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Definition of Collusion:

Collusion occurs when two or more competitors agree to reduce competition by collaborating to set prices, reduce output, or divide the market.

Detailed Explanation:

In an efficient market, businesses act independently and compete with each other to efficiently produce a good or service demanded by consumers and sell the good or service at the market price. The law of supply and demand establishes the market price and socially optimal production level. Collusion disrupts an efficient market by pushing up prices and reducing output. Companies benefit from reducing competition by colluding to raise prices, reduce output, or divide the market among themselves. Collusion is easiest when there are only a few companies in an industry. It is most common among oligopolies because oligopolies have a few dominant companies. Companies are interdependent in an oligopoly because management considers their competition’s probable response before reaching a decision. For example, management may be hesitant to lower its price to gain market share if it fears a price war will be instigated. How can a price war be avoided? Collusion. But, collusion is usually illegal – especially when it undermines the competitiveness of an industry.

Anti-trust laws prohibit discussing pricing or production quotas between competitors. That has not stopped many companies from colluding. Apple was accused of colluding with publishers to increase the price of e-books. Westinghouse and GE were found guilty of colluding to fix prices of heavy electrical equipment in the 1960s. Roche tried to fix the prices of vitamins in the 1990s. Major league baseball owners were guilty of collaborating to restrain the escalation of wages for the league’s best players between 1985 and 1987 when owners agreed to not compete for players entering free agency. All-stars like Kirk Gibson, Ron Guidry, Tim Raines, and Doyle Alexander were forced to sign with their former team because no other owners expressed interest in their services. Michael Andreas, the vice-chairman of Archer Daniel Midland was imprisoned in 1999 for price-fixing of lysine, an animal feed additive. (Mr. Andreas was released from prison in 2002.)

Dig Deeper With These Free Lessons:

Market Structures Part II – Monopolistic Competition and Oligopoly
Market Structures Part I – Perfect Competition and Monopoly
Output and Profit Maximization
Supply and Demand – Producers and Consumers Reach Agreement  

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