Regulation and Antitrust Policy (Econ 180)
Drake University, Spring 2011
William M. Boal

Course page: www.drake.edu/cbpa/econ/boal/180
Blackboard: bb.drake.edu
Email: william.boal@drake.edu

QUIZ 13 ANSWER KEY
Regulation and Deregulation of Telecommunications

Version A

I. Multiple choice [2 pts each: 10 pts total]

(1)c. (2)b. (3)a. (4)c. (5)c.

II. Problems

(1) [Transformation of natural monopoly: 32 pts]

  1. 11 million.
  2. Yes, this is a natural monopoly because cost is subadditive. If 12 million units of output are produced by two firms instead of one firm, total cost will rise.
  3. 5 million.
  4. No. (Cost is no longer subadditive at 20 million units of output.)
  5. $1.
  6. 20 million.
  7. 4 firms.

(2) [Multiproduct cost functions: 32 pts]

  1. Yes, Acme Manufacturing enjoys economies of scope. It is cheaper for one firm to produce two different products, than for two firms to each specialize in a product. For example, C(20,20) < C(20,0) + C(0,20), since 407 < 179 + 268 = 447.
  2. IC(QX) = $35, $139, $280, $450.
  3. AIC(QX) = $3.50, $6.95, $9.33, $11.25.
  4. No, Acme Manufacturing does not enjoy product-specific economies of scale, because AIC(QX) is increasing in QX.

(3) [Cross-subsidization: 20 pts]

  1. Yes, the firm is a natural monopoly. If AC slopes downward, then cost is subadditive. It is cheaper to produce any total output in one firm than in two firms.
  2. Market 1: 10 million, Market 2: 5 million.
  3. Market 1: profit, Market 2: loss.
  4. Market 1: $20 million, Market 2: $20 million.
  5. Another firm will enter market 1 only. This market is profitable for the entrant, provided the entrant produces a large amount of output.

III. Challenge question [8 pts]

  1. Demand has become more elastic.
  2. Mobile phones (and VOIP internet telephones) now provide a close substitute for landline telephone service. The price elasticity of demand increases with the availability of close substitutes.
  3. As a result of the change in price elasticity, landline telephone companies now have less market power, even though most are still monopolies.
  4. The Lerner index of market power, defined as (P-MC)/P, is equal to the reciprocal of the price elasticity of demand (in absolute value). Therefore, if demand because more elastic, the market power of a monopoly decreases.

Version B

I. Multiple choice [2 pts each: 10 pts total]

(1)a. (2)c. (3)b. (4)d. (5)a.

II. Problems

(1) [Transformation of natural monopoly: 32 pts]

  1. 10 million.
  2. Yes, this is a natural monopoly because cost is subadditive. If 13 million units of output are produced by two firms instead of one firm, total cost will rise.
  3. 7 million.
  4. No. (Cost is no longer subadditive at 21 million units of output.)
  5. $1.
  6. 21 million.
  7. 3 firms.

(2) [Multiproduct cost functions: 32 pts]

  1. Yes, Acme Manufacturing enjoys economies of scope. It is cheaper for one firm to produce two different products, than for two firms to each specialize in a product. For example, C(30,30) < C(30,0) + C(0,30), since 323 < 219 + 164 = 383.
  2. IC(QY) = $60, $85, $104, $121.
  3. AIC(QY) = $6.00, $4.25, $3.47, $3.03.
  4. Yes, Acme Manufacturing enjoys product-specific economies of scale, because AIC(QY) is decreasing in QY.

(3) [Cross-subsidization: 20 pts]

  1. Yes, the firm is a natural monopoly. If AC slopes downward, then cost is subadditive. It is cheaper to produce any total output in one firm than in two firms.
  2. Market 1: 5 million, Market 2: 15 million.
  3. Market 1: loss, Market 2: profit.
  4. Market 1: $15 million, Market 2: $15 million.
  5. Another firm might enter market 2 only. The entrant would break even, provided it sold exactly 15 million units. The entrant would certainly not enter market 1, because it would make losses in that market.

III. Challenge question [5 pts]

Same as Version A.

[end of answer key]