Collusion

Updated on April 4, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Collusion Definition

Collusion in economics refers to a situation in which a group of companies cooperates to set prices higher than a competitive benchmark or close enough to resemble a monopoly. This practice aims to take control of the prices of commodities and maximize industry earnings as a whole.

What is Collusion in Economics?

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The idea is unlawful due to the lack of competition created by this collaboration and the resulting degree of injustice among businesses. Furthermore, the equilibrium of a market can be easily destroyed by permitting a small number of enterprises to control the whole supply or pricing of goods and services through cooperation.

Key Takeaways

  • Collusion is a business tactic where firms compete to increase prices and maximize profit.
  • This is an illegal means to acquire additional money. It eliminates healthy competition, and market equilibrium faces disruption.
  • The market forces of demand and supply do not dominate the price action here, and consumers have to pay unfairly greater prices for existing prices. The quality sometimes deteriorates as a result.
  • There are two types of collusive methods: tacit and explicit. The tacit collusive method employs experiments, and businesses openly conspire to decide on collusive tactics in the explicit collusive method.

Collusion Explained

Collusion is an agreement of cooperation between firms or businesses that are often fraudulent, deceitful, and immoral. For example, in a market with competition, each business will sell its products until the point at which the marginal cost of manufacturing the last good equals the selling price. However, if they all cut back on production, the price will go up, and the businesses might each reap the collusion in oligopoly.

A company may declare its pricing and output, which rivals may view as greater than it is to be feasible in a competitive environment. They have the option of doing the same. Such options are challenging to maintain in big marketplaces with numerous sellers. It is in each seller’s best interest to sell at a somewhat lower price, create more, and capture a larger market share. Once a business begins to act competitively, all other companies tend to or are forced to do the same. Otherwise, they risk losing their whole market.

Imposing competitive practices may be possible without proof that the businesses have interacted. They may have only done it independently to refrain from selling in each other’s market spaces or undercutting each other’s pricing. A collusion of this kind arises when antitrust laws and regulations forbid formal agreements concerning such acts. Firms may face pressure to lower their pricing or sell to suppliers in regions other than their typical markets in such circumstances. It is easier to commit deceit in markets with fewer competitors and when businesses can quickly determine the commodity‘s price.

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Effects

Oligarchic enterprises frequently engage in oligopoly collusion to gain an advantage over competitors in the market. An oligopoly market has a few producers whose pricing affects the market but doesn’t control it. Each producer considers how a price change will affect their behavior and that of the other producers. If one firm lowers its price, the other firms could do the same. When this happens, each company may retain roughly the same market share as before but with a smaller profit margin. Therefore, competition in oligopolistic businesses typically takes the form of non-price features.

Collusion eliminates healthy competition in the market and increases the tendency to gather profit by using corrupt methods and practices. Since companies work together to influence prices, they do not compete with each other but cooperate. This reduces the drive to improve product quality, at least for the time being. A price rise affects consumers badly, and they have no other option but to pay prices determined by the formation of companies. This may be high when one compares it to the quality of the product and robs the consumer of their control and choices.

Types

There are two types of collusive tactics, and they are:

#1 – Tacit collusion

It is expensive experimentation to plan for a collusive result. The most usual form of tacit collusion is price leadership. It occurs when one lead competitor company establishes a price that the other companies eventually accept as the market price.

#2 – Explicit collusion

Businesses coordinate to achieve a collusive result and prevent issues brought on by shock adjustments. These businesses formally agree to maintain a high collusion price, which might entail setting up a cartel.

Examples

Check out these examples to get a better idea of the topic:

Example #1

In an economy, let’s say there are solar-powered car manufacturing companies, and “A,” “B,” and “C” companies are the biggest producers in the industry. So “Company A” decides to raise the price of its car to increase its profit. “Company B” and “Company C,” knowing the same, decide to increase the prices.

Now all the big companies have increased their prices, and consumers have no other option but to pay the new price. Since big companies are more famous, consumers gravitate toward them. In the case of new firms, they may not get a chance to be part of the deals in the industry. They are, therefore, pushed out of the competition. This acts as a barrier to entry for new firms.

Example #2

BMW, Audi, Volkswagen, Porsche, and Daimler, some well-known car manufacturing companies, had to pay fines for emissions collusion. They received hefty penalties for conspiring illegally to restrict competition in the diesel engine emission-cleaning equipment in the market. They were fined as their actions restricted competition on effective NOx beyond legal requirements and influenced the Adblue refill market. The authorities found out that these companies agreed on the size of AdBlue tanks.

Injecting AdBlue (urea) into the diesel exhaust gas stream reduces the amount of nitrogen oxide (NOx) released into the environment. The development of selective catalytic reduction (SCR) technology and its diesel emissions-cleaning goals were discussed at regular meetings, which prevented the market from being flooded with more efficient emissions-cleaning solutions. The SCR system reduces NOx emissions by converting them into water and nitrogen. As a result, they conspired and shied away from competing over who could clean more effectively.

Advantages And Disadvantages

While collusion is mostly an illegal or unethical means of business, it can also offer a few benefits depending on the circumstances.

Advantages and Disadvantages of Collusion

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Advantages

#1 – Helps declining industry

In extreme cases where profit declines, the industry struggles to survive because of low profits. Collusion can help fix a price; the supply firms will produce accordingly.

#2 – Profit

The profits are the most significant motive behind the collusive collaboration. It helps firms to make enormous profits, even though it is through immoral means.

#3 – Expansion of business and growth

Businesses with a profit surplus create more outlets or ventures for expansion. They contribute by making further profits, helping to create a brand, or increasing existing brand value. They can also use them for research and business development purposes along with improvement of quality.

Disadvantages

#1 – Market dynamics

The market will experience control by big producers, and prices will rise. As a result, the existing market equilibrium will face disruption.

#2 – Price change

When production is controlled, it tends to create more demand because of the limited supply. This may push the prices to unreasonable levels. Consumers also lose because of this, forcing them to purchase at prices fixed by big companies and not by market forces.

#3 – Effect on new firms and market entry

It discourages new firms from entering the market as the prices set by the existing big businesses may not be sustainable, and the early days are always crucial for small firms. They will be cut off from business deals and will not have enough funds to keep running the business until they make some profit. As a result, it is difficult for them to enter and profit.

Collusion vs Cartel

These two terms find relevance when it comes to two entities coming together for mutual benefits. Listed below are some of the differences between them. Let us have a look at them below:

  • While collusion refers to an agreement whereby two parties secretly agree for mutual benefits, which may also be unethical, cartel is an agreement of cooperation signed by two competitors operating in the same industry.
  • When two competing parties in the same industry mutually agree to keep the market conditions profitable for both of them, cartel comes into force, On the contrary, an instance of collusion is observed when two parties agree to fix prices and control the market conditions according to their combined conveniences, making customers bow down to collusion pricing.
  • Cartel is a more organized and a formal arrangement, while collusion is an informal arrangement.

Frequently Asked Questions (FAQs)

1. What does collision mean?

Collusion in economics typically refers to cooperation between businesses or firms aiming to obtain a significant competitive edge in the market. It is mainly done to earn profits and cut out new competition. For example, this may be done by collaborating and deciding to restrict production and increase prices.

2. Is collusion illegal?

It is illegal, and many countries have antitrust laws against them. They are a series of regulations created to control company practices and ensure fair competition in an open market economy for the best benefit of consumers. For example, practices such as collusion are restricted because it disrupts the market equilibrium.

3. What are the two types of collusion?

There are two types of collusion tacit collusion and explicit collusion. The tacit technique employs various methods to achieve results, the most popular being price leadership. The other type is explicit collusion, where businesses openly coordinate to agree on collusive methods.

This article has been a guide to Collusion and its definition. Here, we explain its examples, types, differences with cartel, advantages & disadvantages. You may also find some useful articles here –

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