Price Theory - Industry Analysis

ECON1048 Price Theory Industry Analysis

Melbourne, Semester 1, 2021

1 Introduction

Decision-makers in government rely on the advice of experts when formulating policy or

discharging their statutory responsibilities. In this assignment you will take the role of an

expert economist, employed by a government department. An expert economist’s role in

the government decision-making process is two-fold:

• Analysis: Economists use their specialist knowledge and skills to analyse the likely outcomes of policy alternatives. They then evaluate these outcomes against the

government’s objectives and statutory obligations.

• Communication: Economists communicate their findings to ministers and senior public servants, who, in many instances, do not share their specialised knowledge.

This assignment will assess your aptitudes in both of these domains. You are to conduct

an industry analysis based on the scenario detailed in section 2. Then use your analysis as

the basis for a brief (a short report) summarising your recommendations and the associated

rationale.

1.1 Formatting requirements

Your assignment must be typed using Microsoft Word, or a similar word processor. Both

parts of the assignment should be included in the same document with the brief placed

before the industry analysis. The document should have a professional appearance, appro-

priate to a government workplace. Format your assignment as follows:

• Use A4 sized paper with all margins at least 2.5cm.

• Body text to be 12pt and black. (There is no minimum line spacing.)

• All pages to be numbered.

• DO NOT include a cover sheet or table of contents.

• Optional: Save your assignment as a PDF to ensure that your document and equa- tions appear as you intend.

1.2 Grading

There are a total of 100 marks available in this assignment (50 marks for the industry

analysis and 50 marks for the brief ), and the assignment contributes 40% of your grade

for Price Theory. The marks allocated to each step of the industry analysis are detailed in

section 3. The marking criteria for the brief can be found in the rubric.

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2 Scenario

Two producers of pre-mixed concrete, Big Industries and ConCorp, have applied to the

Minister for Finance for Merger Authorisation. The two companies are proposing to com-

bine into a single corporate entity to be known as BigCon. The two companies claim that

the merger should be authorised as,

• the merged firm will be able to achieve substantial efficiency gains as a result of combining production and

• a third firm, Aggregate Inc., will remain as a competitor to the merged firm in the pre-mixed concrete market, ensuring that consumers are not adversely affected.

2.1 Your task

The Minister for Finance has instructed you to determine the likely impact of the proposed

merger on the market, and to recommend whether or not authorisation for the merger

should be granted. Under the relevant legislation, authorisation for a merger can be granted

if,

• the proposed acquisition would not be likely to substantially lessen competition OR

• the likely public benefit from the proposed acquisition outweighs the likely public detriment.

Note that competition policy prevents the government from imposing any other form of

market regulation, including price caps.

2.2 Industry structure

Pre-mixed concrete is an important input for the construction industry. Concrete cannot

be stored or transported over long distances as it begins to set after only a few hours. For

this reason, only the three local firms—Aggregate Inc., Big Industries and ConCorp—are

in a position to compete in the market. Moreover, the capital and regulatory requirements

for constructing a new concrete plant are substantial, creating an effective barrier to entry.

Pre-mixed concrete is regarded as a homogeneous good by the construction industry.

Inverse demand in the market has been estimated to be,

P = 520 − Q

50 ,

where P represents the price of a cubic metre of concrete in dollars, and Q is the total

number of cubic metres of concrete supplied into the market on a given day.

At present the three firms appear have identical production costs, with each firm facing

fixed costs of $400,000 per day and a marginal cost of $160 per cubic metre. Big Industries and ConCorp estimate that the proposed merger would reduce their

marginal cost to $145 per cubic metre, while the merged firm is expected to face fixed costs of $600,000 per day.

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3 Industry analysis

For your Industry Analysis you must complete each of the steps detailed below. The

required analysis draws on content covered in lectures 6–10 (primarily lecture 9). When

completing the steps you must:

• Type all equations using the ‘Insert Equation’ function (or equivalent).

• Show all of your working.

• Include sufficient written description for the reader to follow your process.

• Use appropriate notation and economic terminology.

Your audience for the industry analysis is other expert economists who may be required to

review your work. There is no page limit for the Industry Analysis.

3.1 Required steps

When completing the industry analysis you should assume that firms are engaged in

Cournot Competition. Steps 1 to 4 apply to the market in the absence of a merger.

Step 1: Using the information provided in the scenario, derive a profit function for a typical

firm in the industry. Use QA to denote the quantity produced by this firm, and X to denote

the combined production of the remaining two firms. (6 marks)

Step 2: Derive the best-response function for the typical firm. (5 marks)

Step 3: Find the equilibrium quantity for the typical firm, the equilibrium market quantity,

and the equilibrium market price. (7 marks)

Step 4: Find the equilibrium profit for the typical firm and the equilibrium consumer sur-

plus. (6 marks)

When writing your brief you should assume that steps 3 and 4 describe the existing equi-

librium in the market.

Now suppose that the merger takes place and that the merged firm achieves the

expected efficiencies. (Note that Aggregate Inc.’s costs are not be affected by the merger.)

Step 5: Find the new equilibrium quantities and price for the market. Use QA to denote

the quantity produced by Aggregate Inc., and QB to denote the quantity produced by the

merged firm, BigCon. (18 marks)

Step 6: Find the new equilibrium firm profits and consumer surplus. (8 marks)

When writing your brief steps 5 and 6 represent your assessment of the likely market

conditions if the merger is permitted to proceed.

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4 The brief

The purpose of the brief is to communicate your recommendations to the decision-maker

who commissioned your analysis. You need to provide enough information for the decision-

maker to understand your recommendations, and to reach a decision on the matter at hand.

However, senior government officials are extremely busy, so you must be brief.

• The maximum length for your brief is 2 pages.

• Any content in excess of 2 pages will not be read or graded.

When writing the brief remember that it is for a non-expert audience. You must avoid using

specialised economic terminology and state everything in ‘plain English’. For example:

• Terms such as consumer surplus, producer surplus, and deadweight loss, have lit- tle meaning outside of economics and should be avoided. (Note: This is not a

comprehensive list.)

• On the other hand, the significance of terms such as price, revenue, and profit, are generally well understood outside of economics.

The brief should not include any equations or diagrams. Tables and dollar amounts may

be included as appropriate.

4.1 Template

You must compose your brief according to the template detailed on the following pages.

Instructions for each required element of the brief are included within this template. These

instructions are reflected in the requirements of the rubric for the task. Ensure that your

brief includes each of the elements detailed in the template, and that you do not reorder,

rename, or omit any of these elements.

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Briefing for the (insert decision-maker’s title here)

Subject: Include a brief but descriptive subject line. Maximum length 1 line.

Hint: The subject is, in effect, the title of your brief. Compose the subject as you

would the title of a report.

Prepared by: Your name here.

Core Message

Write an executive summary of the brief. Your core message should consist of three

sentences: The first sentence providing a summary of the scenario. The second sen-

tence summarising the key rationale for your recommendation. And the third sentence

summarising your recommendation(s). Maximum length 5 lines.

Hint: The statements in the core message should stand on their own. Provide specific

information and avoid generalities. The reader should be able to understand the core

message without referring to the scenario or the rest of the brief.

Recommendation

Concisely state the principal recommendation that arises from your analysis.

Hint: Your recommendation should be stated as a clear course of action for the gov-

ernment to pursue. Be precise. Avoid generalities and ambiguous statements. DO NOT

explain or seek to justify your recommendation in this section. DO NOT describe the

consequences of your recommendation. DO NOT state conditions or caveats for your

recommendation.

Key Information

Begin your key information section with a short (1–2 paragraph) outline of the context for

the brief (as detailed in the scenario), the problem under consideration, and any additional

issues raised.

Hint: These 1–2 paragraphs should set the scene for the reader. They should provide

the reader with sufficient background information to understand the purpose of the brief.

DO NOT use these paragraphs to foreshadow, explain, or justify your recommendation(s).

Use the remainder of the key information section to present the rationale behind your

recommendation(s). You should highlight any trade-offs involved in your recommenda-

tion(s), and address any additional issues raised in the scenario. Your rationale should be

presented as follows:

• Use subheadings to concisely state the key findings of your industry analysis. The maximum length for a subheading is 2 lines (1 line is preferable).

• Write a short paragraph following each subheading to briefly explain the finding.

Taken together, the findings stated in the subheadings should form a logical argument

supporting your recommendation(s).

Hint: Incorporate all information required to support your recommendation(s) in this

section, regardless of whether or not the same information has been included elsewhere in

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the brief. Each subheading should be written as a statement of fact. DO NOT include an

explanation within a subheading, leave that for the following paragraph. DO NOT assert

facts that are unsupported by either the scenario or your industry analysis.

Financial Implications

Briefly summarise the direct financial implications of your recommendation(s) (if any) for

the Government. Include the precise dollar amounts that come out of your analysis.

Hint: The financial implications section should provide the reader with easy access to

the financial cost and/or benefit of your recommendations to the government. This section

is not a substitute for stating the financial implications elsewhere in the brief. Specifically,

if the financial implications form a part of the rationale for your recommendation(s), they

will need to be included in both the key information section AND the financial implications

section. DO NOT use this section to summarise other market outcomes (eg. profit and

price). DO NOT use this section to present arguments in support of your recommenda-

tion(s). This section must be included even if there are no direct financial implications

from your recommendation(s).

Begin your industry analysis on a new page following the brief.

Hint: Use the ‘Insert Page Break’ function in Microsoft Word to ensure the page break

displays correctly.

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