In pure Cournot competition, a merger will always result in lower profits unless
ID: 1133544 • Letter: I
Question
In pure Cournot competition, a merger will always result in lower profits unless the merged firm experiences increased cost efficiencies. Usually, merged firms experience lower costs and higher profits while charging higher prices.
Think of the airline industry and the case with US Airways and American merging together. The airlines argued that the merger will not result in price increases.
1) Make an argument supporting the airlines’ position based on the Cournot equilibrium for one of the airlines’ largest markets.
2) Make counterarguments illustrating unilateral effect and collusion effect reasons why prices will increase.
Explanation / Answer
1) When the airlines collude as per the Cournot model but do not explicitly collude as in a Cartel, each firm still has a threat from the other firm that it may decrease the prices and outcompete the other. This threat of decrease in prices by the other firm keeps the prices at the original Cournot equilibrium even after collusion. Hence, the airlines may be right in saying that the prices do not increase after Cournot collusion.
2) As a counter argument it may be pointed out that after collusion the firms compete with each other less aggressively and will increase their prices above the Cournot equilibrium. This is due to the unilateral effect where the firms together act as a monopoly and are interested in maximising their joint profits rather than individual profits, enjoying greater market power. Thus the collusion may in fact raise prices.