You will write your response to
EACH question on a SEPARATE sheet of paper.Pleasewrite clearly and legibly!A bit of organization goes a long to not only help yourself but also to show some kindness to your grader.
Econ 142A: Industrial Organization Nilopa Shah Homework Assignment 4 (based on textbook Chapters 10 intro, 11 and 13) Question 1 (Market Power and Market Concentration) (a) Write down the formula for calculating the Herfindahl Hirschman Index (HHI). (b) Explain what the HHI measures and interpret a low/high HHI values. (2-3 sentences) (c) Write down the formula of Learner’s Index (L) for firms with asymmetric costs. (d) Explain the Learner’s Index and interpret its low/high values (2-3 sentences) (e) Write down the relationship between HHI and L. Explain. (1-2 sentences) Question 2 (based on Exercise 11.4 from the textbook) In 2001, HP acquired Compaq. The merger had an impact on two different markets: desktop PCs and servers. The pre-merger market shares in each market are given in the accompanying table. (a) Determine the value of HHI in each market before the merger. Post-merger, the market shares of each firm remains the same and the market share of the merged firm is a simple sum of old shares. (b) Calculate the post-merger HHI in each market. In the US, the Department of Justice (DoJ) has merger guidelines based on the HHI. As a rule of thumb, mergers that lead to an HHI of 1000 or less ordinarily lead to no further scrutiny; those that raise the HHI by 100 or more and produce a post-merger HHI between 1000 and 1800 raise significant questions; and those that raise the HHI by 50 or more and produce a post-merger HHI above 1800 raise significant concern. (c) Considering the values determined above and the DoJ merger guidelines, was the Department of Justice right in allowing the merger take place? Or did the case deserve significant scrutiny? Explain why or why not. (2-3 sentences) Department of Economics of UC Irvine1 3 Pre-Merger Market Shares Desktop PC Market Dell Compaq HP IBM Gateway 13 12 8 6 4 Server Market IBM Compaq HP Dell 26 16 14 7 Econ 142A: Industrial Organization Nilopa Shah Question 3 (Double Marginalization) Suppose that Michelin is the only producer of tires and Toyota the only producer of cars. The demand function for cars is given by Q = 40 − 4P. Michelin's (constant) cost of production for a set of five tires is $3. The production of one car requires a set of five tires plus a bundle of inputs. Toyota can obtain this bundle of inputs at a (constant) cost of $6. Suppose first that Michelin and Toyota are just two departments within the same vertically integrated monopoly (Firm V). (a) What would be the marginal cost of car production for this vertically integrated Firm V? (b) What price would Firm V firm charge for cars and how many cars would it produce? (c) Calculate Firm V’s profit and consumer surplus under this market structure. Suppose now that Michelin and Toyota are separate firms, each a monopoly in its own industry. Michelin quotes a price $w for a set of five tires and Toyota decides how many sets to buy at that price. Now, Toyota’s costs per car includes buying a set of tires from Michelin at $w plus the bundle of other inputs at $6. We will view this as a two-stage game, where Michelin decides on $w in Stage 1 and in Stage 2 Toyota decides how many cars to sell (and, hence, how many sets of tires to buy from Michelin) as a function of $w. Remember that this type of an extensive form game is solved using backwards induction. However, since the strategies are not a discrete set of choices, we will not use a game tree. Instead let us solve for the equilibrium using the steps listed in the sub-parts below. Broadly, Toyota chooses profit-maximizing quantity of cars to sell as a function of w and Michelin sets w to maximize its own profits, given Toyota’s demand for tires. (d) Calculate profit-maximizing quantity of cars ( ) that Toyota will sell as a function of w? (e) Now, calculate the price ( ) that Toyota will charge the consumers as a function of w. (f) Given Toyota’s choice of , Michelin now faces a demand for number of tires. Solve for Michelin’s profit-maximizing choice of w. [Hint: This optimization, unlike the usual profit-maximization, is carried out with MR and MC for Michelin as a function of w.] (g) Substituting the answer calculated for w, now find the quantity of cars sold by Toyota and the price charged by Toyota to the consumers. QT pT QT QT QT pT Department of Economics of UC Irvine2 3 Econ 142A: Industrial Organization Nilopa Shah (h) Calculate the profits earned by Toyota and Michelin. Compare them to the profits earned by the vertically integrated Firm V. (Refer to sub-part (c).) (i) Calculate the consumer surplus under this market structure and compare it to the consumer surplus enjoyed when the firms are vertically integrated as Firm V. (Refer to sub-part (c).) (j) Are consumers better off when Michelin and Toyota are an integrated firm [use your answers to part (a)] or when they are separate firms [use your answers to part (i)]? Question 4 (Exercise 13.1 from textbook with some explanations) McDonald’s runs two business models. Some McDonald’s restaurants are wholly-owned and operated by the main parent company, while some McDonald’s restaurants follow a franchise model i.e. the main parent company charges a franchise fee and the restaurant is then independently owned and operated by the franchise owner. Empirical evidence suggests that McDonald's restaurants that are wholly-owned by the parent company (the first type described above) charge lower prices than the prices charged by independent franchises (the second type described above). How can this difference in prices charged be explained? (3-5 sentences) Department of Economics of UC Irvine3 3