QUESTION 84

P

Q

0

70

5

65

10

60

15

55

20

50

25

45

30

40

35

35

40

30

45

25

50

20

a) Two firms (each with a marginal cost of $10) operate in the oil market. Suppose the market can be modeled as an oligopoly with the following demand schedule:

Firm 1 produces q1 and Firm 2 produces q2. They each receive a price from the market resulting from Q = q1 + q2.

i) If they are interested in operating as a cartel, what is the monopoly level Q that they should split? What profits will this earn each firm? (2)

ii) Firm 1 wants to know if it should cheat on the cartel agreement by increasing q1 by 5 units. Should they? What does this do to their profits and the profits of Firm 2? (2)

iii) Should Firm 2 also increase their quantity q2 by 5 units? Why or why not? (1)

iv) What is the Nash equilibrium in this game? How do you know? (2)

b) Explain how a Monopolistically Competitive firm earns zero profit in equilibrium, even if they are the sole producer of their product (like McDonalds or Starbucks or Honda). (3 marks)