How does a cartel determine the price to maximize the joint profit? Evaluate the advantages and disadvantages of cartel for consumers and producers.

A cartel is a direct, often secret, agreement among competing oligopolists to promote their common interests, such as maximizing joint profit, reducing uncertainty and avoiding price wars. Agreements may be formal or informal, and both are illegal in most countries. OPEC in the oil market is the best-known example. There are two types of cartel: one aiming at joint profit maximization and one aiming at market sharing.

How a cartel determines price for joint profit maximization:

1. Central agency: the member firms set up a central agency and give it the power to decide price, output, quotas and the distribution of profit. The cartel then behaves like a single multi-plant monopolist.
2. Industry MC curve: the agency adds up the marginal cost curves of all members horizontally to get the industry marginal cost curve, ΣMC = MCA + MCB + …
3. Industry demand and MR: the agency estimates the market demand curve (AR) for the industry and its MR curve.
4. Total output and price: joint profit is at its maximum where industry MR = ΣMC. This gives the total industry output OQ. The price OP is read from the demand (AR) curve at that output, and all members must sell at this price.
5. Allocation of output (quotas): total output is divided among members so that the MC of each firm equals the common industry MC at equilibrium: MCA = MCB = MR. Low-cost firms produce more and high-cost firms produce less.
6. Distribution of profit: the joint profit is shared according to the agreed formula, which need not match each firm’s own output.

The diagram below shows this:

Advantages for producers:

1. Higher joint profit: acting like a monopolist, the cartel restricts output and raises the price, so members earn supernormal profit.
2. Less uncertainty and no price wars: because interdependence is managed by agreement, firms avoid costly price-cutting and the risks of rivals’ reactions.
3. Lower selling costs and stability: less need for competitive advertising, plus stable prices and market shares that make planning easier.

Disadvantages for producers:

1. Instability and cheating: each member has an incentive to secretly produce more than its quota or cut prices, so cartels often break down. Disagreements over quotas and profit-sharing are common, especially when costs differ.
2. Legal risk: cartels are illegal in most countries, so members face fines and penalties. High profits may also attract new rivals and substitutes.

Effects on consumers:

1. Disadvantages: consumers pay higher prices for a smaller output, lose consumer surplus, and have less choice. Without competition, firms have weak incentives to improve quality or innovate, so resources are misallocated, as under monopoly.
2. Possible advantages: stable prices and steady supply, with no sudden shortages from price wars. A cartel may also avoid wasteful advertising and allow rationalization of production in low-cost plants.
3. Overall evaluation: a cartel benefits producers in the short run but harms consumers and economic efficiency. It is also unstable because of cheating and legal action. This is why most governments ban cartels and promote competition.

A cartel maximizes joint profit by fixing output where industry MR equals ΣMC, charging the price from the demand curve, and allocating quotas so that each firm’s MC is equal. Its gains go mainly to producers, while consumers bear the cost of higher prices and lower output.