The majority of the world’s diamonds comes from Country A and Country B. Suppose that the marginal cost of mining a diamond is $1,000 per diamond and that the demand schedule for diamonds is as follows:
Price Quantity
$ 6,000 5,500
5,000 6,500
4,000 7,500
3,000 8,500
2,000 9,500
1,000 10,500
If there were MANY sellers of diamonds, what would equilibrium price and quantity? Why?
If there were only one seller, what would be the equilibrium price and quantity? Why?
If Country A and Country B formed a cartel, What would be the equilibrium price and quantity? Why? Is this cartel likely to survive? Why or why not?
To find the equilibrium price and quantity, we need to determine the point at which the quantity demanded is equal to the quantity supplied.
First, let's analyze the scenario where there are MANY sellers of diamonds:
In a competitive market, the price will be determined by the intersection of the demand and supply curves. The supply curve represents the marginal cost of production, which, in this case, is $1,000 per diamond. The demand schedule gives us the quantity of diamonds consumers are willing and able to buy at different prices.
To find the equilibrium price and quantity, we need to match the quantity demanded at a given price with the quantity supplied at that price. Looking at the demand schedule, we can see that at a price of $6,000, the quantity demanded is 5,500 diamonds. However, the marginal cost of mining a diamond is $1,000, so the quantity supplied at that price is considerably higher. Therefore, the price will gradually decrease until the quantity demanded matches the quantity supplied.
Based on the demand schedule, we can see that the equilibrium price will be $2,000, and the equilibrium quantity will be 9,500 diamonds. At this price, the quantity demanded and the quantity supplied are equal.
Now let's consider the scenario with only one seller:
When there is only one seller, it creates a monopoly situation. In a monopoly, the seller has the ability to set both the price and quantity. The seller would want to maximize their profits, so they will set the price where the marginal cost equals the marginal revenue. Since the marginal cost of mining a diamond is $1,000, they will set the price that maximizes their profit, which is $6,000 (the highest price at which demand is non-zero).
At a price of $6,000, the quantity demanded is 5,500 diamonds, which is less than the quantity available (since the marginal cost is $1,000). Thus, the monopolistic seller would restrict the quantity to meet the demand, resulting in an equilibrium quantity of 5,500 diamonds.
Finally, let's analyze the scenario where Country A and Country B form a cartel:
A cartel is a group of sellers who collude to restrict output and raise prices. In this case, if Country A and Country B form a cartel, they would act as a single seller to control the supply of diamonds in the market. By restricting the quantity supplied, the cartel can increase the price.
To determine the equilibrium price and quantity in this scenario, we need to understand the incentives for each country. If the cartel sets a high price, every country has an incentive to cheat and produce more, as they can sell diamonds at a higher price for additional profit.
The cartel would aim to set a price where the quantity demanded matches the quantity supplied, considering their production costs. In this case, if they set the price at, for example, $5,000, the quantity demanded would be 6,500 diamonds, but the production costs ($1,000 per diamond) suggest that they can supply more at that price.
Ultimately, maintaining a cartel in the diamond industry is challenging. The incentive to cheat and produce more diamonds to gain additional profit is strong. In addition, other countries or producers outside the cartel might increase their production to take advantage of the higher prices. Therefore, the cartel is likely to face difficulties in surviving in the long run.