CARTEL - or - cooperative oligopoly

In any market, firms have an incentive to coordinate their production and pricing activities to increase their collective and individual profits by restricting market output and raising the market price. An association of firms that explicitly agrees to coordinate its activities is called a CARTEL. A cartel that includes all firms in an industry is in effect a monopoly, and the member firms share the monopoly profits. Cartels are more likely to occur when there are only a few firms : a cooperative oligopoly. Even without an explicit agreement, firms in a cooperative oligopoly may coordinate their actions to maximize joint profits.

Fortunately for consummers, although firms have an incentive to coordinate activities to restrict market output and raise prices, each member of the cartel has an incentive to "CHEAT" on the cartel agreement. That is, each firm wants to produce more output than is best for the cartel collectively. As a result, cartels tend to break apart without government intervention.

Factors that facilitate the formation of cartels

• The ability to raise the industry price
• A trade Association exists
• Low expectation of severe punishment (antitrust laws)
• Low organizational costs
• Only a few firms are involved in the cartel
• The industry is highly concentrated
• Homogeneous good is produced
• Divide the market
• Fix market shares

Factors that reduce the existence of cartels

• Price wars
• Cheating
• Economic recession
• High economic volatility
• New entrants

But do not forget !

CONSUMMERS GAIN AS CARTELS FAIL !

Example

A cartel with two firms. The market share of each firm is 50 %.

The market demand function is : q = f(p) = - 200p + 2200

• Price function : p = f(q) = 11 - 0,005q

Revenue function : R = pq = 11q - 0,005q²

• Marginal Revenue function : MR = 11 - 0,01q

Total cost function of each firm : TC = 0.001q² + 5q + 500

Tool to find "Total cost function" : Excel "Tools / Data analysis / Regression"

• Marginal Cost function : MC = 0,002q + 5

Results

	Firm 1 (50 %)	Firm 2 (50 %)	Cartel	Monopoly
Demand function	-100p+1100	-100p+1100		-200p + 2200
Price function	11 - 0,01q	11 - 0,01q		11 - 0,005q
Revenu function	11q - 0,01q2	11q - 0,01q2		11q - 0,005q2
MR	11 - 0,02q	11 - 0,02q		11 - 0,01q
TC function	0.001q2 + 5q + 500	0.001q2 + 5q + 500		0.001q2+5q+500
MC	0,002q + 5	0,002q + 5		0,002q + 5
If MR=MC, q =	272.7	272.7	545,4	500
MR	5.546	5.546	5.546	6.00
MC	5.546	5.546	5.546	6.00
Market price	8.27	8.27	8.27	8.50
Revenue	2256.20	2256.20	4512.40	4250.00
Total cost	1938.02	1938.02	3876.04	3250.00
Maximum Profit	318.18	318.18	636.36	1000.00

Comparison beetwen cartel and monopoly

	Monopoly	Cartel	Gain for consummers
Output	500	545,4	+ 45,4
Price	8,50	8,27	- 0,23

 

Sources :

Modern Industrial Organization, 2nd edition, Dennis .W. Carlton , Jeffrey .M. Peroloff, Addfison-Wesley, 1994

Economie Industrielle ( traduction de la 2ème édition par Fabrice Mazerolle), Dennis .W. Carlton , Jeffrey .M. Peroloff, de Boeck Université, 1998

Cours de Microéconomie, Bernard Jaquier, Ecole Hôtelière de Lausanne, 2003

Page publisher : Bernard Jaquier, Professor in Economics and Finance, Ecole Hôtelière de Lausanne, Switzerland, 2003