irst Midterm Examination
February 27, 2001

Do all work on the examination.  If you use the back of a page, indicate you have done so.

 

First Part (10 point questions

1.       Explain whether you agree or disagree with this statement.  There is never a good reason to allow a monopoly.

2.       You and another firm are preparing for the Christmas season.  Each of you has the choice of charging high prices or low prices.  The decision will affect your profits.  The following payoff matrix describes your profits (pY represents your profits and po represents the profits of the other firm): 

 

 

 

The other firm

 

 

High

Low

 

Your firm

High

pO =15

pY = 15

pO = 25

pY = 35

 

Low

pO = 10

pY = 25

pO = 20

pY = 20

 

Should you charge a high price or a low price?  Defend the basis for your decision.

3.       Tell me which of the following statements is false- and explain why that statement is false: 

(a)   In a perfectly competitive industry where all firms have the same cost function the short run supply curve may be upward sloping, but the long run supply curve is infinitely elastic at the current level of operation unless there are pecuniary external diseconomies of scale.

(b)   In a perfectly competitive industry, where many existing firms have one cost function and the other, newer firms, have a different cost function using technology also available to potential entrants, the long run supply curve is infinitely elastic at the current level of operation unless there are pecuniary external diseconomies of scale.

(c)    In a perfectly competitive industry, where each firm has a different cost function, the long run supply curve is infinitely elastic at the current level of operation unless there are pecuniary external diseconomies of scale.

Your answer:

Statement ____________ is false because:

4.       Explain whether you agree or disagree with the following statement: A monopolist always works in the elastic portion of his supply curve.

5.       Explain whether you agree or disagree with the following statement: Two firms locked in a Bertrand Duopoly will not achieve a Nash Equilibrium.

Second Part (25 point questions)

Directions:  Work any two (2) of the following three (3) questions.  In the boxes below, check which problems you have worked:  If you do not check the boxes, I will assume you want to work problems 1 and 2.

I have worked (Check 2)

Problem 1

 

Problem 2

 

Problem 3

 

1.       Acme Widgets has monopoly on the production of widgets.  It has 15plants whose cost function is 

C=98 -3q + q2

 

Acme can also build plants using a new technology.  The cost function for these plants will be

Q

C

0

16

1

20

2

22

3

24

4

28

5

35

6

48

7

63

8

80

The demand for the product is

Q = 91-3P

(a)   What price will Acme charge for widgets?

(b)   How many will it sell?

(c)    How many will it produce at each of the old plants?

2.  Three firms hold a license to produce the Wonder ToyÒ, a perennial Christmas best-seller, having agreed to pay Dawn Cragon $2 for each wonder toy produced.  Each toy costs $10 to produce.  Toys are manufactured throughout the year and brought to market just in time for Santa and his happy elves.

A team of eminent econometricians has estimated the demand curve for the Wonder ToyÒ.  They report the following annual demand curve:

q = 1400 - 40p

(a)   At what price do Wonder Toys sell?

(b)   How much does Dawn make each year?

A fourth firm is considering tooling up to produce Wonder Toys.  To go into the business, it will have to forego a business currently earning them $100 a year.  The three existing manufacturers approach Dawn and urge them not to give permission.

(c)    What is the maximum amount they would be willing to pay Dawn not to give permission?  Explain your answer.

(d)   What is the least Dawn would take?  Explain your answer.

(e)   Assuming Dawn works out a deal with the three manufacturers, what will happen to the price of the Wonder ToyÒ

Note:  you may be tempted to argue that this arrangement might violate anti-trust laws.  Lets assume the deal would be legal?

3.    International Beverages (IB)sells a brand of beer very popular on college campuses.  Although the beer is generally undistinguished, each bottle comes with about three times the amount of caffeine found in a cup of coffee.  Sales are spectacular at exam time.  Currently, the company makes $1000 a year.

It is considering coming out with a new improved brand with four times the amount of caffeine.  If it does, profits will rise to $1100 a year.

Alas, there is a fly in the ointment.  Budweiser is threatening to come out with caffeine-augmented Budweiser.  If IB does nothing, Budweiser’s superior marketing effort will make short work of IB; its profits will drop to $300 a year.  Budweiser figures to make $1500 a year.  If IB does come out with its new beer, code-named IB-4, Bud will lose money, but IB’s profits will only be $200 a year.

(a)   Represent this as a sequential game.

(b)   Using the sequential game you have drawn above, explain why Bud will come out with the Beer anyway. (Sorry, that means you must base your argument on the game representation.)

(c)    If you were the Marketing Manager of IB, how would you react to this potential entrant?  Show why your strategy is desirable.