Dr. Fournier ECP 4413-01 Government Regulation of Business Instructions and Review Questions for Final Exam Date of Exam: Thursday December 12, 2002 Homework #5 is Due in Class on Thursday December 5, 2002. Instructions Given the limited time that remains for us, you need to be sure and structure your remaining studies for maximal effectiveness. To help in the process, I have pared down the material somewhat to give the final a more concentrated focus. The exam will be comprehensive , but a review of these chapters should be sufficient to prepare you fully. The final exam will cover the following chapters in the textbook by Viscusi, Vernon and Harrington. Use your judgment in reviewing this material, concentrating on what was emphasized in class discussion and lectures. Part A: From the Earlier part of the course, please review these items : The Economic Analysis of Antitrust and Regulation VVH ch. 1 The Antitrust Objectives, Laws and Their Enforcement VVH ch. 3 Economic Efficiency: Static and Dynamic VVH ch. 4 Oligopoly Theory and Collaboration Among Rivals VVH ch. 5 Dominant Firms and Barriers to Entry VVH ch. 6. (up to page 165) Part B: After the Second Midterm, we have covered or will be covering these chapters: Introduction to Economic Regulation VVH ch. 10 Public Utility Regulation: Theory and Practice VVH ch. 11 Regulating Competitive Markets: Methodology VVH ch. 16 Note: The exam will be given in class on Thursday, December 12, 2002 at 7:30 - 9:30 a.m. As noted above, the final will cover some earlier material not represented here. Part A. These questions must be turned in during class on December 5th and will be graded. 1. Suppose we have the following demand functions for a regulated, multi-product monopolist. P 1 = 450 Q1 , MC 1 = 50. P 2 = 210 Q2 , MC 2 = 10. Assume that there are $25,000 in fixed costs. Compute the Ramsey prices and explain why this approach is attractive to regulators and economists. 2. Assume that the market demand function in a regulated industry is P = 50 0.05Q Each firm faces a Marginal Cost of 10. There are 20 firms in the industry. Regulation requires that each firm set a price of 20. Suppose an innovation becomes available to all firms that will reduce unit cost from 10 to 5. The cost of adopting this innovation is 50. (a) Derive and show in a diagram the value of this innovation under regulation. (b) Derive and show in a diagram the value of this innovation under deregulation. (c) How might regulators respond to get the best result (social welfare) out this development? Discuss. Part B. These will not be graded, but you should review them as part of your preparation for the final. 3. &quot;Cross-subsidization&quot; plays a role in discussions of regulated industries. (a) Define &quot;cross subsidization&quot; in a regulated firm that provides two services or two groups of customers. Give a clear example of the practice. (b) Why might regulators want to promote this form of pricing as a matter of public policy? Why might regulated firms find it in their interests? (c) Give an economic evaluation of the misallocative effects inherent in cross-subsidization. (d) <a href="/keyword/regulatory-agencies/" >regulatory agencies</a> sometimes receive complaints from customers who feel they are unfairly subsidizing others, or from potential entrants who would like to compete against the regulated firm but cannot because the regulated price is set too low. What evidence could we use to evaluate these complaints? 4. Firms considered candidates for regulation often are claimed to be natural monopolies in two or more services or outputs. Suppose we have a firm with two services at output levels Q1 and Q2 . (a) Proponents and opponents of regulation are debating whether the firm s cost function, shown below, has economies of scale or economies of scope . Explain what these terms mean and present your own expert determination for the agency: C(Q1 , Q2 ) = 20 + Q1 + Q2 0.5 $ (Q1 $ Q2 ) 1/2 (b)What are the economic conditions necessary for an industry to be considered a natural monopoly, for purposes of regulation? Relate them to the concepts of economies of scale and scope. (c) What are the practical objections to the use of natural monopoly as a justification for economic regulation? 5. Economists are especially keen on pointing out various misallocative effects associated with antitrust and regulation. Analyze the following circumstances, taken from the textbook, involving the potential effects of economic regulation. Use the example...