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Government Intervention for Socially Efficient Outcomes

These questions come from Baye's fifth edition of Managerial Economics and Business Strategy. Chapter 14: A Manager's Guide to Government in the Marketplace.

1) You are the manager in a market comprised of five firms, each of which has a 20 percent market share. In addition, each firm has a strong financial position and is located within a 100-mile radius of its competitors.

a. Calculate the premerger Herfindahl-Hirschman index (HHI) for this market.
b. Suppose that any two of these firms merge. What is the postmerger HHI?
c. Based only on the information contained in this question and on the U.S. Department of Justice Horizontal Merger Guidelines, do you think the Justice Department would attempt to block a merger between any two of the firms? Explain.

2) You are an industry analyst that specializes in an industry where the market inverse demand is P = 100 - 5Q. The external marginal cost of producing the product is MCExternal = 10Q, and the internal cost is MCInternal = 20Q.

a. What is the socially efficient level of output?
b. Given these costs and market demand, how much output would a competitive industry produce?
c. Given these costs and market demand, how much output would a monopolist produce?
d. Discuss actions the government could take to induce firms in this industry to produce the socially efficient level of output.

3) Consider a competitive market served by many domestic and foreign firms. The domestic demand for these firms' product is Qd = 500 -1.5P. The supply function of the domestic firms is QSD = 50 + 0.5P, while that of the foreign firms is QSF = 250.

a. Determine the equilibrium price and quantity under free trade.
b. Determine the equilibrium price and quantity when foreign firms are constrained by a 100-unit quota.
c. Are domestic consumers better or worse off as a result of the quota?
d. Are domestic producers better or worse off as a result of the quota?

Solution Preview

1) The Herfindahl-Hirschman Index ("HHI") is calculated by summing the squares of the individual market shares of all the participants and multiplying by 10,000.

a. HHI = 10,000 [(.20)^2 +(.20)^2 +(.20)^2+(.20)^2+(.20)^2] =2000
b. HHI= 10,000 [(.20)^2 +(.20)^2 +(.20)^2+(.40)^2] =2800
The U.S. Dept. of Justice "Merger Guidelines:" The Justice Dept. views industries with HHIs in excess of 1,800 to be "highly concentrated" and may ...

Solution Summary

Government interventions related to industry concentration, pollution, and free trade are discussed to answer the questions in 288 words.