3. Breakdown of a cartel agreement Consider a town in which only two residents, Shen and Valerie, own wells that produce

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3 Breakdown Of A Cartel Agreement Consider A Town In Which Only Two Residents Shen And Valerie Own Wells That Produce 1 (50.11 KiB) Viewed 9 times

3. Breakdown of a cartel agreement Consider a town in which only two residents, Shen and Valerie, own wells that produce water safe for drinking. Shen and Valerie 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) 3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0 Quantity Demanded (Gallons of water) 0 50 100 150 200 250 300 350 400 450 500 550 600 Total Revenue (Dollars) 0 $137.50 $250.00 $337.50 $400.00 $437.50 $450.00 $437.50 $400.00 $337.50 $250.00 $137.50 0 Suppose Shen and Valerie form a cartel and behave as a monopolist. The profit-maximizing price is $ is per gallon, and the total output gallons. As part of their cartel agreement, Shen and Valerie agree to split production equally. Therefore, Shen's profit is , and Valerie's profit is $ Suppose that Shen and Valerie 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, Shen says to himself, "Valerie and I aren't the best of friends anyway. If I increase my production to 50 gallons more than the cartel amount, I can increase my profit even though her profit goes down. I will do that starting tomorrow." After Shen implements his new plan, the price of water Shen's profit becomes $ to $ and Valerie's profit becomes $ per gallon. Given Valerie and Shen's production levels,

After Shen implements his new plan, the price of water Shen's profit becomes $ to 5 and Valerie's profit becomes $ Because Shen has deviated from the cartel agreement and increased his output of water to 50 gallons more than the cartel amount, Valerie decides that she will also increase her production to 50 gallons more than the cartel amount. After Valerie increases her production, Shen's profit becomes $ sum of the profits of Shen and Valerie) is now $ O True O False per gallon. Given Valerie and Shen's production levels, True or False: Based on the fact that both Shen and Valerie increased production from the initial cartel quantity, you know that the output effect was smaller than the price effect at that quantity. This behavior is an example of Valerie's profit becomes $ and total profit (the Note that Shen and Valerie started by behaving cooperatively. However, once Shen decided to cheat, Valerie decided to cheat as well. In other words, Valerie's output decisions are based on Shen's actions.