Managerial Economics

Indian School of Business

DHM 1, 2021-22
Final Exam

1. Jack loves to play loud music in his apartment. His total benefit (in terms of money) from
playing music for Q hours is given by 100Q -Q2. Jack’s neighbor Jill does not like Jack’s taste in
music. Jill’s disutility or loss (in terms of money) from being forced to hear Jack’s music is given
by 20Q where Q is the number of hours of music Jack plays. Assume that Jill has the right to an
environment free of sound pollution and that the Coase theorem holds here. What is the
maximum that Jack is willing to pay Jill to be able to continue to play music?

Please input your numerical answer. The answer must be a number rounded to two decimal
places. Please show work on your rough sheet.

Answer: 2400
Since Coase theorem holds here, bargaining will lead to the efficient outcome. At the efficient
outcome SMB=SMC which implies 100-2Q =20 which means that Q =40. Total benefit to Jack
when playing 40 hours of music = 100*40-40*40 = 2400. Therefore, the maximum that Jack is
willing to pay is 2400.

2. Consider the game below:

Jack
L C R
U 5,3 7,2 2,1
Jill M 1,2 6,3 1,4
D 4,2 6,4 3,3

What is the Nash Equilibrium of this simultaneous game?

a. (U,L)
b. (U,C)
c. (U,R)
d. (M,L)
e. (M,C)
f. (M,R)
g. (D,L)
h. (D,C)
i. (D,R)

The Best responses are in bold.

 3. Consider the game below

Jack
L C R
U 5,3 17,2 2,1
Jill M 1,20 15,3 1,4
D 4,2 6,6 7,8

Suppose Jill and Jack communicate with each other before playing this game. What is your
prediction in this game?

a. (U,L)
b. (U,C)
c. (U,R)
d. (M,L)
e. (M,C)
f. (M,R)
g. (D,L)
h. (D,C)
i. (D,R)

(U,L) and (D,R) are the two Nash Equilibria of the game. Both players are better off in (D,R) compared
to (U,L). Therefore if they communicate before playing they are likely to play (D,R)

4. Consider the game below

Jack
L C R
U 5,3 3,5 2,6
Jill M 6,2 4,4 3,5
D 1,7 6,2 2,6

What is your prediction in this game using iterated elimination of dominated strategies?

a. (U,L)
b. (U,C)
c. (U,R)
d. (M,L)
e. (M,C)
f. (M,R)
g. (D,L)
h. (D,C)
i. (D,R)
Step 1: Eliminate U. Step 2: Eliminate C. Step 3: Eliminate D. Step 4: Eliminate L.
You are left with (M,R), therefore this is the prediction.
 5. Suppose there are 10 fast food vendors in a city. Each vendor can either locate themselves at the
city center or at the city hall. If x vendors locate at city center, then each vendor at city center makes
a profit of 100-9x. All vendors who locate at the city hall make a profit of 40. Assume that this is a
simultaneous game. How many vendors will locate to city center in the Nash Equilibrium? Please
input your numerical answer. The answer must be an integer between 0 and 10. Please show work
on your rough sheet.

Answer =6

Suppose that in the NE, x vendors are at the city hall.

No vendor at city center has incentive to deviate and move to city hall. This means that we must
have 100-9x > 40. This implies x <=6.
No vendor at city hall has incentive to deviate and move to city center. This means that we must
have 40 > 100-(9+1)x. This implies x >=6.
Both conditions are satisfied when x=6.

6. Suppose there are two firms, producing the same good and competing by choosing quantities
(capacities) simultaneously. Each firm has total cost function given as follows.

C(q1)= 10q1
C(q2)= 10q2

Inverse demand in the market is given by P = 100 –Q where Q = q1+q2

What is the Nash equilibrium of this game?

a. 𝑞1 = 20; 𝑞2 = 20
b. 𝒒𝟏 = 𝟑𝟎; 𝒒𝟐 = 𝟑𝟎
c. 𝑞1 = 15; 𝑞2 = 15
d. 𝑞1 = 40; 𝑞2 = 40

Similar questions have been done in lectures and in homework.

7. Consider a household with wealth of Rs. 10 lakhs. Suppose they face a risk of damage to their
house from fire. There can be a large fire in which case the damage is worth Rs 3 lakhs (It costs
3 lakhs to repair and get the house back to the original condition) and there can be a small fire
in which case the damage is worth Rs 1 lakh. The large fire happens with probability 0.1 and the
small fire happens with probability 0.2. Suppose that the household’s utility function from
wealth is given by U(w)=w. What is the household’s maximum willingness to pay for an
insurance that will provide complete coverage, i.e., insurance will take care of the damages
completely.

a. Rs. 50,000
 b. Rs. 60,000
c. Rs. 40,000
d. Rs. 46,562
e. Rs. 54,325
f. Rs. 48,325
g. Rs. 48,693
h. Rs. 55,234
i. None of the other options

Household is risk neutral. Therefore, its maximum willingness to pay is the expected loss which equals
0.1*3 +0.2*1 = 0.5 lakhs = Rs. 50,000

8. Consider the game below:

Jack
L C R
U 5,3 3,5 2,6
Jill M 6,2 10,3 3,5
D 1,7 6,10 2,6

Suppose that jill moves first and then Jack moves after observing the move of Jill. What will be the
outcome of this game?

a. (U,L)
b. (U,C)
c. (U,R)
d. (M,L)
e. (M,C)
f. (M,R)
g. (D,L)
h. (D,C)
i. (D,R)

If Jill chooses U, Jack will choose R and Jill will receive a payoff of 2
If Jill chooses M, Jack will choose R and Jill will receive a payoff of 3
If Jill chooses D, Jack will choose C and Jill will receive a payoff of 6
Anticipating Jack’s move, Jill will choose D and Jack will choose C following Jills move.
 9. Consider the price setting game played by Jio and Airtel below. Each player can choose to set one of
High(H), Medium(M) or Low(L) price for their product. Jio can additionally choose to shutdown(S) its
operations.

Airtel
H M L
H 12,12 -1,6 -2,10
M 6,-1 4,4 -1,5
Jio
L 10,-2 5,-1 1,1
S 0,20 0,15 0,10

a. H is a dominant strategy for Jio

b. M is a dominated strategy for Airtel
c. (L,L) is the unique Nash Equilibrium in this game
d. There are multiple Nash Equilibria in this game
e. None of the options provided are correct

H is not a dominant Strategy for Jio. When airtel plays M the best response of Jio is L

M is not dominated for Airtel. Neither H or L dominates M for Airtel

(L,L) and (H,H) are the two NE in this game.

Therefore (d) is correct