Question: Let's start off by working out a few examples to illustrate the lure of the cartel. To keep it simple on the supply side, we'll assume that fixed costs are zero so marginal cost equals average cost. We'll compare the competitive outcome (P = MC) to what you'd get if the firms all agreed to act "as if" they were a monopoly. In all cases, we'll use terms from the following diagram:
a. First, let's see where the profits are. Comparing this figure with Figure 15.2, shade the rectangle that corresponds to monopoly profit.
b. What is the formula for this rectangle in terms of price, cost, and quantity?
c. Let's look at the market for one kind of apple: Gala. Assume that there are 300 producers of Gala apples and that MC = AC = $0.40 per pound. In a competitive market, price will be driven down to marginal cost. Let's assume that when P = MC, each apple grower produces 2 million pounds of apples for a total market production of 600 million pounds. Now imagine that the apple growers form a cartel and each agrees to cut production to 1 million pounds, which drives the price up to $0.70 per pound. Calculate profit per pound and total industry profit if the apple growers behave "as if " they were a monopoly and are able to produce according to the following table:
d. If a single apple grower broke from the cartel and produced an extra million pounds of apples, how much additional profit (approximately) would this apple grower make?