Econ 101: Monopolies and Cartels

Posted: May 3, 2013 by davishipps in Economics

In Competition and Prices, I wrote that “competition is the mechanism for setting prices in a free market.” But what happens when there is only one provider of a good or service? In this case, that provider is said to have a “monopoly” on the market for that product. What if all of the suppliers of a good or service band together so that there is no competition? These suppliers would be involved in a “cartel.” When a monopoly or cartel exists in an industry, then the prices of the products they offer will tend to be higher than they would in a free market. Let’s look at the effects of these situations individually.

In a free market, monopolies don’t tend to last long, for the reason mentioned earlier: as soon as one company is seen to be making a profit, other companies will enter the market for that same product, hoping to copy the original producer’s success. The entry of other companies into the industry will eventually drive prices down to market-clearing levels, and when the only company in an industry originally has set their prices too high, this process proceeds even more rapidly than usual. Only the government can sustain a monopoly, and it does this by granting the monopolizing company exclusive patent rights for their product or else creating high regulatory barriers to entry into the industry.

Cartels usually break up the moment one member realizes that they can increase their profits by offering the product for just a bit less than the cartel-agreed price. As soon as other members see that one company has lowered its price, they must follow suit or risk losing business, and the cartel is dismantled. However, even if all the cartel members stuck to their agreed upon price, the same issue then arises that the monopoly faced: in a free market, some entrepreneur is bound to notice that all the companies in a industry have set their prices too high and decide to enter the market himself, offering the product for a lower price to satisfy the demand. The cartel must now lower their prices to market-clearing levels or risk losing business, and the cartel is effectively dismantled. The only way for a cartel to remain in force is, again, through the intervention of the government via legislative or regulatory barriers to entry into the industry.

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