FIGURE 11.1 Cartel Instability
A cartel would like to operate as a monopoly, restricting output to 8 (where MR = MC ) and selling each unit at a price of $12 for an industry profit of ($12 – $4) × 8 = $64. If production and profit are shared equally between two firms, each firm earns a profit of ($12 – $4) × 4 = $32. However, Firm A may earn a greater profit by cheating on the agreement and producing another unit, which raises total output in the market and lowers price to $11 per unit. At this price and output, Firm A earns a profit of ($11 – $4) × 5 = $35. So, both firms can earn a higher profit by cheating, and collusion is not stable.