How are cartels formed

The evidences show that cartels often were formed following a period of declining prices, but these price declines were not generally associated with macroeconomic fluctuations. They were the result of increasing competition and market integration. So commission have to be on vigil when there is declining trend in prices and severe competition in market, as these are the situation that form the basis for firms to get together as it is very difficult to get the evidence to prove cartel formation so commission has to be on vigil in advance. The potential profit associated with successful cartelization create a financial rationale for firms to devise means to overcome the short-term incentives to deviate from a cartel agreement; to frustrate entry by new firms; and to prevent detection by competition authority. Some cartels have turned even to govt. policies to achieve their ends; for example, international cartels may employ anti-dumping law, quotas, regulations, or govt. surveillance etc. They also employ a variety of private measures including vertical restraints, or use of a common sales agent, patent pooling, joint venture, and mergers. Here these are additional anticompetitive actions taken by cartels to create barriers to entry through mergers and joint ventures. Why Should Cartels Be Broken Up Cartels are particularly damaging form of anti-competitive activity. Their purpose is to increase prices by removing or reducing competition and allow the businesses to achieve greater profits for less effort to the detriments of consumers and the economy as a whole. As a result they directly affect the purchasers of the goods or services whether they are public or private businesses or individuals. Cartels also have a damaging effect on the wider economy as they remove the incentive for businesses to operate efficiently and to innovate. For the purchasers of their goods or services this means: • higher prices • poorer quality • less or no choice Detecting and taking enforcement action against the businesses involved in cartels is therefore one of commission’s main priorities. Economic theory has got two implications for cartels. Theory identifies the incentives to sell above agreed quotas, or below market prices, as a source of instability underlying all cartels. This has implication for how govt. might allocate scarce resources, if one identifies which firms are most likely to be able to overcome the incentive to cheat and direct resources there.

” while the lower level executives responsible for the day-to-day workings of the cartel were “the sherpas. used similar strategies of assigning customers to eliminate competition between cartel members. given firms’ incentive to compete and the increased competitive pressure of global markets? The answer depends on one’s view of the stability of cartels. there are two levels of organization: a high-level group of top executives and general managers.How do international cartels survive? Is such vigorous prosecution necessary. in light of the obstacles they face.” In the overwhelming majority of recent European prosecutions of international cartels. It is much more challenging where there . they developed an elaborate hierarchical structure. In order to implement their price-fixing conspiracy. so that dividing the market along geographic lines is not feasible. and cartels face three key challenges. each firm has an incentive to increase output beyond their allocation. Creating and maintaining a cartel is not a simple task. Negotiations are simpler in a stable industry. Five citric acid producers fixed prices from approximately July 1991 to June 1995. often with limited communication.Whether or not they rely on geographical divisions. The collective interests of all firms are achieved if they restrict output and raise price. the profits received by all firms in the industry are jointly maximized. however. The senior executives responsible for determining the broad framework of the cartel agreement were nicknamed “the masters. and in several cases there were quarterly meetings. in one of the carbon products cartels. perhaps obvious. By increasing price. and a working level group of sales managers. These conversations often occur at the very highest level of the firm. the vast majority of cartels allocate the largest customers to particular producers. however. there were biannual meetings of the upper echelon. large customer accounts were assigned to individual cartel members in order to avoid “the difficulty of implementing uniform prices for large customers throughout Europe. How do firms come to agreement about how to share the reductions in output necessary to increase prices above the competitive level? The first. Allocating customers allows cartel members to engage in price discrimination without undermining collusion.point is that firms—or at least the firms caught colluding—seem to need to talk to each other. The citric acid cartel exemplifies this pattern of development of hierarchical organization. For certain commodities. In these cases. The vitamin B2 cartel. understand one another’s technology. For example. such as geographic or political borders. Without enforceable contracts. The tension between the collective and individual interests of firms is represented succinctly in the game. But given the price set by the cartel. Producers form cartels with the goal of increasing profit by restricting supply and raising price.Coordination is an ongoing challenge over the life of any cartel. cartels must prevent cheating by cartel member firms. in principle to the price a monopolist would set. For many cartels. producers sell globally (or at least in a large number of countries). The first is coordination: firms must coordinate their actions. for example. was organized by using existing market shares to set future global sales quotas.”Other cartels. in order to choose a price and allocate an output target among member firms. undermining the cartel altogether. such as industrial copper tubes and methylglucamine. with competitors who know each other.The bargaining process often begins by focusing on preexisting market divisions. cartel members set global volume quotas. Second. each firm will do so. and have long-established relationships with particular customers.

For example. both those directly relating to collusion and other types of interactions. Trust may flow from preexisting cultural ties. This is captured in an exchange among members of the lysine cartel. There is remarkably little evidence that linguistic and cultural differences posed insurmountable problems for the EC cases discussed here. diamond miners learned to work cooperatively to address collective action problems such as the resolution of property rights.Cartels also renegotiate their agreements because members change their own behavior in response to the cartel agreement.but make no . interaction in other markets. Ajinomoto indicated that everybody now understood it is necessary to adjust supply. geographic proximity was not strongly related to collusive success. Cartels often begin with pricing agreements and then find that further negotiations are required to achieve the output reductions necessary to maintain the agreed upon price. by establishing the new market shares as a starting point for a new cartel bargain.This was not well received by the incumbent Japanese firms.there would be a price-cutting problem. exchange rate fluctuations can pose significant challenges to international cartels trying to agree on prices and prevent international arbitrage. Having agreed to raise prices in late 1991. when firms set price and quantity. in the lysine case discussed above. For example. They are constantly renegotiating their agreement. ADM alluded to the importance of a company controlling its sales force in order to maintain high prices. ADM entered the market with a new technology and then demanded a one-third share of the cartel’s global allocation. he finds that. These “bargaining price wars” are attempts to redistribute market shares across cartel members. For example.The price war provided a meaningful signal to ADM’s competitors by demonstrating ADM’s ability (and willingness) to produce and sell at low cost. but that low social status entrants more often faced a predatory behavior pricing response. One method of sending such a signal is to refuse to abide by the agreement. contrary to his priors. who were only convinced to cede ADM a large market share by its pursuit of a global price war.has been recent entry or technological change. facilitating a century of collusion in the diamond industry. This is in part because there are external shocks which require that they must the cartel adjust. During this meeting. Simply put. often precipitating a price war. in ways not always foreseen in prior cartel negotiations. and cultural similarities or differences. but it can also develop as a result of interactions among collusive firms.Firms’ expectations about their competitors’ propensity to cooperate can also have a significant impact on the ease of coming to agreement. Podolny and Scott Morton find that members of a shipping cartel were likely to accommodate entry by firms of similar social status. For example. unless the producers had very firm control of their sales people. Ajinomoto and ADM met [in 1993] to restore the relationship between the two companies and begin the process of developing a comprehensive volume agreement. Cartels do not come to an agreement once and for all. In such cases a cartel member may want to signal to other members of the cartel its dissatisfaction with its assigned output or market share allocation. and explained that its sales people have the general tendency to be very competitive and that. Interestingly for the study of international cartels. Firms’ expectations may be influenced by previous interaction.Similarly. Van Driel examines cartel formation and stability for four European transportation industries: he concludes that social background and other characteristics of “group development” that help to construct executives’ social identity influence the prevalence of collusion. trust facilitates collusion. For example.

the provision of credit. For example. extending beyond capacity investment to competition in quality. . the cement cartel included base-point pricing to avoid competition on transportation charges. This problem of “excess” competition in areas that are not explicitly agreed upon by the collusive parties is quite pervasive. Experienced cartels address costly non price competition by including additional such restrictions that limit the incentive to compete in a variety of dimensions. cartel members will sometimes increase their investment. leading to over-capacity.agreement regarding investment. and other nonprice dimensions. the absorption of transportation costs.

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