Economics 1B - California State University, Sacramento



Economics 1B

Fall 2019

Homework #5

Gallet

Note: Questions 5 – 7 are on the reverse side of this sheet.

[1] In February 2015, Staples announced its intention to acquire (i.e., merge with) Office Depot. At the time, Staples had an approximate market share of 35%, Office Depot had a market share of 26%, with all other firms having a combined market share of 39%. In December 2015, the Federal Trade Commission (FTC) filed a lawsuit, seeking to block the Staples-Office Depot merger, arguing that such a merger would be too anti-competitive, resulting in higher prices of office supplies.

Utilizing the merger guidelines of 1982 (treating the market share of all other firms as remaining at 39%, while the estimated market share of the combined Staples-Office Depot would have been the sum of their pre-merger market shares), carefully argue why the FTC sought to block the merger of Staples and Office Depot. To support your answer, make sure to calculate relevant value(s) of the Herfindahl Index prior to and after the proposed merger. For simplicity, in your calculations treat all other firms collectively as just the firm “All Others” (and so prior to the merger there were three firms: Staples, Office Depot, and All Others. Had the merger occurred, though, there would have been two firms: Staples-Office Depot and All Others).

[2] A purely competitive nut and bolt manufacturer faces a market price of $7.00, an average total cost of $7.50, an average variable cost of $6.00, and a marginal cost of $6.75. Should this firm expand output, contract output, or shut down in the short-run? Use a graph to illustrate your answer, making sure to indicate these price and cost values.

[3] In air transportation, markets are defined by city-pairs. For example, flights from Sacramento to Las Vegas would be defined as one market, while flights from Sacramento to Seattle would be defined as another market.

Consider an airline that is flying between Sacramento and Las Vegas. The airline has the following costs associated with a flight:

Type Cost

A. Crew $4000

B. Fuel $1000

C. Landing Fee $1000

D. Plane Daily Depreciation $2000

E. Plane Daily Insurance $2000

Note that whether the airline chooses to make the flight or not, it encounters costs D and E. Furthermore, suppose the airline has an average of 40 passengers paying an average of $200 for this flight. Do you think the airline should be flying between the two cities? Evaluate this question from (a) the short-run perspective and (b) the long-run perspective.

[4] Suppose a monopoly sets a profit-maximizing price of $10 in the short-run. As such, its average total cost is $8, its average variable cost is $6, and its profit equals $100,000. Illustrate the relevant curves (i.e., demand, average total cost, average variable cost, marginal cost, and marginal revenue), as well as the quantity the monopolist produces, that would be consistent with the numbers provided.

[5] Suppose the Alpha (A), Bravo (B), Charlie (C), and Delta (D) families are each considering buying a new home from a local builder. Family A’s reservation price is $400,000, family B’s reservation price is $380,000, family C’s reservation price is $420,000, and family D’s reservation price is $410,000. Suppose the cost to the builder to construct a home is $300,000.

A. If the builder is unable to price discriminate, yet desires to sell a home to each of these families, what price would it charge and what would be the firm’s profit?

B. Now, if the builder is able to price discriminate and desires to sell a home to each of these families, how would it do so and what would be the firm’s profit?

[6] Suppose the market for steel is purely competitive. Then the steel producers merge, effectively becoming a monopoly. The market is indicated below:

[pic]

Determine the values of: (i) Consumer surplus under pure competition, (ii) Producer surplus under pure competition, (iii) Market welfare under pure competition, (iv) Consumer surplus under monopoly, (v) Producer surplus under monopoly, and (vi) Market welfare under monopoly. What is the deadweight loss in welfare associated with this industry becoming a monopoly?

[7] In the game of chicken two individuals drive vehicles towards each other, usually at a high rate of speed. As they approach the impact point, each has the option of continuing to drive down the middle of the road or to swerve. Both believe that if only one driver swerves, that driver loses face (payoff = 0, which perhaps refers to their utility) and the other gains in self-esteem (payoff = 2). If neither driver swerves, they are maimed or killed (payoff = -1). If both swerve, no harm is done to either (payoff = 1). Illustrate the payoff matrix to this game. Use the concept of Nash Equilibrium to argue the most likely outcome(s) of this game.

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