Cartels are difficult to maintain because
A the monopoly output is very difficult to determine.
B the number of firms is always large.
C costs to the firms in a cartel are continually rising.
D each firm has an incentive to deviate from its agreed output level.
The correct answer and explanation is :
The correct answer is:
D. each firm has an incentive to deviate from its agreed output level.
Explanation:
Cartels are agreements between competing firms to coordinate actions like setting prices, limiting production, or dividing markets, with the aim of increasing their collective profits by behaving like a monopoly. Although the idea of working together may seem beneficial in theory, cartels are extremely difficult to maintain in practice due to the internal incentives of individual firms to cheat on the agreement.
The main reason cartels are unstable is that each member firm has a strong economic incentive to deviate from the agreed output level—this is known as the “prisoner’s dilemma” in game theory. When firms in a cartel agree to limit output to keep prices high, any one firm can increase its own profits by secretly producing more than its agreed share. By doing so, that firm can sell more units at the high cartel price and earn more revenue, at least in the short term.
However, if all firms start cheating to gain an advantage, total output increases, leading to lower market prices, which ultimately hurts all members. This creates a conflict between the short-term gains from cheating and the long-term benefits of cooperation. Since there is often no strong enforcement mechanism, firms frequently break the agreement, leading to the collapse of the cartel.
Options A, B, and C do not provide strong reasons for cartel instability:
- A, while it is true that determining the monopoly output may be complex, it is not the main barrier to cartel maintenance.
- B, the number of firms can influence coordination difficulty, but cartels can still form with a few firms.
- C, rising costs affect all businesses, not just cartels.
In conclusion, the strongest and most consistent reason cartels fail is the temptation each firm has to break the agreement to gain an individual advantage, undermining the group’s collective benefit.