BUSINESS AND INDUSTRIAL ECONOMICS [A-L]

A.Y. 2018/2019

Final exam – June 21st, 2018

NAME _____________________________________ SURNAME ____________________________________

STUDENT ID (Matricola)____________________________________________________________________

MULTIPLE-CHOICE QUESTIONS [15 points]

Please, indicate your answers in the following table. We will consider and evaluate only answers reported
in this table. You do not need to provide explanations for your answers. However, if you want to add a note
to an answer (e.g., an assumption, a clarification, an explanation), please write “YES” in the last column.

Question A B C D Notes
1
2
3
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5
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15

1. Which of the following pricing methods give the lowest incentives for a natural monopoly firm to
improve on operating efficiency?
a. Average cost pricing
b. Rate of return
c. Earnings sharings
d. Price caps

2. Consider an industry in which the inverse demand function is: P = 40 – Q, where Q is the total output.
Two firms compete in the industry by choosing simultaneously the quantity to produce. The two firms
produce with identical total costs: TC(q)=10qi (i=1,2). The equilibrium price and quantities for the industry
are
a. q1*=q2*=10, P*=20
b. q1*=q2*=10, P*=30
c. q1*=15, q2*=10, P*=15
d. None of the answers above is correct

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3. Two firms operate in an industry in which the inverse demand function is P = 90 – Q, where Q is the total
output, and compete according to the Stackelberg model. The two firms produce with identical total costs:
TC(q)=30qi (i=LEADER, FOLLOWER). The equilibrium price and quantities for the industry are
a. qLEADER=15, qFOLLOWER =30, P=45
b. qLEADER=30, qFOLLOWER=15, P=45
c. qLEADER=22.5, qFOLLOWER =22.5, P= 45
d. qLEADER=30, qFOLLOWER =15, P=60

4. A coal-fired power plant jointly produces electricity and air pollution. Air pollution adversely affects a
nearby farm. Assume: pe = 24 the price of electricity, pf = 20 the price of the agricultural product of the
farm (both firms are price-taker), ce(e,x) = e2 + (x - 8)2 the cost for the coal-power plant of producing
electricity e jointly with x units of pollution (there are no external costs of pollution), and cf(f,x) = f2 + fx
the cost for the farm of producing f units of agricultural products, when the coal-fired plant emits x units
of pollution. If the two firms merge to internalize the negative externality, then
a. e* = 12, f* = 12/5, x* = 76/5
b. e* = 12, f* = 4, x* = 8
c. e* = 12, f* = 8, x* = 4
d. None of the answers above is correct

5. Consider a second-hand market for bikes. There are high-quality bikes, which buyers value at most 800
euros, and low-quality bikes, which buyers value at most 400 euros. High-quality sellers accept at
minimum 700 euros, while low-quality sellers accept at minimum 300 euros. Assume that buyers cannot
observe quality before purchasing. We conclude that both kinds of bikes are traded on the market if the
fraction q of low-quality bikes is
a. q>3/4
b. q>1/4
c. q<3/4
d. q<1/4

6. In case of platforms, it usually occurs that

a. Cross-side and same-side network externalities are negative
b. Cross-side network externalities are negative, while same-side network externalities are positive
c. Cross-side network externalities are positive, while same-side network externalities may be
negative if, for instance, there is competition among the participants of the same group
d. Cross-side network externalities are positive, while there are no externalities on the same side

7. Cristina and Evila are close friends and own a small holiday apartment in Marina di Carrara, just in front
of the beach. Evila uses the apartment in June, while Cristina prefers to use it in August. They both like
watching TV when they are on holidays (i.e., the TV is a good for them). Thus, they are considering buying
a TV for their holiday apartment. Cristina and Evila do not want to remove the TV from the apartment
when they are not inside. They make their decision about buying the TV independently. Evila’s reservation
price for the TV is 300 euros, while Cristina’s reservation price for the TV is 400 euros. The TV costs 500
euros. We conclude that

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 a. Buying the TV is a Pareto improvement, but neither Evila nor Cristina are willing to buy the TV
alone
b. Buying the TV is not a Pareto improvement as neither Evila nor Cristina are willing to buy the
TV alone
c. Buying the TV causes a negative externality on Evila and Cristina as they are using the apartment
in different periods
d. None of the answers above is correct

8. Which of the following statements about the Vernon model is NOT correct? According to the Vernon
model,
a. Internationalization is not worthy in the introductory phase of a product life-cycle
b. In the mature phase of a product life-cycle, the risk of imitation is high
c. In the growth phase of a product life-cycle, internationalization by locating production in a foreign
country is worthy if the cost of producing abroad is lower than the cost of producing domestically
d. The monopolistic advantage of the innovator gradually vanishes as the product progresses along
its life-cycle

9. All else being equal, in an industry, collusion is more likely when firms
a. Are heterogeneous in size
b. Are “patient” and care about future profits
c. Can hardly access information about rivals’ prices
d. All the answers above are correct

10. According to the transaction cost approach to vertical integration, ceteris paribus, vertical integration is
more likely when
a. Asset specificity is low
b. Market specialists enjoy high economies of scale
c. Coordination costs within the firm are very high
d. The scale of production increases

11. Firm i is active in five diverse industries. The table reports i’s shares of sales in each industry j (Pij, with j
= 1,…,5). The Specialization Index (SI) and the Berry’s index (BI) are
Industry Pij
1 0.35
2 0.25
3 0.2
4 0.15
5 0.05
a. SI=0.35; BI=0.25
b. SI=0.35; BI=0.75
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 c. SI=0.05; BI=0.75
d. SI=0.35; BI=0.95

12. According to industrial economists, which of the following is NOT a typical obstacle to innovation?
a. Information asymmetries in financial markets
b. Presence of unintended knowledge spillovers
c. Uncertainty about consumers’ preferences
d. Separation between ownership and control

13. Identify which of the following situations encompasses a moral hazard issue
a. Mary is studying industrial economics in the library, when she realized that she forgot to lock her
bike, which she parked downstairs. As she has a bike insurance, Mary decides it is not worthy to
interrupt just to go downstairs and lock the bike
b. Elisabeth lives in an apartment above a restaurant, and her apartment always smells like burgers
and fries. She has tried unsuccessfully to get the restaurant owner to remedy the problem
c. Some bank officers are attending a startup competition where innovative startups pitch their
business ideas. The ideas are based on leading-edge AI technologies about which bank officers
have very limited expertise. The bank officers find the ideas very promising, but accept to finance
them just in exchange of a high interest rate
d. None of the answers above is correct

14. Which of the following statements is NOT in the realm of agency theory?
a. The board of directors acts to ensure that interests of the shareholders are met
b. A professional CEO, who indulges in maximizing her own private benefits runs the risk of being
replaced in consequence of an hostile takeover
c. The presence of high quality members in the board of directors signals the high quality of the firm
to external stakeholders
d. In firms in which there is separation between ownership and control, managers are risk-adverse,
while owners are risk-neutral

15. Imagine that labor market is perfectly competitive and workers can signal their ability through education.
Firms pay workers their expected productivity a, conditional on their education level e. Specifically, the
expected productivity of high-ability workers is aH = 400 and their unit cost of education is cH = 2, while
the expected productivity of low-ability workers is aL = 100 and their unit cost of education is cL = 5. Find
the level of education eH that allows high-ability workers to credibly signal their ability on the labor
market.
a. 𝑒𝑒𝐻𝐻 = 150
b. 𝑒𝑒𝐻𝐻 > 60
c. 𝑒𝑒𝐻𝐻 < 150
d. 60 < 𝑒𝑒𝐻𝐻 < 150

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STRUCTURED QUESTION

Exercise [8 points]
a) Market demand for a homogeneous good is Y(p) = 750 - 3p. Assume that two firms (firm 1 and firm 2) are
serving the market. They employ the same technology, that is they have the same cost function (specifically, C1(y1)
= 4y1 and C2(y2) = 4y2). Assume that the two firms compete à la Cournot. Find the equilibrium and the firms’
profits. [3 points]
b) Assume a homogeneous goods market for cellular phones. Two firms, 1 and 2, have a combined demand of
Q=50-0.2P. All cellular phone producers have constant marginal and average costs of $50. Initially the price is
$50. Firm 1 and 2 have decided to merge. They can lower their costs of production from $50 to $48 because of
economies of scale of combined operations. They expect that, as the market leader, they can lead the industry to a
price of $60. Use the above demand curve and compute social costs and benefits of the merger. On this basis,
should the merger be approved? [3 points]
c) Petra owns a factory and hired Anna as a worker. The factory’s output depends on Anna’s effort and is Q = 40E
– E2 . Assume the price is equal to unity (P=1).
Patricia, who is the principal, maximizes her profits πP = Q*P – wE (she will only pay Anna the minimum possible),
where w is the wage she will pay to Anna to exert effort E.
Anna (agent) has payoff πA = 𝑤𝑤E –E2 (notice that this is her utility of wealth net of the cost of exerting the effort).
Instead of working in the factory Anna could do gardening and have a πA0 of 50.
Suppose that the effort is observable. Find the profit-maximizing effort E, wage w and Patricia’s profit. [2 points]
PLEASE REPORT THE SOLUTION BELOW

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Mini-case [7 points]

Read the following mini-case and answer the following questions basing on the concepts and models that
we have studied in class.
In Hong Kong as elsewhere in the world, Uber operates in a grey area. Thousands of passengers are using Uber
service in the crowded city on a regular basis; many drivers make money through Uber by providing quality service
and idle vehicles. On the other hand, taxi drivers have voiced strong oppositions to Uber on the ground of unfair
competition and unlawful businesses, and staged several protests that were widely reported. Officially, Uber
service is illegal in Hong Kong, as the government clarified explicitly that Uber drivers broke the law by offering
car hiring services without any license or third-party insurance. The public is often puzzled: Uber seems such a
nice thing that benefits both passengers and drivers, especially because the traditional taxies have such a poor
quality and are often unavailable during peak hours. Why shouldn't we allow a healthy competition from a new
and promising business model that seems to benefit everybody except the competitors? Isn't competition a good
thing in general? So the question is, should the government allow Uber to operate legally?
1. “The government clarified explicitly that Uber drivers broke the law by offering car hiring services without
any licence”. Why are licenses so important for taxi drivers? [2 points]
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2. Imagine that the government allows Uber to operate legally in Hong Kong. What do you expect is going
to happen to taxi drivers? Why? [3 points]
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3. Once Uber started to operate in Hong Kong, it faced a well-known problem, which is common to all
platform businesses: the chicken-egg problem. Suggest Uber one solution to overcome this problem [2
points]
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