Summarize the three conditions cited in the text under which a cartel is most likely to succeed. Of these three, which do you think is most important? Why?

Question

What will be an ideal response?

Answer 1

A cartel agreement has the greatest chance of success when the cartel can raise the price of its product without inducing significant competition from non-cartel members, when the expected punishment for forming the cartel is low, and when the costs of establishing and enforcing the agreement are relatively low. Regarding the first condition, it would seem that if competition from nonmembers is likely to be an issue, there is a reduced likelihood the cartel will be formed or, if it is, efforts will be made to induce those potential competitors to join the cartel. The second condition also seems rather straightforward. i.e., the cartel in question is either legal or it is not and it will be treated accordingly. Thus, of the three, the third would seem to be most important because it addresses the problem of cheating by the cartel members. The problem of cheating can be very destructive. To the extent that individual members cut side deals with customers (in the form of price concessions or increased output) the credibility of the cartel is weakened. Moreover, there is an increased incentive for other members to cheat on the agreement as well in order to protect their market share and their profits. As the amount of cheating increases, so does the likelihood the cartel will fail.