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 Quantity Demanded Total Revenue (Dollars per gallon) (Gallons of water) (Dollars) 3.60 3,30 25 $82.50 3.00 50 $150.00 2.70 75 $202.50 2.40 100 $240.00 2.10 125 $262.50 1.80 150 $270.00 1.50 175 $262.50 1.20 200 $240.00 0.90 225 $202.50 0.60 250 $150.00 0.30 275 $82.50 300Suppose Gregor and Haidy form a cartel and behave as a monopolist. The profit-maximizing price is per gallon, and the total output s 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 S 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 25 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 S per gallon. Given Haidy and Gregor's production levels, Gregor's profit becomes S and Haidy's profit becomes Because Gregor has deviated from the cartel agreement and increased his output of water to 25 gallons more than the cartel amount, Haidy decides that she will also increase her production to 25 gallons more than the cartel amount. After Haidy increases her production, Gregor's profit becomes S , Hady's profit becomes , and total profit (the sum of the profits of Gregor and Haidy) is now |S True or False: Based on the fact that both Gregor and Haidy increased production from the initial cartel quantity, you know that the output effect was larger than the price effect at that quantity. O True O False Gregor and Haidy have each cheated on their cartel agreement and increased production by 25 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 Gregor's profit when he produces 50 gallons more than the cartel amount compared to his profit when he produces 25 gallons more than the cartel amount.) Neither Gregor nor Haidy has an incentive to increase output further, nor does either have an incentive to decrease output. This outcome is an example of