Why do cartels often dissolve?

Question

Firms in a cartel face different costs than firms outside a cartel.

Their members often find that they do not earn as high profits from the cartel as they had hoped to.

It is difficult to enforce the agreement among the cartel members.

Their members often set a time limit as to how long the cartel should exist.

Answer 1

Cartels often dissolve for several reasons, with key factors including:

1. Difficulty in Enforcing Agreements: Maintaining the cartel requires that member companies adhere to the agreed-upon prices and output levels. However, monitoring and enforcement can be challenging, and members may cheat to gain a competitive advantage, undercutting the cartel's stability.

2. Incentive to Deviate: Members may find that they can increase profits by lowering their prices or increasing their output, even if it harms the cartel's overall profit. When cartel members deviate from their agreements, they can temporarily capture a larger market share.

3. Dynamic Market Conditions: Market conditions can change, making it difficult for a cartel to adapt. New entrants, changes in demand, or shifts in consumer preferences can pressure cartel members to modify their strategies.

4. Legal and Regulatory Pressures: Antitrust laws and regulatory scrutiny can threaten cartels. The risk of legal consequences can deter members from adhering to a cartel agreement.

5. Lack of Commitment: Over time, individual firms may reassess their commitment to the cartel, particularly if they perceive that the benefits of sticking together do not outweigh the potential advantages of competing independently.

6. Short-Term Gains: Even if members set a time limit or anticipate stability, the lure of short-term profits can lead to individual members breaking from the agreement prematurely.

While these factors contribute to the dissolution of cartels, the challenges of coordination and maintaining trust among members are often the most significant hurdles.