3. Breakdown of a cartel agreement Consider a town in which only two residents,
ID: 1204003 • Letter: 3
Question
3. Breakdown of a cartel agreement Consider a town in which only two residents, Rajiv and Simone, own wells that produce water safe for drinking. Rajiv and Simone 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. Price Quantity Demanded Total Revenue Dollars per gallon) (Gallons of water) (Dollars) 3.60 3.30 3.00 2.70 2.40 2.10 1.80 1.50 1.20 0.90 0.60 0.30 0 0 35 70 105 140 175 210 245 280 315 350 385 420 0 $115.50 $210.00 $283.50 $336.00 $367.50 $378.00 $367.50 $336.00 $283.50 $210.00 $115.50 0Explanation / Answer
Answer. Since the total cost = 0 , so there is no marginal cost or MC=0
Hence, the total profits = Total Revenue
So, they will sell the number of units where the total revenue is maximum. On observing the table, we find that they will sell 210 gallons of water and charge $1.80 price for per gallon and the profits would be $378.00.
They will split the production equally. So each will produce 105 gallons of water and earns $189 profits individually.
If Rajiv increases its production by 35 gallons then total production will increase and becomes 245 gallons and price decreases to $1.40 per gallon. But, they will produce it equally i.e, 122.5 galllons individually and split the profits equally. The profits are $367.50 which they share equally. So, each one will receive $183.75 as profits.
Now, if Simon also increases the production by 35 gallons, the total production becomes 280 gallons and price decreases to $1.20 and their joint profits will be $336 which they share equally i.e each will have $168 as profit.
True, we know that the output effect was larger than the price effect at that quantity.
When they dont have any incentive to increase or decrease the output, this is an example of Nash Equilibrium.
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