Oligopoly

Cartel

Cartel
Oligopoly is conducive to collusion
If a few firms face identical or highly similar
demand and costs...
They will seek joint profit maximization...

Incentives for Collusion

Decrease competition, achieve monopoly-like

behavior
Decrease uncertainty
Decrease ease of entry

Perfect Cartel
If the Cartel Maintains the Monopoly Price, in
a perfect cartel the profits made by individual
firms will not be retained by them,

profi
t

MCa AC
a

MCb

ACb

MC
D
MR

Qa

Qb

Perfect Cartel
instead they will be brought under a common
pool. These profits will be divided by the
member firms according to the terms of
agreement reached between them at the time
of forming the cartel.
The allocation of output quota to each of
them is made on the grounds of minimizing
cost and not as a base for determining profit
distribution.

Market Sharing Cartel

In a loose type of cartel the market-sharing

by the firms occurs.
There are two methods of market sharing.
Market sharing by non-price competition.
Only a uniform price is set and member firms
are free to produce and sell the amount of
outputs which will maximize the individual
profits. If the different member firms have
identical costs, the agreed uniform price will
be the monopoly price.

Market Sharing Cartel

But when there are cost differences the price

will be fixed by bargaining. The price will be
such as ensure some profits to high-cost
firms.
But with cost differences such loose cartels
are quite unstable. Because the low cost firms
will have an incentive to cut price to increase
their profits.

Market Sharing Cartel

Market sharing by quota. Member firms agree

on quota of output to be sold. In case of
homogeneous output and identical cost, the
monopoly solution will emerge with the market being
equally shared by them.
Two Criteria are usually adopted to fix the quotas of
firms, past level of sales and productive capacity
The second common base for the quota system is
the geographical division (region wise) of market.

Incentive to Cheat
Firms would be better off cooperating and
jointly maximizing their profits However, each
firm has an incentive to cheat by lowering
price because the demand curve facing each
firm is more elastic than the market demand
curve.
This conflict makes collusive agreements
difficult to maintain.

Gaining from Cheating

Using industry demand Di and marginal revenue MRi,
oligopolists maximize their joint profit where MRi = MC
at output Qi and price Pi .
Demand facing each firm df (where no other firms cheat)
would be much more elastic than industry demand Di .
The firm maximizes its profit where MRf = MC by
expanding output to qf and lowering its price to Pf from Pi

Industry

Pi

Firm

Pi

Pf
MC
MRi Di

Qi

MRf
qf

MC
df

Gaining from Cheating

Using industry demand Di and marginal revenue MRi,
oligopolists maximize their joint profit where MRi = MC
at output Qi and price Pi .
Demand facing each firm df (where no other firms cheat)
would be much
more elastic than
industry
demand Di .
Individual
firms
have
The firm maximizes its profit where MRf = MC by
antointensive
cheat
expanding output
qf and loweringto
its price
to Pf from Pi

by cutting price to
Firm
Industry
expand
out
put
P

Pi

Pf
MC
MRi Di

Qi

MRf
qf

MC
df

Duopoly Model

determine the profit maximizing output for

the industry.
assign a production quota to each firm.

Duopoly Model

One firm cheats on the agreement and

increases production to 3,000 units a week.
With 5,000 units supplied, the price falls to
$7,500 a unit.

Duopoly Model

Despite the fall in price, the cheat makes a

bigger profit, because its average total cost falls.
The cheats profit becomes $4.5 million a week.

Duopoly Model

Here, both firms cheat and increase

production to 3,000 units a week.
With 6,000 units on offer for sale, the price
falls to $6,000 a unit (zero economic profit).

Instability of Cartel
since each firm has incentive to cheat, cartels
often fall apart
cheating problem is exacerbated by the fact that
competition can occur on many margins
competition from new firms
if cartel firms are making economic profits, incentive for
new firms to enter the market
if let new firms into cartel, profit for each member
diminishes
if exclude new entrants, they will cut price and take
business away from cartel

Instability of Cartel
to be successful, a cartel must
get agreement on production levels
prevent cheating by cartel members
restrict entry of new competitors

Instability of Cartel
factors increasing probability of successful collusion
few sellers
easier to reach agreement
easier to monitor production and prevent cheating
stable demand
easier to determine if cheating is occurring by looking at
changes in own sales
similar costs
if have different costs, more difficult to reach agreement
on price and output
for a given P and Q, if have different costs get different
levels of profit

Instability of Cartel

factors increasing probability of successful collusion

homogeneous product
fewer variables to agree on
limits margins on which to compete
sealed-bid auctions
bidding to specifications makes product homogeneous
easy to detect cheaters since all bids are revealed
no antitrust enforcement

Instability of Cartel
factors increasing probability of successful collusion
government regulations help enforce cartel
government established cartels
example: government permitted six New England
states to form a milk cartel (Northeast Interstate Dairy
Compact -- NIDC). In 1999 legislation allowed dairy
farmers in Northeastern states surrounding NIDC to
join NIDC, 7 in 16 Southern states to form a new
regional cartel. Soy milk became more popular.
entry restrictions
licensing
enforce minimum prices
price regulation

American Antitrust Law

The Sherman Act, 1890
Section 1:
Every contract, combination in the form of a trust
or otherwise, or conspiracy, in restraint of trade or
commerce among the several states, or with
foreign nations, is hereby declared to be illegal.

American Antitrust Law

The Sherman Act, 1890
Section 2:
Every person who shall monopolize, or attempt to
monopolize, or combine or conspire with any
other person or persons, to monopolize any part
of the trade or commerce among the several
states, or with foreign nations, shall be deemed
guilty of a felony.

American Antitrust Law

The Sherman Act, 1890
Section 7:
Any person injured in his business or property by
anything forbidden in the act, may sue to recover
threefold the damages sustained, including the
costs of the suit.

American Antitrust Law

The Clayton Act and its Amendments
Clayton Act
Robinson-Patman Act
Cellar-Kefauver Act

1914
1936
1950

These Acts prohibit the following practices only if

they substantially lessen competition or create
monopoly.

American Antitrust Law

The Clayton Act and its Amendments
1. Price discrimination: predatory pricing;
unjustified volume discounts.
2. Contracts that require other goods to be
bought from the same firm (called tying
arrangements).

American Antitrust Law

The Clayton Act and its Amendments
3. Contracts that require a firm to buy all its
requirements of a particular item from a
single firm (called requirements contracts.)
4. Contracts that prevent a firm from selling
competing items (called exclusive dealing).

American Antitrust Law

The Clayton Act and its Amendments
5. Contracts that prevent a buyer from reselling
a product outside a specified area (called
territorial confinement).
6. Acquiring competitors shares or assets.
7. Interlocking directorships among competing
firms.