Consider a town in which only two residents, Daniel and Gabrielle, own wells that produce water safe for drinking. Daniel and Gabrielle 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) Quantity Demanded (Gallons of water) Total Revenue (Dollars)
4.80 0 0
4.40 35 $154.00
4.00 70 $280.00
3.60 105 $378.00
3.20 140 $448.00
2.80 175 $490.00
2.40 210 $504.00
2.00 245 $490.00
1.60 280 $448.00
1.20 315 $378.00
0.80 350 $280.00
0.40 385 $154.00
0 420 0
Suppose Daniel and Gabrielle 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, Daniel and Gabrielle agree to split production equally. Therefore, Daniel's profit is $ , and Gabrielle's profit is $
Suppose that Daniel and Gabrielle 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, Daniel says to himself, "Gabrielle 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."
After Daniel implements his new plan, the price of water to $ per gallon. Given Gabrielle and Daniel's production levels, Daniel's profit becomes $ and Gabrielle's profit becomes $
Because Daniel has deviated from the cartel agreement and increased his output of water to 35 gallons more than the cartel amount, Gabrielle decides that she will also increase her production to 35 gallons more than the cartel amount.
After Gabrielle increases her production, Daniel's profit becomes $ , Gabrielle's profit becomes $ , and total profit (the sum of the profits of Daniel and Gabrielle) is now $
True or False: Based on the fact that both Daniel and Gabrielle increased production from the initial cartel quantity, you know that the output effect was smaller than the price effect at that quantity.
