1.

a) Explain in words the general tradeoffs faced by a firm considering cheating on a cartel.

b) Consider a cartel of 50 identical firms, with no noncartel firms. They agree that they will jointly produce the profit maximizing output. They will revert to playing Cournot output forever if anyone cheats once cheating is detected. The monthly discount factor is = .98. The profit of each firm is 133 per month if they all produce the cartel output. If one firm cheats and produces more, its profits rise to 251 and the other 49 firms' profits fall to 128 each (all figures per month). If the firms each produce Cournot output, their profits are each 65 per month. i) If they adjust their output every month and can detect cheating within a month, use the formula derived in class to figure out if firms have the incentive to cheat on the cartel by increasing output? ii) What do you predict will happen if it takes firms 3 years to detect that a firm is overproducing?

c) What are the effects on possible equilibrium prices if firms cannot commit to play Cournot forever, but will relent after 4 periods and renegotiate to go back to restart the cartel equilibrium?

d) Do you think that it is substantially easier to maintain a cartel if firms meet to make explicit agreements? Why or why not?