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

FINAL EXAM ANSWER KEY

Version A

I. Multiple choice

(1)d. (2)a. (3)b. (4)d. (5)b. (6)d. (7)b. (8)b. (9)c. (10)c. (11)c. (12)b. (13)a. (14)a. (15)a. (16)c. (17)c. (18)b. (19)c. (20)c. (21)a. (22)c. (23)a. (24)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. Sherman Act Section 2.
2. Clayton Act Section 7.
3. Sherman Act Section 1.
4. Federal Trade Commission Act Section 5.

(3) [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.

(4) [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.

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

1. 1800.
2. Moderately concentrated.
3. 2000.
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 points.

(6) [Upward pricing pressure: 8 pts]

1. DAB = 30/(100-40) = 1/3 .
2. DBA = 40/(100-20) = 1/2.
3. UPPA = DAB (PB-MCB) - ΔMCA = (1/3) (23-14) - (17-16) = \$2.
4. DAB (PB-MCB) = \$3.

(7) [Successive monopolies with fixed proportions: 18 pts]

1. MRA = 8 - (Q/5).
2. PC = 5 - (Q/5).
3. MRC = 5 - (2Q/5).
Table of results (i) Successive monopolies (ii) Vertically integrated
monopoly
Q = Quantity of components (and appliances) 10 20
PC = price of component \$3
Profit of upstream firm \$20
PA = price of appliances \$7 \$6
Profit of downstream firm \$10
Total upstream + downstream profits \$30 \$40

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.

(8) [Network effects: 8 pts]

1. The more users on the network, the more each user is willing to pay for access.
2. \$0 < P < infinity.
3. \$15 < P < \$30.
4. \$0 < P < \$25.

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

1. \$20, where economic profit is zero and therefore price=AC=MC.
2. \$40, where economic profit is maximized.
3. \$30, where the regulator's utility is maximized subject to the profit function.

(10) [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 as required, but the two-part tariff has no social deadweight loss.

(11) [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.

(12) [Cross-subsidization: 12 pts]

1. \$200 thousand, the area of a triangle bounded by the demand curve, the average cost curve, and a vertical line at 4 thousand.
2. \$800 thousand.
3. \$200.
4. \$50 thousand, the area of an "upside-down" triangle bounded by the demand curve, the average cost curve, and a vertical line at 8 thousand.
5. DWL is represented by two areas of triangles, described above in parts (a) and (d).
6. \$250 thousand, the sum of parts (a) and (d).

III. Critical thinking

(1) Bridge tolls.

1. Bridges are a joint cost, not a common cost, as defined by Alfred Kahn, because the size needed of the bridge depends on the maximum of weekday traffic and weekend traffic. Put differently, the bridge serves both weekday traffic and weekend traffic without a tradeoff.
2. The cost of bridge construction should be included in weekday tolls only, when usage hits capacity and the short-run marginal cost curve turns vertical. The cost of bridge construction should not be included in weekend tolls only, because weekend traffic does not hit capacity (assuming the "firm peak" case).

(2) Vertical integration in electric power.

• Non-vertically-integrated utilities are subject to greater risk from fluctuations in the price of wholesale electric power. For a utility that only purchases wholesale power and distributes power to retail customers, profit is negatively related to the price of wholesale power.
• For a vertically-integrated utility, which "buys" wholesale power from itself, profit is not affected by the price of wholesale power.

Version B

I. Multiple choice

(1)b. (2)a. (3)a. (4)b. (5)a. (6)a. (7)d. (8)e. (9)a. (10)a. (11)a. (12)d. (13)d. (14)b. (15)b. (16)d. (17)d. (18)d. (19)a. (20)a. (21)c. (22)b. (23)a. (24)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 1.
2. Federal Trade Commission Act Section 5.
3. Sherman Act Section 2.
4. Clayton Act Section 7.

(3) [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.

(4) [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.

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

1. 2000.
2. Moderately concentrated.
3. 2800.
4. Highly concentrated.
5. This merger would be deemed "presumed likely to enhance market power" because the post-merger HHI is greater than 2500 and the change in the HHI due to the merger is greater than 200 points.

(6) [Upward pricing pressure: 8 pts]

1. DAB = 30/(100-40) = 1/3 .
2. DBA = 40/(100-30) = 1/2.
3. UPPA = DAB (PB-MCB) - ΔMCA = (1/2) (21-17) - (14-13) = \$1.
4. DAB (PB-MCB) = \$2.

(7) [Successive monopolies with fixed proportions: 18 pts]

1. MRA = 12 - (Q/5).
2. PC = 9 - (Q/5).
3. MRC = 9 - (2Q/5).
Table of results (i) Successive monopolies (ii) Vertically integrated
monopoly
Q = Quantity of components (and appliances) 20 40
PC = price of component \$5
Profit of upstream firm \$80
PA = price of appliances \$10 \$8
Profit of downstream firm \$40
Total upstream + downstream profits \$120 \$160

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.

(8) [Network effects: 8 pts]

1. The more users on the network, the more each user is willing to pay for access.
2. \$0 < P < infinity.
3. \$10 < P < \$20.
4. \$0 < P < \$15.

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

1. \$5, where economic profit is zero and therefore price=AC=MC.
2. \$20, where economic profit is maximized.
3. \$10, where the regulator's utility is maximized subject to the profit function.

(10) [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 as required, but the declining-block tariff has less social deadweight loss.

(11) [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.

(12) [Cross-subsidization: 12 pts]

1. \$200 thousand, the area of a triangle bounded by the demand curve, the average cost curve, and a vertical line at 4 thousand.
2. \$800 thousand.
3. \$200.
4. \$50 thousand, the area of an "upside-down" triangle bounded by the demand curve, the average cost curve, and a vertical line at 8 thousand.
5. DWL is represented by two areas of triangles, described above in parts (a) and (d).
6. \$250 thousand, the sum of parts (a) and (d).

III. Critical thinking

(1) [Same as version A.]

[end of answer key]