Cartel Definition
A cartel is a group of producers of goods or suppliers of services formed through an agreement amongst themselves, whether or not through a formal agreement in writing, in order to regulate the supply of goods or services with the basic intent to illegally regulate the prices or to restrict competition in respect of the said goods or services. These are even some legalised cartels over the globe such as OPEC, which regulate petrol prices.
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 decide 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 all starts with a company which operates in an oligopoly marketOligopoly MarketThe aviation, media, pharmaceutical, and telecommunications industries are all examples of oligopoly.read more. 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 operate in a standardised manner (like the telecom sector). The competitors in the oligopolistic market have the capacity to downturn the entire market up to the cost of production, thereby vanishing the profits of other competitors. This event provides other competitors to unite & become market leaders for the said product & thus few such companies consolidate to become one.
Another way for consolidation is to form an undisclosed cartel for leading the prices in the industry. In their selfish interest, the members will never agree for a price reduction. Members usually agree to restrict the supply to maintain high prices. However, some member may cheat & supply more to grab more margins at higher prevailing prices. Competitors who are not part of the cartel may distort the market by offering a significant reduction in the prices for said goods. In such a case, customers will move towards the new competitor.
Cartel Examples
Example #1
We can consider the example of legalised cartel famous over the globe, namely, the Organisation of Petroleum Exporting Countries (OPEC). 14 oil-producing countries form OPEC cartel over the globe, whose objective is to stabilise the oil market in the countries. Their objective is 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 cartel for gas-insulated switchgear projects. The group created public utility companies as well as consumers. The Commission collected evidence through documentation available easily. The member units prepared sham bids to manipulate the tenders. However, Swiss-based ABB did not attract the fine since it was the whistleblower & has supported the Commission in providing sufficient evidence to unfold the Cartel.
Types of Cartels
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Source: Cartel (wallstreetmojo.com)
- #1 – Price Cartels – They fix the minimum prices as per their demand-supply ratio. Members cannot sale the products below such prices.
- #2 – Term Cartels – They agree on the terms of business on a standard basis. Each member is obliged to follow the terms of trade. Terms of trade can be delivery-mode, delivery-locations, delivery-time, terms of payment, charging of interest in case of delay, etc.
- #3 – Customer Assignment Cartels – Specific customers are assigned to each member. Thus, all customers are divided amongst the members to ensure appropriate flow of revenue. Each member shall maintain the dignity of allocation & should not grab customers of other members.
- #4 – Quota Cartels – Quota means the quantum of supply. Such type of collaboration offer to restrict the supply, which in turn upscales the prices in the market. Ever member much produce only up to quantum allocated to it & should not exceed the limit.
- #5 – Zonal Cartels – They allocate the geographical locations of the country, to each member in the cartel. Members should ensure to operate on their specific territory.
- #6 – Syndicate Cartels – Here, few members unit to sell jointly & reduce the cost of production. Such cartels intend to achieve the economies of scale.
- #7 – Super Cartels – These are high-level international collaborations. Cartels of the domestic country agree with cartels of the foreign country.
How Cartels Causes Inefficiencies in the Market?
Cartels may be formed for fixing the prices, quantum, or terms of trade or for allocating the trade zones or for achieving the economies of scale. The extra revenue earned by the member is not due to additional efforts of producers or due to 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 to be paid for a specific product. Formation of cartels affects their balance disposable income. Since the supplies are restricted through agreement, the production capacities of large-scale producers are underutilised to the said extent. The large-scale producers could have produced more & dumped excess production in the foreign market. However, super cartels restrict such excess export of goods in the short-term.
Thus, slowly & 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 in 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 backed by the limitation of a few members who do not follow the agreed price and supply at lower than the said price. This exposes the cost of production to the consumers. Such member may also beyond the upper cap of supply limit.
- Cartels do not last long. The average duration can be assumed to be between 5 to 8 years approximately. On the other hand, some cartels are required by Government of various countries to safeguard the sovereignty. In such a case, no legal repercussions can be imposed for any price manipulation or any sort of issue.
When it’s Powerful?
This is usually powerful when the country’s sovereignty is at stake. In such a case, these are not questioned about the prices they charge or the supplies of production. This is also powerful when one of the members in the cartel has complete control over the market & is dominant in nature.
Also, high entry barriers are another reason for powerful cartels. The reason is that less number of competitors drives the market prices & it is not under the control of the demand-supply ratio.
Advantages
- It provides monopoly-type power to the member units.
- Products can be sold at higher margins, which maximises 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.
- Production efficiency can be easily managed as per supply constraints.
- Reasonable margin is assured for each member in 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.
- Its create 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 or may have full regulation over the member, which provides instability to other members.
- There is no motivation to increase the efficiency in the market & thus, prices of product stay at a high cost.
- Demand will fluctuate as per the needs of customers & other economies of scale. This cannot regulate demand.
- The individual members are not able to scale up their operations.
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