MANAGERIAL ECONOMICS

HOMEWORK - 3
Study Group - E7

Krupa Bhulani 62210792

Sai Harika Padmanabhuni 62210973
Saichand Lakkakula 62210280
Tuhin Kumar Sen 62210756
Ashish Goel 62210290

Problem 1: Consider two farmers and two pieces of land. We want to know what the
effect is of each farmer working his own piece of land (we denote these independent
farmers) versus the farmers cooperating and jointly working on the two pieces of land
(collective farmers). Assume that each farmer (whether independent or collective) can
decide on his own how much time to spend on farming. Let farmer’s weekly time spent on
farming be denoted hi (in hours per week; so h1 for farmer 1 and h2 for farmer 2). The
farmer’s productivity (expressed in bushels of grain) is directly proportional to the time he
spends on farming. In particular, an independent farmer produces (80 ∗ hi) bushels of
grain if he works hi hours per week. Farmers in a collective are more productive since they
can specialize: a collective farmer produces (90 ∗ hi) bushels of grain if he works hi hours
per week. Collective farmers share the output of their farm equally. Let bi be the bushels
of grain that farmer i can take home at the end of the year, then bi = 80hi for an
independent farmer, while bi = (90h1 + 90h2)/2 for a cooperative farmer. Farmers dislike
working and more so as they work more. In particular, farmer’s utility is
Ui = bi − h 2 i 2
We assume that a farmer i will choose hi to maximize his utility Ui .
(a) Write out the utility functions of an independent farmer and the collective farmers
completely in terms of h1 and h2.
The utility of independent farmers is:
Ui = 80hi – (hi2/2)
So, utility of farmer 1 is, U1 = 80h1-h12/2
Utility of farmer 2 is, U2 = 80h2-h22/2

The utility of collective farmers is :

Ui = 90(h1 + h2)/2 – hi2/2
So, utility of farmer 1 is, U1 = 45h1+45h2-h12/2
Utility of farmer 2 is, U2 = 45h1+45h2-h22/2
(b) How many hours will an independent farmer work (assuming that farmers choose hi to
maximize their utility)? What is his utility?
The utility of independent farmers is:
Ui = 80hi – (hi2/2)
For maximizing utility, dUi/d hi = 0
80 - hi = 0
Therefore, hi = 80
Ui= 80*80-(80^2)/2 = 3200
The maximum utility of an independent farmer is 3200
(c) How many hours will a collective farmer work? What is his utility?
When farmers work collectively, utility of first farmer is
U1 = 45h1+45h2-h12/2
For maximizing their own utility, dU1/d h1 = 0
=> 45 – h1= 0
=> h1= 45
Similarly, by maximizing U2 we will get that h2 = 45
Since h1 = h2, U1 = U2 which will be 45(45 + 45) – 2025/2 = 3037.5
Thus, the utility of each farmer when both work collectively is 3037.5
(d) What is the problem with a collective farm? What would happen (qualitatively) if 100
farmers worked jointly in a collective farm? How could the farmers solve that problem?
This is similar to “contributing money to build a park” example shown in class.
It’s given that even when farmers are working collectively, each farmer is only trying to
maximize his individual utility. The total number of bushels is equal to 90(h1 + h2), and
when the farmer puts in an extra hour of effort, he is only able to reap half of the benefits
i.e., 45. We don’t know if the other farmer will increase the number of hours he works to
balance this out. So even the first farmer will not have the urge to work more as he is unable
to reap the benefits.
Each farmer has a positive externality on the remaining farmer which goes unconsidered
while maximizing individual utiilty. And the profits enjoyed by a farmer on increased effort
keeps reducing as number of farmers increases. If 100 farmers work collectively, the profits
also get split 100 ways.
So, to address this problem, we should either tell each maximize the overall utility, which
in turn increases their individual utility. Otherwise, we need to provide some incentives so
that the farmer is motivated to put in more effort, and he can get the profits he deserves.

Problem 2
The business district of Bombay2, Hariman's Joint, sits on an island3. Most of the people
who work in this district commute from the mainland. Speci cally, 400,000 people make
this commute. Bombayites are in love with their cars, so each of the 400,000 people drives
to and from work in a private car; there is no carpooling.
There are two routes from the mainland into (and out of) the business district, the
Borli Bridge (B)4 and the Tycoon's Tunnel (T). The time it takes to commute across the
bridge and through the tunnel depend on the number of individuals nB and nT who take
the bridge and the tunnel, respectively. Speci cally, if nB people come via the bridge,
the commute time via the bridge is 30 + nB=20000 minutes, and if nT people come via
the tunnel, the commute time via the tunnel is 40 + nT =5000 minutes.
(a) Suppose each of the 400,000 people who make this commute takes either the bridge
or the tunnel; that is, nB+nT = 400; 000. People choose whether to take the bridge
or the tunnel depending on which takes less time, so in equilibrium, the numbers
nB and nT are chosen so that the two commute times are equal. What are nB and
nT ?

We know that at equilibrium, the total travel time is the same

30 + Nb/20000 = 40+Nt/5000
Nb/20000 – Nt/5000 = 10
1/5000 (Nb/4 – Nt) = 10
Nb – 4Nt = 200000
Nb = 400000- Nt
400000 – Nt – 4Nt = 200000
Nt = 40000
Nb = 360000

(b) We de ne the total commute time as nB times the commute time via the bridge
plus nT times the commute time via the tunnel. In your answer to part (a), what
is the total commute time?
Time taken for Bridge = 30 + Nb/20000 = 30 + 360000/20000 = 48 Minutes
Time Taken for Tunnel = 40 + 40000/5000 = 48 Minutes
Total Time taken = 48 (360000+40000) = 19.2 Mn Minutes

(c) Suppose Bombay's mayor could control the number of people who come via the
bridge and via the tunnel. She chooses these numbers to minimize the total com-
mute time. How should she allocate the 400,000 commuters between the bridge and
the tunnel to minimize total commute time?
To minimise the total commute time,
d ((30 + Nb/20000)Nb) + d(40+ (400000 - Nb /5000) (400000 – Nb) = 0
d ( Nb) d ( Nb)
30 + 2Nb/20000 - 40 – 160 + 2Nb/5000 = 0
10 Nb /20000 = 170
Nb = 340000
Nt = 400000 – 340000 = 60000
This results in a commute time of 47 minutes by bridge and 52 minutes by tunnel

(d) Except for the congestion on the bridge and tunnel, there is a 0 marginal cost of
getting commuters across the bridge and the tunnel. For this reason, transit across
the bridge and through the tunnel has been kept free. But the mayor is considering
whether to impose a toll on one or the other. If a toll of tB is imposed on the
bridge and tT on the tunnel, consumers will rearrange their commute so that (10tB
+ commute time through the bridge in minutes) equals (10tT + commute time
through the tunnel in minutes). In other words, 10 minutes of commute time is
worth Rs. 1 to commuters. Find values for tB and tT , where one is 0, so that,
facing these tolls, commuters arrange their commute in the manner that minimizes
total commute time.
To divide the commuters as 60000 via tunnel and 340000 via the bridge, the toll to be set is
0.1 * (difference in time between bridge and tunnel) i.e. 0.1*5 mins i.e Rs. 0.5. Therefore, a
toll of Rs. 0.50 needs to be levied on the bridge.
Problem 3:
Awbrey Butte is an exclusive neighborhood of big, modern houses surrounded by native
pines in the Oregon mountains (see attached article). Resident Susan Taylor likes to use a
clothesline to dry her laundry, and thus saves $80 on average in annual energy costs
(apart from the obvious environmental benefits). Neighborhood manager Carol Haworth
is concerned that seeing laundry outside might give potential home-buyers the idea that
residents are too poor to afford dryers, and that will drive down property values. Suppose
the decline in property values is proportional to the number of weeks a year Susan dries
her laundry outside. The number of weeks is a multiple of 10 in each of the following
questions.

(a) In the absence of bargaining, how many weeks would Susan dry her laundry if she has
a right to do so?
In the absence of bargaining, Susan would maximize her own benefit and receive a total
benefit of $80. So she would dry her laundry for 50 weeks.
(b) In the absence of bargaining, how many weeks would Susan dry her laundry if Carol
has a right to protect her property value?
In the absence of bargaining, if Carol has a right to protect her property value, She would let
Susan use clothesline for 0 weeks.
(c) What is the socially optimal number of weeks the clothesline should be used?
 Week Total Benefit (S) Marginal Benefit (S) Total Cost ('C) Marginal Cost ('C)
0 0 0 0 0
10 16 16 10 10
20 32 16 25 15
30 48 16 45 20
40 64 16 70 25
50 80 16 100 30

Socially optimal no. of weeks is 20 weeks where Marginal Cost ~ Marginal Benefit
(d) With bargaining, how many weeks would Susan dry her laundry if she has a right to do
so? What is the minimum Carol would pay Susan?
Prioritizing Susan’s payoff of $80, Carol would have to pay the lowest at 20 weeks. Carol’s
expense would be a minimum of $25 + $48 = $73. That is, Carol would have to pay $48 to
Susan for Susan’s payoff to be $80.

Susan's Carol Carol paying

Weeks Benefit Loss Susan Net
0 0 0 80 80
10 16 10 64 74
20 32 25 48 73 (Least loss for Carol)
30 48 45 32 77
40 64 70 16 86
50 80 100 0 100

(e) With bargaining, how many weeks would Susan dry her laundry if Carol has a right to
protect her property value? What is the minimum Susan would pay Carol?
Prioritizing Carol’s payoff of $0 loss, Susan would have to pay the lowest at 20 weeks.
Susan’s expense would be minimal at 20 weeks, where her net benefit is $32 - $25 = $7.
That is, Susan would have to pay $25 to Carol for Carol’s total loss to be $0.

Susan's Carol Susan paying

Weeks Benefit Loss Carol Net
0 0 0 0 0
10 16 10 10 6
7 (Max benefit for
20 32 25 25 Susan)
30 48 45 45 3
40 64 70 70 -6
50 80 100 100 -20
Problem 4
An old lady is looking for help crossing the street 5. Only one person is needed to help her;
more are okay but no better that one. Sunny and Simran are the two people in the vicinity
who can help; each has to choose simultaneously whether to do so. Each of the two will
get utility worth 3 from the old lady’s success (no matter who helps her). But each one
who goes to help will bear a cost of 1, this being the utility value of the person’s time
taken up in helping. Set this up as a game. Write the payoff table, and find all pure-
strategy Nash equilibria.

Let there be two players in the game namely, Sunny and Simran. As per the schedule of the
payoff, every time the old lady gets help, from either Sunny or Simran or both, both of them
get an utility of 3. But, from this, the utility of 1 is deducted from the gained utility of the
one doing the help. In the case of no one helping the old lady, the utility earned for both
Sunny and Simran would be 0. Based on these parameters, the payoff table would be as
follows -
Participants Simran
Actions taken Help Don’t Help
Sunny Help 2,2 2,3
Don’t Help 3,2 0,0

Based on the pay-off table above, there would be 2 pure-strategy Nash Equilibria in this
scenario, namely the cases of (Help,Don’t Help) & (Don’t Help,Help) at (2,3) & (3,2)
respectively.

Problem 5
Having muscled out the other bhelpuri vendors on Chowpatty Beach in Bombay, the
proprietors of Royal Bhelpuri and Modern Bhelpuri have to decide where to locate their
stalls. Customers are situated uniformly along the beach, and will purchase from the
vendor closest to them.
(a) If the beach is 1 km long, what are the Nash equilibrium locations for Royal and
Modern?
Here is a demo considering there are 100 individuals in total, and each number in the matrix
represents how many people visit their stall at each point.

The numbers in bold represent the best response in each scenario, and there is only one
strategy profile with both best responses, i.e., the Nash equilibrium.

Thus, both Royal Bhelpuri and Modern Bhelpuri have Nash Equilibrium at the beach
halfway (0.5 km mark). It is exactly in the middle for both the players since they don't have
incentive to change location given the other vendor’s location. Once both of their stalls are
set up in the middle, moving them apart will simply reduce the vendor's customer share.
Thereby, forcing the vendors to return to the equilibrium point.

(b) If a new entrant, Tasty Bhelpuri, enters the market, what are the equilibrium
Locations?

When there are 3 players, there is no pure strategy to reach Nash equilibrium, each has its
own incentive to deviate. Each vendor will always try to move away from the other vendors
in order to cater to more customers, thus there will no specific point where they can attain
equilibrium.