Consider a town in which only two residents, Andrew and Beth, own wells that pro
ID: 1225192 • Letter: C
Question
Consider a town in which only two residents, Andrew and Beth, own wells that produce water safe for drinking. Andrew and Beth 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. Suppose that Andrew and Beth 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, Andrew says to himself, "Beth and I aren't the best of friends anyway. If I increase my production to 35 gallons more than the cartel amount, I can increase my profit even though her profit goes down. I will do that starting tomorrow." After Andrew implements his new plan, the price of water to per gallon. Given Beth and Andrew's production levels, Andrew's profit becomes and Beth's profit becomes. Because Andrew has deviated from the cartel agreement and increased his output of water to 35 gallons more than the cartel amount, Beth decide^that she will also increase her production to 35 gallons more than the cartel amount. After Beth increases her production, Andrew's profit becomes sum of the profits of Andrew and Beth) is now, Beth's profit becomes, and total profit (the True or False: Based on the fact that on the Andrew and Beth increased production from the initial cartel quantity, you know that the output effect larger than the price effect at that quantity.Explanation / Answer
THE PROFIT MAXIMIZING PRICE IS $1.8, AND THE TOTAL OUTPUT IS 210 GALLONS. ANDREW AND BETH PROFIT WILL BE $189 EACH.
NOW IF ANDREW BREAKS THE AGREEMENT THE QUANTITY WILL RISE AND SELL THE SAME THE PRICES WILL BE LOWERED.
AFTER ANDREWS PLAN THE PRICE WILL BE 1.5 AND THE NEW QUANTITY WILL BE 245 GALLONS.
NOW ANDREWS PROFIT WILL BE 140 * 1.5 = $ 210 AND BETH PROFIT WILL BE 105 * 1.5 = 157.5 AND THE
AFTER THIS IF BETH ALSO INCREASES THE PRICE THEN ANDREWS PROFIT BECOMES 140 * 1.2 = 168 AND BETH'S PROFIT BECOMES 140 * 1.2 = 168 TOTAL PROFIT WILL COME TO 280 * 1.2 = $336.
FALSE, IN BOTH THE CASES THE CHANGE IS ABOUT 33.33% PERCENT THE CHANGE IS EQUAL. HENCE THE OUTPUT EFFECT AND PRICE EFFECT ARE SAME.
IT IS CLEARLY A CASE OF TIT FOR TAT. BETH HAS REACTED AS SHE WAS PROVOKED TO DO SO. IT IS ALSO CALLED AN ITERATED PRISONERS DILEMMA.