University of Delhi 2011 M.A Economics winter semester 608 - of regulation (admissions of 1999 and onwards) - Question Paper
2252 Your Roll No..................................
This question paper contains 4 printed pages.
M.A. / Winter Semester A
ECONOMICS Course 608 Economics of Regulation (Admissions of 1999 and onwards)
Time : 2m hours Maximum Marks : 70
(Write your Roll No. on the top immediately on receipt of this question paper.)
There are three parts. Part A has two questions, both are compulsory.
Answer any two questions from Part B. From Part C, answer one question.
PART-A [2X20=40]
1. A regulator wants to make provision of a good by employing a private firm.
The regulatory contract fixes the per-unit price, p, that the firm can charge, in addition to lump-sum transfers, t, from the regulatory to the firm; p > 0 and t 6 Si. A firm is willing to supply the good. It also agrees to meet all of the demand at price p. However, firm is privately informed about its marginal cost. Regulator knows that 6 {tfi/flj}, 0 < and also the probability
distribution over {$1,O2}; there are no fixed costs of production. Objective of the regulator is to choose (pi,ti) and {P2. tj) to maximize social welfare, which is V(p) + aTl(p)-, where V(p) is the net consumer surplus and II(p) is the net profit for the firm, when all of market demand is met at price p. Assume a {0,1}.
With the help of a suitable model, answer the following:
(a) Under what conditions the optimum regulatory contract will set the price equal to the marginal cost for each firm type?
(b) Will the contract in (a) maximize the consumers surplus? [13+7]
2. The town of Economia has two residents: Ann and Bob. The town currently funds its fire department solely from the individual contributions of these residents. Each of the two residents has a utility function over private goods (X) and total firemen (M), of the form: U = 2log(X) + log(M). The total provision of firemen hired, M, is the sum of the number hired by each of the two persons:
II
2 h
M MA + MB. Ann and Bob both have income of 200, and the price of both the private good and a fireman is 1. They are limited to providing between 0 and 200 firemen. For the purposes of this problem, ytiu can treat the number of firemen as a continuous variable (it could be man-y$ars). [5x4]
ii
(a) How many firemen are hired if the government does not intervene? How many are paid for by Ann? By Bob? |
(b) What is the socially optimal number of firemen? If your answer differs from a), explain why. j
(c) Suppose the government is not happy with the private equilibrium, and it decides to provide 20 more firemen. It taxes A mi. and Bob equally to pay for the new hire'.. What is the new total oumbsf of firemen? How does your answer compare to part a? Have we achieved the social optimum? Why or why not j
(d) Suppose now that the government is still not happy, so it decides to provide 75 new firemen. It taxes Ann 50 to pay for them, and it taxes Bob 25. What is the new total number of firemen? How many are provided by Ann, and how many by Bob? How does this compare to the level of provision in c), and why? is
PAKT-B [2X1020]
3. A profit-maximizing company has the chance to research the cure for the com-mon cold (CCC). If it spends Z > 1 on R&D, then itias probability p(Z) 1 1/Z of discovering the CCC (and zero probability qtherwise). Assume that the company has no other costs besides research costs, $0 other revenues other than those from selling the CCC if it discovers it. The present value (PV) of revenue from the CCC once discovered is II > 5- Units for rWearch costs, and CCC profits are millions of dollars. [2+3+3+2]
(a) How much will the company spend on research as a function of II?
11
(b) What are the expected profits in terms of II? What happens if n < 4?
(c) Assuming no discounting, so that the PV of profits is just the sum of all future profits, and an annual profit of $0.15. million from monopoly exploitation of CCC, what is the minimum patent ength that will induce the company to do any research?
(d) Assume the patent is the length you worked out in the previous section. What is the maximum license fee the company coujd charge for the CCC?
4. Assume that the market demand for watches is Q= 160-11 and that the constant average cost of production is 80. Consider two alternatives. In case C, the
industry is initially organized competitively, and in case M, the industry is
i
I
II
organized as a monopoly. In each case, an invention leads to a lower, constant average cost of production of 60. (The R&D cost of the invention is not relevant here, inasmuch as the issue is the magnitude of the incentive to invent in the two cases). Finally, there is no rivalry to make the invention: in case C, the inventor may be assumed to have a patent of infinite life, and in case M, the inventor is the existing monopolist, and entry is barred. [2x5]
(a) Find the initial equilibrium price and quantity in cases C and M.
(b) What is the return that the inventor in case C could expect from a lower cost production process? Assume that the inventor monopolizes the watch business.
(c) What is the return to the monopolist in case M that results from inventing the lower cost production process?
(d) Interpret your results regarding the incentive to invent under monopoly and competition.
(e) In case C, if society could require that the new process be used efficiently by making it freely available to all what would be the increase in total economic surplus? How does this magnitude compare to the returns found in b and c?
(f) Consider the same situation as above, but where the invention lowers average cost to 5 rather than 60. Does this change the comparative incentives under monopoly and competition?
5. Suppose that there are an unlimited number of firms competing to discover * a calorie-less fat substitute. Each firm can only undertake a single research project for the development of this good. The research project is known to have a constant marginal cost of $1. The probability, P, that one of the n firms will develop this new product is a function of the total number of firms engaged in the research race and is given by P 1 e~Q-5.085n. If this new product is discovered, it will be priced competitively and the present value of total surplus will be $25. Research can only take place this year and if the good is not developed this year, it will not be developed in the future.
* [4*-f4-f-2]
(a) From societys point of view, find the optimal number of research projects (firms engaged in the research race).
(b) Assume now that a competitive R&D industry exists and that n is determined by the zero profit condition (i.e., there is free entry into the research
v race). If the government promises the firm that discovers this new product the entire social benefit of $25, show that 25 firms will enter the patent j race assuming that each firm is equally likely to make the discovery.
!
(c) Briefly explain why your answer !n (a) differs from the number of firms that would enter a competitive patent race from as shown in part (b).
ii
PART-C [1X10=10]
6. Why do public enterprises tend to have higher costs than private enterprises? Do you think this reason is sufficient to always prefer regulated private enterprises over public enterprises? 1 [10]
7. Consider a nationalized industry that produces at the socially efficient point.
a) Is a subsidy necessary and if yes what that would be?
b) Under a two-part tariff pricing Scheme, what fixed charge would be needed if the subsidy is to be replaced by user charges?
c) What variable charge would be needed? [10]
i
:'l
ll
I!
|
Attachment: |
| Earning: Approval pending. |
