Question

Suppose the European Union (EU) was investigated and proposed a merger between two of the largest distillers of premium Scotch liquor. Based on some economists’ definition of the relevant market, the two firms proposing to merge enjoyed a combined market share of about two-thirds, while another firm essentially controlled the remaining share of the market. Additionally, suppose that the (wholesale) market elasticity of demand for Scotch liquor is −1.4 and that it costs $14.80 to produce and distribute each liter of Scotch.

Based only on these data, provide quantitative estimates of the likely pre- and postmerger prices in the wholesale market for premium Scotch liquor.
Instructions: Do not round intermediate calculations. Enter your final responses rounded to the nearest penny (two decimal places).

Answer 1

The pre-merger price of premium Scotch liquor is estimated at $51.88 using the Lerner Index formula with given market elasticity and cost. Without further data, the post-merger price estimate is uncertain and speculative.

Step-by-step explanation:

To estimate the likely pre-merger and post-merger prices in the wholesale market for premium Scotch liquor, we can use the Lerner Index, which is a measure of a firm's pricing power and is calculated as:

Lerner Index = (Price - Marginal Cost) / Price = -1/Elasticity of demand

Given that the market elasticity of demand for Scotch liquor is -1.4, we can isolate the Price (P) in terms of the Marginal Cost (MC), which is the cost to produce and distribute each liter of Scotch ($14.80). Since the Lerner Index = 1/1.4:

Lerner Index = (P - 14.80) / P = 1/1.4

By solving for P, we get:

P = 14.80 / (1 - 1/1.4)

P = 14.80 / (1 - 0.7143)

P = 14.80 / 0.2857

P = $51.88

This would be the estimated pre-merger price. For the post-merger price, we need to consider that with a merger, the combined firms may have greater pricing power, potentially moving the market closer to a monopoly. However, since no changes in elasticity or costs are provided, the post-merger price estimate would be uncertain and any attempt at a quantitative estimate would be speculative without further data on new market dynamics or changes in cost structures.

Answer 2

Using the Lerner Index with a market elasticity of demand for Scotch liquor of -1.4 and a production cost of $14.80 per liter, the premerger price is equal to the marginal cost of $14.80. The postmerger price is estimated to be $51.81, calculated by the formula accounting for the increased market power after merger.

Step-by-step explanation:

To estimate the likely pre- and postmerger prices in the wholesale market for premium Scotch liquor, we can use the Lerner Index, which is a measure of a firm's pricing power and is calculated as (Price - Marginal Cost) / Price = -1 / E, where E is the price elasticity of demand.

In this case, since the market elasticity of demand for Scotch liquor is given as −1.4, the Lerner Index formula can be simplified to (Price - Marginal Cost) / Price = 1 / 1.4. Given the cost to produce and distribute each liter of Scotch is $14.80, we can solve for Price using the formula $14.80 / (1 - 1/1.4).

For premerger conditions, assuming the market is competitive and firms have not yet merged, the price will be closer to marginal cost. According to the Cournot model of oligopoly, postmerger, the market power may increase, leading to higher prices due to less competition.

Calculations:

• Premerger Price = Marginal Cost = $14.80
• Postmerger Price = $14.80 / (1 - 1/1.4) = $14.80 / 0.2857 = $51.81

Therefore, the premerger price is $14.80 and the estimated postmerger price would be $51.81.