Two firms decide to form a cartel and collude in a way that maximizes total profits....

Two firms decide to form a cartel and collude in a way that maximizes total profits. Each firm has zero production costs and each firm is given a positive output quota by the cartel. Which of the following statements is NOT true?

Select one:

a. Output would be lower than if the firms behaved as competitors.

b. All of the other statements are false.

c. Output would be lower than if the firms behaved as Cournot firms.

d. The price elasticity of demand will be 1 at the output level chosen.

e. Each firm would want to produce more than its quota if it knew that the other would continue to produce at its quota.

Solutions

Expert Solution

Ans.

In the Cournot assumption, each firm determines its profit- maximizing production level by assuming that the other firms’ output will not change. This assumption simplifies pricing strategy because there is no need to guess what the other firm will do to retaliate.
Correct option is b.
Each firm attempts to maximize its own profits under the assumption that the other firm will continue producing the same level of output in the future. The Cournot strategy assumes that this pattern continues until each firm reaches its long- run equilibrium position.
In long- run, output and price are stable: There is no change in price or output that will increase profits for either firm.

Rahul Sunny answered 1 year ago

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