AP_Krugman_Textbook

Imagine that there are only two producers of lysine (the animal feed additive men-
tioned in the section opener). To make things even simpler, suppose that once a com-
pany has incurred the fixed cost needed to produce lysine, the marginal cost of
producing another pound is zero. So the companies are concerned only with the rev-
enue they receive from sales.
Table 64.1 shows a hypothetical demand schedule for lysine and the total revenue of
the industry at each price–quantity combination.

module 64 Introduction to Oligopoly 639

Section 12 Market Structures: Imperfect Competition

Demand Schedule for Lysine

Price of lysine Quantity of lysine demanded Total revenue

(per pound) (millions of pounds) (millions)

$12 0 $0

11 10 110

10 20 200

9 30 270

8 40 320

7 50 350

6 60 360

5 70 350

4 80 320

3 90 270

2 100 200

1 110 110

0 120 0

table64.1

If this were a perfectly competitive industry, each firm would have an incentive to pro-
duce more as long as the market price was above marginal cost. Since the marginal cost is
assumed to be zero, this would mean that at equilibrium, lysine would be
provided for free. Firms would produce until price equals zero, yielding a
total output of 120 million pounds and zero revenue for both firms.
However, with only two firms in the industry, it would seem foolish to
allow price and revenue to plummet to zero. Each would realize that with
more production comes a lower market price. So each firm would, like a
monopolist, see that profits would be higher if it and its rival limited
their production.
So how much will the two firms produce?
One possibility is that the two companies will engage in collusion—
they will cooperate to raise their joint profits. The strongest form of col-
lusion is a cartel,a group of producers with an agreement to work
together to limit output and increase price, and therefore profit. The
world’s most famous cartel is the Organization of Petroleum Exporting
Countries (OPEC).
As its name indicates, OPEC is actually a cartel made up of govern-
ments rather than firms. There’s a reason for this: cartels among firms are illegal in the
United States and many other jurisdictions. But let’s ignore the law for a moment. Sup-
pose the firms producing lysine were to form a cartel and that this cartel decided to act

OPEC representatives discuss the car-

tel’s policies of cooperation.

AP Photo/Hans Punz

Sellers engage in collusionwhen they

cooperate to raise their joint profits. A

cartelis a group of producers that

agree to restrict output in order to

increase prices and their joint profits.