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Monopolistic Competition and Oligopoly
Oligopoly Models

Because many different types of oligopolies exist, a number of different oligopoly models have been developed. But all kinds of oligopolies have one thing in common: the behavior of any given oligopolistic firm depends on the behavior of the other firms in the industry comprising the oligopoly.

The Collusion Model

The collusion model argues that when there are few firms in the industry, it is possible for the firms to get together and act like a monopolist. A firm in an oligopoly could compete with the other firms, which means the profits go to zero, or it could get all the firms to act like one big firm and restrict production, while charging a high monopoly price.

When a firm group gets together to collude on price and output, they are referred to as a cartel. If a cartel is effective, it can be very profitable for the firms, as OPEC is for the oil industry. Certain conditions have to hold true for a cartel to work.

They have to be physically able to get all of the firms in the industry together and then be able to agree on a price and quantity for the whole industry. Such a meeting is illegal in the U.S. When firms collude, it is called "price-fixing" and it is a criminal act.

When the firms end up price-fixing without any formal meeting, which is called tacit collusion, there may not be any easy legal recourse. Once the price and quantity are agreed upon, the cartel must decide how much each firm is allowed to make. Most importantly, the cartel must be able to prevent individual firms from cheating on the deal.

If the cartel price is very high, it is tempting for a single firm to go off and make a little more than they are allowed to make because the profit potential is huge! The problem is that if every firm sneaks off to make a little more, the market price will fall and eventually the price will drop to the competitive price. Generally speaking, cartels usually fall apart because of cheating. Even illegal drug cartels have faced plummeting profits in the face of overproduction.

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