DELHI SCHOOL OF ECONOMICS

COURSE # 608: ECONOMICS OF REGULATION

Mid-Term Exam, Winter Semester 2016-17
Write your name and roll no. clearly on the answer sheet. Be legible and brief while answering.
First question is compulsory. Answer any one from 2 & 3.
15th April 2017 Total marks: 7+8=15

1) Consider a firm that produces two commodities X and Y.

a) When will we call this firm a natural monopoly? What’s role of market demand?
b) Now suppose the long-run total cost function is the following –
LTC = F0 + Fx + 3x + Fy + 2y − 0.02xy
Where, F0 = joint fixed costs = Rs. 200
Fx = product specific fixed costs for product X = Rs. 70
Fy = product specific fixed costs for product Y = Rs. 60
x = output of product X = 100
y = output of product Y = 100
i) Find the incremental cost and average incremental cost of product X.
ii) Find the standalone cost of product X.
iii) Find the economies of scope, if any, from the joint production of products X & Y.
iv) Find the economies of scale (you may drop the quantity constraints for this).
v) Does the cost conditions (i.e. sub-additivity) alone sufficiently justify a natural
monopoly in each case?

2) The demand function for movie tickets to be sold by the only theatre hall near north
campus varies between students (S) and non-students (N). Formally, the two inverse
demand functions of the two consumer groups are given by –
PN = 12 – QN and PS = 6 – QS.
So, at any given consumption level non-students are willing to pay a higher price than
students. Assume that the theatre’s total cost function is C(Q) = 10 + 2Q where Q =QN+QS
is to total number of tickets sold. Solve the following problems.
a) Suppose the theatre is able to price discriminate between the two consumer groups by
asking students to present their student ID cards to be eligible for a student discount.
Compute the profit-maximizing prices PN and PS, the number of tickets sold to each
group of consumers, and total monopoly profit.
b) Suppose now that a large number of fake student ID cards are available to nonstudents
as well, so basically every resident has a student ID card regardless of whether the
resident is a student or not.
Compute the profit-maximizing price in a situation described in (b) above, the number
of tickets sold to each group of consumers, and total profit assuming that the
monopoly theatre is unable to price discriminate.
c) By how much the theatre enhances its profit from the introduction student discounted
tickets compared with the profit generated from selling a single uniform ticket price to
both consumer groups.
d) Is this the best pricing strategy? If not, what the ‘best’ pricing strategy would it
employ in a situation described in (b) above? And why?
3) Consider a market for a particular product where there is only one producer who caters to
consumers who could be of either high or low type, and this characteristic is known to
only to the consumer.
The cost function of the producer is given by TC = F + c.q; where F is the fixed cost and c
is marginal cost and q is quantity. So that her profit function is: π(q, T) = T – F – cq,
where T is the transfer she receives from consumers (using prices).

The utility functions of low and high type of buyer are respectively given by –
PL = a – qL and PH = 2a – qH , where a > 0 and qi is respective quantity.
So that the buyer’s utility from the transaction is – u(qi,T) = v(qi) - Ti , where i = L, H,
and v(qi) is the buyer’s net surplus and Ti is the total transfer he pays.
Note that c < a , else the production is infeasible.

Approximately there are ‘m’ high type customers, and ‘n’ low type customers.

a) Suppose, the seller is not able distinguish between the two types of customers. But it
had to set a price structure that would cater to the both the types that also maximizes
its profit. Derive the optimal transfer, prices and quantities.

b) Now suppose, instead there’s a benevolent regulator who sets the prices. The regulator
maximizes the social surplus with discrimination factor α <1 for seller, but can’t pay
any transfer. The regulator knows the cost function of the firm and also the demand
the functions but does not observe consumer’s type perfectly, only knows the
distribution. Therefore, if he has to set the optimal prices and quantities how would it
be different from that in case (a) above?

c) Compare and comment on the differences in the two outcomes above.