However, cartels tend to be unstable, and the degree of instability depends on the authority that the governing body of the cartel can exercise over its members, and also the degree of information it has on the operations of its members. The reason for instability lies in the fact that each individual member of the cartel has an incentive to increase its output, because the monopoly price that the cartel attempts to sustain exceeds the cost of producing a marginal unit of output. In Figure 10.13 each firm has a MC of output equal to $F when the group collectively produces the output Qm. Yet any firm that brings its output to market at the price Pm will make a profit of AF on an additional unit of output – provided the other members of the cartel agree to restrict their output. Since each firm faces the same incentive to increase output, it is difficult to restrain all members from doing so.
Individual members are more likely to abide by the cartel rules if the organization can sanction them for breaking the supply-restriction agreement. Alternatively, if the actions of individual members are not observable by the organization, then the incentive to break ranks may be too strong for the cartel to sustain its monopoly power.
Cartels within individual economies are almost universally illegal. Yet at the international level there exists no governing authority to limit such behaviour. In practice, governments are unwilling to see their own citizens and consumers being ‘gouged’, but are relatively unconcerned if their national or multinational corporations are willing and successful in gouging the consumers of other economies! We will see in Government that Canada’s Competition Act forbids the formation of cartels, as it forbids many other anti-competitive practices.
Application Box: The taxi cartel
While we tend to think of cartels as small groups of suppliers, in fact they often contain thousands of members and are maintained by legal entry barriers. City taxis are an example of such a formation: Entry is limited by the city or province or state, and fares are maintained at a higher level as a consequence of the resulting lower supply. A secondary market then develops for licenses – medallions, in which the city may offer new medallions through auction, or existing owners may exit and sell their medallions. Restricted entry characterizes most of Canada’s major cities, with the result that new medallions frequently generate in excess of $100,000 from the buyer. New York medallions traded in the region of a half million dollars in 2009.
See www.fcpp.org for Canada, and for New York: www.nyc.gov/html/tlc/downloads/pdf/press_release_medallion_auction.pdf
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