Explain the impact of collusion on market outcomes in oligopoly.

Collusion in an oligopoly refers to an agreement or understanding among a few dominant firms in a market to coordinate their actions and behave as a single entity. The impact of collusion on market outcomes in oligopoly can be summarized as follows:

1. Price and output determination: Collusion often leads to firms collectively setting higher prices and reducing output levels compared to what would prevail under competitive conditions. By limiting competition, colluding firms can maintain higher prices and increase their profits.

2. Market power: Collusion enhances the market power of the participating firms. By acting together, they can effectively control the market and restrict entry of new competitors. This reduces competition and allows colluding firms to enjoy higher profits in the long run.

3. Reduced consumer welfare: Collusion typically results in higher prices for consumers, as the colluding firms can charge prices above the competitive level. This reduces consumer surplus and overall welfare in the market.

4. Inefficiency: Collusion often leads to allocative inefficiency, as resources are not allocated to their most productive uses. The higher prices and reduced output resulting from collusion can lead to a misallocation of resources, reducing overall economic efficiency.

5. Potential for breakdown: Collusion agreements are often unstable and prone to breakdown due to various factors such as cheating, changes in market conditions, or the entry of new competitors. When collusion breaks down, it can lead to intense price competition and instability in the market.

Overall, collusion in oligopoly can have negative effects on market outcomes, leading to higher prices, reduced consumer welfare, inefficiency, and potential instability.