Question

Suppose an oligopoly consists of two firms. Firm A lowers price and Firm B responds by lowering its price by the same amount. If average costs and industry output remain the​ same, which of the following will​ occur? A. The profits of the two firms will decrease. B. The profits of the two firms will remain the same. C. The profits of the two firms will increase. D. Barriers to entry will come tumbling down and new firms will enter.

Answer 1

We do not expect the barriers to entry to tumble down because this is an oligopoly market where potential entry is blocked. It is given that there is an undercutting on price. Both firms have reduced their price by the same amount.

Generally they will not attempt to reduce the price if they are not making profit. In oligopoly market there is a special feature that the market size is more or less the same, and every existing firm tries to attract the customer of the other firm, since they share the same market base.

Therefore when prices reduced by both the firms, they will be expecting A reduction in their profits because average cost is same and market share will also remain same. Select option A