Answer to Question #76136 in Microeconomics for Sara

Question

a) You are examining and reporting on the market performance of a very small number of firms that are known to often collude in setting output prices and quantities. Illustrate and explain using a diagram what effect this behaviour is most likely to have on the allocation of factors of production.

b) What will happen if one of these firms’ cheats on the others in some way? Illustrate and explain using a diagram.

Answer 1

a) If you are examining and reporting on the market performance of a very small number of firms that are known to often collude in setting output prices and quantities, then this behaviour will create efficient allocation of factors of production for these firms but not for the market as a whole.
b) If one of these firms’ cheats on the others in some way, then in the short-run this firm will receive higher profits, but then the other firms will stop colluding and create non-colluding equilibrium.