[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

A firm that is part of an oligopolistic market must think strategically. In deciding
what to do, it faces four key questions: (1) Should it cooperate with other firms
or compete? When firms cooperate rather than compete, economists say the firms
are colluding. (2) If it cannot collude explicitly (because there are laws barring such
behavior), how can it reduce the effectiveness of competition through restrictive
practices or other means? (3) How can it deter entry? Like a monopolist, it knows
that the entry of other firms will erode profits. (4) How will rivals react to whatever
it does? Will they, for instance, match price decreases? In the next four subsections,
we take up each of these questions in turn.
Note the contrast between both competitive and monopolistic competitive models
on the one hand and pure monopoly on the other. In the latter, there is no competition,
hence no need to take actions to restrict competition; in the former, by assumption,
there are so many competing firms that attempts to restrict competition
are fruitless.
COLLUSION
In some cases, oligopolists enter into collusion to maximize their profits. In effect,
they act jointly as if they were a single monopoly, and split up the resulting profits.
The prevalence of collusion was long ago noted by Adam Smith, the founder of
modern economics: “People of the same trade seldom meet together, even for merriment
and diversion, but the conversation ends in a conspiracy against the public,
or in some contrivance to raise prices.” 3 A group of companies that formally operate
in collusion is called a cartel. The Organization of Petroleum Exporting Countries
(OPEC), for instance, acts collusively to restrict the output of oil, thereby raising oil
prices and hence the profits of member countries.
In the late nineteenth century, two or more railroads ran between many major
cities. When they competed vigorously, profits were low. So it did not take them long
to discover that if they acted collusively, they could raise profits by raising prices.
In the steel industry at the turn of the century, Judge Elbert H. Gary, who headed
the U.S. Steel Company, the largest of the firms, regularly presided over Sunday
dinners for prominent members of his industry at which steel prices were set.
In the 1950s, a cartel that included General Electric and Westinghouse colluded in
setting the prices of electrical generators. And in the 1990s, the government
uncovered price-fixing by Archer Daniel Midland (ADM).
But the mere fact that collusion is illegal inhibits it. Because the members of the
cartel cannot get together to discuss price-fixing or restricting output, they typically
must rely on tacit collusion—each restricting output with an understanding
that the others will too. They cannot sign a contract that can be enforced in a court
of law, simply because collusion to fix prices is illegal; hence they must rely on selfenforcement,
which can be difficult and costly. Moreover, their artificially high
prices—well in excess of the marginal cost of production—tempt each firm to cheat,
to expand production. The members of the cartel may try to discipline those that
cheat. They may even incur losses in the short run to punish the cheater, in the belief
3 Wealth of Nations (1776), Book One, Chapter X, Part II.
OLIGOPOLIES ∂ 275