ter Amy increases her production, Van's profit becomes S e profits of Van and Amy) is now s Amy's profit becomes s and total pro

ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
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Chapter1: Making Economics Decisions
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3. Breakdown of a cartel agreement
Consider a town in which only two residents, Van and Amy, own wells that produce water safe for drinking. Van and Amy 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
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
540
Suppose Van and Amy form a cartel and behave as a monopolist. The profit-maximizing price is S
per gallon, and the total output is
gallons. As part of their cartel agreement, Van and Amy agree to split production equally. Therefore, Van's profit is s
and
Amy's profit is $
Suppose that Van and Amy 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, Van says to himself, "Amy 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."
After Van implements his new plan, the price of water
v to $
per gallon. Given Amy and Van's production levels, Van's
profit becomes S
and Amy's profit becomes s
Transcribed Image Text:3. Breakdown of a cartel agreement Consider a town in which only two residents, Van and Amy, own wells that produce water safe for drinking. Van and Amy 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 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 $247.50 540 Suppose Van and Amy form a cartel and behave as a monopolist. The profit-maximizing price is S per gallon, and the total output is gallons. As part of their cartel agreement, Van and Amy agree to split production equally. Therefore, Van's profit is s and Amy's profit is $ Suppose that Van and Amy 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, Van says to himself, "Amy 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." After Van implements his new plan, the price of water v to $ per gallon. Given Amy and Van's production levels, Van's profit becomes S and Amy's profit becomes s
Because Van has deviated from the cartel agreement and increased his output of water to 45 gallons more than the cartel amount, Amy decides that
she will also increase her production to 45 gallons more than the cartel amount.
After Amy increases her production, Van's profit becomes $
, Amy's profit becomes $
|, and total profit (the sum of
the profits of Van and Amy) is now $
True or False: Based on the fact that both Van and Amy increased production from the initial cartel quantity, you know that the output effect was
larger than the price effect at that quantity.
O True
O False
Van and Amy have each cheated on their cartel agreement and increased production by 45 gallons more than the cartel amount. However, they both
realize that if they continue to increase output beyond this amount, they'll each suffer a decrease in profit. (To see this for yourself, consider Van's
profit when he produces 90 gallons more than the cartel amount compared to his profit when he produces 45 gallons more than the cartel amount.)
Neither Van nor Amy has an incentive to increase output further, nor does either have an incentive to decrease output. This outcome is an example of
Transcribed Image Text:Because Van has deviated from the cartel agreement and increased his output of water to 45 gallons more than the cartel amount, Amy decides that she will also increase her production to 45 gallons more than the cartel amount. After Amy increases her production, Van's profit becomes $ , Amy's profit becomes $ |, and total profit (the sum of the profits of Van and Amy) is now $ True or False: Based on the fact that both Van and Amy increased production from the initial cartel quantity, you know that the output effect was larger than the price effect at that quantity. O True O False Van and Amy have each cheated on their cartel agreement and increased production by 45 gallons more than the cartel amount. However, they both realize that if they continue to increase output beyond this amount, they'll each suffer a decrease in profit. (To see this for yourself, consider Van's profit when he produces 90 gallons more than the cartel amount compared to his profit when he produces 45 gallons more than the cartel amount.) Neither Van nor Amy has an incentive to increase output further, nor does either have an incentive to decrease output. This outcome is an example of
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