The number of firms in an oligopoly being only a few and limited, each firm while making its own price and output decisions has to take into account the likely reaction of the others with regard to their prices and outputs. Any move by a particular firm to reduce its price with a view to selling more output may not be successful because the other firms too may cut down their prices and thus prevent their customers from going away. In the process every firm is likely to lose.
Hence, there is a close interdependence among firms under oligopoly as no one can assume that if it changes its price or output others will not do it. In order to avoid this uncertainty resulting from price war and cutagree to follow a uniform price – output policy. Such formal agreements are largely informal or secret, as in most of the countries Laws and Anti – Monopoly or Anti – Trust Legislations. Thus all such agreements among various firms to follow a common price output policy results in formation of a collusive oligopoly. This collusion among the firms may take many forms.
The most common types of such Agreements are those that lead to collusion through (a) Price Leadership and (b) Formation of Cartels.
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