Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

CHAP. 10] PRICE AND OUTPUT UNDER MONOPOLISTIC COMPETITION AND OLIGOPOLY 257
In Fig. 10-20, we see that firm 2 wants to sell 200 units at the price of $8 (given by point E 2 , where mr ¼
SMC 2 ) while firm 1 would like to sell 150 units at the price of $9 (given by E 1 where mr ¼ SMC 1 ). Since the commodity
is homogeneous, firm 1 will usually have to follow firm 2 and also sell at the price of $8. Thus only firm 2
(i.e., the price leader) will usually be producing and selling its best level of output.
10.20 Assume that (1) two firms selling a homogeneous commodity share the market equally, (2) the total
market demand schedule facing them is the same as in Problem l0.18, and (3) the cost schedules of
each firm are as given in Tables 10.3 and 10.4. (a) What would be the total profit of each firm if
each were producing its best level of output? (b) What is the most likely result? (c) What other
result is possible?
Fig. 10-20
Table 10.3
q 1 40 50 60 80
SMC 1 ($) 8 10.00 12 16
SAC 1 ($) 13 12.30 12 13
Table 10.4
q 2 50 70 100
SMC 2 ($) 4 6 9
SAC 2 ($) 7 6 7
(a)
(b)
(c)
From Fig. 10-21, we see that firm 1 would like to sell 40 units at the price of $16 (given by point E 1 ), thereby
maximizing its total profits at $120. Firm 2 maximizes its total profits (at $350) by selling 50 units at the price
of $14 (given by point E 2 ).
Since the commodity is homogeneous, it must sell at the single price of $14. That is, the high-cost firm (firm
1) will have to follow the price leadership of the low-cost firm (firm 2). Thus, only firm 2 will produce its
best level of output (given by E 2 ) and maximize its total profits (at $350). Firm 1 will now also have to
charge the price of $14 and sell 50 units, and so it will now make only $85 of profits ($1.70 per unit
times 50 units).
In some cases, the price that the low-cost firm would set at its best level of output is so low that it would drive
the high-cost firm(s) out of business. When this is true, the low-cost firm might want to forgo profit maximization
and set a (higher) price that would allow other firms to remain in business. By doing so, it would avoid
becoming a monopoly and facing possible prosecution under U.S. antitrust laws.