Chapter 07 - The Nature of Industry

Chapter 7: Answers to Questions and Problems

1. The four-firm concentration ratio is:

$ , $ , $ , $ ,
= = 0.38.
$ , ,

2.
$ , $ ,
a. The HHI is = 10,000 + +
, , $ , ,
$ ,
= 4,112.
$ , ,
b. The four-firm concentration ratio is 100 percent.
c. If the firms with sales of $300,000 and $250,000 were allowed to merge, the
resulting HHI would increase by 960 to 5,072. Since the post-merger HHI
exceeds that under the Guidelines (2,500) and the HHI increases by more than
that permitted under the Guidelines (200), the merger is likely to be challenged.

3. The elasticity of demand for a representative firm in the industry is –1.6, since
. .
0.5 = ⇒ = = −1.6.
.

4.
a. $116.28. To see this, solve the Lerner index formula for P to obtain
= = $50 = $116.28.
.
b. Since = , it follows that the markup factor is = 2.33.
.
That is, the price charged by the firm is 2.33 times the marginal cost of producing
the product.
c. The above calculations suggest price competition is not very rigorous and that the
firm enjoys market power.

5. Managers should not specialize in learning to manage a particular type of market

structure. Market structure generally evolves over time, and managers must adapt to
these changes.

6. To the extent that the HHIs are based on too narrow a definition of the product (or
geographic) market or the impact of foreign competition, the merger might be
allowed. It might also be allowed if one of the firms is in financial trouble, or if
significant economies of scale exist in the industry.

7-1
Chapter 07 - The Nature of Industry

7. As shown in the text, the HHI is

10,000 = 10,000 + + ⋯+ + + ⋯+

When firms i and j merge, the HHI becomes

+
10,000 = 10,000 + +⋯+ + ⋯+

The difference before and after the merger is that + becomes .

Thus, we can calculate how a merger between firms i and j will change the HHI by
knowing only those two firms’ market shares. In general, since =

+( )
+ , we know that a merger between firms i and j will cause the

HHI to increase by 2wiwj×10,000, where wi and wj are the pre-merger market shares
of the two merging firms. Using the information in the problem,
2(.3)(.3)(10,000)=1800 represents the increase in the HHI due to the merger.

8. No. The conditions for perfect competition include:

a. There are many buyers and sellers of products.
b. The products are homogenous.
c. Consumers and producers have perfect information.
d. There is free entry and exit.

9.
a. Industry A is a monopolistically competitive industry.
b. Industry B is a perfectly competitive industry.
c. Industry C is a monopoly industry.
d. Industry D is an oligopoly industry.

10. A slight increase in output in industry X will have the greatest impact on increasing
social welfare since the Dansby-Willig index is higher in industry X.

11. The four-firm concentration ratios in Table 7-2 are likely to overstate the level of
concentration in the U.S. Imported beers account for much of the sales in the U.S. It
is likely that the brewing industry is much less concentrated than Table 7-2 leads us
to believe.

7-2
Chapter 07 - The Nature of Industry

12. This industry is most likely monopolistically competitive. Monopolistically

competitive industries have concentration measures close to zero, but since each
firm’s product is slightly differentiated, the Rothschild index will be greater than zero
(unlike perfectly competitive markets).

13. Monopolistically competitive. In a monopolistically competitive market, there are

many firms, but each firm produces a differentiated product. According to the causal
view, the structure of differentiated products causes firms to capitalize on the absence
of close substitutes by charging higher prices and earning higher profit. Thus,
structure causes conduct resulting in performance. According to the feedback critique,
the conduct of firms may determine the market structure. Firms’ products may be
differentiated because of firms’ conduct in the industry. Examples of such conduct
include advertising and other behavioral tactics that feed, back into demand, causing
consumers to view products as differentiated. Thus, it is not at all clear that
differentiated products are a structural variable. The willingness of consumers to pay
for product variety gives firms an incentive to offer different products (thin-and-
crispy pizza, pan pizza, pizza delivery, etc.).

14. Merger (a) is the only horizontal merger, and therefore the only merger that would be
scrutinized under the Guidelines for horizontal mergers. Merger (b) is a conglomerate
merger, while merger (c) is a vertical merger.

15. The post-merger HHI is 1,546.56, and the change in the HHI caused by the merger is
143.42, since the pre-merger HHI is 1,403.13 (with rounding). The merger may be
challenged, but as noted in the text, the agencies likely will rely more heavily on
other factors such as economies of scale and ease of entry.

16. If approved, the merger would raise the HHI by 10,000[(0.22+0.12)2 – (0.22)2 –
(0.12)2] = 528 points. This means the post-merger HHI would be 3293 ( = 2765 +
528). Since the post-merger HHI is greater than 2,500 and the change in HHI is
greater than 200, this merger likely will be challenged by the government.

7-3
Chapter 07 - The Nature of Industry

17. See Table 7-1.

Own Price Elasticity

of Demand for
Own Price Elasticity of Representative Firm's
Market Demand Product Rothschild Index
Agriculture -1.8 -96.2 0.019
Construction -1.0 -5.2 0.192
Durable manufacturing -1.4 -3.5 0.400
Nondurable manufacturing -1.3 -3.4 0.382
Transportation -1.0 -1.9 0.526
Communication and utilities -1.2 -1.8 0.667
Wholesale trade -1.5 -1.6 0.938
Retail trade -1.2 -1.8 0.667
Finance -0.1 -5.5 0.018
Services -1.2 -26.4 0.045
Table 7-1

Based on the Rothschild indices in Table 7-1, wholesale trade most closely resembles
a monopoly, while finance most closely resembles perfect competition.

$ $ .
18. The Lerner index is = = = 0.9, which indicates the firm has
$
considerable market power. This makes sense because the product that the firm sells
is currently under patent protection, which essentially makes the firm a legal
monopoly.

19. Based on the information contained in Table 7-3 of the text, the food and apparel
industries are most competitive and therefore probably represent the best match for
the expertise of these managers.

20. The market for color film in the U.S. is highly concentrated. The five-firm
concentration ratio is 100 percent and Kodak alone accounts for 67 percent of all rolls
sold. Market demand for color film is relatively elastic at -1.75; indicating that a 10
percent increase in price leads to a 17.5 percent decline in quantity demand for color
film. The Rothschild index indicates that market demand relative to the demand for
.
Kodak color film is = = 0.875, indicating that Kodak’s demand is,
roughly, as sensitive to price changes as is the entire market demand. The Lerner
$ . $ .
index for Kodak is = = 0.50, indicating that Kodak’s markup factor
$ .
is 2. For every $1 spent on color film, $0.50 is markup. Taken together, these things
suggest that the color film industry in the U.S. closely resembles an oligopoly.

7-4
Chapter 07 - The Nature of Industry

21. Note first that a merger with Unilever or Tricor Braun is not a horizontal merger.
Moreover, while a horizontal merger with either Dole or Goya is likely to enhance
Del Monte’s profitability (profits as a percentage of sales are 8.7 and 7.1, respectively
and the Lerner Indices are 0.14 and 0.32, respectively), the market for canned
tomatoes and canned pineapple are highly concentrated. The four-firm concentration
ratio and HHI for the canned tomatoes market are, respectively, 86.3 percent and
3,297. Similarly, the four-firm concentration ratio and HHI in the canned pineapple
industry are 94.2 percent and 5,457, respectively. This information suggests that
potential mergers in these industries are likely to be scrutinized.

22. On the surface the industry analysts’ suggestion would represent a merger to
monopoly and the HHI before and after the merger exceeds the threshold for raising
antitrust concerns. However, there are several reasons why the merger might be
allowed. First, satellite radio may not be its own industry, but rather a smaller part of
a larger market that includes MP3 players, AM and FM radios, and the like. Their
market shares in this more broadly defined market are trivial, and therefore the
merger would not impact the HHI in the more broadly defined market. Additionally,
the merger might be allowed if: (1) the firms could show significant cost savings; (2)
rapidly changing technology in the portable music industry would prevent anti-
competitive behavior; (3) the government viewed the firms as financially unstable; or
(4) barriers to entry were low enough to allow competition from new entrants after
the merger.

23. With number portability, the services of the various providers are now closer
substitutes to each other. One implication is that the cost to consumers of switching
service providers is now lower, which increases the likelihood that consumers would
switch for small price reductions. These factors make the demand for the individual
cellular service providers more elastic (increase the price elasticity of demand). Local
number portability, however, is unlikely to affect the elasticity of demand for the
industry as a whole. If the elasticity of demand increases for individual firms, but
remains constant for the industry, the Rothschild index will decrease.

7-5