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Advance Economic Analysis – A business is more likely to vertically integrate and produce

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Advance Economic Analysis

PART I

Multiple Choice questions [30 Points]

Select the option that best answers the question.

1. A business is more likely to vertically integrate and produce an input internally if

a) Specialized investments are important and the contracting environment is

simple

b) Specialized investments are important and the contracting environment is

complex

c) Specialized investments are not important and the contracting environment is

simple

d) Specialized investments are not important and the contracting environment is

complex

2. A problem with using a “revenue sharing” plan to compensate employees is that

the plan

a) Does not provide incentives for employees to work hard

b) Will be costly if revenues are low

c) Does not provide incentives for workers to minimize costs

d) Will have high administrative costs

3. Assume the compensation of a manager is given by the equation

= + Π,

where is the base salary and Π is the profit of the business. Then, an increase

in will create

a) Stronger incentives and more risk for the manager

b) Weaker incentives and more risk for the manager

c) Stronger incentives and less risk for the manager

d) Weaker incentives and less risk for the manager

4. The return from an investment is uncertain and there is a 25% chance that it will

be 100,000 dollars, a 50% chance that it will be 50,000 dollars, and a 25%

chance that it will be 20,000 dollars. The expected return from the investment is

a) 45,000 dollars

b) 50,000 dollars

c) 55,000 dollars

d) 75,000 dollars

5. In a Second-Price, Sealed-Bid auction with independent private values, the

optimal strategy is to

a) Make a bid above your valuation of the item

b) Make a bid below your valuation of the item

c) Make a bid equal to your valuation of the item

d) Not make a bid

1

6. A few years back, Disney switch from a “fee per ride” price strategy to a “fee per

day” price strategy. The “fee per day” price strategy is a form of

a) Two-part pricing

b) Peak-load pricing

c) Transfer pricing

d) Randomized pricing

7. A movie theater will generally charge a lower price to students because

a) Students buy less popcorn than the general public

b) Students buy more popcorn than the general public

c) Students have a less elastic demand for movies than the general public

d) Students have a more elastic demand for movies than the general public

8. There are three businesses in an industry, with sales of 20 million, 10 million,

and 10 million, respectively. The HHI index for this industry is

a) 2250

b) 3500

c) 3750

d) 5000

9. If a monopoly has a marginal cost of MC = 20 and the price elasticity of demand

is E = −3, the optimal price for the monopoly is

a) 25

b) 30

c) 50

d) 75

10. For a business in a monopoly market with inverse demand function p = 50 – q

and total cost function C(q) = 100 + 10q, the optimal price and quantity are

a) pM =30 and qM = 20

b) pM =20 and qM = 30

c) pM =25 and qM = 25

d) pM =15 and qM = 35

PART II

Short answer questions [20 Points]

For each of the following terms, provide an intuitive explanation and discuss its

economic implications.

1. Market Power

2. Industry Concentration

3. Network Markets

4. Product Differentiation

2

Part III

Analytical/essay questions

1. [10 points] Provide an intuitive description of a NASH equilibrium and compute

the NASH equilibrium of the following game with simultaneous moves

Player 2

X

Z

A

3,5

0,3

5,1

B

1,0

2,2

3,0

C

Player 1

Y

5,3

0,1

1,5

2. [20 Points] The Principal-Agent Problem

i. Provide an intuitive explanation of the Principle-Agent problem and discuss

any mechanisms used to mitigate the problem. Initially, you should use the

business owner-manager problem as an illustration.

ii. Then, discuss the Principle-Agent problem (and the related concept of “moral

hazard”), and any mechanisms used to mitigate the problem, in the context

of the healthcare industry (the interaction of consumers, hospitals/doctors,

and health insurance companies).

3. [20 Points] The Adverse-Selection Problem

i. Provide and intuitive explanation of the Adverse Selection problem and

discuss its implications and any mechanisms used to mitigate the problem.

You should use the healthcare industry as an illustration.

ii. A key elements of Obama Care is the “individual mandate” (everyone is

required to have health insurance). Is this likely to increase or decrease

health insurance premiums? How is this likely to affect the consumption of

healthcare? Provide an intuitive explanation for your answers.

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