Welfare Improving Cartel Formation in a Union-Oligopoly Static Framework

Welfare Improving Cartel Formation in a Union-Oligopoly Static Framework

In a union-oligopoly static framework we study the role of unions regarding the possibility and the effects of endogenous cartel formation.

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In the present paper we consider a simple union-oligopoly model where in the product market two technologically identical firms producing differentiated goods may compete, or collude, by independently adjusting their own quantities. We further argue that either of these decisions is taken cooperatively inside each firm/union unit (yet non-cooperatively across the different firm/union units) in a firm-specific bargain where the firm decides on its output and the union decides on the firm-specific wage. 

In this context, a (two-stage) static game arises, with the following envisaged events: At the first stage, firms independently decide to proceed to competitive or to collusive play (e.g. to cartel formation) in the continuation of the game, and unions independently choose the (firm-specific) wage to set in either instance. At the second stage, firms independently adjust their own quantities in the product market, in order either to maximize their own profits or to maximize joint profits, according to the decisions taken, inside each firm/union unit, at the first stage.

Solving this game, our findings suggest that, if union members are not sufficiently risk-averse, and the firms’ products are sufficiently close substitutes, then collusion among firms may quite interestingly emerge in the (static) equilibrium and that − in contrast to conventional wisdom – cartel formation may prove to be a welfare improving market arrangement compared to competition. Remarkably, moreover,  such a gain in social welfare materializes at the cost of union rents, despite it is the union’s presence that effectively sustains collusion. 

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