COMM 295

FINAL 2017
REVIEW SESSION
Agenda
16:00 – 16:55 Short Answer: 6 X 10 = 60 points

16:55 – 17:00 Break

17:00 – 18:00 Multiple Choice: 20 X 2 = 40 points

 Question 1 – Regression Analysis

Explanatory Variable Dependant Variable

Educational Hourly Wage Productivity Length of
Attainment Service
E W P L

wage productivity
education length of service
education productivity
wage length of service
Question 1 – Regression Analysis
D
B

L = a0+ a1*w + a2*E + a3*E2 + e

 Question 2 – Bundle Pricing
350
300
500 Flight Hotel Standalone Profit
700 Price Total Profit Price Total Profit 700 + 400 = 1,100$
400 100*3 = 300$ 100*3 = 300$
350*2 = 700$ 350*1 = 350$
400*1 = 400$ 300*2 = 600$

1,200 Mixed Bundling: We want to sell flight to Elizabeth, hotel to Greg

and bundle to frank.
Pure Bundling
Price
Price Total Profit
Flight 400
500*2 = 100$
Hotel 300
700*1 = 700$
Bundle 649 (Why? To incentivize Greg to buy the bundle instead
400*3 = 1,200$
of the hotel since his surplus for the hotel is 50.)
Total Profit: 1,349$

*Mixed Bundling is the profit maximizing strategy*

Question 2 – Two Part Pricing
50

(10 * (30 – 20) ) / 2 = 50

Question 2 – Two Part Pricing
200

((30-10)*20)/2 = 200

200

Set P = MC, thus not making any

variable profit. Capture the entire
consumer surplus (200) by charging it as
the access fee
Question 2 – Two Part Pricing

Profit is the area below price and above MC. We need to find which price maximizes this
area. We know that the equation is Price = 30 – Quantity.

At P(15), we make 5$ profit per unit At P(15), Q = 15. Thus we can sell 5 additional units
At P(18), we make 8$ profit per unit At P(18), Q = 12. Thus we can sell 2 additional units
CS At P(10), we make 0$ profit per unit At P(10), Q = 20. Thus we can sell 10 additional units

At P(15), we make 75$ total profit (15* 5)

At P(18), we make 36$ total profit (18* 2)
At P(10), we make 0$ total profit ( 0*10)
 Question 3 - Oligopoly
Firm A and Firm B are the sole producers of a products with the following inverse demand function P = 300 – 3Q
where Q = qa + qb . Assume the firms have identical and constant marginal cost equal to $30 and no fixed costs.
Suppose Firm A is the Stackelberg leader and Firm B is the Stackelberg Follower. Find the Stackelberg equilibrium
quantity and profit for each firm.
First, find the profit maximizing quantity for each firm
Substitute Q with 𝑞𝐴 + 𝑞𝐵 Find Firm’s A’s profit function Substitute 𝑞𝐴 back into Firm B’s
best response function to find 𝑞𝐵
𝑃 = 300 – 3𝑞𝐴 − 3𝑞𝐵 𝜋𝐴 = (300 – 3𝑞𝐴 − 3𝑞𝐵 )𝑞𝐴 - 30 𝑞𝐴
𝜋𝐴 = (300 – 3𝑞𝐴 − 3(45 − 0.5𝑞𝐴 ))𝑞𝐴 - 30 𝑞𝐴 𝑞𝐵 = 45 - 0.5𝑞𝐴
Find MR for Firm B in order to find 𝒒𝑩 𝜋𝐴 = (165 – 1.5𝑞𝐴 )𝑞𝐴 - 30 𝑞𝐴 𝑞𝐵 = 45 - 0.5 45
and firm B’s best response 𝜋𝐴 = 135𝑞𝐴 − 1.5𝑞𝐴 2 𝑞𝐵 = 22.5

𝑅𝐵 = 𝑃𝑞𝐵 = (300 – 3𝑞𝐴 − 3𝑞𝐵 ) 𝑞𝐵 Take derivative with respect to 𝑞𝐴 and set it to 0

MR = MC = 30 = 300 – 3𝑞𝐴 − 6 𝑞𝐵 0 = 135 - 3 𝑞𝐴

𝑞𝐴 = 45
𝑞𝐵 = 45 - 0.5𝑞𝐴
 Question 3 - Oligopoly
Firm A and Firm B are the sole producers of a products with the following inverse demand function P = 300 – 3Q
where Q = qa + qb . Assume the firms have identical and constant marginal cost equal to $30 and no fixed costs.
Suppose Firm A is the Stackelberg leader and Firm B is the Stackelberg Follower. Find the Stackelberg equilibrium
quantity and profit for each firm.
Determine price and profit
Since Firm A goes first, it is able to commit to producing a higher quantity forcing Firm
𝑃 = 300 – 3𝑞𝐴 − 3𝑞𝐵 B to produce lower. As a result, firm A makes more profit.
𝑃 = 300 – 3(45)−3(22.5)
𝑃 = 97.5

Firm A’s profit

𝜋𝐴 = 45 * (97.5 − 30)
𝜋𝐴 = 3,037.50$
Firm B’s profit Since Firm B wouldn’t actually benefit from producing at a larger quantity, the
𝜋𝐵 = 22.5 * (97.5 − 30) threat is not credible
𝜋𝐴 = 1,518.75$
 Question 4 – Game Theory

5 8
1

For it to be a Prisoners’ Dilemma, the bottom right cell must be the equilibria and must be worse off for both players compared
to the upper left quadrant. Thus 1 < Z < 5

Both players must have a dominant strategy

There must be some other possible outcome where both players are better off
 Question 4 – Game Theory

10
5

For both the upper left cell and lower left cell to be pure strategy Nash equilibria, no player should be willing to change their
output given the other players output remains constant. Thus Y < 2 and W < 5

The upper left Nash Equilibrium is most likely to arise because both players are better off in that equilibrium
 Question 4 – Game Theory

3 3
1

Z < 1. This guarantees that each player can in fact earn a higher payoff if they chose a different strategy given that the other
player remains with the same strategy, meaning there is no pure Nash Equilibria.

NO. There will be a mixed strategy Nash equilibria.

 Question 5 – Uncertainty

4000 – 1500 = 2500

2400 – 1500 =900

𝑈 𝑊 = 𝑊 0.5
𝑈 𝑊 = 0.5 ∗ 25000.5 + 0.5 ∗ 9000.5
𝑈 𝑊 = 𝟒𝟎

𝑈 𝑊 = 𝑊 0.5 E (p) = 2500*0.5 + 900*0.5=1700

40 = 𝑊 0.5 Risk premium (RP) is the difference between expected
W = 1600 profits with risk and certainty equivalent income of profits
RP = 1700 – 1600 = 100
Question 5 – Uncertainty

2500 – 800 =1700

900 + 1600 – 800 =1700

800 – 800 = 0

800
Question 6 – Behavioural Economics

= 200

(1/3)*600 = 200

600-400 = 200

600 – (2/3)*600 = 200

Question 6 – Behavioural Economics

2000.5 = 14.14
(1/3)*6000.5 + (2/3)*00.5 = 8.16
200 0.5 = 14.14
(1/3)*6000.5 + (2/3)*00.5 = 8.16
 Question 6 – Behavioural Economics
Certainty
WHY?
Uncertainty

Utility with certainty

=N0.5. This is an exponential function.

Utility with uncertainty

A =(N/600)*6000.5 + (1-N/600)*00.5 .With
D uncertainty, 6000.5 is constant thus the
function is linear.

Not Necessary to explain the above answer as you are comparing gains with gains and losses with losses
Question 7 – Agency/Moral Hazard/Contracts

0.2*(0.4*400 + 0.6*1000) = 152

0.2*(0.4*1000 + 0.6*1400) - 100 = 148

LOW

0.8*(0.4*400 + 0.6*1000) = 608

0.8*(0.4*1000 + 0.6*1400) = 992

HIGH LOW
Question 7 – Agency/Moral Hazard/Contracts

41.67 𝑊 = 𝐹𝑖𝑥𝑒𝑑 𝐵𝑎𝑠𝑒 𝑆𝑎𝑙𝑎𝑟𝑦

𝐸𝑉 𝐻𝑖𝑔ℎ 𝐸𝑓𝑓𝑜𝑟𝑡 > 𝐸𝑉(𝐿𝑜𝑤 𝐸𝑓𝑓𝑜𝑟𝑡)
𝑊 + 0.6 ∗ 1400 − 1000 𝑥 − 100 > 𝑊
𝑋 > 41.67%

Jonathan’s income with high effort is risky (uncertain) whereas his income with low effort is
fixed (certain), so he needs a greater return than before to be willing to take on the risk of
high effort (risk premium).
 Break
5 minutes
 Multiple Choice
20 X 2 points = 40 points
Question 1

A. Increase in price of a substitute and increase in supply of complement will both shift demand curve
out
B. Supply curve has not changed, only the demand curve has
C. Supply curve has not shifted in
D. Supply curve has not shifted out
Question 2

Arc Ed = [(Qd2 – Qd1) / midpoint Qd] ÷ [(P2 – P1) / midpoint P]

= [( 120-200) / 160] ÷ [(11-9)/10]
= -2.5
Question 3

A. No, because cost increases

exponentially at high output levels
B. Yes, cost increases at a lower rate
than quantity at low levels of
output
C. There is economies of scale
D. It can be
 Question 4

A. In the long run, ATC = MC

121/q + 12 + q = 12 +2q
q= 11
Price = MC
MC = 12 + 2*(11)= 34
B. As shown in part A, quantity is 11
C. In a long run perfectly competitive industry, no firms enter or leave the industry. Everyone makes 0
profit
D. A is not correct
Question 5

A. At profit-maximizing solution, MC < AC. MC=AC for perfect competition

B. At profit-maximizing solution, the firm must operate in the downward sloping portion of its AC
curve (left of the minimum). Firms must operate at the minimum of its AC in perfect competition.
C. At the profit-maximizing solution, demand must be elastic
D. None of the above
Question 6

A. No, firm maximizes profits in both

periods
B. Only reaches capacity in the peak
period
C. Off peak profit maximizing quantity
is below capacity
D. Peak profit maximizing quantity is
beyond capacity so no cost
expansion would increase peak
period profit
Question 7

A. Normative statement
B. Firms do earn positive profits in the Cournot model and earn zero profits in the Bertrand model.
Even though the firms are identical, as they don’t compete on price, they will earn positive profits.
C. Differentiated products are irrelevant to the question
D. None of the above
Question 8

A. There can be a unique Nash equilibrium without the existence of dominant strategies
B. Nash equilibrium can exist without a dominant strategy
C. When both players have a dominant strategy, the will always be a unique Nash equilibrium
D. None of the above
Question 9

A. Incumbent will chose ACCOMODATE if entrant chooses IN

B. Incumbent will chose ACCOMMODATE because it will receive 2 instead of 1 it gets from FIGHT
C. FIGHT is not credible because the Incumbent gets more by choosing ACCOMODATE
D. None of the above
Question 10

A. Players will be incentivized to break their promise

B. Players will cheat near the end if they know it is repeated for finite number of periods
C. In a repeated Prisoners’ Dilemma, players care about their payoff in future periods as well
D. None of the above
Question 11

A. The problem would not arise if Fisher Body’s investments weren’t sunk costs (if they could recover
their investment)
B. Fisher Body would prefer to negotiate before the investment because after the investment has
been made, GM will have more negotiation power.
C. GM knows that it has negotiation power and will be incentivized to renegotiate
D. This is an ECON class – of course it is about economic efficiency!
 Question 12

A. Sandra could be risk averse, just not as much as Dennis

B. Given that Project B has a lower variance and Dennis prefers it, she is risk averse
C. SD = 12 -> 12 > 0.1*100
D. As utility function becomes more concave, the person becomes more risk averse. Utility function
would have to get more convex for Dennis to switch
 Question 13

A. Both outcomes are the same for the portfolio so it has zero variance
B. Firm prices move in the exact opposite direction and amount
C. Only firm A and B have bid, and there is zero variance, thus there is maximum diversification
D. All answers are correct
 Question 14

A. There is only one Nash Equilibrium

B. Doesn’t have to be an integer above 0
C. Each player will reduce their bids until the Nash equilibrium is 0
D. Most people in the real world don’t think economically. They could display 0-level, 1-level, 2-level
… thinking.
 Question 15

A. Screening is when Amy tries to learn more about the investor. Moral hazard is about taking action
in good faith. Amy’s goal is not to dupe the investors but convince them the technology is good
B. It is not a moral hazard.
C. This is signaling as Amy is sharing information she possesses. It is also adverse selection because
there is asymmetry of information. Amy knows more about the technology than the investors.
D. Not screening.
Question 16

Since buyers are risk neutral, they will pay for their expected value of the car. The EV of what the
buyers are willing to pay must be equal to 7,000 (minimum sellers are willing to accept for a good car)
to find the proportion of good used cars that will prevent an adverse selection problem.

7,000 ≤ 8,000x + 4,000 (1-x)

7,000 ≤ 4,000x + 4,000
X ≤ 3/4
 Question 17

A. Adverse selection occurs when one party knows more than the other party
B. Adverse selection is caused by asymmetric information, doesn’t cause it
C. Efficiency wage contracts prevent moral hazards
D. Not all of the above
 Question 18

A. The insurance covers the full value so the entire financial risk falls on ICBC
B. By setting a limit, Sun Life is able to share the financial risk
C. In efficient markets risk neutral individuals will bear more risk than risk averse
D. All answers are correct
 Question 19

A. Externality is defined as a cost or benefit received by a third party thus eliminating the third party
eliminates the externality
B. An efficient outcome can be reached
C. A pareto improvement is when at least one party is better off without any party being worse off.
Parties getting pollution taxed would be worse off
D. The drug company that had the patent before is worse of thus not a Pareto improvement
 Question 20

The firm would reduce emissions for the first and 2nd units (as it’s cheaper than the tax) and pay taxes
on the 3rd and 4th units.

Combined expenditure = 10 + 20 + 30 + 30 = $90