Consider a town in which only two residents, Carlos and Deborah, own wells that produce water safe for drinking. Carlos and Deborah 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. Quantity Demanded (Gallons of water) Price (Dollars per gallon) 3.60 3.30 Total Revenue (Dollars) 0 $115.50 0 35 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 Carlos and Deborah 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, Carlos and Deborah agree to split production equally. Therefore, Carlos's profit is S , and Deborah's profit is $ Suppose that Carlos and Deborah 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, Carlos says to himself, "Deborah 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." per gallon. Given Deborah and Carlos's production After Carlos implements his new plan, the price of water to $ levels, Carlos's profit becomes $ and Deborah's profit becomes $ Because Carlos has deviated from the cartel agreement and increased his output of water to 35 gallons more than the cartel amount, Deborah decides that she will also increase her production to 35 gallons more than the cartel amount. , Deborah's profit becomes S , and total profit (the After Deborah increases her production, Carlos's profit becomes S sum of the profits of Carlos and Deborah) is now $ True or False: Based on the fact that both Carlos and Deborah increased production from the initial cartel quantity, you know that the output effect was smaller than the price effect at that quantity. a. True
b. False
Carlos and Deborah 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 Carlos'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 Carlos nor Deborah has an incentive to increase output further, nor does either have an incentive to decrease output. This outcome is an example of:.