Why the Cartel Breaks

The idea

A cartel is an attempt to turn an oligopoly into a monopoly by agreement, and game theory explains why the attempt usually fails and sometimes succeeds. Start with the prize. If the few firms restrict output together they reach the monopoly quantity and price and share the monopoly profit; every member is better off than under competition. Now look at one member's incentive. At the cartel price, its own marginal revenue on a little extra output is nearly the full price, far above its marginal cost, because the price cut its extra units cause is spread over the whole industry while the extra sales are its own. So expanding is profitable for it whatever the others do: if they hold, it gains share at a high price; if they cheat, it must cheat too or lose everything. Expanding is a dominant strategy, and all expanding is the Nash equilibrium. The industry lands at the cell every member likes least, with output up and price down toward the competitive level. Three outside forces push the same way: entrants drawn by the high price, members outside the agreement, and the law, which makes the agreement unenforceable. What holds a cartel together is repetition. If the game is played every quarter for years, a member can punish cheating with tit-for-tat or threaten a trigger, a permanent price war, and the expected loss from punishment can outweigh the one-time gain from cheating. That is why tacit collusion survives where formal cartels cannot, and why it frays when demand falls, costs change, or the end of the game comes into view.