdowns of the cartels can lead to increased price fluctuations in the interests of consumers, cartels are deemed illegal in many countries inc luding the UK. Cartels, being against the public interest, its in the interests of the Competition Commission and the note of Fair Trading (OFT) to investigate such cartel behaviour and hamper the cartels intentions. Bearing in mind that cartels are against the public interest, there is one cartel being in favour of consumers and the economy as a whole. It is not formed by a group of member firms, that formed with member countries OPEC (Organization of the Petroleum Exporting Countries).As stated, OPECs mission is to co-ordinate and unify the petroleum policies of Member Countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital to those drop in the petroleum industry (OPEC, http//www.opec.org/home/ ). Assuming OPEC keeps to its mission, it is truthful to judge that OPEC aims to strengthen the global economy, bringing price stability in t he trade good market. However other firms caught with price fixing have not had the same(p) treatment. Just recently the New York Times has published LCD makers fined $585 cardinal for price fixing (New York Times, Published November 13 2008, by Steve Lohr). LG Display, Sharp and Chunghwa find Tubes were investigated and pled guilty of fixing the price of their liquid crystal display panels and were fined a total of $585 million by the U.S. Justice Departments antitrust division.The difficulties faced with open collusion, and the consequences (the Competition Commission can fine the firms involved in cartel behaviour 10% of their worldwide turnover), means that firms are often reluctant to form cartels, therefore take the chances to collude tacitly. There are a few methods of tacit collusion, the popular being Dominant-firm Price Leadership. In ingenuous terms the dominant firm in the industry ferments the price leader, at which the other firms tactically follow the dominant fi rms price changes, yet also keeping a close eye on their rivals. There is several(prenominal)what evidence linking the supermarket industry to this method of dominant-firm price leadership, whereby Tesco being the dominant of all supermarkets. As published by TNSGlobal, for the 12 weeks ending 1st November 2009 certify that Tesco has grown its market share from 30.6% a year ago to 30.7% now. TNSGlobal claims that, Tescos growth rate of 4.7% year-on-year beats the market average of 4.4% (TNSGlobal, www.tnsglobal.com ). Being the dominant in the industry, it therefore acts as a price setter, resulting in the other firms followers the price changes. However this strategy has been a prime condition of Tesco (to control the market), up until the moment one of the supermarket firms cheats by undercutting the price and not following the price leadership strategy. This has been the case recently (from personal experiences), that Asda is the better valuate supermarket, and may be voted as the credit crunch climate favourite.Asdas of import advantage for the consumer is that there are a wide range of discounted products, that even Tesco and other supermarkets cant match. Instead of the price leadership tactic, oligopolies may rape in price parallelism, whereby each firms price movements are parallel with their rivals. Such a policy requires no dominant firm imposing price changes.Besides firms who dominate the industry being the price leader, firms may become a barometer of market conditions, whereby firms engage in the tactic of barometric price leadership. This form of approach unfolds when a firm can successfully anticipate proximo market conditions in the short run, applying their knowledge to price changes. Firms incomplete have to be dominating the industry nor be a large firm. Price changes thus reflect changes in market demand or supply, where the firm who predicts such changes in the market becomes the barometer in the industry in which fellow competit ors follow. From such a policy, it is important to note that firms frequently bastinado between the roles of a price leader to a price follower. As a precaution, following firms may delay their price changes in order to be sure that the price changes by the barometer is consistent with the results obtained of the current market situation. Therefore a time lag may arise, or firms may decide that results are inconsistent with the barometer, thus leave their price unchanged, undercutting the price leader. In the interest of each firm, costs may rise as a result of marker research, therefore in order to downplay the costs, firms may just follow the price changes of the price leader without projection research, in the hope that the barometer is correct about current or future market conditions.Firms may compete in terms of the Bertrand model. This model assumes that there are two firms in the industry (duopoly). Both firms aim for price stability in order to reduce menu costs. Hence twain firms set their prices at where it would have been in a perfectly competitive market, usually making normal profit. This point refers to the Nash equilibrium. This ensures that neither firm can undercut the price, avoiding any price wars.To conclude, it can be suggested that there is some correlation between the policies in which oligopolies compete at, and the contestability of the industry in which they operate in. A highly contestable market in which barriers to entry are low, pressurises firms to compete more aggressively, whereas if incumbent firms have successfully erected high barriers to entry, whether immanent or man-made barriers the industry becomes less contestable, providing incentives to collude to control market share. There is a high probability that the formation of cartels will needfully lead to the breakdown of the cartel, for reasons of cheating. Price fixing or other forms of agreement never maximises each firms benefit. However, this statement only rel ates to the short term, but an agreement with other firms does reduce uncertainty, therefore benefiting firms in the long run to maintain supernormal profits. Member firms must find ways to restrict other members from cheating on the cartel price. Therefore the profit loss incurred by deviating from the cartel should exceed the profit loss by remaining in the cartel. As shown by figure 3, this is difficult to achieve. Theoretically, it is easy to form a cartel when approached via the text-book assumptions. However in the real world, it is difficult without perfect knowledge being available. Research suggests that, differences in product life cycles and fluctuations in demand create instability among agreements, which naturally fractures the cartel (Haltiwanger and Harrington (1991)). Collusion to mimic trading operations as a monopoly allows investment in research and development to be funded collectively via joint profit maximisation, benefiting consumers in the long run. In esse nce, firms who compete without any form of collusion or agreements, have greater stretch to maximise personal utility, by developing brand loyalty among consumers, thus being able to successfully increase market share. This would be the trounce policy to approach benefiting both the firms and the consumer, yet avoiding any government intervention.ReferencesGarner, E. (2009). Tesco serving Turnaround. Available http//www.tnsglobal.com/_assets/files/worldpanel_marketshare_oct2009.pdf. Last accessed 03/12/2009.Haltiwanger, J. and J. Harrington (1991), The impact of cyclical demand movements on collusive behaviour, Rand Journal of Economics, 2289- 106.Lohr, S. (2008) LCD makers fined $585 million for price fixing, New York Times, 13 November. Available http//www.nytimes.com/2008/11/13/technology/13iht-13panel.17777580.html?_r=1scp=1sq=LCD%20makers%20fined%20%24585%20million%20for%20price%20fixingst=cse. Last accessed 03/12/2009OPEC. (n.d.). OPECs Mission. Available http//www.opec.org /home/ . Last accessed 02/12/2009.