Chapter 17 - 3. Breakdown of a cartel agreement

Consider a town in which only two residents, Gregor and Haidyr 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) (Buffers) 3.50 0 0 3.30 40 $132.00 3.00 80 5240.00 2.7-"0 120 $324.00 2.40 150 5334.00 2.10 200 $420.00 1.80 240 5432.00 1.50 280 $420.00 1.20 320 5334.00 0.90 350 $324.00 0.50 400 5240.00 0.30 440 $132.00 0 430 0 Suppose Gregor and Haidy form a cartel and behave as a monopolist. The profit-maximizing price i- per gallon, and the total output is|:| gallons. As part of their cartel agreement, Gregor and Haidy agree to split production equally. Therefore, Gregor's prot is 3 , and Haidy's prot is . 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 40 gallons more than the cartel amount, I can increase my prot even though her prot goes down. I will do that starting tomorrow." Aer Gregor implements his new plan, the price of water 7 to per gallon. Given Haidy and Gregor's production levels, Gregor's prot becomes and Haidy's profit becomes . Because Gregor has deviated from the cartel agreement and increased his output of water to 40 gallons more than the cartel amount, Haidy decides that she will also increase her production to 40 gallons more than the cartel amount. After Haidy increases her production, Gregor's profit becomes Haidy's profit becomes $ and total profit (the sum of the profits of Gregor and Haidy) is now $ 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 Note that Gregor and Haidy started by behaving cooperatively. However, once Gregor decided to cheat, Haidy decided to cheat as well. In other words, Haidy's output decisions are based on Gregor's actions. This behavior is an example of