Key Diagrams - Price Collusion in a Cartel (Oligopoly)

In this video we work through a price-fixing diagram associated with cartel behaviour in an oligopoly.

A cartel is a form of collusion between suppliers. A cartel occurs when two or more firms (usually within an oligopoly) enter into agreements to restrict the market supply and thereby fix the price of a product in a particular industry. The aim is to charge a high cartel price and maximise joint profits for cartel members.

A price-fixing cartel can be modelled using a simple version of the Prisoner’s Dilemma. Please ensure you have a numerical example that you can quickly and accurately use in an exam answer.

The main aim of a cartel is to fix prices at a higher level than would exist in a competitive market. This inevitably has consequences for consumer and producer welfare and also for society as a whole.

Although the cartel as a whole might be maximising joint profits, each individual firm could increase their own profits by expanding output and undercutting the cartel price by a small margin. This is often one reason why cartels are undermined and eventually collapse – namely, cheating on output quotas by cartel members.