UBC

Managerial Economics: Commerce/ FRE 295

October 26, 2017

NAME: _____________________ , __________________________ (please print)

(Family Name) (Given Names)

SIGNATURE: __________________________ Section 101 MW 10:00 – 11:30 - J. Brander

Section 102 MW 11:30 – 1:00 - J. Brander
STUDENT NUMBER ________________ Section 103 MW 1:00 – 2:30 - J. Vercammen
Section 104 MF 10:00 – 11:30 - L. Zrill
SECTION: _______________________ Section 105 TTh 11.00 – 12.30 - R. Shrestha
Section 106: TTh 2:00 – 3:30 – R. Shrestha
PROFESSOR’S NAME: ___________________

EXAM ROOM ________________________

Maximum Score: 100. Time Available: 2 hours.

Instructions: There are two parts to this exam. The first part consists of 20 multiple-choice
questions and the second contains 7 longer questions. Please answer all multiple choice
questions and choose 6 out of 7 longer questions. If you do all 7 questions the last question
will not be marked. The multiple choice questions are worth 40% of the exam (2 marks each)
and the longer questions are worth 60% (10 marks each). Most longer questions have two
parts. If so, each part is worth 5 pts.

This is a closed-book exam. You may not use books, notes, or electronic devices such as
computers or smartphones except that you may use a simple (non-graphing, non-
programmable) calculator.

You may use pen or pencil. Answers must go in the indicated places. For the multiple choice
questions you must transfer your answers to the answer sheet, which is the next page in
this exam. If you do any calculations that involve decimal numbers, round off to two
significant digits after the decimal point.

For each longer question your answer must fit in the indicated space. However, if you wish to
re-do a question, you may cross out your answer and provide the answer somewhere else on
the exam, such as on the back of a page, but the total space used should be no more than
allowed in the original question. Show your working for all longer questions. Print your
answers neatly.

In all diagrams label the axes and, where possible, put numbers for vertical intercepts and for
solution values on the diagram.

Please do not leave the exam room during the final 15 minutes of the exam, as that is
disruptive to other students. If you have a question or want scrap paper just raise your hand.

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PART I. MULTIPLE CHOICE ANSWERS (Use letters A, B, C, or D.) Put your answers here.
Multiple choice answers placed elsewhere will not be marked.

1. ________ 11. ________

2. ________ 12. ________
3. ________ 13. ________
4. ________ 14. ________
5. ________ 15. ________
6. ________ 16. ________
7. ________ 17. ________
8. ________ 18. ________
9. ________ 19. ________
10. ________ 20. ________

Total Multiple Choice Marks: ______ / 40

PART II. Marks for Longer Questions. DO NOT fill in the box below. It is for use by
markers. Put your answers in the indicated place on each page.

Question 1. ________ THIS BOX IS FOR USE BY MARKERS ONLY

Question 2. ________
Question 3. ________
Question 4. ________
Question 5. ________
Question 6. ________
Question 7. ________

Total Longer Question Marks: ________ / 60

Overall Mark: ____________/ 100

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 PART I

MULTIPLE CHOICE QUESTIONS

1. In economics a “positive statement” is

A. A correct statement
B. A statement that incorporates value judgments.
C. A testable assertion of fact.
D. None of the above.

2. Assuming that demand curves slope down and supply curve slope up, which of the
following events would increase both the equilibrium quantity and price of a normal good
or service?

A. An increase in the cost of inputs to production.

B. An increase in the price of a substitute good.
C. A decrease in income.
D. None of the above.

3. The following diagram illustrates supply and demand shifts in the U.S. corn market. Before
the shifts, the market equilibrium is at e1. After the shifts, the new equilibrium is at e3.
Choose the statement that is most consistent with this diagram.

A. Supply has shifted out, putting upward pressure on quantity, but the shift in demand
has more than offset that effect and quantity has fallen.
B. Supply has shifted out, putting upward pressure on the price of corn, but the shift in
demand has more than offset that effect and price has fallen.
C. The supply shift and the demand shift reinforce each other (work in the same
direction) for both price and quantity.
D. None of the above.

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4. A firm’s production function is given by q = K + L0.5.

A. This firm has increasing returns to scale in production.

B. For any positive values of L and K, the marginal product of labor and average product
of labor are equal.
C. This firm has diminishing marginal productivity of labor.
D. This firm’s average product of capital is constant and is equal to 1.

5. ABC Furniture purchased custom equipment two years ago for $100,000. The equipment
has no value to anyone else except for one other firm that has made a one-time-only offer
of $40,000 for the equipment. ABC is considering whether to accept this offer. Which of
the following statements is correct?

A. The sunk cost associated with the equipment is $40,000.

B. The opportunity cost of continuing to use the equipment is $60,000.
C. The opportunity cost exceeds the sunk cost in this case.
D. None of the above.

6. The following diagram shows an estimated cost function. What inference can we draw
from this estimation?

A. The implied average cost curve is U-shaped.

B. Marginal cost is well-approximated by a quadratic function.
C. In the underlying data, factors other than quantity have little effect on cost.
D. All of the above.

7. In the Portland Fish Exchange example from the textbook the estimated inverse demand
function is P = 1.96 – 0.15Q where P is dollars per pound and Q is thousands of pounds.

A. Increasing quantity from Q = 1 to Q = 2 decreases price by 0.15 percent.

B. Total sales revenue, R = PQ, is positive for all positive values of Q.
C. Demand is inelastic when Q = 5
D. Demand is elastic when Q = 5.

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8. Kim wishes to test whether student height affects grades achieved in COMM 295. She
collects data and estimates Y = a + bX + e where Y is the student’s grade, X is the
student’s height, and e is a random error. Her estimate of b is -0.134 with a t statistic
of -0.457, and the R2 statistic is 0.014.

A. Student height has a statistically significant negative impact on grades.

B. About 99 percent of the variation in grades can be explained by student height.
C. Kim cannot reject the hypothesis that height has no effect on COMM 295 grades.
D. The estimated value of a is approximately equal to the average height of the
students.

9. Which of the following statements is true?

A. In order to become incorporated, a closely-held firm must make an initial public

offering (IPO) of its shares on an organized stock exchange.
B. Public sector enterprises do not have publicly traded stock.
C. One advantage of an initial public offering (IPO) is that it allows a firm to obtain the
benefits of limited liability.
D. A publicly traded firm cannot become closely-held or private.

10. A monopolist with a constant marginal cost of production of 10 maximizes its profit by
choosing to produce where the price elasticity of demand is –3.
(Recall that MR = p(1 + 1/ε) where MR is marginal revenue, p is price and ε is the point
price elasticity of demand.)

A. If price is decreased (from its profit maximizing level) by a small amount, revenue of
the monopolist will increase.
B. If the monopolist’s fixed cost increases, its profit maximizing price also increases.
C. The price set by the monopolist is equal to 30.
D. Since marginal cost is constant, both profit-maximizing and revenue-maximizing
quantities are equal.

11. Suppose there are 30 identical, perfectly competitive firms. In the short-run competitive
equilibrium, each firm is earning $500 in revenue, has variable costs equal to $400 and
fixed costs equal to $200. How many firms will there be in this industry in the long run?

A. Less than 30
B. 30 (the same amount)
C. More than 30
D. There is insufficient information to determine the answer.

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12. A short-run competitive equilibrium is considered efficient because

A. Firms are earning positive profits

B. Consumer surplus is maximized
C. There does not exist an additional transaction that would make both a buyer and
seller better off.
D. All of the above

13. A computer hardware firm sells both laptop computers and printers. It has a large
inventory of laptops and printers that it wants to sell, so it has no variable production
cost. Assume that it has 3 customers and that these customers’ reservation prices are as
follows:

Laptop Printer Bundle

Helen $800 $100 $900
Isobel $1,000 $50 $1,050
James $600 $150 $750

A. The reservation prices are positively correlated.

B. The maximum profit from pure bundling exceeds the maximum profit from separate
(stand-alone) pricing by more than $200.
C. The maximum profit from pure bundling exceeds the maximum profit from separate
(stand-alone) pricing, but by less than $200.
D. Pure bundling provides no advantage over separate (stand-alone) pricing in this
case.

14. The following diagram shows demand and marginal cost for a monopoly firm. There are
no fixed costs.

A. Under perfect price discrimination, profit is A + B + D.

B. Under (imperfect) individual price discrimination, profit must exceed A + B + D.
C. If the firm could subdivide the market into two groups and price discriminate
between those groups, there would be no deadweight loss.
D. None of the above.

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15. A buyer has an inverse demand function given by p = 90 – Q. In the following diagram,
panel (a) shows the consequences of nonlinear price discrimination (quantity
discrimination) if the firm charges $70 each for the first 20 units and $50 for any
additional units. Panel (b) illustrates profit-maximizing uniform monopoly pricing.
Marginal cost is constant at 30. There are no fixed costs. Identify the correct statement
(for this case) from the alternatives below

A. The buyer would prefer the nonlinear pricing structure to uniform monopoly pricing
in this case.
B. Nonlinear price discrimination is efficient in that total surplus is maximized.
C. Under profit-maximizing two part pricing, profit would exceed $1600.
D. Deadweight loss is higher under nonlinear price discrimination than under uniform
pricing.

16. Consider the Bertrand model with two firms producing identical products. Firm 1 has
constant marginal cost equal to $5 and Firm 2 has constant marginal cost equal to $10.
Which of the following statements is true?

A. The Bertrand-Nash equilibrium price is $10.

B. The Bertrand-Nash equilibrium price is $5.
C. In the Bertand-Nash equilibrium, Firm 1 will earn positive profits.
D. In the Bertand-Nash equilibrium, neither firm will earn positive profits.

17. In the model of monopolistic competition with symmetric firms, which of the following
statements is true?

A. Firms earn positive above-normal profits in the long-run

B. P > MC
C. There are significant barriers to entry in the long run.
D. None of the above.

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18. Suppose a two-player static game has one pure strategy Nash equilibrium.

A. The Nash equilibrium might also be a dominant strategy equilibrium.

B. Because there is just one Nash equilibrium, there can be no dominant strategy
equilibrium.
C. The Nash equilibrium might involve a player choosing a strategy that is not a best
response to the other player’s strategy.
D. A dominant strategy equilibrium must be a prisoners’ dilemma outcome.

19. In the following payoff matrix, Coke and Pepsi have two choices available to them
regarding their advertising budgets. In each cell the number on the left is the profit of
Coke and the number on the right is the profit of Pepsi. Which of the following
statements is true?

Pepsi
Low High Advertising
Advertising
Low Advertising 100, 50 90, 55
Coke High Advertising 90, 40 95, 45

A. The unique Nash equilibrium is for both firms to use Low Advertising.
B. The unique Nash equilibrium is for both firms to use High Advertising.
C. There is more than one pure strategy Nash equilibrium in this game.
D. None of the above.

20. The payoff matrix below shows the payoffs for a Rock-Paper-Scissors game between
players Angela and Betty.

Angela
Rock Paper Scissors
Rock
0 0 -1 1 1 -1
Paper 1 -1 0 0 -1 1
Betty
Scissors -1 1 1 -1 0 0

A. There is no Nash equilibrium in this game.

B. There are multiple Nash equilibria in this game.
C. There is no maximin solution in this game.
D. There is a mixed strategy Nash equilibrium in this game.

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1. a) Supply and Demand: Suppose that the demand function for haircuts in a small town is
is Qd =500 – 30p, where Qd is quantity demanded per month and p is the price haircuts. The
supply function is given by Qs = 100 + 20p – 5w, where Qs is the quantity supplied and w is the
hourly wage of barbers. If the current equilibrium price is p = $9, calculate the prevailing
market wage rate of barbers. Illustrate in the diagram how an increase in the wage rate of
barbers affects the equilibrium price and quantity and state in words the direction of these
changes.

16.66

500
Quantity (Q)

b) Cost curves: A computer chip manufacturer has a short-run cost function that is given by
C = 100 + 10q. For this firm

Marginal cost (MC) = ______________

Average variable cost (AVC) = ____________________
Average (total) cost (AC) = __________________________

Draw these curves in the following diagram.

Quantity (q)

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2. Regression

a) Suppose the data in the four scatterplots below is used to estimate the following linear
regression: Y = a + bX + e where Y is CEO salary and X is one of four explanatory variables.

A CEO Salary ('000s $) B CEO Salary ('000s $)

XA XB

C CEO Salary ('000s $) D

CEO Salary ('000s $)

XD
XC

Use a √ (check mark) to identify which regression (A, B, C or D) is expected to:

Make one choice per row.

(i) Have the highest R2 A□ B□ C□ D□

(ii) Have an estimate of b that is closest to zero A□ B□ C□ D□

(iii) Should be estimated with a quadratic, Y = a + bX + cX2 + e A□ B□ C□ D□

(iv) Have a negative value for the estimated intercept, a. A□ B□ C□ D□

(v) Which of the four scatterplots is most likely to have a very large standard error for the

estimate of b? A □ B□ C □ D □

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b) There are four X axis variables associated with the four scatterplots in part (a):
CEO Age (ranging from 30 to 75) Number of Employees in CEO’s Firm
Number of Cousins that CEO has Last Year’s Salary for the CEO

Your task is to choose the best match of these four explanatory variables with the four graphs
based on what we might expect to see in the real world.
Make one choice per row.

(i) Best match for CEO Age (ranging from 30 to 75) A□ B□ C□ D□

(ii) Best match for Number of Employees in CEO’s Firm A□ B□ C□ D□

(iii) Best match for Number of Cousins that CEO has A□ B□ C□ D□

(iv) Best match for Last year’s salary for the CEO A□ B□ C□ D□

Based on the information provided in both parts of this question, indicate the multivariate
regression equation that you would propose using to estimate the determinants of CEO
salaries.

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3. a) Monopoly. Assume that Christy owns a factory that produces a specialty on-line service
in a small town. The inverse market demand function for her product is given by p = 240 – 4Q.
The cost function is C = 40Q + Q2. Calculate Christy’s profit-maximizing price and quantity.
Illustrate your results in a well-labeled diagram. Also calculate Christy’s profits. (You do not
need to illustrate the amount of profit on the diagram.)

Quantity (Q)

b) Managerial Objectives. Now assume that Christy hires Paul to manage her firm. Upon
Paul’s insistence, Christy agrees to pay Paul 25% of the firm’s revenue. Assuming that Paul
maximizes his own income, calculate the quantity he decides to produce. What is Paul’s
compensation under this scheme? If Christy wants to use a profit-sharing contract (instead of
revenue sharing), what percentage of profits must she offer Paul so that he is at least as well
off under profit-sharing as under revenue-sharing?

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4. Perfect Competition

Assume that the concentrated orange juice industry is perfectly competitive. There are 50
identical firms. Each firm has the following total cost function in the short run and the long
run: C (q) = 36+11q+q2 where q is quantity measured in tons of concentrated orange juice.
(Do your working in the blank area after each part of the question.)

i) The marginal cost function for each firm is _____________________. It follows that the equation

for the firm’s supply function is __________________, provided price exceeds average variable cost.

(Hint: The supply function shows q as a function of P).

ii) The average variable cost function for each firm is ______________________. It follows that firms

will shut down in the short-run if the market price is less than $________________.

iii) The average (total) cost function for each firm is __________________. It follows that the each

firm will exit the industry in the long run if the market price is less than $_____________ .

iv) Suppose that market demand is given by Q = 445 –5P. The long run industry equilibrium

quantity is _______________ and the price is _________________.

v). In the long run there are _________ firms and each firm produces quantity _________.

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5. Pricing With Market Power

a) Jason’s sandwich shop is trying to come up with a strategy to price the two items it sells for
lunch: soup and sandwiches. The table below shows the willingness to pay (reservation
prices) for four consumers that buy lunch at Jason’s. Assume costs are zero.

Consumer Soup Sandwich Bundle

Aphrodite 2 9
Apollo 9 2
Athena 7 8
Artemis 8 1

Fill in the bundle column showing each person’s maximum willingness to pay for the bundle,

Jason’s maximum profit if he uses separate (stand-alone) pricing is ______________ and he sells

___________ bowls of soup and _______________ sandwiches.

Jason’s maximum profit if he uses pure bundling is _____________ and he sells __________ bundles.

If Jason uses mixed bundling, he earns _____________ by charging __________ for soup, _________ for

sandwiches and _____________ for the bundle.

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b.) Squamish White Water (SWW) sells white water canoeing adventures. Daily inverse
demand in the summer is given by p = 160 – q. In the winter, daily inverse demand is given by
p = 100 – 2q. Marginal cost is 20 in both seasons and there are no fixed costs. SWW has 60
canoes (one person per canoe) so its daily capacity is 60.

SWW uses profit-maximizing peak load pricing. The diagram below illustrates this situation.
Calculate the intercepts where the dashed lines reach the axes and put them on the diagram
and label the lines on the figure.

Now SWW’s canoe supplier offers SWW a special arrangement. It will give additional canoes
to SWW if SWW pays the supplier $5 for each canoe ride taken in one of those additional
canoes. Therefore MC for these additional canoes is 20 + 5 = 25. Do not change the above
diagram but state in words how this would affect the diagram and state how many additional
canoes SWW would want to take on this basis.

The two main changes to the diagram would be:

i)__________________________________________________________________________________________________________

ii)_________________________________________________________________________________________________________

SWW would take __________ additional canoes on this basis from the supplier.

Show your working below.

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6. Duopoly

Consider a market for a homogenous product with linear demand and two identical Cournot
duopoly firms, Firm 1 and Firm 2. The marginal cost of production for each firm is constant
and is equal to $20. Market demand is given by inverse demand function P = 200 – 2Q where P
is the market price and Q is total production by the two firms (i.e., Q = Q1 + Q2).

a. Find the best response functions of the two firms and illustrate them in an appropriate
diagram. Label the Cournot-Nash Equilibrium quantities on your diagram. Put Q1 on the
horizontal axis, put numbers for intercepts on the axes and indicate which best response
function applies to each firm.

b. Calculate the level of output for each firm if they decide to collude to produce the monopoly
quantity. Assume that each firm produces exactly half of this output. Mark this point on your
diagram above and explain below why this point is not a Cournot-Nash Equilibrium. (5 pts)

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7. Static Games

a) Each of two neighboring cities (Newtown and Oldtown) are simultaneously deciding
whether to allow a multinational firm to build a large casino on city-owned vacant land in
their city. The firm would be happy to build casinos in both cities if allowed to do so.

Newtown
Allow Casino Disallow Casino
Allow Casino X, Y 120, 85
Oldtown
Disallow Casino 85, 120 100, 100

Assume X = Y < 100. What is the minimum value for X (and Y) that make this game a
prisoners’ dilemma. Explain briefly.

Now suppose Y = 80 (and X is no longer necessarily equal to Y or less than 100). What range
of non-negative values for X would lead to two pure strategy Nash equilibria? Explain briefly.

If both cities disallow the casino, each gets a payoff of 100. What do you think this value might
represent?

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 b) Once again suppose Oldtown and Newtown are simultaneously choosing whether or
not to allow a multinational firm to build a large casino in their city. The two cities face a
coordination problem because each city wants a casino but only if the other city does not
have a casino. If both cities have a casino then both will get lower benefits because of
insufficient demand. This situation is illustrated by following payoff matrix.

Newtown
Allow Casino Disallow Casino
Allow Casino 50, 70 120, 85
Oldtown
Disallow Casino 85, 130 100, 100

The Pareto criteria [DOES DOES NOT] (circle one) help us predict which of the two cities
will end up with the Casino because

_______________________________________________________________________________________________________

Suppose that the two cities are able to engage in pre-play communication and suppose
further that it is possible to sign an agreement in which one city can pay compensation to
the other city for agreeing not to build a casino. Which city is likely to pay the
compensation (and then build the casino) and which city is likely to receive the
compensation (and not build the casino)?

CITY WHICH BUILDS is (circle one): Oldtown Newtown

because ________________________________________________________________________________________

I would expect the amount of compensation paid under this agreement to be in the range
between _________ and ___________

because _________________________________________________________________________________________________

____________________________________________________________________________________________________________

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Please detach this page and use it as scrap paper.

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