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Economics (oligopoly)
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Table of Contents S. No. Chapter Page No. 1. Introduction…………………….…………..……..2 2. What is Cartel?........................................................3 3. Cartel Theory of Oligopoly………………...……..4 4. Types of Cartel………………………...…………..5 5. OPEC - The World's Largest Cartel...…………...6 6. Other Examples………………...………………….8 7. References……………………………………...…..9 INTRODUCTION There are four basic types of market structure or we should say competitions in market, namely, Monopoly, Perfect Competition, Monopolistic and Oligopoly. All these market structure are marked by their distinct features and requisites: 1. Perfect Competition · Many Sellers/Many Buyers · Homogenous goods · No barriers to entry · Perfect Information · No advertising · Price Taker 2. Monopoly · One Seller/ Many Buyers · Unique good · Extreme barriers to entry · Government (patents) · Location (desert) · Resource (DeBeers) · Tech. (Microsoft) · Imperfect Information · Little advertising · Price Setter 3. Monopolistic Competition · Many Sellers/Many Buyers · Differentiated Products · No barriers to entry · Slightly Imperfect Information · Use advertising to shift demand · Price Setter 4. Oligopoly · Few Firms/Many Buyers · Similar Products · High Barriers to entry · Slightly Imperfect Information · Uses advertising Cartels occur in an oligopolistic industry, where the number of sellers is small (usually because barriers to entry, most notably startup costs, are high) and the products being traded are usually homogeneous. CONDITIONS CONDUCIVE TO FORMATION OF CARTELS If there is effective competition in the market, cartels would find it difficult to be formed and sustained. Some of the conditions that are conducive to cartelization are: · High concentration - few competitors · High entry and exit barriers · Homogeneity of the products (similar products) · Similar production costs · Excess capacity · High dependence of the consumers What Is Cartel? Cartels tend to spring from oligopolistic industries, where a few companies or countries generate the entire supply of a product. This small production base means that each producer must evaluate its rivals' potential reactions to certain business decisions. When oligopolies compete on price, for example, they tend to drive the product's price throughout the entire industry down to the cost of production, thereby lowering profits for all producers in the oligopoly. These circumstances give oligopolies strong incentive to collude in order to maximize their joint profit. A cartel is defined as a group of firms that gets together to make output and price decisions. The conditions that give rise to an oligopolistic market are also conducive to the formation of a cartel; in particular, cartels tend to arise in markets where there are few firms and each firm has a significant share of the market. The Competition Act, 2002 defines Cartels as Cartels are agreements between enterprises (including association of enterprises) not to compete on price, product (including goods and services) or customers. The objective of a cartel is to raise price above competitive levels, resulting in injury to consumers and to the economy. For the consumers, cartelization results in higher prices, poor quality and less or no choice for goods or/and services. Investopedia defines Cartel as an organization created from a formal agreement between a group of producers of a good or service, to regulate supply in an effort to regulate or manipulate prices. A cartel is a collection of businesses or countries that act together as a single producer and agree to influence prices for certain goods and services by controlling production and marketing. A cartel has less command over an industry than a monopoly - a situation where a single group or company owns all or nearly all of a given product or service's market. Oxford Dictionary defines cartel as an association of manufacturers or suppliers with the purpose of maintaining prices at a high level and restricting competition. In the U.S., cartels are illegal; however, internationally, there are no restrictions on cartel formation. Cartel theory of Oligopoly As we can see that the oligopoly has only few firms, what happens is that they have a huge impact in their policies if any one of the firms change their policies. Therefore, these firms instead of competing join hands to form cartels and make some policies together. Such policies are also under direct supervision of government under the competition act so that the cartels formed do not exploit the public and set high prices to earn high profits and therefore, form a monopoly type position. Instead they are allowed to form reasonable cartels which are beneficial for both. Oligopolistic firms join a cartel to increase their market power, and members work together to determine jointly the level of output that each member will produce and/or the price that each member will charge. By working together, the cartel members are able to behave like a monopolist. For example, if each firm in an oligopoly sells an undifferentiated product, the demand curve that each firm faces will be horizontal at the market price. If, however, the firms form a cartel to determine their output and price, they will jointly face a downward‐sloping market demand curve, just like a monopolist. In fact, the cartel's profit‐maximizing decision is the same as that of a monopolist, as Figure reveals. The cartel members choose their combined output at the level where their combined marginal revenue equals their combined marginal cost. The cartel price is determined by market demand curve at the level of output chosen by the cartel. The cartel's profits are equal to the area of the rectangular box labeled abcdin Figure . Note that a cartel, like a monopolist, will choose to produce less output and charge a higher price than would be found in a perfectly competitive market. Types of Cartels One can distinguish private cartels from public cartels. 1. Public Cartel: In the public cartel a government is involved to enforce the cartel agreement, and the government's sovereignty shields such cartels from legal actions. Public cartels work to pass on benefits to the populace as a whole. 2. Private cartel: are subject to legal liability under the antitrust laws now found in nearly every nation of the world. Furthermore, the purpose of private cartels is to benefit only those individuals who constitute it, public cartels, in theory, work to pass on benefits to the populace as a whole. Organization of Petroleum Exporting Countries (OPEC) The World's Largest Cartel OPEC is the Organization of the Petroleum Exporting Countries. It is an oil cartel whose mission is to coordinate the policies of the oil-producing countries. The goal is to secure a steady income to the member states and to secure supply of oil to the consumers. The organization of petroleum‐exporting countries (OPEC) is perhaps the best‐known example of an international cartel Need for OPEC; Few people are aware of it today, but OPEC (The Organization of Petroleum Exporting Countries) was formed in response to the U.S. imposition of import quotas on oil. In 1959 the U.S. government established a Mandatory Oil Import Quota Program (MOIP) restricting the amount of crude oil (and refined products) that could be imported into the United States. The MOIP gave preferential treatment to oil imports from Mexico and Canada. This partial exclusion of the U.S. market to Persian Gulf producers depressed prices for their oil. As a result oil prices "posted" (paid to the selling nations) by the major oil companies were reduced in February 1959 and August 1960. In its early years the U.S. import quota program also discriminated against oil from Venezuela. Formation: In September 1960 four Persian Gulf nations (Iran, Iraq, Kuwait, and Saudi Arabia) and Venezuela formed OPEC, the purpose of which was to obtain higher prices for crude oil. By 1973 eight other nations (Qatar, Indonesia, Libya, the United Arab Emirates, Algeria, Nigeria, Ecuador, and Gabon) had joined OPEC. Ecuador withdrew on the last day of 1992. Price and Production Control: OPEC was unsuccessful in its first decade. Real (that is, inflation-adjusted) world prices for crude oil continued to fall until 1971. In 1958 the real price was $10.85 per barrel (in 1990 dollars). By 1971 it had fallen to $7.46 per barrel. However, real prices began to rise slowly beginning in 1971, and then jumped dramatically in late 1973 and 1974 from roughly $8 per barrel to over $27 per barrel in the wake of the Arab-Israeli ("Yom Kippur") War. Contrary to what many non-economists believe, the 1973 price increase was not caused by the oil "embargo" (refusal to sell) directed at the United States and the Netherlands that year by the Arab members of OPEC. Instead, OPEC reduced its production of crude oil, thus raising world oil prices substantially. The embargo against the United States and the Netherlands had no effect whatever: both nations were able to obtain oil at the same prices as all other nations. The failure of this selective embargo was predictable. Oil is a fungible commodity that can easily be resold among buyers. Therefore, sellers who try to deny oil to buyer A will find other buyers purchasing more oil, some of which will be resold by them to buyer A. Nor, as is commonly believed, was OPEC the cause of oil shortages and gasoline lines in the United States. Instead, the shortages were caused by price and allocation controls on crude oil and refined products, originally imposed in 1971 by President Nixon as part of the Economic Stabilization Program. By preventing prices from rising sufficiently, the price controls stimulated desired consumption above the quantities available at the legal maximum prices. Shortages were the inevitable result. Countries that avoided price controls, such as West Germany and Switzerland, also avoided shortages, queues, and the other perverse effects of the controls. Working: OPEC is a cartel—a group of producers that attempts to restrict output in order to keep prices higher than the competitive level. The heart of OPEC is the Conference, which comprises national delegations, usually at the level of oil minister. The Conference meets twice each year to assign output quotas, which are upper limits on the amount of oil each member is allowed to produce. The Conference may also meet in special sessions when deemed necessary, particularly when downward pressure on prices becomes acute. Problems: OPEC faces the classic problem of all cartels: overproduction and cheating by members. At the higher cartel price, less oil is demanded. That is why OPEC assigns output quotas. Each member of the OPEC cartel has an incentive to produce more than its quota and "shave" (cut) this price because the cost of producing an additional barrel of crude is typically well below the cartel price. The methods available to shave official OPEC prices are numerous. Credit can be extended to buyers for periods longer than the standard thirty days. Higher grades (or blends) of oil can be sold for prices applicable to lower grades. Transportation credits can be given. Buyers can be offered side payments or rebates. This tendency for individual producers to cheat on the cartel agreement is a long-standing feature of OPEC behavior. Individual producers usually have exceeded their production quotas, and so official prices have been unstable. But OPEC is an unusual cartel in that one producer—Saudi Arabia—is much larger than the others. That is why the Saudis are the "swing" producer. When prices start downward, they cut their production to keep prices up. One reason the Saudis have behaved that way is that departures from the official prices impose larger total losses on them than on other OPEC members in the short run. Because other producers have huge incentives to produce in excess of their quotas, the Saudis, in order to defend the official OPEC price, have had to reduce their sales dramatically at times. This erosion of Saudi production and sales has tended to reduce their revenues and profits substantially. In 1983 and 1984, for example, the Saudis found themselves producing only about 3.5 million barrels per day, despite their (then) production capacity almost three times that level. Other Examples Drug Cartels: Drug cartels are criminal organizations developed with the primary purpose of promoting and controlling drug trafficking operations. They range from loosely managed agreements among various drug traffickers to formalized commercial enterprises. The term was applied when the largest trafficking organizations reached an agreement to coordinate the production and distribution of cocaine. Since that agreement was broken up, drug cartels are no longer actually cartels, but the term stuck and it is now popularly used to refer to any criminal narcotics related organization, such as those in Guatemala, Honduras, El Salvador, Jamaica, TrinidadandTobago, SouthKorea, DominicanRepublic, Mexico, Japan, Italy, United States, Colombia, Russia, Brazil, Argentina,Afghanistan and Pakistan. Drug cartels currently take in $64.34 billion from their sales to users in the United States, Mexico’s public safety secretary said.Genaro Garcia Luna cited the figure during a speech Wednesday at the international forum organized in the northern border metropolis of Ciudad Juarez by the OCDA, a federation of center-right parties in the Americas.The drugs that the – mainly Mexican – cartels smuggle into the United States include marijuana, cocaine, heroin, methamphetamines and Ecstasy. Mexico produces substantial amounts of marijuana and crystal meth and smaller quantities of heroin. South America is the source of cocaine that Mexican gangs smuggle into United States. Cement Cartels – In a recent case in India, Competition Commission of India penalised ten top Indian cement companies with Rs. 6,307 crores for froming illegal cartel. CCI found cement makers had violated the provisions of the Competition Act, 2002, which deals with anti-competitive contracts, including cartels. In India, 21 top companies control 90% of the market and 40% of the market is controlled by two groups, Holcim and Aditya Birla Group "The act and conduct of the cement companies establish that they are a cartel. The Commission holds the cement firms acting together have limited, controlled and also attempted to control the production and price in the market in India," CCI said in its 258-page order. Problems Members of a cartel generally agree to avoid various competitive practices, especially price reductions. Members also often agree on production quotas to keep supply levels down and prices up. These agreements may be formal or they may consist of simple recognition that competitive behaviour would be harmful to the industry. Ironically, each member of a cartel has an economic incentive to cheat on any collusive agreements that are reached. For example, some companies or countries may choose to cheat on production quotas -- thereby enabling them to sell more of a particular product at higher prices (prices that are, of course, driven artificially higher when other members adhere to the agreed-upon production quotas). Another way members often cheat on the cartel is to lower prices. An undetected price cut will help a company to attract customers who are buying from the other members, as well as customers who are not buying the product at all. Some of these price adjustments may be subtle, including better creditterms, faster delivery, or related free services. Cartels have less control than monopolies, where only one company or country manipulates supply. For this reason, prices in oligopolistic industries are generally not as high as they would be at the monopolistic level. However, prices are usually well above those that exist in purely competitive markets. References Websites 1. https://sites.google.com/a/spartanpride.net/j-baade/markets-types-and-competition 2. http://www.econlib.org/library/Enc1/OPEC.html 3. http://www.cliffsnotes.com/more-subjects/economics/monopolistic-competition-and-oligopoly/cartel-theory-of-oligopoly 4. http://www.investopedia.com/terms/c/cartel.asp 5. ://econworks.org/wp-content/uploads/2013/01/Characteristics-of-Market-Structure.pdf 6. http://www.laht.com/article.asp?ArticleId=342471&CategoryId=14091 7. http://indiatoday.intoday.in/story/competition-commission-of-india-slaps-penalty-on-cement-cartel/1/201872.html 8. http://competitioncommission.gov.in/advocacy/PP-CCI_CartelsNew_7_12.pdf 9. http://forbesindia.com/article/briefing/cci-the-cement-cartel-of-india/33354/1 Books 1. TR Jain and VK Ohri, Introductory Microeconomics and Macroeconomics, Edition 2010, Reprint 2011, Chapter - Competitive Firms in Market, Page 124-140. 2. NCERT - Introductory Microeconomics of Year 2010, Reprinted 2011, Chapter – Forms of Competetion, Page 70-74. 1
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