Cartels (that are a formal agreement among various firms in industry to set the prices of products and establish the outputs of the individual firms or to divide the market among them) and other arrangements are difficult to create and to maintain. Let’s describe some barriers to collusion for various industries:
Demand and Cost differences
Oligopolists face different cost of production and demand curves, so it’s difficult for them to agree on price, which is true for industries that produce differentiated products and change them frequently. Even if firms have standardized products, they usually have different market shares and operate at different degrees of productive efficiency. That’s why even homogeneous oligopolistic firms may have different demand and cost curves.
Differences in demand and cost mean that even profit-maximizing price and output will be different among firms; there will be no single price acceptable by all firms. Price collusion depends on concessions and compromises which are not easily to obtain, since there are many obstacles to collusion.
Number of Businesses
So, it’s obvious the fact that more firms being present in an industry, harder is to create a cartel or other kind of price collusion. An agreement on price set is relatively hard to accomplish when there are 3 or 4 firms, but what if there are 10 firms that share each about 10% of the market, or there is Big Four that has about 70 percent of market share, and there are 4-5 small firms that have other 30% of this market share.
As it was explained in Game Theory model (previous article), there is a high-temptation for collusive oligopolistic firm to make a secret cut in price that may result in increased revenues. So buyers that are getting price cut by one supplier may wait for price-cut for another. Buyers may attempt to create a play between these two firms, so that it may transform into a real war. Even if cheating between collusive oligopolists may be profitable, this act is destructing it over time. However, collusion is more likely to succeed when cheating is easier to observe and punish.
Greater revenues may result in attracting new firms in this industry. Since this may create increased market supply and reduced prices, successful collusion of oligopolists requires them to block the entry for new producers.
Recessions serves as enemies to collusion, since markets will increase average total costs (ATC), because oligopolists’ demand and marginal revenues (MR) will decrease in response to this recession. Firms will find out that the quantity supplied by them is in excess, so these firms will have to avoid great profit reductions (or losses) after cutting prices and thus they will gain sale at expense of rivals.
Anti-combined law (legal barrier)
Many countries have anti-combined laws that prohibit this price-fixing collusion, so this means that they have a system of price control.