Consider a town in which only two residents, Lorenzo and Neha own wells that produce water safe
Question:
Consider a town in which only two residents, Lorenzo and Neha own wells that produce water safe for drinking. Lorenzo and Neha 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 Lorenzo and Neha 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, Lorenzo and Neha agree to split production equally. Therefore, Lorenzo's profit is,__________ and Neha's profit is___________.
Suppose that Lorenzo and Neha 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, Lorenzo says to himself, "Neha 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 Lorenzo implements his new plan, the price of water DECREASES OR INCREASE to___________per gallon. Given Neha and Lorenzo's production levels, Lorenzo's profit becomes____________ and Neha's profit becomes____________.
Because Lorenzo has deviated from the cartel agreement and increased his output of water to 45 gallons more than the cartel amount, Neha decides that she will also increase her production to 45 gallons more than the cartel amount.
After Neha increases her production, Lorenzo's profit becomes___________ Neha's profit becomes_________ and total profit (the sum of the profits of Lorenzo and Neha) is now___________.
True or False: Based on the fact that both Lorenzo and Neha increased production from the initial cartel quantity, you know that the output effect was larger than the price effect at that quantity.
True
False
Lorenzo and Neha 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 Lorenzo'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 Lorenzo nor Neha has an incentive to further increase output, nor does either have an incentive to decrease output. This outcome is an example of which one below
- a Nash equilibrium
- resale price maintenance
- predatory pricing
- tying
Fundamentals of Thermodynamics
ISBN: 978-0471152323
6th edition
Authors: Richard E. Sonntag, Claus Borgnakke, Gordon J. Van Wylen