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Question from Past Microeconomics Qualifying ExamEdit

Spring 2000- Section I, Question two, George Mason University

True, False, Uncertain. Determine whether or not each of the following statements are true or false. Explain your reasoning briefly in a paragraph or two. (The explanation is often more important than the answer given). Include a carefully labeled diagram or game matrix if it helps to clarify your answer.


Existing firms in a cartelized industry might prefer to be regulated by the government than by gentlemen’s agreement

AnswerEdit

True, Without government regulation, a cartel will have a natural tendency to break down. Cartels increase price by restricting output. However, the restricted output price (which is higher than the perfectly competitive equilibrium price) may tempt cartel members or new firms to expand output beyond the cartel set quantity. The additional output will lower the price below the price the cartel is trying to ensure for all its members. This quantity increasing tactic and the entry of new firms would not be permitted in a regulated market, ensuring the reduced quantity and higher prices the cartel is interested in achieving (See Nicholson p 584).


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