What is cartel - Essay Example

Module Cartels INTRODUCTION A cartel is a group of firms that come together to control output and price in a specific industry with the intention of maximizing profits and locking out competition (Choi and Gerlach 10). Cartels are driven to dictate the dynamics of an industry and are often composed of firms with the biggest market share. Cartels can be formed in any industry, but there are specific conditions that favor the formation of cartels. In essence, the formation of cartels is not limited to certain segments, but those industries often support the existence of cartels.

It is therefore necessary to examine these conditions in order to understand sectors that are likely to encourage formation of cartels. Number of Firms in the Industry Industries with few companies are highly attractive for cartels. The logic is that the smaller the number of firms, the easier it is to control activities and the behavior of other members. For instance, the commodities industry has very few firms because it is expensive to venture into (Frank 35). Diamonds, for example, are cut and sold by very few firms, and they know each other well.

On the other hand, the dairy industry has so many companies that controlling it would prove difficult for prospective cartels (Choi and Gerlach 12). Interestingly, an industry with many firms can also be attractive to cartels because it is difficult to detect price cuts. This means that profits resulting from price cuts are huge. As previously mentioned, there is no single industry that is entirely favorable or unfavorable for cartels because conditions are relative. Nature of Products Sold Commodity industries are more appealing than those based on differentiated products.

For instance, the gold industry is more attractive to cartels than confectionery sector. Homogenous products facilitate monitoring and also make agreement on quantities and prices easier to reach (Wardhaugh 14). Homogenous products make it easy for cartels to know that a fluctuation in market share is probably as a result of quantity increase (or price cut) by another member. On the other hand, changes in the quantity of differentiated products sold can be caused by changes in demand or consumer preferences (Rivoli 46).

It is therefore highly likely to find cartels in the uranium industry, for example, than in the shoe industry. Behavior of Demand An industry with highly elastic demand is too difficult for cartels to flourish in. This is because they find it challenging to determine whether their sales figures are due to varying demand or manipulation by other members (Rivoli 12). Monitoring is harder in industries with demand variations and cartels avoid such segments if they can. For instance, the telecommunications sector experiences demand fluctuations much more than the ecommerce sector, therefore cartels are unlikely to be found there.

Nature of Sales Industries with firms whose sales consist of few high-value contracts are likely to have cartels because they can make quick profits from violating agreements and thereby winning more contracts. On the other hand, industries dominated by firms with plenty of low-value sales have smaller quick profits (Choi and Gerlach 32). Fewer sales combined with high value in each of those sales are unfavorable to cartels. When product demand varies, members of a cartel are less interested in staying in a cartel because they cannot make quick profits.

Cartel Impacts and Example Cartels can manipulate markets in four ways: price fixing, sharing markets, rigging bids, and controlling output. Price fixing involves agreements by competitors to determine pricing instead of competing against one another (Wardhaugh 18). The U.S. Competition and Consumer Act defines it as the “fixing, maintaining or controlling” of prices. Price fixing cartels come into being when competitors make informal, written or verbal agreements on: prices for selling and buying products or services; minimum prices; methods for pricing or discounting products or services; and credit terms, rebates or allowances.

Price fixing affects consumers as well as small companies that depend on suppliers to operate. Bid rigging eliminates rivals among suppliers, increases costs, and affects other firms’ ability to compete (Frank 29). Bid rigging, whether it happens on government tenders or in the private industry, passes increased costs on to the public. It artificially increases the prices of products and/or services submitted in bids to potential clients. Output control involves the prevention, restriction or limitation of the volume or type of specific products or services available.

Controlling output reduces the supply of specific products or services and in turn increases the demand for and price of the good (Klein and Bauman 23). Market sharing involves agreements between competitors to share or allocate clients, suppliers or markets among themselves instead of letting competitive market forces to work. Market sharing includes: assigning clients based on geographic area and sharing contracts by value within a region. It also includes: agreeing not to compete for established clients; producing each other’s goods or services; and moving into competitor’s markets (Mankiw 109).

Market sharing limits competition, increases prices and restricts options on price and quality for customers and other firms. An example of a cartel is the Organization for Petroleum Exporting Countries (OPEC), which is probably the biggest “legal” cartel in the world. OPEC controls oil output, supply and prices in a way that no other industrial organization in the world does (Mankiw 112). Since the 1960s, OPEC has worked to control oil output and prices all over the world by using the production capacity and financial power of its members to influence oil trade.

This cartel’s influence on the oil industry is unparalleled in the world, but its members continue to protest its “innocence.” OPEC controls virtually everything that happens in the global oil sector; and has enough power and influence to be felt everywhere in the world. Policy Actions In the midst of controversy and huge debate in the mid-2000s, the U.S. Congress tried to reprimand OPEC as an official cartel. However, its efforts were rebuffed over worries concerning retaliation and possible negative consequences on American enterprises (Mankiw 115).

In spite of the fact that OPEC is viewed by many as a cartel, its members have strongly insisted that it is not in any way a cartel. All evidence and criteria by which cartels are identified point to the contrary, however. Cartels are illegal in the United States because they violate U.S. antitrust laws. The United States created antitrust laws to regulate the impacts of cartels and buffer the public from the negative consequences resulting from cartels’ activities. The Supreme Court has referred to cartels as “the archenemy of antitrust,” and dealt firmly with cases concerning cartels (Frank 27). U.S.

law enforcement agencies believe that the fixing of output, prices, markets, and bids by cartels has no logical efficiency justification. Antitrust agencies properly view cartel activities as per se illegal and a “blatant” violation of competition laws. The United States has a long experience in convicting cartels, and its efforts have produced solid results. Scott Hammond, a former deputy assistant attorney general for the Antitrust Department, stated that “cartels have no legal purposes and exist only to rob consumers of the realistic blessings of competition.

” In summary, cartels violate U.S. laws and are consequently considered illegal (Wardhaugh 16). They are no different from drug traffickers and arms dealers, and must be dealt with in accordance with the law. Many other countries have passed laws similar to the US’s antitrust laws that limit the operation of cartels. These laws impose heavy fines and stipulate lengthy sentences in case organizations and individuals engage in cartel-like activities. The objective is always to make sure that cartels cannot operate in a particular country and if they operate, their activities cannot endanger the wellbeing of the public or other businesses.

CONCLUSION Cartels have existed for centuries and their longevity is evidence of their surviving power. Efforts to eradicate them must be lauded but they will never be wiped out completely. Cartels are motivated by greed and provided the human race still exists they will remain with us. The solution, for now, is to continue creating conditions that are unfavorable for their operation and nipping them in the bud. Works Cited Choi, Jay Pil, and Heiko A. Gerlach. Global Cartels, Leniency Programs and International Antitrust Cooperation.

Munich: CESifo, 2010. Print. Frank, Robert H. The Economic Naturalist: Why Economics Explains almost Everything. London: Virgin, 2008. Print. Klein, Grady, and Yoram Bauman. The Cartoon Introduction to Economics. New York: Hill and Wang, 2010. Print. Mankiw, Nicholas Gregory. Macroeconomics. 7. Ed., International Edition. New York: Worth, 2010. Print. Rivoli, Pietra. The Travels of a T-Shirt in the Global Economy: An Economist Examines the Markets, Power and Politics of World Trade. Hoboken, N.J.: John Wiley & Sons, 2005. Print. Wardhaugh, Bruce. Cartels. New York: Cambridge University Press, 2013. Print.