Joint Profit Maximization Model; Why Cartels Can Fail

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Do curso por University of California, Irvine

O Poder da Macroeconomia: Princípios da Economia no Mundo Real

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University of California, Irvine

O Poder da Macroeconomia: Princípios da Economia no Mundo Real

819 ratings

In this course, you will learn all of the major principles of microeconomics normally taught in a quarter or semester course to college undergraduates or MBA students. Perhaps more importantly, you will also learn how to apply these principles to a wide variety of real world situations in both your personal and professional lives. In this way, the Power of Microeconomics will help you prosper in an increasingly competitive environment. Note that this course is a companion to the Power of Macroeconomics. If you take both courses, you will learn all of the major principles normally taught in a year-long introductory economics college course.

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Oligopoly and Strategic Behavior

Joint Profit Maximization Model; Why Cartels Can Fail4:52

The Price Leadership Model; The Kinked Demand Curve Model 5:48

Game Theory and the Prisoner’s Dilemma; The Nash Equilibrium10:18

Conheça os instrutores

Dr. Peter Navarro
Professor
Paul Merage School of Business

[MUSIC]

Let's start with the simplest model of oligopoly,

known as the lucrative oligopoly, or joint profit maximization.

The cartel model provides insight into the price and quantity

that oligopolists are likely to set when they can collude successfully.

Consider then, a four-firm industry, in which each

firm had grown tired of ruinous price wars.

So, during the industries annual trade show in Las

Vegas, the chief executive officers of all four companies ignore

anti-trust laws against explicit collusion, and risk a possible

jail sentence, as they slip off to a secret rendezvous.

During that rendezvous, they then negotiate what

price should be charged for the product.

And of course, as part of their secret cartel agreement

each firm will also have to agree to restrict its

output so the price can be maintained in the market.

So where do you think these oligopolies will set price?

Okay, maybe that really was an obscure question.

But if you think about it, the answer is simple.

If the oligopolists can truly coordinate their activities, the obvious price to

set is the same as that which would be set by a monopolist.

That means of course that, price will be set by

the profit maximizing rule of marginal revenue equals marginal cost.

And if the price is set at that point, the oligopolists will jointly maximize

their profits, which is why this model

is often called the joint profit maximization model.

Now one other point, in order for the monopoly price to

hold in the marketplace, total industry output must equal the monopoly output.

This is where problems with the cartel are likely to emerge.

Because, if any one firm in the oligopoly decides to cheat by producing

more than its agreed upon share of output, it can make higher profits.

Than if it adheres to the cartel agreement.

It is precisely such cheating that has made OPEC, the international oil cartel,

so unsuccessful over the past several decades at propping up oil prices.

Note however that in the dark

days of 1973 and 1974.

During those years, the members of OPEC banded together, slapped an oil embargo

on the U.S for its support of Israel, and more than quadrupled prices.

The result was long gas lines and a strong

negative shock to the American economy.

And I might add here that under

international law, OPEC's cartel behaviour was quite legal.

Even if cartels are illegal within the U.S. Note however

that in the ensuing years the OPEC cartel has been

unable to keep the price of oil high, and at

least part of the problem has been on the demand side.

After the 1970s

oil price shocks, motorists started driving smaller, more fuel-efficient cars.

Home owners more fully insulated their homes.

Businesses adopted new technologies to dramatically cut energy use,

and the world in general adopted wide-ranging energy conservation measures.

At the same time, on the supply side, higher

oil prices stimulated the search for new oil reserves.

And many non-OPEC members like Norway and Mexico entered the global oil market.

Nonetheless the biggest problem was not these forces of supply and demand,

but rather that OPEC has faced wide scale cheating within its ranks.

This is due largely to the economic and political diversity of

members as well as the large number of members in the cartel.

On the one hand, this sparsely populated

and fabulously wealthy members of the cartel like

Saudi Arabia, Kuwait and Qatar have been perfectly

content with restrict output and enjoy monopoly profits.

On the other hand, other much more

populous and poorer nations, like Venezuela and

Nigeria, haven't been able to resist the urge to cheat on their production quotas.

Because of large external debts to be paid and growing needs for cash.

The broader problem has been that OPEC has

no effective enforcement mechanism to police its agreements.

That is, OPEC has little effective way to punish

any members who do cheat on the collusive bargain.

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