If a real industry were as simple as our lysine example, it probably wouldn’t be necessary for the company presidents to meet or do anything that could land them in jail. Both firms would realize that it was in their mutual interest to restrict output to 30 million pounds each and that any short-term gains to either firm from producing more would be much less than the later losses as the other firm retaliated. So even without any explicit agreement, the firms would probably achieve the tacit collusion needed to maximize their combined profits.

Real industries are nowhere near that simple. Nonetheless, in most oligopolistic industries, most of the time, the sellers do appear to succeed in keeping prices above their noncooperative level. Tacit collusion, in other words, is the normal state of oligopoly.

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. As we discuss next, there are four factors that make it hard for an industry to coordinate on high prices.

Less Concentration In a less concentrated industry, the typical firm will have a smaller market share than in a more concentrated industry. This tilts firms toward noncooperative behavior because when a smaller firm cheats and increases its output, it gains for itself all of the profit from the higher output. And if its rivals retaliate by increasing their output, the firm’s losses are limited because of its relatively modest market share. A less concentrated industry is often an indication that there are low barriers to entry.

Complex Products and Pricing Schemes In our lysine example the two firms produce only one product. In reality, however, oligopolists often sell thousands or even tens of thousands of different products. Under these circumstances, keeping track of what other firms are producing and the prices they are charging is difficult. This makes it hard to determine whether a firm is cheating on the tacit agreement.

Differences in Interests 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 real industries, however, firms often differ both in their perceptions about what is fair and in their real interests.

For example, suppose that Ajinomoto was a long-established lysine producer and ADM a more recent entrant to the industry. Ajinomoto might feel that it deserved to continue producing more than ADM, but ADM might feel that it was entitled to 50% of the business. (A disagreement along these lines was one of the contentious issues in those meetings the FBI was filming.)

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

Bargaining Power of Buyers 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 Walmart 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 chocolate industry. An older, classic example was the U.S. electrical equipment conspiracy of the 1950s, which led to the prosecution of and jail sentences for some executives. The industry was one in which tacit collusion was especially difficult because of the reasons just mentioned.

Tacit collusion just didn’t seem practical—so executives met secretly and illegally to decide who would bid what price for which contract.

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 collusion breaks down and there is a price war. A price war sometimes involves simply a collapse of prices to their noncooperative level. Sometimes they even go below that level, as sellers try to put each other out of business or at least punish what they regard as cheating.