1. Three oligopolists, A, B and C, produce an identical product, Q. Q is produced under conditions of constant costs, that is, AC = MC = $100. The market demand schedule for Q is:
Price Quantity Demanded
a) A, B, and C decide to act illegally as a cartel, to divide the market equally among the three of them, and to set the price and output that will maximize their total profits. What price and output do they set? What is the output level that each of the firms agrees to? What profit is earned by each firm and by the three firms together?
b) A is impressed with the honesty of B and C, and believes they will keep to their agreements. They do, and A cheats by increasing output by 25 units. What is the new market price? How have the profit levels of A, B, and C changed? How have total profits in the industry changed?
c) What actions are B and C likely to take in retaliation? Show how these actions will affect the market price, and the profit levels of the three firms.
d) What can you learn from this problem about the likely stability of a cartel?
2. Draw the relevant diagrams for a typical farm, and for the market as a whole, when the market for wheat is in long run equilibrium. Assume the farm faces perfect completion. (hint, make sure to include Demand, MC, MR and AC on the firms graph based on what we learned about perfect competitors and show the profit maximizing quantity (you will not be able to calculate but show it on the graph) for that farmer). Show the market equilibrium at $3.50/bushel and 1200 thousand bushels of wheat.