Consider a town in which only two residents, Dmitri and Frances, own wells that produce water safe for drinking. Dmitri and Frances 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)
6.00 0 0
5.50 45 $247.50
5.00 90 $450.00
4.50 135 $607.50
4.00 180 $720.00
3.50 225 $787.50
3.00 270 $810.00
2.50 315 $787.50
2.00 360 $720.00
1.50 405 $607.50
1.00 450 $450.00
0.50 495 $247.50
0 540 0
Suppose Dmitri and Frances 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, Dmitri and Frances agree to split production equally. Therefore, Dmitri's profit is, and Frances's profit is.
Suppose that Dmitri and Frances 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, Dmitri says to himself, "Frances 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 Dmitri implements his new plan, the price of water (Increases or decreases?) to per gallon. Given Frances and Dmitri's production levels, Dmitri's profit becomes and Frances's profit becomes.
Because Dmitri has deviated from the cartel agreement and increased his output of water to 45 gallons more than the cartel amount, Frances decides that she will also increase her production to 45 gallons more than the cartel amount.
After Frances increases her production, Dmitri's profit becomes, Frances's profit becomes, and total profit (the sum of the profits of Dmitri and Frances) is now.
True or False: Based on the fact that both Dmitri and Frances increased production from the initial cartel quantity, you know that the output effect was larger than the price effect at that quantity.
True
False
Dmitri and Frances 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 Dmitri'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 Dmitri nor Frances has an incentive to further increase output, nor does either have an incentive to decrease output. This outcome is an example of .
A) resale price maintenance
B) predatory pricing
C) a Nash equilibrium
D) tying