a) All the firms in the perfectly competitive market structure are the price takers while the price is fixed by the industry through the forces of price mechanism. The diagram below indicates the equilibrium state for the Bottled Water market and each individual firm:
Figure A represents market demand curve, while Figure B represents demand curve of an individual firm in the perfectly competitive market
b) At the announcement of tap water being toxic, the market for Bottled Water will see a positive change in the demand figures and as a result, the demand curve will shift rightwards. On the other hand, assuming that the supply of bottled water cannot be increased momentarily, an upward pressure on the price levels will be built and the equilibrium price for bottled water will increase in the market and each individual firm will also sell the product at the higher equilibrium price. The diagram below indicates the effect more comprehensively:
c) As for short run, a firm in the perfectly competitive market may earn super normal profit. However, this super normal profit works as incentive for the new firms to enter the industry and claim their share of profit. In other words, in the long run, as the new firms enter the market, the overall supply in the market is increased. As a result, the market price falls for all the firm until normal profit is made. Therefore, in the long run, firms in the perfectly competitive market will only make normal profit.
Perfectly Competitive Market in short run:
Perfectly Competitive Market in long-run:
Problem 2:
Under the agreement to collude, the duopolist firms, just like a monopolist, will fix their output at MR=MC. However, since MC= 0, therefore Marginal Revenue (MR) will also be equal to 0. As we can see from the table below, it is at the production of 600 units, the Marginal Revenue turns out to be 0. Therefore, if both the firms decided to collude, they will produce 600 units at the price of $5 while earning profit of $3000.
ii) If both firms compete:
-Dominant Strategy:
In the above section, we found that if both of the duopolist firms agree to collude, they will produce 600 units at the price of $5 and earn $3000 profit. However, if both the firms decides to compete, each of them will have their own dominant strategy related to production output
*Firm A represents columns while Firm B represents rows
As we can see from the above payoff matrix, the dominant strategy will be top produce 400 units earning profit of $1200, making this as Nash Equilibrium. However, since this profit is less than that under cartel, it is suggested that each of them should collude and earn $1500 as profit by producing 600 units.
References
Perfect Competition. (2015, June 25). Retrieved from http://www.economicsonline.co.uk/Business_economics/Perfect_competition.html
