The following equation represents the daily market demand for crude oil. Q = 10,

Question

The following equation represents the daily market demand for crude oil. Q = 10, 000,000 - 500,000 P Suppose there are four oil producers in the crude oil market, A, B , C and D. The marginal cost of A is $10. The marginal cost of B is $12. The marginal cost of C is 13. The marginal cost of D is $15. Note that in all three cases MC =AVC. (Hint: Do not be concerned about fixed costs in this problem; assume TFC = zero for all producers.) a. If collusion is not allowed, what kind of market arrangement do you think is likely to result from competitive interactions among these four firms? b. Now suppose collusion is allowed. Is it possible for these firms to form an effective cartel? c. Calculate the profits of these firms in either case (a and b).

Explanation / Answer

a.

Each producer will sell at the marginal price because MC = AVC and A will capture the entire market share since it has lowest Marginal Cost. Other producer will feel comfortable to produce. Producer A will earn profits of $11.9999

b.

if collusion is allowed then the price the price of sold will be at least greater than of all MCs. And price will be $15. Therefore, profit will be as follows A >B>C>D.

c.

part a) Q = 10,000,000 – 500,000P

when P = 12, Q = 10,000,000 – 500,000*12 = 4,000,000

Profit = 4,000,000(12-10) = $8,000,000

part b)

Let assume that four producer gets equal share $15

Q = 10,000,000 – 500,000*15 = 250,000

Each sells = 250,000/4 units

Therefore profit for each firm = 62,500 units

Profits is as follows

A = 62,500 * (15-10) = $312,500

B = 62,500 *(15-12) = $187,500

C = 62,500 (15-13) = $125,000

D = 62,500 (15-15) = 0

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