Breakdown of a cartel agreement Consider a town in which only two residents, Jake and Latasha, own wells that produce water safe for drinking. Jake and Latasha 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 Jake and Latasha 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, Jake and Latasha agree to split production equally. Therefore, Jake's profit is , and Latasha's profit is . Suppose that Jake and Latasha 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, Jake says to himself, "Latasha 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 Jake implements his new plan, the price of waterincreases to per gallon. Given Latasha and Jake's production levels, Jake's profit becomes and Latasha's profit becomes . Because Jake has deviated from the cartel agreement and increased his output of water to 35 gallons more than the cartel amount, Latasha decides that she will also increase her production to 35 gallons more than the cartel amount. After Latasha increases her production, Jake's profit becomes , Latasha's profit becomes , and total profit (the sum of the profits of Jake and Latasha) is now . True or False: Based on the fact that both Jake and Latasha increased production from the initial cartel quantity, you know that the output effect was smaller than the price effect at that quantity. True False Jake and Latasha 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 Jake'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 Jake nor Latasha has an incentive to further increase output, nor does either have an incentive to decrease output. This outcome is an example oftying .