Regulating Market Power in the Commons: In exercises 21.9 and 21.10, we investigated the case of many firms emitting pollution into a lake. We assumed the only impact of this pollution was to raise the marginal costs for all firms that produce on the lake. A: Revisit part (g) of exercise 21.10.
(a) How does a merging of all firms around the lake (into one single firm) solve the externality problem regardless of how large the pollution externality is?
(b) Suppose you are an anti-trust regulator who cares about efficiency. You are asked to review the proposal that all the firms around this lake merge into a single firm. What would you decide if you found that, despite being the only firm that produces output x on this lake, there are still plenty of other producers of x such that the output market remains competitive.
(c) Suppose instead that, by merging all the firms on the lake, the newly emerged firm will have obtained a monopoly in the output market for x. How would you now think about whether this merger is a good idea?
(d) How would your answers to (b) and (c) change if the externality emitted by firms on the lake lowered rather than raised everyone’s marginal costs?
B: Suppose, as in exercise 21.9 and 21.10, that each of the many firms around the lake has a cost function c(x) = βx2 +δ X where x is the firm’s output level and X is the total output by all firms around the lake.
(a) In exercise 21.10B (a), we discussed how a social planner’s cost function for each firm would differ from that of each individual firm. Review this logic. How does this apply when all the firms merge into a single company that owns all the production facilities around the lake?
(b) Will the single company make decisions different from that of the social planner in exercise 21.10? What does your answer depend on?