Cartel Formation in oligopoly market || price and output equilibrium in oligopoly market

How Cartel is formed in oligopoly market? Explain how price and output equilibrium is determined in the Oligopoly market ? 

In an oligopoly market, cartels can form when a small number of firms dominate the industry. These firms have significant market power, allowing them to collude and coordinate their actions to maximize collective profits. Cartels typically involve agreements among firms to restrict competition by controlling prices, output levels, and market shares.

The formation of a cartel in an oligopoly market usually involves several key steps:

Identification of Dominant Firms: In an oligopoly, a few firms often dominate the market. These firms recognize their market power and the potential benefits of collaboration.

Agreement: The dominant firms enter into an agreement to coordinate their actions. This agreement may involve setting prices, allocating market shares, or limiting production to maximize joint profits.

Enforcement Mechanisms: Cartels require mechanisms to enforce compliance with the agreement. This can include monitoring systems, penalties for non-compliance, and mechanisms for resolving disputes among cartel members.

Market Segmentation: Cartels may segment markets to reduce competition among members. This can involve dividing territories, customer segments, or product lines to minimize direct competition.

Price Fixing: One common strategy in cartel formation is price fixing, where members agree to set prices at a certain level to avoid undercutting each other. This allows cartel members to maintain higher prices and increase profits.

Output Limitation: Cartels may also agree to limit production levels to artificially reduce supply and drive up prices. By restricting output, cartel members can create scarcity in the market and maintain higher price levels.

Once a cartel is formed, determining the price and output equilibrium involves considering the interplay of various factors:

Demand and Cost Conditions: Cartel members must assess demand conditions in the market, including price elasticity and consumer preferences. They also consider production costs, including fixed and variable costs, to determine the profit-maximizing level of output.

Collusion and Coordination: Cartel members coordinate their pricing and output decisions to maximize joint profits. This coordination ensures that members do not undercut each other or engage in price wars that could erode profits.

Market Dynamics: Cartels must consider the potential reactions of non-cartel firms and the regulatory environment. Antitrust laws may prohibit collusion and price fixing, leading to legal risks for cartel members.

Monitoring and Enforcement: Cartels require mechanisms to monitor compliance with the agreed-upon pricing and output levels. Enforcement mechanisms such as fines, expulsion from the cartel, or legal action may be used to punish members that violate the agreement.

Long-Term Stability: Cartels aim to maintain stable prices and profits over the long term. This requires ongoing coordination among members and adaptation to changes in market conditions, such as shifts in demand, changes in input costs, or entry of new competitors.

Overall, determining the price and output equilibrium in an oligopoly market with a cartel involves a complex interplay of economic, strategic, and regulatory factors. Cartel members must balance the pursuit of individual profits with the need for cooperation and coordination to sustain the cartel over time.