Question

Briefly discuss the concept of "collusion" and how oligopolistic firms can benefit from it..

Answer 1

Oligopoly is a market structure characterized by the presence of a few large firms who produces homogeneous or differentiated products intensely competing against each other and recognizing interdependence in their decision-making. Under this type of market, prices are normally rigid as firms are afraid of immediate reactions of the rival firms which may start price war. The demand curve facing an oligopoly firm is indeterminate because of high degree of interdependence and uncertainty among oligopolistic firms. The firm does not know how his rival firms react to its decisions. Sales and profits of the firms are affected by the rivals' firm's actions. Example: there are only a few auto-producers in the Indian market. Maruti, Tata, Ford, Fiat are some well-known brand names.

Collusive Oligopoly: It is a form of market in which there are few firms in the market and all decide to avoid competition through a formal agreement. They collude to form a cartel, and fix for themselves output quotas and market price. Sometimes a leading firm in the market is accepted by the cartel as a price leader. Members of the cartel choose the price as that fixed by the price leader.

A cartel is a formal collusive agreement among the firms under oligopoly. Firms collude to avoid competition. When firms avoid competition then it means monopoly exists and firms earn more profit in the market. Due to this collusion is beneficial for oligopolistic firms.