Question

OPEC is an example of a cartel. Explain and depict in detail, how the price and quantities are determined in the cartel market for cartel members and other companies! Denote clearly all curves, prices and quantities!

Answer 1

A cartel is a group of producers who work together to protect their interests. The formation of cartel is due to the same conditions which give rise to oligopolistic market. Cartels are formed in a market where there are few producers & each producer has a significant share of the market. The organization of petroleum-exporting countries also known as OPEC is a best example of a cartel. By working together OPEC members are able to behave like a monopolist. They can fix prices for petroleum products to avoid competition among its members. They also restrict output by setting oil production quotas & limits.

OPEC members raise price together which reduces elasticity of demand for any single member. They also restrict output to create demand for the output. Since OPEC members determine their output & prices they will face a downward sloping market demand curve. They also try to maximize their profit same like a monopolist. The OPEC members choose their total output at the level where their combined marginal revenue equals their combined marginal cost. So in a cartel members will choose to produce less output and charge a higher price than would be found in a perfectly competitive market.

Though in long run cartels are difficult to survive. Because cartel members tend to cheat on their agreements to increase their share of market or profits. Since there is a built in incentive for each member to cheat, now a days OPEC is not able to earn monopoly profits.