EC304 Industrial Organization Instructor: Sharif F.

Khan

Department of Economics Wilfrid Laurier University Winter 2012

Assignment 1 (Optional)
Total Marks: 70 Marks

Read each part of the question very carefully. Show all the steps of your calculations to get full marks, unless it is mentioned otherwise.
1. [20 Marks] Let the market demand for widgets be described by Q = 1000 50 P , where P is the price of widgets and Q is the quantity demanded for widgets. Suppose further that widgets can be produced at a constant average and marginal cost of $10 per unit. a) What is the equilibrium price and quantity of widgets if the market is competitive? Illustrate your results on a graph. b) What is the equilibrium price and quantity of widgets if the market is monopolized? Illustrate your results on the graph which you drew for part (a). c) What is the deadweight or welfare loss of monopoly in this market? Show the area of the deadweight or welfare loss of monopoly on the graph which you drew for part (a) and (b). d) Define the point elasticity of demand, denoted by D , at a particular price and quantity combination as the ratio of price to quantity times the slope of the Q P Q demand curve, , all multiplied by -1. That is, D = . What is the P Q P elasticity of demand in the competitive equilibrium? What is the elasticity of demand in the monopoly equilibrium? e) Denote marginal cost as MC. Show that in the monopoly equilibrium, the P MC 1 following condition is satisfied: = . P D

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2. [20 Marks]
The following three tables give U.S. market share data in percentages for three paper product markets / industries in 1994.

Facial Tissue Industry

Company Kimberly-Clark Proctor & Gamble Scott Georgia Pacific Other companies Market Share (%) Si 48 30 7 6 9

Toilet Paper Industry

Company Proctor & Gamble Scott James River Georgia Pacific Kimberly-Clark Other companies Market Share (%) Si 30 20 16 12 5 16

Paper Towels Industry

Company Proctor & Gamble Scott James River Georgia Pacific Kimberly-Clark Other companies Market Share (%) Si 37 18 12 11 4 18

a) Write the down the formula for calculating the four-firm concentration ratio (CR4). Calculate the four-firm concentration ratio for each industry. b) Write the down the formula for calculating the Herfindahl-Hirschman Index (HHI). Calculate each industrys HHI index. c) Which industry do you think exhibits the most concentration? Explain.
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3. [10 Marks]
Let the cost function be C = 100 + 4q + 4q 2 .

a) Derive an expression for average cost. b) Derive an expression for marginal cost. c) Compute the index of scale economies, S. Is there any range of production characterized by scale economies (where S >1)? If yes, find that range of production. d) At what production level are scale economies exhausted (where S = 1)? 4. [20 Marks]
Suppose that Coca-Cola uses a new type of vending machine that charges a price according to the outside temperature. On hot days defined as days in which outside temperature is 25 degrees Celsius or higher demand for vending machine soft drinks is: Q = 300 2 P . On cool days when the outside temperature is below 25 degrees Celsius demand is: Q = 200 2 P . Suppose further that tinned soft drinks can be produced at a constant average and marginal cost of 20 cents per unit.

a) What price should the machine charge for a soft drink on hot days? What price should it charge on cool days? b) Suppose that half of the days are hot and the other half are cool. If Coca-Cola uses a traditional machine that is programmed to charge the same price regardless of the weather, what price should it set? [Hint: to solve this question you have to first find the expected aggregate demand and the expected marginal revenue faced by Coca-Cola] c) Compare Coca-Colas profit from a weather-sensitive machine to the traditional, uniform pricing machine. Calculate Coca-Colas profit in both cases.

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