11 Apr

No Formal Agreement Is Possible Among Firms


How did this soap opera end? Following an investigation, the French antitrust authorities fined Colgate-Palmolive, Henkel and Proctor and Gamble for a total of 361 million euros (US$484 million). Ice manufacturers have had a similar fate. Ice bags are a commodity, a perfect substitute that is usually sold in 7 or 22 pound bags. No one cares about the label on the bag. By agreeing to cut out the ice market, control large geographic areas and set prices, ice cream manufacturers have moved from perfect competition to a monopoly model. Under the agreements, each company was the sole supplier of ice bags in an area; Both in the long term and in the short term, there have been benefits. According to the court, these companies conspired illegally to manipulate the market. The fines were about $600,000 — a large fine considering that a bag of ice is sold for less than $3 in most parts of the United States. Can the two companies trust each other? Think of the situation of Company A: in an oligopoly, companies operate under imperfect competition. Given the strong price competitiveness generated by this sticky demand curve, firms are taking advantage of non-tariff competition to generate higher revenues and market share. An example of the pressure these companies can exert on each other is the demand curve, in which competing oligopolies companies commit to harmonizing price declines, but not price increases. This situation is illustrated in Figure 1.

Say that an oligopoly company has agreed with the rest of a cartel to provide 10,000 seats on the road from New York to Los Angeles for a price of $500. This selection defines the elbow in the demand curve perceived by the company. The reason the company is facing a demand curve is how other oligopolists react to the company`s price changes. If the oligopoly decides to produce more and lower its price, the other cartel members will immediately face cheap price declines – and therefore a lower price results in a very small increase in the quantity sold. Like the prisoner`s dilemma, cooperation in an oligopoly is difficult to maintain, because cooperation is not in the best interests of the various actors. However, the collective bottom line would be improved if companies cooperated and were thus able to maintain low production, high prices and monopolistic profits. Assuming that the withdrawals of the two companies are known, what is the likely outcome in this case? If a company lowers its price to $300, it can only sell 11,000 seats. However, if the airline tries to raise prices, other oligopolists will not increase their prices and the company that has increased prices will lose a significant share of sales. For example, if the company increases its price to 550 $US, the turnover drops to 5,000 seats sold. Therefore, if oligopolists still reassess the price declines of other antitrust firms, but no price increases, none of the oligopolists will have a strong incentive to change prices, as the potential benefits are minimal. This strategy can function as a silent form of cooperation in which the cartel manages to maintain production, increase price and share a level of profit monopoly, even without a legally binding agreement.

Teck Lee Tan

Field Engineer and Tech Artist at Unity Technologies


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