A cartel is a form of market power in which suppliers collude with each other to manipulate supply. The most famous cartel in the world is OPEC, the Organization of Petroleum Exporting Countries. It turns out that crude oil is found in many countries in the world. In fact, there are probably oil wells in pretty much every country in the world. But there are a few countries that have large supplies of oil that is relatively cheap to produce.
The history of the international oil industry is convoluted and full of lots of stories about power, colonialism, and nationalism. The oil in many parts of the world was controlled for about half a century by a group of American and European companies called the "Seven Sisters." The countries in which the oil was found resented this control, as they believed that the price was being kept artificially low to benefit the consuming, and not producing countries. Several of these countries banded together to take control of their own resources and formed the organization we know as OPEC.
As I mentioned, there is a lot of fascinating history in the oil industry and OPEC. If you have more interest, I suggest you look at the Wikipedia page for OPEC for a quick overview, and if you are interested in investing a little more time, I recommend reading the book "The Prize" by Daniel Yergin. However, this is an economics course, and I want to focus on the economics of cartels.
OPEC is able to act somewhat like a monopolist, even though the oil industry is not a monopoly. OPEC countries produce about 30% of the world's oil. However, they produce a lot of low cost oil, so they are able to effectively control the supply curve and where it intersects the demand curve by restricting their output. This is shown in Figure 5.6 below.
As mentioned in Figure 5.6, OPEC controls the "low cost" part of the supply curve. By exercising control and reducing output from where it would be in an uncontrolled, competitive market, they are able to shift the equilibrium from the competitive point (P*, Q*) to what I call the "OPEC" point: (P(O), Q(O)), which gives us a price that is higher than the competitive market price.
I should make it clear that OPEC is not trying to maximize the price in the short run. Since the elasticity of demand for oil is quite steep in the short run, OPEC could raise the price quite a bit more with slightly lower production. However, such actions are likely to be damaging to the OPEC nations in the longer run: it will cause recession, which hurts long-term demand, but, more importantly, having a very high oil price will incentivize the development of alternative energy sources, which means that oil would then have substitutes, and its demand elasticity would not be as steep. OPEC would not, then, be able to control the price as much.
Instead, OPEC is playing a bit of a game, whereby they are trying to find the price that is as high as possible without spurring the development of alternatives. OPEC tries to "stage-manage" the price of oil to provide the long-term maximum profit.
It should be said that cartels are difficult to hold together. The principal reasons are as follows:
These are the main reasons why cartels like OPEC are difficult to maintain. Please read the full list on pages 248-249 in Chapter 11.