Suppose there are two firms maintaining a cartel agreement. If one firm suddenly drops its price, the other firm could interpret this as signaling

a. cartel pricing.

b. limit pricing

c. cooperative pricing

d. under-pricing.

• The answer is d. under-pricing.

Prices set by a cartel are higher than prices that would result from the demand and supply equilibrium. This is because the supply is limited, which pushes the price up. Thus, if one of the cartel members drops its price, it would be seen as underpricing by other members. Due to this action, the cartel could be broken, and the agreement between members would no longer be followed. It is a typical situation for a cartel since this type of cooperation often fails to survive in the long run.