Oligopolies and Criminals: Whats the Link?

 Let's say the police catch 2 criminals, Jace and Jack. They are taken to the police station, where the police suspect they have committed a more serious crime on top of what they were caught doing- in order to have some concrete evidence, they need to extract a confession from Jace and Jack. The police start interrogating them in different rooms- they have no contact with each other. So here's the dilemma. If Jace cooperates (remains silent) but Jack defects (testifies that Jace did it), Jack gets away with the crime, whereas Jace gets a 3 year prison sentence. The same thing would happen but to Jack if Jace defects and he remains silent. However if both cooperate, they just get a 1 year prison sentence each. If both defect, then each get a 2 year prison sentence. It would be more easily understandable with this diagram: 

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From both Jace and Jack's perspective, defection is always better than cooperation- if they don't, there is a risk of serving 3 years in prison. So they both end up snitching, and get a 2 year sentence each. This is known as Nash Equilibrium, where, if they change their "strategy", i.e. stay silent instead, they'll be worse off- so there is no incentive to change their strategy. However, those of you who are eagle-eyed may have noticed that if they had both remained silent, they'd have gotten only a 1 year sentence each. But since they acted in self interest, in hope of going free, they ended up worse off. Therefore, the outcome is Pareto inefficient- there was still a way in which both could've had a better outcome without harming the other. 

Now onto explaining that strange term "oligopoly" in the title. Put simply, oligopolies are markets which are controlled by a small number of firms, all of which have significant market power and the ability to influence the price of the products in the market. Common examples include Nike and Adidas in the sneaker market, Apple and Samsung in the smartphone market and, of course, Tesco, Sainsbury's, Asda and Morrisons in the UK's supermarket industry. Note that these are not strictly oligopolies, as other firms like Puma, Xiaomi & Lidl do exist, but for illustrative purposes we can see how these companies are the most prominent when it comes to these markets. The actions of one firm in an oligopoly can affect the others, hence they are mutually interdependent. Some characteristics of oligopolies include: 

• Price Setting. Firms set the prices, rather than adopt them. 
• High barriers to entry and exit. Advanced technology, government licenses, established businesses are all factors which can make it quite hard for companies to break into an oligopolistic market. 
• Non-price competition. If Firm A lowers their price while Firm B keeps it high, it will experience more sales and will generate higher total revenue than Firm B. Consequently, to avoid losses, Firm B would also reduce their prices- the outcome, as highlighted before, is Pareto inefficient. In order to avoid this - i.e., to boost sales without affecting the price - companies would utilise other strategies such as marketing to ensure that their product is more appealing than their competitors'. This is known as non-price competition.

You may be wondering why I went from talking about prisoners to companies. This is because the companies in an oligopoly are a bit like the prisoners, except on a larger scale, and they are able to influence each other's actions (more on this in the next paragraph). A common real-world example, now illegal, is cigarette advertising - an industry that was also an oligopoly. Let's take the example of two cigarette companies - Blue Smoke and Red Fire, each selling cigarette packs for £2 with a 50/50 share of customers. They sell 500,000 packets annually, generating a revenue of £1M. Say Blue Smoke wanted to increase its sales. One such strategy to achieve this is advertising, e.g. through posters, billboards, etc. Now, it attracts more customers, meaning they control 75% of the market, whereas Red Fire only 25%. Therefore, they now make 750,000 sales a year, earning £1.5M, however because of advertising costs income cuts down to £1.25M. Red Fire, on the other hand, faces a reduced income- they sell only 250,000 packets now, earning a total of £500,000. To avoid this, they'd also start advertising. Now both are back to having an even split of customers, however, each is earning only £750,000 because they also face advertising costs. As you may have noticed, they are in the same situation as the prisoners- both are worse off than if they just stuck to selling 500k cigarette packets without advertising. 

You may now be starting to see how things may get messy here. If both cooperate and don't advertise, they receive higher profits. If one advertises and other follows suit, they would earn an equal amount of profit -  but it would be lower than the latter. The same would work with price reductions. This uncertainty over whether a company will advertise or reduce prices leads firms to form collusions to ensure they don’t face mutual losses. Collusions, illegal in many countries such as the USA, are written or even tacit agreements to control prices of products to mutually ensure that each firm involved receives the highest profit margins without adversely affecting other firms. The group of companies which have formed a cartel are collectively known as a cartel. If we were to bring back our old friends Jace and Jack, it would be as if they had a private agreement (even though they weren't allowed to talk to each other) to cooperate and remain silent so that they only get a one year sentence- benefitting both of them rather than one. Or it's like Blue Smoke and Red Fire agreeing not to advertise to maintain their £1M revenue. One real-world example is the Organisation of the Petroleum Exporting Companies (OPEC), which is a group of leading oil-extracting countries such as Saudi Arabia, which collectively work to influence the oil market and maximise profits. 

Collusions can be the bane of small firms, as it would be hard to compete with lower prices set by the cartel due to there being higher start-up costs. Thankfully, there are many laws and organisations in place to ensure the security of these firms. The Competition and Markets Authority (CMA) in the UK, for example, is a body which investigates and prosecutes cartel behaviour. The Article 101 of the Treaty on the Functioning of the European Union (TFEU) prohibits companies from forming agreements that lead to price fixing, restricting competitions, etc., with serious penalties such as a 10% fine on the company's annual worldwide turnover. 

I would like to end this article with one question- should oligopolies be made illegal?

Vihaan Zawar

Sources: 

1= https://bobhannahbob1.medium.com/the-prisoners-dilemma-a-legal-critique-7ba3b27ee93d