The disruption of cartel on oil prices

A cartel is defined as a group of firms that collaborates to make output and price decisions (Smith 2016). The conditions that give rise to an oligopolistic market are also conducive to the formation of a cartel; in particular, cartels tend to arise in markets where there are few firms and each firm has a significant share of the market. In the U.S., cartels are illegal; however, internationally, there are no restrictions on cartel formation. The organization of petroleum exporting countries (OPEC) is one of the best known examples of an international cartel; OPEC members meet regularly to decide how much oil each member of the cartel will be allowed to produce.

Oligopolistic is defined as a state of limited competition, in which a market is shared by a small number of producers or sellers. Oligopolistic firms join a cartel to increase their market power, and members work together to determine jointly the level of output that each member will produce and the price that each member will charge. By working together, the cartel members are able to behave like a monopolist. For example, if each firm in an oligopoly sells an undifferentiated product like oil, the demand curve that each firm faces will be horizontal at the market price. If, however, the oil producing firms form a cartel like OPEC to determine their output and price, they will both face a downward sloping market demand curve, just like a monopolist. In fact, the cartel’s profit maximizing decision is the same as that of a monopolist, as the graph demonstrates. The cartel members choose their combined output at the level where their combined marginal revenue equals their combined marginal cost. The cartel price is determined by market demand curve at the level of output chosen by the cartel. The cartel’s profits are equal to the area of the rectangular box labeled abcd in Figure. A cartel, like a monopolist, will choose to produce less output and charge a higher price than would be found in a perfectly competitive market.