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What is collusion?
Collusion is an agreement, either formal or informal, among competing firms to fix prices for goods or services. The goal of collusion is to deter new entrants from entering a market or to gain the upper hand in a market. In either case, collusion disrupts the laws of supply and demand and unbalances markets.
Collusion is most often found in markets where there are only a few sellers. When a small number of organizations are involved in collusion, it is easier to monitor and control outputs. Though not common, collusion may happen when there is a large number of sellers but one dominant group of significant dealers, facing many lesser sellers who control only a fragment of the market.
The more standardized a product or service is, or the more it is viewed as a necessity, the easier it is for colluding firms to set a unified pricing strategy. Pricing is much easier to manipulate as companies may find it much harder to form a collusion based on other factors such as quality, design, features, or even service.
Without proper regulation, collusion can have adverse effects that disrupt markets, and customers are forced to buy goods or services at higher prices. New firms are discouraged from entering the market by cartels. Innovation may become compromised since the colluding firms can easily make profits without putting forth much effort.
Formal collusion, also known as oligopoly, often leads to the formation of cartels. A few firms in the market may plot to set the cost or the production levels for a given product or service so as to increase their profits. Subsequently, the cost for the product or service is higher than the equilibrium price and total output declines. When a cartel become powerful enough, it may monopolize an industry and maximize the profits each member earns.
Tacit collusion is also known as informal collusion. It takes place when competing firms make informal agreements without speaking about it. This usually happens to elude detection.
Price leadership collusion occurs when a more dominant firm sets the prices, also known as parallel pricing. For the less dominant but competing organizations to gain stability, they will engage in collusive behavior by selling the goods or services at the set prices. The dominant firm sets the prices in such a way that its profits are maximized. This may not necessarily be the case with lesser companies.
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In the 1950s, General Electric, Westinghouse, Allis-Chalmers and other manufacturers colluded to establish a notorious price-fixing scheme for heavy equipment such as turbines and electrical transmission gear. Corporate executives would meet periodically to coordinate their bids for contracts with electric utility companies, industrial corporations and contractors. At these secret meetings, the executives agreed to rotate their bids and disguise collusion: one corporation would quote the low price, others would quote intermediate prices and another would quote the high price. Their positions would rotate, and each would know the exact price it and every other defendant corporation would quote in sealed bids for contracts.
The Tennessee Valley Authority (TVA) unwound the conspiracy. When reviewing its records, the TVA found that for a three-year period, 47 manufacturers had been submitting identical bids for various projects. Nearly 50 corporate executives were found guilty in the collusion scheme, and nine served prison sentences.