3. Breakdown of a cartel agreement
Consider a town in which only two residents, Gregor and Haidy, own wells that produce water safe for drinking. Gregor and Haidy 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 Gregor and Haidy form a cartel and behave as a monopolist. The profit-maximizing price is $
output is
gallons. As part of their cartel agreement, Gregor and Haidy agree to split production equally. Therefore, Gregor's profit is
$
and Haidy's profit is $
Suppose that Gregor and Haidy 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, Gregor says to himself, "Haidy 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 Gregor implements his new plan, the price of water
to $
per gallon. Given Haidy and Gregor's production
levels, Gregor's profit becomes $
and Haidy's profit becomes $
