Reference no: EM133204167 , Length: Words Count:100

Assignment:

Read the following press release of the European Commission (Brussels, 28, March 2012). We model the European air cargo market as follows. First, only the 14 firms associated in the cartel were active on the market. Second, these firms are symmetric and had the same constant marginal cost, c, for supplying airfreight services. Third, these firms competed as in the Cournot model by choosing the quantity of airfreight services. Finally, the inverse demand for airfreight services (per month) was given by p=a-2q, where q denotes the total quantity of airfreight services supplied by the 14 firms.

The Commission fined the cartel members a total of 169 million euros. Given the cartel lasted for 72 months, this is roughly equivalent to 2.35 million euros per month. This fine is meant to compensate the European consumers for the reduction in the consumer surplus because of the existence of the cartel.

a. Show that (a-c) had to be equal to 3.89 million per month to justify the fine 2.35 million per month imposed by the Commission.

b. Set (a-c)to 3.89 million. Assuming that the cartel profits were equally shared among the cartel members, show that any of these firms would have been better off by leaving cartel (then the defecting firm and the cartel will compete like a two-firm Cournot model). Discuss the stability of the cartel.

c. Now suppose that the 14 firms were following a grim trigger strategy and were expecting to continue to continue to compete indefinitely on that market. Under the grim trigger strategy, all 14 firms compete independently in the Cournot model. Compute the minimum discount factor that allowed the 14 firms to sustain full collusion.