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Chapter 11: Problem 9

At one point, Time Warner and the Walt Disney Company discussed merging their news operations. Time Warner owns Cable News Network (CNN), and Disney owns ABC News. After analyzing the situation, the companies decided that a combined news operation would have higher average costs than either CNN or \(\mathrm{ABC}\) News had separately. Use a long-run average cost curve graph to illustrate why the companies did not merge their news operations.

Short Answer

Expert verified
Both Time Warner and Disney companies might already be operating at the point of minimum efficient scale (MES) on the long-run average cost (LRAC) curve individually. Combining their news operations might cause the new merged entity's output to go beyond their individual MES, thereby leading to higher per unit costs due to the diseconomies of scale.

Step by step solution

01

Identification of the Situation

Identify that the situation is about two big companies, Time Warner and Disney, considering the merger of their news operations, CNN and ABC News respectively. The decision against the merger is based on their analysis that a combined operation would lead to higher average costs.
02

The Production Function

Recognize that such a situation typically involves the concept of economies of scale in a firm’s production function. This means that as these companies increase output, average cost per unit of output decreases until a certain point (Minimum Efficient Scale - MES). Beyond this point, the cost per unit begins to rise again due to the difficulties associated with managing increasingly complex operations.
03

Illustration on the LRAC Curve

It's important to use a Long Run Average Cost (LRAC) curve to explain this scenario. On the LRAC curve, point A represents the MES of CNN, and point B represents the MES of ABC. If both news operations are combined, the output level will increase, and this might lead to moving beyond the MES points. This results in higher average costs due to diseconomies of scale (which are management difficulties associated with larger scale), as represented by point C.
04

Conclusion

Realize that because both companies are likely already operating at or near their MES (points A and B), combining operations would cause the combined entity to operate at a scale larger than their MES (point C), leading to higher average costs. Therefore, this could explain why the companies decided not to merge their news operations.

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