How does a cartel determine the price to maximize the joint profit? Evaluate the advantages and disadvantages of cartel for consumers and producers. (9+6)

How a Cartel Determines the Price to Maximize Joint Profit

A cartel is a formal agreement among independent firms in an industry to coordinate their output, pricing, and market strategies to maximize joint profits. Unlike competitive markets, where firms act independently, a cartel behaves like a monopolist by restricting output and raising prices to exploit consumers. The key to a cartel’s success lies in its ability to collude and act as a single profit-maximizing entity.

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Step-by-Step Process of Price Determination by a Cartel

To determine the profit-maximizing price, a cartel follows these steps:

1. Determine the Market Demand Curve

   • The cartel must first estimate the total market demand for the product.
   • The demand curve shows the relationship between the total quantity demanded (Q) and the price (P).
   • Example: Suppose the market demand is given by: $$P=100-2Q$$ where $P$ is the price and $Q$ is the total quantity demanded.

2. Determine the Marginal Revenue (MR) Curve

   • Since the cartel controls the total output, it must derive the marginal revenue (MR) curve.
   • MR is the additional revenue gained from selling one more unit.
   • For a linear demand curve $P=a-bQ$, the MR curve is: $$MR=a-2bQ$$
   • Using the example above: $$MR=100-4Q$$

3. Determine the Marginal Cost (MC) Curve

   • The cartel must know the marginal cost (MC) of production, which is the cost of producing one additional unit.
   • Assume the MC is constant at $MC=20$ (for simplicity).

4. Find the Profit-Maximizing Output (Q)

   • A firm (or cartel) maximizes profit where MR = MC.
   • Setting $MR=MC$: $$100-4Q=20$$ $$4Q=80⟹Q=20$$
   • So, the cartel will produce 20 units in total.

5. Determine the Profit-Maximizing Price (P)

   • Substitute $Q=20$ back into the demand equation: $$P=100-2(20)=60$$
   • Thus, the cartel sets the price at ₹60 to maximize joint profit.

6. Calculate Total Profit

   • Total Revenue (TR) at $Q=20$, $P=60$: $$TR=P\times Q=60\times 20=1200$$
   • Total Cost (TC) at $Q=20$, $MC=20$: $$TC=MC\times Q=20\times 20=400$$
   • Total Profit (π): $$\pi =TR-TC=1200-400=800$$
   • Each firm in the cartel earns a share of this profit based on agreed output quotas.

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How Cartels Allocate Output Among Members

Since cartels consist of multiple firms, they must allocate total output (Q) among members to prevent cheating. Common methods include:

• Equal Output Quotas: Each firm produces the same amount.
• Market Share-Based Allocation: Firms produce based on their pre-cartel market shares.
• Cost-Based Allocation: Firms with lower costs produce more to minimize total costs.

Example: If a cartel has 3 firms, and total output is 20 units, each firm may produce: $$Q_1=Q_2=Q_3=\frac{20}{3}\approx 6.67\text{ units}$$

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Advantages and Disadvantages of Cartels

Cartels have significant economic implications for both consumers and producers.

Advantages of Cartels

Disadvantages of Cartels

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Real-World Example: OPEC (Organization of the Petroleum Exporting Countries)

OPEC is the most famous cartel, controlling ~40% of global oil production. Its objectives include:

1. Stabilizing Oil Prices: By controlling supply, OPEC aims to prevent price volatility.
2. Securing Revenue for Member Countries: Higher prices mean greater government revenue (e.g., Saudi Arabia, Iran, Venezuela).
3. Preventing Overproduction: Ensures that no single country floods the market, leading to price crashes.

Criticisms of OPEC:

• Artificially High Prices: Consumers (especially in developed nations) pay more for gasoline.
• Geopolitical Conflicts: Oil price manipulations can disrupt global markets (e.g., 1973 oil crisis).
• Cheating by Members: Some countries (e.g., Iraq, Iran) exceed quotas to gain short-term profits.

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Why Cartels Are Illegal in Many Countries

Most economies (including Nepal under the Competition Act, 2018) prohibit cartels because:

1. Anti-Competitive Practices: Cartels restrict competition, harming consumer welfare.
2. Market Distortion: They lead to inefficient resource allocation.
3. Unfair Advantage: Small firms cannot compete, leading to market dominance by a few.
4. Price Manipulation: Consumers are exploited through artificially high prices.

Exceptions:

• Some legal monopolies (e.g., public utilities) are allowed to set prices under government regulation.
• Farmers’ cooperatives (e.g., dairy cartels) are sometimes exempt if they improve bargaining power without harming consumers.

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Conclusion

A cartel maximizes joint profit by acting as a monopolist, restricting output, and setting prices where MR = MC. While cartels provide short-term benefits to producers (higher profits, stability), they harm consumers through higher prices, reduced choice, and inefficiency. Governments worldwide regulate or ban cartels to protect competition and consumer welfare. However, enforcement remains challenging due to cheating and hidden collusion.