Collusion in Economics: Definition & Examples

Collusion in Economics: Definition & Examples
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  • 0:01 What Is Collusion?
  • 1:13 The Legal Issues…
  • 2:31 Examples of Collusion
  • 3:55 Lesson Summary
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Lesson Transcript
Instructor: Brianna Whiting
In this lesson we will explain the act of collusion. We will look at different factors that affect the legality of the term and break down a real life scenario. A lesson summary and quiz will follow.

What is Collusion?

Meet Eddie. Eddie is the owner of a large corporation that sells pizza. Eddie has always prided himself on following the rules and regulations where his business is concerned. This all changed one day when three other owners of pizza companies approached him. They wanted Eddie to join them in a secret agreement to set the price for their pizzas in order to keep any other firm from entering the market. What Eddie was involved in is known as collusion.

While you may be able to vaguely understand the term based upon the example above, let's further define collusion so that you have a better grip on what it means. Collusion is an agreement between firms that usually compete against each other in efforts to set the prices for their goods in order to gain an advantage. In doing so, the equilibrium of the market is disrupted because supply and demand are no longer natural. When competitive firms work together, they're able to increase profits via price increases, restriction of supply, and/or sharing insider information. For example, firms may agree to limit the supply of their goods, making them harder to find and purchase. In doing so, consumers are willing to pay a higher price because of the limited amount available.

The Legal Issues Surrounding Collusion

So you may be wondering: is collusion an illegal practice? Well, this is a tricky question because many factors can contribute to collusion. In short, collusion is generally thought of as an illegal practice, but let's break it down a bit to understand why.

Collusion can involve price-fixing. Price fixing is an agreement between competitive firms on the prices for goods. This can mean increasing or decreasing prices to gain an advantage. Price fixing is an illegal practice. An example of price-fixing is when competitive firms get together to set an agreed upon price for their product, like in our above example with Eddie. The firms then agree not to deviate from that price.

Collusion may involve price leadership, otherwise known as parallel pricing. This occurs when the leading firm in the market publishes their prices before the other firms in the market, which then forces the other firms to match the price. When doing this, the leading firm publishes prices that will benefit their firm and maximize their profits. This doesn't mean that competitive firms will also see maximized profits. However, even if competitive firms won't benefit from the leading firms' announced prices, they often utilize the same price for their goods only to stay competitive. This type of collusion is generally thought of to be a legal practice.

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