Herfindahl-Hirschman Index, Merger Guidelines, Monopoly, Contestable Markets, Profit Maximisation, Antitrust Laws, Music Industry Consolidation

This study material covers various topics in microeconomics such as Herfindahl-Hirschman Index, Merger Guidelines, Monopoly, Contestable Markets, Profit Maximisation, Antitrust Laws, Music Industry Consolidation. It includes questions and answers with detailed explanations.

ECONOMICS
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Question 2
The computation of Herfindahl-Hirschman Index (HHI) is indicated below.
HHI (Before Merger) = 702 + 152 + 52 + 20*(10/20)2 = 5,155
HHI (After Merger) = 702 + 202 + 20*(10/20)2 = 5,305
It is apparent that after the merger, there is an increase in the HHI and hence the merger is
anti-competitive since it leads to lower competition through higher concentration
(Mankiw,2014).
Question 3
A key factor considered by government when deciding on merger challenges is HHI as per
the 2010 merger guidelines. The merger proposal faces the highest likelihood of challenge to
merger if the HHI exceeds 2500 while the likelihood of challenge to merger is quite low
when HHI is less than 1500. Also, another crucial aspect if whether the merger increases HHI
by more than 200 or not (Nicholson & Snyder, 2015).
The computation of HHI before merger taking into consideration the given market shares of
respective players is shown below.
a) The revised HHI when there is merger of Firm C and Firm D is computed below.
Change in HHI = 2264-1964 = 300
As the increase in HHI as a result of the merger exceeds 200, hence the merger would be
challenged.
b) The revised HHI when there is merger of Firm F and Firm G is computed below.

Change in HHI = 2044-1964 = 80
As the increase in HHI is less than 200 and also the HHI after merger is lesser than 2,500,
hence this merger would not be challenged.
Question 4
A product innovation can potentially occur in a manner which tends to lower the average
production cost. This is beneficial for the company as it would lead to cost savings which
would translate into higher profits and thereby provide incentive for innovation. This
potentially is a vicious cycle as innovation leads to higher profits and these are invested in
innovation to further enhance profits (Nicholson & Snyder, 2015). In case of innovation
where patent protection is not possible, monopoly would be the preferred market structure as
compared to competitive markets. This is because in case of monopoly there are very high
entry barriers which prohibit any new entrant and hence the innovation of the monopolistic
firm cannot be copied which allows the firm to earn higher profits. However, in case of
perfectly competitive markets, the innovation would not occur as without patent protection it
would be easily copied and thereby result in zero economic profits in the long run (Krugman
& Wells, 2013).
Question 5
It is easy to manage contestable markets since exiting or shifting capital is quite easy. As a
result, the potential competitors in these markets do not worry about the response of the
others players and instead consider if the incumbent’s firm price can be matched or not. In
order to prevent any new players from entering the market, the existing player would set the
price equal to the average cost so that new player does not have any incentive to enter the
market. A classic deployable asset would be Jet taxi as the fund shifting is quite easy. If the
Jet taxi is put for sale, the replacement value can be easily derived for the asset within a few

weeks. As a result, it would be appropriate to consider the jet taxi fractional ownership as a
contestable market (Pindyck & Rubinfeld, 2014).
Question 6
a) For profit maximising in case of monopoly, the necessary condition is MR = MC
The demand function is given below.
P = 800-20Q
TR= P*Q = (800-20Q)*Q = 800Q – 20Q2
MR = dTR/dQ = 800 -40Q
The total cost function is given below.
TC = 300 + 500Q + 10Q2
MC=dTC/dQ= 500 + 20Q
For profit maximisation, 800-40Q = 500 + 20Q
Solving the above, we get Q= 5 million pounds
Hence, P = 800-(20*5) = $ 700
b) Total profits = Total Revenue – Total Costs
Total Revenue = P*Q = 700*5 = $3,500 million
Total Cost = 300 + 500Q + 10Q2 = 300 + 500*5 + 10*52 = $3,050 million
Hence, total profits = 3,500 – 3,050 = $ 450 million
c) The demand function remains the same but the price is fixed at $620 for the 500 firms that
comprise the industry.

Hence, 620 = 800-20Q
Solving the above, Q = 9 million pounds
Thus, the profit maximising price and quantity is $ 620 and 9 million pounds respectively.
The quantity has been provided on industry basis and not individual firm.
d) Total profits = Total Revenue – Total Costs
Total Revenue = P*Q = 620*9= $5,580 million
Total Cost = 300 + 500Q + 10Q2 = 300 + 500*9+ 10*92 = $6,610 million
Hence, total loss for the industry =6610–5580= $30 million
e) Total industry investment = $2 billion or $ 2,000 million
Rate of return required = 15%
Minimum profits desired by the investors = (15/100)*2000 = $ 300 million
However, as is apparent from the computation in part (b) that in case of monopoly market,
the profits are $ 450 million and therefore this would justify the investment on the part of the
investors.
f) Based on the computations in part (d), it is apparent that the industry is making losses to
the tune of $ 30 million. However, in a perfectly competitive market, it is expected that in
long term equilibrium the economic profit would be zero. Thus, the market is clearly not
in equilibrium as there is excess supply and hence some firms would need to exit to ensure
that break even occurs (Mankiw, 2014).
g) The total cost curve for the industry under monopoly has been changed to the following.
TC = 400 + 560Q + 10Q2
MC=dTC/dQ= 560 + 20Q
For profit maximisation, 800-40Q = 560 + 20Q

Solving the above, we get Q= 4 million pounds
Hence, P = 800-(20*4) = $ 720
Total Revenue = P*Q = 720*4 = $2,880 million
Total Cost = 400 + 560Q + 10Q2 = 400 + 560*4 + 10*42 = $2,800 million
Hence, total profits = 2,880– 2,800 = $ 80 million
From the above computation above, it is apparent that the equilibrium price has increased
from $ 700 to $720 while the equilibrium quantity has decreased from 5 million pounds to 4
million pounds. Also, the profits have decreased from $ 450 million previously to only $ 80
million.
h) The new standards would lead to higher costs for the Texas firms as compared to the other
firms. Owing to this the profitability of these firms would be lower and these would
eliminate in the long run as these would make losses. It is possible that other 450 firms
would make temporary higher profit when 50 firms from Texas would stop functioning
but in the long run 50 firms would be set up in other places where the cost structure is
lower and hence no economic profit situation would be restored.
Question 8
With regards to the present problem, the following outcomes are likely (Nicholson & Snyder,
2015).
 The issue of water contamination is solved amicably with both parties sharing
responsibility and hence the contract between the parties continues.
 There is no amicable solution between the parties leading to termination of contract
for mineral rights lease. In this regards the following possibilities arise.
1) The lease money returned would be adjusted for the time period for which mining
was performed and the lease proceeds for the remaining duration can be returned.
2) A key issue with regards to the above solution is the amount of investment made
and recouping of the same may be expected by the oil company.

Case Exercise
Microsoft Typing Arrangement
Question 1
Option (b) would be a violation of antitrust laws in the USA. This is because attempts on part
of Microsoft to use internet portals for monopolising would be anticompetitive tactics. The
typing arrangement with regards to products along with disagreeing to deal with specific
market players results in monopoly power being spread. An apt example of this was the
pushing of IE (Internet Explorer) by Microsoft which commanded 92% market share through
the Windows software. It provided IE as a bundled product which led to issues for
competitors such as Netscape. As a result, in the year 1998, lawsuit was filed against
Microsoft and the company was found guilty (Krugman & Wells, 2013).
Question 2
Typing arrangement is one of the leading anticompetitive practices deployed by firms.
Through these arrangements, the buyer behaviour is impacted as there is very little choice
owing to bundling of product resulting in associate product also emerging as the preferred
product owing to the success of the primary product. With regards to the automobile industry,
the advantage is not the radio but the steering post interlock device. This is because radio for
the automobile industry is not a functionally integrated product unlike steering post interlock
device which may inferior as the consumers are forced to purchase the same. Thus, IE is a
functionally integrated product in the Windows operating system owing to which it is pushed
despite being an inferior product. The customers are not left with a choice as if they want
Windows, they would get IE as the bundled product (Mankiw, 2014).
Question 3
Considering the fact that telecommunication has high competition, hence for developing
suitable applications, the company should deploy different strategies in order to maximise
revenue generation through innovations. These innovations could be related to website design
(friendly and easy to navigate), voice quality and user interface being compatible. The
company should aim at providing superior service while ensuring low cost so as to gain an
edge over competition and hence have higher user base (Samuelson & Mark, 2013).

Music Recording Industry Consolidating
The pros with regards to the merger approval decisions are as follows (Pindyck & Rubinfeld,
2014).
 It leads to reaping of synergies as is apparent from the acquisition of EMI by
Universal. This could potentially benefit both the merged entity along with the
consumers.
 Mergers can potentially lead to improvement in aspects related to records such as
technology, user experience.
 Mergers can help consolidation in the industry and thereby promote long term growth.
The cons with regards to the merger approval decisions are as follows (Nicholson & Snyder,
2015).
 The decision to go ahead with merger may create unfair competition for the merged
entity and reduce competition.
 This practice in the long run can result in a monopolistic market which would be
detrimental to interest of consumers and lead to inefficiencies.
At present the merger policy is driven to a large extent by the HHI changes by the proposed
merger. However, it is imperative that other aspects particularly the potential synergies that
could be realised ought to be taken into consideration. Additionally, the key motive for the
companies to merge or acquire other company needs to be considered. The ethical standards
highlighted by the company in the past can also be considered as dubious practices in the past
could imply abuse of a dominant position (Krugman & Wells, 2013).

References
Krugman, P. & Wells, R. (2013).Microeconomics (2nded.). London: Worth Publishers.
Mankiw, G. (2014) Microeconomics (6thed.). London: Worth Publishers.
Nicholson, W. & Snyder, C. (2015).Fundamentals of Microeconomics (11thed.). New York:
Cengage Learning.
Pindyck, R. & Rubinfeld, D. (2014).Microeconomics (5th ed.). London: Prentice-Hall
Publications.
Samuelson, W. & Marks, S. (2013). Managerial Economics (4th ed.). New York: Wiley
Publications.