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You are the manager of a firm that competes
against four other firms by bidding for government contracts. While you
believe your product is better than the competition, the government
purchasing agent views the products as identical and purchases from the
firm offering the best price. Total government demand is Q = 750 8P
and all five firms produce at a constant marginal cost of $50. For
security reasons, the government has imposed restrictions that permit a
maximum of five firms to compete in this market; thus entry by new firms
is prohibited. A member of Congress is concerned because no
restrictions have been placed on the price that the government pays for
this product. In response, she has proposed legislation that would award
each existing firm 20 percent of a contract for 270 units at a
contracted price of $60 per unit. Would you support or oppose this
legislation? Explain.
I would support this legislation. Without this deal, the firms will compete for the contract to give a zero profit condition, like in a perfect competition. No matter how low another firm bids, I can always bid a little lower, to try to win the contract until P=MC. The rational outcome of this “game” is a contract that gives zero profit. The proposed legislation is like a collusive agreement…

ranteeing each firm positive profit. At the proposed contract, we will produce q=.2(270)=54 If 270 units are produced in the industry, and we charge $60/unit, we get Profit=q(MR-MC)=54(10)=$540. (assuming no fixed costs, as long as fixed cost<540 we want this contract)

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