exam q / tutorial Flashcards
12 MARKS] What are the main two effects that a competition authority must con- sider when deciding whether or not to allow a merger or acquisition to go through? Explain how each one influences the decision. [max: 100 words]
A competition authority considers the efficiency gains and the loss of competition induced by the merger or acquisition. The efficiency gains drive prices down, while the competition loss drives the price up. Typically, the competition authority will allow the merger or acquisition to go through as long as it does not increase the price; that is, as long as the efficiency gain offsets the competition loss.
[12 MARKS] What allowed the German retail market study of Rickert, Shain, and Stiebale (2021, Journal of Industrial Economics) to distinguish those two effects? What were the results? [max: 100 words]
The efficiency gains of the acquisition were the same across the country, while the competition loss varied from region to region. In some regions, only one of the two supermarket chains was present before the acquisition, so only the efficiency gain applied. Prices decreased by about 1% in those regions. In regions where both supermarket chains were present, both effects applied. Prices went up by about 0.5% on average in those regions, but the larger the combined market share of the acquirer and the target before the acquisition, the larger the price increase. In some regions, prices increased by 4%.
[4 MARKS] Without additional calculations, determine how the managers’ friend- ship affects the consumer surplus and the efficiency of the market. [max: 50 words]
As the friendship increases (i.e., as t decreases), the equilibrium quantities de- crease, so the price increases. Smaller quantities and a larger price mean smaller consumer surplus and lower efficiency (i.e., larger deadweight loss). Therefore, the stronger the friendship, the worse off the consumers and the less efficient the market.
[4 MARKS] How does the managers’ friendship affect the firms’ profits?
Weknowthat(a−c)2 >0sincea>candthatb>0,sothefirstfractionis
positive. As t > 0.5, (1 + 2t) and (1 + 2t)4 are positive but (1 − 2t) is negative
so the second fraction is negative. We conclude that ∂πi < 0, so each firm’s ∂t
profit is decreasing in t, i.e., it is increasing in the strength of the friendship.
[4 MARKS] Does the managers’ friendship provide a reason for a competition au- thority to intervene? [max: 50 words]
Yes, a competition authority might intervene because the firms are not competing properly due to the managers’ friendship, which has negative consequences for consumers and the efficiency of the market.
In the first season of the TV show “Friends,” each of the main cast members was paid US$22,500 per episode. The amount increased each season and, by the tenth and last season, each of them was paid US$1M per episode.
(a) How can what we learn about competition and market power help explain this large increase?
When a show starts, several people could play each role. If an actor asks for too much (s)he can be replaced. Once the show has aired, you cannot recast a role, so each actor has a monopoly over their character. This improves their bargaining position: if an agreement is not reached, the show has to continue without that character. The longer the show runs, the harder it is to remove or replace a character, so each actor’s market power increases from season to season. In fact, for the 2021 reunion, each cast member was paid US$ 2.5-3M. The reunion just would not have made sense unless all six of them took part, so each of them had a large amount of market/bargaining power.
Of course, this is not the whole story. The show became a cultural phenomenon and made more and more money each year, so it makes sense that actors would be paid more. But market power is a part of this, and the point is that ideas we study in this course show up in what might seem to be unrelated situations.
In the first season of the TV show “Friends,” each of the main cast members was paid US$22,500 per episode. The amount increased each season and, by the tenth and last season, each of them was paid US$1M per episode.
(a) How can what we learn about competition and market power help explain this large increase?
answer B
(b) How can you use these tools to your advantage during your career?
You should try to differentiate yourself. If 10,000 people can do the exact same job as you, you will just have to accept whatever conditions you are offered, or employers can just hire someone else. If you have something unique to offer (approach, skills, experience), employers cannot get this from someone else. In some sense, you have some market power (maybe even a monopoly) over your skills, improving your negotiating position.
You can do this in many ways, including networking (if employers know you, they are less likely to think of you as interchangeable with someone else), doing things a little bit differently, or learning a lot about something specific that few people know.
In most seasons, the cast of “Friends” negotiated as a group rather than individually.
(c) Why might this have helped them increase their salary?
It would be very bad for the show if one of the main actors left; but if all six of them left, it would be simply the end of the show. The group had more market power than the actors individually because the network had to reach an agreement or it would end the show.
In most seasons, the cast of “Friends” negotiated as a group rather than individually.
(c) Why might this have helped them increase their salary?
answer:
(d) What does this tell us about the role of trade unions?
There is often an imbalance between the market power of employers and employees, with employers having much more of it. There are typically not that many companies to choose from to get a job in your profession but many potential employees are available to companies. Trade unions allow repairing that imbalance: as a group, employees have some market (and therefore some negotiating) power.
This is particularly important in low-skill professions (fast food, Amazon depot, etc); however, the “Friends” example shows that negotiating as a group can even be helpful for employees who already have a lot of market/negotiating power.
In the context of the game-theoretic analysis of mergers, briefly [max 100 words per subquestion] explain what is meant by
(a) the “mergers’ paradox” in the Cournot model, and
The “mergers’ paradox” was first described and analyzed by Salant, Switzer, and Reynolds (1983). They observed that in a Cournot market, a merger is only prof- itable if it involves a high share of the firms participating in the market. Therefore, unless the market is very competitive, only a merger that creates a monopoly is actually profitable
In the context of the game-theoretic analysis of mergers, briefly [max 100 words per subquestion] explain what is meant by
(b) the “free-riding paradox” in the Bertrand model.
If some firms merge in a differentiated Bertrand market, all firms benefit from the merger (in contrast to the Cournot model, see part (a)). However, the outsider firm benefits from the merger more than the insiders themselves. This result is puzzling because it suggests that firms should wait for their competitors to merge in order to free ride on that merger. The result was first highlighted by Davidson and Deneckere (1986) and holds for any number of firms in the market and merging.
