Why might price collusion occur in oligopolistic industry
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Price wars are a form of competition that can benefit the consumer but can be highly detrimental to producers. As a result, oligopolists are naturally drawn to the idea of price-fixing among themselves, i.e., colluding with regard to price. In a recession, it is nice to know whether one’s rivals will cut prices or quantity, so that a mutually satisfactory solution can be reached. It is also convenient to be able to agree on what price to set to bankrupt any would-be interloper in the industry.From the viewpoint of society, collusive pricing is not economically desirable. From the oligopoly’s viewpoint it is highly desirable since, when entirely successful, it allows the oligopoly to set price and quantity as would a profit-maximizing monopolist.The main obstacles to collusion are demand and cost differences (which result in different points of equality of MR and MC); the number of firms (the more firms, the lower the possibility of getting together and reaching sustainable agreement); cheating (it pays to cheat by selling more below the agreed-on price—provided the other colluders do not find out); recession (when demand slumps, the urge to shave prices—to cheat—becomes much greater); potential entry (the above-equilibrium price that is the reason for collusion may entice new firms into this profitable industry—and it may be hard to get new entrants into the combine, quite apart from the unfortunate increase in supply they will cause); legal obstacles (for a century, antitrust laws have made collusion illegal).Price leadership is legal because although the firms may follow the dominant firm’s price, they are not compelled to. Also, the tacit agreement on price does not also include an agreement to control quantity and to divide up the market.