Consider an industry with two firms, each having marginal costs and total costs equal to zero. The industry demand is P = 100 Q where Q = Q1 + Q2 is total output.

4. If the firms interact only once, is there a profitable deviation (cheating) from cartel for any firm? Find the profit of the firms in case of cheating. If a firm deviates from cartel (cheats) it will play its profit maximizing quantity, which is the quantity on its best response function. Now, use the best response function of firm 1 to find firm 1's cheating quantity, when firm 2 follows the rules of the cartel. Use the demand curve to find the new price level and then calculate profits.

5. Design a 2x2 normal form payoff matrix with strategies cartel and cheat. Complete the payoffs using the profits you calculated in the previous parts. Firm 2 Cartel Cheat Firm 1 Cartel Cheat

6. Now, assume that players interact twice. Hence the game is a twice repeated game. Is it possible to have (cartel,cartel) as an outcome? Explain.