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Part III: Market Structures and the Decision-Making Environment
9. Substitute qB = 140 in the equation from Step 5 to determine qA.
10. Solve for Q, the quantity the cartel produces.
11. Solve for P, the price the cartel establishes for the good.
The cartel establishes a price of $18.60 for the good. Firm A produces 130 units and firm B produces 140 units.
Cartel participants jointly determine quantity and price based upon marginal revenue, derived from the market demand curve, equaling each participant’s marginal cost.
Profiting from the Long Run Economies of scale serve as a barrier to entry in oligopolistic markets. Economies of scale mean that existing firms produce a large quantity of the good at very low average total cost per unit. The existing firms tend to have substantial fixed costs, so producing a larger quantity of output reduces their fixed cost per unit and thus their average total cost per unit. On the other hand, a new firm entering the market isn’t likely to have many customers at first. Therefore, the new firm produces a much smaller quantity of output and can’t spread its fixed costs as far. The result is much higher average total cost per unit for a new firm. Because their cost per unit is lower than the new firm’s cost per unit, the existing firms charge lower prices than the new firm. Yet, even with the lower price, the existing firms earn positive economic profit because their cost per unit is so low. If the new firm tries to match this low price, it loses money because it has a much higher cost per unit. Thus, even with the attraction of positive profit, new firms can’t effectively compete with existing firms who take advantage of economies of scale. Positive economic profit means the firm earns more than a normal rate of return. When economic profit is positive, you’re receiving more income — or a return that’s higher than normal — as compared to your next best alternative.
