When oligopoly firms cheat on price fixing agreements, the resulting price and output quantity approaches that of perfect competition. How? Please explain this, thank you in advance.
Plz give the reference. I don’t think it is possible.
It was one of the questions i was solving, it had two statements:
Consider the following statements:
Statement 1: “When oligopoly firms cheat on price fixing agreements, the resulting price and output quantity approaches that of perfect competition.”
Statement 2: “Monopolistic competition is inefficient because a large deadweight loss from advertising and marketing costs is a characteristic of this form of competition.”
I chose the option which said both statements are incorrect, but in the answer they explained only the second and not the first one.
^^Think OPEC. (Oil Export Producing Countries). THere are 12 countries that, every once in a while, get together and “fix” the amount of oil that they will produce and supply to the world market. They think that by artificially lowering the quantity supplied, they can keep prices artifically high.
The problem is–they start cheating. First, Iraq cheats and starts producing more. That makes Kuwait want to cheat and produce more. Then Venezuela notices the cheating and starts producing more. Pretty soon, all 12 countries are producing as much as they can, and they’re no longer able to control the price. The price is dictated TO them, because they aren’t able to control the price anymore.
As a result, the supply/demand and price start to move toward what you would expect in a perfect competition, where no firm/country can command a price premium. All economic (or excess) profits have been “competitioned” away.
Got it, thank you so much.
Thanks for the question. May I ask the source? What about statement 2? Is it correct? In what kind of markets are advertisement costs significant?
I would think that firms would run into losses if they go for advertising in perfect market
The problem with using an example such as OPEC is that oil is a commodity: Saudi oil is essentially the same as Kuwaiti oil, which is essentially the same as Venezualan oil, and so on.
Oligopolies tend to exist in industries where the products are differentiated, not in markets for commodities. Your example would be more difficult to apply when the products are differentiated.
(Note: this is a problem with the context of the question, not really with your example.)
India_28 plz reply
I dont know if i should reveal the source but the second statement is incorrect too. They say:
The efficiency of monopolistic competition is not clear. While increased opportunity cost is associated with the intensive marketing and advertising activities that are characteristic of monopolistic competition, consumers definitely benefit from these selling activities because they receive information that often enables them to make better purchasing decisions. Hence the advertising and marketing costs may be more than the efficient amount, but do not represent a deadweight loss.