Question

In an attempt to increase tax revenues, legislators in several states have introduced legislation that would increase state excise taxes. Examine the impact of such an increase on the equilibrium prices paid and quantities consumed by consumers in markets characterized by

(a) Sweezy oligopoly,

(b) Cournot oligopoly, and

(c) Bertrand oligopoly,

and determine which of these market settings is likely to generate the greatest increase in tax revenues

Short answer

1. In Sweezy oligopoly an increase in marginal costs will not generate changes in the equilibrium output level or in the price that maximize the firm's profits.

   
   

2. In the Cournot oligopoly, both firms will increase their prices to obtain higher marginal revenues and higher profits.

3. In the Bertrand oligopoly, when there is an increase in tax revenues, the firms will see that their marginal costs will also increase.

Step-by-step solution

Define oligopoly

A market structure known as an oligopoly is one that has few competitors and high entrance barriers.

To examine the Sweezy oligopoly

a.

On the Sweezy model, rival firms will react to a price decrease by matching it, however, if one of these firms considers increasing its prices, rivals will not follow it in this decision.

When the price decrease occurs, the marginal revenue curve becomes discontinuous while the marginal cost curve intersects this discontinuous part. Therefore, if an increase in taxes occurs, it will have repercussions on marginal costs, but in this model, an increase in marginal costs will not generate changes in the equilibrium output level or in the price that maximize the firm's profits.

Step 3:To examine the Cournot oligopoly 

b.

In the Cournot duopoly model, firm l's production decisions affect the rival firm's marginal revenues. By increasing marginal costs from tax increases, both firms will have incentives to reduce their output level, and since both firms face the same situation, both firms will increase their prices to obtain higher marginal revenues and higher profits.

Step 4:To examine the Bertrand oligopoly model

(c)

On the Bertrand oligopoly model, rival firms face price competition since they have the same marginal costs, therefore firms will reduce their prices until they equal their marginal costs.

When there is an increase in tax revenues, the firms will see that their marginal costs will also increase.

Therefore, to remain in the same equilibrium situation in which their output is equal and the profit is zero for both firms, they will have to increase prices to the same extent. It means the increase in taxes will be equal to the increase in their marginal costs.

Among the firms, the Cournot oligopoly is likely to generate the greatest increase in tax revenues.