Collusion: causes, detection, and prevention strategies

Collusion has no place in a free market economy. Collusion distorts the market for a good by artificially limiting supply. This has a detrimental affect on consumers, since the price of the good is higher than it otherwise would be. In a free market, producers are free to collude should they so desire. In a regulated market, collusion can be outlawed, as is the case in the United States where antitrust laws prevent collusion, specifically because of the detrimental affect it has on consumers.

The case against collusion derives largely from the consumer impacts of the three major market structures -- monopolies, oligopolies and monopolistic competition (i.e. A competitive market). Monopolies have pricing power over their goods because there are no alternatives for buyers. Generally, governments promoting free and open markets seek to minimize the number of monopolies. Oligopolies can benefit consumers because they typically react to each other's moves. This means that firms in an oligopoly will compete on the basis of both price and innovation. In a competitive market, the presence of a number of competitors -- assuming no switching costs -- will keep prices low as some producers seeks to compete on the basis of cost leadership.

Thus, the structure most likely to see collusion is the oligopoly structure. The reason is that if the two companies end up competing on price, they will continually lower prices. This price war will be mutually destructive, particularly if the two firms are the same size. If the firms are of different sizes, one will be destroyed and the other will win, even if it is ends up being a Pyrrhic victory. The rationale for collusion, then, is to avoid such devastating price wars. The companies will set prices at a level where all firms can survive, and then compete on other attributes. Many Western telecommunications markets demonstrate these attributes -- their prices are high relative to much of the world and they compete on marketing, distribution, differentiation and occasionally on service.

Collusion, therefore, has the impact of delivering higher prices to consumers than they would otherwise experience. In the long-run, this keeps all firms in the industry in business but in the short-run it is detrimental to consumers, so most forms of collusion are not allowed by regulators. The irony is that regulators are needed to maintain the "free" nature of the market -- to keep prices competitive. This is necessary when barriers to entry are high, as few new firms will enter an oligopolistic industry that is engaging in dangerous price wars.