P2 Nov–Dec 2021

Applied Microeconomics
Timothy Van Zandt

Sample Exam

Final Exam

Applied Microeconomics

PLEASE READ THESE INSTRUCTIONS

• The following is probably different from your other exams. This exam does not
use separate answer books. Instead, you must write your answers only on the exam
itself. Do not unstaple the pages. Do not attach extra pages. Try to use only the
space allocated. However, if you need to continue an answer on the back of any
pages or on the blank pages included at the end of the exam, indicate this clearly.

• You have three hours to complete this exam.

• This is a closed book exam. Two “A4 cheat sheets” (total 4 sides) are allowed.

• A non-communicating calculator is allowed (though unlikely to be needed).

• In case of doubt about the interpretation of any question, state your interpretation
and proceed. (Professors are not allowed to answer questions during the exam.)

• The exam has 22 questions worth 98 points, on 16 numbered pages, plus 2 blank
numbered pages. Check that your exam is complete before proceeding.

• Pace yourself and be aware that the longest question (timewise) is the final
problem.

• Don’t be fussy about weak or strict inequalities: something “goes up” if it would
probably really go up but might not change at all.
Applied Microeconomics • Sample Exam

Do not write on this page.

Problem 1. [4]

Problem 2. [4]

Problem 3. [3]

Problem 4. [4]

Problem 5. [3]

Problem 6. [4]

Problem 7. [3]

Problem 8. [4]

Problem 9. [3]

Problem 10. [6]

Problem 11. [3]

Problem 12. [3]

Problem 13. [6]

Problem 14. [3]

Problem 15. [3]

Problem 16. [6]

Problem 17. [6]

Problem 18. [8]

Problem 19. [5]

Problem 20. [6]

Problem 21. [4]

Problem 22. [7]

TOTAL: [98]
Applied Microeconomics • Sample Exam 1

Part I Multiple choices without explanations

For each problem, circle any of the options that are true—which may include all options
or none.
No explanations are necessary. However, you may provide clarifying interpretations
or brief explanations if you are in doubt. These may be used for giving partial credit, in
your favor or against.

Problem 1. [4 points] Huawei is considering a 10% price decrease for the rest of 2020
on its P30 Pro phone, from a wholesale price of $350 to $315. It estimates that it will sell
5,250,000 phones with the price decrease, compared to only 5,000,000 if it continues to
charge $350. That is, the price decrease would lead to 5% higher sales.

a. Based on this information, Huawei’s demand is inelastic (E < 1).

b. Huawei’s total revenue would be higher with the price decrease than without.

c. Huawei’s total cost would be higher with the price decrease than without.

d. Huawei should carry through the price decrease.

Applied Microeconomics • Sample Exam 2

Problem 2. [3 points] In the following graph, the solid line is the demand for natural
gas in Moscow in January 2019 and the dashed line is demand in January 2020
(hypothetical data). The shift was due to a difference in temperature in the two winters.

2
d 2019 d 2020
1

100 200 300 400 500 600 700 800 900

Q

a. Keeping the price fixed at 3.5, demand became less elastic following the shift.

b. At the price of 1.5, demand is elastic both before and after the shift.

c. Based on this information, it was colder in 2019.

Problem 3. [3 points] Demand for raw recyled plastic in Brazil is given by

Q = 2400 − 3P .

a. The price at which elasticity is 1 is P = 400.

b. Demand is more elastic at higher prices.

c. The price that maximizes total revenue (equivalently, expenditure by the buyers)
is P = 400.
Applied Microeconomics • Sample Exam 3

Problem 4. [3 points] Which of the following are reasons that the supply curve may
slope upward in the model of perfect competition?

a. Firms in the market have increasing marginal cost.

b. Potential entrants have heterogeneous break-even prices.

c. Firms exert market power.

Problem 5. [4 points] Which of the following statements hold in the

simultaneous-move 2-firm game of quantity competition with homogeneous goods
(Cournot), as studied in class?

a. The quantities are strategic complements.

b. The reaction curves are downward sloping.

c. Each firm’s profit is an increasing function of the other firm’s quantity.

d. Price ends up equal to marginal cost.

Applied Microeconomics • Sample Exam 4

Problem 6. [4 points] In the last class, I mentioned that the previous evening I had
seen this in the Financial Times while I was having dinner.

I mentioned that there are many shale oil producers, each of which have very small
market shares in the global market for oil, even though collectively they make up a
significant share of that market. As discussed in class, for understanding this and the full
article (which I didn’t show):

a. You should view OPEC as having market power.

b. It would be a reasonable simplification to view the shale oil producers as price

takers.

c. OPEC does not need to consider the shale oil producers’ costs when determining
the impact that its volume reduction will have on the worldwide price for oil.

d. It is indeed surprising that the shale oil producers would support OPEC’s
reduction in volume.
Applied Microeconomics • Sample Exam 5

Part II Multiple choice without explanations

These are true multiple-choice questions. Only one option is correct. Circle the best
option.
No explanations are necessary. However, you may provide clarifying interpretations
or brief explanations if you are in doubt. These may be used for giving partial credit, in
your favor or against.

Problem 7. [1 point] In our last class, I mentioned that the previous evening I had
been looking for tickets for a short holiday in Kiev on my phone. I showed these
screenshots of different options for the same flight on Air France.

They are in French, so I will point out that the different options have different costs to the
airlines. For example, Economy Light doesn’t allow a checked bag, which saves on fuel
and baggage handling costs. The flexibility of the Economy Flex ticket has some extra
costs because the it makes the flight occupancy less predictable. As discussed in class
(circle one):

a. This is an example of explicit price discrimination.

b. This is an example of implicit price discrimination.

c. It is not useful to view this as price discrimination because the airline’s costs for
the different options are not the same.
Applied Microeconomics • Sample Exam 6

Problem 8. [1 point] In the last class, I mentioned that the previous evening I had
recommended my hair salon in Paris to a friend, a woman. I pay €25 but the salon charges
€36 for women (in both cases, for shampoo, cut, and blow-dry). As discussed in class
(circle one):

a. This is an example of explicit price discrimination.

b. This is an example of implicit price discrimination.

c. It is not useful to view this as price discrimination because, on average, a woman’s

haircut takes longer and hence is more costly to do than a man’s haircut.
Applied Microeconomics • Sample Exam 7

Part III Short Answers

Problem 9. [4 points] Consider the following picture of demand and supply.

€
45

40

35

30

25

20

15

10

50 100 150 200

Q

9.1. [2] Label the demand and supply curves, and label the equilibrium price and
quantity.

9.2. [1] Suppose that each consumer in this market purchases only zero or one unit.
Illustrate (approximately) in the graph the surplus earned by the consumer with the 50th
highest valuation.

9.3. [1] Suppose that there is a tax of 10 per unit, to be paid by the sellers. We model
this as a shift of the supply curve. State precisely in which direction the curve shifts by 10.
(You do not have to draw the shifted supply curve.)
Applied Microeconomics • Sample Exam 8

Problem 10. [4 points] The following table shows the Nash equilibria of a Cournot
(quantity competition) game for different numbers of firms in the market. All the firms
have the same constant marginal cost. The “profit per firm” column is the variable profit,
taking into account the marginal cost but not any entry costs (long-run fixed costs).

Number Total Output Profit per

Price
of firms Output per firm firm
1 500 20.00 500 5,000
2 667 16.67 333 2,222
3 750 15.00 250 1,250
4 800 14.00 200 800
5 833 13.33 167 556
6 857 12.86 143 408
7 875 12.50 125 313
8 889 12.22 111 247
9 900 12.00 100 200
10 909 11.82 91 165
11 917 11.67 83 139
12 923 11.54 77 118
13 929 11.43 71 102
14 933 11.33 67 89
15 938 11.25 63 78

10.1. [1] I have deliberately omitted the market demand curve. From this table, what
is the market demand when the price is 12? (Give no explanation.)

10.2. [1] I have also not told you the firms’ common marginal cost. What is it?

10.3. [1] Suppose that there is free entry, and all firms have the same fixed cost of 240.
How many firms will enter the market?

10.4. [1] Suppose that, similar to before, there are many identical firms with the same
fixed cost of 240. But there is also a single firm with a cost advantage: its fixed cost is 100.
How many firms will enter the market?
Applied Microeconomics • Sample Exam 9

Problem 11. [3 points] The following graph illustrates dynamic adjustment of prices
under perfect competition. D 1 is the original demand curve, Slong is the long-run supply,
Sshort is the short-run supply curve starting from the initial long-run equilibrium, and D 2
is a shifted demand curve.

Figure 1
$
Sshort
60
Slong
50

40

30

20
D2
10
D1
10 20 30 40 50 60 70 80 90
Q

11.1. [1] Mark on the graph the short-run equilibrium following the shift in demand.

11.2. [1] Mark on the graph the long-run equilibrium following the shift in demand.

11.3. [1] Is the price more volatile in the short run or the long run? Circle one:

SHORT RUN LONG RUN

Applied Microeconomics • Sample Exam 10

Problem 12. [3 points] CMB has an aircraft leasing business with operations in China.
It is a newcomer to the market, and given the complexity and capital cost of expanding
operations, it has increasing marginal cost. It’s MC curve is shown below:

$K
700
MC
600

500

400

300

200

100

100 200 300

Q

It is a small player in this market, which is dominated by subsidiaries of GE and AIG. The
current market price that it faces, which is largely determined by the demand side and
the decisions of GE and AIG, is $400K per aircraft. We can treat CMB as a price taker.
12.1. [1] Draw on the graph the price–quantity “trade-off” that CMB faces, i.e., the
demand curve that CMB faces for its own leasing services.

12.2. [1] What is its marginal revenue when producing 300 units?

12.3. [1] Illustrate on the graph (approximately) the profit-maximizing level of output.
Applied Microeconomics • Sample Exam 11

Problem 13. [3 points] Didi operates a taxi-booking service in Shanghai that is much
like Uber. (Uber’s Chinese operations ended in 2016 when these were bought out by Didi.
As part of the deal, Uber took an 18.8% stake in Didi.) Didi has a pricing system for the
customer that combines a booking fee, a charge per kilometer, and a charge per minute.
The driver receives approximately 80% of the revenue. For simplicity, let’s consider a
simplified fee structure in which there is only a charge per kilometer.
The actual services are provided by independent taxi drivers who register with Didi.
There are many potential taxi drivers and each has an indifference point, in terms of the
RMB/kilometer received from Didi, such that for higher prices the driver prefers to register
with and work for Didi, whereas for lower prices the driver prefers not to. These
“willingness-to-sell” values are plotted on the graph below.

Figure 2

10
RMB/K
9

10 20 30 40 50 60 70 80 90 100
Q

Suppose that Didi sets a price of 6 RMB/k. Illustrate on the graph how many drivers
register, and total surplus (per kilometer) that these drivers get by working for Didi.
Applied Microeconomics • Sample Exam 12

Problem 14. [4 points] The data are the same as from a previous problem, but I will add a
story, which is hypothetical.
The following table shows the Nash equilibria of a Cournot (quantity competition)
game for different numbers of firms in the market. This is for the Indonesian cement
market. All the firms have the same constant marginal cost. The “profit per firm” column
is the variable profit, taking into account the marginal cost but not any entry costs
(long-run fixed costs).

Number Total Output Profit per

Price
of firms Output per firm firm
1 500 20.00 500 5,000
2 667 16.67 333 2,222
3 750 15.00 250 1,250
4 800 14.00 200 800
5 833 13.33 167 556
6 857 12.86 143 408
7 875 12.50 125 313
8 889 12.22 111 247
9 900 12.00 100 200
10 909 11.82 91 165
11 917 11.67 83 139
12 923 11.54 77 118
13 929 11.43 71 102
14 933 11.33 67 89
15 938 11.25 63 78

Until October last year, the market had a single state-owned firm, and the Indonesian
government did not allow other cement firms to operate. In October, the government
privatized that firm and opened up the market to new entrants. One firm has already
entered. Neither the privatized firm nor this new entrant will exit the market, so we are
not going to model their decisions. Our focus is on two new potential entrants, ICA and
JC. They have the same entry cost of 1000. But ICA is well ahead of JC in its business
planning and makes its entry decision first. After this irreversible decision is made, JC
decides whether to enter.
Draw a game tree that models these firms’ entry decisions. As studied in class, label
carefully the actions, the players, and the payoffs. Then use arrows to show the
backward-induction solution.
Applied Microeconomics • Sample Exam 13

Problem 15. [5 points] Before my first trip to Beijing, I guessed I shouldn’t step in front
of cars (as a pedestrian) and expect them to stop. And I was right.
But last August, I visited Almaty, the former capital and largest city of Kazakhstan. I
expected that the same would be true there. Instead, the drivers have more respect for
pedestrians than in any city I have visited: at marked pedestrian crossings, the
pedestrians cross streets without looking and the drivers are on the look-out and stop,
even if it means slamming on the brakes.
Let’s model those two situations (Beijing and Almaty) as multiple equilibria of a
simultaneous-move game, with two players: “drivers” and “pedestrians”.
The action of the drivers is either “careful” or “careless”. “Careful” means that the drivers
look out for pedestrians and stop for them; “careless” means they don’t, and will hit a
pedestrian who happens to walk in front.
Likewise, the action of the pedestrians is either “careful” or “careless”. “Careful” means
that a pedestrians looks out for cars and will not step in front of a car; “careless” means
that a pedestrians walks in front of cars, getting hit if a car doesn’t stop.
15.1. [2] Draw a plausible payoff matrix for this game.

15.2. [1] Indicate best responses the way we did in class.

15.3. [2] Indicate the Nash equilibria of the game, and which equilibrium is played in
Almaty and which is played in Beijing.
Applied Microeconomics • Sample Exam 14

Problem 16. [3 points] The following graph shows a demand curve in the wholesale
market for standing desks (demand is per year).

Figure 3

1000
€
900

800

700

600

500

400

300

200

100

10 20 30 40 50 60 70 80 90 100 (1000s)
Q

The only decision a producer makes is whether to enter the market or not; the scale of
any producer is fixed at 10,000 desks per year. (Pay careful attention to units here and on
the graph of the demand curve.)
16.1. [1] Illustrate on the graph the approximate price if 3 producers enter the market.

16.2. [2] Suppose that there are 11 potential entrants, whose per-unit break-even
prices are as follows: 150, 200, 250, 300, 350, 450, 500, 550, 600, 650. Use the graph to
determine how many firms enter the market.
Applied Microeconomics • Sample Exam 15

Problem 17. [6 points] During the second half of Applied Microeconomics, Yvonne
realizes that game theory can help her understand the studying patterns of students in
the course. The exam is graded on a curve, and so the effort by one student affects the
grade of another student.
17.1. [2] At the end of MSD, Sections E8 and E9 hold a “decompression” social hour.
Yvonne explains to everyone that they will end up in the Nash equilibrium of a game, in
which the players are the students in the class and each player chooses how hard to
prepare for the P&N exam. She gets some puzzled looks. In the space below, write a few
sentences that Yvonne could say in order to explain this.

17.2. [1] Plausibly, for each student, the harder the other students work, the harder
she/he wants to work. Does this mean that the game has strategic complements or
strategic substitutes? Circle one:

STRATEGIC COMPLEMENTS STRATEGIC SUBSTITUTES

17.3. [2] After a few drinks, her classmates have a harder time following Yvonne’s
story. Finally, Yvonne decides to illustrate the equilibrium in a two-player version of the
game by drawing a picture on the wall using a black marker that she always carries. In the
space below, draw and carefully label a plausible version of her graph.
Applied Microeconomics • Sample Exam 16

17.4. [1] Yvonne then says that this equilibrium is not efficient from the point of view
of the students. Now finish this sentence for Yvonne: “We would all be better off if we all
….”

Problem 18. [2 points] Consider a firm that is making a business plan, with all
numbers as flows (yearly fixed costs, year demand, etc.). The firm has a good estimate of
its demand and cost curves. It has positive marginal cost and has a fixed cost of 3000.
18.1. It concludes that, if it operates, then it should charge 60, resulting in sales of 150.
Based on this data, circle the most likely value for the elasticity of demand at a price of 60:

0.7 1.0 1.9

18.2. They begin operating and everything is as expected except that the fixed cost is
4000 rather than 3000. The firm cannot exit the market for one year. Until then, how
would you advise the firm to modify its operating plan? Circle one:

Raise price in
order to cover the
higher average cost
Sell more in
order to take advantage
No change
of economies of scale
and reduce average cost
Applied Microeconomics • Sample Exam 17

Part IV Applications

These problems involve applying P&M concepts and reasoning to “real-life” situations
(the balance between fact and fictions varies). Your answers will be graded not merely for
correctness but also clarity. Therefore, though each story is relatively long, your answer
should be very concise and to-the-point. (The grading is analogous to how your colleagues
will evaluate what you say in your next job, but I am your target audience. That is, you can
assume that the listener understands the P&M terminology and concepts that you apply.)

Problem 19. [4 points] (This story is a mix of fact and fiction.) Žemaitijos Pienas is a
Lithuanian dairy company. Its most famous product is Dziugas cheese, a hard ripened
cheese. About 45% of its production goes to Russia and 55% to the EU (including local
sales in Lithuania). Surprisingly, while some markets have higher demand than others,
they all have equally elastic demand and so the company charges the same wholesale
price in all markets.
Here is how things stood at the end of 2019: To meet anticipated growth in demand,
the company had expanded its production capacity. Its resulting cost structure had over
€60,000,000 of fixed expenses on a yearly basis (cost of capital, depreciation, long-term
leases of land and equipment, non-variable management, etc.) Up to capacity, it had a
constant marginal cost of €4 per kilo (including inputs, labor, and distribution), but it
could not produce beyond capacity. Its wholesale price for the cheese was €9/kilo and it
operated at 85% capacity. It was pricing correctly. At the resulting volume of sales, its
average cost (including the variable costs and the fixed costs) was €7/kilo, so this was
quite a profitable business.
Then, in January, Russia banned imports of its cheese, as part of evolving restrictions
on agricultural products from the EU, in retaliation for EU sanctions on Russia that
originated in the Ukraine crisis of 2014 and continue today. Žemaitijos Pienas thus saw
45% of its market disappear and its average cost jumped to €9.45/kilo. The management
has been debating whether to raise the price in the EU market in order to restore
profitability. What would you advise?
Applied Microeconomics • Sample Exam 18

Problem 20. [5 points] When we discussed the Roxy case, which is fictional, I told a
related story about a Norwegian auto parts company. It was based on a true story told to
me by a TIEMBA student. (TIEMBA is our part-time EMBA that is joint with Tsingua
University in Beijing, the class was taking place in Beijing, and the student was involved in
the firm’s decisions the day we discussed the Roxy case.) Here is a more accurate version
of that story, with some fictional numbers thrown in. The story takes place in October of
2014.
Kongsberg Automative is a Norwegian company that manufactures auto parts and
sells them around the world. One of its products is a patented transmission control
system (TCS), which is made entirely in plants in Norway. Two of its large markets for the
TCS are China and Japan. Due to differences in the elasticity of demand, it has been
charging a higher price in Japan than in China for the same system.
20.1. [1] In which market is demand more elastic?

20.2. [4] Up to September, its plants in Norway were operating at 80% capacity.
However, on September 20, its largest plant was destroyed in a fire, and so the current
flow of orders is 120% of the remaining capacity. It will take one year to rebuild the plant.
Describe how the firm would want to adjust its pricing in China and Japan. One of the
vice-presidents argues that the firm should stop offering a lower price in China, since now
it will be sell at capacity and hence a unit sold to a Chinese company comes at the
opportunity cost of selling that same unit at a higher price to a company in Japan. Should
the company follow the VP’s strategy? Explain.
Applied Microeconomics • Sample Exam 19

Problem 21. [4 points] To chill out and get some skiing in now that I’m done teaching,
I’m booking a long weekend in Chamonix for March 12–15. I’ve found an apartment,
owned and run by the Chalet-Hôtel Hermitage but separate from it, with an awesome
bathroom. Check it out!

Linen and daily cleaning are including, but otherwise it’s self-catering, i.e., no meals
included, except that hotel delivers a basket of croissants and jams each morning,
depending on the occupancy.
It’s going to cost me €900 for the three nights, for me and a friend. But it’s got two
bedrooms, so we’re thinking of inviting two more friends along. In that case, the price
goes up to €1350. [This is hypothetical. I don’t pay that kind of money. Nor do I have
friends. But the situation is similar to one I face for a trip in June to Barcelona.]
21.1. [1] The two multiple-choice questions in Part II of this exam mention two stories
given in class: prices of haircuts and prices of airplane tickets. To which of those two
stories is this one most related? Circle one:

HAIRCUTS AIRPLANE TICKETS

21.2. [3] Help me understand these price differences using, as specifically as possible
but without giving a long answer, the tools and terminology of this course.
Applied Microeconomics • Sample Exam 20

Problem 22. [7 points] Other than that one apartment, the Chalet-Hôtel Hermitage’s
main business is as a hotel. It has several different room types and rates, but for this
exercise, ignore all this: It has one kind of room and one rate for the room.
Although there are a number of other hotels in Chamonix, the Chalet-Hôtel Hermitage
(CHH) is in its own category and in a special location, and it has only one direct
competitor, another 4-star hotel that is located only 100 meters away, the Heliopic Hotel
& Spa (HHS). These hotels are constantly checking each other’s prices as they set their
own. The goal of this exercise is to model the price-competition game between these
two hotels.
22.1. [2] Draw a graph that illustrates plausible reaction curves (best-responses) of the
two hotels. You do not need to worry about calibrating the scale or even showing the
scale on the axis, but you should mark carefully what each axis represents and which
reaction curve is for which hotel.

22.2. [1] Does this game have strategic complements or substitutes? Explain how that
is reflected in your graph.

22.3. [1] Mark on the graph the Nash equilibrium of the game.
Applied Microeconomics • Sample Exam 21

22.4. [3] What you have just drawn is the status quo, before a sudden outbreak of
coronavirus in the region. This causes a big drop in demand. Explain in words how your
graph changes. Specifically, you should carefully state how each curve shifts and what
that shift represents.
[I am not asking you to draw the curves because (a) it would clutter your previous
answer; (b) I am interested in your being able to explain. However, you might find it
helpful to draw the shifts on scratch paper.]

Problem 23. [2 points] Your firm is moving its headquarters from Hong Kong to
Singapore in search of cheap real estate (ha!). It owns its building in Hong Kong; you are
in charge of selling it. You propose to use a sealed-bid, second-price auction, like I used
for selling the t-shirt in class. You explain the procedure to the other senior managers.
They are puzzled that you would want to make the winner pay the second-highest bid
rather than her own higher bid. Explain, as simply and clearly as possible, why charging
the winner her own bid does not necessarily lead to greater revenue for your firm.
Applied Microeconomics • Sample Exam 22

For scratch or continuation of answers. Make clear what you want us to do with
anything written here. Do not detach.
Applied Microeconomics • Sample Exam 23

For scratch or continuation of answers. Make clear what you want us to do with
anything written here. Do not detach.