In: Economics
SENTENCES IN BOLD ARE THE QUESTIONS
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 | Quantity Demanded | Total Revenue |
---|---|---|
(Dollars per gallon) | (Gallons of water) | (Dollars) |
3.60 | 0 | 0 |
3.30 | 35 | $115.50 |
3.00 | 70 | $210.00 |
2.70 | 105 | $283.50 |
2.40 | 140 | $336.00 |
2.10 | 175 | $367.50 |
1.80 | 210 | $378.00 |
1.50 | 245 | $367.50 |
1.20 | 280 | $336.00 |
0.90 | 315 | $283.50 |
0.60 | 350 | $210.00 |
0.30 | 385 | $115.50 |
0 | 420 | 0 |
1. 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 $____???, and Janet's profit is $___???.
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, Felix says to himself, "Janet 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."
2. After Felix implements his new plan, the price of water DECREASES OR INCREASES to $____ ???per gallon. Given Janet and Felix's production levels, Felix's profit becomes $___??? and Janet's profit becomes $____???.
Because Felix has deviated from the cartel agreement and increased his output of water to 35 gallons more than the cartel amount, Janet decides that she will also increase her production to 35 gallons more than the cartel amount.
3. After Janet increases her production, Felix's profit becomes $_____???, Janet's profit becomes $____???, and total profit (the sum of the profits of Felix and Janet) is now $____???.
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.
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.
5. This behavior is an example of A TIT FOR TAT STRATEGY/ A DOMINANT STRATEGY/ TYPING/ OR A PRISONERS DILEMMA?? .
1)
Answer to blank 1: $1.80
Answer to blank 2: 210
Answer to blank 3: 189 (i.e. 378 / 2 = 189)
Answer to blank 4: 189 (i.e. 378 / 2 = 189)
2)
Answer to blank 1: decreases
Answer to blank 2: $1.50
Explanation for blank 1 & 2:
When Felix increases production by 35 gallon, total production will be 245 gallon. So, the price will be $1.50 as shown in the table. In means price decreases.
Answer to blank 3: $210 (i.e. $1.50 * 140)
Answer to blank 4: $157.50 (i.e. $1.50 * 105)
3)
Answer to blank 1: $168
Answer to blank 2: $168
Answer to blank 3: $336
Explanation for blank 1, 2 & 3:
When Janet increases production by 35, the total production will be 280 gallon, each producing 140 gallon. Now the price will be $1.20 per gallon. Each earning a profit of $1.20 * 140 = $168 and the total profit will be $336.
5) Ans: 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.