Consider the following demand schedule for rainbow looms. assume that the marginal cost of producing a rainbow loom is a constant $2.50. note that when marginal cost is constant, average cost is constant. fixed costs are assumed to be zero.

price
($/rainbow loom) quantity demanded
(rainbow loom)
$17.50 0
$15.00 12
$12.50 42
$10.00 36
$7.50 48
$5.00 60
b. recall that a monopoly facing this demand schedule would produce 36 rainbow looms. if instead of a monopoly, a two-firm cartel controlled the rainbow loom market, how many rainbow looms would each firm want to produce in order to maximize industry profits?

each firm would produce looms

c. calculate each firm's profits if each firm produces output at the level you calculated in part b.

firm profits: $

now suppose one firm decides to break from the cartel and produce 12 more units of output than what you calculated in part b. what are the deviating firm's profits now? what about the profits of the "cooperating" firm whose production levels stay at the agreed-upon quantity?

deviating firm's profits: $

cooperating firm's profits: $

do firms in this cartel have an incentive to deviate from the agreed-upon level in part b?

yes; a firm will earn higher profits if it deviates from the agreement while the other continues to honor the agreement.

no; each firm earns more profits by cooperating than by deviating.