Question

You are the manager of a firm that competes against four other firms by bidding for government contracts. While you believe your product is better than the competition, the government purchasing agent views the products as identical and purchases from the firm offering the best price. Total government demand is Q = 1900 -10P and all five firms produce at a constant marginal cost of $120. For security reasons, the government has imposed restrictions that permit a maximum of five firms to compete in this market; thus entry by new firms is prohibited. A member of Congress is concerned because no restrictions have been placed on the price that the government pays for this product. In response, she has proposed legislation that would award each existing firm 20 percent of a contract for 500 units at a contracted price of $140 per unit.

If this legislation is passed, by how much should you expect your profits to change?

Answer 1

Without the Legislation,the industry is operating under homogeneous product Bertrand oligopoly.

All the firms in the industry will produce at marginal cost pricing and so all the five firms will earn zero profits.

Under the legislation,the contracted price of $140 per unit will mean that each firm can earn a profit of 140-120 = $20 profit per unit.

As each firm will be awarded 20% of 500 units so each firm is awarded 100 units.

Q=20%x500 = 100

Profit = Qx(MR-MC)

100x(140-120)

100x20 = $2000

Therefore the legislation will bring profits of $2000 for each firm as compared to zero profits under bertrand competition.