ATC and MC curves of one of the firms. If perfectly competitive conditions prevail, then each firm will produce the quantity OR (in B) and the total output of the industry will be OQ (in A). The market price will be OP, and each firm will just cover its cost. If however, each firm restricts its output to OF, industry output will be only OI; with the smaller quantity OI being offered on the market, the price OM can be charged. Each firm is now able to earn profit. Its cost of production per unit is FG (its output being OF); selling price per unit being equal to FH, it earns a profit of GH on each of the OF units which it sells, for a total profit amounting to the shaded area LKHG.
In order for all firms to achieve this profit, each must keep its output down to OF, so that the output of the industry as a whole is only OI, enabling firms to charge a market price of OM. The agreement may be in the form of a binding contract, a verbal undertaking, or perhaps an unspoken “understanding”. A more detailed description is given in the next chapter of the various methods whereby oligopolists may achieve such collusion.
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