Price fixing is an agreement between or among firms in an industry to set prices jointly in order to increase PROFITs. Horizontal price fixing is an agreement among directly competing firms, while vertical price fixing involves attempts by manufacturers to control the resale price of their PRODUCTs. Price fixing, which is illegal under Section 1 of the SHERMAN ANTITRUST ACT (1890), undermines the social benefit of COMPETITION. In competitive markets, firms compete on the basis of product quality, service, and price, resulting in lower prices. Price fixing results in higher prices than would occur if competition existed. In one of the most famous price-fixing cases, during the 1950s executives from General Electric, Westinghouse, Allis-Chalmers and other leading electrical manufacturing firms met secretly to conspire to rig bids for major government CONTRACTs. They developed what was later known as the “phase of the moon” bidding system, taking turns being the low bidder for the government contract, but at a price that was extremely profitable to the winning firm. Brought to trial in 1961, seven executives were found guilty; given fines (which were paid by their companies); served short jail sentences, during which time they were paid their salaries; and, upon release, were given their old positions. In addition to covert agreements on fixed prices, market share, quota, and output limitations are sometimes used to support price fixing. While CARTELs are open agreements to restrict output in order to raise prices, firms sometimes agree to divide up markets—i.e., “I will not sell in your territory if you will not sell in mine”—or restrict SUPPLY to create an artificial shortage (something U.S. oil companies were accused of doing during the 1970s oil crises) as strategies to increase market prices. Price fixing and other collusive activities occur most frequently in oligopolies, markets where there are only a few competitors. In markets where there are many competitors, it is usually difficult or impossible to gain agreement. When there are only a few firms in a market, executives often know each other on a first-name basis, engaged in continual MARKET INTELLIGENCE to keep track of what their competitors are doing, and can readily benefit from agreements not to compete on a price basis. About 1900, U.S. Steel president Judge Gary hosted dinners at which steel prices would be agreed on. After price fixing became illegal, firms in oligopolistic markets developed new ways to reduce price competition. Price leadership is a system in which one firm announces a price change and the few other firms in the industry quickly follow by matching the change. Done openly in a press conference, price leadership is not a covert action, and many oligopolistic U.S. industries practice it.
See also OLIGOPOLY.