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Understanding Cartel: Formation, Functioning and Regulation

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Sin Kiat Chai

on 4 March 2013

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Transcript of Understanding Cartel: Formation, Functioning and Regulation

Formation What is CARTEL? •A group of firms gets together to make output and price decisions.
•Usually oligopolistic industry (small number of sellers, homogenous product)
Aim: increase individual’s profit & market power by reducing competitors Functioning •Cartel act as a monopolist.
•They produce less output and charge a higher price.
•Their profit maximization is similar as monopolist.
•They combine their output where MR=MC
•The profits equal to the rectangular box, abcd. Example of an international cartel :- Organization of petroleum-exporting countries (OPEC)
How does OPEC work?
•They meet at least twice a year to decide how much oil each member of the cartel will be allowed to produced and price set (balance the demand and supply).
•Set production quotas for each member country
•Lack of a mechanism to control member quotas Regulation •Cartel focus on law origination costs by join with few firms or with a few big companies

•It should maintain low expectation for severe government punishment
•Barriers to entry also can be reason of success of cartel
•Cartel need to control market
•.It is also act as national association
•Consist of many small buyers Advantages:
•cartels are a very good way to optimize and earn additional money
•they protect the weaker participating firms
•do away to an extent with limitations on trade resulting from high tariff
•distribute risks and profits equitably
•stabilize markets
•reduce costs Saudi Arabia has enough spare capacity at times to be able to increase production sufficiently to offset the impact of lower
prices on its own revenue Saudi Arabia could enforce discipline by threatening to increase production enough to crash prices. Disadvantages:
•Hard to maintain once establish.
•Some firms may cheat on the agreement to limit production (output increase, profits increase).
•Drive the competing firms out of existence
•Decrease volume of trade
•Raised prices to consumers
•Protected inefficient members from competition
•Increase inflation level and decrease purchasing power
•They are generally unstable Summary Sources: •Cliffsnotes (2013) Economics: Cartel Theory of Oligopoly. [ONLINE] Available at: http://www.cliffsnotes.com/study_guide/Cartel-Theory-of-Oligopoly.topicArticleId-9789,articleId-9779.html. [Accessed 27 February 2013].
•Fatimz (2011) Cartels. [ONLINE] Available at: http://www.scribd.com/doc/62559500/Cartels. [Accessed 27 February 2013].
•Kohen.M (2013) How Does OPEC Work? [ONLINE] Available at: http://structure.harvard.edu/courses/eps109/student_presentations/Kohen_OPEC.pdf. [Accessed 28 February 2013]. The profit need to be more then establishing and enforcing cost of cartel Cartel need to be well maintained so that cheating can detected and also prevented Cartels have both advantages & disadvantages. Cartels are a classical example of game theory that describes the prisoner’s dilemma. Long term stability of a cartel
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