Question

Suppose that Boeing and Rolls-Royce Holdings are the sole producers of a particular turbo engine. The two firms currently charge the same price for their products. If neither firm reduces the price of its turbo engine, each firm earns $50 million in profit. If both firms reduce their prices, then each firm will earn $10 million in profit. If one firm reduces its price and the other does not, then the firm that reduces price will earn a profit of $70 million while the other firm will earn a profit of $5 million. If the firms can operate as a cartel, what will they do

Answer 1

Answer:

The two firms will manipulate the market in unison, to maintain the same price, which guarantees the optimum benefit for both firms, as opposed to if one or both of them reduces its price.

Explanation:

A cartel is a group of independent market participants that collude with each other in order to improve their profits and dominate the market. Cartels are usually in the same line of business, and they form a type of alliance as competitors. Cartel use price fixing, bid rigging, and reductions in output, to dominate the market and to maximize their profit. They are usually frowned upon in a free market system.

In this case, if the the two firms Boeing and Rolls-Royce operates as a cartel, they will bend the market rules by fixing their prices, instead of letting market drivers like demand and supply to determine their selling price, they might also reduce their output so that they both have the same level of output, or do any other form of manipulation in unison to maintain the same price. This is because both companies will benefit equally if they maintain the same price, as opposed to if one or both of them reduces price.