Question

. Assume the following facts concerning the horizontal merger model developed by Williamson and shown in Figure 7.3 of the textbook. Demand is q = 100-P; average cost premerger is AC0=$50; average cost postmerger is AC1=$44; and premerger price, p0=$50. Assume that the postmerger price, p1=$70, results from the market power created from the merger.

a. Calculate the value of the deadweight loss, area A1

b. Calculate the value of the cost savings created by the merger, area A2.

Should the potential merger discussed in Question 4 be allowed? What qualifications should be considered?

Answer 1

a) Area A1 = 1/2 x base x height

for q1 substitute value of P1 in the demand equation

q = 100 - P

q1 = 100 - 70

q1 = 30

for q0 substitute the value of p0 in the demand equation

q = 100- P

q0 = 100 - 50

q0 = 50

Area A1 = 1/2 x ( q0 - q1) x ( p1 - p0)

= 1/2 x ( 50 - 30 ) x ( 70 - 50 )

= 1/2 x 20 x 20

= 200

b) Area A2 = area of rectangle ( lenghth x breadth )

= ( q1- 0) x ( P0 - AC1)

= 30 x 6

= 180

c ) Merger should not be allowed as social benefits( A2) are less than cost( A1) so it is not beneficial to merge.