Consider two firms that sell substitute products and compete with one another in
ID: 1103514 • Letter: C
Question
Consider two firms that sell substitute products and compete with one another invarious markets across the country. As a casual observer of the market, you do not know the demand function for each of these products nor the firms’ cost functions. You read a newspaper article that claims these two firms are colluding for the following reasons:
(a) The firms’ price changes match each other quite closely over time
(b) When it is known or likely that their costs have risen, both firms raise their prices
(c) When a rival firm selling a substitute product entered the market, both of the original firms lowered their prices 1
(d) There are markets where only one of the firms is operating, indicating that the firms have divided the country into local monopolies among themselves
Explanation / Answer
Correct option: (d) There are markets where only one of the firms is operating, indicating that the firms have divided the country into local monopolies among themselves
Reason: If two firms selling substitute goods collude, it is only possible if they intend to rule the market collectively as a monopoly. This way the firms will be able to charge more and make more profits.