2. Deviating from the collusive outcome Mays and McCovey are beer-brewing compan
ID: 1202499 • Letter: 2
Question
2. Deviating from the collusive outcome
Mays and McCovey are beer-brewing companies that operate in a duopoly (two-firm oligopoly). The daily marginal cost (MC) of producing a can of beer is constant and equals $0.80 per can. Assume that neither firm had any startup costs, so marginal cost equals average total cost (ATC) for each firm.
Suppose that Mays and McCovey form a cartel, and the firms divide the output evenly. (Note: This is only for convenience; nothing in this model requires that the two companies must equally share the output.)
Place the black point (plus symbol) on the following graph to indicate the profit-maximizing price and combined quantity of output if Mays and McCovey choose to work together.
Monopoly Outcome PRICE (Dollars per can)QUANTITY (Thousands of cans of beer)DemandMRMC = ATC
When they act as a profit-maximizing cartel, each company will producecans and chargeper can. Given this information, each firm earns a daily profit of, so the daily total industry profit in the beer market is.
Oligopolists often behave noncooperatively and act in their own self-interest even though this decreases total profit in the market. Again, assume the two companies form a cartel and decide to work together. Both firms initially agree to produce half the quantity that maximizes total industry profit. Now, suppose that Mays decides to break the collusion and increase its output by 50%, while McCovey continues to produce the amount set under the collusive agreement.
Mays’s deviation from the collusive agreement causes the price of a can of beer to toper can. Mays's profit is now, while McCovey’s profit is now. Therefore, you can conclude that total industry profit when Mays increases its output beyond the collusive quantity.
Explanation / Answer
PRICE (Dollars per can}
1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
0 80 160 240 320 400 480
QUANTITY (Thousands of cans of beer per day}
PRICE (Dollars per can}
1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
0 80 160 240 320 400 480
QUANTITY (Thousands of cans of beer per day}
When they act as a profit-maximizing cartel, each company will produce 40,000 cans per day and charge
$0.80 per can. Given this information, each firm earns a daily profit of $8,000 so the total industry profit in the beer market is $ 16,000 per day. A cartel acting as a monopolist will produce an output level at which marginal revenue equals marginal cost. Unlike a firm in a competitive market, however, a monopolistic cartel can charge a price that is above marginal cost, namely, the price corresponding to the demand curve above this quantity. This occurs at a quantity of 80,000 cans per day and a price of $0.80 per can. If the companies equally split production, they produce 40,000 cans each per day at the monopolist's price of $0.80 per can.
Each Firm's Profit = Total Revenue - Total Cost
- ($0.80 per can x 40,000 cans) - ($0.60 per can x 40,000 cans)
= $0.20 per can x 40,000 cans
= $8,000
Each firm makes the same profit, so the total industry profit is $8,000 + $8,000 = $16,000.
Mays's deviation from the collusive agreement causes the price of a can of beer to decrease to $0.75
per can. Mays's profit is now $9,000 per day, whereas McCovey's profit is now $6,000 per day. Therefore, you can conclude that total industry profit decreases when Mays increases its output beyond the collusive quantity.
Seeing the previous question, we found that the profit-maximizing output is 40,000 cans of beer for each company. Because Mays increases its output by 50%, it now produces 40,000 + (40,000 x 50%) = 40,000 + 20,000 = 60,000 cans of beer per day. McCovey's output remains at 40,000 cans per day, so total output becomes 60,000 + 40,000 = 100,000 cans per day. According to the demand curve, the highest price that can be charged at a quantity of 100,000 cans per day falls to $0.75 per can.
Therefore, the firms will now make a different profit, because they are producing at different quantities.
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