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Lecture 7 - Lecture 7 Where do monopolies come from Chapter...

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10/11/10 1 Lecture 7 Where do monopolies come from? Chapter 9: Monopoly, Oligopoly, and Monopolistic Competition G. Price discrimination H. Natural monopoly I. Where does monopoly or oligopoly come from? 1. Cartels or producer co-operatives Example: consider a cartel consisting of 10 countries each producing 2 million barrels of oil per day. Suppose total marginal cost is $20/barrel and current price is $51.50/barrel Suppose further that if OPEC increased production 1 million barrels per day, price would fall from $51.50/barrel to $50/barrel Then the marginal revenue for OPEC as a whole from producing another million barrels per day is: $50/b x 1 M b/day - $1.50/b x 20 M b/day = $20 M /day Marginal cost we supposed was $20/b, so additional cost of producing extra 1 M b/ day is $20 M Conclusion: MR = MC = $20 M So for these figures, OPEC would be maximizing the collective profit of all its members if it charged a price of $51.50
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10/11/10 2 However, suppose one country (say Kuwait) by itself could produce an extra 1 M b/day without the other countries finding out Kuwait’s marginal revenue: $50/b x 1 M b/day - $1.50/b x 2 M b/day = $47 M /day Kuwait’s marginal cost: $20 M/day So Kuwait would make an extra $27 M each day by “cheating” on the rest of the cartel Obstacles to running a cartel : (1) They’re illegal in the United States. (2) Each member of a cartel has an incentive to cheat on their agreement. Marginal revenue for OPEC as a whole from producing 1 more barrel of oil = price received for that barrel minus the loss from lowering price on all OPEC’s other barrels sold (e.g., 20 Mb/d) Marginal revenue for Kuwait alone from producing 1
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