Two firms produce luxury sheepskin car seat covers, Western Wear and Shorn Sheep Inc. The inverse market demand for seat covers is given by P = 50 − 5Q. The firms’ marginal costs are MC1 = MC2 = 20. Each firm behaves as a Cournot competitor, and the pre-merger industry output and price are: Q = 4 and P = $30 (Make sure you know how to obtain this.) Western Wear wants to acquire Shorn Sheep Inc.

1. (a) (5 points) Suppose there are no-cost synergies. The marginal cost of the merged firm will equal MC = 20. Calculate the post-merger quantity and price.

2. (b) (4 points) How will deadweight loss change as a result of the merger? Calculate the change using this formula:

   to obtain this answer with pen and paper alone).

3. (c) (2 points) How will total surplus change as a result of the merger? Should this merger be allowed to proceed?

4. (d) (4 points) Now suppose there are cost synergies, and the marginal cost of the merged firm will fall to MC = 15. Calculate the post-merger price and quantity.

5. (e) (6 points) Illustrate with a diagram cost savings and the additional deadweight loss resulting from the merger. Clearly mark the post- and pre-merger quantity, prices, and marginal cost.

6. (f) (3 points) Calculate the cost savings resulting from the merger.

7. (g) (3 points) Calculate the change in deadweight loss as a result of the merger using the formula for ∆DWL provided above.

8. (h) (4 points) Now calculate the change in deadweight loss by finding the area of a relevant trapezoid in your diagram. Make sure your answer is the same as above.

9. (i) (4 points) How will total surplus change as a result of the merger? Should this merger be allowed to proceed? Explain.

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Mergers are one of the business expansion strategies that the firm ... View the full answer