Final answer:
A cartel maximizes profit by behaving as a monopolist, reducing output and increasing prices to earn economic profits. However, individual incentives and legal barriers often challenge the stability of cartel agreements.
Step-by-step explanation:
In a typical cartel agreement, the cartel maximizes profit when it behaves as a monopolist. When firms in an oligopoly act together to hold down industry output and keep prices high, the result is called collusion. A formal agreement among firms to collude to produce the monopoly output and sell at the monopoly price is what defines a cartel. Cartels seek to maximize profits by reducing output and raising price, acting as a single producer would under monopoly conditions.
By choosing the quantity of output where marginal revenue (MR) equals marginal cost (MC), and setting prices accordingly, cartels can earn significant economic profits. However, because each member of an oligopoly can benefit individually from expanding output, and since explicit collusion is illegal in many parts of the world, maintaining a cartel agreement can be challenging. Hence, while the ideal behavior for a cartel is to mimic a monopolist, the temptation for individual firms to cheat on the agreement by increasing output often leads to the eventual breakdown of such cartels.