BUSINESS AND INDUSTRIAL ECONOMICS

A.Y. 2020/2021
BIE classroom exam – January 12th, 2022

NAME _____________________________________ SURNAME ____________________________________

STUDENT ID_(matricula)___________________________________________________________________

MULTIPLE-CHOICE QUESTIONS [10 points]

You do not need to provide explanations for your answers. However, if something is not clear in the text
and you want to add a note to an answer (e.g., an assumption, a clarification, an explanation), please write
it in the paper sheets that you will upload as a unique .pdf file.

1. How are (non-merging) competitors likely to react to a horizontal merger that impedes effective competition
because of unilateral and coordinated effects? These competitors likely have incentives to
a. Decrease prices to counteract the market power of the merged entity
b. Increase prices because of both unilateral and coordinated effects
c. Increase prices because of unilateral effects and decrease them because of coordinated effects
d. Not react to the merger because the merger only affects the merging parties’ pricing strategies

2. A retailer A chooses to bear costs of training its staff to demonstrate potential customers how a new kitchen
appliance works. Instead, another retailer B, which sells a homogeneous product, decides not to bear these
costs. Customers, who have participated in the product demo of A, are free to choose to buy the kitchen
appliance from B, which charges lower price than A. This is a case of
a. Price discrimination since the two retailers set different prices for a homogeneous good. Because of
this pricing strategy, only one firm will win the entire market
b. Signaling since retailer A has already shown customers the better quality of its products
c. Free riding problem since retailer B benefits from the actions and efforts of retailer A without
bearing any cost
d. None of the other answers is correct

3. Which of the following statements is TRUE? According to industrial economists

a. The divide-and-conquer strategy prescribes that a platform owner should charge low prices to the
group of participants with the lower demand elasticity to get this group on board and, thus, to attract
participants from the other group
b. A Board of Directors formed only by internal members reduces principal-agent problems in
managerial firms
c. There is consistent evidence that innovation negatively relates to industry concentration
d. All the other statements are FALSE

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4. Consider a second-hand market for motorbikes. There are high-quality motorbikes, which buyers value at
most 10,000 Euros, and low-quality motorbikes, which buyers value at most 6,000 Euros. High-quality
sellers accept (at the minimum) 7,500 euros, while low-quality sellers accept (at the minimum) 5,000 euros.
What should be the share of high-quality motorbikes in the market to have a pooling equilibrium?
a. 0.375
b. 0.5
c. 0.625
d. All the other answers are WRONG

5. Which of the following statements on innovation is TRUE?

a. Empirical evidence found an inverse U-shaped relation between firms’ size and innovation. Indeed,
small firms have financial resources for innovation because of their cost-efficacy, while large firms
suffer from core rigidities and risk of cannibalizing their current product portfolio
b. Attracting external finance for innovation is even more difficult for large established firms as their
large size complicates investors’ monitoring activities
c. Assessing the impact of mergers on the market by policymakers is an example of an innovation policy
d. All the other statements are FALSE

6. The firm DISK2.0 manufactures 1 million hard disks per year specifically for Dell laptop computers. Dell has
committed ex-ante to assure to DISK2.0 a rent of $10 million. The average variable cost of DISK2.0 is c =
$15/unit, the yearly cost of investment to build a hard disk factory is I = $15 million, and the market price (pM)
for DISK2.0 hard disks is pM = $18/unit. What is the price that Dell (pD) has committed to pay to DISK2.0?
a. pD is equal to pM since Dell is a rational agent and wants to capture all the DISK2.0’s rent
b. pD is lower than pM since relational-specific investments cause market imperfections
c. pD is equal to $40/unit
d. pD is equal to $22/unit

Solution
𝑝𝐷 ∗ 𝑞 − 𝑐 ∗ 𝑞 − 𝐼 = 𝜋 𝑅

𝐷
𝜋𝑅 + 𝐼 + 𝑐 ∗ 𝑞 10.000.000 + 15.000.000 + 15 ∗ 1.000.000
𝑝 = = $ = $40
𝑞 1.000.000

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7. Which of the following statements on “born global firms” and internationalization is FALSE? Born global
firms
a. Are smaller than traditional multinational companies, although both types of firms target international
markets and perform value-adding activities in different countries
b. Are young entrepreneurial firms in terms of ownership and managerial structure
c. Have little or no experience about international markets. Thus, they initially grow their
businesses into the domestic market. Once successful, these firms become increasingly
committed to internationalization
d. Pursue an internationalization expansion that does not align with the mainstream stage theory

8. Consider two firms, a manufacturer (M, upstream firm), and a retailer (R, downstream firm). Which of the
following statements on vertical relations is FALSE?
a. The demand of M depends on the price that R sets and on other variables that M does not directly
control (e.g., advertising, sale services)
b. The sum of the profits of the two unintegrated firms is lower than the profit of the merged entity that
would result from vertical integration
c. The total profit of the two firms is higher than it would be under vertical integration because of
double marginalization
d. The demand of M also depends on the degree of competition that R faces by the other firms in the
downstream market

9. Which of the following statements on network industries is FALSE?

a. The value of a computer operating systems depends only on users’ ability to exchange files and
interact with other compatible systems
b. Consumers may incur high switching costs if they chose to migrate from a network good with a large
installed base to another one of better quality, but with a limited installed base
c. Network effects may cause market imperfections in network industries, making them unattractive for
new entrants because of high entry barriers
d. As synchronisation value of a network good is directly and indirectly tied to the size of its installed
base, network industries are characterized by path dependence since current performances strongly
depend on past events

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10. Firms 1-6 are active in industries A-F. The table reports firms’ shares of sales in each industry (a blank cell
means that a firm does not operate in an industry, e.g., firm 1 does not operate in industry A). Industries A, B
and C are related industries; the same holds for industries D, E, F. Which of the following statements is TRUE?
Of note, more than one statement can be true
Firm Industry A Industry B Industry C Industry D Industry E Industry F
1 0.01 0.005 0.975 0.01
2 0.675 0.16 0.025 0.14
3 0.1 0.7 0.2
4 0.1 0.705 0.025 0.17
5 0.125 0.225 0.65
6 0.125 0.725 0.125 0.025

a. According to the Herfindahl index (HI), industries B and C are more concentrated than
industries A and F
b. According to the Herfindahl index (HI), industries E and C are more diversified than all the other
industries
c. Firms 1 and 5 have a higher Gort index (D2) than firms 2 and 4
d. Firms 3 and 4 have a higher Specialisation Index (SI) than firms 2 and 5

EXERCISE 1 [7 points]
Consider a duopoly situation with two firms (1 and 2) facing the demand curve P = 15 - Q, where Q = q1 + q2.
Both firms have the same cost function: Ci(qi) = 3qi, i=1,2
a.) Compute the Cournot equilibrium (quantities, prices, profits). [1.5 points]
b.) Compute the von Stackelberg equilibrium (quantities, prices, profits). [1.5 points]
c.) Find the price, quantities, and profits under collusion. [1.5 points]
d.) If you were firm 2 (the follower), which competitive regime would you prefer? [0.5 points]
e.) Calculate the total consumer surplus, total producer surplus, and the total welfare in the market in each of the
three competitive regime (i.e., Cournot, von Stackelberg, and Collusion). If you were the State, which
competitive regime would you prefer? [2 points]

Solution

a.) Compute the Cournot equilibrium. Starting from the inverse demand function P = 15 - (q1 + q2), firm 1
chooses the quantity q1 that maximizes its profit function:
𝛱1 (𝑞1 , 𝑞2 ) = ((15 − ( 𝑞1 + 𝑞2 ))𝑞1 − 3𝑞1 = 15𝑞1 − 𝑞12 − 𝑞1 𝑞2 − 3 𝑞1 = 12𝑞1 − 𝑞12 − 𝑞1 𝑞2

From the first order condition, we get firm 1’s best reply function:
∂𝛱1 (𝑞1 , 𝑞2 ) 1
= 12 − 2𝑞1 − 𝑞2 = 0 → 𝑞1 = 6 − 𝑞2
∂𝑞1 2

Similarly, firm 2 chooses the quantity q2 that maximizes its profit function. The results are symmetrical to those
of firm 1. From the first order condition, we get firm 2’s best reply function:

1
𝑞2 = 6 − 𝑞
2 1

By solving the system with the two best reply functions, we obtain:

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 1 1
𝑞1 = 6 − 2 (6 − 𝑞 )
2 1
→ 𝑞1 = 4
1
𝑞2 = 6 − ∗ 4=4
2

The Cournot equilibrium quantities are 𝑞1 = 𝑞2 = 4

Hence, the quantity Q = q1+q2 = 8 is sold at the price pC = 7, which is the same for both firms, and the two firms
get the profits:

𝛱1𝐶 =P*q1-C1= 7 ∗ 4 − 3 ∗ 4 = 16
𝛱2𝐶 =P*q2-C2= 7 ∗ 4 − 3 ∗ 4 = 16

b.) Compute the von Stackelberg equilibrium (quantities, prices, profits).

The game is solved via backward induction, that is, starting from the second stage. In this stage, firm 2
chooses its quantity as in the simultaneous game (Cournot), so its best reply function is:
1
𝑞2 = 6 − 𝑞1
2

(For calculation, see the first order condition of firm 2 in point a.)
Going to the first stage of the game, we find the optimal price for firm 1 by plugging the best reply function of
firm 2 into the profit function of firm 1:

1 1
𝛱1 (𝑞1 , 𝑞2 ) = ((15 − ( 𝑞1 + 𝑞2 ))𝑞1 − 3𝑞1 = (15 − 𝑞1 − 6 + 𝑞1 )𝑞1 − 3 𝑞1 = 6𝑞1 − 𝑞12
2 2

From the first order condition, we get firm 1’s optimal quantity:
∂𝛱1 (𝑞1 , 𝑞2 )
= 6 − 𝑞1 = 0 → 𝑞1 = 6
∂𝑞1
From q1, it is possible to derive the optimal quantity for firm 2,

1 1
𝑞2 = 6 − 𝑞1 = 6 − ∗ 6 = 3
2 2

In equilibrium, the overall quantity is Q = q1 + q2 = 6+3 = 9, which is sold at the price P = 15-9 = 6

πS1=P*Q1-C1= 6*6 – 3*6=18

πS2=P*Q2-C2= 6*3 –3*3=9

c.) Find the price, quantities, and profits under collusion.

P = 15 – Q,
MR=15-2Q
MR=MC → 15-2Q=3, Q = 6 (q1=q2=3)
P=15-6=9
Πcoll1 =πcoll2=P*q-c*q=9*3-3*3=18

d.) If you were firm 2 (the follower), which competitive regime would you prefer?
Q1 Q2 P Π1 Π2
Cournot 4 4 7 16 16
Von 6 3 6 18 9
Stackelberg
Collusion 3 3 9 18 18

Firm 2 prefers collusion because:

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 • In the Von Stackelberg game, firms 2 is the follower and can only respond to the quantity set by firm 1,
the leader, which benefits from the first mover advantage.
• Firm 2 would prefer the collusive regime rather than the Cournot’s regime since the former enables it to
gain a higher profit

e.) Calculate the total consumer surplus, total producer surplus, and the total welfare in the market in each of the
three competitive regimes (i.e., Cournot, von Stackelberg, and Collusion). If you were the state, which
competitive regime would you prefer?
CS PS TW
Cournot 32 32 64
Von 40.5 27 67.5
Stackelberg
Collusion 18 36 54

The State would prefer the Von Stackelberg regime as it enables to gain the highest total welfare.
.

EXERCISE 2 [3 points]
Assume a market for car tires, where tires are homogeneous. The two firms (1 and 2) have a combined demand of
Q=100-0.4P. Likewise, their marginal and average costs amount to $100. Initially, the market price is $110. Firm
1 and 2 have decided to merge. They can lower their costs of production from $100 to $85 because of economies
of scale in combined operations and, being now the monopolist, charge a price of $120. Use the combined demand
to evaluate the merger.

a.) Calculate the consumer surplus, producer surplus and social (total) surplus pre-merger and post-merger [2
points]
b.) Should the merger be approved? Why? [1 point]

Solution:

Social surplus pre-merger:

P=110
MC=AC=100
Q=100-0.4*110 = 56
The inverse demand function if P=250-2.5Q

The consumer surplus is the triangle below the demand function and above the price charged in equilibrium. It
follows that:
CS0 = ½ (250 – 110)(56) = 7840/2=3920
For each firm, the profit equals the producer surplus.
PS0 = (110-100)(56)=560
It follows that the total (social) surplus amounts to:
TS0=3920 +560 = 4480

Social surplus post-merger:

P=120
MC=AC=85
Q=100-0.4*120 = 52
The inverse demand function if P=250-2.5Q

CS1 = ½ (250 – 120)(52) = 6760/2= 3380

PS1 = (120-85)*52=1820
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TS1=3380+1820=5200

TS1>TS0 Merger approved

Do you want your submitted exam to be corrected?

a. Yes, I want
b. No, I withdraw