Question

Consider the curve in the figure below, which shows the market demand, marginal cost, and marginal revenue curve for firms in an oligopolistic industry. In this example, we assume firms have zero fixed costs.

a. Suppose the firms collude to form a cartel. What price will the cartel charge? What quantity will the cartel

supply? How much profit will the cartel earn?

b. Suppose now that the cartel breaks up and the oligopolistic firms compete as vigorously as possible by cutting the price and increasing sales. What will be the industry quantity and price? What will be the collective profits of all firms in the industry?

c. Compare the equilibrium price, quantity, and profit for the cartel and cutthroat competition outcomes.

Short answer

Part(a).

In this situation the cartel would earn more profits and prices would go up.

Part(b).

When cartel breaks up prices are expected to go back to approximately pre-cartel levels as competition is restored.

Part(c).

It is based on the various forces of supply and demand.

Step-by-step solution

Part(a) - Step 1: To determine

The price, amount supplied, and profit of the company if the firms establish a cartel can be calculated using the graphic provided.

Part(a)-Step 2. Explanation

The enterprises will monopolise their prices and quantity supplied if they join a cartel. They will generate the following output: MR=MC. MC and Average cost (AC) will be equal if the fixed costs are zero. Because the MC curve is horizontal, the AC curve will be as well.As a result, in the diagram below, the shaded area represents the economic profit.

Part(a)-Step 3: Final answer

$P_m$stands for price, $Q_m$for quantity, and profit is the shaded area in the diagram.

Part(b)- Step 4:To determine 

If the cartel disbands and each company competes on its own. What will the new price, quantity, and profit margins be in the industry?

Part(b)- Step 5: Explanation

Individual enterprises will face cutthroat competition if the cartel breaks down. To attract clients, businesses lower their prices and increase output. They'll keep doing it till they're out of money. When demand equals AC, the long-run equilibrium is attained. As a result, the industry price and quantity supplied will vary, and there will be no economic profit.

Part(b)- Step 6: Final answer

The price is $P{1}_m$, the quantity is $Q{1}_m$, and the profit is zero.

Part(c)- Step 7: To determine

Compare the prices, quantities, and profits of the old and new industries.

Part(c)- Step 8: Explanation

When a company forms a cartel, its profit increases $(P_m>P{1}_m,Q_m<Q{1}_m)$. However, if the cartel is broken apart, their profit is reduced to zero.

Part(c) - Step 9: Final answer

The price is larger than $P{1}_m$, the quantity is less than $Q{1}_m$, and the profit is zero.