Question

3. Breakdown of a cartel agreement 

Conslder a town In which only two resldents, Paolo and Sharon, own wells that produce water safe for drinking. Paolo and Sharon 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	45	$198.00
4.00	90	$360.00
3.60	135	$486.00
3.20	180	$576.00
2.80	225	$630.00
2.40	270	$648.00
2.00	315	$630.00
1.60	360	$576.00
1.20	405	$486.00
0.80	450	$360.00
0.40	495	$198.00
0	540	0

Suppose Paolo and Sharon 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, Paolo and Sharon agree to split production equally. Therefore, Paolo's profit is _______ and Sharon's profit is _______ .

Suppose that Paolo and Sharon 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, Paolo says to himself, "Sharon 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 Paolo implements his new plan, the price of water _______ to _______  per gallon. Given Sharon and Paolo's production levels, Paolo's profit becomes _______ and Sharon's profit becomes _______  .

Because Paolo has deviated from the cartel agreement and increased his output of water to 45 gallons more than the cartel amount, Sharon decides that she wlill also Increase her production to 45 gallons more than the cartel amount.  

After Sharon increases her production, Paolo's profit becomes _______ , Sharon's profit becomes _______ , and total profit (the sum of the profits of Paolo and Sharon) Is now_______  . 

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

Paolo and Sharon 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 Paolo'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 Paolo nor Sharon has an incentive to increase output further, nor does either have an Incentive to decrease output. This outcome is an example of ______________ .

Answer 1