a. Consider the iron ore production industry, and assume that there are just two

Question

a. Consider the iron ore production industry, and assume that there are just two producers, FM and BHP. Initially assume that both firms are identical in terms of their production costs. If the two firms can cooperate, what should they do in order to maximise industry profits? How does your answer change if: (i) price discrimination is feasible; or (ii) the two firms have different costs of production? If you are working as a consultant for the ACCC, how would you view cooperation between the two iron ore producers?

b. Thinking more broadly than iron ore, how can two oligopolists try to avoid being caught in a competitive outcome? Are any of these relevant for the iron ore industry?

Explanation / Answer

a.If the two firms can cooperate then in order to maximize their profits they must collaborate. In the previous case the cost structure is exactly same thus the price will be equal to the marginal cost and thus there would be no profits. If one were to keep the price even a little higher above the marginal cost he would lose the entire market. If the decide to collaborate they can together keep the price a level x above the marginal cost and share the profits.

i. If price discrimination is possible the profits would rise further, because with right targeting we can pull up the prices higher and higher based on the willingness to pay of the customers

ii. if the two firms have differing cost structures it is possible for the firm with the lower cost structure to capture the entire market and still make profits. He can keep the price a little lower than the marginal cost of the other firm and have the whole market. So in this case collaboration is not a good deal for him. He should be given an incentive to get into such collaboration.

b.In an iron ore market we can have an oligopolistic market structure and earn higher profits than competitive markets. The collaboration can help keep prices above marginal cost and give profits to both. In case cost structures differ the lower cost company must be given incentive to participate in the collaboration.

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