ECO 610 Practice Final Exam TEI Piraeus/University of Kentucky MBA Program September 2016

Transcription

1 ECO 610 Practice Final Exam TEI Piraeus/University of Kentucky MBA Program September 2016 Name: Answer Key for Practice Final address: Instructions: Answer each question in the space provided. Point values are indicated beside each question. There are 14 questions and 100 points total. You have four hours to complete this exam, so you should use your time wisely so that you are able to answer all questions. You may use your own textbook, class notes, handouts, or other written material from the course, but you may not borrow anything from another student during the exam. You may use your own calculator, but you may not borrow a calculator from another student. Talking with another classmate during the exam is forbidden! You may ask Petros if you have any questions. Please write clearly. Good luck!

2 Multiple Choice Question: 2 points each, circle the correct answer. 1. What happens in a perfectly competitive industry when economic profit is greater than zero? a. Existing firms may get larger. b. New firms may enter the industry. c. There may be pressure on prices to fall. d. All of the above may occur. 2. Nash equilibrium a. Is where one player maximizes his payoff and the other doesn t. b. Is where each player maximizes his own payoff given the action of the other player. c. Is where both players are maximizing their combined payoff. d. Is a unique prediction of the likely outcome of the game. Answer: b 3. Which of the following would cause the demand curve for Greek wines to increase, i.e., shift to the right? a. A fall in the price of Italian and French wines. b. A fall in the price of Greek wines. c. A fungus that ruins grapes in Greek vineyards. d. An increase in the price of beer. 4. In a recent article, two economists estimated that the 37.5% increase in price that would result from a 75 cent tax increase on cigarettes in Greece would lead to a decrease in smoking among Greek MBA students of 30%. What can you conclude about the demand for cigarettes among Greek MBA students? a. It is unit elastic. b. It is normal. c. It is price elastic. d. It is price inelastic. 5. When a firm charges each customer the maximum price that the customer is willing to pay, the firm a. engages in a discrete pricing strategy. b. charges the average reservation price. c. engages in second-degree price discrimination. d. engages in first-degree price discrimination.

3 Answer each of the following questions in the space provided. Point values are indicated beside each question. 6. (5 points) What are the characteristics of the market for cruise ships in the Mediterranean Sea? What kind of market structure is it? Answer: Small number of firms Differentiated product Significant barriers to entry Therefore, this is an oligopoly market 7. (5 points) What are some of the factors that prevented U.S. oil producers from agreeing to reduce output when oil prices started falling in 2015? Answer: It is illegal in the U.S. for companies to collude and agree on the amount of output they will produce. There are a large number of smaller suppliers, making it difficult for them to reach a tacit agreement. A large number of suppliers also makes it difficult to detect any cheating on an agreement. One of the dominant firms in the market was no longer willing to act as the enforcer of any agreement. Individual companies each had a strong incentive to keep producing as much oil as possible. 8. (10 points) Briefly explain why we see the following patterns in many industries: a. Small firms are more likely to outsource production of inputs than large firms. Answer: Economies of scale A small firm is less likely to be able to use enough of one input to exhaust economies of scale in the production of the input. b. Standard inputs (used by several different firms) are more likely to be outsourced than are inputs that are made specifically for the firm. Answer: Specific assets Inputs that are made specifically for the firm are more likely to involve the use of specific assets, so vertical integration (where the firm makes the input) is more likely. Inputs that are standard and are purchased by a number of firms are more likely to be outsourced.

4 9. (15 points) Suppose that the oil industry consists of only two producers, Russia and OPEC. Russia chooses between producing either 2 million or 4 million barrels of oil per day, while OPEC chooses between producing either 8 million or 10 million barrels of oil per day. Depending on their decisions, total output in the world market will be 10, 12, or 14 million barrels. Suppose that the world price of oil will be $120, $90, or $60 depending on how much oil is produced by each. Extraction costs are $40 per barrel in Russia and $20 per barrel in OPEC. Illustrate the choices of strategy and the profit payoffs of each nation in a 2x2 matrix. What do you predict will be the outcome of this game? Answer: If world output is 10M barrels, then price=$120/barrel. ΠΠ RR = 2222($ $4444) = $ ΠΠ OOOOOOOO = 8888($ $2222) = $ If world output is 12M barrels, then price=$90/barrel. ΠΠ RR = 2222($9999 $4444) = $ ΠΠ OOOOOOOO = ($9999 $2222) = $ Or ΠΠ RR = 4444($9999 $4444) = $ ΠΠ OOOOOOOO = 8888($9999 $2222) = $ If world output is 14M barrels, then price=$60/barrel. ΠΠ RR = 4444($6666 $4444) = $ ΠΠ OOOOOOOO = ($6666 $2222) = $ Payoff Matrix: Russia OPEC 8M barrels 10M barrels 2M barrels 160, ,700 4M barrels 200,560 80, 400 Given this payoff matrix OPEC has a dominant strategy to produce 8M barrels. Given this, Russia s best response is to produce 4M barrels.

5 10. (10 points) Because your aunt was just elected mayor of Athens, you are granted a monopoly on the sale of bottled water on the top of Lycabettus Hill. Your marginal costs are 1.5 per bottle sold. From experience you know that when you raise or lower your price by x%, quantity falls by 2x%. Currently you are charging 2.5 per bottle. Is this the profit-maximizing price? Explain why or why not, include any formula that you use in your answer. Answer: The rule of thumb for a monopolist in setting prices is given by: PP = MMMM 11+( 11 EE DD ) where EE DD is the own price elasticity of demand. Based on the information given in the question we know that the elasticity of demand for bottled water on the top of Lycabettus Hill is -2 (2x/-x). So: P=(1.5/0.5)=3, so you should be charging 3 per bottle. 11. (10 points) In what ways are monopolistically competitive markets monopolistic? In what ways are they competitive? Answer: Monopolistic competitors produce products that are slightly differentiated. In this regard, in the short-run, monopolistic competitors can earn economic products by advertising the differences in their products from their competitors. This slight product differentiation makes a firm s product unique, or monopolistic. Monopolistic competition also has elements of being competitive. Relatively low barriers to entry allow other firms to enter the market and compete. This increase in selling firms reduces individual market share and in the long-run eliminates economic profits. Monopolistic competitors become price-takers, not unlike perfect competitors and earn only returns on their factors of production. 12. (10 points) One of the textbooks argues that price wars (one type of deviation from cooperative pricing) are more likely to occur during low-demand periods than during high-demand periods. Why might a firm deviate from cooperative pricing during high-demand periods? Answer: There are a several possible reasons: 1. During periods of high demand if the firm is small, other firms won t care that the firm is deviating from the collusive price. 2. If it is hard to observe a firm s price, in periods of high demand other firms may not realize that one firm is deviating since they just know their profits are higher. 3. The firm may deviate (and suffer some penalty from the other firms) in order to attract more customers and perhaps build up brand loyalty, which will be beneficial in future periods when demand may be lower.

6 13. (10 points) The price of a 0.5l glass of beer at Athens bars and restaurants is typically between three and four Euros. Residents and tourists consume Q D glasses of beer in a typical week. The mayor and city government in Athens are concerned that poor university students have to limit their intake of beer because the price is so high. They decide to impose a price ceiling (maximum price) of two Euros on every glass of beer sold in Athens. Illustrate in the diagram below the current market situation and then show the effect a price ceiling will have. What will happen to overall consumption of beer in Athens? Will students be able to drink more beer after the price ceiling is imposed? What other unintended consequences might occur? Answer: Price per glass Supply $3.5 $2.0 Demand Excess Demand Q S 2 Q D Q D 2 Quantity The price ceiling will create a shortage or excess demand. Overall consumption of beer will fall to Q S 2. We don t know what will happen to student consumption of beer because we don t know how the limited supply will be allocated. If customers are forced to stand in line then student consumption could increase because students have a low value of time and are more willing to stand in line. On the other hand, if people start to bride bartenders (through larger tips) to get served, then student consumption could fall quite a bit because they have less money than the other customers. However, it seem likely that student consumption of beer will fall along with other people s consumption. Bars may also start serving beer in smaller glasses to allocate the more limited supply. Student s may also be hurt if bars start to employ fewer workers due to less revenue and if students are more likely to work in bars.

7 14. (15 points) Your sister is the mayor of Napfilio. She awards you the monopoly franchise rights to provide cable TV service to the citizens of Napflio. As such, you are the only provider and, as long as you have no competition, the value of your economic profit stream is Trouble looms on the horizon, however, because a satellite TV company is considering entering your market. Your monopoly franchise rights only apply to hard-wired cable TV, and do not apply to satellite signals and rooftop satellite dishes. If entry occurs and you share the market with your competitor, your economic profit will fall to Your competitor will also have economic profit of If you contest entry and fight a price war, both you and your competitor will have economic profits of (both of you will lose ). a. You announce publically that if entry occurs you will fight. Is your threat credible? Why or why not. Answer: Profit with no entry= 24M, profit with entry and sharing the market= 10M, profit with entry and fighting=- 1M. Your threat is not credible since profit is higher after entry if you share the market. b. In preparing to fight a price war, you could add capacity to your system, so that you could offer additional channels that your competitor could not offer. The cost of adding such capacity in preparation to fight for customers is Only if entry occurs would you find it necessary to utilize this capacity. Should you make such a commitment to deter entry? Explain why or why not. It would help if you draw the decision tress for this sequential-move game. Answer: You should add capacity. If you add capacity then your rival knows that you will fight (your loss is - 1M if you fight, - 2M if you don t fight). Given this, your rival will not enter the market. If you commit and your rival doesn t enter, your profit is 12M. If you don t commit and your rival enters your profit is 10M. You have higher profits if you commit. Don t enter ( 24M, 0) Don t commit Cable Dish Enter Don t enter Accommodate Cable Fight ( 12M, 0) ( 10M, 10M) (- 1M, - 1M) Commit Dish Accommodate (- M, 10M) Enter Cable Fight (- 1M, - 1M)