An image of two hands in agreement.
Cartelism Meaning
What is Cartelism?
Cartelism refers to the practice of forming and managing a formal group of independent firms, called cartel, in order to control the market for a product. In other words, in cartelism, firms formally agree to cooperate for their mutual benefit instead of competing in the market. Cartelism is common in the collusive model of oligopoly, where the market structure is conducive to cooperation.
What is a Cartel?
A cartel refers to a small group of large independent firms that formally agree to cooperate in order to control a market. In a cartel, the member firms behave collectively for their mutual benefit, which is mostly the profit they want to maximise. In many countries, cartels are illegal due to their non-competitive nature.
History of Cartelism
Cartelism has been in practice since the Industrial Revolution of the 18th and 19thth centuries. In this era, businesses used to compete with each other at an intense level. Then cartels were found to eliminate or reduce the competition. Early examples of cartelism practice include the oil cartel formed by John D. Rockefeller in the late 19th century and the sugar trust in the early 20th century. These historical instances set the stage for today’s cartelism. In cartelism, members collaborate with each other to control the production levels, market shares of firms, and prices of products to increase their overall profit.
In some countries, cartelism had a negative impact on the economy. That’s why those countries passed laws to overcome the impact of cartels. One major example of the countries with strict laws is the United States where government exert tight control on cartelism and its negative effects on the economy.
Example of Cartelism
The following are some main examples of cartelism:
OPEC
OPEC is the abbreviation of the Organization of Petroleum Exporting Countries. OPEC was formed in 1960, and its member countries that produce excess amounts of oil collaborate with each other to manage the supply and control the prices of oil.
De Beers
De Beers is a cartel known for mining and trading diamonds. De Beers had significant status in the diamond industry and it controls the supply and price of diamonds.
The Sinaloa Cartel
The Sinaloa cartel is a cartel involved in criminal activities such as drug trafficking. This cartel operates in Mexico and controls the manufacturing, distribution, and supply of illegal drugs. The Sinaloa cartel is on of the major Mexican drug cartels.
Types of Cartel
Some major types of cartels are explained below:
Price-Fixing Cartels
As the name suggests, in price-fixing cartels, firms collaborate with each other to set the prices of their products or services to abolish competition and increase their profit to the maximum.
Output-Restriction Cartels
The operators in these cartels create artificial scarcity to gain maximum profits by increasing prices according to their will and operate to eliminate competition.
Market-Division Cartels
These cartels divide the market into segments and then operate in different geographic areas and manage the supply and prices of products in those jurisdictions.
Bid-Rigging Cartels
These cartel members exploit the bidding process for contracts by contacting bids directly through collusive tendering. These cartels make sure that one member wins while others pay intentionally.
Customer-Allocation Cartels
These cartels are involved in the allocation of customers between each other and make sure that there is no competition in the market or between them. These cartels have to set a specific customer base for each member of the cartel.
Research and Development Cartels
In these cartels, members join on the basis of research and development efforts and contribute to cost and resource sharing. This will hinder competitors and prohibit them from entering the market.
Workings of Cartelism
Let’s explain the mechanism and workings of cartelism in detail.
Suppose that some firms have formally agreed to make a cartel and decided to act collectively for their common interest. These firms will act together as a monopoly.
Long Run Abnormal Profits
The following diagram illustrates the long run abnormal profits earned by a cartel acting as a monopoly.
In the above graph, we have quantity on the horizontal axis (x-axis) and revenue, cost and price on the vertical axis (y-axis). The equilibrium for profit maximisation is at point E0 where marginal revenue (MR) curve is intersecting with the marginal cost (MC) curve. The equilibrium price is P0 and the equilibrium quantity is Q0. The abnormal profit for cartel is shown by the shaded area.
Cartelism vs. Perfect Competition
Now, let’s compare the price and output of the cartel with perfect competition.
In the above diagram,
EC = Equilibrium point for cartel
QC = Output produced by cartel
PC = Price charged by cartel
EP= Equilibrium point for perfect competition
QP= Output produced by Industry in perfect competition
PP= Price charged by firms in perfect competition
We can see that the price charged by cartel is higher as compared to the price in perfect competition (PC>PP). Also, the output produced and sold by cartel is less than the output produced in perfect competition (QC<QP). Hence, cartel, as a price maker, is charging a higher price by restricting the output produced. This is bad for customers as they have to pay a higher price and get less output.
Efficiency Analysis
Now, let’s do the efficiency analysis of cartel.
In the above diagram,
QC = Output produced by cartel
QS= Socially desirable output
We can see that cartel is producing less output as compared to the socially desirable level. So, cartel is the case of under-allocation of resources (market failure). The shaded area (area X) shows the deadweight loss (DWL) due to cartel which is the welfare loss to the society due to the presence of cartel. Moreover, cartel is productively inefficient because it is not producing output at the minimum average cost.
The following diagram illustrates different types of inefficiencies created by cartelism.
Output Quota and Profit Sharing
Now, let’s explain the output quota and division of profits in cartelism.
In cartelism, all member firms charge the same price as decided by the cartel. Output and profit of each member firm may be different. Output quota for each firm is decided by cartel. Output of the cartel (total industry output) is the Sum of outputs of all the member firms. Profit of the cartel is the sum of profits of all the member firms.
Suppose that there are two members firms of the cartel named firm A and firm B.
In the above diagrams, both firms are charging the same price as decided by cartel. So, the prices P0, PA, and PB are equal. Both firms might have different costs.
Output of the cartel = Q0
Output of Firm A = QA
Output of Firm B = QB
Q0 = QA + QB
Profit of the cartel = Area X
Profit of Firm A = Area Y
Profit of Firm B = Area Z
Area X = Area Y + Area Z
Effects of Cartelism
The following are the effects of cartelism:
Market Control
Cartel controls the price, output quota, profits and market share of its members. This means controlling and dominating the markets in which they operate.
Reduced Competition
Cartel controls the market by creating entry barriers. That is why cartels are anticompetitive. The anticompetitive practices of cartels limit, reduce or eliminate competition from the market.
Higher Prices
Cartel acts as a monopoly and it can increase the price as being the price maker. This is a bad news for customers who have to pay higher prices for the products they buy. Moreover, customers also get lower quantity of products because of the output restrictions of the cartel.
Reduced Innovation
Cartel members control all the activities of the market. It means no competitive pressure for innovation. As a result, there is a reduced innovation in cartelism.
Economic Distortions
Cartels also hinder market dynamics, which lead to economic distortions. Cartels, by dominating the markets, do not allow for the efficient allocation of resources. This leads to market failures and inefficiencies.
Organisation of Cartel
The following are some important points about the organization of cartel:
Formation
Cartels came into existence when the competing firms in an industry become friends with each other by collaborating rather than competing. There must a higher tendency to cooperate in the market in order to form a cartel.
Membership
In cartels, different members coordinate with each other in terms of their actions, production quotas, setting prices for products of the industry, and market share.
Secret Meetings
Cartel members held secret meetings. In these secret meetings, they discuss the strategies that every cartel member is going to follow and the pricing of new products that are going to launch in the near future.
Enforcement
Cartels also enforce penalties on those members who do not follow the agreed-upon rules. Those members must pay those penalties either in terms of cash or other forms of punishment.
Market Division
Cartels, in order to reduce competition, divide the market into different geographical territories. Then these territories are divided among its members as a form of market allocation. These members then operate in the given territory without facing any competition.
The Largest Global Cartel
The largest global cartel is the OPEC (Organization of the Petroleum Exporting Countries). This cartel organization consists of 13 member countries that directly control oil production and supply throughout the world. These countries comprise a large portion of the oil industry. OPEC members coordinate with each other to make strategies for oil supply and oil prices. The actions taken by OPEC have a negative impact on the global oil industry and cause market inefficiencies.
Laws for Cartelism
International competition authorities dislike and discourage cartels due to anticompetitive cartel behaviour. There are some antitrust laws and competition laws in many countries for controlling cartelism. These laws promoted fair competition between firms in an industry. These laws also prohibit anti-competitive behavior between firms, such as price fixing and market sharing agreements.
Legal Consequences for Cartelism
Cartels and their members face legal consequences, such as court actions, high fines, bans and imprisonments. The business reputation can also be damaged as being the member of a cartel.
Conclusion
In conclusion, cartelism is the practice of making cartels to control the markets and is an example of formal collusion in oligopoly. Cartelism results in higher prices of products, lower output, reduced competition and less innovation. Cartelism leads to market failures and inefficient resource allocation. In many countries, cartels are illegal due to their non-competitive nature.
