Written Exam at the Department of Economics summer 2021

Micro II

Final Exam

20 August 2021

(3-hour open book exam)

Answers only in English.

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exam number only (e.g. ‘127.pdf’) and uploaded to Digital Exam.

This exam question consists of 5 pages in total

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Question 1

There is one cinema in a scenic small Danish town at the seaside, and the cinema acts as monopolist.

There are two groups of residents in this town. There are rich residents (consumers of group R), who

have moved into the town from Copenhagen, and there are poor residents (consumers of group P ), who

have lived in the town for a long time. The demand for cinema tickets of the two groups of consumers

can be described as follows:

xd R (p) = max(100 − p, 0) for rich consumers

xd P (p) = max(80 − 2p, 0) for poor consumers

The cost of running the cinema depends on the number of movies shown (and therefore the number

of cinema tickets sold) as follows:

1 2
C(x) = x
2

where x is the total number of movie tickets sold by the cinema. There are no fixed costs in running

the cinema.

a) Write down the total market demand function accounting for the demand of both groups of

consumers. (end part a))

The total inverse market demand function

 is given as follows:
 100 − x for 0 ≤ x < 60

d
p =
 60 − 1 x for 60 ≤ x ≤ 180

3

b) Write down the the marginal revenue curve M R(x) faced by the monopolist.

c) What are the equilibrium price and quantity in this market if the cinema cannot distinguish

between the two types of consumers, and therefore cannot engage in price discrimination? Are all

consumers served in this market? What is the surplus earned by poor consumers? What are the profits

of the monopolist? (end part c))

For parts d)-g) assume that the cinema finds out how to distinguish between the two types of consumers

and is able to charge different prices.

d) Write down the new profit maximization problem with respect to the quantities x∗R and x∗P and

find the first-order conditions.

e) What are the new equilibrium prices charged to rich and poor consumers, p∗R and p∗P , and quantities

of cinema tickets sold to the different groups, x∗R and x∗P ? What is the surplus earned by poor consumers?

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What are the profits of the monopolist?

f ) Due to an upcoming election a party proposes to ban monopolists from charging different prices

from different consumers, as it claims that this practice only serves to exploit poor individuals. Comment

on this proposal in light of your results under c) and e). (no calculations necessary)

g) Assume that the income of the rich consumers increases further (and cinema tickets are a normal

good). Will the quantity sold to the poor consumers change? If so, in which direction? What is the

economic mechanism at play? (no calculations necessary)

Question 2

At a hedge fund, Morten (agent) works for partner Claus (principal) at a new investment project. If

the project is successful, it brings Claus a revenue of 500. If the project fails, it only brings a revenue

of 50. In his work, Morten can either provide effort (e = 1) or be lazy (e = 0). The probability that

the project is successful increases with the effort provided by Morten, and is given by p(e) = 0.2 + a · e,

where a ∈ [0, 0.8). When providing effort, Morten incurs private costs of c(e) = 70e.

The level of effort provided by Morten is unobservable to Claus, but Claus can observe whether

the investment project is a success or not. Claus therefore can pay different wages wS and wF in case

of success or failure of the project. Morten’s outside option gives him a utility of 0. Moreover, both

parties are risk-neutral, and Morten’s utility depends additively on the expected wage and effort costs.

Throughout this question, we will assume that Claus wants Morten to provide effort.

a) Write down Claus’ profit maximization problem subject to the relevant constraints. Label and

interpret the constraints.

b) Assume that wF = 0. Which level of wS does Claus specify as a function of a? Do both constraints

bind? If not, which one binds? Explain the mechanism through which changes in a affect the specified

level of wS .

c) What is the expected level of utility that Morten achieves as a function of a?

d) What is Claus’ expected profit as a function of a?

e) Is there a clear direction in which a change in a affects Claus’ expected profits? What are the two

economic forces through which a change in a affects Claus’ expected profits?

f ) Now imagine that in case the project is successful, it would bring Claus a revenue of 1,000 instead

of 500, while it would still bring a revenue of 50 in case it fails. How would this affect the wage paid to

Morten in case of success, ws ?

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Question 3

Think about the following game. Four players each have 10 units available. In the game, each player has

to decide how much of the 10 units to keep, and how much to invest into a common project. Player i’s

contribution to the common project is denoted gi . Each contribution to the common project is multiplied

by a factor α and subsequently divided equally among the four players. α is currently unknown. However,

you know that 0 ≤ α < 4.

a) Is there a strictly dominant strategy for player i? If yes, what is it?

b) What is the payoff function Π2 of player 2? Player 2’s payoff function indicates the number of

units player 2 owns after the game as a function of player 2’s own contribution to the common project

and the contributions of the other players.

c) What is the Nash equilibrium? For which values of α is the Nash equilibrium socially optimal

from the perspective of a social planner who wants to maximize the combined number of units owned by

all players after the game?

d) What is player i’s payoff-maximizing contribution if α > 4? What is the Nash equilibrium if

α > 4? Is it socially optimal from the perspective of a social planner who wants to maximize the

combined number of units owned by all players after the game? (end part d))

For parts e) and f) assume that for each unit contributed by player i (where i = 1, 2, 3), player i + 1
3 1
receives 2 · α units, and player i receives 2 · α units. That is, if player 1 invests one unit, player 2 receives
3 1
2 · α units and player 1 receives 2 · α units, etc. Moreover, if player 4 invests one unit, player 1 receives
3 1
2 · α units and player 4 receives 2 · α units. You know that α ≥ 0.

e) Write down the new payoff function Πnew

2 of player 2.

f ) For which values of α is there a unique Nash equilibrium that is socially optimal from the perspec-

tive of a social planner who wants to maximize the combined number of units owned by all players after

the game?

Question 4

Respond critically to each of the following two questions by writing a text for each one. No calculations

are necessary.

a) Think about a market for pre-paid phone plans only including a certain number of minutes of

phone time, which are offered by two companies. Do you think that the Cournot model or the Bertrand

model will provide a more accurate description of competition in this market? Why?

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 b) In a country that is a small island, there is one national airline connecting the island to the main

land, which is operating as monopolist. The government wants to break up their monopoly and move to

a situation where there are many private airline companies flying to the mainland. Discuss the welfare

implications of this proposal, including two potential alternative policies. Also think about the market

size and cost structure of the airline.