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Collusion or competition?

When oligopoly firms in a certain market decide what quantity to produce and what price to charge, they face a temptation to act as if they were a monopoly. By acting together, oligopolistic firms can hold down industry output, charge a higher price, and divide up the profit among themselves. When firms act together in this way to reduce output and keep prices high, it is called collusion    . A group of firms that have a formal agreement to collude to produce the monopoly output and sell at the monopoly price is called a cartel    . See the following Clear It Up feature for a more in-depth analysis of the difference between the two.

Collusion versus cartels: how can i tell which is which?

In the United States, as well as many other countries, it is illegal for firms to collude since collusion is anti-competitive behavior, which is a violation of antitrust law. Both the Antitrust Division of the Justice Department and the Federal Trade Commission have responsibilities for preventing collusion in the United States.

The problem of enforcement is finding hard evidence of collusion. Cartels are formal agreements to collude. Because cartel agreements provide evidence of collusion, they are rare in the United States. Instead, most collusion is tacit, where firms implicitly reach an understanding that competition is bad for profits.

The desire of businesses to avoid competing so that they can instead raise the prices that they charge and earn higher profits has been well understood by economists. Adam Smith wrote in Wealth of Nations in 1776: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

Even when oligopolists recognize that they would benefit as a group by acting like a monopoly, each individual oligopoly faces a private temptation to produce just a slightly higher quantity and earn slightly higher profit—while still counting on the other oligopolists to hold down their production and keep prices high. If at least some oligopolists give in to this temptation and start producing more, then the market price will fall. Indeed, a small handful of oligopoly firms may end up competing so fiercely that they all end up earning zero economic profits—as if they were perfect competitors.

The prisoner’s dilemma

Because of the complexity of oligopoly, which is the result of mutual interdependence among firms, there is no single, generally-accepted theory of how oligopolies behave, in the same way that we have theories for all the other market structures. Instead, economists use game theory    , a branch of mathematics that analyzes situations in which players must make decisions and then receive payoffs based on what other players decide to do. Game theory has found widespread applications in the social sciences, as well as in business, law, and military strategy.

The prisoner’s dilemma    is a scenario in which the gains from cooperation are larger than the rewards from pursuing self-interest. It applies well to oligopoly. The story behind the prisoner’s dilemma goes like this:

Questions & Answers

price elasticity of demand is the degree of responsiveness of a quantity demanded to the change in price of the commodity in question.
Gladys Reply
what is the importance of learning economics?
Thelma Reply
it helps to make the correct choice
it helps firm to produce products that will bring more profit
the difference between needs and wants
londiwe Reply
needs are things that we basically can't live without wants are just luxury things
needs are things without them we can't live but want are things without we can live
what is education
it's a process in which we give or receiving methodical instructions
what is mixed economy
what is a deadweight loss? how monopoly creates a deadweight loss?
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what is type of economic
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how to understand basics of economics
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what is demand schedle
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When you make a Scedule of the demand you made
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What is macroeconomics
Kauna Reply
It's one of the two branches of Economics that deal with the aggregate economy.
it's about inflation, occupation, gdp and so on
What is differences between Microeconomics and Macroeconomic?
microeconomics focuses on the action of individual agents in the economy such as businesses, workers and household. while macroeconomics looks at the economy as a whole. it focuses on broad issues in the economy such as government deficit, economy growth, levels of exports and imports, and
inflationary increase in prices
a price floor of 24 imposed
Annie Reply
monopolistic competition
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Richard Reply
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one of the scarce resources that constrain our behaviour is time. each of us has only 24 hours in a day. how do you go about allocating your time in a given day among completing alternatives? once you choose a most important use of time. why do you not spend all your time to it. use the notion of op
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Economics- The study of how people use their limited resources to tey and satisfy unlimited wants.
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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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