Econ 142A: Industrial Organization Nilopa Shah
Homework Assignment 4 (based on textbook Chapters 10 intro, 11 and 13)
Question 1 (Market Power and Market Concentration)
(a) Write down the formula for calculating the Herfindahl Hirschman Index (HHI).
(b) Explain what the HHI measures and interpret a low/high HHI values. (2-3 sentences)
(c) Write down the formula of Learner’s Index (L) for firms with asymmetric costs.
(d) Explain the Learner’s Index and interpret its low/high values (2-3 sentences)
(e) Write down the relationship between HHI and L. Explain. (1-2 sentences)
Question 2 (based on Exercise 11.4 from the textbook)
In 2001, HP acquired Compaq.
The merger had an impact on two
different markets: desktop PCs
and servers.
The pre-merger market shares in
each market are given in the
accompanying table.
(a) Determine the value of HHI in each market before the merger.
Post-merger, the market shares of each firm remains the same and the market share of the merged
firm is a simple sum of old shares.
(b) Calculate the post-merger HHI in each market.
In the US, the Department of Justice (DoJ) has merger guidelines based on the HHI. As a rule of
thumb, mergers that lead to an HHI of 1000 or less ordinarily lead to no further scrutiny; those
that raise the HHI by 100 or more and produce a post-merger HHI between 1000 and 1800 raise
significant questions; and those that raise the HHI by 50 or more and produce a post-merger HHI
above 1800 raise significant concern.
(c) Considering the values determined above and the DoJ merger guidelines, was the
Department of Justice right in allowing the merger take place? Or did the case deserve
significant scrutiny? Explain why or why not. (2-3 sentences)
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Pre-Merger Market Shares
Desktop PC
Market Dell Compaq HP IBM Gateway
XXXXXXXXXX
Server
Market IBM Compaq HP Dell
XXXXXXXXXX
Econ 142A: Industrial Organization Nilopa Shah
Question 3 (Double Marginalization)
Suppose that Michelin is the only producer of tires and Toyota the only producer of cars. The
demand function for cars is given by Q = 40 − 4P. Michelin's (constant) cost of production for a
set of five tires is $3. The production of one car requires a set of five tires plus a bundle of inputs.
Toyota can obtain this bundle of inputs at a (constant) cost of $6.
Suppose first that Michelin and Toyota are just two departments within the same vertically
integrated monopoly (Firm V).
(a) What would be the marginal cost of car production for this vertically integrated Firm V?
(b) What price would Firm V firm charge for cars and how many cars would it produce?
(c) Calculate Firm V’s profit and consumer surplus under this market structure.
Suppose now that Michelin and Toyota are separate firms, each a monopoly in its own industry.
Michelin quotes a price $w for a set of five tires and Toyota decides how many sets to buy at that
price. Now, Toyota’s costs per car includes buying a set of tires from Michelin at $w plus the
undle of other inputs at $6.
We will view this as a two-stage game, where Michelin decides on $w in Stage 1 and in Stage 2
Toyota decides how many cars to sell (and, hence, how many sets of tires to buy from Michelin)
as a function of $w. Remember that this type of an extensive form game is solved using
ackwards induction. However, since the strategies are not a discrete set of choices, we will not
use a game tree. Instead let us solve for the equili
ium using the steps listed in the sub-parts
elow. Broadly, Toyota chooses profit-maximizing quantity of cars to sell as a function of w and
Michelin sets w to maximize its own profits, given Toyota’s demand for tires.
(d) Calculate profit-maximizing quantity of cars ( ) that Toyota will sell as a function of w?
(e) Now, calculate the price ( ) that Toyota will charge the consumers as a function of w.
(f) Given Toyota’s choice of , Michelin now faces a demand for number of tires. Solve
for Michelin’s profit-maximizing choice of w. [Hint: This optimization, unlike the usual
profit-maximization, is ca
ied out with MR and MC for Michelin as a function of w.]
(g) Substituting the answer calculated for w, now find the quantity of cars sold by Toyota
and the price charged by Toyota to the consumers.
QT
pT
QT QT
QT
pT
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Econ 142A: Industrial Organization Nilopa Shah
(h) Calculate the profits earned by Toyota and Michelin. Compare them to the profits earned by
the vertically integrated Firm V. (Refer to sub-part (c).)
(i) Calculate the consumer surplus under this market structure and compare it to the consumer
surplus enjoyed when the firms are vertically integrated as Firm V. (Refer to sub-part (c).)
(j) Are consumers better off when Michelin and Toyota are an integrated firm [use your
answers to part (a)] or when they are separate firms [use your answers to part (i)]?
Question 4 (Exercise 13.1 from textbook with some explanations)
McDonald’s runs two business models. Some McDonald’s restaurants are wholly-owned and
operated by the main parent company, while some McDonald’s restaurants follow a franchise
model i.e. the main parent company charges a franchise fee and the restaurant is then
independently owned and operated by the franchise owner. Empirical evidence suggests that
McDonald's restaurants that are wholly-owned by the parent company (the first type described
above) charge lower prices than the prices charged by independent franchises (the second type
described above). How can this difference in prices charged be explained? (3-5 sentences)
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