Consumer and producer surplus in perfect competition market

The cartel case which would be referred to and discussed in detailed would be titled, Antitrust: Commission fines wax producers Euro 676 million fines on 9 groups - ENI, ExxonMobil, Hansen &Rosenthal, Tudapetrol, MOL, Repsol, Sasol, RWE and Total for taking part in price fixing and market sharing cartel for paraffin wax in the European financial area. This cartel case was investigated by your competition Commission in April 2005 after one of the companies involved, Shell, revealed the existence of the cartel to the Commission. The Commission thus decided to start out investigation by implementing surprise inspections on the firms mentioned to be involved in the cartel and it was not a long time before the existence of the cartel was confirmed.

Collusion is the attempt by firms to set and maintain artificially high prices. Additionally it is an act of anti-competitiveness. The group of businesses acting together and agreeing never to sell below confirmed price by participating in price fixing agreements is referred to as cartels. Which means that firms have the ability to control quantity and fix prices. Cartel is much profitable than profits earned in a competitive oligopoly as it help firms involved in the cartel to maximize joint profits in an act much like monopoly when they set and keep maintaining artificially high prices. Every firm that colludes will definitely gain even profits from the collusion hence assists with reducing market uncertainty. This is an edge in the eyes of many firms and the full total profit would attract organizations in the market to be part of a collusive agreement or cartel. However cartel is illegitimate in general which is not easy to detect a cartel.

This portion of this essay would discuss reasons in relation to cartel agreements being bad for the consumer, producers and the competitiveness of the economy as a whole and measure the strategies that only facilitate in maintaining collusions.

With a cartel, businesses involved would be shielded from competition in the market as cartel allows these companies to charge higher prices thus removing the pressure on these organizations to improve their efficiency in production. Furthermore, high prices would mean that consumers would need to pay an increased price now which is in fact, harms the consumers.

When markets grow and develop, firms would increase their expectations of the quantity of profits that they would be more likely to earn over time. Having a cartel, it ensures that firms involved would maximize joint profits and gain even profits from the cartel. If there is a new product on the market, the buyer demand in the market will probably increase hence should firms stick to collusion, they might be guaranteed a straight profit when compared with companies deviating from the cartel. This acts as a motivation to firms, making them less inclined to deviate and therefore cartel has been facilitated to sustain. However, should there be considered a decline in the market, there would be lesser demands which would result in a decline in the incentive for companies to collaborate. Hence, only an evergrowing market can facilitates firms to be in collusion.

Different firms operate on different capacities for production. Some companies have high capacity while others would have low convenience of production. In cartel cases, organizations do not need to have high capacity in order to gain that even amount of profits. It will always be due to this that companies with low capacity would prefer to be involved in collusion. When firms decide to deviate from the collusion, they might require high capacity to be able to supply the entire market. Making a proceed to deviate from collusion would not be considered a smart option for companies which activities capacity constraints. Should they continue being involved with cartel, it is much more likely that they would earn a higher profit as compared to them needing to struggle to produce enough to meet up with the demands of the marketplace. This is because factories with limited capacity may not be huge or resourceful enough to produce more units. Therefore, capacity constraints would facilitate businesses to collude.

In some markets, the costs set by the various firms tend to be noticeable than others. For example, prices of products in the supermarket are being shown on the shelves and everyone can browse the price from the label. As prices are able to be seen, information of deviations would be observable as well. In order to avoid being found out to be involved in a cartel, businesses on the market would probably to restrict output and prices to monopoly level. It can therefore be assumed that the greater the information is open to the competitive firms, a lot more firms will adhere to collusion hence facilitating companies to collude.

Firms that set low prices would attract consumers' attention and obtain greater consumer demand. However, when firms set low prices, they detached the existence of competitive advantage for the firm. Furthermore, there is no incentive for another firm to create a price less than the rest of the firms in the market. It is because once a company sets less price, the prices of other competitive firms in the market may very well be influenced by the first firm and prices would decline. Hence, it brings about businesses earning lesser profits than they actually do initially prior to the fall in prices. Furthermore consumers would also report any organizations which deviate from the price set by most firms on the market, making it apparent that businesses are in a cartel. Therefore, setting high prices in the market would facilitate collusion.

This portion of the essay covers economy analysis to look at cartel agreements using the case as reference and the effect of cartel on consumer surplus, producer surplus and total welfare.

Collusion may be tacit or explicit collusion. Tacit collusion refers to organizations in a cartel setting prices and quantity with no formal contact or meetings while explicit collusion refers to firms in a cartel setting prices and quantity in a gathering which is really as illustrated in the procedure of cartel this case. The organizations involved had regular meetings held for prices discussions. The meetings of the cartel occurred at top hotels all over Europe following the initial meeting in Germany.

Cartel agreement may be legally enforced by the binding contract. In cases like this, there is no binding agreement. Although deviation from the agreement and undercutting its rivals is thus being permitted for just about any firms, there is not much to gain from doing so since regular meetings are held. If a firm deviates and sets a lower price or more output than the prices and quantity set by the cartel, this firm may earn much more profits this week but would not make any profits another week. In an economic perspective, a firm would rather choose to cooperate and earn constant profits rather than risking to be exposed and earn less or even no profits. Therefore, deviation from the agreement would not be an intelligent move to be taken by any organizations involved in the cartel.

In general, cartel is unlawful in countries such just as the European countries. It is not easy to identify a cartel. Even though businesses in a cartel would set high prices, these high prices on the market and common price changes is definitely not equivalent to firms participating in a cartel. Furthermore, companies can exploit their market power but being competitive with other organizations at the same time, hence adding to the difficulties of detecting a cartel. Despite price data in the market having to provide information needed to investigate an industry, the data is insufficient to provide true proof cartel. Hard evidence would be necessary to prove that collusion does exist among those firms.

Before any firm participates in collusion of your cartel, these businesses will probably have operated on the perfect competition market structure where firms compete in the market. No organizations have any influence on the prices set by other firms with regards to the output. Give the existence of competition on the market, should one firm make an effort to raise its price, consumers would turn to some other producer to instead hence the first firm wouldn't normally be able to sell anything. Furthermore, competitive firm would set pricing at Marginal Revenue (MR) = Marginal Cost (MC) as a means of profit maximization.

Figure 1: Graph on consumer and producer surplus in Perfect Competition market

Consumer surplus refers to the differences in cost which the consumer is willing and able to pay and the actual price they pay whereas producer surplus identifies the difference in expense which the producers are willing and in a position to produce and the actual price they receive. Inside a competitive market, the consumer surplus would be area Some time the producer surplus would be area B in above Figure 1. This means that consumers and producers enjoy equal welfare.

With cartel, organizations behave in a market structure near to monopoly where companies produce at high prices with low output to earn monopoly profits. There is absolutely no existence of competition between firms as organizations have colluded to form a cartel; prices and output would have been discussed. Within a monopoly market structure, firms would produce where Marginal Revenue (MR) meets Marginal Cost (MC). However, unlike a competitive firm, the marginal income would be afflicted by the output of the firm. Within a cartel, firms produce lesser (QM) at a higher price (PM) than what companies would produce (QC) and price (PC) their outputs when in a perfect competition market structure.

Figure 2: Graph on consumer and producer surplus in Perfect Competition and Monopoly markets

The consumer surplus would be area A and producer surplus would be area B and C of Figure 2. As discussed above, prior to the cartel, consumer surplus was a blend of areas A, C and D and producer surplus was a mixture of areas B and E. With cartel, there's been a significant loss in total welfare of consumer and producers. Although producers gained from consumer surplus of area C, this gain is still smaller than losing in consumer surplus and producer surplus as an overall welfare analysis. The deadweight loss in this case is the combination of areas D and E.

In Figure 1, individuals are able and willing to pay more than the actual price when compared with Figure 2. Therefore, consumers benefit more when firms operate in a perfect competition market structure and the authorities might use this price information as part of the investigation.

The last section of the essay would evaluate on the authority's decision on the cartel agreements with regards to the situation used as reference.

It is actually a main challenge for competition authorities to prove that collusion does exist. Yet, in this case, Shell revealed the existence of the cartel to the Commission. This instigated the Commission to conduct a random and surprise investigation on the firms mentioned to be engaged in the cartel namely ENI, ExxonMobil, Hansen & Rosenthal, Tudapetrol, MOL, Repsol, Sasol, RWE and Total. Secret cartel is serious offence with regards to competitiveness of businesses on the market. Your competition regulators would impose regulations on companies to prevent them from affecting the competitiveness of the market because of the fact that anti-competitive market would harm consumer. The investigation revealed that different organizations held different names for the cartel in their individual businesses such as "Paraffin mafia" in Shell and "Blauer salon" in the Sasol group.

In setting the fines to impose on the 10 businesses involved in this cartel case, the Commission took into consideration the sales influenced by this collusion. As Sasol is the leader of the cartel, the fine for Sasol was increased by 50%. Furthermore, given that it isn't the very first time ENI and Shell have been fined for cartel agreements, both fines were increased by 60%. However, as Shell was the first firm that came forward to report that it's part of the collusion, Shell was granted 100% leniency of reduction in 96 000 000 Euros of fine, therefore received full immunity from fines. Leniency act was formed to encourage involved organizations to provide the Commission with insider information of the cartel. Sasol, Repsol and ExxonMobil cooperated with the investigation and were hence rewarded with reduction of fines of 50%, 25% and 7% respectively.

The fines imposed and the leniency reductions granted by the Commission in cases like this are as listed

The fines imposed were decided by the Commission based on a sigificant number of factors such as the firm's depth of involvement in the cartel, the benefits on sales which the firm obtained, the amount of cooperativeness in investigation and the cartel records of the average person firms. Guilty companies were fined up to 10% with their turnover during cartel and the fines collected would go to the Commission Budget which really helps to ease the burdens of heavy taxations on individuals. Furthermore, it's been granted that organizations or people that feel that these were damaged by this illegal agreement and anti-competitive behavior may seek damages from the Commission. It is agreeable that the correct decision was reached.

However, it can be arguable that leniency granted in this case went too far. Shell is a repeat offender of cartel agreements and was already fined the second time. Despite these records, Shell was granted 100% leniency from the original fines imposed in your choice made by the Commission for this case because Shell was the first firm involved to report on the unlawful cartel agreement. A stricter law could be suggested and created to be imposed on repeat offenders. It could be recommended that once a company participates in a cartel agreement and is found guilty by the Commission, the firm would be suspended from procedure for at least per year. This act would hence probably discourage businesses from participate in the illegitimate cartel agreements because being suspended from operation would mean that the firm's market shares, profits and reputations would be at stake.

In conclusion, this essay has provided discussions on cartel agreements, examined a cartel case handled by the European Commission in 2005, analyzed the economics involved and evaluated the detection of the cartel and the policy responses and fines imposed by the European Commission on the participants in relation to the truth attached in Appendix 1.

Also We Can Offer!

Other services that we offer

If you don’t see the necessary subject, paper type, or topic in our list of available services and examples, don’t worry! We have a number of other academic disciplines to suit the needs of anyone who visits this website looking for help.

How to ...

We made your life easier with putting together a big number of articles and guidelines on how to plan and write different types of assignments (Essay, Research Paper, Dissertation etc)