Question 1. In class, we discussed how merger simulation involved inferring marginal cost from observing demand and market shares. This problem is related. Two firms produce a homogenous good and set quantities simultaneously (that is, they play a static Cournot game). Suppose that demand is Q = 100-P.

a. What is the inverse demand function?

b. What are the best response functions? Write them in terms of MC₁ and MC₂.

c. If both firms pick quantities Q₁= Q₂= 30, what is the marginal cost of each firm?

d. If firm 1 picks Q₁ = 25 and firm 2 picks Q₂ = 35, what is the marginal cost of each firm?

Question 2. Go to the web site for the Antitrust Division of the Department of Justice (http://www.usdoj.gov/atr/). Click on "Antitrust Case Filings" on the left. Pick a merger case. Merger cases tend to be against two firms (e.g. U.S. v. Firm X and Firm Y). Click on the "Complaint".

The Complaint is normally the first document that the DOJ files in a merger case. If there is no Complaint, it is probably not a merger case.

If it is a merger case, the Complaint will say something about Section 7 of the Clayton Act on the first few pages. For instance, you will see a sentence like "This action is filed by the United States under Section 15 of the Clayton Act, as amended, 15 U.S.C. § 25, to prevent and restrain defendants from violating Section 7 of the Clayton Act, as amended, 15 U.S.C. § 18.".

Read the Complaint and answer the following questions:

a. What is the name of the case you chose?

b. What is the relevant geographic market?

c. What is the relevant product market?

d. What are the barriers to entry? Did the DOJ list these explicitly or are you inferring from the description of the case?

e. What are potential cost efficiencies? If the DOJ does not list them explicitly, you should guess as to what they might be.

Question 3. Assume the following facts concerning the horizontal merger model developed by Williamson and shown in figure. Demand is q = 100 - P; average cost premerger, AC₀ = $50; average cost postmerger, AC₁ = $44; and premerger price, p_o = $50. Assume that the postmerger price, p₁ = $70, results from the market power created from the merger.

a. Calculate the value of the deadweight loss, area A₁.

b. Calculate the value of the cost savings created by the merger, area A₂.

c. Should the merger be allowed? What qualifications should be considered?

Question 4.

Suppose that the demand for long-distance telephone service is D(P) = 50 - 2P, where P is price. Prior to recent deregulation, this market was monopolized by AT&T. Assume that AT&T's cost function is C(q) = 100 + 5q.

a. If AT&T had been an unregulated monopolist, derive the price that it would have charged.

b. Derive the price that a regulatory agency would set if it was interested in maximizing con¬sumer welfare subject to AT&T earning at least normal profits.

Since deregulation, AT&T has continued to be the dominant firm. Suppose AT&T's competitors are small price-taking firms that can be represented by the supply function S(P) = 2P - 20.

c. Using the static dominant firm model, derive the price that AT&T would charge. Derive AT&T's market share.

d. How much is AT&T willing to pay to be an unregulated monopolist?

Suppose that we extend this model to a multiperiod setting, and assume that the fringe finances growth through retaining earnings.

e. Will AT&T's current price be higher or lower than that derived in part c?

Question 5. In class, we discussed how heterogeneous firms make collusion more difficult. In this problem, we consider collusion by firms with different market shares. This problem is related to Problem 2 from Assignment 2.

There are two firms in a market that produce an identical good. Firm 1 has a marginal cost of 8 and firm 2 has a marginal cost of 42. Fixed costs are zero for both firms. Suppose inverse demand for a product is P = 130 - Q.

a) Suppose that firm 1 produces 44 and firm 2 produces 16. Note that this implements the monopoly price in the related problem. What are profits for each firm?

b) If firms set quantities simultaneously (that is, play a Cournot game), what are best response functions. What quantities do they choose? What are profits?

c) If firm 1 knows firm 2 will play as in (a), what is firm 1's best response? What are profits in this case? If firm 2 knows firm 1 will play as in (a), what is firm 2's best response? What are profits in this case?

d) Suppose the firms meet infinitely often. They can save money at interest rate r. What interest rate is necessary to justify trigger strategies? You should solve for a separate interest rate for each firm.

e) Comparing this problem to the one in Assignment 2, is cheating more likely when firms are asymmetric? If so, is cheating more likely by the small firm or the large firm?

Question 6. Firm 1 sells its product for P₁ = 80 and has constant marginal cost, MC₁ = 40, and sells Q₁ = 100. Firm 2 has P2 = 90 and MC₂ = 50. If Firm 1 raised price to P₁ = 90, it would sell Q₁=70, and sales at Firm 2 would rise by 10.

a) Suppose that Firm 1 and Firm 2 were considering a merger. Would the merger create Upward Pricing Pressure for Firm 1?
b) Suppose that the merger causes Firm 2 to reduce cost to MC2=30. Would the merger create UPP for Firm 1?
c) What is problematic about this example for the use of UPP?

Question: Detail answers with clear explanations.