Econ Midterm

What is a "natural monopoly"? How are those markets typically regulated?

A natural monopoly is a market with significant economies of scale over the entire industry output. The economies of scale come from high fixed capital investment (fixed cost or FC) and low marginal cost (MC). The classic example is a public utility such as the power company or water company. Typically their prices aren't directly regulated since if they were regulated to set a price equal to MC, they would probably lose money since FC is very high and MC is low. Rather, they are regulated to charge a price such that they earn a reasonable or "competitive" rate of return (ROR). (This is called ROR regulation, as opposed to price regulation.) In these regulated markets it is customary to have "rate hearings" to assess whether current pricing is leading to a competitive ROR.

What are the characteristics of a monopolistic market?

A single firm producing something with no close substitutes or significant barriers to entry.

Farmer Bill raises chickens which he sells to chicken processors. The market is very competitive. Suggest some ways in which he might gain a competitive advantage.

Given that the market is very competitive, probably the only way to gain a competitive advantage would be a cost reduction strategy, and even that would be difficult to maintain as rival producers could probably achieve the same efficiencies.

What are the characteristics of a perfectly competitive market?

Perfectly competitive markets are characterized as having many firms of equal or similar size an cost structure, no product differentiation and free or easy entry and exist (in the long run.)

Suppose a firm's linear demand is given by P = 250 - 0.25Q and marginal cost is given by MC = 30. (Assume the firm can only set one price.) Calculate the point price elasticity at P* and Q* from part (a) and the price elasticity between prices of 150 and 170 using the midpoint method.

Point: Ep = (Change in Quantity demanded/Change in Price)*(Price/Quantity demanded) Ep = (1/-0.25)*(140/440) = -1.27 Midpont method: Ep = (Change in Quantity demanded/Change in price)*(Price/Change in Quantity demanded) = (1/-0.25)(160/360)* = -1.78 * at P = 150, Q = 400 and at P = 170, Q = 320

Does Apple seem to have a competitive advantage that enables it to sustain positive economic profits? Apply the external (SCP) and internal (RBV) approaches to explain Apple's success.

The external (SCP) approach: Apple produces (among other things) electronic devices such as MP3 players, smartphones, tablets, and computers. These submarkets are characterized by high barriers to entry (economies of scale, learning curve effects, high brand loyalty, intellectual property, network effects, highly efficient supply chains, etc.) and significant product differentiation, which results in relatively low competitive intensity, relatively high prices and profits, and significant innovation and new product development. The internal (RBV) approach: Apple possesses "rare and valuable" resources such as specialized capital equipment and a staggering level of financial capital, in addition to intangible resources such as high brand loyalty, intellectual property, unique creative and executive talent, and perhaps a superior organizational culture. Apple leverages these resources to sustain a competitive advantage.

How do monopolistically competitive (MC) markets differ from perfectly competitive (PC) markets? Are MC firms "stuck" with zero economic profits in the long run? How does competitive strategy in MC markets differ from PC markets?

The key difference is that in MC markets, firms produce a differentiated product and thus experience some degree of market power (price setting ability). As such, they will choose the optimal(profit maximizing) output (where MR=MC) but also set an optimal price (unlike PC firms who are "price takers"). Firms in MC markets tend to earn zero economic profits (like PC firms do) in the long run because of easy or free entry and imitation by other incumbent firms. However, MC firms can innovate and produce new and unique goods that, at least temporarily, generate positive economic profits. So they are not stuck with zero economic profits and at the mercy of overall market conditions in the same sense that PC firms are. Competitive strategy for the MC firm includes product differentiation and lessening competitive intensity.

Suppose the 4th and 5th largest firms have 12% and 8% market shares, respectively. If they were to merge, how would the CR4, CR8 and HHI change?

The merged firm would have 20% market share. The CR4 would increase by 8% and the CR8 would increase by the market share of whatever was the 9th largest firm before the merger. The change in the HHI would be: Change HHI = -(12^2 + 8^2)+20^2 = 192

Explain the relationship between price and the elasticity of demand of your consumers.

The optimal or profit maximizing price is inversely related to elasticity of demand. As your demand is becoming less elastic (or more inelastic), you have more market power and the optimal price is becoming higher. The optimal markup formula is: (P-MC)/P = 1/ | Ep | From this we can see that, given MC, the profit maximizing price increases as the elasticity falls. This makes perfect sense. As your consumers become less sensitive to price, you will charge them more.

What is the difference between "product space" and "geographic space"? If markets are defined too narrowly, how will this impact our assessment of the market power of incumbent firms?

The proper product space includes all the products that are reasonably competing with each other to determine the market price. The proper geographic space includes all the firms (local, regional, national, etc.) that are reasonably competing with each other to determine the market price. Too narrow a market definition in either dimension will leave out close substitutes and will thus tend to overestimate the market power of incumbent firms.

What are some examples of barriers to entry in the industry in which you are currently employed?

This is obviously a wide open question. Barriers to entry may include economies of scale, learning curve effects, brand loyalty, intellectual property (licenses, patents, etc.), network effects, exclusive distributor or supplier contracts, high R&D expenses, and control of key inputs.

A firm started advertising its product and this changed the product's elasticity from -2 to -1.5. The firm should a. Raise price from $10 to $15 b. Reduce price from $15 to $10 c. Raise price from $7.5 to $10 d. Reduce price from $10 to $7.5

a.

A sudden decrease in the market demand in a competitive industry leads to a. Losses in the short-run and average profits in the long-run b. Above average profits in the short-run and average profits in the long-run c. New firms being attracted to the industry d. Demand creating supply

a.

After firm A producing one good acquired another firm B producing another good, it raised the prices for the bundle of goods. One can conclude that the goods were a. Substitutes b. Complements c. Not related d. None of the above

a.

After running a promotional campaign, the owners of a local shoe store decided to decrease the prices for the shoes sold in their store. One can imply that a. The promotional expenditures made the demand for their shoes more elastic b. The promotional expenditures made the demand for their shoes more inelastic c. The promotional expenditures has no effect on the shoe demand elasticity d. The owners got it wrong. To cover the promotional expenses, they should have raised the prices.

a.

Attractive industries have all the following, except a. High supplier power b. Low buyer power c. High entry barriers d. Low rivalry

a.

For products like parking lots and hotels, costs of building capacity are mostly fixed or sunk and firms in this industry typically face capacity constraints. Therefore, a. If SRMR>SRMC at capacity, then the firms should price to fill capacity b. If SRMR<SRMC at capacity, then the firms should price to fill capacity c. If LRMR>LRMC at capacity, then the firms should price to fill capacity d. If LRMR>LRMC at capacity, then the firms should price to fill capacity

a.

Prisoners Dilemma show a. Rational choices lead to bad outcomes b. Rational choices lead to good outcomes c. That there are no ways to learn where the pitfalls lie d. None of the above

a.

The concept that explains firms possessing different bundles of resources is a. Resource heterogeneity b. Resource immobility c. Barriers to entry d. Imitability

a.

Your company has a customer list that includes 200 people. Of those 200, your market research indicates that 140 of them hate receiving coupon offers whereas the remainder really likes them. If you send a coupon mailer to one customer at random, what's the probability that he or she will value receiving the coupon? a. 0.3 b. 0.6 c. 0.70 d. 1.4

a.

A firm that acquires a substitute product can try and reduce inter-product cannibalization by a. Doing nothing b. Repositioning its product or the substitute so that they do not directly compete with each other c. Pricing each product at the same level d. Raising prices on the low-margin products

b.

A perfectly competitive firm's profit maximizing price is $15. At MC=MR, the output is 100 units. At this level of production, average total costs are $12. The firm's profits are a. $300 in the short run and long run b. $300 in short-run c. $500 in the short-run and long-run d. $500 in the short-run

b.

A shoe-producing firm decides to acquire a firm that produces shoe laces. This implies that a. The firm's aggregate demand will be less elastic than the individual demand b. The firm's aggregate demand will be more elastic than the individual demand c. The firm's aggregate demand will be of the same elasticity as the individual demand d. None of the above

b.

All the below choices are examples of promoting a firm's product, except a. Advertising b. Pricing c. Discount coupons d. End-of-aisle displays

b.

George and KC have been working jobs that pay $20,000 and $30,000/year, respectively. They are trying to decide whether to quit their jobs and jointly open up a taco stand on the beach, which they estimate can earn $60,000/year. How will the taco stand proceeds be split? a. They won't quit their jobs. b. George gets $25,000, and KC gets $35,000. c. George gets $30,000, and KC gets $30,000. d. George gets $35,000, and KC gets $25,000.

b.

If a firm successfully adopts a product differentiation strategy, what should happen to the elasticity of demand for its product? a. Increase b. Decrease c. Become unit elastic d. Is unaffected

b.

Nash equilibrium is: a. Is where one player maximizes his payoff and the other doesn't b. is where each player maximizes the expected payoff c. is similar to a dominant strategy d. difficult to determine

b.

On average, if demand is unknown and costs of underpricing are _______ than the costs of overpricing, then _________. a. Smaller; overprice b. Smaller; underprice c. Larger; underprice d. None of the above

b.

The game of chicken has a. a second-mover advantage. b. a first-mover advantage. c. no sequential-move advantage. d. potential sequential-move advantages, depending on the players.

b.

The prisoner's dilemma is an example of: a. A sequential game b. A non-cooperative game. c. A shirking game d. A dating game

b.

Which of the following types of firms are guaranteed to make positive economic profit? a. Both a perfectly competitive firm and a monopoly b. Neither a perfectly competitive firm nor a monopoly c. A perfectly competitive firm but not a monopoly d. A monopoly but not a perfectly competitive firm

b.

Which of the products below is closest to operating in a perfectly competitive industry? a. Nike shoes b. Eggs c. Purdue Chicken d. Restaurants

b.

You have two types of buyers for your product. The first type values your product at $10; the second values it at $6. Forty percent of buyers are of the first type ($10 value); 60% are of the second type ($6 value). What price maximizes your expected profit? a. $10 b. $6 c. $7.60 d. $8

b.

You want to price posters at the Poster Showcase profitably and run an experiment to estimate the demand elasticity. You raise the price of kitten posters by 10% but keep your dog poster prices unchanged. After a month, kitten poster unit sales fall by 12% but dog posters rise by 8%. What is the difference-in-difference estimate of the demand elasticity? a. - 1.2 b. - 2.0 c. - 0.8 d. - 0.4

b.

A firm in a perfectly competitive market (a price taker) faces what type of demand curve? a. Unit elastic b. Perfectly inelastic c. Perfectly elastic d. None of the above

c.

All of the following are examples of entry barriers, except a. Government protection through patents or licensing requirements b. Strong brands c. Low capital requirements for entry d. Lower costs driven by economies of scale

c.

Buyers have higher power when: a. firms sell a highly differentiated product. b. they are not a significant purchaser of the supplier's output. c. switching costs are low. d. the buyer industry is highly fragmented (buyers are not concentrated).

c.

For threats or commitments to be effective, they must be a. irrational. b. rational. c. credible. d. None of the above.

c.

In repeated games, all of the below make it easier to get out of bad situations except a. Be nice, no strikes first b. Respond immediately to rivals c. Punish competitors as much as you can d. Make sure your competitors can easily interpret your actions

c.

Suppose an investment project has an NPV of $150 million if it becomes successful and an NPV of - $50 million if it is a failure. What is the minimum probability of success above which you should make the investment? a. 0.5 b. 1/3 c. 0.25 d. 0.1

c.

The forces that create high rivalry within an industry include all of the following except: a. Numerous competitors. b. High fixed costs. c. Fast industry growth d. Low switching costs for buyers.

c.

What is the main difference between a competitive firm and a monopoly firm? a. The number of customers served by the firm b. Monopoly firms are more efficient and therefore have lower costs. c. Monopoly firms can generally earn positive profits over a longer period of time. d. Monopoly firms enjoy government protection from competition.

c.

You are considering entry into a market in which there is currently only one producer (incumbent). If you enter, the incumbent can take one of two strategies, price low or price high. If they price high, then you expect a $60k profit per year. If they price low, then you expect a $20k loss per year. You should enter if: a. You believe demand is inelastic. b. You believe the probability that the incumbent will price low is greater than 0.75. c. You believe the probability that the incumbent will price low is less than 0.75. d. You believe the market-size is growing.

c.

Your firm is considering a potential investment project, and your finance group has prepared the following estimates: an NPV of $10 million if the economy is strong (30% probability), an NPV of $4 million if the economy is normal (50% probability), and an NPV of - $2 million if the economy is poor (20% probability). What is the expected value of NPV (to the nearest dollar) for the following situation? a. $3.4 million b. $4.0 million c. $4.6 million d. $5.2 million

c.

Your production line has recently been producing a serious defect. One of two possible processes, A and B, could be the culprit. From past experience you know that the probability that A is causing the problem is 0.8 but investigating A costs $100,000 while investigating B costs only $20,000. What are the expected error costs of shutting down process B first? a. $80,000 b. $20,000 c. $16,000 d. $4,000

c.

Your software development company is considering investing in a new product. If it is very well received by users (30% probability), you expect an NPV of $500,000; if users are mildly happy with the product (50% probability), you expect an NPV of $400,000; and if users are not that excited about the product (20% probability), you expect an NPV of $300,000. What is the expected NPV of the product? a. $390,000 b. $400,000 c. $410,000 d. None of the above

c.

After massive promotion of Justin Bieber's latest music album, the producers reacted by raising prices for his albums. This implies that promotion expenditures made the album demand a. More Elastic b. Unitary elastic c. The Change is due to psychological pricing d. Less elastic

d.

An industry is defined as: a. a group of firms producing the exact same products and services. b. firms producing items that sell through the same distribution channels. c. firms that have the same resources and capabilities. d. a group of firms producing products that are close substitutes.

d.

At the individual firm level, which of the following types of firms faces a downward-sloping demand curve? a. Both a perfectly competitive firm and a monopoly b. Neither a perfectly competitive firm nor a monopoly c. A perfectly competitive firm but not a monopoly d. A monopoly but not a perfectly competitive firm

d.

Consider a vendor-buyer relationship. Which of the following conditions would lead to the buyer having more bargaining power? a. Lots of substitutes for the vendor's product are available. b. There are relatively few buyers and many vendors. c. It costs little for buyers to switch vendors. d. All of the above.

d.

Firms tend to raise the price of their goods after acquiring a firm that sells a substitute good because a. They lose market power b. There is an increase in the overall demand for their products c. The bundle has a more elastic demand than individual goods d. The bundle has a more inelastic demand than individual goods

d.

Fred is a salesman who can sell enough to generate $200,000/year worth of profit for his company. He earns only $110,000 in compensation. What is the value of his outside or next best alternative? a. $0. b. $5,000. c. $10,000. d. $20,000.

d.

If a firm in a perfectly competitive industry is experiencing average revenues greater than average costs, in the long-run a. Some firms will leave the industry and price will rise b. Some firms will enter the industry and price will rise c. Some firms will leave the industry and price will fall d. Some firms will enter the industry and price will fall

d.

In the long-run, which of the following outcomes is most likely for a firm? a. Zero accounting profits but positive economic profits. b. Zero accounting profits. c. Positive accounting profits and positive economic profits. d. Zero economic profits but positive accounting profits.

d.

Pete and Lisa are entering into a bargaining situation in which Pete stands to gain up to $5,000 and Lisa stands to gain up to $1,000, provided they reach agreement. Who is likely to be the better bargainer? a. Pete b. Lisa c. They will be equally effective. d. These potential gains will have no impact on bargaining.

d.

Two hospitals are bargaining with an MCO to get into its provider network. The MCO can earn $100 if it puts one of the hospitals in its network; and $200 if it puts both hospitals in its network. If both hositals merge, and bargain jointly, how much more will they earn? a. $0 b. $50. c. $. d. It depends on the ability of the merged hospital to credibly commit to a take-it-or-leave-it offer

d.

What would happen to revenues if a competitive firm raised prices? a. They would increase b. They would increase but profit would decrease c. They would increase along with profit d. They would fall to zero

d.

When a resource or capability is valuable and rare, a firm may gain a: a. sustainable competitive advantage. b. competitive parity. c. cost advantage. d. temporary competitive advantage.

d.

When a resource or capability is valuable, rare, hard to imitate, and non-substitutable firms may gain: a. A temporary competitive advantage. b. A complex competitive advantage. c. Competitive parity. d. A sustainable competitive advantage

d.

Which of the following is critical for a firm adopting a cost-reduction strategy? a. The firm must be the first to adopt the cost-reduction strategy. b. The strategy reduces costs by at least 10%. c. The strategy is focused on reducing internal production costs. d. The methods of achieving cost reductions are difficult to imitate.

d.

You are taking a multiple-choice test that awards you one point for a correct answer and penalizes you 0.25 points for an incorrect answer. If you have to make a random guess and there are five possible answers, what is the expected value of guessing? a. 0.5 points b. 0.25 points c. - 0.25 points d. 0 points

d.

You' ve just decided to add a new line to your manufacturing plant. Compute the expected loss/profit from the line addition if you estimate the following: There' s a 70% chance that profit will increase by $100,000. There' s a 20% chance that profit will remain the same. There' s a 10% chance that profit will decrease by $15,000. a. Gain of $100,000 b. Gain of $71,500 c. Loss of $15,000 d. Gain of $68,500

d.

Suppose a firm's linear demand is given by P = 250 - 0.25Q and marginal cost is given by MC = 30. (Assume the firm can only set one price.) a. Find the profit maximizing price (P*) and quantity (Q*).

demand -> P=250-0.25Q marginal revenue -> MR=250-0.5Q The profit maximizing quantity is where MR = MC or where 250-0.5Q = 30. Solving for Q we get Q* = 440, which we can plug into demand to get P* = $140.

Consider Porter's Five Forces model. Try to assess whether each force/threat is high or low for a manufacturer of (A) combat fighter aircraft and (B) high‐end leather handbags. (Do your best, understanding that these markets may be unfamiliar to you.)

this slide sucks +--------------------------+-------------------+---------------------+ | | combat fighter aircraft | high-end leather handbags | +--------------------------+-------------------+---------------------+ | threat from entry | low | medium | +--------------------------------+-------------------------+---------------------------+ | threat from substitutes | low | medium | +--------------------------------+-------------------------+---------------------------+ | buyer power | high | medium | +--------------------------------+-------------------------+---------------------------+ | supplier power | high | low | +--------------------------------+-------------------------+---------------------------+ | rivalry between existing firms | low | medium | +--------------------------------+-------------------------+---------------------------+