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

FINAL EXAM ANSWER KEY

### Version A

I. Multiple choice

(1)a. (2)b. (3)a. (4)d. (5)a. (6)b. (7)d. (8)c. (9)a. (10)d. (11)b. (12)a. (13)b. (14)a. (15)a. (16)d. (17)a. (18)d. (19)b. (20)b. (21)a. (22)b. (23)c. (24)b. (25)a.

II. Problems

(1) [Monopoly, markup formula, Lerner index: 4 pts]

1. \$18.
2. 2/3.

(2) [Cournot duopoly: 14 pts]

1. RevA = P qA = 20 qA - (qA2/10) - (qA qB/10).
2. MRA = d RevA / d qA = 20 - (2qA/10) - (qB/10).
3. qA = 90 - (qB/2).
4. qA* = 60.
5. Q* = 120, P* = \$8.
6. L = (P-MC)/P = 3/4 = 0.75.
7. Deadweight loss = \$180.

(3) [Entry barriers and contestable markets: 26 pts]
1. Min AC = \$2.
2. Min efficient scale = 6 million.
3. L = (P-MC)/P = 2/3.
4. P = \$3.
5. AC = \$4.
6. Loss, because P < AC.
7. \$3 million.
8. Q = 8 million.
9. AC = \$2.
10. Profit, because entrant's P > AC.
11. \$24 million.
12. \$2, to prevent profitable entry.
13. L = (P-MC)/P = 0, since P=AC=MC.

(4) [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.

(5) [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) 400400
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.

(6) [Tying: 28 pts]
1. \$15.
2. \$50.
3. \$25.
4. \$105.
5. \$40.
6. \$120.
7. package.

(7) [Multipart tariffs: 26 pts]

(i) Two-part tariff (ii) Declining-block tariff
a.100 units100 units
b.0 units30 units
c.\$400 million\$490 million
d.\$400 million\$490 million
e.break evenbreak even
f.\$80\$5 million
1. Favor the declining-block tariff. Both tariffs break even, but the declining-block tariff has less social deadweight loss.

(8) [Peak-load pricing: 22 pts]

1. 90 thousand kWh is the capacity of the generating system.
2. \$0.14 per kWh.
3. 90 thousand kWh.
4. \$0.02 per kWh.
5. 70 thousand kWh.
6. 100 thousand kWh.
7. 50 thousand kWh.
8. increase.
9. 10 thousand kWh.
10. DWL is represented by two areas: a triangle bounded by SRMC, off-peak demand, and a vertical line at 50 thousand kWh; and another "upside down" triangle bounded by LRMC, peak demand, and a vertical line at 100 million kWh.
11. \$1 thousand, the total area of the two triangles.

III. Critical thinking [5 pts]

(1) The 2010 Horizontal Merger Guidelines describe situations where the government might approve a merger, despite a substantial increase in industry concentration. [An answer containing any two of the following would receive full credit.]

1. If entry into the market is so easy that the merged firm could not profitably raise price, the government might approve the merger anyway.
2. If efficiencies (that is, cost savings) from the merger are sufficient to prevent price increases in a market, the government might approve the merger anyway.
3. If one of merging firms was about to fail and exit the market, the government might approve the merger anyway.

(2) The same bridge is used to carry weekday traffic and weekend traffic.

1. The cost of constructing the bridge is therefore a joint cost, not a common cost, as defined by Alfred Kahn. An increase in weekend traffic does not require a reduction in weekday traffic. [Full credit requires a production-possibility curve with a rectangular shape, showing that weekday traffic may be increased without reducing weekday traffic, until bridge capacity is reached.]
2. Because bridge construction is a joint cost, and the bridge is not used to capacity on weekends, it should be included in weekday tolls only.

### Version B

I. Multiple choice

(1)c. (2)c. (3)b. (4)c. (5)b. (6)a. (7)b. (8)a. (9)b. (10)b. (11)d. (12)b. (13)c. (14)b. (15)b. (16)b. (17)b. (18)c. (19)c. (20)c. (21)c. (22)d. (23)c. (24)a. (25)a.

II. Problems

(1) [Monopoly, markup formula, Lerner index: 4 pts]

1. \$20, using formula P = MC / (1 + (1/ε)).
2. 2/5 = 0.4, using formula L = (P-MC)/P or for monopoly L = 1/|ε|.

(2) [Cournot duopoly: 14 pts]

1. RevA = P qA = 15 qA - (qA2/10) - (qA qB/10).
2. MRA = d RevA / d qA = 15 - (2qA/10) - (qB/10).
3. qA = 60 - (qB/2).
4. qA* = 40.
5. Q* = 80, P* = \$7.
6. L = (P-MC)/P = 4/7.
7. Deadweight loss = \$80.

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

1. Min AC = \$3.
2. Min efficient scale = 5 million.
3. L = (P-MC)/P = 4/7.
4. P = \$4.
5. AC = \$5.
6. Loss, because P < AC.
7. \$3 million.
8. Q = 8 million.
9. AC = \$3.
10. Profit, because entrant's P > AC.
11. \$24 million.
12. \$3, to prevent profitable entry.
13. L = (P-MC)/P = 0, since P=AC=MC.

(4) [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.

(5) [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) 200400
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.

(6) [Tying: 28 pts]

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

(7) [Multipart tariffs: 26 pts]

(i) Two-part tariff (ii) Declining-block tariff
a.100 units100 units
b.60 units40 units
c.\$680 million\$620 million
d.\$680 million\$620 million
e.break evenbreak even
f.\$0\$20 million
1. Favor the two-part tariff. Both tariffs break even, but the two-part tariff has no social deadweight loss.

(8) [Peak-load pricing: 22 pts]

1. 80 thousand kWh is the capacity of the generating system.
2. \$0.12 per kWh.
3. 80 thousand kWh.
4. \$0.04 per kWh.
5. 60 thousand kWh.
6. 90 thousand kWh.
7. 30 thousand kWh.
8. increase.
9. 10 thousand kWh.
10. DWL is represented by two areas: a triangle bounded by SRMC, off-peak demand, and a vertical line at 30 thousand kWh; and another "upside down" triangle bounded by LRMC, peak demand, and a vertical line at 90 million kWh.
11. \$1 thousand, the total area of the two triangles.

III. Critical thinking

Same as Version A.

[end of answer key]