Definition of cartel
- illegal drug cartels
a cartel of oil-producing nations that controls production and influences prices
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The literal meaning of Italian cartello, a derivative of carta, “leaf of paper,” is “placard.” The word is also used for a letter of defiance or a challenge. In this sense the Italian word was borrowed into Middle French as cartel, and the French word was borrowed into English. In English, a cartel was originally a letter of defiance. Later the word came to be used for a written agreement between warring nations to regulate such matters as the treatment and exchange of prisoners. Another type of agreement, a combination of commercial enterprises, is now called a cartel.
A cartel is an organization of a few independent producers for the purpose of improving the profitability of the firms involved. This usually involves some restriction of output, control of price, and allocation of market shares. Members of a cartel generally maintain their separate identities and financial independence while engaging in cooperative policies. Cartels can either be domestic or international. Because cartels restrict competition and result in higher prices for consumers, they are outlawed in some countries. The only industry operating in the U.S. with a blanket exemption from the antitrust laws is major-league baseball.
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.
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 behavior 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 credit terms, 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.
Federal antitrust laws, most notably the Sherman Act, make cartels and collusive activity illegal in the United States. One of the world's best-known cartels is the Organization of Petroleum Exporting Countries (OPEC).
Cartels are most effective when the demand for the cartel's product is not very price sensitive. This is why cartels are more effective in the short term; over the long term, prices often become elastic as consumers find cheaper substitutes for the product. Also, demand volatility usually leads to disagreements within cartels regarding limits on output and capacity. In addition, the incentive for equity fund members to cheat on their agreements is often high, and this can lead to further disputes and difficulties maintaining cartel unity.
Cartels also do not last long in industries with low barriers to entry. In these types of industries, the threat of potential rivals generally reduces the gains to be had from collusive behavior. Although new producers may join a cartel, when membership levels increase, this often makes communication, negotiation, and enforcement more difficult.
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