Cartels and Collusion

How Cartels Raise Price

1. Members agree a single price and share the market using output quotas.
2. Restricting total output raises the market price, just as a monopoly would.
3. When demand is price-inelastic, the higher price raises total revenue and joint profit.
4. Each member can gain by secretly selling more than its quota at a slightly lower price.
   1. If enough members cheat, total output rises and the agreed price collapses.
5. This is a Prisoner's Dilemma: each member is better off cheating whatever the others choose, so cheating is the dominant strategy and the cartel is inherently unstable unless it can detect and punish rule-breakers.

Conditions for an Effective Cartel

1. A small number of firms, so an agreement is easy to reach and monitor.
2. Agreed output quotas or market shares that members keep to.
3. The ability to detect and punish members who cheat by undercutting.
4. High barriers to entry, so new firms cannot undercut the agreed price.
5. Price-inelastic demand, so a higher price raises total revenue.
6. Similar costs among members and stable market conditions.
7. A similar or homogeneous product, so members can agree on a single price without quality differences complicating the deal.

Consequences of a Cartel

1. Price is higher and output lower than under competition, as with a monopoly.
2. Consumers lose surplus and the market is allocatively inefficient, creating a deadweight welfare loss.
3. Member firms earn higher profits at the expense of consumers.
4. Choice narrows and the incentive to innovate weakens.
5. Members may argue the agreement brings price stability and secure supply.

Are cartels always against the public interest?

1. Cartels usually work against the public interest, because by restricting output they raise price above marginal cost like a monopoly, transferring surplus from consumers to producers and creating a deadweight welfare loss.
2. But not always: in some markets a cartel can deliver price stability that shields producers and consumers from damaging price swings, and pooled revenues may fund investment or safety standards a cut-throat market would neglect.
3. Cartels are also often self-defeating, because each member's incentive to exceed its quota tends to break the agreement, so without enforcement the harm may be short-lived.
4. On balance, cartels are usually against the public interest because the welfare loss outweighs any stability gain, but it depends on the market, since where price volatility is severe or the agreement is unstable the net harm is smaller, which is why authorities weigh each case rather than assuming automatic damage.