Cartel Definition Types Examples How It Works

Cartel Definition

Purpose

These are formed to protect the self-interest of a group of producers. The producers work in a group to regulate the prices of commodities.Through this, the producers can easily raise the prices by observing the demand-supply ratio for the goods.This member can decide jointly to restrict the supply in the market.They can also choose to provide entry barriersEntry BarriersBarriers to entry are the economic hurdles that a new entrant must face in order to enter a market. For example, new entrants must pay fixed costs regardless of production or sales that would not have been incurred if the participant had not been a new entrant.read more to their market.

How does it Work?

It starts with a company that operates in an oligopoly marketOligopoly MarketThe aviation, media, pharmaceutical, and telecommunications industries are all examples of oligopoly.read more. An OligopolyOligopolyAn oligopoly in economics refers to a market structure comprising multiple big companies that dominate a particular sector through restrictive trade practices, such as collusion and market sharing. Oligopolists seek to maximize market profits while minimizing market competition through non-price competition and product differentiation. read more market is an extended form of monopoly wherein only a few sets of companies are standardized (like the telecom sector). The competitors in the oligopolistic market can downturn the entire market up to the cost of production, thereby fading the profits of other competitors. This event provides other competitors to unite and become market leaders for the said product. Thus, few such companies consolidate to come together.

Another way for consolidation is to form an undisclosed cartel to lead the industry’s prices. The members may never agree to a price reduction in their selfish interests. Instead, members usually agree to restrict the supply to maintain high prices. However, some members may cheat and supply more to fetch more margins at higher prevailing prices. The competitors who are not part of the cartel may distort the market by significantly reducing the costs for said goods. In such a case, customers may approach the new competitor.

Cartel Examples

Example #1

We can consider the example of legalized cartels famous over the globe, such as the Organisation of Petroleum Exporting Countries(OPEC). Fourteen oil-producing countries formed OPEC cartels worldwide, whose objective is to stabilize the oil market in the countries. They aim to sell oil at reasonable prices to consuming countries.

Example #2

The European Commission has imposed a whopping fine of 750 million Euros on 11-group of companies who participated in illegal cartels for gas-insulated switchgear projects. The group created public utility companies and consumers. The commission collected evidence through easily available documentation. For manipulating the tenders, the member units prepared sham bids. However, Swiss-based ABB did not attract the fine since it was the whistleblower and has supported the commission in providing sufficient evidence to unfold the cartel.

Types of Cartels

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Price Cartels – They fix the minimum prices per their demand-supply ratio. Members cannot sell products below those prices.Term Cartels – They agree on business terms on a routine basis. Each member is obliged to follow the terms of tradeTerms Of TradeTerms of Trade (TOT) is defined as the ratio of a country’s import and export prices. The concept of terms of trade is important in economics as it explains the extent to which a nation can fund its imports based on the returns of its exports.read more. The terms of work can be delivery-mode, delivery locations, delivery time, terms of payment, charging of interest in case of delay, etc.Customer Assignment Cartels – Specific customers are assigned to each member. Thus, all customers are divided amongst the members to ensure a proper flow of revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more. Each member shall maintain the dignity of allocation and must not fetch customers of the other members.Quota Cartels – Quota means the quantum of supply. Such collaboration offers to restrict the reserve of goods, which in turn upscales the prices in the market. Every member produces up to the quantum allocated and must not exceed the limitZonal Cartels – They assign the geographical locations of the country to each member of the cartel. Members should ensure to operate on their specific territory.Syndicate Cartels – Several members unite to sell collectively and reduce the cost of production. Such cartels intend to achieve economies of scale.Super Cartels – These are high-level international collaborations. Cartels of the domestic country agree with cartels of the foreign country.

How do Cartels Cause Inefficiencies in the Market?

One may form cartels to fix the prices, quantum, or terms of trade, allocate the trade zones, or achieve economies of scale. However, the extra revenue earned by the member is not due to additional efforts of producers or extra production supplies. Rather such agreements make the producers inefficient in the long run.

From the consumer’s perspective, they are concerned with only the prices for a specific product. Therefore, the formation of cartels affects their balanced disposable income. Since the supplies are restricted through agreement, the production capacities of large-scale producers are underutilized to the said extent. The large-scale producers may have produced more and abandoned excess production in the foreign market. However, super cartels restrict such extra export of goods in the short term.

Thus, slowly and steadily, economies of scaleEconomies Of ScaleEconomies of scale are the cost advantage a business achieves due to large-scale production and higher efficiency. read more get reduced, which becomes one of the causes of rising inflationInflationThe rise in prices of goods and services is referred to as inflation. One of the measures of inflation is the consumer price index (CPI). Rate of inflation = (CPIx+1–CPIx )/CPIx. Where CPIx is the consumer price index of the initial year, CPIx+1 is the consumer price index of the following year.read more.

Effects

It has been found that the prices of commodities increase significantly due to price manipulations by Cartels. International cartels have more impact on such price increases. However, these are supported by the limitation of a few members who do not follow the agreed price and supply at lower than the mentioned price. That exposes the cost of production to the consumers. Such members may also be beyond the upper cap of the supply limit.
Cartels do not last long. The average duration can be between 5 years to 8 years approximately. On the other hand, some cartels are required by the governments of various countries to safeguard their sovereignty. In such a case, can impose no dire consequences for any price manipulation or issue.

When is it Powerful?

That is usually powerful when the country’s sovereignty is at stake. In such a situation, cartels are not questioned about the prices they charge or the production supplies. They are also powerful when one of the cartel members has complete control over the market and is dominant.

Even high entry barriers are another reason for powerful cartels. The reason is that fewer competitors drive the market prices, and it is not under the control of the demand-supply ratio.

Advantages

It provides monopoly-type power to the member units.They can sell products at higher margins, maximizing the gross profitsGross ProfitsGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more.The cost of advertising is reduced, and the product is easily known to the customers.No effect of the business cycleBusiness CycleThe business cycle refers to the alternating phases of economic growth and decline.read more on the individual players.They can easily manage production efficiency as per supply constraints.A reasonable margin is assured for each member of the cartel.Big savings are achieved on economies of scale.

Disadvantages

Individual monopolies affect the disposable incomeDisposable IncomeDisposable income is an important mechanism to measure household incomes, and includes all sorts of income such as wages and salaries, retirement income, investment gains. In other words, it is the amount of money left after paying off all the direct taxes.read more of customers.It creates inefficiencies in the marketInefficiencies In The MarketAn inefficient market represents the one which fails to exhibit the actual value of the assets. Such a market doesn’t provide transparent information and is unavoidable in the real world, but it benefits arbitrage traders.read more, which may affect the quality of the end product.It may have full regulation over the member, destabilizing other members.There is no motivation to increase efficiency in the market. Thus, prices of products remain at a high cost.Demand will fluctuate as per customers’ needs and other economies of scale. However, that cannot regulate the market.The individual members are not able to scale up their operations.