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Imperfect Competition: Tacit Collusion
Today the word market is used almost everywhere. In simple words, it can be defined as a complex system, where market parties counteract in order to interchange goods and services (Sullivan & Sheffrin, 2003). In the modern economic world, the number of markets and market players is growing substantially. Today there are various types of markets, but all of them have a common peculiarity competitiveness. However, many have the so-called imperfect competitive structure. It is similar to a competitive market, but only considering some features (Sullivan & Sheffrin, 2003). One of the latter making it different from perfect competition is collusion. It can be defined as an agreement between market parties to divide a market or to set prices. This term also includes limiting opportunities or product production by leaving out the law. In most cases, collusion is secretive and illegal and involves such instruments as wage fixing, kickbacks, and other unfair actions (Sullivan & Sheffrin, 2003). This kind is known as tacit collusion. In contradistinction to the perfect competitive model, the imperfect competitive market has higher entry barriers. For example, the monopolistic competitive model has low barriers to entry in contrast to zero ones of perfect competition (Gans, King, & Stonecash, 2003). Nowadays, the former is the most popular business structure with almost no entry barriers, independent decision-making process along with imperfect competition, and a noticeable product differentiation level.
A Market Environment with Tacit Collusion
One of the kinds of the imperfect competitive market system is oligopoly. In comparison to monopolistic competition, it has rather high barriers to entry. The most critical and important ones are innovative technologies, severe government regulations, law restrictions (licenses or patents), and others. The product may be homogeneous or differentiated. Thus, it is up to the company what to produce. Another distinctive trait of oligopoly is interdependence. It is a situation when companies are dependent on each other and work as a group (Melvin & Boyes, 2002).
The Profitability of Entering the Market
One more vital thing is the fact that oligopolies can obtain huge profits in the long run because of high entry barriers. Companies outside cannot just enter the market and gain extra profits. Therefore, excess profits are divided among inner players.
To demonstrate the situation, the beverages market and two major players in the sphere will be examined, namely, Firm A and Firm B.
Figure 1. Tacit collusion. This figure illustrates a market environment with tacit collusion.
The graph on the left side represents Firm A, while the one in the middle relates to Firm B. As it can be seen, the latter has higher costs than the former. The industry marginal cost curve MCM on the third graph represents combined MCO and MCJ curves. Further, the third graph provides the demand curve D and the marginal revenues curve MR in regard with a monopolistic player. Profit maximization in this situation can be defined as a point, at which the MCM curve intersects with the MR curve with the quantity of sixteen units. In other words, it is the equation of MCM and MR. Proceeding the process, the companies that collude identify the price of the product. They act just like a monopoly, because as it has been mentioned before, they have a mutual interest in collusion. The price of sixteen units is one monetary unit per product. The next step is product division. The point is that both companies have different marginal costs volumes. The latter will be defined amenably to MC of every business (Collusion, n.d.). Firm B will produce six units of the product while Firm A will make ten units. The profit of each business in the industry can be evaluated as the difference between revenues at the $1 price and the total cost of the production quota. It can be presented as a yellow quadrangle for both companies.
Collusion can be present only if each player in the market maintains the very same price. Moreover, sometimes there is a quantity supply restriction for all companies in the business. Therefore, if everything is fine and no one cheats, each firm will get higher profits. However, if some company decreases prices and increases product output at the same time, it will have the opportunity to broaden its market horizons and gain more profit than other parties of the agreement (Collusion, n.d.).
To avoid cheating, it is better to keep few companies in the business, because it is easier to coordinate actions of two or three companies than the ones of a lot of them (Riley, 2012). If profits in the industry are high, outer companies will try to enter the business and get some market share. If there are many entry barriers, the colluding companies may go on and keep prices high without worrying at all. The next factor is a stability degree. The more stable the industry is, the easier it will be for companies to collude. Also, the more accurate and timed information is, the better business will perform (Riley, 2012). The last but not the least factor is the law. The most important industries (for example, transport, communication, and others) have the highest level of law limitations, making the collusion harder or even impossible. However, such industries as entertainment and other spheres are less regulated, so there is a higher probability of collusion (Collusion, n.d.).
Effects of the Time Horizon on the Profitability
One more question is whether time has an impact on collusion. The point is that the latter is declining over some time, but it will not be equal to zero. If there is a finite interim, collusion will not emerge. However, in the infinite interim, it will demonstrate growth. Companies will collude every time, but because of the market forces, they will try to cheat, breaking the agreement (Collusion, n.d.). Thus, collusion brings about competition and vice versa.
To conclude, it is impossible to answer the question whether to enter the market in an area where there is imperfect competition and possible tacit collusion because of too many factors being unknown. The traditional decision of the company to enter the market will be positive if the price of the product is higher than average total costs. However, despite positive expectations, the oligopoly market is almost impossible to enter because of few key players, immense financial resources, and strict entry barriers mentioned before. In most cases, all factors needed for entering are just inaccessible. Thus, it is almost impossible to become a competitor in the oligopoly industry.