ECON 550 FINAL 2013

Your Name: __________________

FINAL EXAMINATION

Write your name at the top of all pages of the exam.

You will have two hours and thirty minutes to complete the exam.
There are 4 questions spread over 14 pages. Question 1 has parts aand b, question 2 has
parts a and b, question 3 has parts a through c, and question 4 has parts a through d.
Each question is worth 30 points. Make sure to answer fully all parts of all questions on
the exam.
Show your work and explain your answers using sentences. The correct number is
not nearly as important as your explanation of how you came to find that answer.
An answer without a clear explanation will not receive many points. In cases where
your final answer may be incorrect, many of the logical steps you followed might well be
correct. We will not be able to award you partial credit if you do not show the process
through which you obtained your answer.
When performing graphical analysis, make sure to include captions that describe
precisely what is happening on the graph.
If you are struggling with the math or the graph at least give a well-reasoned intuitive
answer to the questions.
When you complete the exam, turn it in, and move well down the hallway before you talk
to others about the exam. Dont disturb people still in the exam.
If part of your answer is on one of the extra sheets, make sure to write a message telling
us where it is on the original question sheet.

ECON 550 FINAL 2013

Your Name: __________________

Question 1.
Consider the market for RVs (recreational vehicles) in Germany. There are two major
producers, Liebchen and Fromholz. The demand for RVs is characterized by the
following equation:
P = 3100 QL QF,
where QL and QF represent the number of tractor trailers produced in a year by Liebchen
and Fromholz, respectively.
The two companies have the same cost structures. Each have a marginal cost that is
equal to average cost equal to 300 for every level of output.
a.

This is a Stackelberg situation where Liebchen chooses first and Fromholz

chooses second. They are building the RVs in the current year and then
selling them for the price determined by the market in the next year. In the
Nash equilibrium identify
1) the quantities chosen by Liebchen and Fromholz,
2) the market price that will result,
3) , and the profits received by Liebchen and Fromholz.
Make sure to explain clearly how you are solving the problem and show
your work. (15 points)

In a Stackelberg setting where Liebchen (L) moves first L must try to figure out
what Fromholzs (F) reaction function to predict what F will do in response to any
choice that L makes.
First, derive Fs reaction function by maximizing Fs profits given any QL.
Total Revenue for F will be
TRF = P*QF = (3100 QL QF)QF = 3100 QF QL QF QF2.
Total Cost = ATC*QF = 300 QF
Total Profit (QF) = TR-TC= 3100 QF QL QF QF2 - 300 QF.
To maximize total profit, find the first order conditions for a maximum by
differentiating the total profit function with respect to QF and then setting the
differential equal to zero.
TP(QF) = 3100 QL 2 QF 300 = 0.
Rearrange terms and we get
2800 QL = 2 QF
Divide by 2
QF = 1400 0.5 QL.

ECON 550 FINAL 2013

Your Name: __________________

Since F moves second, F knows exactly what L has chosen, so L is confident that this
reaction function is correct.
Substitute Fs reaction function into the Market Demand to find the Residual
Demand available to L.
P = 3100 QL (1400 0.5QL)
P = 3100 QL 1400 + 0.5QL
P= 1700 0.5 QL
Total Revenue for F is (1700 0.5 QL) QL
Total Cost is 300 QL.
Total Profit
TP(QL) = 1700 QL 0.5 QL2 300 QL
To maximize total profit, find the first order conditions for a maximum by
differentiating the total profit function with respect to QL and then setting the
differential equal to zero.
TP(QL) = 1700 QL 300.
QL = 1400.
To find Fs choice, substitute QL into Fs reaction Function.
QF = 1400 0.5 (1400) = 1400 700 = 700.
The price is then
P = 3100 1400 -700 = 3100 2100 = 1000.
QF= 700
QL=1400
Total profit for Liebchen = (P ATC) QL = (1000 300) 1400 = 700 * 1400 =
980,000.
Total profit for Fromholz = (P ATC) QF = (1000 300) 700 = 700*700= 490,000.
Points. If they follow a Cournot, Dominant firm, or Bertrand process and walk
through that process correctly and get the numbers right for that process, they lose
7 points.
If they follow other processes, show it to me.
Incorrect numbers but proper Stackelberg process lose 1 for each incorrect number.
(although if they make a mistake on one that leads to the others and process is
correct, then lose only 1)
(There are 5 numbers, Price, quantity for each, profits for each).

ECON 550 FINAL 2013

b.

Your Name: __________________

(15 points). Say that Liebchen and Fromholz decided to form a cartel.
1) If the cartel were successful, what would be the total output, price, and
total profits in the RV market? (6 points)
2) Say Liebchen and Fromholz had made an agreement to each produce
half of the successful cartel total output. Liebchen moves first and
produces exactly that amount. What would be the profit maximizing
output choice that Fromholz would make at that point? (6 points)
3) List 3 factors that would influence the success of a cartel and describe
the direction of change for each that would lead to a more successful
cartel. (3 points)

If they form a cartel, they will choose the monopoly solution and then find a way to
split it. To find the monopoly solution substitute Q for (QL+QF).
The Demand becomes P = 3100 Q
Total Revenue = P Q = (3100 Q) Q.
Total Cost = 300 Q
Total Profit = 3100Q Q2 300 Q.
To maximize total profit, find the first order conditions for a maximum by
differentiating the total profit function with respect to Q and then setting the
differential equal to zero.
TP(Q) = 3100 2 Q 300 = 0.
Rearrange terms and we get
2800 = 2 Q.
Divide through by 2
Q = 1400.
P = (3100 1400) = 1700.
Total profits = (P ATC) Q = (1700 300)1400 = 1,960,000
(part 1 is worth 6 points)
3 points for the correct process, 1 point for each incorrect number (although if they
make a mistake on one that leads to the others and process is correct, then lose only
1)
Part b(2)
If Liebchen follows the agreement to produce half of the cartel total, Liebchen will
produce 700.
Fromholz can then choose between following the cartel agreement and choose 700,
or Fromholz can examine the reaction function we derived in part a.
Substituting 700 into that reaction function

ECON 550 FINAL 2013

Your Name: __________________

QF = 1400 0.5 QL = 1400 0.5*700 = 1400 350 = 1050.

Fromholz chooses 1050.
Fromholzs profits if it follows the cartel are
(1700 300)*700 = 980,000.
Fromholzs profit if it choose the reaction function will be based on a different price
P = 3100 700 1050 = (3100 1750) = 1350
Profits = (1350-300)*1050 = 1050*1050 = 1,102500
Part b(2) is worth 6 points. If they do not make the profit comparisons they lose 1.
Correct choice of output is worth 1.
Process is worth 4.

Part b(3) is worth 3 points, one point for each choice. (1/2 for choice for direction).
Many possible choices.
Stronger enforcement
More similar in costs or more homogeneous
Quality is more similar
More inelastic demand
More inelastic supply
Higher barriers to entry
Fewer participants
More multi-market contact.

ECON 550 FINAL 2013

Your Name: __________________

Question 2.
Pebble Beach and St. Andrews are two tennis resorts in competition in the same market.
They are similar in terms of their cost structures. Each is trying to decide whether to add
a golf course. If one adds a golf course and the other does not, the resort that adds the
golf course will pick up a significant number of customers at the expense of the other. If
both add the course, they will end up with the same market shares as before. The matrix
below shows the payoffs in millions of dollars to each resort; Pebble Beachs payoff is
listed first, and St. Andrews payoff is listed after the comma. They move simultaneously
and this is a one-shot game.

Pebble Beach does not add

the course
Pebble Beach Adds the
course
a.

St. Andrews does

not add the course
100, 130
120,

70

St. Andrews adds the

course.
70, 120
105, 105

(20 points) What will be the Nash Equilibrium? Explain your answer.
They move simultaneously, so we should treat them the same way. Find both
best responses (reaction function) and then work through logic.
Consider the Best Responses for Pebble Beach first.
If St. Andrews does not add the course, Pebble Beach will choose to add the
course because the profits of 120 from adding the course exceed the profits of
100 from not adding the course.
If St. Andrews adds the course, Pebble Beach will choose to add the course
because the profits of 105 from adding the course exceed the profits of 70
from not adding the course.
Pebble Beach has a dominant strategy to add the course. No matter what St.
Andrews does, Pebble Beach always chooses to add the course.
Consider the best responses of St. Andrews.
If Pebble Beach does not add the course, St. Andrews will choose not to add
the course because the profits of 130 from not adding the course exceed the
profits of 120 from adding the course.
If Pebble Beach adds the course, St. Andrews will choose to add the course
because the profits of 105 from adding the course exceed the profits of 70
from not adding the course.
St. Andrews does not have a dominant strategy.
Since Pebble Beach has a dominant strategy to add the course, St. Andrews
will only have the options on the bottom row. St. Andrews will choose to add

ECON 550 FINAL 2013

Your Name: __________________

the course because the profits of 105 from adding the course exceed the
profits of 70 from not adding the course.
The Nash Equilibrium will be that they both add the course.
The question is worth 20 points.
The correct outcome is worth 5 points.
The correct process is worth 15 points.
Once they see that Pebble Beach has a dominant strategy, If they choose not
to go through the full best response function for ST. Andrews that is fine.
(10 points). Is the situation described in part 2a. considered a prisoners
dilemma? Define a prisoners dilemma and then describe reasons for why this
situation does or does not fit the definition.
In a prisoners dilemma, both participants have a dominant strategy and they both
would be better off if they both followed the nondominant strategy. (4 points
4 for each)
This does not fit a prisoners dilemma because St. Andrews does not have a
dominant strategy. (2 points).
They might also argue that the both would be better off with the nondominant
strategy but this is not quite true. If this is their only argument they would lose 1.

ECON 550 FINAL 2013

Your Name: __________________

Question 3.
You have developed a new powerful computer chip, Chips Ahoy, that you market
to consumers. The chip can be used to replace the current chips in a variety of
consumer electronic devices, including calculators, alarm clocks, and GPS
devices. You have not been sure about the optimal price to charge. You also are
trying to figure out the cross-price elasticity of the quantity of Chips Ahoy with
respect to a new battery called Dante that could also be used to replace existing
batteries in the same devices. In the first year of operation you experimented by
randomly adding and subtracting different amounts from a base price in 175
markets around the world. You then had a consulting firm run a regression on the
quantity in thousands of Chips Ahoy (Q) sold in each market as a function of the
price of Chips Ahoy (P), the price of Dante (D), and the per capita incomes in
thousands of dollar (Y) of the people in the different markets . The regression
results led to the following equation. All coefficients were statistically
significantly different from zero.
Q = 200 - 0.2 P - 1 D + 0.5 Y.
The means from the sample were 2 for quantity in thousands (Q), 20 for the price
of Chips Ahoy (P), 2 for the price of Dante (D), and 10 for per capita income in
thousands (Y). In making your elasticity calculations just use the numbers that
are listed as numbers. For example, do NOT convert the mean of 2 for the
quantity in thousands (Q) into 2000.
a. Based on the information in the regression equation, what is the price
elasticity of demand for Chips Ahoy? Is it elastic, unit elastic, or inelastic?[8
points]
The price elasticity for Chips Ahoy is
dQ/dP *P/Q
The coefficient in the regression is dQ/dP = -0.2 (recognizing this 2).
Using the means for P and Q.
The elasticity of demand is - 0.2 *20/2 = -0.2* 10 = -2 (1 is number is not
right)
The demand is elastic because -2 is less than -1. (2 for the elasticity)
USING the RIGHT FORMULA is worth 3).

ECON 550 FINAL 2013

Your Name: __________________

b. Based on your answer to part a, how much in percentage terms would total
revenue change if you were to RAISE the price by 1 percent? You should be
able to give me a number. 6 points)
Since the elasticity is -2.
%change in Q/%change in P = elasticity
Substitute -2 for elasticity, and 1 for the percentage change in price
%change in Q/1 = -2
The %change in TR = % change in Price + % change in Q.
Substitute 1 for %change in Price and -2 for % change in Q
The %change in TR = 1 -2 = -1
Total Revenue will fall by -1 percent.
2 points for Elasticity equation
2 points for Total Revenue equation
2 for right % change. (If have different elasticity in a and correct
calculations given that elasticity, then they do not lose points)
3.c. You have not been able to patent Chips Ahoy; therefore, in two years you
expect to be in a competitive industry where others are producing the same
product. You want to make predictions about the market price and market
quantity two years from now in the typical city. Using supply and demand
analysis and the signs of the coefficients in the regression, describe in detail what
would happen to the market price and market quantity of Chips Ahoy in 2015 in
the typical city if the price of Dante were to fall and income were to rise at the
same time. Just talk about directions of change and why demand moves the
direction it does in each case. Do NOT try to come up with numbers. Describe
all possible outcomes for price and quantity and under what conditions they will
occur. [16 points].
The cross-price elasticity is negative because the coefficient is negative for
Dante; therefore Dante is a complement. If the Dante price falls, people will
buy more Chips Ahoy and Demand will rise for Chips Ahoy. This will cause
the price and quantity of Chips Ahoy to rise. [2 for complement, 1 for
correct shift, 2 for correct price, 2 for correct quantity.]
The coefficient on Income is positive, so it is a normal good. Income rises
and thus the demand for Chips Ahoy would rise. This will cause the price

ECON 550 FINAL 2013

Your Name: __________________

and quantity of Chips Ahoy to rise. [2 for normal good, 1 for correct shift, 2
for correct price, 2 for correct quantity.]
Both push the demand for Chips Ahoy to rise. Therefore the market price
and the market quantity will rise. [1 point for correct price, 1 for correct
quantity).
Question 4
The information below shows the demand and the cost structure faced by Wendell Ladner
in his production of leisure suits. Answer the following questions and give
explanations for your answers. The explanations are as important as the
numerical answer.

Price

Quantity
97
96
95
94
93
92
91
90
89
88
87
86
85
84
83
82
81
80
79
78

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19

Total
Revenue
0
96
190
282
372
460
546
630
712
792
870
946
1020
1092
1162
1230
1296
1360
1422
1482

Marginal
Cost
0
73.5
72.5
71.5
70.5
69.5
70.5
71.5
72.5
73.5
74.5
75.5
76.5
77.5
78.5
79.5
80.5
81.5
82.5
83.5

Fixed
Cost
100
100
100
100
100
100
100
100
100
100
100
100
100
100
100
100
100
100
100
100

Average
Variable
Cost
73.50
73.00
72.50
72.00
71.50
71.33
71.36
71.50
71.72
72.00
72.32
72.67
73.04
73.43
73.83
74.25
74.68
75.11
75.55

Average
Total
Cost

MR

173.50
123.00
105.83
97.00
91.50
88.00
85.64
84.00
82.83
82.00
81.41
81.00
80.73
80.57
80.50
80.50
80.56
80.67
80.82

96
94
92
90
88
86
84
82
80
78
76
74
72
70
68
66
64
62
60

a. (9 points) Wendell Ladner is in a position where the company has to charge the same
price to all customers. He has not yet paid the fixed cost. What price and

10

ECON 550 FINAL 2013

Your Name: __________________

quantity of leisure suits should the company choose if they wish to maximize
profits? In the process decide whether it should shut down or produce. Explain.
They can do this two ways. Brute Force with TR and TC and find the largest
profits.
Largest profits are at 11. TP=TR-TC = 946 81.41*11=50.49. Choose a price of 11
and quantity of 86.
These profits of 50.49 are higher than the profits of 0 at a quantity of zero.
Points (Correct price and quantity each worth 1, describing the total profit
calculations is worth 5, making the long run comparison for profits at zero
and at 11 is worth 2.

OR marginal revenue and marginal costs.

Calculate MR and then compare the marginal revenues and marginal costs.
Marginal Revenue exceeds marginal cost at every level of output until 11. After 11
marginal cost exceeds marginal revenue, so Wendell should stop at a quantity
of 11 and charge a price of 86.
Since Wendell has not yet paid the fixed cost, this is the long run. At the quantity of
11, the price of 86 is greater than ATC of 81.41, so the profits at 11 are
greater than the profits of zero at a quantity of zero and Wendell should
choose 11.
Points (Correct price and quantity each worth 1, describing the MR and MC
process is worth 5, making the long run comparison for profits at zero and at
11 is worth 2.

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ECON 550 FINAL 2013

Your Name: __________________

b. (9 points) Let Wendell Ladner become a 1st-degree price discriminator. How many
leisure suits should the company sell and what pricing policy should it follow if it
wishes to maximize profits? Explain.
If Wendell becomes a perfect price discriminator, he will charge a different price for
each leisure suit. He will start with a price of 96 for the 1st consumer, 95 for
the second consumer, and keep reducing the price until he reaches a price of
81 for the 16th consumer.
He will choose a quantity of 16 because his price (which is his marginal revenue in
this situation exceeds the marginal cost at all quantities up to 16 but does not
exceed marginal cost after 16.
5 for the price discussion
4 for the quantity discussion

c. (3 points) What three conditions would have to be present for Wendell Ladner
to be able to practice first degree price discrimination?
He must face a downward sloping demand.
He must be able to identify his consumers willingness to pay.
He must stop resale.
d. (9 points)Who gains and who loses from the move from the single price
setting to the first-degree price discrimination setting? Be specific and
explain why each gains or loses (you do not need to tell me how large the
gains and losses are).
Wendell clearly gains because he earns higher profits. (3 points).
The first 11 customers lose because they pay a higher price than under the single
price (3 points)
The customers from 12 to 16 gain because the now get the good. They only get a
sliver of benefit. (3 points). Some might say that they are indifferent or get
no consumer surplus. That is fine.

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