A cartel maximizes combined economic profits. Which of the following is true?

Each company has an incentive to cheat by reducing prices.

Each company has a demand curve that is perfectly inelastic.

Each company has a kinked demand curve.

Each company has a demand curve that is perfectly elastic.

1 answer

The correct statement in the context of a cartel maximizing combined economic profits is:

Each company has an incentive to cheat by reducing prices.

In a cartel, firms agree to limit production and set prices at a level that maximizes their collective profits. However, each individual firm may have an incentive to cheat by lowering its prices to capture a larger market share, which can lead to a situation where all firms end up lowering prices, undermining the cartel's efforts to maintain higher prices and profits.

The other options are not true in the context of a cartel:

  • A perfectly inelastic demand curve implies that quantity demanded does not change with price changes, which is not typically the case for firms in a cartel.
  • A kinked demand curve suggests that firms face different elasticities of demand above and below a certain price, which is more relevant in oligopolistic competition rather than a cartel setting.
  • A perfectly elastic demand curve means that firms can sell any quantity at a certain price but would sell nothing at any higher price, which is also not typical for firms in a cartel agreement.