where its marginal cost is equal to the price set by the cartel. This would
allow the firm to earn much larger profits, shown by the diagonally
striped area. However, if all firms increase their output in such a manner,
industry output will increase far beyond and the resulting fall in price
will reduce the joint profits of the cartel.
Cartels tend to be unstable because of the incentives for individual firms to violate the output
restrictions needed to sustain the joint-profit-maximizing (monopoly) price.The predicted instability of cartels is evident in the data. After the
tremendous successes in 1973 and 1979 in restricting the output of crude
oil and significantly elevating its world price, the members of the OPEC
cartel began to encounter difficulties in enforcing their agreements. After
several years of sluggish world demand for oil, the cartel almost collapsed
in 1986 as several OPEC members increased their output in efforts to
generate more income. Throughout the 1990s, however, OPEC members
learned the important lesson that their attempts to push oil prices very
high attract entry, encourage the development of alternative oil supplies,
and undermine their output restrictions. As a result, OPEC members
avoided the large output restrictions and price increases of the 1970s,
instead trying to keep oil prices relatively stable at more moderate levels.
Over time, however, OPEC’s market power declined considerably as its
share of global oil production fell to just over 30 percent (down from 55
percent in the 1970s). While OPEC countries still meet regularly and have
agreements regarding each member’s annual output, the cartel’s ability to
influence the world price of oil is much smaller than it was 45 years ago.
Q 1 ,