10.2 Cartels and Monopoly Power Flashcards
What is a cartel?
An organization of producers who agree to act as a single seller in order to maximize joint profits.
What is a second way that a monopoly can arise?
A second way a monopoly can arise is for several firms in an industry to agree to cooperate with one another, eliminating competition among themselves. In this case, they would band together and behave as if they were a single seller with the objective of maximizing their joint profits. Such a group of firms is called a cartel.
If firms come together to form a cartel, what must they recognize?
If all firms in a competitive industry come together to form a cartel, they must recognize the effect their joint output has on price. That is, like a monopolist they must recognize that they face a downward-sloping demand curve and, as a result, an increase in the total volume of their sales requires a reduction in price.
Where does the incentive for a firm to form a cartel lie?
The incentive for firms to form a cartel lies in the cartel’s ability to restrict output, thereby raising price and increasing profits
What does the profit-maximizing cartelization of a competitive industry cause?
The profit-maximizing cartelization of a competitive industry will reduce output and raise price from the perfectly competitive levels.
Cartels encounter two characteristic problems….
The first is ensuring that members follow the behaviour that will maximize the cartel members’ joint profits.
The second is preventing these profits from being eroded by the entry of new firms.
What happens if all members of the cartel try to cheat?
Cooperation leads to the monopoly price, but individual self-interest can lead to production in excess of the monopoly output.
Why do Cartels tend to be unstable?
Cartels tend to be unstable because of the incentives for individual firms to violate the output restrictions needed to sustain the joint-profit-maximizing (monopoly) price.
Other the policing the behavior of its members, what else must a Cartel do to be successful?
A successful cartel not only must police the behavior of its members but also be able to prevent the entry of new producers. An industry that is able to support a number of individual firms presumably has no overriding natural entry barriers. Thus, if it is to maintain its profits in the long run, a cartel of many separate firms must create barriers that prevent the entry of new firms that are attracted by the cartel’s profits.
What are two ways that Cartels can create barriers of entry?
Successful cartels are often able to license the firms in the industry and to control entry by restricting the number of licenses. This practice is often used by doctors, lawyers, dentists, and engineers, whose professional organizations restrict entry to those individuals who meet certain qualifications.
At other times, the government has operated a quota system and has given it the force of law. If no one can produce without a quota and the quotas are allocated among existing producers, entry is successfully prevented.
