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Market Cartels
The formation of perfect cartels, has been quite rare in the real world even where their formation is not illegal. In a perfect cartel not only the price but also the output to be produced by each member of a cartel is decided by a central management authority and profits made in all of them are pooled together and distributed among the members according to the terms of a prior agreement. But when cartels are loose, instead of being perfect, the distribution of profits and fixation of outputs of individual firms are not determined in a manner perfect cartel does. In a loose type of cartel the market sharing by the firms occurs. Further, there are two methods of market sharing: non price competition and quotas.
Market sharing by non-price competition: under market sharing by non price competition, only a uniform price is set and, the member firms are free to produce and sell the amount of outputs which will maximise their individual profits. Though the firms agree not to sell a price below the fixed price they are free to vary the style of their product and the advertising expenditure and to promote sales in other ways. That is, the price being a fixed datum, the firms compete on upon price basis. If the different member firms have identical costs then the agreements differences between the firms as is generally in the case, which will ensure maximization of joint profits. But when there are cost differences between the firms as is generally in the case, the cartel price will be fixed by bargaining between the firms. The level of this price will be such as will ensure some profits to high cost firms.
But with cost differences such loose cartels are quite unstable. This is because the low cost firms will have an incentive to cut prices to increase their profits and therefore they will tend to break away from the cartel. However, they may not openly charge lower price than the fixed one and instead cheat the other firms by giving secret price concessions to the buyers. However, as the rivals gradually lose their customers, the cheating by the low cost firms will be ultimately discovered and consequently open price war may commerce and cartel breaks down.
Market sharing by output quota: the second type of market sharing cartel is the agreement reached between the oligopolistic firms regarding quota of output to be produce d and sold by each of them at the agreed price. If all the firms are producing homogeneous products and have same costs, the monopoly solution will emerge with the market being equally shared by them. However, they may not openly charged and the different quotas for various firms will be fixed and therefore their market shares will differ. The quotas and market shares in case of cost differences are decided through their bargaining between the firms. During the bargaining process, two criteria are usually adopted to fix the quotas of the firms. One is the past period sales and productive capacity of various firms is not very firm criteria as they can be easily manipulated. Ultimately the quotas fixed for various firms depend upon their bargaining power and skill.
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Market sharing by non-price competition: under market sharing by non price competition, only a uniform price is set and, the member firms are free to produce and sell the amount of outputs which will maximise their individual profits. Though the firms agree not to sell a price below the fixed price they are free to vary the style of their product and the advertising expenditure and to promote sales in other ways. That is, the price being a fixed datum, the firms compete on upon price basis. If the different member firms have identical costs then the agreements differences between the firms as is generally in the case, which will ensure maximization of joint profits. But when there are cost differences between the firms as is generally in the case, the cartel price will be fixed by bargaining between the firms. The level of this price will be such as will ensure some profits to high cost firms.
But with cost differences such loose cartels are quite unstable. This is because the low cost firms will have an incentive to cut prices to increase their profits and therefore they will tend to break away from the cartel. However, they may not openly charge lower price than the fixed one and instead cheat the other firms by giving secret price concessions to the buyers. However, as the rivals gradually lose their customers, the cheating by the low cost firms will be ultimately discovered and consequently open price war may commerce and cartel breaks down.
Market sharing by output quota: the second type of market sharing cartel is the agreement reached between the oligopolistic firms regarding quota of output to be produce d and sold by each of them at the agreed price. If all the firms are producing homogeneous products and have same costs, the monopoly solution will emerge with the market being equally shared by them. However, they may not openly charged and the different quotas for various firms will be fixed and therefore their market shares will differ. The quotas and market shares in case of cost differences are decided through their bargaining between the firms. During the bargaining process, two criteria are usually adopted to fix the quotas of the firms. One is the past period sales and productive capacity of various firms is not very firm criteria as they can be easily manipulated. Ultimately the quotas fixed for various firms depend upon their bargaining power and skill.
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