Why are cartel and collusion inherently unstableSolutionThe

Why are cartel and collusion inherently unstable?

Solution

The reasons lies in a situation termed Prisoners Dilemma, which is a situation where, if the two players collude in decision making, then even if individual gain is lower, the collective gain is higher. In the case of an oligopoly, assume there are 3 firms. If they take price/output decisions independently without collusion, for each firm, its individual profit is higher even if at the expense of the other 2 firms (whose profits are lower due to action taken by this firm). But if the three firms collude & decide together, then total profit will be higher than the sum of individual profits in earlier case.

In a cartel or collusion, the participant firm will eventually see that, if it breaks the collusion agreement, its own profit will be higher (even if at the expense of the other two). Therefore, it gets an incentive to break the collusion arrangement.

Therefore, even though cartels & collusions maximize the industry profits, they don\'t maximize individual firm profits, and this is the point of instability.