A Cartel Is a Collusive Agreement among

Game theory suggests that cartels are inherently unstable because the behavior of cartel members is a prisoner`s dilemma. Each member of the cartel would be able to make a higher profit, at least in the short term, if it broke the agreement (produced a larger quantity or sold it at a lower price) than if it joined it. However, if the cartel collapses because of the defectors, the companies would return to competition, profits would fall and everything would be worse. A collusive agreement or cartel leads to a circular flow of incentives and behaviors. When companies in the same sector act independently, they are each encouraged to collude or collaborate to make higher profits. If firms can jointly determine monopoly production, they can share the profit level of the monopoly. When companies act together, there is a strong incentive to cheat on the deal in order to get higher individual profits at the expense of other members. The business world is competitive and, therefore, oligopolistic companies will strive to maintain collusive agreements as much as possible. These types of strategic decisions can be understood significantly with game theory, the subject of the next two chapters. Assessment of the role of competition and collusion in the formation of cartels Oligopolistic undertakings enter into a cartel in order to increase their market power and members work together to jointly determine the level of production of each member and/or the price that each member will charge. By cooperating, cartel members can behave like a monopolist.

For example, if every company in an oligopoly sells an undifferentiated product like oil, the demand curve that each company faces is horizontal relative to the market price. However, if oil-producing companies form a cartel like OPEC to determine their production and price, they will face together a downward market demand curve, just like a monopolist. In fact, the cartel`s decision to maximize profits is the same as that of a monopolist, as shown in the figure. The cartel members choose their combined production at the level at which their combined marginal incomes correspond to their combined marginal costs. The cartel price is determined by the market demand curve at the level of production chosen by the cartel. The benefits of the cartel correspond to the surface of the rectangular box, which is labeled abcd in the figure. Note that a cartel, like a monopolist, chooses to produce less production and charge a higher price than would be the case in a completely competitive market. Several factors deter collusion. First, pricing is illegal in the United States, and antitrust laws are in place to prevent collusion between companies.

Secondly, coordination between undertakings is difficult and becomes all the more difficult the greater the number of undertakings concerned. Third, there is a threat of overflow. A company can agree to agree and then break the agreement, thus undermining the profits of the companies that still keep the agreement. Finally, a company can be deterred from collusion if it is not able to effectively punish companies that might break the agreement. A cartel is an agreement between competing companies in order to make higher profits. Cartels usually occur in an oligopolistic industry where the number of sellers is small and the products traded are homogeneous. The cartel members can agree on these issues: price agreements, total industry production, market share, customer division, territories division, tender agreements, creation of joint sales agencies and distribution of profits. Perhaps the best-known and most effective cartel in the world is OPEC, the Organization of the Petroleum Exporting Countries. In 1973, OPEC members reduced their oil production. As middle Eastern crude oil was known to have few substitutes, OPEC members` profits soared. From 1973 to 1979, the price of oil rose by $70 a barrel, an unprecedented figure at the time. In the mid-1980s, however, OPEC began to weaken.

The discovery of new oil fields in Alaska and Canada has led to new alternatives to Middle Eastern oil, leading to lower OPEC prices and profits. Around the same time, OPEC members also began cheating to increase individual profits. A cartel is a group of companies that have made an explicit agreement to reduce production in order to increase the price. For example, game theory may explain why oligopolies struggle to maintain collusive agreements to make monopolistic profits. While companies collectively would do better to cooperate, each sole proprietorship has a strong incentive to cheat and underlist its competitors to increase its market share. Because the incentive to defect is strong, companies can`t even make a collusive deal if they don`t think there`s a way to effectively punish defectors. Once established, cartels are difficult to maintain. The problem is that cartel members will be tempted to cheat on their production limitation agreement.

By producing more production than it promised, a cartel member can increase its share of the cartel`s profits. Therefore, there is a built-in incentive for each cartel member to cheat. Of course, if all members cheated, the agreement would stop making monopoly profits and companies would no longer be encouraged to stay in the agreement. The problem of fraud has plagued both the OPEC cartel and other cartels, which may explain why there are so few cartels. The best-known example is the Medellin Cartel, led by Pablo Escobar in the 1980s until his death in 1993. The cartel traded large quantities of cocaine in the United States and was known for its violent methods. In non-collusive agreements, companies would try to improve their production or product in order to gain a competitive advantage. In a cartel, these companies have no incentive to do so. How did this soap opera end? Following an investigation, French antitrust authorities fined Colgate-Palmolive, Henkel and Proctor & Gamble a total of 361 million euros ($484 million).

A similar fate befell the ice cream makers. Ice packs are a commodity, a perfect replacement, usually sold in 7 or 22 pound bags. No one cares about the label on the bag. By agreeing to divide the ice cream market, control large geographical areas and set prices, ice cream manufacturers have moved from perfect competition to a monopoly model. According to the agreements, each company was the sole supplier of bag ice cream for a region; there have been long-term and short-term profits. According to the court, "these companies illegally conspired to manipulate the market." The fines totaled about $600,000 – a hefty fine given that an ice pack is sold for less than $3 in most parts of the United States. Collusion occurs when oligopolistic companies make joint decisions and act as if they were one company. Collusion requires an explicit or implicit agreement between the cooperating companies to restrict production and reach the monopoly price. This leads companies to be interdependent, as each company`s profit levels depend on the company`s own decisions and the decisions of all other companies in the industry. This strategic interdependence is the basis of game theory.

Cartel = An explicit agreement between members to reduce production in order to increase the price. Watch this video to get an explanation of the collusion and learn more about why cartels often collapse. Cartels have an adverse effect on the consumer, since their activity aims to increase the price of a product or service above the market price. However, their behavior also has a detrimental effect in other respects. Cartels deter new entrants and act as a barrier to entry. The lack of competition due to price fixing leads to a lack of innovation. Prisoner tarnishing is very common in oligopolistic markets: gas stations, grocery stores, garbage companies are often in this situation. If all the oligopolists in a market could agree to raise the price, they could all make higher profits.

Collusion or the result of cooperation could lead to monopoly gains. In the United States, explicit collusion is illegal. .