Answered: Consider a town in which only two…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Consider a town in which only two residents, Larry and Megan, own wells that produce water safe for drinking. Larry and Megan 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)
6.00	0	0
5.50	45	$247.50
5.00	90	$450.00
4.50	135	$607.50
4.00	180	$720.00
3.50	225	$787.50
3.00	270	$810.00
2.50	315	$787.50
2.00	360	$720.00
1.50	405	$607.50
1.00	450	$450.00
0.50	495	$247.50
0	540	0

Suppose Larry and Megan form a cartel and behave as a monopolist. The profit-maximizing price is

per gallon, and the total output is

gallons. As part of their cartel agreement, Larry and Megan agree to split production equally.

Suppose that Larry and Megan 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, Larry says to himself, "Megan 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."

Because Larry has deviated from the cartel agreement and increased his output of water to 45 gallons more than the cartel amount, Megan decides that she will also increase her production to 45 gallons more than the cartel amount.

Note that Larry and Megan started by behaving cooperatively. However, once Larry decided to cheat, Megan decided to cheat as well. In other words, Megan's output decisions are based on Larry's actions.

This behavior is an example of which of the following?

1. tying

2. dominant strategy

3. tit for tat strategy

4. Prisoner's dilemma

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