How does collusion work in an imperfectly competitive market?

In an imperfectly competitive market, collusion occurs when rival firms agree to cooperate for their mutual benefit, often by fixing prices or dividing markets.

Collusion in an imperfectly competitive market is a scenario where firms, instead of competing against each other, decide to work together. This cooperation is usually aimed at increasing their market power, which allows them to control prices, output, or even the entire market. The main forms of collusion are price fixing, where firms agree to sell at a certain price, and market sharing, where firms divide the market among themselves.

The reason why firms might choose to collude is to maximise their joint profits. In an imperfectly competitive market, firms have some degree of market power, meaning they can influence the price of their product. However, competition among these firms can lead to a decrease in prices and profits. By colluding, firms can avoid this competition, allowing them to maintain higher prices and earn greater profits.

However, collusion is not always easy to maintain. It requires a high level of trust and cooperation among firms, which can be difficult to achieve. There is always the temptation for individual firms to cheat on the agreement, for example by secretly lowering their prices to attract more customers. This can lead to the breakdown of the collusion agreement.

Moreover, collusion is generally considered to be illegal and unethical, as it can lead to higher prices and reduced choice for consumers. Competition authorities, such as the Competition and Markets Authority in the UK, are tasked with detecting and preventing collusion. They have the power to impose heavy fines on firms found to be colluding.

In conclusion, collusion in an imperfectly competitive market involves firms cooperating to increase their market power, often by fixing prices or dividing markets. While this can lead to higher profits for the firms involved, it is generally considered to be harmful to consumers and is therefore subject to regulation by competition authorities.