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Delhi School of Economics

Course # 608: Economics of RegulationMake up Mid-Term, 2010-11

Instruction: Answer all 3 questions in 1 hour and 10 minutes.

Total marks 30=3x10.

1. In a certain city where all parking is controlled by the city, it is possible toprovide parking facilities in the downtown area at a constant marginal capital-investment of $10,000 per space. Costs of operation can be neglected. Therearethree equal periods during the day of eight hours each, and spaces are rentedonly for complete eight-hour periods. During the peak period of each of 250days peryear, the demand for parking is given by P =a bQ, where P is theprice perperiod for a parking space. During the other two o-peak periods ofthose 250 days, the spaces demanded are half that in the peak period, for each

possible price. On other days demand is zero. Assume that the interest rate is10 percent and the facilities do not depreciate.

(a) If a = $16, b = 0.08, and existing spaces are 120, what would be thesociallyoptimal prices during the three periods?

(b) What is the optimal number of spaces and what are the correspondingprices?

(c) The above case is a so-called rm peak case, with peak demanders payingallcapital costs. Now suppose that a = $5 and b = 0.08. If peak demanderspayall capital costs, what quantity is demanded by peak demanders? If

o-peak demanders pay zero, what is their quantity demanded? (Fractionsof spaces arelegitimate.) This is the shifting-peak case.

(d) For the demand curves in (c), nd the optimal number of spaces andthecorresponding prices.

2. A breakfast cereal product, Cheers, has demandQ= 5P=2and constantaver-age cost of$1. Under existing conditions, the supplier of Cheers charges $5:50.Now, a new product, Kips, is introduced by a rival supplier. Afterequilibriumis reached, Cheers price is unchanged at $5:50 and Kips price is also $5:50.Cheers demand has shifted leftward and can be described as Q = 4:25 P=2.

Kips demand can be described asq= 4:25p=2 and its constant average cost is$1.

(a) What is the social benet resulting from the introduction of Kips? (IgnoreR&D cost for now.)

(b) What is the private benet of Kips introduction?

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(c) If the R&D cost of introducing Kips is $6, what is the net social bene-t?That is, subtract $6 from your answer to part (a). Compare this withthe netprivate benet.

(d) Discuss the ndings above from the perspective of welfare economics.Inthis instance, Kips would be introduced even though it is not sociallybenecial. Is this nding true in general? Explain.

3. (a) Is there a multiproduct natural monopoly with respect to products X andY if therm cost function is C(QX;QY) = 100 + 20QX+ 10QYQXQY ?Assume thatQX 10 andQY 10.

(b) Suppose the local government decides to issue thefranchise to the rm thatoers the biggest fee where market demand is 100 - P. Suppose there are

just two rms competing for this franchise. One rms cost function isC1(q) = 100 +q while the other rms cost functionis C2(q) = 12q. AnEnglish auction is used wherethe rm oering the biggest payment to thelocal government wins the franchise.The franchise owner is free to charge

any price that it likes.i) Who will win the franchise?

ii) What will the winning franchise fee be?

iii) What will price be?

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