You may ask yourself why firms don

You may ask yourself why firms don - total profit...

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You may ask yourself why firms don't agree to work together to maximize profits for all rather than competing amongst themselves. In fact, we will show that firms do benefit when cooperating to maximize profits. Assume both Firm 1 and Firm 2 face the same total market demand curve: Q = 90 - P where P is the market price and Q is the total output from both Firm 1 and Firm 2. Furthermore, assume that all marginal costs are zero, that is: MC = MC1 = MC2 = 0 Verify that the reaction curves according to the Cournot model can be described as: Q1* = 45 - Q2/2 Q2* = 45 - Q1/2 Solving the system of equations, we find: Cournot Equilibrium: Q1* = Q2* = 30 Each firm produces 30 units for a total of 60 units in the market place. P is then 30 (recall P = 90 - Q ). Because MC = 0 for both firms, the profit for each firm is simply 900 for a total profit of 1,800 in the market. However, if the two firms were to collude and act as a monopoly, they would act differently. The demand curve and the marginal costs remain the same. They would act together to solve for the
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Unformatted text preview: total profit maximizing quantity Q . Revenues in this market can be described as: Total Revenue = P * Q = (90 - Q) * Q = 90 * Q - Q^2 Marginal Revenue is therefore: MR = 90 - 2 * Q Imposing the profit maximizing condition ( MR = MC ) , we conclude: Q = 45 Each firm now produces 22.5 units for a total of 45 in the market. The market price P is therefore 45. Each firm makes a profit of 1,012.5 for a total profit of 2,025. Notice that the Cournot equilibrium is much better for the firms than perfect competition (under which no one makes any profits) but worse than the collusive outcome. Also, the total quantity supplied is lowest for the collusive outcome and highest for the perfectly competitive case. Because the collusive outcome is more socially inefficient than the competitive oligopoly outcome, the government restricts collusion through anti-trust laws....
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