The Following Table Shows Your Neighborhood's Demand For Dri

The Following Table Shows Your Neighborhoods Demand For Drinking W

1. The following table shows your neighborhood’s demand for drinking water. Assume that only two firms (Waterland and Aquataste) produce and sell water in this market. Each firm offers the same quality, no fixed costs are incurred in the production of water, and each firm’s marginal cost is constant and equal to $0 because either company can pump as much water as needed without cost. Because marginal cost is constant and equal to $0, total revenue is equal to total profit.

Price (per gallon) | Quantity (gallons) | Total Revenue (TR)

--- | --- | ---

$0.00 | 250 | $0.00

$0.00 | 450 | $0.00

$0.00 | 600 | $0.00

$1.00 | 700 | $700.00

$1.00 | 750 | $750.00

$1.00 | 750 | $750.00

$1.00 | 700 | $700.00

$2.00 | 600 | $1,200.00

$2.00 | 450 | $900.00

$2.00 | 250 | $500.00

$2.00 | 0 | $0.00

Assume that Waterland and Aquataste make a nonbinding, informal agreement that each will produce 250 gallons of water, charge $1.50 per gallon, and evenly split the profit of $750. If Aquataste reneges on the agreement and produces 350 gallons, Waterland has an incentive to renege on the agreement by producing 350 gallons because Waterland’s profits would then increase from $375 to:

Paper For Above instruction

In analyzing the scenario where Waterland and Aquataste initially agree to produce 250 gallons each at a price of $1.50 per gallon, resulting in a combined profit of $750, it is essential to understand the incentives driving each firm's decision to maintain or renege on such an agreement. Under the assumption of identical firms with zero marginal costs and no fixed costs, each firm's profit depends on the total quantity produced and the market price.

Originally, each firm produces 250 gallons, and the total profit, split equally, is $375 for each. If Aquataste decides to produce 350 gallons instead, the total quantity supplied to the market increases, likely pushing the market price downward according to the demand curve. Nevertheless, since marginal cost is zero, any additional gallons sold contribute directly to profit. With Aquataste increasing output by 100 gallons, the firm's total sales elevate, and the market price at this increased output level can be estimated based on demand elasticity depicted in the demand table.

Calculating the new profit for Waterland involves understanding the change in total revenue as Aquataste increases its production from 250 to 350 gallons. The simplest approach is to analyze the market demand and the corresponding prices at these quantities, as per the demand table. Assuming linear demand, an increased supply from 500 gallons (combined from both firms) to 700 gallons shifts the market price from approximately $1.50 to around $1.00 per gallon, which impacts the total revenue and profit.

Given the demand table and assuming the same market behavior, by producing 350 gallons, Waterland's profit would increase from the initial $375 to approximately $437.50. This is because the additional 100 gallons sold at the marginal revenue per gallon—given the demand elasticity and price drop—contribute directly to profit without incurring additional costs. Therefore, Waterland's incentive to deviate from the collective agreement stems from the possibility of increasing their profit from $375 to $437.50, a clear individual benefit overshadowing the cooperative split, thus exemplifying a classic Prisoner's Dilemma in competitive markets with shared or collusive arrangements.

Conclusion

In conclusion, in the context of game theory and market behavior, the incentive for Waterland to renege and produce 350 gallons results from the potential increase in profit from $375 to $437.50. This scenario demonstrates the tendency of rational profit-maximizing firms to deviate from cooperative agreements when independent incentives to increase individual profits exist, especially in settings characterized by zero marginal costs and demand-driven prices.

References

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