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Consider a town in which only two residents, Rajiv and Simone, own wells that produce water safe for drinking

Economics

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Consider a town in which only two residents, Rajiv and Simone, own wells that produce water safe for drinking. Rajiv and Simone 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 Rajiv and Simone form a cartel and behave as a monopolist. The profit-maximizing price isper gallon, and the total output isgallons. As part of their cartel agreement, Rajiv and Simone agree to split production equally. Therefore, Rajiv's profit is, and Simone's profit is.

Suppose that Rajiv and Simone 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, Rajiv says to himself, "Simone 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 Rajiv implements his new plan, the price of water   toper gallon. Given Simone and Rajiv's production levels, Rajiv's profit becomes and Simone's profit becomes.

Because Rajiv has deviated from the cartel agreement and increased his output of water to 45 gallons more than the cartel amount, Simone decides that she will also increase her production to 45 gallons more than the cartel amount.

After Simone increases her production, Rajiv's profit becomes, Simone's profit becomes, and total profit (the sum of the profits of Rajiv and Simone) is now.

True or False: Based on the fact that both Rajiv and Simone increased production from the initial cartel quantity, you know that the output effect was larger than the price effect at that quantity.

True

False

Rajiv and Simone 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 Rajiv'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 Rajiv nor Simone has an incentive to increase output further, nor does either have an incentive to decrease output. This outcome is an example of   .