There are three leading manufacturers of smart phones in Techland. Their products are considered to be perfect substitutes
a) Will these firms earn zero economic profits in the long run? Explain your answer.
b) What can the firms do to earn maximum profit?
a) The market for smart phones in Techland is an example of an oligopoly with homogeneous products. Firms in an oligopoly with homogeneous products often enter into a price war to increase their market share. Each firm cuts its price slightly below its rival's price to capture a larger market share. Because their goods are perfect substitutes, the price-cutting firm faces the entire market demand. This continues as long as the rival's price exceeds marginal cost. In equilibrium, all the firms charge a price equal to marginal cost and earn zero economic profits.
b) The firms can enter into a collusive agreement and decide to set prices jointly. They can coordinate and act like a monopoly. In this case, each firm will charge a price equal to that charged by a monopolist. At this price, each firm will face one-third of the market demand and earn one-third of the total profit earned by a monopolist.
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Government can overcome the free rider problem by collecting taxes and using the funds to provide individuals with nonexcludable public goods that they want to buy but the market cannot provide.
Answer the following statement true (T) or false (F)
Which of the following is characteristic of a perfectly competitive market?
A. Exit of small firms when profits are high for large firms. B. Marginal revenue lower than price for each firm. C. Zero economic profit in the long run. D. A small number of firms.