Cartels, Collusion, Output and Price Effect

Cartels, Output and Price Effect

Perfect Competition

• Remember in perfect competition P = MC.
• Since the MC = 0, the price would be equal to

  0

  ---

  and the quantity sold would be

  120

  ---

  litres.

Monopoly

• Remember in a monopoly MR = MC
• Since the MC = 0 we go to the row where MR = 0.
• This would be at a price equal to

  $60

  ---

  and the quantity sold would be

  60

  ---

  litres.
• Since there are no costs, the profit for the monopoly would be

  $60 * 60 = $3600

  ---

Duopoly

• Forming a cartel or colluding means acting like a monopoly. They would take the same price as the monopoly and divide the monopoly output by two.
• Each firm in the duopoly would make an output of

  60/2 = 30

  ---

  , charge a price of

  $60

  ---

  and profit of

  3600/2 = $1800

  ---

  each.
• At this output price is

  greater

  ---

  than marginal cost. So if one firm cheats and increases output to 40 units the total output in the market would now be

  70

  ---

  units. The market price would fall to

  $50

  ---

  and profit for the cheating firm would increase to

  $50 * 40 = $2000

  ---

  while the other firm's profit would fall to

  $50 * 30 = $1500

  ---

  .
• For the cheating firm the output effect is

  stronger

  ---

  than the price effect because their profit increased.
• If the other firm increases output to 40 units also then the total output would be

  80

  ---

  units. The profit for each firm would become $

  40 * 40 = $1600

  ---

  .
• Now if one firm cheats and makes 50 units the total output would be

  90

  ---

  units and profit for the cheating firm would become $

  30 * 50 = $1500

  ---

  .
• In this case the output effect is

  weaker

  ---

  than the price effect because their profit decreases.

• If they compete, they will produce at the point where neither firm has an incentive to cheat.
• In the example above this would be when each firm is producing

  40

  ---

  units of output at a price of

  $40

  ---

  .
• Profits are

  higher

  ---

  for each firm under collusion rather than competing. But at the collusion outcome there is an incentive to cheat so they both end up at Nash equilibrium producing 40 units each.

Output and Price Effect

• The output effect: Because price is above marginal cost, selling 1 more litre of water at the going price will raise profit.
• The price effect: Raising production will increase the total amount sold, which will lower the price of water and lower the profit on all the other litres sold Example: If the output effect is stronger than the price effect, it will cause the overall profit to increase.