ECON 180 - Regulation and Antitrust Policy Drake University, Spring 2013 William M. Boal Course page: www.cbpa.drake.edu/econ/boal/180 Blackboard: bb.drake.edu Email: william.boal@drake.edu

### Version A

I. Multiple choice [1 pt each: 23 pts total]

(1)d. (2)b. (3)c. (4)b. (5)b. (6)c. (7)a. (8)c. (9)a. (10)c.
(11)b. (12)b. (13)b. (14)e. (15)d. (16)a. (17)c. (18)c. (19)c. (20)b.
(21)a. (22)b. (23)b.

II. Problems

(1) [Long-run cost and supply: 8 pts]

1. MC = dTC/dq = 3q2 - 160 q + 1630.
2. AC = TC/q = q2 - 80 q + 1630.
3. Set dAC/dq = 0 and solve to get the efficient scale qES = 40.
Minimum average cost = AC(qES) = \$30.
4. Long-run industry supply is a horizontal line at price = \$30.

(2) [Monopoly, profit maximization: 14 pts]

1. MC = dTC/dQ = 2 + (Q/200).
2. AC = TC/Q = 2 + (Q/400).
3. Rev = P Q = 17 Q = (Q2/200).
MR = dRev/dQ = 17 - (Q/100).
4. Set MR = MC and solve to find Q* = 1000.
5. P* = 17 - (1000/200) = \$12.
6. Profit = Rev(1000) - TC(1000) or equivalently Profit = Q*(P*-AC(1000)) = \$7500.
7. Social deadweight loss is the area of a triangle bounded by demand, MC, and a vertical line at Q* = 1000. (Note that demand and MC intersect at Q = 1500.) This area = \$1250.

(3) [Cournot duopoly: 6 pts]

1. q1* = 600 - (q2/2).
2. Q* = 800, P* = \$7.
3. Social deadweight loss = \$800.

(4) [Entry barriers and contestable markets: 26 pts]

1. \$3.
2. 5 million.
3. 2/5 = 0.4.
4. \$2.
5. \$5.
6. loss.
7. \$9 million.
8. 10 million.
9. \$3.
10. profit.
11. \$10 million.
12. \$3.
13. zero, since price = marginal cost.

(5) [HHI and merger guidelines: 12 pts]

1. 2043.
2. moderately concentrated.
3. 2691.
4. highly concentrated.
5. (i) presumed likely to enhance market power.
6. The post-merger HHI > 2500 and the change in HI > 200 points.

(6) [Vertical integration with fixed proportions: 26 pts]

1. MRP = 8 - (Q/250).
2. PS = 5 - (Q/250).
3. MRS = 5 - (Q/125).
Table of results (i) Successive monopolies (ii) Vertically integrated monopoly
Q = Quantity of sauce (and pizzas) 500 1000
PS = price of sauce \$3
Profit of upstream firm \$1000
PP = price of pizza \$7 \$6
Profit of downstream firm \$500
Total upstream + downstream profits \$1500 \$2000

4. The government should not try to block this merger. The merger increases the quantity of pizzas, lowers the price of pizzas for consumers and raises profit (a Pareto improvement!) and thus increases social welfare.

(7) [Monopoly price discrimination: 4 pts]

1. \$4.50.
2. \$8.00.

(8) [Pricing with economies of scale: 20 pts]

1. \$2.
2. loss.
3. \$36 million.
4. \$0 million.
5. \$6.
6. neither.
7. \$0 million.
8. \$6 million.
9. \$2.
10. \$9.

1. 90 million kWh is the capacity of the system.
2. \$0.16 per kWh.
3. 90 million kWh.
4. \$0.04 per kWh.
5. 70 million kWh.
6. 100 million kWh.
7. 50 million kWh.
8. increase.
9. 10 million kWh.
10. Deadweight loss in the off-peak period is a triangle bounded by off-peak demand, SRMC, and a vertical line at 50 million kWh. Deadweight loss in the peak period is a triangle bounded by peak demand, LRMC, and a vertical oine at 100 million kWh.
11. \$1.0 million.

(10) [Multiproduct cost functions: 12 pts]

1. Yes, Tasty Bakery enjoys economies of scope. C(QC,QP) < C(QC,0) + c(0,QP). Here is a numerical example: C(20,20) = \$586, but C(20,0) + C(0,20) = \$268 + \$358 = \$626.
2. IC(QP) = \$155, \$220, \$269, \$310.
3. AIC(QP) = \$16, \$11, \$9, \$8.
4. Yes, Tasty Bakery enjoys product-specific economies of scale for pies, because AIC(QP) decreases as QP increases.

(11) [Effect of regulation on quality: 14 pts]

1. 5 million.
2. 5 million.
3. 0 million.
4. \$12.5 million.
5. 4 million.
6. \$4.5 million.
7. \$17 million.

(12) [Maximum prices and exit restrictions: 10 pts]

1. \$2 million.
2. \$16 million.
3. \$6.
4. \$8 million.
5. \$10 milllion.

III. Critical thinking [3 pts]

There are at least two ways to answer this question. Either way, it is helpful to sketch a graph.

1. This merger would decrease social welfare. Before the merger, firms enjoy total profits equal to (5-4)×10 million, or \$10 million. After the merger, firms enjoy profits equal to (7-3.50)×7 million, or \$24.5 million. So firms' total profits increase by \$14.5 million. Meanwhile, the loss of consumer surplus is the area of a trapezoid with parallel sides of length 7 and 10 million, and height \$7-\$5=\$2. So consumer surplus decreases by \$17 million. So overall social welfare decreases by \$2.5 million.
2. This merger would decrease social welfare. The loss from reduced supply is a trapezoid with parallel sides (\$7-\$4)=\$3 and (\$5-\$4)=\$1, and height (10 million-7 million)=3 million. So this loss equals \$6 million. Meanwhile, the gain from cost savings is the area of a rectangle with base 7 million and height (\$4.00-\$3.50)=\$0.50. So this gain equals \$3.5 million. So overall social welfare decreases by \$2.5 million. [See the diagram in Viscusi, et al., fourth edition, page 213, figure 7.4.]

### Version B

I. Multiple choice [1 pt each: 23 pts total]

(1)a. (2)c. (3)a. (4)a. (5)c. (6)b. (7)b. (8)b. (9)b. (10)b.
(11)c. (12)d. (13)c. (14)c. (15)c. (16)b. (17)d. (18)c. (19)b. (20)a.
(21)b. (22)c. (23)b.

II. Problems

(1) [Long-run cost and supply: 8 pts]

1. MC = dTC/dq = 3q2 - 200 q + 2520.
2. AC = TC/q = q2 - 100 q + 2520.
3. Set dAC/dq = 0 and solve to get the efficient scale qES = 50.
Minimum average cost = AC(qES) = \$20.
4. Long-run industry supply is a horizontal line at price = \$20.

(2) [Monopoly, profit maximization: 14 pts]

1. MC = dTC/dQ = 1 + (Q/100).
2. AC = TC/Q = 1 + (Q/200).
3. Rev = P Q = 19 Q = (Q2/100).
MR = dRev/dQ = 19 - (Q/50).
4. Set MR = MC and solve to find Q* = 600.
5. P* = 19 - (600/100) = \$13.
6. Profit = Rev(600) - TC(600) or equivalently Profit = Q*(P*-AC(600)) = \$5400.
7. Social deadweight loss is the area of an "upside-down" triangle bounded by demand, MC, and a vertical line at Q* = 600. (Note that demand and MC intersect at Q = 900.) This area = \$900.

(3) [Cournot duopoly: 6 pts]

1. q1* = 900 - (q2/2).
2. Q* = 1200, P* = \$8.
3. Social deadweight loss = \$1800.

(4) [Entry barriers and contestable markets: 26 pts]

1. \$1.
2. 8 million.
3. 3/4 = 0.75.
4. \$0.
5. \$2.
6. loss.
7. \$8 million.
8. 11 million.
9. \$1.
10. profit.
11. \$22 million.
12. \$1.
13. zero, since price = marginal cost.

(5) [HHI and merger guidelines: 12 pts]

1. 2282.
2. moderately concentrated.
3. 2828.
4. highly concentrated.
5. (i) presumed likely to enhance market power.
6. The post-merger HHI > 2500 and the change in HI > 200 points.

(6) [Vertical integration with fixed proportions: 26 pts]

1. MRP = 8 - (Q/250).
2. PS = 5 - (Q/500).
3. MRS = 5 - (Q/250).
Table of results (i) Upstream market monopolized,
downstream market competitive
(ii) Vertically integrated monopoly
Q = Quantity of sauce (and pizzas) 1000 1000
PS = price of sauce \$3
Profit of upstream firm \$2000
PP = price of pizza \$6 \$6
Profit of downstream firm \$0
Total upstream + downstream profits \$2000 \$2000

4. The government should not try to block this merger. There are no effects on profit or the price of pizzas, so there are no effects on social welfare.

(7) [Monopoly price discrimination: 4 pts]

1. \$3.50.
2. \$9.00.

(8) [Pricing with economies of scale: 20 pts]

1. \$3.
2. loss.
3. \$60 million.
4. \$0 million.
5. \$8.
6. neither.
7. \$0 million.
8. \$7.5 million.
9. \$3.
10. \$15.

1. 70 million kWh is the capacity of the system.
2. \$0.14 per kWh.
3. 70 million kWh.
4. \$0.02 per kWh.
5. 60 million kWh.
6. 80 million kWh.
7. 40 million kWh.
8. increase.
9. 10 million kWh.
10. Deadweight loss in the off-peak period is a triangle bounded by off-peak demand, SRMC, and a vertical line at 40 million kWh. Deadweight loss in the peak period is an "upside-down" triangle bounded by peak demand, LRMC, and a vertical oine at 80 million kWh.
11. \$1.0 million.

(10) [Multiproduct cost functions: 12 pts]

1. Yes, Tasty Bakery enjoys economies of scope. C(QC,QP) < C(QC,0) + c(0,QP). Here is a numerical example: C(20,20) = \$417, but C(20,0) + C(0,20) = \$260 + \$197 = \$457.
2. IC(QP) = \$77, \$220, \$392, \$584.
3. AIC(QP) = \$8, \$11, \$13, \$15.
4. No, Tasty Bakery does not enjoy product-specific economies of scale for pies, because AIC(QP) increases as QP increases.

(11) [Effect of regulation on quality: 14 pts]

1. 6 million.
2. 7 million.
3. 0 million.
4. \$18 million.
5. 5 million.
6. \$8 million.
7. \$26 million.

(12) [Maximum prices and exit restrictions: 10 pts]

1. \$0.5 million.
2. \$8 million.
3. \$6.
4. \$2 million.
5. \$2.5 milllion.

III. Critical thinking [3 pts]

Same as Version A.