Question 2 [40 marks]

This question refers to (a) a hypothetical situation where the government intervenes to break a monopoly and creates a quadropoly; and (b) the implications of collusion in oligopoly markets.

Statement

There used to be a monopolist in the market for diamonds facing the market demand curve

Q = 1600 - 5 P

The graphical representation of this demand curve is shown in Figure 2. Using the criterion for profit maximization, the monopolist established that the profit-maximizing output level was 600 diamonds. The profit-maximizing price charged by the monopolist was exorbitant and the government allowed three new firms to enter the market. Each of the four (4) firms was independently producing and selling 350 diamonds. There was a drastic reduction in the market price. Unfortunately, the quadropoly colluded and agreed to produce 150 diamonds each.

1. What was the quadropoly market price without collusion? [5 marks]
2. What was the market price emerging from the cartel? [5 marks]
3. What is the fundamental implication emerging from a market switching from monopoly to quadropoly with collusion? Use of the numbers resulting from the information provided in the statement is compulsory. [30 marks]

Figure 2