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, Tim and Alyssa, own wells that produce water safe for drinking. Tim and Alyssa can pump and sell as much water as they want at no cost. For them, total revene equals profit. The following table shows the town's demand schedule for water Price Quantity Demanded Gallons of water Total Revenue Dollars Dollars per ga llon 4.20 3.85 3.50 3.15 2.80 2.45 2.10 1.75 1.40 1.05 0.70 0.35 40 80 120 160 200 240 280 320 360 400 440 480 S154.00 $280.00 S378.00 S448.00 S490.00 S504.00 S490.00 S448.00 S378.00 $280.00 S154.00 Suppose Tim and Alyssa form a cartel and behave as a monopolist. The profit-maximizing price is S the total output is Tim's profit is per gallon, and gallons. As part of their cartel agreement, Tim and Alyssa agree to split production equally. Therefore, , and Alyssa's profit is Suppose that Tim and Alyssa 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, Tim says to himself, "Alyssa 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 wil do that starting tomorrow." After Tim implements his new plan, the price of water production levels, Tim's profit becomes per gallon. Given Alyssa and Tim's and Alyssa's profit becomes Because Tim has deviated from the cartel agreement and increased his output of water to 40 gallons more than the cartel amount, Alyssa decides that she will also increase her production to 40 gallons more than the cartel amount.

Explanation / Answer

1) $ 2.10

2) 240 gallons of water

3) Tim's profit = 504/2 = 252

4) Alyssa's profit = 504/2 = 252

5) Falls to $ 1.75

6) Tim's profit = (120 + 40) x 1.75 = 280

7) Alyssa's profit = 120 x 1.75 = 210

8) Tim's profit = 160 x 1.40 = 224

9) Alyssa's profit = 160 x 1.40 = 224

10) Total profit = 448

11) False

12) Tit-for-tat strategy

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