The 7 key factors that lead to cartel formation and the impact on the economy

Open market operations have a critical role in maintaining economic stability. However, when certain economic actors form a cartel, it can have disastrous effects on the economy. Cartels often form in industries with high barriers to entry, limited competition, and where there is profit to be shared. Discover the seven key factors that lead to cartel formation and its impact on the economy.

Impact on the economy

A cartel is a group of producers or sellers who collude together to limit production, fix prices, and monopolize the market. This results in a net negative impact on the economy, as it reduces competition and distorts the market price.

  • Studies show that cartels can lead to up to a 20% increase in prices
  • Cartels lead to reduced output levels as member firms restrict production levels to keep prices high
  • Cartels harm innovators and entrepreneurs who find it difficult to penetrate a market that is dominated by cartel members

Lack of competition

One of the primary reasons cartels form is because of a lack of competition. Industries that have high barriers to entry are prime candidates for cartel formation, as it is difficult for new entrants to break into the market. This can be seen in markets such as the petroleum industry, where a small group of major players control most of the market share.

  • Cartels hinder competition and prevent smaller players from competing on an equal footing with larger firms in the market
  • Barriers to entry such as high start-up costs, strict licensing requirements, and intellectual property barriers favor established players, making it harder for new entrants to enter the market

Influence on pricing

Cartels aim to maintain high prices for their goods and services by colluding to set prices and limit output. This results in consumers having to pay more for goods and services than they would in a competitive market.

  • As there is limited competition, the cartel members can agree to set prices above what would otherwise be the market price
  • Cartels often maintain their high prices by limiting supply, which leads to artificially high prices and reduced choice for consumers

Negative impact on consumers

The negative effects of cartels are felt most acutely by consumers, who pay higher prices for goods and services while receiving less output overall. Consumers ultimately bear the brunt of the cartel’s actions, as they are left with fewer options and higher costs.

  • Cartels limit consumer choice by limiting supply and pushing up prices
  • Cartels often stifle innovation and reduce the quality of goods and services. In a market with limited competition, there is little incentive to improve products and services as customers have few alternatives or choices
  • Cartels also make it difficult for consumers to hold businesses accountable for unethical or illegal practices

Cartels are detrimental to the economy and harm consumers in particular by limiting competition and driving up prices. Governments and regulatory bodies play a key role in monitoring and enforcing antitrust laws to prevent cartels from forming and to ensure a healthy and competitive market.