An agreement between two duopolists to function as a monopolist usually breaks down because:

• A. Consumer demand for the product becomes perfectly elastic.
• B. Each firm has an incentive to cheat and increase its own output for higher profits.
• C. Government regulations always prevent such agreements from forming.
• D. The firms are unable to communicate with each other.

Answer: (B)

Verified step by step guidance

1. Understand the context: In a duopoly, two firms dominate the market. When they agree to act like a monopolist, they try to restrict output to raise prices and maximize joint profits.
2. Recognize the incentive structure: Each firm benefits from the agreement if both stick to the restricted output. However, if one firm increases its output secretly, it can capture more market share and increase its own profit.
3. Analyze the stability of the agreement: Because each firm can gain by cheating (producing more than the agreed quantity), there is a strong temptation to break the agreement.
4. Consider the role of communication and enforcement: Without a way to enforce the agreement or communicate effectively, the firms cannot ensure mutual compliance, making the agreement fragile.
5. Conclude that the main reason such agreements break down is the incentive for each firm to cheat and increase output to gain higher profits, undermining the collusion.