Question

How does the joint best (cartel) price compare to the Nash Equilibrium prices? Provide an economic explanation for the differences in prices.

Answer 1

At the joint best(cartel) prices, both the firms produce an output at a price where the total revenue is maximized as both firms will produce by acting as a monopolist by setting MC=MR.

However, at the Nash equilibrium price, the price will be lower and the output will be higher than the cartel situation.

It happens because both the firms have an incentive to cheat in a cartel arrangement. One firm will produce more output which will increase the industry output but decrease the market price as the firms face downward sloping demand curve so the profits for the cheating firm will increase but the profits for the non-cheating firm will decrease.

When one firm cheats, the other firm will also increase its output in order to increase its profits,but by doing this,the industry output increases further and the price decreases further so that the total profit for both the firms will decrease but both the firms will be at the Nash Equilibrium where neither of them has an incentive to output further, nor to decrease output so, at this level, the price will be lower than the cartel arrangement.