Question

Assume that the demand curve for milk is given by q = 100 – 10p, where p is the price per gallon, and q is the quantity demanded per year. the supply curve is horizontal at a marginal cost of $2.

Assuming that the market is competitive, what is the price per gallon of milk and the number of gallons sold?
The dairy farmers lobby members of Congress, and get permission to form and maintain a dairy cartel (Yes, cartels like this actually exist in the dairy industry). If a cartel is formed, what is the price of milk and how many gallons are sold?
What is the deadweight loss from the cartel?
Suppose the dairy farmers had to hire lawyers to lobby to create and maintain the cartel. How does this fact affect the deadweight loss you calculated in part c?

Answer 1

If the firms form a cartel, they will act like a monopoly, choosing the quantity of output where MR = MC.

Step-by-step explanation:

If the firms form a cartel, they will act like a monopoly, choosing the quantity of output where MR = MC. Drawing a line from the monopoly quantity up to the demand curve shows the monopoly price. Assuming that fixed costs are zero, and with an understanding of cost and profit, we can infer that when the marginal cost curve is horizontal, average cost is the same as marginal cost. Thus, the cartel will earn positive economic profits equal to the area of the rectangle, with a base equal to the monopoly quantity and a height equal to the difference between price (on the demand above the monopoly quantity) and average cost, as shown in the figure below: