In-Depth Notes on Collusion and Cartels

Date & Context: Week seven of the semester; discussions of term tests ongoing.
Overview of Collusion:
- Definition: Collusion involves firms forming agreements to coordinate their actions to maximize joint profits, with a formal cartel representing explicit collusion.
- Types of Collusion:
- Explicit Collusion (Cartel): Firms communicate and agree on price, output, or market sharing.
- Tacit Collusion: Firms coordinate without explicit communication (actions influence each other).
Legality: While collusion itself isn't illegal, communication between competitors to influence market mechanisms is illegal, such as agreements to set prices or limit output.

Incentives: Firms collude to increase market prices and profits. If one firm increases output, the market price drops affecting profits negatively for other firms.
- Dependence on competitors’ actions leads to a desire to form cartels.
Market Examples:
- Cartels are likely to succeed in concentrated markets with few competitors, allowing firms to manipulate prices efficiently.

Cournot Model: Utilized to analyze how firms decide on output given competitors’ outputs.
Best Response Functions: Use graphs to show firm outputs responding to competitors, leading firms to find Nash Equilibrium where neither firm can benefit by changing their output unilaterally.
Isoprofit Curves: Similar to indifference curves; show combinations of outputs leading to the same profit.
- When firms collude, they shift towards points on isoprofit curves that yield higher profits.

Examining Nash Equilibrium: Discusses scenarios where any deviation from marketed outputs provides less profit, creating tension between firm interests.
Prisoner’s Dilemma: Firms could achieve higher profits through collusion, yet individual incentives lead to cheating; thus, firms end up at a lower profit equilibrium rather than maximizing joint profits via collusion.

Characteristics Favorable for Cartels:
- Market Share Control: A cartel must control a significant portion of the market to influence prices effectively.
- Entry Barriers: High barriers to entry prevent new competitors from undermining cartels.
- Demand Inelasticity: Ensures demand remains stable even with price increases.
Transaction Costs: Smaller numbers of firms ease coordination, monitoring, and enforcement against deviations from collusive agreements.

Legislation: Cartel activity is illegal under competition law, focusing on price-fixing, output restrictions, and market allocations.
Evidence Gathering: Detecting collusion is challenging; governments rely on tips, internal communications, or evidence from whistleblowers.
Studies & Findings: The role of leniency policies in encouraging whistleblowing amongst competitors.
Case Example: The first criminal cartel case in New Zealand (Max Build) demonstrated the legal consequences firms face when engaging in collusion.

Challenges in Sustaining Cartels: Incentives to cheat, costly penalties for detection, and the potential for other firms to enter the market influence the longevity of cartels.
Monitoring Difficulties: Firms need effective mechanisms to ensure compliance without signaling other competitors.

Future Lectures: Expanding on market conditions, and types of collusion will continue in upcoming classes, alongside real-world examples to illustrate concepts better.
Critical Thinking: Identifying cases of collusion and understanding market conditions that allow for cartel formation is essential.
Discussion Prompts: Students are encouraged to explore real-world examples of cartels and analyze the reasons for their formation and sustainability in particular markets.