How a Cartel Operates

1
How a Cartel Operates?
Moonsu Han Dept. of Economics University of
Wisconsin-River Falls
March, 2004
2
Cartel
A Cartel is a group of sellers of a product who
have joined together to control its production,
sales, and price to obtain the advantages of
monopoly.
Definition
Organization of Petroleum Exporting Countries
(OPEC)
Example
3
Types of Market Structure
Number of Firms
Many firms
Type of Products
One firm
Few firms
Differentiated products
Identical products

• Monopoly
• Tap water
• Cable TV

• Oligopoly
• Crude oil
• (Cartel)

• Monopolistic Competition
• Movies

• Perfect Competition
• Wheat

4
Characteristics of Cartel

• A market is dominated by a few sellers.
• Products are not much differentiated.
• Once a cartel is formed, the market is served by
• a monopoly.
• They must agree not only total level of
• production but also on the amount produced by
• each member.

5
Unstable Cartel Agreements

• Cartels are difficult to organize and even more
• difficult to enforce.
• Once the cartel drives up the price and
  increases
• profitability, each member faces the temptation
  to
• violate a cartel agreement for even bigger
  profits.
• Firms frequently negotiate prices on a
  customer-by-
• customer basis and often offer special
  discounts.
• Open collusion on prices and outputs among firms
  is
• illegal in the U.S.

6
Case Study - OPEC

• 1960 Founded by Iran, Iraq, Kuwait, Saudi
  Arabia and
• Venezuela.
• 1973 High oil prices cause world economic
  crisis.
• 1990 Iraqs anger at Kuwait over-production
  sparks
• Gulf War.
• 1998 World oil price drops to 10 a barrel.
• 2000 OPEC puts squeeze on production to boost
  prices.

7
Crude Oil Prices (1960-2004)
Source U.S. Dept. of Energy, Commerce, and Labor.
8
Application Problem
Situation
The New York Times (Nov., 30 1993) reported that
the inability of OPEC to agree last week to cut
production has sent the oil market into turmoil
(leading to) the lowest price for domestic crude
oil since June 1990.
Two Questions
Q1. Why were the members of OPEC trying to agree
to cut production? Q2. Why do you suppose
OPEC was unable to agree on cutting
production?
9
Q A
Thank You!