In: Economics
3. Breakdown of a cartel agreement Consider a town in which only two residents, Yakov and Ana, own wells that produce water safe for drinking. Yakov and Ana 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 Yakov and Ana 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, Yakov says to himself, "Ana 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." After Yakov implements his new plan, the price of water (increases/decreases) to ____ per gallon. Given Ana and Yakov's production levels, Yakov's profit becomes _____ and Ana's profit becomes _____.Because Yakov has deviated from the cartel agreement and increased his output of water to 40 gallons more than the cartel amount, Ana decides that she will also increase her production to 40 gallons more than the cartel amount. After Ana increases her production, Yakov's profit becomes _____, Ana's profit becomes ____, and total profit (the sum of the profits of Yakov and Ana) is now ________.True or False: Based on the fact that both Yakov and Ana increased production from the initial cartel quantity, you know that the output effect was larger than the price effect at that quantity. -True -False Note that Yakov and Ana started by behaving cooperatively. However, once Yakov decided to cheat, Ana decided to cheat as well. In other words, Ana's output decisions are based on Yakov's actions. This behavior is an example of (a prisoner's dilemma, tying, a dominant strategy, a tit-for-tat strategy . |