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Royal Holloway - ECONOMICS 120Church Ware IO solutions

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Chapter 1 Introduction Welcome to the solutions manual for Industrial Organization: A Strategic Approach (IOSA) by Jeffrey Church and Roger Ware. This m ... [Show More] anual contains the solutions to the end of chapter problems found in IOSA. The solutions should have sufficient detail that students can follow the derivations and replicate the solutions. The solutions are available by chapter in three different configurations: all problems, odd problems, and even problems at http://www.econ.ucalgary.ca/iosa/IM/ In addition there are three versions of this solutions manual, corresponding to all, odd, or even problems. The solutions were prepared with the assistance of David Krause at the University of Calgary and Andrea Wilson and Alexendra Lai both at Queen’s University. Warning Instructors may not post these pdf files on their websites unless they are able to restrict access to only their students. Please be considerate of other instructors who may use these problems for exams and assignments and will not appreciate their students having access to the solutions. Resist the temptation to post the answers and impose—potentially significant—costs on other IO instructors. Comments If you have questions, comments, and/or find errors please contact either Jeffrey Church (jrchurch@ucalgary.ca) for chapters 2, 3, 4, 7, 8, 9, 10, 11, 12, 13, 14, 19, 24, 25, and 26 or Roger Ware (ware@qed.econ.queensu.ca) for chapters 5, 6, 15, 16, 17, 18, 20, 21, 22, and 23. 1 2 Church and Ware Solutions Manual Chapter 2 The Welfare Economics of Market Power 1. Profit maximization by a monopolist requires producing where P m (1 1 " ) = MC(Qm ): On the inelastic portion of demand, " < 1 which implies that (1=") > 1. So on the inelastic portion of demand MR is negative and since MC is not, the monopolist can increase profits by reducing output. Intuitively, on the inelastic portion of the demand curve a 1% increase in price leads to a reduction in demand less than 1%, so total revenue increases as price increases and quantity decreases. Profits will increase because total revenue rises and total cost decreases. This will be true until demand becomes elastic, in which case an increase in price (or equivalently a reduction in output) will decrease both total revenue and total cost. Provided MC > MR, the reduction in output will increase profits. 2. Deadweight loss is equal to DWL = (1=2)(P m MCm )(Qc Qm ). Multiply through by (P m =P m )(Qm =Qm ), rearrange and let K = (Qc Qm )=Qm . Then DWL equals (1=2)KLP mQm : If MC is constant then Qc = 2Qm and K = 1. For K < 1, Qc < 2Qm which is true if marginal cost is increasing. 3. The welfare effects of lowering the price of long distance service (market one) to its marginal cost and raising the price of local service (market two) to its marginal cost are shown in Figure 2.1. Consumers of local service suffer a loss of surplus equal to the sum of areas A and B, so the move is not a Pareto improvement. It is however a PPI since total surplus increases by F in market one and by G in market two. If the firm was breaking even at the initial prices, quasi-rents in market one of E would equal the sum of its operating losses in market two (the sum of areas G, A, and B) and its fixed costs. 4. (a) Since the number of cabs is unstated, it is reasonable to infer that this is a question about the long-run equilibrium and that the number of cabs is variable. If so zero economic profits requires that the equilibrium price be 5. At this price the number of rides is 1000, so if each taxi cab operates at capacity, the minimum number of taxi cabs is 50 4 Church and Ware Solutions Manual P A B C D E F G MC D2 D1 P1 P2 Q2 Q1 Figure 2.1: Problem 2.3 Chapter 2. The Welfare Economics of Market Power 5 Q P (a) (b) (c) D D 1 2 SSR(n=70) SSR(n=50) 1000 1400 5 25 Figure 2.2: Problem 2.4 (b) For P 5 the supply of rides is perfectly inelastic and equal to 1000. The price that clears the market by setting the quantity demanded equal to 1000 is 25. So P = 25, Q = 1000, and the profit per taxi cab is 400. (c) Free entry insures that the price is restored to 5. At this price 1400 rides are demanded and the minimum number of taxi cabs will be 70. Profits of 400 attracts entrants, and price falls as supply increases until profits become zero. (d) See Figure 2.2 5. (a) For p 5 the short-run supply is 1900 rides. Demand equals supply when p = 5 and the profit per taxi cab is zero. The taxi cab market is in long-run equilibrium because economic profits are zero. (b) In the short-run capacity is fixed and the price must increase to 55 to reduce demand to 1900 rides. At this price the profit per taxi cab is 1000. The long-run competitive price is 5, so the new long-run equilibrium number of rides is 2900, provided by 145 taxi cabs, and the profit per taxi cab is zero. (c) In aggregate at p = 5 the taxi cab drivers are willing to supply up to 2900 rides. At p = 5 demand is 1400 rides, so there is no capacity constraint and the short-run equilibrium is 6 Church and Ware Solutions Manual q = 1400, p = 5, and = 0. It is reasonable to assume that each cab will operate at capacity in the long run, so there will be exit and the number of cabs will fall to 70 and the long-run equilibrium will be q = 1400, p = 5, n = 70, and = 0. 6. (a) Setting price equal to marginal cost and solving for y, the supply function of a competitive firm is y(p) = p 2w if f is a sunk expenditure since then marginal cost is always greater than average avoidable cost. If f is not sunk then this is the supply function provided p > pmin. Setting MC = 8y equal to AC = 4y + 100=y and solving for y yields ymin = 5, so pmin = 40. If p = pmin then the firm is indifferent between supplying 0 and 5. For p < pmin the firm will supply 0. Since there are n identical firms, the market supply function is ny(p) = S(p) = np 2w if f is sunk. If f is avoidable then this is the supply function provided p > 40. For p < 40 supply is zero. (b) The competitive equilibrium price is found by setting supply equal to demand, D(p) = S(p), or A p = np 2w : Solving for p, p c(n) = 2wA 2w + n : Substituting this into either D(p) or S(p) the equilibrium quantity is Qc(n) = nA 2w + n : Substituting the equilibrium price into the supply function for a firm, each firm produces y c(n) = A 2w + n : The profits of each firm are defined as = py C(y). Substituting in the expressions for p, y, and C(y) as a function of n, equilibrium profits as a function of n are c(n) = wA2 (2w + n)2 f if f is avoidable and equilibrium quasi-rents are c(n) = wA2 (2w + n)2 if f is a sunk expenditure. (c) For f avoidable p = 80, Q = 20, y = 10, and = 300. The market equilibrium is illustrated in Figure 2.3 and the representative firm in Figure 2.4. For f sunk the market equilibrium is illustrated in Figure 2.5 and the representative firm is illustrated in Figure 2.6 in the short-run and Figure 2.4 in the long-r [Show Less]

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Royal Holloway - ECONOMICS 120Church Ware IO solutions