Although tacit collusion is common, it rarely allows an industry to push prices all the way up to their monopoly level; collusion is usually far from perfect. A variety of factors make it hard for an industry to coordinate on high prices.

Suppose that there were three instead of two firms in the lysine industry and that each was currently producing only 20 million pounds. In that case any one firm that decided to produce an extra 10 million pounds would gain more in short-term profits—and lose less once another firm responded in kind—than in our original example because it has fewer units on which to feel the price effect. The general point is that the more firms there are in an oligopoly, the less is the incentive of any one firm to behave cooperatively, taking into account the impact of its actions on the profits of the other firms. Large numbers of firms in an industry also make the monitoring of price and output levels more difficult, and typically indicate low barriers to entry.

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In our simplified lysine example the two firms produce only one product. In reality, however, oligopolists often sell thousands or even tens of thousands of different products. A Walmart Supercenter sells over 100,000 items! Under these circumstances, as when there are a large number of firms, keeping track of what other firms are producing and what prices they are charging is difficult. This makes it hard to determine whether a firm is cheating on the tacit agreement.

In the lysine example, a tacit agreement for the firms to split the market equally is a natural outcome, probably acceptable to both firms. In other situations, however, firms often differ both in their perceptions about what is fair and in their real interests.

For example, suppose that one firm in a duopoly was a long-established producer and the other a more recent entrant into the industry. The long-established firm might feel that it deserved to continue producing more than the newer firm, but the newer firm might feel that it was entitled to 50% of the business.

Alternatively, suppose that the newer firm’s marginal costs were lower than the long-established firm’s. Even if they could agree on market shares, they would then disagree about the profit-maximizing level of output.

Often oligopolists sell not to individual consumers but to large buyers—other industrial enterprises, nationwide chains of stores, and so on. These large buyers are in a position to bargain for lower prices from the oligopolists: they can ask for a discount from an oligopolist, and warn that they will go to a competitor if they don’t get it. An important reason large retailers like Target are able to offer lower prices to customers than small retailers is precisely their ability to use their size to extract lower prices from their suppliers.

These difficulties in enforcing tacit collusion have sometimes led companies to defy the law and create illegal cartels. We’ve already examined the cases of the lysine industry and the bulk vitamin industry. An older, classic example was the U.S. electrical equipment conspiracy of the 1950s, which led to the indictment of and jail sentences for some executives. The industry was one in which tacit collusion was especially difficult because of all the reasons just mentioned. There were many firms—40 companies were indicted. They produced a very complex array of products, often more or less custom-built for particular clients. They differed greatly in size, from giants like General Electric to family firms with only a few dozen employees. And the customers in many cases were large buyers like electrical utilities, which would normally try to force suppliers to compete for their business. Tacit collusion just didn’t seem practical—so executives met secretly and illegally to decide who would bid what price for which contract.

The FYI describes yet another price-fixing conspiracy: the one between the very posh auction houses Sotheby’s and Christie’s.

Because tacit collusion is often hard to achieve, most oligopolies charge prices that are well below what the same industry would charge if it were controlled by a monopolist—or what they would charge if they were able to collude explicitly. In addition, sometimes tacit collusion breaks down and aggressive price competition amounts to a price war. A price war sometimes precipitates a collapse of prices to their noncooperative level, or even lower, as sellers try to put each other out of business or at least punish what they regard as cheating.

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