ECON 120 - Regulation and Antitrust Policy Drake University, Spring 2019 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

(1) [Antitrust statutes: 4 pts] See Viscusi, Harrington, and Sappington textbook, appendix to chapter 3.

1. Sherman Act Section 2.
3. Clayton Act Section 7.
4. Sherman Act Section 1.

(2) [Cournot duopoly: 14 pts]

1. TRA = P qA = 10 qA - (qA2/100) - (qA qB/100).
2. MRA = d TRA / d qA = 10 - (2qA/100) - (qB/100).
3. qA = 300 - (qB/2).
4. qA* = 200.
5. Q* = 400, P* = \$6.
6. L = (P-MC)/P = 1/3.
7. Deadweight loss = \$200. (Note that competitive supply curve is horizontal at \$4, and intersects demand at Q=600.)

(3) [Price-setting (Bertrand) duopoly with differentiated products: 15 pts]

1. TRA = 300 P qA - 20 PA2 + 10 PA PB.
2. Set 0 = dTRA/dPA = 300 - 40 PA + 10 PB, and solve for PA to get
PA = (30 + PB) / 4.
3. Substitute PA for PB in the best reply function and solve to get
PA* = \$10 = PB*.
4. Subsitute \$10 for PA and PB in Firm A's demand function to get
QA* = 200 = QB*.
5. TRA* = PA* × QA* = \$2000 = TRB*.

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

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

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

1. 1250.
2. Unconcentrated.
3. 1300.
4. Unconcentrated.
5. This merger would be deemed "unlikely to have adverse competitive effects" because the post-merger HHI is less than 1500, and because the change in the HHI is less than 100.

(6) [Upward pricing pressure: 8 pts]

1. DAB = 20/(100-50) = 2/5 .
2. DBA = 50/(100-20) = 5/8.
3. UPPA = DAB (PB-MCB) - ΔMCA = 2/5 (20-15) - (17-16) = \$1.
4. DAB (PB-MCB) = \$2.

(7) [Monopoly extension with fixed proportions: 17 pts]

1. MRA = 14 - (2Q/50).
2. PC = PA - 4 = 10 - (Q/50).
3. MRC = 10 - (2Q/50).
Table of results (i) Upstream monopoly,
downstream competition
(ii) Vertically
integrated monopoly
Q = Quantity of components (and appliances) 200 200
PC = price of component \$6 NA
Profit of upstream firm \$800 NA
PA = price of appliances \$10 \$10
Profit of downstream firm zero NA
Total upstream + downstream profits \$800 \$800

4. This merger would not be profitable, because total profits would remain the same. This merger would not harm social welfare because the price of appliances would not change.

(8) [Price discrimination: 6 pts]

1. To maximize profit, segment A should get the higher price because its demand is less elastic.
2. \$18.
3. \$9.

(9) [Positive theories of regulation: 6 pts]

1. \$15.
2. \$35.
3. \$25.

(10) [Two-sided platforms: 8 pts]

• Substituting into the demand equations, q1 = 1300 and q2 = 400.
• MR2 = 16 - 2q2/50 = 16 - 2(400/50) = \$0, ignoring revenue from the other group.
• MR2 = 16 - 2q2/50 + 1.0(p1 = \$0 + 1.0(\$10) = \$10, including additional revenue from group 1.
• Recommend lowering p2 in order to increase q2, because marginal revenue (including impact on group 1) > MC2.

(11) [Multipart tariffs: 26 pts]

(i) Two-part tariff (ii) Declining-block tariff
a.100 units100 units
b.60 units40 units
c.\$520 million\$480 million
d.\$520 million\$480 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.

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 [4 pts]

(1) Average quality would increase. If both low-quality and high-quality meals had the same price, no one would buy low-quality meals. Nevertheless, consumers would be worse off because some of consumers clearly preferred low-quality, low-price meals which are now unavailable.

(2) Classrooms.

1. Classrooms are a joint cost because there is no tradeoff in production. Increased use in the summer term does not displace courses in the regular term. The production possibility curve is rectangular. (Full credit requires a graph of a rectangular production possibility curve. One axis should be labeled "regular-term courses" and the other "summer-term courses.")
2. If Drake wants to set tuition so as to price courses at marginal cost, then the cost of classrooms should be included in the regular-term tuition because capacity is fully used. The cost of classrooms should not be included in summer-term tuition because capacity is not fully used in summer.

### Version B

I. Multiple choice

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

II. Problems

(1) [Antitrust statutes: 4 pts] See Viscusi, Harrington, and Sappington textbook, appendix to chapter 3.

1. Clayton Act Section 7.
2. Sherman Act Section 1.
3. Sherman Act Section 2.

(2) [Cournot duopoly: 14 pts]

1. TRA = P qA = 15 qA - (qA2/10) - (qA qB/10).
2. MRA = d TRA / d qA = 15 qA - (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. (Note that competitive supply curve is horizontal at \$3, and intersects demand at Q=120.)

(3) [Price-setting (Bertrand) duopoly with differentiated products: 15 pts]

1. TRA = 200 P qA - 30 PA2 + 10 PA PB.
2. Set 0 = dTRA/dPA = 200 - 60 PA + 10 PB, and solve for PA to get
PA = (20 + PB) / 6.
3. Substitute PA for PB in the best reply function and solve to get
PA* = \$4 = PB*.
4. Subsitute \$4 for PA and PB in Firm A's demand function to get
QA* = 120 = QB*.
5. TRA* = PA* × QA* = \$480 = TRB*.

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

1. Min AC = \$2.
2. Min efficient scale = 8 million.
3. L = (P-MC)/P = 3/5 = 0.6 .
4. P = \$3.
5. AC = \$4.
6. Loss, because P < AC.
7. \$4 million.
8. Q = 12 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.

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

1. 1250.
2. Unconcentrated.
3. 1650.
4. Moderately concentrated.
5. This merger would be deemed to "raise significant competitive concerns," because the post-merger HHI is greater than 1500 and the change in the HHI due to the merger is greater than 100.

(6) [Upward pricing pressure: 8 pts]

1. DAB = 20/(100-40) = 1/3 .
2. DBA = 40/(100-20) = 1/2.
3. UPPA = DAB (PB-MCB) - ΔMCA = 1/3 (20-8) - (20-19) = \$3.
4. DAB (PB-MCB) = \$4.

(7) [Monopoly extension with fixed proportions: 17 pts]

1. MRA = 14 - (2Q/50).
2. PC = PA - 4 = 10 - (Q/50).
3. MRC = 10 - (2Q/50).
Table of results (i) Upstream monopoly,
downstream competition
(ii) Vertically
integrated monopoly
Q = Quantity of components (and appliances) 50 50
PC = price of component \$11 NA
Profit of upstream firm \$250 NA
PA = price of appliances \$15 \$15
Profit of downstream firm zero NA
Total upstream + downstream profits \$250 \$250

4. This merger would not be profitable, because total profits would remain the same. This merger would not harm social welfare because the price of appliances would not change.

(8) [Price discrimination: 6 pts]

1. To maximize profit, segment A should get the higher price because its demand is less elastic.
2. \$12.
3. \$8.

(9) [Positive theories of regulation: 6 pts]

1. \$30.
2. \$5.
3. \$15.

(10) [Two-sided platforms: 8 pts]

• Substituting into the demand equations, q1 = 1600 and q2 = 300.
• MR2 = 16 - 2q2/50 = 16 - 2(300/50) = \$4, ignoring revenue from the other group.
• MR2 = 16 - 2q2/50 + 1.0(p1 = \$4 + 1.0(\$20) = \$24, including additional revenue from group 1.
• Recommend lowering p2 in order to increase q2, because marginal revenue (including impact on group 1) > MC2.

(11) [Multipart tariffs: 26 pts]

(i) Two-part tariff (ii) Declining-block tariff
a.100 units100 units
b.0 units40 units
c.\$300 million\$360 million
d.\$300 million\$360 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.

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 [4 pts]

Same as Version A.