Question

Three companies, Optimax, Megachug, and Thirstoid, each with about the same market share, dominate the sports drink market. In an attempt to increase profits, the three companies coordinate their actions and agree to restrict their collective output of sports drinks, thereby increasing the price of sports drinks in the market.

This is an example of:

• A price war
• Price leadership
• A cartel

Answer 1

Above mentioned situation is that of cartel.

let's see what cartel means

A cartel is a grouping of producers that work together to protect their interests. Cartels are created when a few large producers decide to co-operate with respect to aspects of their market. Once formed, cartels can fix prices for members, so that competition on price is avoided. In this case cartels are also called price rings. Cartels are more likely to occur when there are only a few firms : a cooperative oligopoly. They can also restrict output released onto the market, such as with OPEC and oil production quotas, and set rules governing other aspects of the behaviour of members. Setting rules is especially important in oligopolistic markets, as predicted in game theory. A significant attraction of cartels to producers is that they set rules that members follow, thus reducing risks that would exist without the cartel.

A cartel can have a negative impact on consumers but if cartel prooves to be utter failure then it is certainly helpful for consumers.

They are at their most powerful when there are high barriers to entry into the market or industry, and when all members can be ‘policed’ by a dominant member.

Factors that facilitate the formation of cartels

• The ability to raise the industry price
• A trade Association exists
• Low expectation of severe punishment (antitrust laws)
• Low organizational costs
• Only a few firms are involved in the cartel
• The industry is highly concentrated
• Homogeneous good is produced
• Divide the market
• Fix market shares

Factors that reduce the existence of cartels

• Price wars
• Cheating
• Economic recession
• High economic volatility
• New entrants

In the above mentioned situation we can see that the three firms decide to co-ordinate with each other which is one of the main feature of cartel hence it can't be a price war situation. Also it can't be price leadership situation because in price leadership a single price is decided by a dominant company which isn't the case here hence it is an example of a cartel.