You are the manager of a firm that competes against four other firms by bidding

Question

You are the manager of a firm that competes against four other firms by bidding for
government contracts. While you believe your products is better than the competition,
the government purchasing agent views the products as identical and purchases
from the firm offering the best price. Total government demand is Q = 750 – 8P and
all five firms produce at a constant marginal cost of $50. For security reasons, the
government has imposed restrictions that permit a maximum of five firms to compete
in this market; thus entry by new firms is prohibited. A member of Congress is
concerned because no restrictions have been placed on the price that the
government pays for this product. In response, she has proposed legislation that
would award each existing firm 20% of a contract for 270 units at a contracted price
of $60 per unit. Would you support or oppose this legislation? Explain.

Explanation / Answer

I would support this legislation. Without this deal, the firms will compete for the contract to give a zero profit condition, like in a perfect competition. No matter how low another firm bids, I can always bid a little lower, to try to win the contract until P=MC. The rational outcome of this "game" is a contract that gives zero profit. The proposed legislation is like a collusive agreement guaranteeing each firm positive profit. At the proposed contract, we will produce q=.2(270)=54 If 270 units are produced in the industry, and we charge $60/unit, we get Profit=q(MR-MC)=54(10)=$540. (assuming no fixed costs, as long as fixed cost

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