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, Nick and Rosa, own wells that produce water safe for drinking. Nick and Rosa 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 Revern Total Revenue (Dollars per gallon) Gallons of water) (Dollars) 6.00 5.50 5.00 0 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0 90 135 180 225 270 315 360 405 450 495 540 0 $247.50 $450.00 $607.50 $720.00 $787.50 $810.00 $787.50 $720.00 $607.50 $450.00 $247.50 0 Suppose Nick and Rosa 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, Nick and Rosa agree to split production equally. Therefore, Nick's profit , and Rosa's profit is $ Suppose that Nick and Rosa 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, Nick says to himself, "Rosa and I aren't the best of friends anyway. If I increase my production to 45 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

Profit maximizing price = $ 3.00 (where TR is highest), output = 270, Nick's and Rosa's profit = $405 each

After Nick implements his new plan, price of water decreases to $2.5 per gallon. nick's profit = 180*2.5 = 450 and Rosa's profit = 135*2.5 = 337.5

After Rosa implements her decision, Rosa's profit = 2*180 = $360, nick's profit = 180*2= $360 and total profit = $720

TRUE

a dominant strategy

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