3. Breakdown of a cartel agreement Consider a town in which only two residents,

Question

3. Breakdown of a cartel agreement Consider a town in which only two residents, Manuel and Poornima, own wells that produce water safe for drinking. Manuel and Poornima can pump and sell as much water as they want at no cost. For them, total revenue equals profit. The following table shows the town's demand schedule for water Quantity Demanded (Gallons of water) Price Total Revenue (Dollars per gallon) (Dollars) 5.40 4.95 4.50 4.05 3.60 3.15 2.70 2.25 1.80 1.35 0.90 0.45 0 80 120 160 200 240 280 320 360 400 440 480 0 $198.00 $360.00 $486.00 $576.00 $630.00 $648.00 $630.00 $576.00 $486.00 $360.00 $198.00 0 Suppose Manuel and Poornima form a cartel and behave as a monopolist. The profit-maximizing price is $ output is per gallon, and the total gallons. As part of their cartel agreement, Manuel and Poornima agree to split production equally. Therefore, Manuel's profit is , and Poornima's profit is $ Suppose that Manuel and Poornima have been successfully operating as a cartel. They each charge the monopoly price and sell half of the monopoly quantity. Then one night before going to sleep, Manuel says to himself, "Poornima and I aren't the best of friends anyway. If I increase my production to 40 gallons more than the cartel amount, I can increase my profit even though her profit goes down. I will do that starting tomorrow."

Explanation / Answer

Behaviour as a monopolist:

Profit maximizing price = $ 2.7 per gallon

Total output = 240 gallons

Manuel's profit = $324

Poornima's profit = $324

After Manuel increases production:

Price of water = $ 2.25 per gallon

Manuel's profit = 160 x 2.25 = $360

Poornima's profit = 120 x 2.25 = $270

After Poornima increases production:

New price level = $1.8

Manuel's profit = 160 x 1.8 = $ 288

Poornima's profit = 160 x 1.8 = $ 288

Total profit = $576

The statement is false (Revenue earned by each individual increased, price effect < output effect)

This outcome is an example of Nash equillibrium.

Related Questions

Navigate

• Browse (All)
• Browse 3
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.