Collusion
What is Collusion?
Collusion is an agreement between firms in a market to cooperate rather than compete, in order to limit competition and increase profits.
Collusion involves firms coordinating their actions to reduce competition and act like a single monopolist. This can include agreeing to fix prices, limit production, or divide the market. Collusion is illegal in many countries as it harms consumers.
Collusion: a worked example
Two filling stations share a corner. Competing hard, each sells 1,000 gallons a day at $3.20 against a marginal cost of $3.00, clearing 1,000 x $0.20 = $200 a day above variable cost. They begin matching each other at a posted $3.60. Sales per station fall to 700 gallons, but the margin widens to $0.60, so each clears 700 x $0.60 = $420 and the pair goes from $400 a day to $840. Drivers who still fill up pay $0.40 extra on 1,400 gallons, a transfer of $560 a day from buyers to sellers. The 600 gallons no longer sold were worth between $3.20 and $3.60 to the drivers who wanted them and cost $3.00 to supply, so the surplus destroyed averages $0.40 a gallon: 600 x $0.40 = $240 a day of deadweight loss. No contract was signed and no phone call was needed, which is why this pattern is difficult to prosecute.
The mistake students make with collusion
Two claims lose points here. The first is that collusion requires a signed agreement, so a market where rivals silently match a leader's posted price counts as competitive. Tacit collusion delivers the same restricted output and raised price with no communication at all. The second is writing that collusion gets easier with many firms because more firms means more cooperation. The opposite holds: every extra firm adds another potential defector to monitor and shrinks each member's share of the joint gain, so coordination survives best with few firms, similar costs, a standardized product and prices everyone can observe.
Collusion questions
What is the difference between explicit and tacit collusion?
Explicit collusion involves direct communication, a meeting or a written schedule of prices and quotas. Tacit collusion reaches the same outcome without any of that: one firm posts a higher price, rivals read the signal and match it, and each understands that undercutting would start a price war nobody wins. Regulators can prosecute an explicit deal once they have evidence of the agreement, while tacit coordination is usually legal, since parallel pricing on its own is not proof of a conspiracy.
What conditions make collusion easier to sustain?
Collusion holds together when a market has few firms, similar cost structures, a fairly standard product and prices members can watch. Repeated dealing helps as well, since a firm that cheats today can be punished with lower prices tomorrow. Coordination falls apart when demand swings unpredictably, when secret discounts hide cheating from the group, or when one firm has much lower costs and would rather take the whole market at a low price.
Why is collusion bad for consumers?
Colluding firms cut the quantity sold and lift price above marginal cost, so buyers who keep purchasing pay more while buyers who valued the good above its production cost but below the new price drop out entirely. The first group suffers a transfer of surplus to producers, and the second is pure deadweight loss, trades that would have made both sides better off and now never happen. Consumer surplus shrinks on both counts.
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