In a cartel, the incentive to cheat is significant because

• A. Each firm has an incentive to decrease its own output
• B. Each firm has an incentive to raise its price
• C. Each firm has an incentive to expand its output
• D. Each firm's marginal cost exceeds the price that the cartel sets

Answer: (C)

Verified step by step guidance

1. Understand the concept of a cartel: A cartel is a group of firms that collude to make collective decisions about production and pricing to maximize their joint profits, often by restricting output to raise prices.
2. Recognize the incentive to cheat: Each firm in a cartel has an incentive to cheat by expanding its output because by doing so, it can increase its own profits at the expense of the cartel's collective profit.
3. Analyze the relationship between marginal cost and price: In a cartel, the price is typically set above the marginal cost to maximize profits. However, if a firm's marginal cost is below the cartel's price, the firm can increase its profit by producing more units.
4. Consider the impact of cheating on the cartel: When a firm cheats by expanding output, it can lead to a decrease in the market price, which reduces the profits of all firms in the cartel, potentially destabilizing the cartel agreement.
5. Evaluate the sustainability of the cartel: The incentive to cheat makes it challenging for cartels to sustain their agreements in the long term, as individual firms prioritize their own profit maximization over collective goals.