n 2014, the boards of AT&T and DirecTV agreed to a $48.5 billion merger. You have been tasked with evaluating the merger. Here are some basic facts about the companies:

AT&T is the second-largest US telecom company. AT&T offers wireline video, broadband, and phone service in 22 states and wireless phone service nationwide. AT&T U-Verse's TV service has about 5.7 million customers in 22 states.

DirecTV is the second-largest pay-TV provider in the US (after Comcast), with 22 million pay TV subscribers.

Consumer groups have raised concerns that the merger will raise pay-TV prices. AT&T and DirecTV argued that the merger will lead to cost savings. Consider the following model to help you think through these issues: Let j denote a firm, where j {1, 2}. (Think of AT&T as firm 1 and DirecTV as firm 2). They face a symmetric demand function: Dj (pj , pj ) = 66 5pj + 2pj . Each firm has a marginal cost of c = 6.

(a) Suppose that prior to the merger, the firms are engaged in Bertrand competition. What are equilibrium quantities and prices?

(b) If Firms 1 and 2 merge, what will be the new equilibrium price and quantity?

(c) Suppose that following the merger, the marginal cost decreases from c to c . How much does the new marginal cost c need to be so that the post-merger price equals the pre-merger price?

Complements: After you submit your analysis using the above model, AT&T and DirecTV point out that AT&T also provides broadband services, which is a complement to DirecTV's video services: many consumers want both broadband and video services. Thus, the demand function should really be written as: Dj (pj , pj ) = 66 5pj 2pj . Each firm has a marginal cost of c = 6.

(d) Suppose that prior to the merger, the firms are engaged in Bertrand competition. What are equilibrium quantities and prices? (e) If Firms 1 and 2 merge, what will be the new equilibrium price and quantity?

(f) Does consumer surplus increase or decrease following the merger? What about industry profits?

(g) Given your answers to the preceding question, should the merger be approved?