Oligopolistic market has a relatively small number of competing firms. In such field, every firm’s output and pricing decisions are likely to have a major effect on its rivals. every firm is interdependence to each others. It can be seen if an individual firm embarks an increase in output or reduction in price.
The sales of its rivals will suffer a big impact, and then they are likely to react. Prior to it is impossible for firm to act independently of each other. a firm need try and predict how rival firms are going to react which causing uncertainty and makes it complicate to plan for the future.So it provokes firms to work on together to reduce the uncertainty. They might agree to restrain their independent decision making. Collusion that takes place in a cartel is an agreement made by a number of independent firms to co-ordinate decisions. Interpreting to Adam Smith, The Wealth of Nations, 1776.
“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices”.Cartel is established and maintained by explicit collusion or tacit collusion. The purpose of the cartel is to earn monopoly profits by fixing the price and restricting output.
A cartel seeks to maximise the profits of all its member firms. It is easier to form a cartel in a market with inelastic demand, because the more inelastic the demand curve, the higher the price that can be set by the cartel with relatively lower reductions in quantity.Firms will have an incentive to stay in or join the cartel if it is difficult to entry the market for non-member firms and there is no prefect or similar substitute products in other industries. Members in cartel need to be able to detect when violations of an agreement take place and be able to enforce the agreement with sanctions against the violators. But these conditions are not easily met and this often explains why cartels tend to break down over time.Referring to the article says, the major petrol firms occupied over 78 % market share in the oil industry and they followed a pattern of parallel pricing since the early 1970s, charging roughly the same wholesale price and offering similar discount for within a geographic region which can be seen they worked as a cartel. It is because cartel members can have an agreement and divide up the market between them and agreeing not to sell in each other’s designated area.
This enables each firm to set prices knowing that its ‘rivals’ will not undercut them.A market-sharing cartel may be no more than an agreement among firms not to approach each other’s customers or not to sell to those in a particular area. It may involve secretly allocating specific territories to one another or agreeing lists of which customers are to be allocated to which firms.
Also cartel is likely to take place in concentrated industries and in smaller geographic areas. Though in this oligopolistic industry are selling homogeneous products (petrol), then it is easier for them to reach the price agreement. Because in this circumstances firms are less difficult to compute whether change in sales.And after Rotterdam spot the petrol price fell by 40 per cent in 1974-75. the major oil companies lost almost 7% market share and reacted was collective, they didn’t reduce scheduled prices but rather introduced almost identical temporary discounts to retailers.
As they didn’t deduct the prices and lost the ability to compete the non-member companies with lower prices petrol selling, but as long as the members of an oligopolistic market are behaving as a cartel, they lose their ability to compete for customers by varying prices.In the absence of price competition, firms are more likely to undertake forms of non-price competition. Therefore, it could remain their relative shares within the reduced total even the smaller companies took some market share away from them. By the end of 1979 and between 1985 to 1990, UK majors searched to gain a greater share in the market by using price competition against each other. At the both strokes, price were cut down as each major sought an increase in retail sales to absorb under-utilised refining capacity.When the number of firms is few, the cost of organizing collusion will be low. Also as this case, the largest firms co-ordinated their activity without the participation of the smaller firms in a market in order to gained the dominant market share. Because the prices were down, and the demand rose for the cheaper, so for those smaller companies were less financial to sustain lowering prices, they lost their share.
It is easier to form a cartel in a market with inelastic demand, because the more inelastic the demand curve, the higher the price that can be set by the cartel with relatively lower reductions in quantity, in other words, it is more complex to form a cartel when the market demand is more elastic. What is more, a cartel among few firms the probability of spotting by the government is correspondingly lower and the negotiations between firms are less complicate and enforcement and monitoring costs of the cartel are low, it will be easily to form combination.Overall, low expectation of serve sanctions would be a factor that incentive oil firms gathered to collude if the cartel might not expect cartel behaviours to be easily unveiled or severely punished. All these expectations come from the legislation might not be as strict to against cartels as the government is not very effective in managing and punishing cartels or when the penalties are not too heavily