A cartel is a group of companies that work together to reduce output, increase prices and thus increase economic profits. If companies agree to set prices and output instead of competing with others, they will be better off. However, if a member increases its output and the rest of the members of the cartel do not, the profits of the cheating member will increase substantially. As a result, once an agreement is reached, each firm has an incentive to cheat on its cartel partners and to increase its profits at the expense of its partners. It can be argued that agreements are less likely to be stable when the number of companies not participating is large, the threat of potential competition is serious, and the competition authorities are imposing large fines. Moreover, if the heterogeneity of the product is significant, the cost asymmetries are large, or the agreement is difficult to monitor, the agreements may not be stable.
Cartels in the United States are illegal. For example, a price agreement was reached by a group of railway companies in the United States in 1897, despite the defence that prices were reasonable and still illegal. Also, exempted agreements must pass four tests that improve efficiency, share profits with consumers, do not contain unnecessary restrictions and do not significantly weaken competition.
Economies of scale is defined as the reduction of the average cost when there is an increase in the of units of good produced.
The economies of scale can be implemented by a company at a certain stage of the production process. There are four components in the production process of a company, including production, purchase, advertising and R&D. First, the source of economies of scale in production is variable. For example, the average cost can be lowered through the spread of fixed input costs over a large number of output units. The impact of fixed costs on an enterprise could change based on the quantity of products it produces. The most common examples of product-specific fixed costs include set-up costs for production, research and development costs, specialized production equipment and training costs. Also, if production technology can increase capacity utilization, the average cost will decrease and lead to a short-term economy of scale. However, it is only by choosing alternative technologies to replace a low fixed-high variable cost plant with a high fixed-low variable cost plant that average costs can be reduced over the long term. Second, specialization could also achieve economies of scale and lower costs. Since the specialization could lead to higher productivity, the costs are correspondingly reduced. Also, larger companies can afford to keep smaller inventories when comparing them with smaller ones. It can be argued that inventory costs are proportional to inventory and sales and that if inventories are relatively large, the average cost may increase. Also, the source of economies of the scale contains the physical properties of production. The increase in the capital may lead to a decrease in the average cost.
Moreover, the sources of purchasing economies of scale may relate to the volume of sales. Generally, there is a price discount on the high volume of purchases of inputs. Moreover, from advertising, given that cost per consumer is the ratio of cost per potential consumer and the proportion of potential consumers who become actual consumers, larger firms could spread fixed costs over a larger base of potential customers and lower costs per potential customer. Also, larger firms have higher advertising reach. Last but not least, it is easier for large companies to bear the burden of complicated research and development ( R&D) costs. For example, complementary assets, internal and external knowledge inflows are all sources of research and development on a firm-level economy.