In the context of externalities, how can collusion among firms be harmful to consumers?

• A. Collusion increases market competition, which benefits consumers through lower prices.
• B. Collusion encourages firms to invest more in product quality, directly benefiting consumers.
• C. Collusion can lead to higher prices and reduced output, resulting in a loss of consumer surplus.
• D. Collusion eliminates all negative externalities in the market, improving overall welfare for consumers.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the concept of collusion. Collusion occurs when firms in a market agree to cooperate rather than compete, often by setting higher prices or limiting output to increase their joint profits.
2. Step 2: Recognize the effect of collusion on market competition. When firms collude, competition decreases because firms act as a single entity rather than competing against each other.
3. Step 3: Analyze the impact on prices and output. Reduced competition typically leads to higher prices and lower quantities of goods or services supplied compared to a competitive market.
4. Step 4: Connect these changes to consumer surplus. Higher prices and reduced output mean consumers pay more and have less access to the product, which reduces consumer surplus—the difference between what consumers are willing to pay and what they actually pay.
5. Step 5: Conclude why collusion is harmful to consumers in the context of externalities. Although externalities involve costs or benefits not reflected in market prices, collusion worsens consumer welfare by raising prices and limiting output, leading to a loss of consumer surplus.