Sunk costs and cartel formation: Theory and application to the dyestuff industry

Abstract

We first develop a simple model of entry showing that cartels are more likely to emerge during periods of downturns and in industries with significant sunk costs. Cartel formation is also accompanied by a decline in profits. We then use the framework to investigate the emergence of the Swiss dyestuff export cartel during the inter-war period and find empirical evidence that supports the main predictions of the model. The analysis indicates that sunk costs and entry may be important determinants of cartel formation and are complementary to the traditional cartel stability conditions.