The Dairy market in New Zenland is highly concentrated. Fonterra is the dominant firm in the market of milk processing with its market share more than 90%. Due to the regulation under the Dairy Act, Fonterra is not allowed to monopolize the market. It faces competition from several small independent processors, which can be regarded as competitive fringe firms. Suppose Fonterra faces total costs in milk processing Ca(g) = 100 + ⅗g?, while each fringe firm incurs total conts C, (4) = 100 + (assume competitive fringe firms have the same costs). Fonterra incurs a lower marginal cost than the fringe firms, as it is owned by farmers and can get a better deal in the supply of raw milk; moreover economies of scale matter in this industry. Assume the estimated demand

function for milk is D(p) = 90 - p.

(1). Suppose there are n = 4 fringe firms in the market and no other firms will enter in the short run.

(a) What is the supply function of the fringe firm? What is the residual demand facing the dominant firm?

(b) Solve for the equilibrium price, output, and the profits for the dominant and the fringe firm.

(2) Fonterra is a farmer cooperative and controls the supply of the raw milk. TIms, it can exclude the fringe firms and monopolize the market by refusing to supply the raw milk to the independent processors. However, the dairy market is regulated by the government, and Fonterra is obliged to supply g = 1.5 (hundred million liters per day) raw milk to each competitive fringe firm. Assume there are n = 4 competitive fringe firms in the short-run:

(c) What are the dominant firms output and the market price then?

Explain now why consumers face high milk prices.

(3) In the loug run, more independent processors will enter as long as the enter barrier is low. In the long-run equilibrium, each fringe firm makes z0ro profit (break-even). Assume the entry cost is zero, and the new entrant incurs the same production cast as the existing fringe firm:

(d) Solve for the supply of the fringe firm and the break-even price for the competitive fringe firm. Solve for the dominant firms supply and profit. What are the break-eves number of fringe firms and the market price in equilibrium?