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1. The Sherman and Clayton Acts The Clayton Act of 1914 classifies several business practices as illegal, including price discrimination and tying contracts, if they "substantially lessen competition or tend to create a monopoly." The Clayton Act of 1914 is an example of which of the following? Antitrust laws Price regulations 2. The Clayton and Celler-Kefauver Acts Which of the following activities are prohibited by the Clayton Act when they lead to less competition? A buyer is forced to buy multiple products from a producer in order to get a desired product. Each of these answers is correct. A director from one business sits on the board of a competing firm. A firm acquires a major percentage of the stocks of a competing firm. 3. The Herfindahl index Suppose that three firms make up the entire wig manufacturing industry. One has a 40% market share, and the other two have a 30% market share each. The Herfindahl index of this industry is _3400________ (a.10,000 b.6,000 c.3,400 d.4,000 e.3,000). A new firm, Mane Attraction, enters the wig manufacturing industry and immediately captures a 15% share of the market. This would cause the Herfindahl index for the industry to __fall_________ (a.fall b.rise c.remain the same). The largest possible value of the Herfindahl index is 10,000 because: An industry with an index higher than 10,000 is automatically regulated by the Justice Department An index of 10,000 corresponds to a monopoly firm with 100% market share An index of 10,000 corresponds to 100 firms with a 1% market share each 4. 90-60-30, Herfindahl, and the FTC Suppose that in the market for soft drinks, market share is divided among six companies in the following manner: Firm Market Share Coca-Cola 90% Pepsi-Cola 3% Cadbury 2% Cott 2% National Beverage 2% Royal Crown 1% Based on the Herfindahl index of the market for soft drinks, the FTC would __challenge________ (a.challenge b.encourage c.not challenge) a merger between Cadbury and National Beverage. HHI= 90^2+3^2+2^2+2^2+2^2+1^2 =8122 A merger between Cadbury and National beverage HHI= 92^2+3^2+2^2+2^2+1^2 = 8482 Postmerger Index level IF HHI> 2500 , highly concentrated market and FTC will challenge the merger if it increases between 100 to200 5. Three types of mergers Categorize each of the following examples as a horizontal, vertical, or conglomerate merger. Horizontal A retail coffee chain merges with a sports equipment manufacturer. Vertical Conglomerate Horizontal Vertical Conglomerate A newspaper publisher merges with a paper and pulp mill. In 1999, two large oil companies merged to form a single company. 6. Network monopolies A lock-in effect __increases _________ (a.increases b.decreases) the costs of switching from one network good to another network good. How do network externalities help a monopoly retain its market power? If there are strong network externalities associated with a good, other goods are poor substitutes for it. By exploiting network externalities, a firm can become a natural monopoly. Goods with network externalities are more likely to receive a government patent. 7. When fewer firms are better II Secure Corp is a home security provider. In the long run, Secure Corp can provide home security for 20,000 homes each month at a total cost of $700,000, home security for 30,000 homes at a total cost of $900,000, or home security for 40,000 homes at a total cost of $1,000,000. Use the purple points (diamond symbol) on this graph to plot points of the long-run average cost curve at outputs of 20,000, 30,000, and 40,000 homes. 20,000 homes each month at a total cost of $700,000 AC = 700000/20000 = 35 30,000 homes at a total cost of $900,000, AC = 900000/30000 = 30 Home security for 40,000 homes at a total cost of $1,000,000 AC = 1000000/40000 = 25 Suppose that there are 40,000 households that purchase home security in this area. All of Secure Corp's potential rivals face the same long-run average cost curve. True or False: Because Secure Corp faces falling long-run average cost over the relevant output range, it would be inefficient for another firm to enter this home security market. True False 8. Regulating a natural monopoly Consider the local telephone company, a natural monopoly. The following graph shows the monthly demand curve for phone services, the company's marginal revenue (MR), marginal cost (MC), and average total cost (ATC) curves. Suppose that the government has decided not to regulate this industry, and the firm is free to maximize profits, without constraints. Complete the first row of the following table. Short Run Pricing Mechanism Quantity Price (Subscriptions) (Dollars per subscription) Long-Run Profit Decision Short Run Quantity (Subscriptions) Pricing Mechanism Price (Dollars per subscription) Profit Multiple Choice Maximization a.6,000 b.11,000 c.12,000 a.30 b.35 c.40 d.60 Long-Run Profit Decision a. Neg a. Exit the b. Pos industry c. Zero b. Stay in business c. Stay or exit Marginal-Cost Multiple Choice Pricing a.6,000 b.11,000 c.12,000 a.30 b.35 c.40 d.60 a. Neg a. Exit the b. Pos industry c. Zero b. Stay in business c. Stay or exit Average-Cost Multiple Choice Pricing a.6,000 b.11,000 c.12,000 a.30 b.35 c.40 d.60 a. Neg a. Exit the b. Pos industry c. Zero b. Stay in business c. Stay or exit Suppose that the government forces the monopolist to set the price equal to marginal cost. Complete the second row of the previous table. Suppose that the government forces the monopolist to set the price equal to average total cost. Complete the third row of the previous table. True or False: Over time, the telephone company has a very strong incentive to lower costs when subject to average-cost pricing regulations. True False 9. More theories of regulation Which of the following points supports the capture theory of regulation? Regulators tend to promote regulations that will expand the power, size, and budgets of their agencies. Regulators tend to be highly moral and civic-minded people who seek to do what is best for the public interest. Regulators often accept jobs in the industries that they once regulated after they leave the regulatory agency. 10. The costs and benefits of regulation Additional regulation in a sector of the economy is socially advantageous whenever _(c)_____________. (a. The total benefit to society of regulation exceeds the total cost of regulation (b. Regulation does not lead to job loss in the sector (c. The marginal benefit to society of additional regulation exceeds the marginal cost to society 11. Deregulation Which of the following theories does not support deregulation? Public interest theory of regulation Capture theory of regulation Public choice theory of regulation 1. Externalities If the consumption of a good generates positive externalities, then which of the following is correct? Market forces may lead to an underallocation of resources to producing the good. The government can subsidize consumption of the good to increase efficiency. Both of these answers are correct. 2. Externalities - Definition and examples An externality arises when a firm or person engages in an activity that affects the well-being of a third party, yet neither pays nor receives any compensation for that effect. If the impact on the third party is beneficial, it is called a _positive__________ (a.negative b.positive) externality. The following graph shows the demand and supply curves for a good with this type of externality. The dashed drop lines on the graph reflect the market equilibrium price and quantity for this good. Shift one or both of the curves to reflect the presence of the externality. If the social cost of producing the good is not equal to the private cost, then you should shift the supply curve to reflect the social costs of producing the good; similarly, if the social value of producing the good is not equal to the private value, then you should shift the demand curve to reflect the social value of consuming the good. With this type of externality, in the absence of government intervention, the market equilibrium quantity produced will be ___________ (a.greater b.less) than the socially optimal quantity. Which of the following generate the type of externality previously described? Check all that apply. The local airport has doubled the number of runways, causing additional noise pollution for the surrounding residents. Jake has planted several trees in his backyard that increase the beauty of the neighborhood, especially during the fall foliage season. Your roommate, Nick, has bought a bird that keeps you up at night with its chirping. A microbiology lab has published its breakthrough in swine flu research. 3. The effect of negative externalities on the optimal quantity of consumption Consider the market for bolts. Suppose that a hardware factory dumps toxic waste into a nearby river, creating a negative externality for those living downstream from the factory. Producing an additional ton of bolts imposes a constant external cost of $165 per ton. The following graph shows the demand (private value) curve and the supply (private cost) curve for bolts. Use the purple points (diamond symbol) to plot the social cost curve when the external cost is $165 per ton. The market equilibrium quantity is __________ (a.1.5 b.2 c.2.5 d.3 e.3.5 f.4 g.4.5 h.5 i.5.5) tons of bolts, but the socially optimal quantity of bolt production is __________ (a.1.5 b.2 c.2.5 d.3 e.3.5 f.4 g.4.5 h.5 i.5.5) tons. To create an incentive for the firm to produce the socially optimal quantity of bolts, the government could impose a _____tax______ (a.tax b.subsidy) of $165 per ton of bolts. 4. Efficiency in the presence of externalities Parks confer many external benefits on society: open space, trees that reduce pollution, and so on. Therefore, the market equilibrium quantity of parks is not equal to the socially optimal quantity. The following graph shows the demand for parks (their private value), the supply of parks (the private cost of producing them), and the social value of parks, including both the private value and external benefits. Use the black point (plus symbol) to indicate the market equilibrium quantity. Next, use the purple point (diamond symbol) to indicate the socially optimal quantity. Finally, use the grey polygon (star symbol) to indicate the area representing market failure. Which of the following policies could help the government achieve the efficient outcome? Check all that apply. Introduce emission taxes Offer a subsidy equal to the price at the efficient outcome Offer a subsidy to consumers equal to the vertical distance between the marginal private benefit curve and the marginal social benefit curve Offer a subsidy to producers equal to the vertical distance between the marginal private benefit curve and marginal social benefit curve Implement tradable pollution permits 5. The effects of property rights on achieving efficiency Consider a lake found in the town of Center Barnstead, and then answer the questions that follow. The town has a hiking lodge whose visitors use the lake for recreation. The town also has a tannery that dumps industrial waste into the lake. This pollutes the lake and makes it a less desirable vacation destination. That is, the tannery's waste decreases the hiking lodge's economic profit. Suppose that the tannery could use a different production method that involves recycling water. This would reduce the pollution in the lake to levels safe for recreation, and the hiking lodge would no longer be affected. If the tannery uses the recycling method, then the tannery's economic profit is $1,300 per week, and the hiking lodge's economic profit is $2,300 per week. If the tannery does not use the recycling method, then the tannery's economic profit is $2,100 per week, and the hiking lodge's economic profit is $1,100 per week. These figures are summarized in the following table. Complete the following table by computing the total profit (the tannery's economic profit and the hiking lodge's economic profit combined) with and without recycling. Profit Action Tannery Hiking Lodge Total (Dollars) (Dollars) (Dollars) No Recycling 2,100 1,100 3200 Recycling 1,300 2,300 3600 Total economic profit is highest when the recycling production method is __used________ (a.not used b.used). When the tannery uses the recycling method, the hiking lodge earns $2,300-$1,100 = $1,200 more per week than it does with no recycling. Therefore, the hiking lodge should be willing to pay up to $1,200 per week for the tannery to recycle water. However, the recycling method decreases the tannery's economic profit by $2,100-$1,300=$800 per week. Therefore, the tannery should be willing to use the recycling method if it is compensated with at least $800 per week. Suppose the hiking lodge has the property rights to the lake. That is, the hiking lodge has the right to a clean (unpolluted) lake. In this case, assuming the two firms can bargain at no cost, the tannery will ____________ (a.not use b.use) the recycling method and will pay the hiking lodge __between $400 and $800_____ (a.$0 b. between $0 and $400 c. Between $400 and $800 d. between $800 and $1,200) per week. Now, suppose the tannery has the property rights to the lake, including the right to pollute it. In this case, assuming the two firms can bargain at no cost, the tannery will ___use______ (a.not use b.use) the recycling method, and the hiking lodge will pay the tannery __$800and $1200___________ (a.$0 b. between $0 and $400 c. Between $400 and $800 d. between $800 and $1,200) per week. The hiking lodge will make the most economic profit when _____________ (a.the tannery has property rights to pollute the lake b.It has property rights to a clean lake). True or False: The lake will remain polluted, regardless of who has the property rights. True False 6. Achieving lower pollution Suppose the Environmental Protection Agency (EPA) wants to mandate that all methane emissions must be reduced to zero in order to alleviate global warming in the United States. Which of the following describes why most economists would disagree with this policy? Society would not benefit from lower air pollution. The opportunity cost of zero pollution is much higher than its benefit. Reducing methane emissions is desirable, but whatever levels of pollution firms decide to emit privately are already efficient. The environment isn’t worth protecting. 7. Correcting for negative externalities - Regulation versus tradable permits Suppose the government wants to reduce the total pollution emitted by three local firms. Currently, each firm is creating 4 units of pollution in the area, for a total of 12 pollution units. If the government wants to reduce total pollution in the area to 6 units, it can choose between the following two methods: Available Methods to Reduce Pollution 1. The government sets pollution standards using regulation. 2. The government allocates tradable pollution permits. Each firm faces different costs, so reducing pollution is more difficult for some firms than others. The following table shows the cost each firm faces to eliminate each unit of pollution. For each firm, assume that the cost of reducing pollution to zero (that is, eliminating all 4 units of pollution) is prohibitively expensive. Cost of Eliminating the . . . First Unit of Pollution Second Unit of Pollution Third Unit of Pollution (Dollars) (Dollars) (Dollars) Firm Firm X 90 125 180 Firm Y 55 70 110 Firm Z 650 800 1,500 Now, imagine that two government employees propose alternative plans for reducing pollution by 6 units. Method 1: Regulation The first government employee suggests to limit pollution through regulation. To meet the pollution goal, the government requires each firm to reduce its pollution by 2 units. Complete the following table with the total cost to each firm of reducing its pollution by 2 units. Total Cost of Eliminating Two Units of Pollution Firm (Dollars) Firm X 215 Firm Y 125 Firm Z 1450 Method 2: Tradable Permits Meanwhile, the other employee proposes using a different strategy to achieve the government’s goal of reducing pollution in the area from 12 units to 6 units. He suggests that the government issue two pollution permits to each firm. For each permit a firm has in its possession, it can emit 1 unit of pollution. Firms are free to trade pollution permits with one another (that is, buy and sell them) as long as both firms can agree on a price. For example, if firm X agrees to sell a permit to firm Y at an agreed-upon price, then firm Y would end up with three permits and would need to reduce its pollution by only 1 unit, while firm X would end up with only one permit and would have to reduce its pollution by 3 units. Assume the negotiation and exchange of permits are costless. Because firm Z has high pollution-reduction costs, it thinks it might be better off buying a permit from firm Y and a permit from firm X, so that it doesn't have to reduce its own pollution emissions. At which of the following prices are both firm Y and firm X willing to sell one of their permits to firm Z ? Check all that apply. $109 $149 $170 $579 $787 There exists some Pp such that MAC1 > Pp > MAC2 Which means there exits some Pp such that firm z will want to buy permits and firm X and Y will want to sell permits. Suppose the owners of the three firms get together and agree on a trading price of $498 per permit. Complete the following table with the action each firm will take at this permit price, the amount of pollution each firm will eliminate, and the amount it costs each firm to reduce pollution to the necessary level. If a firm purchases two permits, assume that it buys one permit from each of the other firms. (Hint: Do not include the prices paid for permits in the cost of reducing pollution.) Firm Initial Pollution Final Amount of Cost of Pollution Permit Allocation Pollution Eliminated Reduction (Units of pollution) (Dollars) (Units of Action pollution) (Multiple Choice) Initial Pollution Final Amount of Cost of Pollution Permit Allocation Pollution Eliminated Reduction (Units of pollution) (Dollars) Firm Firm (Units of Action pollution) (Multiple Choice) 2 a.Buy one permit X 1 90 1 55 0 0 b. Buy two permits c.Don’t buy/sell d. Sell one permit e. Sell two permits Firm 2 a.Buy one permit Y b. Buy two permits c.Don’t buy/sell d. Sell one permit e. Sell two permits Firm 2 a.Buy one permit Z b. Buy two permits c.Don’t buy/sell d. Sell one permit e. Sell two permits Regulation Versus Tradable Permits Determine the total cost of eliminating six units of pollution using both methods, and enter the amounts in the following table. (Hint: You might need to get information from previous tasks to complete this table.) Total Cost of Eliminating Six Units of Pollution Proposed Method (Dollars) Regulation 3474 Tradable Permits 2988 In this case, you can conclude that eliminating pollution is __________ (a.less b.more) costly to society when the government distributes tradable permits than when it regulates each firm to eliminate a certain amount of pollution. 8. Rivalry and excludability A good is nonrivalrous if: One person's benefit from the good does not reduce the benefit available to other people. It is not possible to prevent an individual from using the good. The quantity of the good is affected by the price a consumer pays for the good. Those who are unwilling or unable to pay for the good do not obtain its benefits. 9. Market failure associated with public goods A group of university students buys coconuts from a farmers' market. The students consume the meat of the coconuts for food and use the shells to make sculptures. These sculptures are placed in a public park that any student can visit. The park sustains itself through students' donations. Some individuals have no incentive to donate to the park and will, instead, depend on those who do donate. This is an example of which of the followingf? Overuse of coconuts Socially efficient allocation of coconuts The free-rider problem A negative externality 10. The market for lemons Consider a market in which there are many potential buyers and sellers of used cars. Each potential seller has one car, which is either of high quality (a plum) or low quality (alemon). A seller with a low-quality car is willing to sell it for $3,500, whereas a seller with a high-quality car is willing to sell it for $9,000. A buyer is willing to pay $4,500 for a low-quality car and $11,000 for a high-quality car. Of course, only the seller knows whether a car is of high or low quality, as illustrated in the accompanying image. Suppose that 85% of sellers have low-quality cars. Assume buyers know that 85% of sellers have lowquality cars but are unable to determine the quality of individual cars. If all sellers offer their cars for sale and buyers have no way of determining whether a car is a highquality plum or a low-quality lemon, the expected value of a car to a buyer is $4325 (Hint: The expected value of a car is the sum of the probability of getting a low-quality car multiplied by the value of a low-quality car and the probability of getting a high-quality car multiplied by the value of a high-quality car.) Suppose buyers are willing to pay only up to the expected value of a car that you found in the previous question. Since sellers of low-quality cars are willing to sell for $3,500, while sellers of high-quality cars are willing to sell for $9,000, ___________ (a.only low-quality sellers b.only high-quality sellers c.no sellers d.all types of sellers) will be willing to participate in this market at that price. The dilemma in this problem is an example of which of the following economic concepts? Moral hazard Signaling Adverse selection Screening 11. How asymmetric information prevents gains from trade Larry sees a classified ad from Megan offering a used DVD player for $30. On the opposite page, he sees a big color ad from a national electronics chain offering a new DVD player for $175. Larry values a DVD player at $220 as long as it works, regardless of whether it is new or used. For each of the scenarios listed, determine the principle illustrated by each person’s reasoning. Scenario Suppose Megan, the seller of the DVD player, knows the player works well— she is selling it only because she got a better model as a gift. She thinks about asking $45 and offering a guarantee: She will replace the DVD player with a new $175 DVD player if it turns out not to work. Then she thinks, "That's not a good idea! Someone can just buy it, handle it carelessly, and, if it breaks, can pretend it didn't work and get a new DVD player for $45— meanwhile, I'll be out $130!" Suppose Larry buys the new DVD player from the national electronics chain, thinking "Someone would ask $30 for a used DVD player only if it didn't work well." Why is Megan unable to sell Larry the DVD player? Check all that apply. Moral Adverse Hazard Selection Moral hazard can prevent sellers from offering guarantees of quality, because they can't be sure that buyers won't try to take advantage of the guarantees by filing false claims. Adverse selection can cause buyers to avoid purchasing high-quality goods because of uncertainty about their quality.