ECON 180 - Regulation and Antitrust Policy Drake University, Spring 2015 William M. Boal Course page: www.cbpa.drake.edu/econ/boal/180 Blackboard: bb.drake.edu Email: william.boal@drake.edu

ANSWER KEY: REGULATION AND DEREGULATION OF TELECOMMUNICATIONS

### Quiz 12 Version A

(1)b. (2)c. (3)d. (4)b. (5)c. (6)c. (7)a. (8)c. (9)c. (10)d.

### Quiz 12 Version B

(1)a. (2)a. (3)b. (4)d. (5)a. (6)a. (7)c. (8)a. (9)a. (10)d.

### Test 12 Version A

(1) [Legal cases and decisions: 12 pts]

1. Hush-a-Phone Corp. v. FCC (1956).
2. FCC's "Computer Inquiry II" (1980).
3. Modified Final Judgement (1982).
4. FCC's "Specialized Common Carrier" decision (1971).

(2) [Transformation of natural monopoly: 25 pts]

1. 7 million.
2. Yes, this is a natural monopoly because cost is subadditive. If 8 million units of output are produced by two firms instead of one firm, total cost will rise.
3. No. (Costs are no longer subadditive. Two firms each producing 9 million units of output would have the same average cost as one firm producing 18 million. Put differently, the minimum efficient scale is less than half of total output.)
4. 6 million.
5. Yes. (Costs are again subadditive. Two firms each producing 5 million units of output would have higher average cost as one firm producing 10 million. Put differently, the minimum efficient scale is greater than half of total output.)
6. \$4. (minimum average cost).
7. 20 million. (Demand when price equals minimum average cost).
8. 3 firms. (Total output divided by the minimum efficient scale, rounded down because fractional firms are impossible.)

(3) [Multiproduct firms: 32 pts]

1. Yes, Spike's Barbeque 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: C(QB,QH) < C(QB,0) + C(0,QH).
For example, C(30,30) = \$355 < C(30,0) + C(0,30) = \$237 + \$178 = \$415.
2. IC(QH) = \$28, \$96, \$177, \$265.
3. AIC(QH) = \$2.80, \$4.80, \$5.90, \$6.63.
4. No, Spike's Barbeque does not enjoy product-specific economies of scale, for hamburgers because AIC(QH) increases as QH increases.

(4) [Cross-subsidization: 20 pts]

1. Yes, the firm is a natural monopoly. If average cost slopes downward, then cost is subadditive. It is cheaper to produce any total output in one firm than in two firms.
2. City A: 5 million, City B: 15 million.
3. City A: loss, City B: profit.
4. City A: \$15 million, City B: \$15 million (so the firm breaks even).
5. The other firm will enter City B only. The other firm's average cost is less than the regulated price of \$5, provided the entrant produces at least about 12 million units of output. This action is called "cream-skimming."

Critical thinking [11 pts]

1. Telecommunications companies include local landline companies, long distance companies, mobile (cellular) companies, and companies providing internet (VOIP) phone service. The "essential Facilities" doctrine enunciated in MCI v. AT&T (1982) says that a monopoly firm is guilty of Section 2 monopolization if
1. the monopolist controls the facility,
2. the competitor cannot duplicate the facility,
3. the monopolist has denied the facility to the competitor,
4. it is feasible for monopolist to provide the facility to competitors.
In most places, markets for long distance, mobile and VOIP are competitive, but local landline service is more or less a monopoly. Since many people and businesses have landline service (and often only landline service) the long distance, mobile, and internet phone companies companies need to connect with them. Moreover, these other companies cannot easily duplicate the landline network. So it would seem that the "essential facilities" doctrine should still apply to local landline companies.

### Test 12 Version B

(1) [Legal cases and decisions: 12 pts]

1. Modified Final Judgement (1982).
2. FCC's "Specialized Common Carrier" decision (1971).
3. Hush-a-Phone Corp. v. FCC (1956).
4. FCC's "Computer Inquiry II" (1980).

(2) [Transformation of natural monopoly: 25 pts]

1. 12 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. Yes. (Costs are again subadditive. Two firms each producing 8.5 million units of output would have higher average cost as one firm producing 17 million. Put differently, the minimum efficient scale is greater than half of total output.)
4. 5 million.
5. No. (Costs are no longer subadditive. Two firms each producing 7 million units of output would have the same average cost as one firm producing 14 million. Put differently, the minimum efficient scale is less than half of total output.)
6. \$6. (minimum average cost).
7. 18 million. (Demand when price equals minimum average cost).
8. 3 firms. (Total output divided by the minimum efficient scale, rounded down because fractional firms are impossible.)

(3) [Multiproduct firms: 32 pts]

1. Yes, Spike's Barbeque 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: C(QB,QH) < C(QB,0) + C(0,QH).
For example, C(20,20) = \$345 < C(20,0) + C(0,20) = \$166 + \$199 = \$365.
2. IC(QB) = \$133, \$174, \$204, \$228.
3. AIC(QB) = \$13.30, \$8.70, \$6.80, \$5.70.
4. Yes, Spike's Barbeque enjoys product-specific economies of scale, for bratwursts because AIC(QB) decreases as QB increases.

(4) [Cross-subsidization: 20 pts]

1. Yes, the firm is a natural monopoly. If average cost slopes downward, then cost is subadditive. It is cheaper to produce any total output in one firm than in two firms.
2. City A: 12 million, City B: 4 million.
3. City A: profit, City B: loss.
4. City A: \$12 million, City B: \$12 million (so the firm breaks even).
5. The other firm will enter City A only. The other firm's average cost is less than the regulated price of \$5, provided the entrant produces at least about 10 million units of output. This action is called "cream-skimming."

Critical thinking [11 pts]

• Same as Version A.