Cartels (Cambridge (CIE) A Level Economics): Revision Note

Conditions for cartels

• A cartel is formed when firms engage in collusive behaviour, cooperating to fix prices and restrict output

  • They cease to compete as vigorously as they can

  • The incentive to collude in these markets is high

A collusive oligopoly

Diagram analysis

•  Five firms meet secretly and agree to fix prices at a particular level

  • The five firms present in the market as a single firm

• The firm produces at the profit maximisation level of output, where MC = MR (Q₁)

  • At this level, AR (P₁) > AC (C₁)

  • The cartel is making higher levels of supernormal profit

• A cartel is the most restrictive form of collusion and is illegal in most countries

  • The consequences of overt collusion include:

    • Higher prices for consumers

    • Less output in the market

    • Poor quality products and/or customer service

    • Less investment in innovation

• Overt collusion often happens in the following ways:

  • Price fixing

  • Setting output quotas, which limit supply and naturally result in price increases

  • Agreements to block new firms from entering the industry

Conditions for an effective cartel

• Small number of firms in the market

  • Fewer firms makes monitoring and enforcing agreements easier

  • Large numbers of firms increase the incentive to cheat

• High barriers to entry

  • New firms find it difficult to enter the market, reducing the threat of competition and helping existing cartel members maintain control

• Price stability among members

  • Members must resist the temptation to undercut each other. A price war—where one firm lowers prices to gain market share—can quickly unravel the cartel

• Similar cost structures

  • If all members have similar production costs, they benefit equally from the agreed price. Large cost differences can lead to dissatisfaction and defection

• Presence of a dominant firm

  • A strong leader within the cartel can enforce discipline, coordinate actions, and deter cheating among members

• Legal environment that tolerates cartels

  • In regions like the EU and USA, cartels are illegal because they restrict competition and harm consumers. Legal enforcement can dismantle cartels quickly