Economics of Cartels


This paper sets out the basic economics of cartel formation and stability, methods of estimating overcharges and but for prices, and concludes with a brief discussion of multiple damage claims for price-fixing. It draws on some evidence of cartel prosecutions in the Europe.

Price-fixing is said to be the most ‘evil’ anti-competitive abuse. It is an agreement (explicit collusion) or other cooperation (‘tacit collusion’) between firms that restricts output, overcharges customers and generates excess profits for its members. In recent years competition authorities across the world have waged war against cartels. This is certainly true of the EC Commission, which has intensified its prosecution of cartels, raised the fines1 and reformed the law to make it more effective. In this chapter I review the economics of cartels, and the issues surrounding the quantification of damages in private actions.

The theory of cartels is simple to state. A group of firms supplying similar products or services come to an agreement or understanding to fix prices and to share the market in order to overcharge their customers. As long as the firms adhere to the agreement or understanding they can profitably raise their prices above current levels and earn greater profits. This harms their consumers who now pay more and consume less, because in order for the cartel to raise prices its members must restrict output.

In most jurisdictions price-fixing and market-sharing are for all intents and purposes per se infringements. This is not to say that price-fixing has not been defended from time to time. It is well known that price and market sharing arrangements were until recently seen as the usual way of doing business. Others have claimed that price fixing is sometimes necessary to prevent ‘ruinous’ or ‘destructive’ competition in oligopolistic industries with high fixed costs subject to frequent ‘price wars’. This was the defence in the celebrated US Trans-Missouri2 case where 18 railroad companies formed an association to set their rates, arguing that absent their agreement there would be ruinous competition, and eventual monopoly and even higher prices. The Court rejected their justification. Some recent literature suggests that competition in high fixed cost industries can lead to an inefficient market structure and that there may be social gains from price-fixing arrangements3. However, these are likely to be special cases.

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