Question

Consider a town in which only two residents, Raphael and Susan, own wells that produce water safe for drinking. Raphael and Susan 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)	(Dollars)
3.60	0	0
3.30	35	$115.50
3.00	70	$210.00
2.70	105	$283.50
2.40	140	$336.00
2.10	175	$367.50
1.80	210	$378.00
1.50	245	$367.50
1.20	280	$336.00
0.90	315	$283.50
0.60	350	$210.00
0.30	385	$115.50
0	420	0

Suppose Raphael and Susan form a cartel and behave as a monopolist. The profit-maximizing price isper gallon, and the total output isgallons. As part of their cartel agreement, Raphael and Susan agree to split production equally. Therefore, Raphael's profit is, and Susan's profit is.

Suppose that Raphael and Susan 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, Raphael says to himself, "Susan 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 Raphael implements his new plan, the price of water toper gallon. Given Susan and Raphael's production levels, Raphael's profit becomes and Susan's profit becomes.

Because Raphael has deviated from the cartel agreement and increased his output of water to 35 gallons more than the cartel amount, Susan decides that she will also increase her production to 35 gallons more than the cartel amount.

After Susan increases her production, Raphael's profit becomes, Susan's profit becomes, and total profit (the sum of the profits of Raphael and Susan) is now.

True or False: Based on the fact that both Raphael and Susan 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 Raphael and Susan started by behaving cooperatively. However, once Raphael decided to cheat, Susan decided to cheat as well. In other words, Susan's output decisions are based on Raphael's actions.

This behavior is an example of .

Answer 1