Sometimes the market leader in an oligopoly can start a round of price increases and cuts by making its plans clear to other firms. Price leaders can set prices and output for entire industries as long as other member firms go along with the leader's policy. But disagreements among member firms can spark a price war, when competitors cut their prices very low to win business. A price war is harmful to producers but good for consumers.

Collusion refers to an agreement among members of an oligopoly to set prices and production levels. One outcome of collusion is called price fixing, an agreement among firms to sell at the same or very similar prices. Collusive agreements set prices and output at the levels that would be chosen by a monopolist. Collusion is illegal in the United States, but the lure of monopolistic profits can tempt businesses to make such agreements despite the illegality and risks.

Collusion is not, however, the only reason for identical pricing in oligopolistic industries. Such pricing may actually result from intense competition, especially if advertising is vigorous and new lines of products are being introduced.

A computer manufacturer can distinguish its computers with bright colors or a sleek design.

Cartels

Stronger than a collusive agreement, a cartel is an agreement by a formal organization of producers to coordinate prices and production. Although other countries and international organizations permit them, cartels are illegal in the United States. Cartels can only survive if every member keeps to its agreed output levels and no more. Otherwise, prices will fall, and firms will lose profits. However, each member has a strong incentive to cheat and produce more than its quota. If every cartel member cheats, too much product reaches the market, and prices fall. Cartels can also collapse if some producers are left out of the group and decide to lower their prices below the cartel's levels. Therefore, cartels usually do not last very long.

Section 3 Assessment

Key Terms and Main Ideas

1. What are the four conditions of monopolistic competition?
2. How do economists determine whether a market is an oligopoly?
3. Give three examples of nonprice competition.
4. How would price fixing and collusion help producers?

Applying Economic Concepts

5. Using the Databank The map on page 545 indicates which countries are members of OPEC, a cartel made up of oil-exporting countries. In the 1970s, OPEC successfully raised oil prices by cutting production. Based on what you have read in this section, explain how this situation illustrates (a) how cartels operate (b) why cartels can be dangerous.
6. Decision Making Would you describe the following markets as monopolistic competition or oligopoly? (a) refrigerators (b) video game systems (c) gourmet ice cream (d) sunscreen (e) cable sports channels
7. Critical Thinking Which of the four forms of nonprice competition described on pp. 167–168 would you emphasize for the following products? Explain your reasoning. (a) a new brand of bottled water (b) in-home computer repair (c) protein bars

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