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Collusive oligopoly refers to a situation where in the firms in a particular industry decide to come together as a single unit for the purpose of maximizing their joint profits and to negotiate among themselves regarding their market share.

Perfect cartel is an extreme form of perfect collusion oligopoly wherein the firms producing homogeneous product form a centralized agency. The individual firms surrender their price-output decision to this agency which determines output quotas for its members, the price here to be charged and the distribution of industry profits.

Let us assume that a cartel consists of three firms A, B and C are producing homogeneous products with different costs of production. Before price and output are determined by the cartel central agency, it will estimate the industry demand curve showing the different quantities which can be sold by the industry as a whole at different prices. Once, this done, the corresponding marginal revenue curve will also be known. The industry's marginal cost curve is derived by horizontal [addition] of the marginal cost curves of individual firms A, B and C. Here, the profit maximizing output will be determined at the point where the industry's marginal cost curve intersects with the industry's marginal revenue curve. This can be explained in below mentioned figure.

As shown in above figure- MC1, MC2, MC3 are the marginal cost curves of three oligopolistic firms A, B and C. Here, the horizontal summation of MC1, MC2 and MC3 gives the combined MC (marginal cost) which intersects industry's MR (marginal revenue) curve at point T. The industry's equilibrium level of output is OS and the profit maximisation price is OP or SB as shown in figure.

The cartel agency had to allocate the total output OS among the member firms. Here, the agency tackles this problem by equating the industry's marginal revenue to the marginal cost of individual firms. Thus, the share of firm A is OQ1, the share of firm B is OQ2 and the share of firm C is OQ3 which is equal to the total output OS that is (OQ1 + OQ2 +OQ3 = OS). Here, it should be noted that the firm C with lower cost will sell a large output OQ3 , means greater than OQ2 and OQ1. However, it does not mean that firm C will get more profit than firm B or firm A. The joint profit as shown in figure PBTA will be pooled into fund and it is distributed by the cartel agency according to the agreement arrived at the three firms at the time of the formation of the cartel.

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