Tag Archives: standardized product

Obstacles to collusion

2 Aug

Obstacle to collusion (oligopolies)
     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.
Possible Entry
   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.


Characteristics of Pure Competition Market System

10 Jul

Pure competition

  Very large number of producers An important feature of this type of market system is the presence of big number of sellers that act independently and offer their products to large national and international markets. Example: the stock market, the exchange market.

  • Standardized product Pure competitive firms produce a standardized product. Since price is the same demanders won’t care which product to buy. All goods are substitutes of each other.  They make no attempt to differentiate their products and there is not any non-price competition, because their goods are homogeneous.
  • Price-Takers In pure competitive markets firms don’t try to control the price, because each firm is producing only a small amount of the total product, so increasing or decreasing their output won’t affect the price. We may say that firms and pure-competitive markets are price-takers: they can’t change the market price, they only adjust to it. Selling their goods on a higher price will results in loss of revenue, because 1000 sellers will offer their goods for a smaller price so the consumers, since the goods are identical, will buy less costly one, because in this way they get more marginal benefit. There isn’t any reason to decrease the price, because sellers want to get higher revenues if it is possible. By decreasing price they may lose higher profits. So the price of the sellers will be the same, since their goods are identical.
  • Free entry and free exit  New firms can freely enter and the existing ones may exit the pure competitive industry. No legal, financial, technological or other obstacles prohibit suppliers to sell their goods in any pure-competitive market.

Even if pure competition is relatively rare in our real world, it is meaningful starting point for any discussion about price and output determination. It provides a standard for evaluating the efficiency of real world economy. Even if this kind of market system is extremely rare some industry may be a close approximation of it: market for agricultural goods, foreign exchange, and stock share market. So by means of them we can learn more about this model of market system.

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