Firstly, if there are few firms involved, it is easy to monitor each other in terms of quantity and price setting.
It is easy to detect because it is observable if one firm’s Market share has risen, especially where there are a larger number of firms involved. Secondly, a cartel is more stable in markets where price and quantity are easy to observe. If a Market has frequent change in demand, input costs and other factors, then the price of product has to be adjusted according to the fluctuation. Consequently, cheating in cartel may be difficult to detect as it cannot be easily distinguished from other factors.
Cartel is sustainable if prices are widely known, so no one firm is willing to step over the boundary. A cartel can inspect each other by agreeing to see each other’s books, and exchange information. But sometimes, books can be faked by government help in some cases. In a Market where the prices are stable and don’t fluctuate frequently.
Furthermore, in the case where the products of firms offer are of identical quality and properties and of which the the products are at the same point of the distribution channel, the likeliness of cheating is low.The cartel firms will have an idea of each other’s product techniques and know the process, so if one drops it’s price, the observed firm will retaliate by charging a lower price that it knows it is not bearable for the cheated firm(where if the cheated firm react to the price set, it will not make a profit). A cartel is more likely to sustain when there there is public information of the price changes of certain products. Sustainability is questioned if some companies are vertically integrated, where others cannot easily observe the point where the distribution chain cheating occurs.
But cheating is easy to observe if all the companies have the same type of customers, e. g. Customers in retail market. In order to sustain a cartel, there are also methods of prevent cheating, so that a cartel exists for longer.
Firstly, by fixing Market shares. As long as Market shares are easily observable, no firm has an incentive to cut the price. E. g.
Cartel members who detected change of other firm’s output levels will adjust their own production level in order to maintain their proportion of share of the Market. Secondly, by using most-favoured-nation clauses.It guarantees buyer that the seller is not selling the product at a lower price to another customer. So if the seller reduce it’s prices, it will reduce price to all previous customers.
So it is more expensive to cheat for firms that stayed in the Market for a long time. Thirdly, the meeting-competition clause in an advertisement guarantees that if one firm lowers its price, the other firms will match it or release the buyer from the contract. It is difficult for firms to cheat because buyers will brings news of the lower prices to other cartel members.Forthly, by establish trigger prices.
This means that if the Market price drops below a certain level, each firm will expand it’s output to the ore-cartel level. So the cheated firm might gain in extremely short run, but will lose in the end be because of the destruction of the cartel agreement by this predetermined punishment mechanism. Lastly, fix more than must price by dividing the market geographically. This involves in assigning different firms to different geographical areas and this allows cheating to be detected easily.
E. g. The two-country mercury cartel used a geographic division of Market, Spain supplied the US, and Italy supplied europe. In conclusion, it is difficult for some markets to distinguish between random fluctuations and cheating by other firms.
If firms agreed to behave competitively only for a predetermined length of time and then revert to the cartel behaviour, a random fluctuation would not destroy the cartel permanently. Why do we observe price wars? Does this mean collisions are absent in these industries?Many observers argue that firms are trying to form a cartel that keeps breaking apart. The competitive forces keep destroying the cartel. The trigger-price argument holds that price wars occur more often during unexpected business cycle downturns when price is likely to decline in response to lower demand.
So we expect that a cartel is more likely to terminate when there is a price war. But others argue, that during a business boom, then incentive to cheat is greatest because of the greatest benefit from cheating.