Question: You recently acquired an established bakery on the main downtown street. There is another established bakery not far away. Otherwise, you face no real competition. At this point, you are still unclear about the personality and management style of the owner of the other bakery. You have contemplated three possible strategies:

(1) produce a lot of cakes and mark down their prices to try to sell a large quantity;

(2) limit your production of cakes, but charge a high price for them;or

(3) politely engage the owner of the other bakery in a conversation, and consider proposing that the two of you collude on prices and adjust your production levels accordingly. Depending on what the owner seems to be like, which of the choices would be best from the standpoint of profitability?

(a) duopoly models;and

(b) cartel theory and the possibility of cheating.

Do not concern yourself with the legality of collusion. Assume that the other bakery is going to remain in business indefinitely.