Question

Suppose that Airbus and Boeing decide to form a cartel. Is it likely that they both stick to an agreement where each of them produces equal quantities in order to maximize total revenue? In other words, does a formation of such a cartel constitute a Nash equilibrium? Explain carefully (hint: try to figure out if there is a profitable deviation for one of the firms while the other sticks to the cartel agreement).

1. In the commercial aircraft business, Boeing and Airbus form a de facto duopoly in the market for "large" jets. Suppose that the constant marginal cost of producing a large jet is $50. The demand for large jets is described by the following schedule: Assume Table 1: Demand Schedule Price Quantity 350 0 300 200 500 1000 1500 2000 2500 3000 100 50 that the total number of jets produced by both firms can only be one of the numbers mentioned in the table above.

Answer 1

P	Q	TR	MR	MC	TC	PROFIT
350	0	0			0	0
300	500	150000	300	50	25000	125000
250	1000	250000	200	50	50000	200000
200	1500	300000	100	50	75000	225000
150	2000	300000	0	50	100000	200000
100	2500	250000	-100	50	125000	125000
50	3000	150000	-200	50	150000	0

When they form a cartel they would produce by acting as a monopolist and set MR=MC for profit maximization so they will produce 1500 units at P=200 where each will produce 1500/2 = 750 units and earn a total profit of (200-50)*750 =  112500

However, since in a cartel, the partners have a tendency to cheat in order to earn more profits, one firm will increase its output by 500 which will increase total output to 2000 and price will decrease to 150

In this case, the cheating firm will earn a total profit of (150-50)*1250 = 125000 while the non cheating firm will earn total profit of (150-50)*750 = 75000