Econ 103 Assignment 05 1. Consider the perfectly competitive market for dairy. W
ID: 1121863 • Letter: E
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Econ 103 Assignment 05 1. Consider the perfectly competitive market for dairy. Where the dairy farmers find themselves at their long-run level of output and profit. Suppose these dairy farmers organize to form a cartel. Demonstrate on a graph the transition from their perfectly competitive level of output and profit to their cartel level of output and profit. 2.Briefly explain why this cartel arrangement is unstable, and why firms are going to be encouraged to cheat 3.What are the two things the cartel would need to be able to do in order to prevent the cartel from collapsing? 4. Let us focus on dairy farmer brown, a member of the dairy cartel. In addition, another representative firm, farmer Braun. Presently at the cartel level of output all firms are facing: $8 100 $5 If any firm cheats from the cartel agreement, they will be facing the following price, cost and output: P Q* ATC If any firm does not cheat, while everyone else is, they will face the following price, cost and output $6 100s5 Complete the game matrix below for Farmer Brown and another representative dairy farmer (Farmer Braun). Determine a suitable payoff based on our assumptions of firm Behavior. Determine if there is a NASH equilibrium Determine if there is an optimal strategy: Dairy Farmer cartel decision Farmer Braun Cheat Cartel level Cartel level Cheat Farmer BrownExplanation / Answer
The dairy firms in a perfectly competitive market face a horizontal Demand curve. Here the Average Revenue(AR)equals the Marginal Revenue(MR). Where the marginal cost equals the Marginal revenue the firm produces an equilibrium quantity, q*. All the firms collectively produce Q*. The firm here is a price taker in such a market set up.
A cartel on the othe hand is set up when a group of firms get together to make price or output decisions in a market. In a monoply situation there is a single firm who is a price marker. Under a cartel a few players get together to regulate the output and price decisions in the market area. In a oligopoly situation the market players collude to maintain sticky prices. So a cartel formed here means that the output is restricted to these market players only. A perfect example here is that of OPEC.( Organisation of Petroleum Exporting Countries) A cartel faces a downward sloping Demand curve along with a downward sloping MR curve which lies below the Demand curve. Here where the MC=MR, the firm produces the equilibrium quantity of goods and the vertical distance between AR and Average cost curve gives the profit earned by the Cartel.
The cartel is unstable as there is an incentive to cheat for the players. Each player produces the designated amount and earns a profit on it. However, he knows that if he produces more than the designated amount at the given price so he will make more profits. Likewise, other players also think alike in order to maximise their profit. So everyone has an incentive to cheat. This makes the cartel unstable.
Inorder for the cartel to remain in place, the firms must not cheat and they shouldn't try to alter their output and price decisions.
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