ECONOMICS 121A

INDUSTRIAL ORGANIZATION
SPRING QUARTER 2009
PROFESSOR REQUENA

PROBLEM SET 1

DUE: APRIL 8TH

Problem 1
1.1
If the market is competitive, firms are price takers and marginal revenue is the market price.
Therefore, the supply curve is given by:

The price is a constant here, so the competitive price is 20.

The industry profit is given by:

P
1.2 300

CS
D
P*=20 MC/

Q*=280 300 Q
080000
Note that producer surplus is zero and efficiency loss is zero.

1.3
If the market is monopoly, firm sets the price at the given quantity by exploiting the demand
curve.
The first order condition of profit maximization is:

The monopoly price is therefore:

 The industry profit is given by:

1.4
P
300

CS Efficiency
Pm=160 loss
PS
D
P*=20 MC
Qm=140 150 300 Q
1.5 MR
The Lerner Index is:

Problem 2
2.1
P
200

Social
Pm=110

P*=20 MC
50 Q
Qm=22.5 *
MR Q =45

In the basic model, is the same for both the perfect competitors and monopoly. If there is
perfect competition:

Plug in the demand function we have:

If there is a monopoly:

Plug in the demand function we have:

From the graph, the social cost of monopoly is the shaded area given by:

2.2
P
200

Pm=112.5
Social

25 MCm
P*=20 MCp
50 Q
Qm=21.875 *
MR Q =45

In the Leibenstein’s approach, is higher for monopoly than for perfect competitiors (i.e. the
monopoly is less efficient). If there is perfect competition:

Plug in the demand function we have:

If there is a monopoly:

Plug in the demand function we have:

From the graph, the social cost of monopoly is the shaded area given by:
 2.3 P

200
Social Cost = A -
B
Pm=107.5
A

P*=20
15 MCmMCp
50 Q
Qm=23.125 *
MR Q =45

In the Williamson’s approach, is lower for monopoly than for perfect competitors (i.e. the
monopoly is lmore efficient). If there is perfect competition:

Plug in the demand function we have:

If there is a monopoly:

Plug in the demand function we have:

From the graph, the social cost of monopoly is the shaded area (the loss) less the shaded area
(the gain):

Problem 3

3.1
The equations for these two market concentration measurements are:

Where S is the market share of each firm S=q/Q

3.2
From the above equations we can see that if the merger between the 5th and the 6th firms is
smaller than S4 , then the merge will not affect but it will affect .
 3.3
Again from the above equations we can see this partial purchase between the 5th and the 6th
firms may or may not affect but it will affect .

3.4
Write the as a function of share variation coefficient:

When there is an entry of a large firm, both the number of firms (n) and the variation coefficient
(c2) increase, therefore the direction of the change in HHI is ambiguous.

Problem 4

To find the range of production characterized by scale economies, equate AC(q) with MC(q). The
range of production characterized by scale economies is:

For q between 0 and 5 , production is characterized by scale economies. At the

production level equals 5 (S=1) the scale economies are exhausted.

Problem 5
This consultant based his argument on the total cost of making a trip; however, a good
economist should determine the operation based on the variable costs of making a trip.
Since the fixed costs will be incurred regardless of whether the train runs or not, there is
no increase in fixed cost from making a trip during off-peak hours. What matters are the
variable costs of making an off-peak hour trip? As long as they are less than the revenue
from the sales of 10 tickets, the train should make the trip.
Problem 6 (see instructor’s slides)
A firm decides to exit when the profit from running business is smaller than the profit of
not producing at all:

Therefore, sunk costs (FCs) do not into the decision making equation.

Problem 7
The scale economies are exhausted at a production level of 1500 (where the AC is the
minimum).
Complete the table with columns for total cost, marginal cost, and scale economy index:
Q AC TC=Q*AC MC=∆TC/∆Q S=AC/MC
250 28.78 7195 -- --
500 25.73 12865 22.68 1.13
750 23.63 17722.5 19.43 1.22
1000 21.63 21630 15.63 1.38
1250 21.00 26250 18.48 1.14
1500 20.75 31125 19.50 1.06
1750 20.95 36662.5 22.15 0.95
2000 21.50 43000 25.35 0.85