What this lesson teaches
I can explain the strategies firms use to raise revenue or cut unit costs: growth, pricing, price discrimination, innovation, marketing and collusion.
Syllabus 9570, 2.2.3(a). Firms' Decisions and Strategies: Firms make decisions and engage in pricing, cost and product differentiation strategies aimed at raising revenue and/or lowering unit costs. These include:; growth, diversification and shut-down; price competition; third degree price discrimination; innovation, research and development; marketing; collusion with other firms
Make a guess
Three suppliers agree to keep prices high. One of them is tempted to cut its price secretly. Why?
- It could win many customers while others keep prices high.
- Its costs are higher than the others', so it must sell at a lower price.
- It wants to lower prices to help its loyal customers.
Show the answer
It could win many customers while others keep prices high.
If rivals stick to the agreement, the cheater sells far more at a slightly lower price. This pull is why collusion often breaks down.
Firms in an oligopoly may agree to limit competition, but each has a reason to cheat, and collusion is illegal.
Collusion is when firms agree to act together instead of competing, for example by fixing prices or sharing out customers.
By acting like a single monopoly, they can raise prices and their combined profits. Consumers pay more and have less choice.
But each firm has an incentive to cheat: if the others keep prices high, one firm can quietly undercut them and win many customers. This is why collusion often breaks down.
In Singapore, collusion is illegal under the Competition Act. The Competition and Consumer Commission of Singapore (CCCS) has fined fresh chicken distributors for agreeing not to compete for each other's customers.
- Collusion
- Firms agree to limit competition.
- Unstable
- Each firm has an incentive to cheat.
- Singapore
- Illegal under the Competition Act; enforced by CCCS.
Worked example: Why one supplier may cheat
Three suppliers of a similar product agree to limit how much they sell, to keep prices high. One supplier considers secretly selling more.
- Together, restricting output keeps the price high and joint profit high.
- The cheating supplier gains extra sales at the high price.
- If the others notice, they will also sell more, the price falls and the agreement collapses.
- The threat of CCCS penalties adds a further risk.
Watch out for this
Similar prices across firms prove they are colluding.
Similar prices can simply result from competition, since firms with similar costs and products end up charging similar prices. Proof of an agreement is needed.
Check your understanding
Why is collusion often unstable?
- Consumers find out and refuse to buy from the colluding firms, so sales collapse.
- Each firm can gain by secretly cutting its price or selling more.
- Collusion lowers the firms' joint profits, so each would rather compete.
Show the answer
Each firm can gain by secretly cutting its price or selling more.
Right. The incentive to cheat undermines the agreement.