HOMEWORK ASSIGNMENTS

ECON375: INDUSTRIAL ORGANIZATION

HOMEWORK ASSIGNMENTS

Weekly homework assignments will be assigned from this package on every Thursday on the course web page. Please visit the course web page on Thursdays for homework announcement. You will not be reminded in class again, as there will be an assignment every week throughout the semester and it will be your responsibility to keep track of these assignments. The homework announcement will indicate the due date and the particular questions included in each week's assignment.

For the questions marked with , graph paper is provided in your "Graph

Paper Handout". Please detach that graph paper page and hand it in with the rest of your answers.

HOMEWORK ASSIGNMENT FOR CHAPTER 1

1) Suppose the long run cost function for an auto manufacturer is given as:

TC=Q3 ?25Q2+500Q

and MC=3Q2-50Q+500

For an output level of Q=10 determine whether the cost function exhibits economies of scale (IRS), constant returns to scale or diseconomies of scale (DRS).

2) A new intermediate micro textbook is marketed by the E-commerce Company

EconBooks-R-Us directly to the students. As the CEO of the company you have to decide on the output level for your company. TR curve as well as the associated MR curve for your company are given below. The cost of providing the book to students is: the cost of advertising ($2,500), plus the cost of buying the book from the publisher ($30), plus the cost of shipping the book to the student ($10), plus the staff and maintenance costs of the webserver ($5,000).

25000

TR

$

20000

15000

10000

5000

0 0

$100

80 60 40 20

0

50

100 150 200 250 300 350 400 450 500 Q

MR

50

100

150

200

250

300

350

400

450

Q

a) Find TC and MC equations for EconBooks-R-Us. b) Find the profit maximizing output level for EconBooks-R-Us.

What is the maximum value of the profit? c) How would the profit maximizing output level change, if the advertising costs increase? (Explain)

3) Read the attached USA Today article which describes the differences between the Kohl's department store and other "mall department stores" such as JC Penney and Sears. The article attribute's Kohl's success to its cost cutting strategies, which enable Kohl's to compete with low prices. Two cost cutting strategies described in the article are locating in strip centers and and a store layout with centralized checkout and no sales assistants. For each of the two cost cutting strategies, answer the following questions: i) Does this strategy lower variable or fixed costs? ii) How does this strategy affect AVC, MC, ATC curves of Kohl's?

Copyright 1999 Gannett Company, Inc. USA TODAY

October 14, 1999, Thursday, FINAL EDITION SECTION: MONEY; Pg. 12B

HEADLINE: Thriving Kohl's turns up pressure on competitors Low overhead cuts prices on brand names

BYLINE: Lorrie Grant

BODY: Kohl's department store is rapidly expanding beyond its Midwest roots and snatching market share from national retailers in the process. Based in the Milwaukee suburb of Menomonee Falls, Wis., Kohl's sells moderately priced apparel, shoes, accessories and home products. It has thrived in a market niche between mall department stores, such as Macy's and Sears, and discount retailers, such as Wal-Mart and Target.

And it has been outperforming some of its bigger competitors. Kohl's stores open at least a year have steadily grown sales over the past 12 months. Meanwhile, average sales growth has been flat at national department store chains Sears and J.C. Penney.

"Kohl's is a growing threat to a lot of companies," says Richard Church, retail analyst at Salomon Smith Barney, "but Sears and J.C. Penney have been particularly vulnerable."

Analysts attribute Kohl's success to a low cost structure based on having relatively small stores and few sales agents. That enables Kohl's to offer brand-name products at competitive prices.

It opened stores in Denver and St. Louis this year, following entry into the mid-Atlantic in 1997, building its chain to 246 stores. That compares with almost 3,000 for Sears and more than 1,000 for J.C. Penney. Dillard's, another expanding regional player, operates 337 stores in 29 states.

Kohl's plans to add 13 stores in Dallas by November and 32 in the New York metropolitan area next year. Both are new markets. This year shares of Kohl's are up 13%, while Sears' and J.C. Penney's shares tumbled 28% and 30%, respectively. The Standard & Poor's 500 index is up 5% over the same period.

A nimble competitor, Kohl's builds stores in densely populated markets with household incomes of at least $ 35,000. "If we can get within a 10-mile radius of that population, we'll do it, so the customer won't have to go to the mall," CEO Larry Montgomery says. The stores mainly anchor strip centers that have other high-profile retailers. Strip centers have become increasingly popular because parking is readily available and consumers avoid the crowds and distraction of other stores at malls.

Analysts describe Kohl's as a "hybrid" that directly corresponds to consumers' desire for value. "They combine department store, moderately priced national brands with the convenience of discount store shopping: off mall and centralized checkout," says Shari Eberts, retail analyst at J.P. Morgan.

The retailer targets women shopping for themselves, their family and their home. Sound familiar? Sears' long-running "Softer Side of Sears" advertising campaign pegged the same group for the same reason. It recently switched its slogan: "The good life at a great price. Guaranteed."

How it works for Kohl's:

* Location. Without high rents associated with regional malls, operating costs stay controlled. The company also tends to occupy existing buildings. The 32 stores for its Northeast expansion, for example, were purchased from bankrupt Caldor.

* Size. Ideally one level and 86,500 square feet, the stores are laid out in racetrack format with goods placed along the periphery and in the center. Cash registers are in the front of the store only. By not having registers interspersed in various departments, staff is kept at a minimum -helping keep overhead low.

Critics say the strategy has its flaws, though, namely slow customer service. For example, in the shoe department, shoppers are left to serve themselves, unlike in a major department store, where sales assistants pull the desired size and style from a stockroom.

* Brands. From Bugle Boy clothes for the kids to Oneida flatware to Norton McNaughton apparel, major brand names, which make up 80% of inventory, are available at value prices. Low overhead allows for moderate pricing.

"The convenience of the location will get people (in stores) the first time, but the merchandise and pricing keeps them coming back," says Walt Geiger, retail analyst with Tucker Anthony Cleary Gull.

HOMEWORK ASSIGNMENT FOR CHAPTER 2

1) Consider two industries, each comprising ten firms. In industry A, the largest firm has a market share of 49 percent. The next three firms have market shares of 7 percent each, and the remaining six firms have equal shares of 5 percent each. In industry B, the top four firms share the bulk of the market with 19 percent apiece. The next largest firm accounts for 14 percent, and the smallest five firms equally split the remaining 10 percent of the industry.

a) Compute the four-firm concentration ratio and HHI for each industry. Compare these measures across the two industries. Which industry do you think truly exhibits a more competitive structure? Which measure do you think gives a better indication of this? Explain.

b) Now assume that the three second largest firms in industry A merge their operations while holding on to their combined 21 percent market share. Recalculate the HHI for industry A.

2) The following table gives the market share of beer producers in 1997.

COMPANY Anheuser-Busch Miller/Molson Coors Brewing Stroh/G. Heileman Pabst Brewing Heineken Labatt USA Barton

MARKET SHARE 47 % 24 % 12 % 9% 4% 2% 1% 1%

Assume that Heineken and Pabst Brewing decide to merge their Beer business. Investigate the effects of this merger on market concentration in beer industry, by calculating pre- and post-merger Herfindahl-Hirschman Index (HHI) and Four Firm Concentration Ratios (CR4).

3) Assume that there are n firms with equal share in the market. Calculate the HHI for this market. (Hint: your final answer should be HHI = 10,000 )

n

4) United States v. Aluminum Co. of America (1964) (Alcoa-Rome) involved a merger between Alcoa, a producer of aluminum electrical conductor cable, and Rome Cable, one of the largest producers of copper cable. In this case, the Court had many possible choices for the relevant market. The two alternative definitions considered were as follows: I. A narrow definition that considered aluminum conductors and copper conductors as separate markets. II. A broader definition that combined aluminum and copper conductors.

a) Which issues would you consider to determine which of these two definitions is the best?

b) In general what are the disadvantages of using a narrow market definition? What about using a broad market definition?

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