Question

3. Breakdown of a cartel agreement Consider a town in which only two residents, Felix and Janet, own wells that produce water safe for drinking. Felix and Janet 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 (Dollars per gallon) 5.40 Quantity Demanded (Gallons of water) 0 Total Revenue (Dollars) 0 4.95 40 $198.00 4.50 80 4.05 120 3.60 160 3.15 200 $360.00 $486.00 $576.00 $630.00 $648.00 $630.00 $576.00 2.70 240 2.25 280 1.80 320 1.35 360 $436.00 0.90 400 $360.00 0.45 440 $198.00 0 480 0 Suppose Felix and Janet 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, Felix and Janet agree to split production equally. Therefore, Felix's profit is s and Janet's profit is s Suppose that Felix and Janet 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, Fellx says to himself, "Janet 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 will do that starting tomorrow." per gallon. Given Janet and Felix's production levels, After Felix implements his new plan, the price of water Felix's profit becomes and Janet's profit becomes $ Because Felix has deviated from the cartel agreement and increased his output of water to 40 gallons more than the cartel amount, Janet decides that she will also increase her production to 40 gallons more than the cartel amount.

Answer 1

Answer :

As I drop down the answers in the blanks with respectively numbers.

(1) :- Profit maximizing price = 2.70 because total revenue or profit is highest at this price.

240 gallons

Total profit = $ 648

So, each firm's profit = 648/2 = $ 324

Felix's profit = $ 324

Janet's profit = $ 324

When production increases by 40 units then the price of water decreases to $ 2.25 per gallon.

• Suppose Felix and Janet form a cartel and behave as a monopolist. The profit-maximizing price is $2.70 per gallon, and the total output is 240 gallons. As part of their cartel agreement, Felix and Janet agree to split production equally. Therefore, Felix's profit is $324 and Janet's profit is $324.

(2) :- When production increases by 40 units then the price of water decreases to $2.25 per gallon.

Felix's new profit = (240/2 + 40units) X $ 2.25 = $ 360

Janet's new profit = (240/2) X $ 2.25 = $ 270

• After Felix implements his new plan, the price of water DECREASES to $1.80 per gallon. Given Janet and Felix's production levels, Felix's profit becomes $360 and Janet's profit becomes $270.

(3) :- When Janet also increases production by 40 units then price of water again decreases and reaches at $ 1.80 per gallon.

Felix's profit = 320/2 X 1.80 = $288

Janet's profit = 320/2 X 1.80 = $288

Total profit = $288 + $288 = $576

After Janet increases her production, Felix's profit becomes $288  Janet's profit becomes $288 and total profit (the sum of the profits of Felix and Janet) is now $576.

(4) :- True or False: Based on the fact that both Felix and Janet increased production from the initial cartel quantity, you know that the output effect was larger than the price effect at that quantity.

The given statement is False.

(5) :- Note that Felix and Janet started by behaving cooperatively. However, once Felix decided to cheat, Janet decided to cheat as well. In other words, Janet's output decisions are based on Felix's actions.

This behavior is an example of TIT FOR TAT STRATEGY

Explanation :

Tit for Tat strategy means both player cooperate at the first play; then, on subsequent plays, do the same action the other player choose on the immediately previous play.

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