Question: Consider two firms that sell substitute products and compete with one

Question

Question: Consider two firms that sell substitute products and compete with one another in various markets across the country. As a casual observer of the market, you do not know the demand function for each of these products nor the firms’ cost functions. You read a newspaper article that claims these two firms are colluding for the following reasons:

(a) The firms’ price changes match each other quite closely over time

(b) When it is known or likely that their costs have risen, both firms raise their prices

(c) When a rival firm selling a substitute product entered the market, both of the original firms lowered their prices

(d) There are markets where only one of the firms is operating, indicating that the firms have divided the country into local monopolies among themselves

Explanation / Answer

The main reason for collusion is to appropriate the entire consumer surplus. In this the firms try to raise price and cut down on quantity production. In the above casse this is done when the firms divide the country into local monopolies and generate high profit.

Thus the correct option is (d).

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