Managerial Economics & Business Strategy 8th Edition by Michael Baye,Jeff Prince

Exercise 20

The French government announced plans to convert state-owned power firms EDF and GDF into separate limited companies that operate in geographically distinct markets. BBC News reported that France's CFT union responded by organizing a mass strike, which triggered power outages in some Paris suburbs. Union workers are concerned that privatizing power utilities would lead to large-scale job losses and power outages similar to those experienced in parts of the eastern coast of the United States and parts of Italy in 2003. Suppose that prior to privatization, the price per kilowatt-hour of electricity was €0.13 and that the inverse demand for electricity in each of these two regions of France is P = 1.35 - 0.002 Q (in euros). Furthermore, to supply electricity to its particular region of France, it costs each firm C ( Q ) = 120 + 0.13 Q (in euros). Once privatized, each firm will have incentive to maximize profits. Determine the number of kilowatt-hours of electricity each firm will produce and supply to the market, and the per-kilowatt-hour price. Compute the price elasticity of demand at the profit-maximizing price-quantity combination. Explain why the price elasticity makes sense at the profit-maximizing price-quantity combination. Compare the price-quantity combination before and after privatization. How much more profit will each firm earn as a result of privatization?