Cartel Definition
Purpose
How does it Work?It starts with a company that operates in an oligopoly marketThe aviation, media, pharmaceutical, and telecommunications industries are all examples of oligopoly.read more. An OligopolyAn oligopoly in economics refers to a market structure comprising multiple big companies that dominate a particular sector through restrictive trade practices, such as collusion and market sharing. Oligopolists seek to maximize market profits while minimizing market competition through non-price competition and product differentiation. read more market is an extended form of monopoly wherein only a few sets of companies are standardized (like the telecom sector). The competitors in the oligopolistic market can downturn the entire market up to the cost of production, thereby fading the profits of other competitors. This event provides other competitors to unite and become market leaders for the said product. Thus, few such companies consolidate to come together. Another way for consolidation is to form an undisclosed cartel to lead the industry’s prices. The members may never agree to a price reduction in their selfish interests. Instead, members usually agree to restrict the supply to maintain high prices. However, some members may cheat and supply more to fetch more margins at higher prevailing prices. The competitors who are not part of the cartel may distort the market by significantly reducing the costs for said goods. In such a case, customers may approach the new competitor. Cartel ExamplesExample #1We can consider the example of legalized cartels famous over the globe, such as the Organisation of Petroleum Exporting Countries(OPEC). Fourteen oil-producing countries formed OPEC cartels worldwide, whose objective is to stabilize the oil market in the countries. They aim to sell oil at reasonable prices to consuming countries. Example #2The European Commission has imposed a whopping fine of 750 million Euros on 11-group of companies who participated in illegal cartels for gas-insulated switchgear projects. The group created public utility companies and consumers. The commission collected evidence through easily available documentation. For manipulating the tenders, the member units prepared sham bids. However, Swiss-based ABB did not attract the fine since it was the whistleblower and has supported the commission in providing sufficient evidence to unfold the cartel. Types of Cartels You are free to use this image on your website, templates, etc.,
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How do Cartels Cause Inefficiencies in the Market?One may form cartels to fix the prices, quantum, or terms of trade, allocate the trade zones, or achieve economies of scale. However, the extra revenue earned by the member is not due to additional efforts of producers or extra production supplies. Rather such agreements make the producers inefficient in the long run. From the consumer’s perspective, they are concerned with only the prices for a specific product. Therefore, the formation of cartels affects their balanced disposable income. Since the supplies are restricted through agreement, the production capacities of large-scale producers are underutilized to the said extent. The large-scale producers may have produced more and abandoned excess production in the foreign market. However, super cartels restrict such extra export of goods in the short term. Thus, slowly and steadily, economies of scaleEconomies of scale are the cost advantage a business achieves due to large-scale production and higher efficiency. read more get reduced, which becomes one of the causes of rising inflationThe rise in prices of goods and services is referred to as inflation. One of the measures of inflation is the consumer price index (CPI). Rate of inflation = (CPIx+1–CPIx )/CPIx. Where CPIx is the consumer price index of the initial year, CPIx+1 is the consumer price index of the following year.read more. Effects
When is it Powerful?That is usually powerful when the country’s sovereignty is at stake. In such a situation, cartels are not questioned about the prices they charge or the production supplies. They are also powerful when one of the cartel members has complete control over the market and is dominant. Even high entry barriers are another reason for powerful cartels. The reason is that fewer competitors drive the market prices, and it is not under the control of the demand-supply ratio. Advantages
Disadvantages
Recommended ArticlesThis article has been a Guide to What is Cartel and its Definition. Here, we discuss its purpose, examples, types, how it works, advantages and disadvantages. You can learn more about it from the following articles: –
Why is it difficult to form a cartel?Once established, cartels are difficult to maintain. The problem is that cartel members will be tempted to cheat on their agreement to limit production. By producing more output than it has agreed to produce, a cartel member can increase its share of the cartel's profits.
What two conditions must be present for a cartel to work?The cartel theory states that there are seven characteristics that must exist in a group of producers in order to be labeled a cartel: A cartel must assign quotas to its members, monitor members to avoid violations, punish violators, target a minimum price, take action to defend the price, have a large market share, ...
What factors determine the cartel formation?Factors Conductive for Cartel Formation:
Single product in heavy demand cycle. Geographical proximity of producers. Disparity in production and market share of the producers.
What conditions are favorable to the formation and maintenance of a cartel?A competitive environment forces the firms to lower their prices and earn normal profits, so in order to to earn more profits, firms may decide to try and form a cartel. Interdependency among firms: Firms colluding to form a cartel are interdependent.
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