Today, large suppliers” (Bannock et el 2003:282)

Today,
there are many industries that are considered to be oligopolies “A market which
is dominated by a few large suppliers” (Bannock et el 2003:282) But even the
most successful companies compete with each for the market share, in many
instances, this competition is decided to be solved with collusion
“Co-operation between independent firms so as to modify competition” (Bannock
et el 2003:59).The firms that have colluded are called a Cartel “An association
of producers to regulate prices by restricting output and competition” (Bannock
et el, 2003:49). This essay will first discuss the characteristics of
oligopolies, later, it will highlight the factors that encourage firms to
collude explaining the risk of collusion, and finally, it will discuss the
factors that discourage firms to collude and whether the oligopolistic markets
always end up in a collusion.

There are
several characteristics of firms in oligopolies. One of the most important ones,
is that the firms in an oligopoly are interdependent, meaning that actions of
one firm have influence on other firms and the decisions made are affected by
prediction of actions of others (Mankiw and Taylor, 2014:330). Another
important characteristic is high barriers to entry. Firms in oligopolies can
afford to set their prices low due to economies of scale and demand which
creates a natural barrier to entry (Parkin et al, 2012:318). Also, big firms
are able to cover high capital costs due to big volumes of production. These
barriers deter competition and prevent new competitors from entering the market.
Like the fuel retailing market in UK, which is dominated by 6 firms, including
Tesco, Shell and Morrisons (economics online (n.d)). The fuel market in UK has
high barriers to entry, also, these firms are interdependent because they
provide identical goods, and therefore can be substituted by other firms in the
market. This leads to another important characteristic of oligopolies,
non-price competition. Identical products force the firms to find other ways to
compete for market share, nobody wants to start a price war, so a lot of branding
using advertising is done by firms. Many characteristics of an oligopoly also create
a risk of collusion because it allows firms to operate more efficiently.

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A decision
maker in the industry, a monopolist, would choose to maximize total profits.
Hence, multiple producers in an industry can maximize their total profit by
acting like a monopoly (Begg et al, 2014:202). There are a lot of benefits
firms may get from collusion, hence, there is always a risk of an oligopoly
forming a cartel to maximize output. To better explain the benefits of a
cartel, diagrams can be used to illustrate them.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Figure a.)
shows an industry in a cartel where it is able to maximize profits at quantity
Q1 and price P1, and figure b.) shows a firm operating in a cartel. Figure a.)
shows the benefits of a cartel because the whole industry is making maximum
profit where MR=MC. A cartel allows firms to manipulate the market easily
because the firms involved know each other well and their goods are similar in
production and average costs, therefore, they are likely to change the prices
at the same time by the same percentage. (Sloman, 2013:122). Firms being familiar
with one another creates a risk for them to collude because they can make
profit due to well-coordinated choices, also, knowing the production methods removes
uncertainty which causes the most trouble in oligopolies. Another benefit of
collusion is low cost of competition because the firms in a cartel won’t need
expensive marketing. Another risk of collusion is that barriers to entry can be
raised even higher in a cartel so that the firms involved in a cartel are able
to dominate the industry and deter any competition. Even though cartels create
a lot of benefits there are also some factors that prevent collusion.

 

Analysis
shows that attraction of collusion is that it leads to higher levels of
profits, however, collusions are unstable due to an incentive to cheat to
further raise profits (Estrin and Laidler,1995:245). The biggest internal
problem cartels face is cheating. If a cartel is looked upon like a game of
strategy were there are two options: to cheat or to abide the quota the cartel
faces the prisoner’s dilemma which can only be resolved satisfactory by an
enforceable contract like a negotiated rule between the members of the cartel
(Osborne,1976:836). The reason for firms to cheat is illustrated in the figure
b.), the quota only allows production at Q1 where MR does not equal MC while at
Q2, the firm would maximize its profit. Because of the temptation to cheat the
trust within the members is likely to break down, leading to a breakdown of the
cartel. Also, because the cartels are illegal in most countries, the members
can face a fine If the collusion is discovered, like Tesco and other members or
the cartel had to in 2013 (Louisa Peacock, 2013). Another discouraging factor
is that even though there are high barriers to entry there still could be new
entrants that would sell goods at lower price and damage the cartel’s output
and weaken it.

The research has shown that oligopolies might be
better off financially in a cartel while acting like a monopoly, and there are
a lot of incentives for oligopolies to collude. However, there are also many
problems that could arise from a collusion leading to much bigger costs than if
the companies were to operate separately. A lot of thought goes into a decision
to form a cartel and a lot of mutual trust and discipline is needed for it to
properly function in the long run. Therefore, a concluding statement can be
made contradicting the given statement that oligopolies are bound to end up in
a collusion. Oligopolies may sometimes refrain from forming a cartel due to a lack
of trust amongst the members of the oligopoly or simply because the risks are
too high, despite the idea being financially promising.

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