1. (25 points) An excerpt from an article appearing in Tuesday s Wall Street Journal follows:

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1 Amherst College Department of Economics Economics 111 Section 5 Fall (25 points) An excerpt from an article appearing in Tuesday s Wall Street Journal follows: Senators Call for Hearing on AB InBev Deal for SABMiller In first indication of regulatory scrutiny, Senate subcommittee to review proposed deal s effect on competition, U.S. consumers By Tripp Mickle Updated Oct. 20, :43 p.m. ET The top two lawmakers on the Senate Judiciary Subcommittee on Antitrust plan to hold a hearing to examine Anheuser-Busch InBev s planned $104.2 billion takeover of SABMiller PLC. It is the first indication of regulatory scrutiny facing the global beer deal in the U.S. Sens. Mike Lee (R., Utah) and Amy Klobuchar (D., Minn.) said in a statement the hearing will review how the merger would affect competition and U.S. consumers. The hearing hasn t been scheduled but is expected to be held before the end of the year.. Suppose that the Senate Judiciary Subcommittee on Antitrust hired you as a consultant to analyze the impact of a Anheuser-Busch takeover of SABMiller. They ask you to base your analysis on the following premises: Anheuser-Busch and SABMiller are the only firms producing and selling beer in the United States (there are no microbreweries, beer imports, etc.) Currently both Anheuser-Busch and SABMiller are operating as though they were in a perfectly competitive industry. After the takeover, there will be a single firm producing and selling beer in the U.S., AB-Miller; that is, AB-Miller would operate as a monopoly. The subcommittee staff provides you with the marginal cost curves of each firm and the market demand curve for beer: Anheuser-Busch MC AB Miller MC M P Demand Curve.50 D q AB q M Q (million cans) (million cans) (million cans) NB: You should base your analysis on the premises you were given and the information that was provided.

2 2 Anheuser-Busch Miller Market Demand P Curve for Beer MC AB MC M Consumer surplus S Producer surplus D q AB q M Q (million cans) (million cans) (million cans) a. Describe the current state of affairs of the beer industry. Remember that you should base your analysis on the premises you were. 1) Carefully plot the market supply curve in the above diagram. 2) What is the equilibrium price of beer? $1.50 3) What is the equilibrium quantity of beer? 300 million cans 4) How much beer is Anheuser-Busch producing? 225 million cans 5) How much beer is SABMiller producing? 75 million cans 6) What is consumer surplus? $225 million = ) What is producer surplus? $225 million = 225 2

3 3 Anheuser-Busch Miller Market Demand P Curve for Beer MC AB MC M Consumer surplus S Producer surplus D q AB q M Q (million cans) (million cans) (million cans) Now, suppose that the takeover is consummated; we now have a single monopoly firm AB-Miller. b. Will AB-Miller continue to produce the same quantity of beer? Yes No X Explain. Since AB-Miller is now a monopoly, its marginal revenue is less than the price. If it were to produce the same quantity, 300 million cans, its marginal revenue would be less than the price, $1.50, as a consequence of the price effect. But, its marginal revenue would still equal $1.50. If AB-Miller produced 300 million cans MR < $1.50 MC = $1.50 When marginal revenue is less than price, a firm reduces production to increase profit. c. Suppose that AB-Miller produces a total of 200 million cans of beer. 1) How much beer will be produced each division, the AB division and the Miller division? AB division 150 million cans Miller division 50 million cans Explain. If a firm has two divisions, it will divide total production between the two divisions to minimum total cost. To minimize total cost, the marginal cost of equal division is equal. So, if AB-Miller produces 200 million cans in total, the Anheuser-Busch division will produce 150 million cans and the Miller division 50 million cans so that marginal cost of each division equals $ ) What does AB-Miller s marginal revenue equal? $1.00. Explain. Since AB-Miller is maximizing profit, its marginal revenue equals its marginal cost. Since marginal cost equals $1.00, marginal revenue equals $1.00 also.

4 4 3) What is consumer surplus? $100 million A monopoly also produces a quantity and charges a price that lies on the market demand curve; therefor AB-Miller will charge a price of $2.00 per can = ) What is producer surplus? $300 million = = Last, compare the current consumer and producer surplus (part a) with the post takeover consumer and producer surplus (part c) d. Fill in the blanks below: Current Post-Takeover Change Consumer surplus $225 million $100 million Decrease by $125 million Producer surplus $225 million $300 million Increase by $75 million Total surplus $450 million $400 million Decrease by $50 million

5 5 2. (15 points) While labor unions certainly have many priorities, most would agree that their top one is to raise the wages earned by their members. The diagram to the right illustrates the market demand curve and market supply curve for office custodians in a large city. Assume that currently custodians have not organized into a union. Labor Market for Custodians Wage ($/hour) S a. Illustrate the equilibrium on the diagram to the right. Now, suppose that a union organizer is speaking to the custodians urging them to join a union. He contends correctly that if the custodians join the union, the union will be able to raise their wages above the equilibrium. b. What would happen to the hours of labor demanded? w* D Increase Decrease X No change Explain. L* L (Hours) Since the demand curve is downward sloping an increase in the wage will reduce the quantity of labor demanded. When labor becomes more expensive, firms demand less. c. What would happen to the income earned by the office custodians? Increase Decrease No change Cannot tell X If you cannot tell, what additional information do you need? Explain. We need to know the wage elasticity of demand for labor. Income earned by custodians = w L If elastic: The increased wage Reduces the quantity of labor hired by a lot If inelastic: The increased wage reduces the quantity of labor hired by a little w L w L w L down w L up d. How does your answer to part c explain why some occupations are highly unionized and others are not? It should be much easier for a union organizer to convince workers to unionize when the demand is inelastic because on only will their wage rise, but also they will be taking home more income.

6 6 3. (20 points) The following is from an op-ed article written by Bill Gates appearing in the June 23, 2003 edition of the Wall Street Journal: Like almost everyone who uses , I receive a ton of spam every day. Much of it offers to help me get out of debt or get rich quick. It would be funny if it weren't so irritating Bill Gates and many others have railed against spam urging that measures be taken to eliminate it. The purpose of this question is to determine if there is an economic justification for regulating spam. Each day most of us are bombarded with spam. Even when we have a spam filter, it takes time for us to deal with these unsolicited messages. NB: For the purposes of this question assume that it costs nothing for the sender to the spam messages. a. What query do we pose in order to determine if a given state of affairs is efficient? Pareto s Query: Given the state of affairs in question, is it possible to make one individual better off without hurting anyone? If the given state of affairs is inefficient what is the answer to this question? Yes X No If the given state of affairs is efficient what is the answer to this question? Yes No X Consider a firm that is paying each of its 120 workers $15.00 per hour. Each worker receives a total of 60 spam s daily at his/her office desk from a single spam source. The workers are intelligent; none of them fall for the advertisements contained in the spam. Nevertheless, it takes 10 seconds for the recipient to deal with each spam ; that is, it takes 10 seconds to scan the message and determine that it is spam before deleting it. b. How much time does each worker spend dealing with spam per day? 10 minutes = 600 seconds = 10 minutes c. In total, how much time do the owner s workers spend dealing with the spam? 20 hours = 1,200 minutes = 20 hours d. How much does it cost the owner of the firm for his/her workers to deal with the spam? $ = 300 e. In general, when does an externality exist? An externality exists whenever consumers or firms do not account fully for the ramifications of their actions. f. Does an externality exist here? Yes X No Explain. The sender of the spam does not account for the costs he/she is imposing on the owner of the firm. g. Is the current state of affairs efficient? Yes No X If yes, explain why. If no, devise a special deal between the sender of the spam and the owner of the firm that would make both of them better off without hurting anyone else. Special Deal: Owner of the firm gives the sender of the spam $150 on the condition that no more spam will be sent. The owner of the firm is $150 ($300 $150) ahead. The spam sender is $150 ahead. No one is hurt.

7 7 4. (20 points) An excerpt from an article appearing in last Friday s Wall Street Journal follows: Move Over Apple: Companies, from Walgreens to Bank of America, Race to Patent Tech Inventions By Kim S. Nash Updated Oct. 16, :13 p.m. ET Companies outside the technology business, including Bank of America Corp., Equifax Inc. and Walgreens Boots Alliance Inc., are racing to patent technology inventions and lay claim to future revenue that may stream from new products.. The best way for a business to protect their investment in R&D is to patent their ideas, said Dave Ballai, chief information officer and vice president of operations at Reed Technology, a LexisNexis business unit.. Companies in industries from banking to retail to logistics have opened innovation labs and are rushing to patent what they produce there, said Will Callender, managing director of global consulting firm AlixPartners LLP and co-head of its financial services practice.. To address the issues involved, consider a researcher who has discovered how to produce computer chips that run ten times as fast as today s chips and cost less to manufacture. In other words, this researcher has just discovered some knowledge the knowledge of how to manufacture computer chips that are both very fast and very cheap. a. Define the term nonrival. A good is nonrival whenever individuals can use the good simultaneously; that is, whenever one individual s use of the good does not reduce the possibility of others to use the good. b. Is the knowledge discovered by the researcher nonrival? Yes X No Explain. The knowledge discovered by the researcher is nonrival. The researcher s use of the knowledge does not limit the ability of anyone else to use it. c. Define the term nonexcludable. A good is nonexcludable when it is impossible to restrict the benefits of a good to a selected group of individuals. A patent grants to an individual the exclusive right to use the knowledge he/she discovered for a given period of time. d. Assume that patent laws are effective. Can the knowledge discovered by the researcher be made excludable? Yes X No Explain. The knowledge discovered by the researcher can be made excludable assuming that patent laws are effective. The patent enables the discoverer to restrict the use of his/her discovery to whatever group of individuals he/she desires. e. From society s standpoint, which process should be used to produce computer chips: the old process that produces slow, expensive chips or the new process that produces fast, cheap chips? Old Process New Process X f. Is there an economic rationale for patent laws which limits the use of the knowledge to the inventor of the new process? Yes X No Explain. At first glance, it looks like patent laws are undesirable because the discoverer can exclude others from using the better technology when it is in society s interest to allow all to use the

8 better technology. We must consider the incentives of researchers, however. If there were no patent laws, what incentive would an individual have to expend time and energy to search for the new technology? There is a tradeoff here. Patents may restrict the use of a superior technology to a selected group which is undesirable; on the other hand, without patent laws (or something like them) researchers would not have the incentive to expend efforts to discover the technology in the first place. 8

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