3. Breakdown of a cartel agreement Consider a town in which only two residents, Edison and Hilary, own wells that produce water safe for drinking. Edison and Hilary 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 Total Revenue Quantity Demanded (Gallons of water) (Dollars per gallon) (Dollars) 5.40 0 0 4.95 40 $198.00 4.50 80 $360.00 4.05 120 $486.00 3.60 160 $576.00 3.15 200 $630.00 2.70 240 $648.00 2.25 280 $630.00 1.80 320 $576.00 1.35 360 $486.00 0.90 400 $360.00 0.45 440 $198.00 0 480 0 Suppose Edison and Hilary 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, Edison and Hilary agree to split production equally. Therefore, Edison's profit is $ and Hilary's profit is $ Suppose that Edison and Hilary 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, Edison says to himself, "Hilary and I aren't the best of friends anyway. If I increase my production to 40 gallons more than the cartel amount, I can increase my profit even though her profit goes down. I will do that starting tomorrow." per gallon. Given Hilary and Edison's production levels, After Edison implements his new plan, the price of water decreases to $ Edison's profit becomes S and Hilary's profit becomes $ Because Edison has deviated from the cartel agreement and increased his output of water to 40 gallons more than the cartel amount, Hilary decides that she will also increase her production to 40 gallons more than the cartel amount. Hilary's profit becomes $ and total profit (the After Hilary increases her production, Edison's profit becomes $ sum of the profits of Edison and Hilary) is now $ True or False: Based on the fact that both Edison and Hilary increased production from the initial cartel quantity, you know that the output effect was smaller than the price effect at that quantity. O True O False Edison and Hilary 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 Edison'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.) Neither Edison nor Hilary has an incentive to increase output further, nor does either have an incentive to decrease output. This outcome is an example of