(Solved): 3. Breakdown of a cartel agreement Consider a town in which only two residents, James and Amber, o ...

3. Breakdown of a cartel agreement Consider a town in which only two residents, James and Amber, own wells that produce water safe for drinking. James and Amber 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. Suppose James and Amber 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, James and Amber agree to split production equally. Therefore, James's profit is , and Amber's profit is Suppose that James and Amber 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, James says to himself, "Amber 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." levels, James's profit becomes and Amber's profit becomes Because James has deviated from the cartel agreement and increased his output of water to 35 gallons more than the cartel amount, Amber decides that she will also increase her production to 35 gallons more than the cartel amount. After Amber increases her production, James's profit becomes , Amber's profit becomes , and total profit (the sum of the profits of James and Amber) is now True or False: Based on the fact that both James and Amber increased production from the initial cartel quantity, you know that the output effect was larger than the price effect at that quantity. True False Note that James and Amber started by behaving cooperatively. However, once James decided to cheat, Amber decided to cheat as well. In other words, Amber's output decisions are based on James's actions. This behavior is an example of