AP Syllabus focus: ‘Firms in an oligopoly have an incentive to collude and form cartels.’
Oligopolies feature a few interdependent firms, so rivalry can be costly.
This kinked demand curve illustrates how an oligopolist can face more elastic demand for price increases (rivals do not match) and more inelastic demand for price cuts (rivals match), creating price rigidity. The diagram also shows the discontinuity in marginal revenue and why small cost changes may not change the prevailing price. Source
Collusion and cartels are attempts to reduce competition, raise price, and increase joint profits—often by imitating monopoly outcomes.
What collusion and cartels are
Collusion is cooperation among firms to influence price, output, or other competitive choices.
Collusion: An agreement (explicit or tacit) among firms to coordinate decisions such as price, output, or market division to increase profits.
Collusion can be explicit (direct communication) or tacit (coordination without direct agreement, e.g., “following” a common pricing pattern).
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FAQ
If a regulator offers reduced penalties to the first firm that confesses, each cartel member faces a stronger incentive to report.
This can destabilise cartels by creating a “race to confess,” especially when detection risk rises.
Side payments can persuade high-cost or smaller firms to accept quotas that otherwise feel unfair.
They can also reduce conflict when demand shifts and quota renegotiation is necessary.
They may rely on indirect signals such as public price announcements, standardised surcharges, or trade association meetings with ambiguous agendas.
They may also coordinate on non-price terms (delivery timing, contract clauses) that effectively raise price.
If firms are near full capacity, cheating is harder because they cannot expand output much beyond quota.
When spare capacity is large, the temptation to exceed quota is stronger because extra units can be sold at high cartel prices.
In some markets, rapid price matching can reduce the gain from undercutting, supporting stable high prices.
However, frequent price changes can also create noise, making it harder to identify intentional undercutting versus automated adjustments.
