Question

(6 points) Consider a market with two identical firms. The market demand curve is: P-140 10Q And the marginal cost and average cost of each firm is constant: AC-MC-10 6. (3 points) Consider a world in which collusion is legal a. i. At what price will these firms maximize their combined profits? ii. What is the quantity produced at which they maximize their profits? b. (3 points) Suppose collusion is illegal. Firm 1 decides that they will send a signal to firm 2 (without technically colluding) that they are open to setting prices at the level you found in part a. Should firm 2 set the price at this high level? Why or why not?

Answer 1

a..)

P = 140 – 10Q

AC=MC = 10

TR = P*Q

= 140Q – 10Q^2

On differentiating TR function:

MR = 140 – 20Q

MR = MC

140 – 20Q = 10

130 = 20Q

Q =6.5

P = 140 – 10(6.5)

= 140 – 65

=75

i ..)

Profit maximizing price = $ 75

ii)

Profit Maximizing output = 6.5

b)

if collusion is illegal, firms might get involved in implicit collusion. Economists believe that such instances of collusion can be seen in market.

But on other side, some economists contend that even the formal collusions tend to collapse. The question of informal collusion does not arise. Firms always tend to cheat each other and they are less likely to get involved in any kind of implicit collusion.