Question

2) (Merger with cost synergies) Suppose the demand for widgets is p(Q) = 100 – Q. Initially, there are two firms producing widgets, each with cost function C(q) = 40q, and these firms engage in Cournot quantity competition. Now suppose these two firms propose to merge so as to reduce their marginal costs by 0<?. In other words, after the merger there will be a monopolist with cost function CM(q) = (40 – ?)q.

a) For what values of ? will the merger increase social welfare, and for what values of ? will the merger decrease social welfare?

b) One case where the antitrust authorities often accept an efficiency defense (i.e. a claim that the merger would lower cost making production more efficient) for an anticompetitive merger is when the efficiency gains are so large that the market price will actually decrease despite the anticompetitive effects. How large would ? have to be for this case to hold?

Answer 1