ECONOMICS 121A

INDUSTRIAL ORGANIZATION
SPRING QUARTER 2009
PROFESSOR REQUENA

PROBLEM SET 1
DUE: APRIL 8TH

Problem 1
Consider a market in which the demand curve is given by:

P = 300 - Q

Total costs for the industry is given by TC = 20Q. (Hint: what does this imply about
marginal cost)

1.1 : What is the competitive price? What are industry profits? (Hint: what is the
supply curve in a competitive industry?)
1.2 : Represent your answers in 1.1 in a graph and shade the area of consumer
surplus, producer surplus and any efficiency loss for the market structure.
1.3 : What is the monopoly price? What are profits?
1.4 : Represent your answers in 1.2 in a graph and shade the area of consumer
surplus, producer surplus and any efficiency loss for the market structure.
1.5 : Calculate the Lerner Index.

Problem 2 [Use the lecture notes to solve this problem]

The inverse demand function is the industry is p(Q)= 200-4Q. Explain in each of the cases
below the social cost of the monopoly (use graphs to support your answer):
2.1 : Basic model: MgC=20
2.2 : Leibenstein´s approach: MgC=25
2.3: Williamson´s approach: MgC=15.

Problem 3
Suppose that an industry has six firms. They are ordered according to their market share,
s1> s2> s3> s4 > s5> s6.

3.1 : Define the concentration ratio of the four largest firms (CR4) and the Herfindal-
Hirsmann index (HHI)
3.2 : Suppose that firms 5 and 6 merge. ¿Does the merge affect CR4? ¿And HHI?
3.3 : Suppose that firm 5 buys 40% of the business of firm 6. ¿Does the ppartial
purchase affect CR4? ¿And HHI?
3.4 : The HHI can be expressed as a function of the variation coefficient and the
number of firms. Use the formula [see lecture notes] to describe the effect of an
entry of a large firm in the industry on the degree of market concentration using the
HHI.
Problem 4.
Let the cost of function be C = 100 + 4q + 4q 2 . Derive an expression for average cost.
Derive an expression for marginal cost. Is there any range of production characterized by
scale economies? At what production level are scale economies exhausted?

Problem 5
An urban rapid-train line runs crowded trains (200 passengers per car) at rush hours, but
empty trains (20 passengers per car) at off-peak hours. A management consultant argues
as follows: “The total cost of running a car per one trip on this line is about $50 dollars
regardless the number of passengers. So the passenger cost is about 25 cents at rush hour
but rises to $5 dollars in off-peal hours. Consequently, we had better discourage the off-
peak business”. Is the consultant a good economist? Why or why not?

Problem 6
Show mathematically that sunk costs do not affect a firm’s decision to exit a market.

Problem 7
Some estimates of the cement industry suggest the following relationship between
capacity (thousands of tons) and average cost (in dollars):

Q AC
250 $28.78
500 25.73
750 23.63
1000 21.63
1250 21.00
1500 20.75
1750 20.95
2000 21.50

a. At what production level are scale economies exhausted?

b. Calculate the scale economy index for the production levels 500, 750,
1000, 1500 and 1750.