Consider a town in which only two residents, Bob and

Consider a town in which only two residents, Bob and Cho, own wells that produce water safe for drinking. Bob and Cho 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 Bob and the 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, Bob and Cho agree to split production equally. Therefore, Bob’s profit is ————-, and Cho’s profit is $

Suppose that Bob and Cho 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, Bob says to himself, “Cho 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 Bob implements his new plan, the price of water increases/decrease to ———- per gallon. Given Cho and Bob’s production levels, Bob’s profit becomes————-and Cho’s profit becomes————

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

After Cho increases her production, Bob’s profit becomes ———, Cho’s profit becomes ———–, and total profit (the sum of the profits of Bob and Cho) is now————-

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