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INDUSTRIAL ORGANIZATION AND FIRM STRATEGY

ECON - 3742, section A01-Winter 2022

Assignment #4

1 True/False questions (20 points)

Determine if the statements are true or false. Justify your answer.

1. Personalized pricing is the modern term that is equivalent to Örst degree price discrimination according to the classiÖcation of Pigou (1920).

2. A case the illustrates the discrepancies in approach and standards between the Unites States and the European Union antitrust competition law is the Virgin/British Airways cases in the year 2000.

3. Uniform pricing across di§erent international geographic locations is always dominated by local geographic group price discrimination.

4. It is fair to state that over the last couple of decades European Competiton law and practice has moved farther from the antitrust approach of the United States.

5. Menu pricing is the modern term that is equivalent to third degree price discrimination according to the classiÖcation of Pigou (1920).

6. A partial cartel formation can be stable in a single market where Örms compete ‡ la Cournot with su¢ ciently di§erentiated products.

7. Two factors that explains the divergent approaches between competition policy in the United States (U.S.) and the European Union (EU) are: i) the historical development of the business environment in both geographic areas and ii) the importance of economic analysis which was more relevant in the E.U. than in the U.S.

8. A horizontal merger between two Örms is basically the same as a partial cartel formation between the two Örms.

9. Main social issue for a horizontal merger is when it is proÖtable and reduces the welfare of society .

10. Consider an industry in which Örms compete a la Cournot with homogenous products. In a sequential cartel formation process less than 80% of the Örms in the industry form a cartel while the complement remain independent.

Problems (40 points)

11. (10 points) Regulation of a monopolist that can choose between uniform and personalized pricing. Consider a market that has a linear demand function Q = 95 一 p. The monopolist has a cost function C (Q) = 5Q.

a. (2 points) Find the price (pm ) and optimal amount of output (Qm ) as well as proÖts (πm ) the monopolist would get if it cannot establish personalized pricing. Compute the consumer surplus and deadweight loss for this scenario.

b. (3 points) Consider now a monopolist that can set up personalized pricing assuming it has all the information to do this. Find the price schedule, the amount of output it produces and the proÖts (πp ) it attains. Compare this situation with the previous scenario.

c. (3 points) A regulator faces the issue of regulating the monopolist in order to maximize consumer surpluses. It sets up the following policy: if the monopolist charges a uniform price for all units sold the monopolist pays 50% of its proÖts while if the monopolist engages in personalized pricing it has to pay x% of its proÖts. Find the level of x that makes the monopolist indi§erent between a uniform price and a personalized price schedule. Suppose that what is collected as corporate income tax is redistributed back to consumers of the market as consumer surplus. Explain.

d. (2 points) Suppose the regulator o§ers the scheme as in c) to the monopolist given the value of x% found previously such that the monopolist would prefer strictly to implement personalized pricing. Find the amount of corporate income tax collected by the policy and compare it with the consumer surplus in part a). Which scenario would generate the greatest consumer surplus? Discuss the advantage or disadvantage of this policy. Explain.

12. (10 points) Geographical and uniform pricing. "Vitamin Strong" has the monopoly on the produc- tion of vitamin C. It faces geographically separated markets, denoted A and B. The demand on these two markets are respectively QA = 1 一 pA and QB = 0:5 一 pB . The transport and production costs are zero for simplicity.

a. (3 points) Assume that the Örm chooses to set a uniform price across the two markets. Determine the optimal uniform price. What are the quantities sold on the two markets at this price? Explain

b. (3 points) Assume the monopolist uses local group pricing (third degree price discrimination). What are the prices and ouput levels for the two markets? Explain.

c. (4 points) Calculate consumer surplus for both markets individually and proÖts under a uniform price and local geographic prices. Compare the two situations and comment on the result. Would the consumers of both markets prefer uniform pricing over local pricing (price discrimination)? Explain.

13. (10 points) Collusion and quantity competition ‡ la Cournot. Consider the following market in which two Örms compete in quantities ‡ la Cournot. The Örms are symmetric and produce with a marginal cost of 20. The inverse demand function is p = 260 一 q where q = q1 + q2 ∈ [0; 260]. Suppose that the two Örms compete in this market for an inÖnite number of periods where the common discount factor for each Örm is s ∈ (0; 1).

a. (2 points) Find the equilibrium quantities under Cournot competition as well as the quantity that a monopolist would produce. Calculate the equilibrium proÖts under the Cournot duopoly and the monopoly.

b. (4 points) The Örms would like to form a cartel by restricting the amount of production for each Örm such that it would produce the monopoly level. What grim trigger strategy can each Örm follow that could allow the cartel to form? Explain.

c. (4 points) For which values of s is the tacit collusion sustainable using the strategies of part b)? Justify your answer. (Hint: use the best response function of a Cournot competitor for a deviation of the other Örm to Önd the optimal deviation. Compute the proÖts for each situation and use equation 14.2 on page 360)

14. (10 points) Cournot mergers and synergies. Consider a homogenous-product Cournot oligopoly 4

with 4 Örms. Suppose that the inverse demand function is P (q) = 64 一 q where q = 8 qi and q i = q 一 qi .

i=1

a. (2 points) Suppose that Örms incur a constant marginal cost c = 4. Characterize the Nash equilibrium of the game in which all Örms simultaneously choose quantity.

b. (3 point) Suppose that Örms 1 and 2 consider merging and that there are synergies leading to a lower marginal cost for the merged organization of cm < c = 4. Characterize the Nash equilibrium. At which level the two Örms are indiferent whether to merge or not? Explain

c. (2 points) At the Nash equilibrium would non merged Örms 3 and 4 prefer the merger between Örms 1 and 2? Would the merger generate a negative or a positive external e§ect for non merged Örms? Explain.

d. (3 point) At which level of cm would the merger be consumer surplus-neutral, if at all? Is it possible that the merger is at the same time proÖtable for the Örms and consumers of that industry? Would a regulator block the merger based on your result? Explain. .

Completion questions (15 points)

15. If a Örm can observe a buyerís characteristics then it can charge di§erent prices as a function of these characteristics. This type of price discrimination is referred to as ___________ in Pigouís taxonomy or as _________ in Shapiro and Varianís.

a. third-degree price discrimination; group pricing

b. second-degree price discrimination; group pricing

c. third-degree price discrimination; personalized pricing

d. Örst-degree price discrimination; personalized pricing

16. In a monopoly setting _________ allows the monopolist to extract more surplus from each consumer relative to the benchmark ____________.

a. group pricing; Örst degree price disc discrimination

b. group pricing; duopoly setting

c. personalized pricing; Örst degree price discrimination

d. personalized and group pricing; monopoly setting with a unique price

17. In a competitive duopoly setting group pricing allows Örms to extract ________ from each consumer while at the same time it ___________. When the quality of information is su¢ ciently large, the former e§ect _________ the latter.

a. more surplus; decreases price competition; dominates

b. less surplus; increases price competition; dominated by

c. more surplus; exacerbates price competiton; dominates

d. less surplus; exacerbates price competiton; dominated by

18. In a monopolist group pricing setting, the monopolist optimally charges ________ with a ________ elasticity of demand.

a. more in market segments; lower

b. less in market segments; higher

c. more in market segments; higher

d. less in market segments; lower

19. Competiton policy can be deÖned broadly as "the set of _________ which ensure that ____________ is not restricted in such a way as to ______ economic welfare".

a. policies and laws; competition in the marketplace; reduce

b. behaviours; competition in the marketplace; reduce

c. policies and laws; competition in the marketplace; increase

d. behaviours; monopolist pricing in the marketplace; increase

20. Antitrust legislation in the United States is contained in the ________Act of 1890, _________ of 1914 and the ___________ Act of 1914.

a. Clayton Antitrust; Sherman Act; Federal Trade

b. Sherman Antitrust; Clayton Act; Federal Trade Commission

c. Federal Trade Antitrust; Sherman Act; Clayton

d. Shapiro Antitrust; Varian Antitrust; Hotelling Commission

Multiple choice questions (15 points)

21. A famous case of cartel formation is:

a. Vitamin cartel for the sale of bulk vitamins.

b. The Organization of the Petroleum Exporting Countries.

c. a and b are correct.

d. None of the other answers are correct.

22. A cartel in an industry:

a. eliminates the competition that was existing between Örms.

b. leads to the coordination of the reduction in output supplied to the market.

c. leads to the coordination of the increase in prices in the market.

d. all of the above answers are correct.

23. A cartel can be formed as a tacit collusion when:

a. they interact strategically in an inÖnite horizon.

b. the discount factor of each Örm is su¢ ciently large.

c. Örms strategically act in accordance with a grim trigger strategy.

d. all of the above are correct.

24. The 80% rule applies:

a. for a partial cartel formation in a sequential Cournot industry with homogenous goods.

b. in horizontal mergers of symmetric Örms in Cournot industries that are highly concentrated.

c. a and b are correct.

d. none of the other answers are correct.

25. The proÖtability of a merger depends:

a. on internalizing previous rivalry between the merged Örms.

b. on the reaction of outside Örms to the merger of the Örms.

c. a and b are correct answers.

d. none of the other answers are correct.