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Managerial Economics: Mergers and Market Equilibrium

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In 1989, the Detroit Free Press and Detroit Daily News (the only daily newspapers in the city) obtained permission to merge under a special exemption from the antitrust laws. The merged firm continued to publish the two newspapers but was operated as a single entity.

a. Before the merger, each of the separate newspapers was losing about $10 million per year. What forecast would you make for the merged firm's profits? Explain.

b. Before the merger, each newspaper cut advertising rates substantially. What explanation might there be for such a strategy? After the merger, what prediction would you make about advertising rates?

Samuelson and Marks, Discussion Question, p. 314.

Over the last 30 year in the US, the real price of a college education (i.e. after adjusting for inflation) has increased by almost 70 percent. Over the same period, an increasing number of high school graduates have sought a college education. (Nationwide college enrollments almost doubled over this period.) While faculty salaries have barely kept pace with inflation, administrative staffing (and expenditures) and capital costs have increased significantly. In addition, government support to universities (particularly research funding) has been cut.

a. College enrollments increased at the same time that average tuition rose dramatically. Does this contradict the law of downward-sloping demand? Explain briefly.

b. Use supply and demand curves (or shifts therein) to explain the dramatic rise in the price of a college education

Samuelson and Marks, Discussion Question, P. 268.

Explain why the cost structure associated with many kinds of information goods and services might imply a market supplied by a small number of large firms. (At the same time, one internet business such as grocery home deliveries have continually suffered steep losses regardless of scale. Explain why.) Could lower transaction costs in e-commerce ever make it easier for small suppliers to compete? As noted in Chapter 3, network externalities are often an important aspect of demand for information goods and services. (The benefits to customers of using software, participating in electronic markets, or using instant messaging increase with the number of other users.) How might network externalities affect firm operating strategies (pricing, output, and advertising) and firm size?

Samuelson & Marks, number #4, page 264

The last decade has witnessed an unprecedented number of mega-mergers in the banking industry: Bank of America's acquisitions of Fleet Bank, MBNA, and U.S. Trust; Bank of New York's acquisition of Mellon Financial; and Wells Fargo's acquisition of Wachovia, to name several of the largest consolidations. Besides growth for its own sake, these superbanks are able to offer one-stop shopping for financial services: everything from savings accounts to home mortgages, investment account, insurance vehicles, and financial planning.
a. In the short run, what are the potential cost advantages of these mergers? Explain.
b. Is a $300 billion national bank likely to be more efficient than a $30 billion regional bank or a $3 billion state-based bank? What economic evidence is needed to determine whether there are long-run increasing returns to scale in banking?
c. Do you think these mergers are predicated on economies of scope?

Text Book:
Managerial Economics 7th Edition. John Wiley & Sons, Inc.
William F. Samuelson & Stephen G. Marks. (2012).

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1. a. My forecast for the merged firm's profits is that the losses will get reduced and the merged firm will start earning profits. The two newspapers have been losing in the past because of fierce rivalry. Competition forces the rivals to cut prices to maintain their market share. This leads to lower profits or losses. But if there is merger the company enjoys monopoly power and so earns higher profits. In addition, the company also gains because of synergies and cost reduction.

b. Before the merger each newspaper cut advertising rates substantially. The explanation for such a strategy is that before the merger each newspaper was cutting prices to protect its market share. Each was cutting advertising rates to prevent its customers from leaving for its competitors. After the merger, I predict that advertising rates will increase. The prediction is based on the fact that since the rival has been acquired, the peril of losing the market share does not exist. Both newspapers are owned by the same company.

2 a) College enrollments increased at the same time that average tuition rose dramatically. This does not contradict the law of downward sloping demand. The increase in college enrollments at that same time that average tuition costs increased indicates a change in demand. This means an increase in demand or an outward shift in the demand curve. At the same prices higher quantity is demanded and at the same quantity higher prices are paid. The increase in demand can occur because of the increase in incomes of people, an increase in population, or a positive change in attitudes of people towards education.

b) The dramatic rise in the price of college education can be explained by an increase in demand and ...

Solution Summary

This solution explains the economics related to mergers and market equilibrium. The references which were used to create this solution have been included. An Excel file is also attached and provides a diagram which compliments this response.

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Managerial Economics

1. How would you expect antitrust authorities to react to:

(a) a proposed merger of Ford and General Motors;

(b) evidence of secret meetings by contractors to rig bids for highway construction projects;

(c) a proposed merger of a large shoe manufacturer and a chain of retail shoe stores;

(d) a proposed merger of a small life insurance company and a regional candy manufacturer; and

(e) an automobile rental firm that charges higher rates for last-minute rentals than for rentals reserved weeks in advance.

2. Carefully evaluate: "The supply and demand for agricultural products are such that small changes in agricultural supply result in drastic changes in prices. However, large changes in farm prices have modest effects on agricultural output." (Hint: A brief review of the distinction between supply and quantity supplied may be of assistance.) Do exports increase or reduce the instability of demand for farm products? Explain.

3. Briefly discuss the major causes of income inequality. With respect to income inequality, is there any difference between inheriting property and inheriting a high IQ? Explain.

4. Using the concepts in Chapter 7's discussion of consumer behavior, explain how health care insurance results in an overallocation of resources to the health care industry. Use a demand and supply diagram to specify the resulting efficiency loss.

5. Use the accompanying table for Neon and Zeon to answer the questions that follow. Assume that the wage rate shown equals hourly output and income and that the accumulated output and income are the sum of the marginal revenue products (MRPs) of each worker.

"**SEE attached tables***

a. Which country has the greater stock of capital and technological prowess? How can you tell?

b. Suppose the equilibrium wage rate is $19 in Neon and $7 in Zeon. What is the domestic output (=domestic income) in the two countries?

c. Assuming zero migration costs and initial wage rates of $19 in Neon and $7 in Zeon, how many workers will move to Neon? Why will not more than that number of workers move to Neon?

d. After the move of workers, what will the equilibrium wage rate be in each country? What will the domestic output be after the migration? What is the amount of the combined gain in domestic output produced by the migration? Which country will gain output; which will lose output? How will the income of native-born workers be affected in each country?

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