Equilibrium under Collusive Oligopoly

So, when firms under oligopoly engage in collusion, they may agree on prices. They may also agree on market share and advertising expenditure and so on. So, such collusion reduces the uncertainty they face. It reduces the fear of engaging in competitive price cutting, retaliation or advertising. So, a formal collusion is called a cartel. The cartel will maximize profits like as if it’s a monopoly. Then in that case we can analyze it exactly like a monopoly. The total market demand curve becomes the collective market demand of the firms. MC curve is the horizontal sum of the MC curve of its members. So, the profits are maximized at Q where MC equals to MR. The cartel must therefore set a price at P having agreed on the cartel price because it behaves like a monopoly as a whole but individually they agree to this price. The members then compete with one another for maybe using non-price competition or they may agree not to compete at all and maybe given a quota. In many countries cartels are illegal. The only legal cartel in the world is probably OPEC and a bunch of countries that just produce oil but most cartels are actually illegal and this is seen by the government as a means of driving up prices and profits and thereby against public interest. So, where open collusion is illegal, firms may break the law and they try and collude. So, they do it kind of like implicitly. They do it tacitly. So, one form of tacit collusion is where the firms keep to the price set by established leader. This is called the Dominant Firm Leadership or sometimes it may not actually be the dominant firm but just the one that has proved to be the most reliable guy to follow. This is called the Barometric Firm Price Leadership. An alternative to following a leader is following simple rules or thumb. Now, this may be easier than price leadership and prevents immediate outbreak and maintaining profits in the long run. For example, they may use the cost plus method to just price themselves and agree not to fight with each other.