2. Deviating from the collusive outcome Mays and McCovey are beer-brewing compan

ID: 1217477 • Letter: 2

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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 $0.60 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.

2. Deviating from the collusive outcome

Explanation / Answer

(1) When they act as cartel, profit is maximized when MR = MC with Price = $0.8 and total quantity = 20,000.

Each company will produce 10,000 cans (= 20,000/2) and charge $0.80.

Each firm earns a profit of $2,000 [= Q x (P - ATC) = 10,000 x $(0.8 - 0.6) = 10,000 x $0.2], so total daily profit is $4,000 [= $2,000 x 2].

(2) Next, Mays increases its output by 50%, to (10,000 x 1.5) = 15,000 units and McCovey continues to produce 10,000 units, so total output is (15,000 + 10,000) = 25,000, and price becomes $0.75 (reading from demand curve).

May's deviation causes price to decrease to $0.75. Mays' profit is now $2,250 [= 15,000 x $(0.75 - 0.6) = 15,000 x $0.15], while McCovey's profit is now $1,500 [= 10,000 x $(0.75 - 0.6) = 10,000 x $0.15]. Therefore, total industry profit decreases [New total profit = $2,250 + $1,500 = $3,750 < $4,000].

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