Question 1
1. 
A business is more likely to vertically integrate and produce an input internally if
 
 Specialized investments are important and the contracting environment is simple
 
 Specialized investments are important and the contracting environment is complex
 
 Specialized investments are not important and the contracting environment is simple
 
 Specialized investments are not important and the contracting environment is complex
3 points  
Question 2
1. 
A problem with using a "revenue sharing" plan to compensate employees is that the plan
 
 Does not provide incentives for employees to work hard
 
 Will be costly if revenues are low
 
 Does not provide incentives for workers to minimize costs
 
 Will have high administrative costs
3 points  
Question 3
1. 
Assume the compensation of a manager is given by the equation W = S + bΠ, where Π is the profit of the business. Then, an increase in the bonus rate (b) and a decrease in the base salary (S) will create
 
 Stronger incentives and more risk for the manager
 
 Weaker incentives and more risk for the manager
 
 Stronger incentives and less risk for the manager
 
 Weaker incentives and less risk for the manager
3 points  
Question 4
1. 
The return from an investment is uncertain and there is a 25% chance that it will be 100,000 dollars, a 50% chance that it will be 50,000 dollars, and a 25% chance that it will be 20,000 dollars. The expected return from the investment is
 
 45,000 dollars
 
 50,000 dollars
 
 55,000 dollars
 
 75,000 dollars
3 points  
Question 5
1. 
In a Second-Price, Sealed-Bid auction with independent private values, the optimal strategy is to
 
 Make a bid above your valuation of the item
 
 Make a bid below your valuation of the item
 
 Make a bid equal to your valuation of the item
 
 Not make a bid
3 points  
Question 6
1. 
A few years back, Disney switched from a "fee-per-ride" pricing strategy to a "fee-per-day" pricing strategy. The "fee-per-day" pricing strategy is a form of
 
 Two-part pricing
 
 Peak-load pricing
 
 Transfer pricing
 
 Randomized pricing
3 points  
Question 7
1. 
A movie theater will generally charge a lower price to students because
 
 Students buy less popcorn than the general public
 
 Students buy more popcorn than the general public
 
 Students have a less elastic demand for movies than the general public
 
 Students have a more elastic demand for movies than the general public
3 points  
Question 8
1. 
There are three businesses in an industry, with sales of 20 million, 10 million, and 10 million, respectively. The HHI index for this industry is
 
 2250
 
 3500
 
 3750
 
 5000
3 points  
Question 9
1. 
If a monopoly has a marginal cost of MC = 20 and the price elasticity of demand is E = −3, the optimal price for the monopoly is
 
 25
 
 30
 
 50
 
 75
3 points  
Question 10
1. 
In regression analysis, the fraction of the total variation in the dependent variable explained by the regression is called the
 
 P-value
 
 R-square
 
 t-statistic
 
 F-statistic

*******************************************************8
ADVANCED ECONOMIC ANALYSIS 
 
Exam II
 
Part II
Analytical/Essay questions
You must show and explain your work
 
1. [20 Points] Monopoly
You are the manager of a business in a monopoly market with the following
inverse demand function
p = 30  
1
10q
 
In addition, assume your production technology is described by the total cost
function
C(q) = 500 + 10q
 
a) Determine the optimal quantity to produce (qM), the price you should charge
for your product (pM), and compute the profit of your business.
b) Provide an intuitive explanation of market power. What is market power? How
do we measure the market power of a business? Compute the market power
of your business.
c) What determines the market power of a business? Explain.
 
2. [10 points] Game Theory
Firm 1 and Firm 2 compete in an industry and must decide whether to introduce
an upgrade to their existing products. The nature of the strategic interaction is
described by the game box, where (Y) means “upgrade” and (N) means “do not
upgrade”. The upgrade is costly and may or may not be a good business
decision.
 
a) Assume Firm 1 and Firm 2 move simultaneously. Derive the NASH equilibrium
of this game.
b) Assume Firm 1 and Firm 2 move sequentially. In particular, Firm 1 makes the
initial move and decides whether to introduce the upgrade. Then, Firm 2
observes the decision of Firm 1 and decides whether to introduce the
upgrade.
Determine the subgame perfect NASH equilibrium of this game.
 
0 , 0 2 , 1
1 , 3 3 , 2
Y N
Y
N
Firm 2
Firm 1 
2
 
3. [10 Points] Pricing Strategies
A business can produce its product in different versions: Version A has a basic
design and a lower cost and Version B has an upgraded design and a higher cost
of production. The business knows there are different types of customers, “High”
demand (H) and “Low” demand (L), but cannot separate the different types of
customers. The number of customers of each type and the maximum each type is
willing to pay for the different versions of the product are illustrated in the table.
In addition, the table gives the marginal cost of production for each version of
the product.
 
Number Type Version A Version B
50 H 30 45
100 L 20 25
Marginal Cost 10 20
 
a) Assume the business offers the product in Version A only. Determine the
optimal price (ܲ஺

) and compute the profit of the business.
b) Assume the business offers the product in Version A and Version B.
Determine the optimal prices (ܲ஺

 and ܲ஻
∗) and compute the profit of the
business.
 
4. [10 Points] Imperfect Competition
For each of the following terms, provide an intuitive explanation and discuss its
economic implications.
a) Product Differentiation: What is it? How does it affect competition?
b) Network Market: What is it? What is the nature of the equilibrium in a
network market? Why has Windows been able to maintain a monopoly
position in the market for operating systems?
 
5. [20 Points] Economics of Information
a) Provide an intuitive explanation of the Principal-Agent problem and discuss
any mechanisms used to mitigate the problem. You should use the business
owner-manager problem as an illustration.
b) Provide and intuitive explanation of the Adverse Selection problem and
discuss its implications. You should use the health insurance industry as an
illustration.
 
Extra Credit [5 points]: Assume the demand for the product of a monopoly is given
by the function q =100p−3/2. If the cost function of the monopoly is C(q) = 10q,
the optimal price for the monopoly is
a) 20
b) 25
c) 30
d) 35

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