Question 80 of 80 Firms A, B, and C, the only firms in an industry, have formed

Question

Question 80 of 80 Firms A, B, and C, the only firms in an industry, have formed a cartel. Each firm has a quota for the quantity that the firm is allowed to sell If Firm A deviates from the quota and sells a higher quantity, but Firm B and Firm C stick to their quota, which of the following will most likely occur in the short run? Firm A will earn lower profits, and firms B and C will earn higher profits O Firm A will earn higher profits, and firms B and C will earn lower profits O All three firms will earn lower profits 0 All three firms will earn higher profits O All three firms will ean zero economic profits

Explanation / Answer

In an economy when a relatively few firms control all or most of the production and sales of a product, the market is characterized as Oligopoly. The oligopoly is characterized by the mutual interdependence among firms, that is, a firm must shape its policy with an eye on its competing firms.

It is very difficult to predict how firm will react in situation of mutual interdependence. This uncertainty of deciding the right policy of its opponent seriously jeopardizes the firm’s position. Hence the firms tempted to collude in order to maximize its profits. The firms who collude and agree on various sales, pricing and other decisions are called cartel and their agreement is cartel agreement.

However, the more the number of firm in the cartel the more difficult it should be to reach in the consensus. As more firm enter the market, competition in the market increases. This competition increases the chances of non-cooperation and increases the difficulty of cartel outcome.

The kinked demand curve theory states that as the oligopolistic firms are dependent on each other on pricing decision, each firm will be respond to the price cut of its competitors but will mostly ignore any rise in price.

Thus as the firm rises its quantity the price charged by the firm will fall. Then there will rise in profit for this firm. But as other firm continuw to operate at the monopoly cartel price, there demand and hence profit will fall in short run.

Then the correct option is

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