A2 – Cartels: Theory and Practice – Airline Freight Cartel

THEORY
With the A2 essay paper on Friday here is an example of a cartel that got caught. Remeber the theory behind cartels. A cartel operates in the Oligopoly market. It is a mistake to believe that ALL oligopolists face a KINKED DEMAND CURVE. Oligopolists may either:

a) COMPETE VIGOROUSLY or
b) COLLUDE (e.g. in cartels) or
c) PLAY SAFE (as in Kinked Demand Curve Theory)

Collusion in oligopoly
Where oligopolists agree formally or informally to limit competition between themselves they may set output quotas, fix prices, or limit product promotion or development. A formal collusive agreement is called a cartel. A cartel can achieve the same profits as if the industry were a monopoly. Covert (formal) collusion occurs where firms meet secretly and make decisions about prices or output. Tacit (informal) collusion is much more difficult to control. This is when firms act as if they have agreements in place without actually having communicated with each other.

Collusion between firms whether formal or informal is more likely when:

• there are only a few firms in the industry, so reaching an agreement is easier and any cheating can be spotted quickly.
• they have similar costs of production and methods of production making any agreement on price easier to reach.
• the firms produce similar products. Cartels have been common in industries such as cement production in recent years.
• the products have price inelastic demand meaning that a rise in price by the cartel will lead to a rise in sales revenue for the firms.
• the laws against collusion in a country are weak or ineffective.

PRACTICE – CARGO CARTEL

Yesterday the European Commission fined 11 airlines almost 800m euros for fixing the price of air cargo between 1999 and 2006. The airlines colluded on some surcharges between December 1999 and February 2006.

* Initially, the airlines contacted each other so as to ensure that worldwide airfreight carriers imposed a flat rate surcharge per kilo for all shipments.
*The cartel members extended their co-operation by introducing a security surcharge and refusing to pay a commission on surcharges to their clients.

The Commission imposed the biggest fine – 340m euros – on Air France-KLM, which was formed from a merger in 2004 and which now owns Martinair, which was also fined (see table). Lufthansa escaped a fine because it alerted the regulatory authorities to the cartel. Obviously companies that used the freight service were affected by this therefore a group of firms, led by the Swedish telecoms group Ericsson and Dutch electronics giant Philips, are suing Air France-KLM and its Martinair subsidiary for 400m euros. (NZ$ = €0.56)

1 thought on “A2 – Cartels: Theory and Practice – Airline Freight Cartel

  1. Jim Rose

    I don’t think any of your criteria applies to the airline cartel. Maybe they are being punished for attempted collusion rather than successful collusion

    Reply

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