Question

One theory of oligopoly is the cartel theory.

1. State the key behavioral assumption of the cartel theory.

b. Describe the problems associated with forming and maintaining a cartel.

Answer 1

1. The key behavioral assumption of the cartel theory is that in a cartel many firms join together and make decision as if it is one single firm. This gives them an unfair advantage as many firms making the same product join together and decide to reduce their output leading to an increase in demand which in turn unnaturally drives the price up. The firms together as one makes output and price decisions for all the firms in that cartel. Well known examples of cartels are OPEC in the oil industry or the de Beers group in the diamond industry. OPEC is a cartel comprising of 14 different nations that has most of the oil resources in the world who manipulate oil prices in the world by controlling its supply. Saudi Arabia being the largest owner of oil reserves decided on the production quota which all the member countries adhere to. They make other decisions as well acting as a single firm like the 1973 oil embargo against countries supporting Israel .

2. The problems associated with forming and maintaining a cartel is that cartel members don’t always follow the cartel’s decisions regarding output level decisions. Sometimes a member firm might go back on their agreement and increase their output to get more profit. There is a possibility of higher profits for every cartel member if they decide to cheat and if many members decide to cheat the cartel won’t earn monopoly profits anymore. This is the main problem associated with cartels and is probably the reason why there are not a lot of cartels except for a few with member firms powerful enough to strongarm the rest of the firms into not cheating.