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3. Breakdown of a cartel agreement Consider a town in which only two residents, Brian and Crystal, own wells that produce water safe for drinking. Brian and Crystal 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 (Dollars per gallon) 3.60 Quantity Demanded (Gallons of water) Total Revenue (Dollars) 0 0 3.30 35 $115.50 3.00 70 2.70 105 2.40 140 $210.00 $283.50 $336.00 $367.50 $378.00 2.10 175 1.80 210 1.50 245 $367.50 1.20 280 $336.00 0.90 315 $283.50 $210.00 0.60 350 0.30 385 $115.50 0 420 0 is Suppose Brian and Crystal form a cartel and behave as a monopolist. The profit maximizing price is 5 per gallon, and the total output gallons. As part of their cartel agreement, Brian and Crystal agree to split production equally. Therefore, Brian's profit is 1. and Crystal's profit is 5 Suppose that Brian and Crystal 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, Brian says to himself, "Crystal and I aren't the best of friends anyway. If I increase my production to 35 gallons more than the cartel amount, I can increase my profit even though her profit goes down. I will do that starting tomorrow." After Brian implements his new plan, the price of water to s Brian's profit becomes 5 and Crystal's profit becomes 5 per gallon, Given Crystal and Brian's production levels, Because Brian has deviated from the cartel agreement and increased his output of water to 35 gallons more than the cartel amount, Crystal decides that she will also increase her production to 35 gallons more than the cartel amount. After Crystal increases her production, Brian's profit becomes sum of the profits of Brian and Crystal) is now 5 J.Crystal's profit becomes 5 and total profit (the True or False: Based on the fact that both Brian and Crystal increased production from the initial cartel quantity, you know that the output effect was smaller than the price effect at that quantity, True False Brian and Crystal have each cheated on their cartel agreement and increased production by 35 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 Brian's profit when he produces 70 gallons more than the cartel amount compared to his profit when he produces 35 gallons more than the cartel amount.) Neither Brian nor Crystal has an incentive to increase output further, nor does either have an incentive to decrease output. This outcome is an example of

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