Three Oligopolists A, B, And C Produce An Identical P 664534

three Oligopolists A B And C Produce An Identical Product Q Q I

Three oligopolists, A, B, and C, produce an identical product, Q. Q is produced under conditions of constant costs, with average cost (AC) and marginal cost (MC) both equal to $100. The market demand schedule for Q is: at a price of $1, a certain quantity demanded (though the specific demand schedule is not provided in detail). The assignment involves analyzing cartel behavior, cheating, retaliation, and the stability of collusion, as well as constructing diagrams for a perfect competitive wheat market in long-run equilibrium.

Paper For Above instruction

Introduction

The dynamics of oligopoly markets, where a few firms dominate and have significant market power, are complex and critically important in understanding market behavior and outcomes. When firms attempt to collude—either legally or illegally—the stability of such arrangements depends on their incentives and the potential for deviation and retaliation. This paper explores a scenario involving three oligopolists (A, B, and C) producing an identical product Q under conditions of constant costs, analyzing their strategic interactions, the consequences of cheating, retaliation, and the broader implications for cartel stability. Additionally, the paper discusses the market for wheat in a long-run equilibrium under perfect competition, illustrating how firms and the market function together in such conditions.

Market Conditions and Cartel Formation

Initially, the three firms A, B, and C plan to operate as a cartel, dividing the market equally to maximize joint profits. Given the constant costs where AC = MC = $100, the firms aim to set a price and output that maximize total industry profits. In collusive behavior, they act as a monopoly, restricting output to raise prices and profits. Since the demand at price $1 is noted, but without specific quantities, we infer a typical downward-sloping demand curve where higher prices correspond to lower quantities demanded.

Assuming the cartel maximizes industry profit, they will set the marginal revenue (MR) equal to marginal cost (MC). Since all firms have constant costs of $100, they will agree on total output where MR equals $100. However, because the demand schedule is not explicitly provided, precisely calculating the optimal output and price is challenging. Nevertheless, the general principle is that the cartel will produce a quantity where the intersection of MR and MC occurs, and set the corresponding price determined by the demand curve.

Equally Divided Market and Profit Calculation

Dividing the output equally, each firm would produce one-third of the cartel's total output. The profits for each firm depend on the difference between the price and the constant marginal cost, multiplied by its share of total output. Total industry profit is shared equally if the firms cooperate effectively. If, for example, the optimal total output is Q, and each firm produces Q/3 units, then each firm's profit equals (Price - $100) × (Q*/3).

Impact of Cheating on Market Outcomes

Suppose Firm A, feeling confident in B and C's adherence to the cartel agreement, cheats by increasing output by 25 units. This deviation results in a shift in market supply, leading to a decline in the market price. The new market price can be determined by exceeding the original supply level, which pushes the equilibrium to a lower point on the demand curve. As a result, Firm A’s profit margin diminishes because although it sells more units, the lower price reduces total revenue.

The other firms, B and C, will experience similar declines in profit if they do not also cheat or retaliate. This scenario illustrates how individual incentives to cheat undermine cartel stability and lead to a breakdown of cooperation over time.

Retaliation and Strategic Behavior

In response to A’s deviation, B and C are likely to retaliate by increasing their own outputs to regain market share and reduce A’s profits. This retaliation further enlarges the total supply in the market, further depressing the market price. As a consequence, all firms’ profits fall compared to the initial cartel scenario.

This cycle of cheating and retaliation exemplifies the Prisoner’s Dilemma in oligopoly markets, where individual rational actions (cheating) lead to collective downfall, destabilizing the cartel structure.

Implications for Cartel Stability

The analysis highlights that cartels are inherently unstable unless there are credible mechanisms to enforce agreements and prevent cheating. In real-world applications, regulations, monitoring, and the threat of penalties help sustain collusion, but the profit incentives to deviate endure. The classic outcome is a fragile cooperation that often collapses under the temptation to cheat, resulting in more competitive market outcomes.

The Market for Wheat in Long-Run Equilibrium

Shifting to a different context, consider the wheat market under perfect competition in the long run. The diagram would include the demand curve, showing the price at $3.50 per bushel and the equilibrium quantity at 1,200 thousand bushels. On the firm’s graph, the marginal cost (MC), marginal revenue (MR), average cost (AC), and demand are depicted for a typical farm. Under perfect competition and free entry and exit, firms produce where P = MC, ensuring zero economic profit in the long run.

The profit-maximizing quantity on the firm’s diagram corresponds to the point where the firm’s MC curve intersects the demand line at $3.50. Since P = MC at equilibrium, the firm’s average cost at this point is tangent to the demand curve at the profit-maximizing output level. The diagram illustrates that, in long-run equilibrium, firms operate at minimum average cost, earning normal profits, with supply matching demand at the equilibrium price and quantity.

Conclusion

The exploration of cartel behavior among oligopolists demonstrates the inherent fragility of collusive arrangements, driven by incentives to cheat and retaliate, ultimately undermining mutual cooperation. The analysis of wheat markets under perfect competition underscores the efficiency and stability of competitive markets in the long run, where firms earn zero economic profits and resources are allocated efficiently. Both scenarios exemplify fundamental principles of microeconomic theory, including strategic interaction, market equilibrium, and the role of costs and demand in shaping market outcomes.

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