Tutorial+10+Solutions

Tutorial+10+Solutions - by the cartel, while everyone else...

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Eco1010f Tut assignment 10 Due date: week beginning 26 th April 2010 Answer the following two questions 1) If a product has many small producers who are not able to brand their products and advertize, the assumption of free entry and exit ensures that they produce at the lowest possible level of average costs in the long run. Once each firm can give a brand identity to its product, however, free entry and exit no longer ensures cost minimization. Explain using diagrams where appropriate. Advertising means product differentiation i.e. a downward sloping demand curve where DD=AR=P. Free entry and exit means normal profit in the long run => AR is just tangent to ATC. But since AR is downward sloping, the point of tangency can’t be at min ATC MC ATC P DD=AR=P MR Q/t TC TR
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2) Cartels are typically unstable. Using a diagram to show the benefits of cheating, explain why this is the case. This is the simple story in Lipsey, if you cheat and produce more than the quota set for you
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Unformatted text preview: by the cartel, while everyone else abides by the rules, there is a quick profit for you. .. BUT either they will all follow suit and also exceed their quotas, or they will get nasty and bring you to heel by using the threat of market power (This was the approach taken by De Beers and by the Saudis in OPEC for many years). The point is that successful long lasting cartels are relatively rare. .. this tells us that the tendency is for cheating to undermine the cartel (the Nash outcome). EG profit is max for industry at Q2, so set each firm a quota of q2 MC ATC P2 P1 Q2 Q1 q2 q1 q3 Initial profit from abiding by quota is cross hatched area. If you cheat it increases by the yellow shaded block. If EVERYONE cheats you all end up back where you started making normal profits at P1q1...
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This note was uploaded on 02/28/2012 for the course ECO 1010F taught by Professor Catherinekannemeyer during the Spring '11 term at University of Cape Town.

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Tutorial+10+Solutions - by the cartel, while everyone else...

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