An ideal market place is one where demand is equal to supply leading to the right quantity of goods being supplied into the market. The goods that are supplied in the market must also be used or at least bought by the consumers in order to create a “perfect” market place. If this balance is changes or forced to change, then the resulting market would not be an ideal market. It would either be more goods supplied than demanded or more goods demanded then supplied. In either case, this will lead to higher than the actual or lower than the actual price. Both these conditions hinder the market efficiency and sooner or later market corrects itself. The process through which market forces balance the market place is called market mechanism. They lead the market toward a level of equilibrium. At this point the resources being consumed or are working in order to produce the right amount of goods and services and then these goods and services are sold at the right price to the people/buyers who want to consume or use these goods and services. (Lipsey and Chrystal, 2007)
Unfortunately, the condition of market equilibrium is not present in the diamonds industry. It is being controlled by a giant firm that, according to an estimate, owns up to 80% of all diamond mines in the world. The motive or purpose behind such an action is to limit the supply of diamonds in the market and forcing up its supply. This concept can be better understood by the demand and supply graph.
De Beers enjoyed a great deal of power in the diamond industry and operated as a cartel. It mined it diamonds in South Africa and Namibia. After polishing them, they were then brought to a clearing house in London where they were sorted into grades and later sold to the people who wanted to buy these luxurious stones. De Beers maintained a monopoly position by buying whatever diamond anyone wanted to sell in the market and thus enjoyed huge profits by operating as a monopolized cartel.
The graph (Fig 1.) clearly shows that motives for a company to limit the supply of resources it owns either by controlling all or most of the supply or by colluding with other companies and creating a cartel. This practice is not just common in the diamond industry, but it is also prevalent in the oil industry where a cartel by the name of Organization of Petroleum Exporting Countries. This organization is more commonly known as OPEC (Gately, 1995). The figure above shows the marginal cost line. This is a straight line because the cost of producing one extra diamond is same as producing one less diamond. In other words, the cost of producing or polishing a diamond remains almost same whether the output is one or hundred. Demand curve is a downward sloping curve. It is in line with the principle of demand, that, as price increases demand for a good or service goes down. The line that is towards the left of demand curve is the marginal revenue line. It again is in line with the normal demand principle that demand and prices are inversely related, and so is the revenue. For example, in order to sell more of a product, the retailer or manufacturer will have to offer some discount to the buyer and hence marginal revenue curve is less than or towards the left of demand curve. We can see in the diagram, had the industry been a perfectly competitive market, the product would have been sold at competitive output Qc at price Pc. However, since the industry is being operated as a cartel, the members of this organization will limit the output and increase the price and sell at monopolistic level of output and price (Goldschien, 2011). It is being shown in the diagram as Qm and Pm respectively.
In other words, we can see that a cartel converts some of the consumer surplus into the producer surplus or profit. It is the main purpose of operating as a cartel and that is what De Beers, the diamond cartel, is doing. They have limited or constrained the supply of diamonds in the world. They control eighty percent of all the output in the industry and as a result, they have increased the prices and kept the supply at a level far below than quantity demand. Referring back to Fig 1, it can be seen that the market wanted the supply to be at the level of Qc so that the entire market can be satisfied at a reasonable price. However, the monopolist kept the quantity supplied in the market to Qm that is far below the quantity demanded in the market. By doing so, the monopolist has signaled the market forces that it demands a premium or higher price from those who want the product. It is exactly the same thing that is happening in the diamond market. People are being forced to pay a premium that can actually afford the product and are willing to spend extra bucks in order to satisfy their need of self actualization or signal the rest of the world that they are richer and belong to a different class than ordinary people (Sloman, 2004).
These days there is a convention stating that diamond ring is an acceptable ring for engagements. Due to this it has increased the demand of diamond rings and in diamonds. If this convention is reversed then demand of diamonds will go down and so is the price.
Gately, D., 1995. Strategies for OPEC's pricing and output decisions. Energy Journal, 16(3),
Goldschien, E., 2011. The History of De Beers Created and Lost Most Powerful Monopoly Ever.
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Lipsey, R. and Chrystal, K., 2007. Economics. 1st ed. Oxford: Oxford University Press
Sloman, John, 2004. Economics. 5th ed. London: Prentice
The Economist. (2004). The cartel isn't for ever. Available:
http://www.economist.com/node/2921462. Last accessed 18th May 2014