ECON 120 - Regulation and Antitrust Policy
Drake University, Spring 2017
William M. Boal

EXAM 3 ANSWER KEY

Version A

I. Multiple choice

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

II. Problems

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

  1. 2400.
  2. Moderately concentrated.
  3. 2800.
  4. Highly concentrated.
  5. Yes, would likely oppose merger.
  6. The postmerger HHI is greater than 2500 and the change in the HHI is greater than 200.

(2) [Successive monopolies with fixed proportions: 26 pts]

  1. MRP = 12 - 2Q/100.
  2. PS = 9 - 2Q/100.
  3. MRS = 9 - 4Q/100.
    Table of results (i) Successive monopolies (ii) Vertically integrated monopoly
    Q = Quantity of sauce (and pizzas) 200 400
    PS = price of sauce $5
    Profit of upstream firm $800
    PP = price of pizzas $10 $8
    Profit of downstream firm $400
    Total upstream + downstream profits $1200 $1600

  4. The government should not try to block this merger. The merger will lower price and increase profit, so both consumers and producers benefit (a Pareto improvement!). The merger increases social welfare.

(3) [Tying: 28 pts]

  1. $15.
  2. $50.
  3. $25.
  4. $105.
  5. $40.
  6. $120.
  7. package.

(4) [Monopoly price discrimination: 4 pts]

  1. $7.50.
  2. $18.00.

(5) [Predatory pricing: 22 pts]

  1. $10.
  2. $500.
  3. $12.
  4. $980.
  5. $740.
  6. No, because the start-up costs are greater than the expected profit in Town 2.
  7. $40.
  8. 100. This quantity gives causes Allgreen to make losses in Town 1, but deters Bosco from entering Town 2.
  9. 90, because Allgreen will then be a monopoly in Town 2. Profit-maximizing quantity is found by setting MR = Allgreen's true MC.
  10. $305, because Allgreen's profit will be -$100 in Town 1 and +$405 in Town 2.
  11. Allgreen is engaged in predatory pricing to maintain its reputation as a low-cost firm. By acting as if it has low costs in Town 1, the "demonstration market," Allgreen deters Bosco from entering Town 2. Allgreen then enjoys a monopoly in Town 2, the "recoupment market."

III. Critical thinking [5 pts]

(1) "Protecting competition" means encouraging vigorous price competition so that price falls to marginal cost. This policy maximizes total social welfare. "Protecting competitors" means prohibiting vigorous price competition so that price remains above the marginal cost of the most efficient firms, so that inefficient firms can survive. This policy helps inefficient firms, but does not maximize social welfare. Supreme Court Justice Potter Stewart pointed out the error of "protecting competitors" in his dissenting opinion in the case of Utah Pie v. Continental Baking (1967).

(2) To determine the effect of the merger on social welfare, one must subtract the deadweight loss caused by the price increase from the cost savings. Deadweight loss, the area of a triangle, is $125. Cost savings, the area of a rectangle, are $100. (The merger also causes a transfer of $1000 from consumers to producers, but transfers have no net effect on social welfare.) So social welfare would fall by $25. (Full credit requires a graph showing the demand curve, the deadweight-loss triangle, and the cost-savings rectangle.)

Version B

I. Multiple choice

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

II. Problems

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

  1. 1350.
  2. Unconcentrated.
  3. 1450.
  4. Unconcentrated.
  5. No, would not likely oppose merger.
  6. The postmerger HHI indicates the market is still unconcentrated.

(2) [Monopoly extension with fixed proportions: 26 pts]

  1. MRP = 12 - 2Q/100.
  2. PS = 9 - Q/100.
  3. MRS = 9 - 2Q/100.
    Table of results (i) Upstream monopoly,
    downstream competition    		 (ii) Vertically integrated monopoly
    Q = Quantity of sauce (and pizza) 400 400
    PS = price of sauce $5
    Profit of upstream firm $1600
    PP = price of pizzas $8 $8
    Profit of downstream firm $0
    Total upstream + downstream profits $1600 $1600

  4. The upstream monopoly would not try to merge with firms in the downstream market. Vertical integration for monopoly extension does not increase profit if production requires fixed proportions.

(3) [Tying: 28 pts]

  1. $20.
  2. $25.
  3. $20.
  4. $85.
  5. $35.
  6. $105.
  7. package.

(4) [Monopoly price discrimination: 4 pts]

  1. $8.
  2. $12.

(5) [Predatory pricing: 22 pts]

  1. $10.
  2. $250.
  3. $12.
  4. $490.
  5. $370.
  6. No, because the start-up costs are greater than the expected profit in Town 2.
  7. $20.
  8. 50. This quantity gives causes Allgreen to make losses in Town 1, but deters Bosco from entering Town 2.
  9. 45, because Allgreen will then be a monopoly in Town 2. Profit-maximizing quantity is found by setting MR = Allgreen's true MC.
  10. $152.50, because Allgreen's profit will be -$50 in Town 1 and +$202.50 in Town 2.
  11. Allgreen is engaged in predatory pricing to maintain its reputation as a low-cost firm. By acting as if it has low costs in Town 1, the "demonstration market," Allgreen deters Bosco from entering Town 2. Allgreen then enjoys a monopoly in Town 2, the "recoupment market."

III. Critical thinking

Same as Version A.

[end of answer key]