Question 5
a) The two big fast food chains, CafeÌ de Coral and Fairwood, occupy a very large share in the Chinese fast food market in Hong Kong. Suppose these two fast food chains try to form a cartel to charge higher prices for their food. Each fast food chain can choose to charge high prices (H) or low prices (L). The payoffs to each of the fast food chains are summarized in the following matrix:
Fairwoodâs payoffs
Fairwoodâs payoffs
L H CafeÌ de Coralâs payoffs L (2,2) (12,0) CafeÌ de Coralâs payoffs H (0,12) (10,10)
Note: The first entry is CafeÌ de Coralâs payoffs and the second entry is Fairwoodâs payoffs.)
i The cartel agreement is for each fast food chain to charge high prices (H). What are the payoffs to the two fast food chains if the agreement is observed?
ii Explain why an individual fast food chain has no incentive to charge high prices as specified in the agreement.
b Why do economists say that a monopolistically competitive firm is producing too little output from an efficiency point of view? Briefly explain with a diagram.
Question 5
a) The two big fast food chains, CafeÌ de Coral and Fairwood, occupy a very large share in the Chinese fast food market in Hong Kong. Suppose these two fast food chains try to form a cartel to charge higher prices for their food. Each fast food chain can choose to charge high prices (H) or low prices (L). The payoffs to each of the fast food chains are summarized in the following matrix:
| Fairwoodâs payoffs | Fairwoodâs payoffs | ||
| L | H | ||
| CafeÌ de Coralâs payoffs | L | (2,2) | (12,0) |
| CafeÌ de Coralâs payoffs | H | (0,12) | (10,10) |
Note: The first entry is CafeÌ de Coralâs payoffs and the second entry is Fairwoodâs payoffs.)
i The cartel agreement is for each fast food chain to charge high prices (H). What are the payoffs to the two fast food chains if the agreement is observed?
ii Explain why an individual fast food chain has no incentive to charge high prices as specified in the agreement.
b Why do economists say that a monopolistically competitive firm is producing too little output from an efficiency point of view? Briefly explain with a diagram.
Related textbook solutions
Related questions
The collusion problem of a cartel is simplified as follows. There are two firms, A and B. Each firm can choose to produce two levels of output, H (high) or L (low). The payoffs to the firms are summarized in the following matrix:
| B's payoff | |||
| A's payoff | H | L | |
| H | (2,2) | (14,0) | |
| L | (0,14) | (8,8) |
i. The cartel agreement is for each firm to produce a low level (L). What are the payoffs to the firms if the agreement is observed?
ii. Explain why an individual firm has no incentive to produce a low level of output as specified in the agreement.
(a) The collision problem of a cartel is simplified as follows. There are two firms, A and B. Each firm can choose to produce two levels of output, H (high) or L (low). The payoffs to the firms are summarized in the following matrix:
| B's payoff | |||
| A's payoff | H | L | |
| H | (2,2) | (14,0) | |
| L | (0,14) | (8,8) |
i. The cartel agreement is for each firm to produce a low level (L). What are the payoffs to the firms if the agreement is observed?
ii. Explain why an individual firm has no incentive to produce a low level of output as specified in the agreement.
(b) Why do we say that a monopoly is inefficient?
