Cartels Work Unless They Don’t

unicornI spend a lot of time describing unicorns in my undergraduate classroom. And by unicorns, I mean perfectly competitive markets and their features. If you’re a little rusty on this stuff, it goes like this: no single consumer or firm can affect the market price. This requires perfect information, no externalities, free entry and exit, blah, blah, blah.

Most markets are not perfectly competitive. For example – there can be huge returns for firms to try and raise prices above competitive levels. There are several ways to do this, but one of the most popular is to collude with your frenemies in a so-called cartel. Cartels can restrict output, which reduces total supply and leads to higher market prices. Consumers suffer, cartels (and most other producers) make out like bandits!

When everyone in the cartel sticks to the plan, this can work beautifully. So beautifully that in the US we have antitrust laws that prevent firms from colluding and setting prices artificially high (If you are in need of an excellent and entertaining summer read, read this). But on the international stage, one of the most well-known cartels is OPEC. These oil producing nations get together and set production targets that serve their interests (usually higher prices). In order for OPEC to function, its members need to stick to the agreed targets. A problem arises when the members of a cartel cannot agree to targets and do what is optimal for the individual countries, not the whole of OPEC.

And this is what appears to be happening in Qatar right now. Sixteen oil producing nations (essentially the OPEC nations and Russia) who jointly produce a significant share (yet less than 50%) of global output are engaged in talks about restricting output in order to prop up prices. Observers are suggesting that no meaningful restrictions will emerge from the talks. The markets agree with this. Oil prices fell on Friday and early morning trading in Asia raised fears of a significant drop in oil prices when major markets in the Western Hemisphere open, which is exactly what happened.

What does this mean for the average US consumer? If you are planning a road trip in your RV, which gets a glorious 3 mpg, to the national parks this summer, you should rejoice. The failure of oil producers to collude will lead to lower prices during driving season.

What does this mean for the atmosphere? Despite massive and unprecedented policy efforts to reduce emissions from transportation fuels, this lack of collusion leads to even lower prices and more miles driven. People in the market for a new car are already buying less fuel efficient cars than they would have if prices were high, which is bad news for the environment.

What I am saying may sound crazy on the surface; but if you are the global environment, successful collusion here might be a good thing! In unregulated markets with externalities, prices are too low and production/emissions are too high. Collusions will drive up prices and drive down consumption, which is a net gain for society.

Of course, there will be no domestic tax revenues that can be redistributed – all the revenues will go to a bunch of oil rich countries. This means no dollars to be redistributed, invested in the development and deployment of more renewable energy in the countries where the majority of consumption takes place. So in a perfect world, where I am the king of carbon, I would like not cartels, but a carbon tax. But, since I am missing this title I am going to stick to Severin’s proposal for a gas price floor domestically. Yes. It’s time for higher gas prices.

About Maximilian Auffhammer

Maximilian Auffhammer is the George Pardee Professor of International Sustainable Development at the University of California Berkeley. His fields of expertise are environmental and energy economics, with a specific focus on the impacts and regulation of climate change and air pollution.
This entry was posted in Uncategorized and tagged , . Bookmark the permalink.

5 Responses to Cartels Work Unless They Don’t

  1. Pingback: Cartels Work Unless They Don’t - Berkeley-Haas Insights

  2. Paul D Brooks says:

    The solution of letting cartels pocket the higher price for gasoline is a very expensive way of reducing green house gas production. Putting more money in the pockets of a cartel who see no benefit to cutting greenhouse gas production may well be counter productive. A more realistic approach world wide would be to charge a revenue neutral carbon tax that rebates all consumers with what would amount to a dividend payment every year. Large producers of green house gases would be penalized, low producers would see a benefit. Being revenue neutral this might be politically possible for some Republicans to support. Poorer countries might also embrace this proposal as they may see some benefit.

  3. dzetland says:

    I always tell my students that monopolies are FANTASTIC for conserving resources, as they are motivated to “hoard” inputs in their quest to limit supply and raise prices. This is an excellent application… and think of all the money that Americans would keep at home (maybe to lower income taxes) while OPEC countries struggle to fianance their broken regimes with $40/bbl oil. Win win!

  4. Jun Ishii says:

    I agree that there may be social gains from oil and gas prices being raised above their current levels. However, I think this and the earlier discussion led by Severin (on a binding gasoline price floor) misses a key point: so-called “free markets” not only help determine the quantity of trade but also, to some extent, the consumers and producers involved in the trades.

    In the simple (simplistic?) Econ 101 version of free markets, a market equilibrium helps ensure that supply comes from units with the lowest marginal cost and demand from units with the highest marginal value. When binding price controls are introduced, the resulting market “disequilibrium” may still pin down the quantity of trade, but not the set of producers and consumers. In the case of a binding price floor, the set of consumers may be determined but not the set of producers — the surplus resulting from the high price floor may lead to some low marginal cost units being excluded in favor of high marginal cost units. This complicates welfare calculations.

    This is in contrast to taxes. A tax can discourage the quantity of trade, similar to binding price controls, but has the economic advantage of the market (possibly) achieving an equilibrium. As such, a tax can also help ensure that trade involves low marginal cost supply and high marginal value demand. The decreased amount of trade is allocated on an economically sound basis (at least from the simple perspective of total surplus)

    This point may have been raised before — if so, sorry for the duplication. But I feel strongly that, in Econ 101 and the policy arena, we “over-emphasize” the quantity of trade issue and not enough the allocation of trade issue

  5. Jardinero1 says:

    Markets can be flexible; cartels are inherently rigid. Markets weed out inefficient operators via business failure. Cartels keep inefficient producers in business(think Venezuela). Cartels keep innovative substitutes from infiltrating(think the taxi cartels vs uber).

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s