Consider an industry that could operate as a cartel with 2 firms or as a Cournot game with 2 firms. The demand and marginal costs are the same for each scenario.

What is true about the amount of total profit (sum of profit made by both firms) that would be made in that industry under a Cournot game, relative to the amount of total profit (sum of profit made by both firms) that would be made in that industry under a cartel (two firms acting as a monopoly)?

Question

Consider an industry that could operate as a cartel with 2 firms or as a Cournot game with 2 firms. The demand and marginal costs are the same for each scenario.

What is true about the amount of total profit (sum of profit made by both firms) that would be made in that industry under a Cournot game, relative to the amount of total profit (sum of profit made by both firms) that would be made in that industry under a cartel (two firms acting as a monopoly)?

BlackTom AI · Accepted Answer

Reframe the scenario in my own words to ensure clarity: we’re comparing two market structures with the same demand schedule and identical marginal costs, but different strategic settings for two firms: (a) a cartel behaving like a single monopolist, and (b) a Cournot duopoly where each firm chooses its output simultaneously.
Option 1: 'total industry profit is higher for the Cournot game' In standard industrial organization results, a Cournot duopoly produces more output than a monopoly (cartel) would, because the cartel restricts output to raise price and maximize joint profits. When two firms compete Cournot-style, the total quantity is higher, price falls, and total profit across both firms tends to be lower than the monopoly profit. Therefore, this option claims the opposite of the typical outcome and is incorrect under the usual assumptions of identical costs and linear (or otherwise well-behaved) demand.
Option 2: 'total industry profit is lower for the Cournot game' This statement aligns with the classic result: the cartel (monopoly) restricts output to maximize joint profits, yielding a higher total profit for the industry than the Cournot outcome where each firm independently chooses output and the total quantity is larger but the price is lower, reducing overall profits. Hence, the Cournot total profit is typically lower than the monopoly/cartel total profit.
Option 3: 'total industry profit is the same for Cournot games and monopolies/cartels' This would require identical outputs and prices under both structures. In general, with identical costs and a standard downward-sloping demand curve, the Cournot outcome does not replicate monopoly output; the increased competition in Cournot typically reduces total profit relative to monopoly. So this equality is not generally true.
Option 4: 'it's impossible to answer this question without more information' The basic comparative statics of a two-firm Cournot duopoly versus a two-firm cartel with identical demand and costs are well-established. While specifics can vary with nonlinear costs or demand, the general qualitative result—monopoly/cartel yields higher total profit than Cournot in this setup—holds under standard assumptions. Therefore, another layer of information is not strictly required to determine the direction of the profit comparison.
In summary, we analyze the intuition behind each claim: the cartel aims to maximize joint profits by restricting output, the Cournot setup distributes market power between two firms leading to higher total output and typically lower industry profit. The second option expresses the conventional outcome directly, while the first and third contradict it, and the fourth questions the sufficiency of information despite the established general result. The reasoning hinges on the standard monopoly versus Cournot comparison with identical costs and a downward-sloping demand curve, where the monopoly’s higher price and lower output yield a higher total profit than the Cournot pair. This line of reasoning explains why the Cournot total profit is not higher and not equal in general, making the second option the consistent conclusion under the given assumptions.

ECON_104B_001_25S Lecture Quiz #6

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