Economics For Dummies, 3rd Edition
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In some industries, cartels are effective at reducing output and raising prices in the economy. Typically, these are industries where one firm is large enough and powerful enough to truly threaten other firms with bankruptcy.

In some cases, the industry will be broken up into even more firms to promote competition in the economy, but in others, regulations may be installed that regulate the prices firms can charge or the quantities they can produce. The specific policy often depends intimately on the circumstances of the firms in the industry and what policymakers think will best promote the general welfare.

Breaking up dominant firms in the economy

One important strategy for regulating an oligopoly is for the government to break it up into many smaller companies that will then compete with each other. In the 19th century, cartels were called trusts — for example, the Sugar Trust, the Steel Trust, the Railroad Trust, and so on. Therefore, laws that broke up monopolies and cartels were called antitrust laws. The most famous of these in the United States was the Sherman Anti-Trust Act. Most countries have now passed similar legislation to break up monopolies and cartels.

In U.S. history, the Standard Oil Company run by John D. Rockefeller during the 19th century dominated an oligopoly industry. It controlled something like 90 percent of the oil sold in the United States, and if a competitor didn’t do what Rockefeller wanted, he would simply bankrupt the other firm by offering oil at a ridiculously low price that the competitor couldn’t match.

Rockefeller would lose money temporarily while taking this action, but by bankrupting the competitors who disobeyed him, he was able to convince the remaining firms to help him restrain output and make huge profits. Indeed, because Standard Oil exerted so much control, its industry was much more like a monopoly than an oligopoly.

Rockefeller’s effectiveness, however, soon brought a governmental response. Standard Oil was broken up into dozens of smaller, independent oil companies, none of which was large enough and powerful enough to dominate its industry and enforce collusion the way that Standard Oil had.

Attempting to apply antitrust laws to economics

A big problem with antitrust laws is deciding when to regulate oligopolies or break them up to promote competition. The first sign that there may potentially be a cartel is, of course, when you see only a few firms in an industry. But because of the Prisoner’s Dilemma, in some cases even a two-firm industry won’t be able to form an effective cartel. Consequently, prosecutors typically have to do more than just show that there aren’t many firms in an industry.

Typically, there has to be concrete proof of collusion. In other words, if one day every firm in an oligopoly industry decides without coordination to cut its output in half and thereby raise prices, that may not be illegal. But if even a single text message from a manager of one firm to a manager of another firm is found saying that the firms should enter into a cartel, that is illegal and enough for a prosecutor to hang a case on.

About This Article

This article is from the book:

About the book author:

Sean Flynn, PhD, is an associate professor of economics at Scripps College in Claremont, California. A specialist in behavioral economics, Dr. Flynn has provided economic commentary for numerous news outlets, including NPR, ABC, FOX Business, and Forbes.

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