ECON 120 - Regulation and Antitrust Policy Drake University, Spring 2023 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

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

1. P = \$6
2. L = 1/3.

(2) [Antitrust statutes: 8 pts]

1. Sherman Act Section 2.
2. Clayton Act Section 7.
3. Serman Act Section 1.
4. Federal Trade Commission Act Section 5.

(3) [Measures of concentration: 4 pts] Data are for 2022.

1. 4CR = 64 percent.
2. HHI = 1160.

(4) [Cournot duopoly: 14 pts]

1. TRA = P qA = 26 qA - (qA2/10) - (qA qB/10).
2. MRA = d TRA / d qA = 26 - (2qA/10) - (qB/10).
3. qA = 120 - (qB/2).
4. qA* = 80.
5. Q* = 160, P* = \$10.
6. L = (P-MC)/P = 4/5 = 0.8.
7. Deadweight loss = \$320. This is the triangle bounded by the demand curve, the horizontal line at MC, and the vertical line at Q*. Note that competitive supply curve is horizontal at \$2, and intersects demand at Q=240.

(5) [Joint profit maximization: 10 pts]

1. MR = 26 - (Q/5). Find this by multiplying demand equation by Q and taking derivative with respect to Q, or by using rule "same intercept, twice the slope as demand."
2. Set MR = MC and solve to get Q* = 120.
3. Substitute into demand equation to get P* = \$14.
4. L = (P-MC)/P = 6/7.
5. Deadweight loss = \$720. This is the triangle bounded by the demand curve, the horizontal line at MC, and the vertical line at Q*. Note that competitive supply curve is horizontal at \$2, and intersects demand at Q=240.

(6) [Equilibrium entry: 14 pts]
Number of firms Equilibrium market quantity Equilibrium market price Quantity per firm Annual profit per firm PDV profit per firm
1300\$35300 \$9000\$90,000
2400\$25200 \$4000\$40,000
3450\$20150 \$2250\$22,500
4480\$17120 \$1440\$14,400
5500\$15100 \$1000\$10,000

1. 2 firms.
2. 4 firms.

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

1. Min AC = \$2.
2. Min efficient scale = 6 million.
3. L = (P-MC)/P = 1/2 .
4. P = \$2.
5. AC = \$3.
6. Loss, because P < AC.
7. \$4 million.
8. Q = 14 million.
9. AC = \$2.
10. Profit, because entrant's P > AC.
11. \$14 million.
12. \$2, to prevent profitable entry.
13. L = (P-MC)/P = 0, since P=AC=MC.

III. Critical thinking [4 pts]

(1) In the airline industry, a market is really a route, not the whole country. An airline ticket from New York to Chicago is not a close substitute for a ticket from Dallas to Los Angeles, in the eyes of consumers. So to measure competition, it would be better to have market-share data on particular routes like New York to Chicago, rather than market-share data for the whole country. No airline flies all routes, so it is likely that 4CR and HHI will be higher for individual routes than for the whole country. For example, as of March 2023, only three airlines fly between Des Moines and Chicago: United, American, and Delta. So on this route, the 4CR is actually 100% and the HHI is at least 3,333.

(2) If each firm sets its price while taking as given the other firm's price as given, then the Nash equilibrium is that both firms set price equal to marginal cost. (This is the Bertrand model of duopoly.) So the equilibrium market price is \$2 and the equilibrium total market quantity is 240. This answer is different from problem (4) because when firms set prices, each firm has an incentive to undercut the other firm slightly until price falls to marginal cost. (Full credit requires a graph showing market equilibrum at the intersection of demand and horizontal marginal cost.)

### Version B

I. Multiple choice

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

II. Problems

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

1. P = \$8
2. L = 1/4 = 0.25.

(2) [Antitrust statutes: 8 pts]

1. Serman Act Section 1.
2. Federal Trade Commission Act Section 5.
3. Sherman Act Section 2.
4. Clayton Act Section 7.

(3) [Measures of concentration: 4 pts] Data are for 2019.

1. 4CR = 63 percent.
2. HHI = 1121.

(4) [Cournot duopoly: 14 pts]

1. TRA = P qA = 14 qA - (qA2/10) - (qA qB/10).
2. MRA = d TRA / d qA = 14 - (2qA/10) - (qB/10).
3. qA = 60 - (qB/2).
4. qA* = 40.
5. Q* = 80, P* = \$6.
6. L = (P-MC)/P = 2/3.
7. Deadweight loss = \$80. This is the triangle bounded by the demand curve, the horizontal line at MC, and the vertical line at Q*. Note that competitive supply curve is horizontal at \$2, and intersects demand at Q=240.

(5) [Joint profit maximization: 10 pts]

1. MR = 14 - (Q/5). Find this by multiplying demand equation by Q and taking derivative with respect to Q, or by using rule "same intercept, twice the slope as demand."
2. Set MR = MC and solve to get Q* = 60.
3. Substitute into demand equation to get P* = \$8.
4. L = (P-MC)/P = 3/4 = 0.75.
5. Deadweight loss = \$180. This is the triangle bounded by the demand curve, the horizontal line at MC, and the vertical line at Q*. Note that competitive supply curve is horizontal at \$2, and intersects demand at Q=240.

(6) [Equilibrium entry: 14 pts]
Number of firms Equilibrium market quantity Equilibrium market price Quantity per firm Annual profit per firm PDV profit per firm
1150\$17150 \$2250\$22,500
2200\$12100 \$1000\$10,000
3225\$9.5075 \$562.50\$5,625
4240\$860 \$360\$3,600
5250\$750 \$250\$2,500

1. 3 firms.
2. 1 firm.

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

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

III. Critical thinking [4 pts]

(1) [Same as version A.]

(2) If each firm sets its price while taking as given the other firm's price as given, then the Nash equilibrium is that both firms set price equal to marginal cost. (This is the Bertrand model of duopoly.) So the equilibrium market price is \$2 and the equilibrium total market quantity is 120. This answer is different from problem (4) because when firms set prices, each firm has an incentive to undercut the other firm slightly until price falls to marginal cost. (Full credit requires a graph showing market equilibrum at the intersection of demand and horizontal marginal cost.)