Econ Exam 3
Traditionally the Harrison Resort Hotel sponsors an annual festival, making a significant investment in marketing to attract tourists to the Harrison Resort. Julie, the manager of nearby Lakeshore Flowers, normally orders extra merchandise in preparation for the festival. However, Harrison was recently bought by a large chain, so its management has changed. Julie is not sure that the new manager knows that investing in marketing will pay for Harrison. The corresponding payoff matrix is shown to the right. What is the Nash equilibrium? What can Julie do to make sure that Harrison's new manager does what's best for the resort (and also best for her)?
The Nash equilibrium is for Harrison and Julie to invest. Julie and the manager could form a joint venture.
Given the diagram to the right, use the supply-and-demand curves provided to analyze the effects of usury laws on consumer loans. (Hint: The supply curves and demand curves are drawn for a group of individuals who have a high probability of defaulting on their loans.) Use the line drawing tool to draw a horizontal line at a rate of interest that makes the usury laws effective.
New horizontal line must be below the equilibrium point The effective usury law creates a shortage in the market for consumer loans.
An insurance agent (interviewed in Jonathan Clements, "Dare to Live Dangerously: Passing on Some Insurance Can Pay Off," Wall Street Journal, July 23, 2005, D1) states, "On paper, it never makes sense to have a policy with low deductibles or carry collision on an old car." But the agent notes that raising deductibles and dropping collision coverage can be a tough decision for people with a low income or little savings. Collision insurance is the coverage on a policyholder's own car for accidents where another driver is not at fault. Suppose that the loss is $4,300 if an old car is in an accident. During the six-month coverage period, the probability that the insured person is found at fault in an accident is StartFraction 1/36. Suppose that the price of the coverage is $150. Should a wealthy person purchase the coverage? Should a poor person purchase the coverage?
No, the expected loss over the term is $119.00, hence the coverage is not justifiable. Yes, because person cannot afford to replace the car.
Use a game tree to illustrate why an aircraft manufacturer may price below the current marginal cost in the short run if it has a steep learning curve. (Hint: Show that learning by doing lowers its cost in the second period.) Assume for simplicity the game tree is illustrated in the figure to the right. Pricing below marginal cost reduces profits but gives the incumbent a cost advantage over potential rivals. What is the subgame perfect Nash equilibrium?
The Nash equilibrium is for the incumbent to price below marginal cost and for the rival to only enter if the incumbent prices above marginal cost.
An automobile company has two factories, one in Vietnam and one in Australia each with the same number of workers. The Vietnamese factory can produce either 150 engines or 100 transmissions per day. The Australian factory can produce either 100 engines or 75 transmissions per day.
The Vietnamese factory has a comparative advantage in the production of engines.
Some sellers offer to buy back a good later at some prespecified price. Why would a firm make such a commitment?
The firm is in effect guaranteeing the product will hold a certain value, and thus is trying to eliminate asymmetric information to increase the demand for its product.
Variance formula
[%*(Earnings - Expected Value)^2]
Which of the following is likely to increase the exchange rate of Yen to euros
a decrease in investment opportunities in the eurozone
Negative externalities are created when
a driver drives recklessly on a busy highway.
"Cheap talk" is considered cheap because
a firm can say anything, but may actually do something different.
According to a 2007 study by the Federal Trade Commission, 4.8 million U.S. consumers were victims of weight-loss fraud, ranging from a tea that promised to help you shed the pounds to fraudulent clinical trials and fat-dissolving injections. Do these frauds illustrate adverse selection or moral hazard? Weight loss frauds are an example of
adverse selection because weight-loss companies know more about the effectiveness of their products than consumers.
Two firms compete by advertising. Given the payoff matrix to this advertising game, identify each firm's best response to its rival's possible actions. If Firm 2 does not advertise, then Firm 1 should _________ and if Firm 2 advertises, then Firm 1 should _____________ If Firm 1 does not advertise, then Firm 2 should ___________ and if Firm 1 advertises, then Firm 2 should ______________ Does either firm have a dominant strategy? Firm 1's dominant strategy is to _________ and Firm 2's dominant strategy is to _________ . What is the Nash equilibrium?
advertise, advertise advertise, advertise advertise, advertise The Nash equilibrium is for both firms to advertise.
In contrast to expected utility theory, prospect theory:
allows people to treat gains and losses asymmetrically.
Catherine is risk−averse. When faced with a choice between a gamble and a certain level of wealth she will
prefer the gamble if the expected utility from it is higher than the utility from the certain level of wealth.
Joe lost a substantial amount gambling at a race track today. On the last race of the day, he decides to make a large enough bet on a longshot so that, if he wins, he will make up for his earlier losses and break even on the day. His friend Sue, who is up for the day, makes just a small final bet so that she will end up ahead for the day even if she loses the last race. This is typical race track behavior for winners and losers. Would you explain this behavior using over-confidence bias, prospect theory, or some other principle of behavioral economics? Joe and Sue's behavior can be explained by
prospect theory because they are making decisions relative to their wealth at the start of the day.
The government sets a minimum wage above the current equilibrium wage. What effect does the minimum wage have on equilibrium in the labor market? What are its effects on consumer surplus, producer surplus, and total surplus in the labor market?
raises, decreases will decrease, could increase or decrease, will decrease employers, workers
Regulatory capture is where
regulators of an industry look out for the industry instead of society.
Many substandard condo developments have been built by small corporations that declare bankruptcy or go out of business when legal actions are started against them by condo buyers. What legal remedies might reduce this moral hazard problem? Legal remedies that might reduce moral hazard among small corporations that build condos include If you were considering buying a condo in a new building, what characteristics of the builder would make you more likely to buy? Explain. To reduce problems associated with moral hazard, you should be more willing to buy a condo from a builder who
required these builders to post a surety bond. is well-known with a good reputation.
Which of the following is a simultaneous decision game?
rock, paper, scissors
A U.S.−based multinational has two subsidiaries, one in Lithuania where the tax rate is 15%, and one in Ireland where the tax rate is 2%. The tax rate in the U.S. is 35%. If the Lithuanianminus−based subsidiary is transferring a good to the Irish subsidiary and the goal is to avoid taxes, it will
set the transfer price to the Irish subsidiary at marginal cost.
A familiar adage is that it is important to "never underestimate a rival." Does behavioral game theory also suggest that it is important not to overestimate rivals? Explain. Behavioral game theory suggests that managers
should not overestimate their rivals because they may have psychological biases.
An informed party can use ________ to give information to an uninformed or lesser−informed party.
signaling
Standard Deviation formula
square root of the variance
The figure at right shows a graph of the market for pizzas in a large town. Suppose that concern over dietary habits has led the government to impose a restriction that limits suppliers to produce only 40 pizzas. As a result, for prices greater than $7, the
supply curve is vertical
If the U.S. can produce pizza for $5 each and barrels of beer for $25 each, and Germany can produce pizza for $7 each and barrels of beer for $21 each, then
the U.S. will produce pizza and trade with Germany for beer.
If a Cournot duopolist announced that it will double its output, the other firm does not view the announcement as credible because
the announcing firm's profits will fall if it carries out the threat.
If a production process creates pollution, a competitive market produces excessive pollution because
the firms do not include the social cost of the pollution in their profit−maximizing decisions.
One of the major effects of trade liberalization has been
the globalization of supply chains.
Oculus and Maxygen are small drug companies. Oculus has obtained a patent on a new antibiotic that is effective against an emerging superbuglong dash—a bacteria that is resistant to traditional antibiotics. Unfortunately the Oculus drug has severe side effects, making the drug unsuitable except for patients who are desperate. Ownership of this drug is worth $30 million to Oculus under the current situation. Maxygen has a patent on another drug that is of no therapeutic value in itself so the drug generates no current income for Maxygen. However, when combined in a particular way with the Oculus drug, it dramatically reduces the negative side effects. The value of the two drugs together is estimated at $40 million. Maxygen is negotiating to sell its patent to Oculus. Situations of this type are fairly common in the drug business and sales of patent rights are common. However, sometimes negotiations over such sales take a long time and sometimes negotiations are unsuccessful. Why would such wasteful outcomes occur? Nash bargaining sometimes fails because
the parties behave irrationally. OR the parties have incomplete information
If the government places a $1.20 tax on each pizza sold
the supply curve will shift left by $1.20.
The winner's curse occurs when
the winning bid is higher than the good's common value
The figure shows the effect on the exchange rate (U.S. dollars per euro) on the demand for euros by U.S. residents. What would happen if the U.S. government tried to establish a fixed exchange rate at X1 after demand shifted to D2? If the U.S. government established a fixed exchange rate at Upper X 1X1 with demand at D2, then
there would be a shortage/surplus of euros.
If the managers of your firm have bounded rationality, then
they are limited in their ability to calculate and may not succeed in maximizing profits.
An incumbent firm uses limit pricing
to set price below a potential rival's marginal cost, thus making entry unprofitable.
In a bargaining game, players
voluntarily negotiate
A holdup problem occurs
when one firm must make a specific investment and a second firm takes advantage of it.
Rent seeking is
where firms expend effort and money to profit from government actions.
In the Mini-Case "Tit-for-Tat Strategies in Trench Warfare," why did soldiers advise new recruits not to shoot at the enemy? In the trench warfare of World War I, soldiers advised new recruits not to shoot at the enemy because the enemy
would then shoot at them.
Your U.S.−based company is selling parts to a company in Chile and the company will pay you 9.8 million pesos in 3 months. The current exchange rate is 490 pesos/US$. If the exchange rate at the time of payment is 510 pesos/US$
you earn less profit.
The state of California set up its own earthquake insurance program in 1997. Because the state agency in charge has few staff members, it will pay private insurance carriers to handle claims for earthquake damage. These insurance firms will receive 9% of each approved claim. Is this compensation scheme likely to lead to opportunistic behavior by insurance companies? What would be a better way to handle the compensation?
Yes, it creates a moral hazard. It would be better to pay a flat fee per claim plus a modest hourly rate to handle claims.
Bargaining does NOT normally occur in
posted price markets
Regarding fixed costs of entry,
potential entrants are affected by them while incumbents are not.
A firm charging prices below marginal cost is said to be engaged in
predatory pricing.
Global Gas International offers to contract the Halidurton Heavy Construction Corporation to build an oil pipeline from Canada to New Orleans that will provide Halidurton $600 million in income. The probability that the oil pipeline will leak, causing environmental damage is θ. If so, the legal liability will be $6,000 million. If Halidurton is risk neutral and liable for the damages from a leak, what is the thetaθ such that it is indifferent between accepting and rejecting the contract? If Halidurton is risk averse and fair insurance is offered, how much insurance would it buy? Assume θ is such that it is worthwhile for Halidurton to build the oil pipeline. If Global Gas International will partially indemnify Halidurton so that the largest damages that Halidurton would have to pay is $3,000 million, what is the thetaθ that leaves it indifferent about accepting the contract?
10% 25% 600-6,000θ 20% 600 - 3,000theta
Suppose that the only two firms in an industry face the market (inverse) demand curve p=130−Q. Each has constant marginal cost equal to 10 and no fixed costs. Initially the two firms compete as Cournot rivals (Chapter 11) and each produces an output of 40. Why might these firms want to merge to form a monopoly? What reason would antitrust authorities have for opposing the merger? (Hint: Calculate price, profits, and total surplus before and after the merger.)
400, 20, 1,400, 1,000 If its p = 100 - Q with 16 and 28: 196, 14, 686, 490
Which of the following is an alternative to patents that still encourages research?
A. the government funding research by firms B. offering a prize for discovery C. government grants to universities D. All of the above. (Answer)
Use Akerlof's lemons model to explain why restaurants that cater to tourists are likely to serve low quality meals. Tourists will not return to this area, and they have no information about the relative quality of the food at various restaurants, but they can determine the relative price by looking at menus posted outside each restaurant.
Before eating, consumers cannot determine the quality of the food; they can only compare relative prices and type of cuisine. Since tourists will not return, the restaurant owner has an incentive to reduce the quality to save money.
If the Mexican peso (MXN) to Brazilian real (BRL) exchange rate goes from 5.9 MXN/BRL to 5.2 MXN/BRL
Brazilians decrease their demand for Mexican goods
Curtis manages an electronics store in Wichita, Kansas. He considers carrying either cameras from Nikon Americas that come with a U.S. warranty or black market Nikon cameras from a European supplier, which are the same cameras but their warranties are only good in Europe. The black market cameras have a lower wholesale price. Curtis earns 10% of the store's profit (and no wage). If the store loses money, he leaves with nothing. He believes that if he sells the Nikon Americas cameras, the store's profit will be $1,600,000. The profit on the black market cameras is more uncertain—will locals be willing to buy a less expensive camera without a warranty? If he goes with the black market camera, he believes that there's a 50% chance that the store's profit will be $4,000,000 and a 50% probability that the store will lose $1,200,000. Curtis and the store's owner are both risk neutral. Which camera does Curtis choose to sell? What choice would the owner prefer (if he was fully informed)?
Curtis will choose to sell balck market Nikons and the store owner will prefer Curtis sell Nikons Americas cameras. Curtis would be dissuaded from selling black market cameras if his compensation were a fixed salary of $160,000 unless the store loses money.
An auction in which the price announced by the auctioneer DESCENDS is called a
Dutch Auction
Receiving flu shots provides private benefits to recipients. However, since pandemic influenza spreads between cities through the international airline network and between cities and rural areas through ground transport, it may be in the self-interest of rich countries to pay for flu shots in poor countries (Bobashev et al., 2011). Discuss using the concepts of externalities, public goods, and free riders.
Flu shots generate positive externalities. Flu shots are most accurately categorized as a public good As such, with flu shots, there is free riding
Calculating Expected Value
For each outcome, multiply the probability of that outcome by the amount you will receive. Add together these amounts over all the possible outcomes. percentage times value plus percentage times value...and so on
In the presence of asymmetric information, a piece−rate contract
In the presence of asymmetric information, a pieceminus−rate contract
Woz Enterprises specializes in electrical components. The market for one particular component is perfectly competitive and in long run equilibrium. The marginal cost is constant at 30. Woz can develop a much cheaper process for producing this component, lowering its marginal cost to 10. The R&D cost of developing the new process would be F and Woz would be able to obtain a patent for it and become a monopoly supplier of this component. Demand for the product over the relevant period is given by p=46−2Q. Show the R&D investment would be worthwhile (raise profit) for Woz if F=62 but not if F=222. If F=62, then the monopoly's profit including the cost of the R&D investment if it invests is
Make equation MR (given in problem) = 46 - 4Q so 10 = 46 -4Q Q = 9 Solve for p using original (2Q not 4 Q)to get $28 So monopoly profit (pi) is pi = p x Q - 10Q - F (remember F = 62) pi = 100 So monopoly profit (pi) is pi = p x Q - 10Q - F (remember F = 222) pi = -60 Critical value for F by making equation equal to zero 0 = p x Q - 10Q
During the Great Recession, many homeowners around the world owed more on their houses than they are worth. Often, U.S. borrowers who cannot meet their mortgage payments can give their houses to the banks that hold their mortgage without declaring bankruptcy or being held accountable for any unpaid balance (known as a non-recourse loan). However, Europeans, who face tougher bankruptcy laws, are responsible for unpaid mortgage balances even after losing their homes (Gabriele Steinhauser and Matthew Dalton, "Lingering Bad Debts Stifle Europe Recovery," Wall Street Journal, January 31, 2013). Using a decision tree, show that Americans are more likely to buy houses than Europeans, all else equal. Suppose the decision tree illustrates the situation during a severe recession. If the consumer buys a home, then they are assumed to be unable to meet their mortgage payments, although they receive some enjoyment from living in the house. If the bank loses the unpaid mortgage balance when the consumer gives house to the bank, then the consumer's payoff is 4 and the bank's payoff is −20. If the bank makes the consumer pay the unpaid mortgage balance, then the consumer's payoff is −16 and the bank's payoff is 20. If the bank pays unpaid mortgage balances (as may occur in the U.S.), then the consumer should ______ a house; if the bank makes the consumer pay unpaid mortgage balances (as typically occurs in Europe), then the consumer should _______
buy, not buy
As a result of the North America Free Trade Agreement, many iconic "American" cars are not assembled in the United States. Explain why. Some "American" cars are not assembled in the United States because other countries
can assemble cars at lower opportunity cost.
Consider the network scheduling profit matrix. Can the Pareto Criterion help the networks settle on a single equilibrium? Explain. The Pareto Criterion
cannot help the networks settle on a single equilibrium because no Nash equilibria is better for both networks
Rental cars are sold on the used car market are sold for lower prices than cars of the same model and year that were owned by individual owners. Does this price difference reflect adverse selection or moral hazard? Cars that were used as rentals sell for less than used cars owned by individuals because Could car rental companies reduce this problem by carefully inspecting rental cars for damage when renters return such cars? Problems associated with moral hazard Why do car companies normally perform only a cursory inspection? Companies that rent cars often only perform cursory car inspections because
car renters may drive rental cars harder due to moral hazard. can be reduced with inspections because they are a form of monitoring. car inspections are expensive.
Outsourcing generally results from
comparative advantage.
A price ceiling that is set below the equilibrium price
creates a shortage
A ban on imports, a tariff, or a quota raise the price to domestic consumers. This means that consumers will buy less of the product at a higher price. The loss associated with this is called
deadweight loss
Use a supply-and-demand diagram to show the effects of occupational licensing on the equilibrium wage and number of workers in an occupation as described in the Mini-Case "Occupational Licensing." Consider the labor market illustrated in the figure to the right. Suppose the government begins requiring occupational licenses.
draw a supply curve line above the original
Outsourcing of services by American firms has contributed significantly to wage growth in India. Explain why using a graph of the Indian labor market.
draw new demand curve above the original with new equilibrium
To prevent overfishing, could regulators set a tax on fish or on boats? Explain and illustrate with a graph. Assume the figure to the right illustrates the competitive market for fishing. The market's private marginal cost curve is MC Superscript pMCp. 1.) Using the point drawing tool, identify the competitive market equilibrium price and quantity. Label this 'e Subscript ec.' 2.) Using the line drawing tool, draw a new marginal cost line representing the social marginal cost of fishing. Label this 'MC Superscript sMCs.' 3.) Using the point drawing tool, identify the socially optimum price and quantity. Label this point 'es.' What can be done to prevent overfishing? To prevent overfishing, the government could
draw the new mc curve with the same bottom point as old but sloped higher (above) original tax fish caught
Chanel perfume is sold in France and in the United States. Assume initially that one euro is worth $1.25 and that a 100 ml bottle of perfume sells for $84 in the United States. If Chanel does not price discriminate internationally, what is the price that would be paid for this perfume in France? Next, explain what happens if the value if the euro rises by 25% in terms of the dollar. Now suppose that Chanel decides to price discriminate and finds that it would maximize its profit by lowering its price in the United States to $65 and raising its price by 20% in France. Explain why. Chanel might maximize profit by price discriminating because
for part A: divide $84 by 1.25 for part B: multiple 1.25 x .25 and add what you get back to 1.25, then divide $84 by the new number for part C: demand for the perfume in the U.S. is lower.
Priscilla hires Arnie to manage her store. Arnie's effort is given in the left column of the table. Each cell shows the net profit to the Priscilla (ignoring Arnie's cost of effort). Arnie's personal cost of effort is 0 at low effort, 10 at medium effort, and 30 at high effort. It is equally likely that demand will be low or high. Arnie and Priscilla are risk-neutral. They consider two possible contracts: (1) fixed fee: Arnie receives a fixed wage of 1010 and a bonus of 80% of store net profit; and (2) profit sharing: Arnie receives 50% of the firm's net income but no wage. With the fixed fee plus bonus contract, Arnie will put forth ______ effort With the profit-sharing contract, Arnie will put forth _____ effort Which contract does each prefer?
high, medium Arnie prefers the fixed fee with bonus contract and Priscilla prefers the profit-sharing contract
Priscilla hires Arnie to manage her store. Arnie's effort is given in the left column of the table. Each cell shows the net profit to the Priscilla (ignoring Arnie's cost of effort). Arnie's personal cost of effort is 0 at low effort, 10 at medium effort, and 30 at high effort. It is equally likely that demand will be low or high. Arnie and Priscilla are risk-neutral. They consider two possible contracts: (1) fixed fee: Arnie receives a fixed wage of 10 and a bonus of 80% of store net profit; and (2) profit sharing: Arnie receives 50% of the firm's net income but no wage.
high, medium, prefers the fixed fee with bonus contract, prefers the profti-sharing contract
A distribution with "fat tails" may reflect
higher probability of a rare event a "black swan" event higher risk than a normal distribution Answer: all of the above.
dropbox ch 12-17
https://www.dropbox.com/sh/4r985guw6cjhuty/AAAD1SEu39nVkxFfikmnJqc1a?oref=e
Rent seeking in the form of lobbying for an increase in import tariffs by domestic producers
increases the deadweight loss.
A price floor that is set below the equilibrium price
is non-binding
ABC Software, a small software producer, decides to renovate its premises. Instead of hiring an outside contractor and tradespeople, the firm decides to use its employees—secretaries, programmers, sales staff, and others—to do most of the work. The firm makes all its employees try painting and carpentry and other tasks needed for the renovation and selects the people with the strongest skills in those areas to take time off from their regular tasks and work on the renovation. Is this strategy a good one? Why or why not? This strategy
is not a good one because it should be based on opportunity costs.
If a change passes the cost−benefit test, then
it may be a Pareto improvement.
A firm becomes a multinational enterprise when
it undertakes foreign direct investment.
List at least two major advantages and two major disadvantages of being the first firm in a new product class. Two major advantages of being the first firm in a new product class include (check the two correct answers): Two major disadvantages of being the first firm in a new product class include (check the two correct answers):
lowering marginal costs, learning by doing getting held up by other firms, producing inadequate products.
One interesting feature of a prisoner's dilemma game is that
non−cooperative behavior leads to lower payoffs than cooperative behavior.
In the case of a good that has no exclusion and no rivalry, private markets fail because
of free−ridership
