Definition: Cartel is a formal or informal agreement between a number of oligopolistic firms to exploit and share the market, usually by defining common prices of their goods.
What Does Cartel Mean?
What is the definition of cartel? In fact, cartels are a form of collaborative activity of firms in an oligopolistic industry with the aim of monopoly pricing, sharing of the market, imposing uniform sales, etc. Cartels are considered the worst form of a market because there are no economies of scale as in the case of a monopoly, and the policy protection of competition is weak. Also, the barriers to entryare high due to high costs. Other characteristics of a cartel include:
Homogenous products and costs: it is easier to establish a cartel when products are homogenous, and their cost does not differ substantially. For instance, a company with a low cost of production will set a relatively low price for a larger quantity of product, whereas a company with higher costs will set a higher price for a lower quantity of product.
Demand for the product: large and unpredictable fluctuations in demand make it more difficult to reach a cartel agreement.
The rivalry between firms: firms that seek to establish a cartel should not be intensely competitive.
Let’s look at an example.
Example
Company A and Company B are two identical firms in the industry. If the firms were price-takers (in the case of perfect competition), they would produce 3 units at a price of $6,000. By forming a cartel, both companies sell a total of 4 units at a price of $9,000 and realize monopoly profits. Company A sells 2 units, and Company B sells 2 units, and their total profit is $3,000.
Company A breaks the deal and produces 3 units instead of 2 units. In this case, the total that both companies produce is 5 units at a price of $7,500. Company A that broke the deal has a profit of $4,500, which is higher than the monopolistic profits of $3,000, whereas Company B realizes a loss of $1,000.
The most likely scenario is that Company B will also produce 3 units so that the two firms reach a new equilibrium in perfect competition.
Summary Definition
Define Cartels: Cartel means a number of companies collude to control the supply and price of a commodity in which they collectively own the majority of the market share within that market.
