Breakdown of a cartel agreement Consider a town in which only two residents, Antonio and Caroline, own wells that produce water safe for drinking. Antonio and Caroline 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 45 $247.50 5.50 5.00 $450.00 90 135 $607.50 4.50 $720.00 4.00 180 225 $787.50 3.50 $810.00 3.00 270 315 $787.50 $720.00 2.00 360 $607.50 1.50 405 1.00 450 $450.00 495 $247.50 0.50 540
1. Suppose Antonio and Caroline 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, Antonio and Caroline agree to split production equally. Therefore, Antonio's profit is $, and Caroline's profit is $.
Suppose that Antonio and Caroline 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, Antonio says to himself, "Caroline 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."
2. After Antonio implements his new plan, the price of water (increases or decreases) to $per gallon. Given Caroline and Antonio's production levels, Antonio's profit becomes $ and Caroline's profit becomes $.
Because Antonio has deviated from the cartel agreement and increased his output of water to 45 gallons more than the cartel amount, Caroline decides that she will also increase her production to 45 gallons more than the cartel amount.
3. After Caroline increases her production, Antonio's profit becomes $, Caroline's profit becomes $, and total profit (the sum of the profits of Antonio and Caroline) is now $.
4. Larry and Megan have each cheated on their cartel agreement and increased production by 40 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 Larry's profit when he produces 80 gallons more than the cartel amount compared to his profit when he produces 40 gallons more than the cartel amount.)
a. true
b. false
5. Neither Antonio nor Caroline has an incentive to further increase output, nor does either have an incentive to decrease output. This outcome is an example of:.