Question

Collusion: Exploitation or benefit?

In 2011, two soap and detergent firms, Unilever and Procter & Gamble, were fined a total of €315m (US$ 220m) for fixing the price of washing powder in eight European countries. Procter & Gamble is the world’s largest consumer products company.

The two firms had colluded over prices for more than three years. The collusion began when they agreed to implement an industry-wide programme to improve their environmental impact by obtaining their raw materials from sustainable sources. They also agreed to reduce the amount of packaging they used but to keep the prices unchanged. Then, later, they collectively agreed to raise prices in Belgium, France, Germany, Greece, Italy, Portugal, Spain and the Netherlands. This collusion was against the European Union competition laws and was regarded as ‘unfair competition’.

1. Explain what is meant by ‘collusion’ and when it is most likely to occur in an industry.

Answer 1

COLLUSION

Collusion is a non-competitive ,secret , and sometimes illegal agreement between rivals which attempts to disrupt the market's equilibrium.Collusion occurs when entities or individuals work together to influence a market or pricing for their own advantage.Acts of collution include price fixing ,synchronized advertising ,and sharing insider information.Antitrust and whistleblower laws help to deter collusion.

NON -COLLUSIVE MODELS OF OLIGOPOLY

The theory of non-collusive model of oligopoly or uncordinated oligopoly is one of the oldest theories of competition and monopoly or perhaps of all the theories of the behaviour of the individual firm.The non collusive models of oligopoly explain the price and output determination in a market structure in which oligopolists recognise their interdependence.A model of oligopoly was first of all put forth by Cournot in 1838.Cournot's model of oligopoly was subjected to criticism in 1883 by Joseph Bertrand,a French mathematician,whose critisicm of Cournot provided a substitute model of oligopoly.In 1897,Edgeworth offered another model of oligopoly in an article published in an Italian Journal.Ith should be noted that in Cournot's model .it is rival's output which is assumed by an oligopolist to remain fixed at the present level,while the contemplates a certain change in his own output.On the other hand,Bertand and Edgeworth in their models assume that the oligopolist believes that rival's price remains unchanged at present level.

COLLUSIVE OLIGOPOLY

There are at least three major factor which bring collusion between the oligopolistic firms.Firsts collusion reduces the degree of competition between the firms and helps them act monopolistically in their effort of profit maximisation.Second ,collusion reduces the olligopolistic uncertainity surrounding the market since cartel members are not supposed to act independently and in the manner that is detrimental to the interest of other firms.Third ,collusion forms a kind of barrier to the entry of new firms.

Collusion between oligopoly firms may take many forms depending on their relative strength ,their objective and whether collusion is legal or illegal.There are however two main types of collusion :

1. Cartels

2. Price Leadership

CARTELS

A cartel is a formal organisation of the oligopoly firms in an industry .Cartel are the perfect form of collusion.A cartel is an organisation of independent firms within the same industry formed for the purpose of increasing the profits of the members of subjecting their competitive tendencies to some form of control.If follows common policies in relation to prices.output and sales territories.Cartels may be in the form of open collusion or secret collusion.Whether open or secret ,cartel agreements are explicit and formal in the sense that agreements are enforceable on member firms willing to pursue an independent pricing policy.Cartels are therefore regarded as the perfect form of collusion.

A cartel performs a variety of services for its members.The two typical services of central importance are (a)fixing price for joint maximisation of industry profits; and (b) market sharing between its members .

A. CARTELS AIMING AT JOINT -PROFIT MAXIMISATION

Cartels imply direct agrrement among the competing oligopolist with the aim of reducing the uncertainity arising from their mutual interdependence.In this particular case the aim of the cartel is the maximisation of the industry profit.Let us suppose that a group of firms producing a homogeneous commodity form a cartel aiming at joint profit maximisation .The firms appoint a central management board with powers to decide (a) the total quantity to be produced ;(b) the price at which it must be sold ; and (c) share of each firm in the total output .The central management board is provided with cost figures of individual firms.Besides ,it is supposed to obtain the necessary data required to formulate the market demand (AR) curve.The management board calculates the marginal cost(MC) and marginal revenue (MR) for the industry .Further , the management board holds the position of a multiplant monopoly .It determines the price and output for each firm in the manner a multiplant monopoly determines the price and output for each plant.

B. MARKET -SHARING CARTELS

This form of collusion is more common in practice because it is more popoular .The firms agree to share the market, but keep a considerable degree of freedom concerning the style of their output,their selling activities and other decisions .There are two basic methods for sharing the market :non- price competition and determination of quotas.

PRICE LEADERSHIP

Another form collusion is price leadership.In this form of co-ordinated behaviour of oligopolists one firm sets the price and the others follow it because it is advantageous to them or because they prefer to avoid uncertainty about their competitor's reactions even if this implies departure of the followers from their profit -maximising position .Price leadership is widespread in the business world .It may be practised either by explicit agreement or informally.In nearly all cases price leadership is tactit since open collusive agreement are illegal in most countries.

Price leadership is more widespread than cartels, because it allows the members complete fredom regarding their product and selling activities and thus is more acceptable to the followers than a complete cartels, which requires the surrendering of all freedom od action to the central agency.

If the product is homogeneous and the firms are highly concentrated in a location the price will be identical.However ,if the product is differentiated prices will differ, but the direction of their change will be the same,while the same price differentials will broadly be kept.

TYPES OF PRICE LEADERSHIP

Price leadership is of various types.Firstly, there is a price leadership of dominant firm.Under this one of the few firms in the industry may be producing a very large proportion of the total production of the industry and may therefore dominate the market of the product.This dominant firm wields a great influence over the market of the product , while other firms are small and are incapable of making any impact on the market.As a result ,the dominant firm estimates its own demand curve and fixes a price which maximises its own profits .The other firms which are small having no individual effects on the price, follow the dominant firm and accepting the price set by him,they adjust their output accordingly.

Secondly ,there is a barometric price leadership under which an old ,experienced ,largest or most respected firm assumes the role of a custodian who protects the interest of all.He assesses the change in the market conditions with regard to the demand for the product, costs of production , competition from the related products etc.and makes changes in price which are best from the viewpoint of all the firms in the industry.

Thirdly,there is exploitative or aggresive price leadership under which a very large or dominant firm establishes its leadership by following aggressive price policies and thus compel the other firms in the industry to follow him in respect of price .Such a firm will often initiate a move threatening to compete the others out of the market if they do not follow him in setting their prices .