Prof. Bryan Caplan

Econ 370


HW#2 (please type; diagrams may be drawn by hand)


I.                     Explain how superior efficiency allows a firm to price above AC.  What limits the final price charged?  Discuss one form of superior efficiency that has been subject to antitrust prosecution.


II.                   Most historical discussions of collusion and predation overlook the many difficulties associated with successfully pursuing these strategies.  Find one discussion of collusion or predation in a source of your choosing.  Summarize the charges.   What economic checks on collusion/predation does your source ignore? 


III.                  Draw a graph of a naturally monopolistic industry (you will need to show both the AC curve and the demand curve).  Show where the unregulated firm would price if equally efficient potential competitors exist.


IV.               A natural monopoly has AC of $5, and charges $25 per unit.  The government imposes rate-of-return regulation on the firm, forbidding it to charge more than 10% above AC.  Explain both of the strategies the firm could use to deal with this regulation.


V.                 If firms use collusion and/or predation on the free market to gain monopoly positions, what sign would the correlation between concentration and profit have (positive, negative, or zero)?  If firms gain monopoly positions through superior efficiency, what sign would the correlation between market share and profit have?


VI.               Label the following as horizontal, vertical, or conglomerate mergers.

A.                 Boeing merges with McDonnell-Douglas.

B.                 Microsoft buys Quicken.

C.                The Olive Garden buys Prego spaghetti sauce.

D.                McDonald's buys the Olive Garden.

E.                 Microsoft buys Intel.


What implicit assumptions about market definitions did you have to make in each case?  What would lawyers for the government probably argue if they were contesting a merger?  What would the lawyers for the companies involved argue?


VII.              Which of the following are per se illegal?  Which are subject to a "rule of reason"?  Which are for practical purposes legally safe?

A.                 Vertical mergers.

B.                 Research joint ventures

C.                Setting low prices.

D.                Setting high prices.

E.                 Setting the same price as your competitor.

F.                 Calling up your competitor to discuss prices.


VIII.            Dairy Queen is debating whether to run its restaurants itself, or to use franchises.  DQ can run them itself for $100,000 per restaurant per year.  Franchisees can run them for $80,000 per restaurant per year (since the franchisee's owner-manager has an incentive to run the them more efficiently than an employee-manager).  Each restaurant can expect to sell 100,000 ice cream comes per year; because they face competition, they must be produced in the lowest-cost way and priced at average cost.

A.                 If franchisees are unable to sue Dairy Queen, how will cones be produced (by DQ directly, or by franchises)?  What will the price of ice cream cones be?

B.                 Suppose that franchisees have the right to sue DQ.  10% of franchisees sue, costing an average of $100,000 in damages and legal expenses.  Now what will the price of ice cream cones be?

C.                Suppose the legal system becomes more sympathetic to franchisees, so now 20% sue and cost an average of $250,000 in damages and legal expenses.  How will DQ ice cream produced, and at what price?


IX.               Suppose that an industry has 3 firms, with market shares of 50%, 40%, and 10%.  A deconcentration bill is passed, setting the maximum market share at 9%.  What would be one legal way to re-organize the industry?  How would your answer be affected if this ruling bankrupted the firm that originally had a 10% market share?