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boons and banes of cartelization

boons and banes of cartelization

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Published by: khan adeel khan on Aug 09, 2009
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11/24/2012

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BOONS &BANES OF CARTELS:Cartels:People of the same trade seldom meet together, even for merriment and diversion,but the conversation ends in a conspiracy against the public, or in somecontrivance to raise prices. It is impossible indeed to prevent such meetings, byany law which either could be executed, or would be consistent with liberty andjustice. But though the law cannot hinder people of the same trade from sometimesassembling together, it ought to do nothing to facilitate such assemblies; muchless to render them necessary.—Adam SmithA cartel is a formal (explicit) agreement among firms. It is a formal organizationof producers that agree to coordinate prices and production. Cartels usually occurin an oligopolistic industry, where there are a small number of sellers andusually involve homogeneous products. Cartel members may agree on such matters asprice fixing, total industry output, market shares, allocation of customers,allocation of territories, bid rigging, establishment of common sales agencies,and the division of profits or combination of these. The aim of such collusion isto increase individual members' profits by reducing competition. Competition lawsforbid cartels. Identifying and breaking up cartels is an important part of thecompetition policy in most countries, although proving the existence of a cartelis rarely easy, as firms are usually not so careless as to put agreements tocollude on paperORBy Cartel we mean a combination of several firms into a group sharing anidentical interest. When a large number of firms or industries join hands theyenjoy extra power. They can exert considerable influence on the market conditions.They can charge exorbitantly high prices and exploit consumers. For this reason,cartels are normally banned in various nations. In some implicit or explicit formscartels do exist in different parts of the world. Generally cartel organizationstake undue advantages of the loopholes in the legal provisions. Cartels aretheoretically akin to monopolies but in practice are far more menacing anddamaging in effect.The best and most notorious example of cartels in the recent past is that of OPEC- Oil Producing and Exporting Countries.Advantages of Cartels:1.The basic advantage and the foremost reason for the formation of cartels isthe increased profit level. When the firms join together they act as a monopolythus they fix price and quota. This leads to the end of non price competition inform of excessive advertising thus they are able to reduce marketing cost.Cartelization puts an end to all the price wars between members thus they need notto undergo excessive price cutting thus leading to increased profit level. Whencartels are formed all members charge a price that is equivalent to the monopolistprice and provide quantity equivalent to monopolist quantity after that allmembers are provided with fix quotas.When they acted as rivals firm they charged price P1 and produced quantity q1 butas they formed a cartel they were able to charge p and sell q resulting in beingbetter off.2.When firms form a cartel their bargaining power increases they are able tofulfill their demands effectively for example in 1973 & 1978 OPEC lead to theprice hike of petroleum there was a increase of more than 500% prices rose from $6per/barrel to $32 this lead to increase in cost of production and a recessionaryphase over the world. However since all firms exporting oil was in mutualconsensus thus they had a lot of bargaining power and no super power was able toaffect them.3.Cartels are beneficial for the host countries for they are able to increaseGDP, achieve positive B.O.P and high employment. Rapid global economic integration
 
has created invaluable opportunities for developing countries to grow, throughgaining foreign technology, participating in global market competition by openingthe countries’ borders to foreign goods and services. The growth of trade in goodsand services, however, has also made developing countries more vulnerable toforeign sources of anti-competitive behavior.Some Basic Advantages of Cartels are:4. The member units in the cartel do not lose their identity.5. It is more stable than pool.6. The members can reduce the cost of production with efficient organizationstructure.7. The members can earn monopoly profits if the market bears it.8. The firms have not to incur expenditure on publicity.9. It is economical to market the commodities as a single seller.10. The cartel is better market condition as compared to the competing firms whichoften resort to undercutting.11. The inefficient firms are able to keep its head above water in cartel as theyhave not to face any competition.Disadvantages of Cartels:1.Cartels are not a very successful form of operations for there is always anincentive to cheat charge a bit lower price, sell higher output and increaseprofits. For example The Organization of Petroleum Exporting Countries (OPEC)includes major oil producers Saudi Arabia, Iran, Kuwait, and Venezuela. Like anyother cartel, OPEC suffers from the problem that individual members prefer toexceed their quotas. From a short-term perspective, no matter what others do, eachmember’s best strategy is to cheat.In November 1994, OPEC members met to decide production quotas for the followingyear. Iran’s oil minister Gholamreza Aqazadeh remarked, “it will be very good forthe market . . . I hope everybody will agree to the quota without violations”.Twelve months later, it was estimated that Venezuela had exceeded its 2.359million barrel per day (bpd) quota by 300,000 bpd.Besides cheaters within the cartel, OPEC had also to contend with high output fromnon-member countries. In June 1998, OPEC agreed that its members would reduceproduction by 2.6 million bpd, and non-members Mexico, Norway, Oman, and Russia by500,000 bpd. Saudi oil minister Ali Ibrahim Naimi was cautiously optimistic: “Idon’t think that anybody expects 100% compliance. . . . Is three million bpd goingto be pulled out of the market? Probably not. But is 2.5 million? That is stillgood.”Predictions of the impending demise of the OPEC cartel or its continued importanceabound. As late as 2001, OPEC was referred to as a “historically doomedorganization” but the subsequent rise in oil prices to record levels has led manyto question this prediction. Oil production data indicate that OPEC production(April 2006) was 27.94 mbd, almost equal the total OPEC quota target of 28 mbd,although 6 of the 10 OPEC members (excluding Iraq) were exceeding their individualquotas. A recent assessment of the future of OPEC states that “Large price swingsreveal errors in forecasting and execution, not a lack of power to move theprice.”2.Cartels like monopoly do lead to dead weight loss for they charge P and sellq but they should have charged P1 and sold Q1 this leads to decrease in consumersurplus and resources being kept ideal. Allocative efficiency is achieved when thevalue consumers place on a good or service (reflected in the price they are
 
willing to pay) equals the cost of the resources used up in production. Conditionrequired is p=mc but since cartels do not meet this condition they are surelyinefficient. Productive efficiency refers to a firm's costs of production and canbe applied both to the short and long run. It is achieved when the output isproduced at minimum average total cost (AC). For example we might consider whethera business is producing close to the low point of its long run average total costcurve. When this happens the firm is exploiting most of the available economies ofscale. Productive efficiency exists when producers minimize the wastage ofresources in their production processes. Thus they don’t even match this categorythey are even productively inefficient.3.Cartels are not even of a great help to their own economies for exampleOPEC’s stated mission is to promote the economic development and growth of itsmember states while minimizing volatility in the oil markets. But after apromising beginning many member states’ economies have declined rather thanprospered—a clear indication of OPEC’s failure to meet their development goals.Thus, we ask if a resource cartel can achieve the joint goals of development andresource marketstability. In a model in which oil producing countries choose whether to join anoil cartel or remain in the fringe, we find that, in a highly elastic oil market,a profit maximizing cartel is inconsistent with oil market stability in the faceof demand shocks.Thus, it is inimical to macroeconomic stability, an essential requirement forlong-lasting capital investment, and therefore economic development and growth.Consequently, itmay not be optimal for an oil-exporting country that cares adequately aboutmacroeconomic stability to join the cartel. But for a country where short-runconsiderations overwhelm long-run concerns, cartel membership may be the correctchoice. Yet the oil rich are ultimately cursed by their excessive reliance ontheir resource wealth—current profligacy begets future decline.4.Cartels lose on their unity very easily for exampleOPEC net oil export revenues for 1971 - 2007.After 1980, oil prices began a six-year decline that culminated with a 46 percentprice drop in 1986. This was due to reduced demand and over-production thatproduced a glut on the world market. This caused OPEC to lose its unity. OPEC netoil export revenues fell in the 1980s.5.Cartel as a power can lead to various crisis for others such as OPEC did in1973-1978 it was an advantage for them but a disadvantage for masses as it lead toinflation that has not been under control till now.6.Any problem between the members of cartels effect the entire cartel badly andevery involved firm has to suffer for example the division of OPEC countriesoccasioned by the Iraq-Iran War and the Iraqi invasion of Kuwait marked a lowpoint in the cohesion of OPEC. Once supply disruption fears that accompanied theseconflicts dissipated, oil prices began to slide dramatically.After oil prices slumped at around $15 a barrel in the late 1990s, concerteddiplomacy, sometimes attributed to Venezuela’s president Hugo Chávez, achieved acoordinated scaling back of oil production beginning in 1998. In 2000, Chávez

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