Problems That Cartels Face
Cartels encounter two characteristic problems. The first is ensuring that
members follow the behaviour that will maximize the cartel members’
joint profits. The second is preventing these profits from being eroded by
the entry of new firms.
Enforcement of Output Restrictions
The managers of any cartel want the industry to produce its profit-
maximizing output. Their job is made more difficult if individual firms
either stay out of the cartel or join the cartel and then “cheat” by
producing too much output. Any one firm, however, has an incentive to
do just this—to be either the one that stays out of the organization or the
one that enters and then cheats. For simplicity, assume that all firms enter
the cartel; thus enforcement problems are concerned strictly with
cheating by its members.
If Firm X is the only firm to cheat, it is then in the best of all possible
situations. Other firms have restricted their output and the industry price
is near its monopoly level, allowing all cartel members to jointly share the
monopoly profits. Firm X can then earn extra profits by violating the
cartel agreement and selling additional output at the high monopoly
price. However, if all firms think this way and decide to cheat, the total
level of output will obviously rise and the price will be pushed down to