Econ100A(UCBerkeley) Fall2011 Prof.

Santesteban

FinalExam(150points)
Pleasewriteyourname,IDnumber,andGSIatthetoprightofthispage. Pleasewriteyourlastnameoneveryotherpageofthisexam. Youmayuseacalculator.Nootherreferencematerialisallowed,i.e.,nocheatsheets. Pleaseshowyourwork.Otherwise,nopartialcreditwillbegiven.Goodluck! PartI:LongProblems.Eachquestionifworth25points.Pleaseshowallworkandexplain eachstep.Nocreditwillbegivenforjustanswersorformathematicalscribblethatishardto follow. Problem1 Afirminaperfectlycompetitiveindustryhaspatentedanewprocessformakingwidgets.The newprocesslowersthefirmsaveragecost,meaningthatthisfirmalone(althoughstillaprice taker)canearnrealeconomicprofitsinthelongrun. a)Ifthemarketpriceis$20perwidgetandthefirmsmarginalcostisMC=0.4q,whereqisthe dailywidgetproductionforthefirm,howmanywidgetswillthefirmproduce?(10points) MC=.4q Setp=MC q=50.
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p=$20 20=.4q

b)Supposeagovernmentstudyhasfoundthatthefirmsnewprocessispollutingtheairand estimatesthesocialmarginalcostofwidgetproductionbythisfirmtobeSMC=0.5q.Ifthe marketpriceisstill$20,whatisthesociallyoptimallevelofproductionforthefirm?What shouldbetherateofagovernmentimposedperunittaxtobringaboutthisoptimallevelof production?(20points) SMC=.5q Setp=SMC 20=.5q Attheoptimalproductionlevelofq=40,themarginalcostofproductionisMC= .4q=.4(40)=16,sothetaxt=2016=$4. c)Graphyourresults.(5points) q=40.

Problem2 Supposetherearetwotypesofusedcars:plumsandlemons.Aplumisworth$3000toabuyer and$1900toaseller.Alemon,ontheotherhand,isworth$1000toabuyerand$500toa seller.Thefractionofusedcarsthatareplumsisandthefractionthatarelemonsis. Assumethatwhenbuyersandsellersbargain,theagreeduponsalespriceisalwaysthe maximumthatbuyersarewillingtopay. a)Whatwouldbethepricesforlemonsandplumsiftherewereperfectinformationaboutused carquality?(4points) PricePlums=$3000 PriceLemons=$1000 b)Whatwouldbethepriceofausedcarifneitherbuyernorsellerknewwhetheraparticular carwasalemonoraplum?(4points) AverageWTP=3000*0.25+1000*0.75=1500 AverageWTS=1900*0.25+500*0.75=850 Priceofausedcar=$1500

c)Assumethatbuyerscannottellwhetherausedcarisaplumoralemon.Sellersknowwhich typeofcartheyown.Whatwillbethemarketpriceforusedcars?Explain.(4points) SincetheWTPislowerthanthereservationpriceofaplumowner,noplumswillbe offered.Assuch,onlylemonswillsellfor$1000. Priceofausedcar=$1000 d)Nowassumethatthereareasmanyplumsaslemons.Continuetoassumethatbuyers cannottellifacarisaplumoralemon.Whatwillbethemarketpriceforusedcars?Explain. (4points) AverageWTP=$2000 Nowplumownersarewillingtosell. Priceofausedcar=$2000

e)Continuetoassumethatthedistributionoflemonsandplumsis5050.TheAkerlofInstitute offersanewservice.ForapriceP,itwillinspectanyusedcartodeterminewhetheritisaplum oralemon.Theinspectionis100%accurate.WhatisthemaximumpriceP*thatownersof plumswouldbewillingtopaytohavetheircarsinspected?[Hint:Bearinmindthatifoneplum owneriswillingtopayP*,allplumownerswillbewillingtopayP*](5points) Ownersofplumswillwanttopayfortheserviceaslongas: 3000P*1900>=20001900 Hence,P*=1000.Atthatprice,ownersofplumsareindifferentbetweenbuying theserviceornot. Atapriceof$1000(oranyP*>0),ownersoflemonswouldnotwanttopayfor theservice. Hence,themaximumpriceplumownerswouldbewillingtopayisP*=1000. f)TheAkerlofInstitutedecidestochargeP*.Howmuchwillplumssellfor?Andlemons?(4 points) AtP*=1000,theresperfectsignalingandplumssellfor$3000andlemonsfor $1000.

Problem3 Considertwofirms,AandB,whichsimultaneouslysetpricesineachperiodt=0,1,2,...Firm AhasmarginalcostofCA=12,whilefirmBhasmarginalcostofCB=20.Marketdemandin eachperiodisgivenbyQ(P)=140P/2. (a)WhataretheBertrandequilibriumprices,outputlevels,andprofitsinthesingleperiod staticstagegame?(6points)

(b)WhatisfirmAsmonopolyprice,output,andprofitsinthesingleperiodstaticstagegame? SameforfirmB.(6points)

(c)Supposethetwofirmsstarttocolludeinthefollowingway:Int=0,bothchargefirmBs monopolyprice,andfirmAgetsa70percentmarketshare,whilefirmBgets30percent.In eachsubsequentperiod,theykeeppriceandmarketsharesunchangedunlessonefirm deviates.Ifonefirmdeviates,thenbothfirmschargetheBertrandequilibriumpriceforever. CalculatefirmAsandfirmBscriticaldiscountfactor.(7points)

(d)Supposethattheactualdiscountfactorofbothfirmsis0.6.Isthecollusiveagreementin(c) sustainable?(6points)

Problem4 Therearetwobookstores,AandB,inasmalltowninSwitzerland.InSwitzerland,bookscan onlybesoldatthepricessetbythepublishers,sothereisnopricecompetitionattheretail level.Rather,thebookstorescompetebydifferentiatingthemselvesintheirhoursof operation.Ifstoreisellsqibooksduringsihours,thenisprofitisgivenby5qi100si.Intotal, 1000booksaresoldinBernperday.Thenumberofbookssoldbyeachbookstoredependson itshoursofoperation.IfstoreAisopenforsahoursandstoreBforsbhours,thenAsellsqa= 1000*sa/(sa+sb)andBsellsqb=1000*sb/(sa+sb). a)Supposethecityregulatesthebookstoresandrequiresthemtobeopenforexactly8hours perday.ComputetheprofitsoffirmsAandB.(8points)

b)Themayorofthetownsuggeststoderegulateandtoallowbookstorestoeitherbeopenfor 8orfor12hoursaday.Thecitycouncilhiresyouasagametheoristtopredictwhatthe outcomeofthederegulationisgoingtobe.Whatisyourpredictionifstoreshavetochoose independentlywhethertobeopenfor8orfor12hours?Isthederegulatedoutcomeefficient (fromthepointofviewofthebookstores)?Whyorwhynot?[Hint:Writeoutthenormal formofthisgameandsolveforanyNashequilibria.](8points)

c)Thereisapowerfultradeunionofbookstoreemployeesinthetownthatwantstoknow whetherornotitshouldopposederegulation.Theyhiredagametheoristthattellsthemthat theyshouldpushforderegulationandthat,afterderegulation,bothbookstoreswillbehappy toincreasewagessuchthatonehourofoperationcosts$140ratherthan$100toeachbook store.Furthermore,inthiscase,noemployeewouldhavetobeafraidthatthestoreswillbe openformorethan8hoursperday.Thissoundedcrazytotheunionandtheyfiredthegame theorist.Wastheunionjustifiedinfiringthegametheorist?Whyorwhynot?(9points)

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PartIITrue/False/Uncertain.Pleasechoose10outof12.Eachquestionifworth5points. Pleaseexplainyouranswersusingmath,graphs,oreconomiclogic.Allcreditisbasedonthe qualityoftheexplanation. Question1 DeBeers(anunregulatedmonopolist)determinesthat,atcurrentpricesandquantities,the elasticityofaggregatedemandfordiamondsis0.8.DeBeersnowknowsthatitcanincrease profitsbyloweringtheprice.

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Question2 ThefollowingextensiveformgamehasexactlyoneNashEquilibrium.

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Question3 SupposethatamancommutestoworkeverydayeitherbywalkingortakingBART.Itcosts$1 perride,andthemanusesBARTfourtimespermonth.Now,supposethatBARToffersa monthlypasscoveringunlimitedridesfor$20.Holdingallotherfactorsconstant(includingthe mansutilityfunction),themanwillnotfinditoptimaltopurchasethemonthlypass.[Hint: AssumethatourcommuterhasadownwardslopingdemandforuseofBARTasafunctionof price.Considerwhatthemarginalcosttothecommuteriswithpassandwithout.]

Question4 IftwosimultaneousmoveBertrandpricecompetitorshavedifferentconstantmarginalcosts, thenanypricebetweentheirmarginalcostscouldbeaNashequilibriumprice.

ANS: T Solongasfirm1pricesjustbelowfirm2andbelowfirm2sMC,firm2isbestrespondingbypricingjust abovefirm1.Butfirm1isbestrespondingonlyifitpricesaboveitsownMC.

Question5 Inaduopoly,ifyoucanchoosetoeitherbeasimultaneousmoveCournotcompetitorora Stackelbergleader,youwillalwayschoosetobeaStackelbergleader.

ANS: T YougainafirstmoveradvantagebybeingaStackelbergleader.AndyoucanalwaysearnCournot profitsbyplayingtheCournotquantityastheleaderinthesequentialgame.

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Question6 Supposeaplayerinasequentialgamehas5potentialdecisionnodes,with2possibleactionsat eachnode.Thenshehas25possiblepurestrategies.

ANS: F Hehas possiblestrategies.

Question7 CooperationisdifficulttoachieveinaPrisonersDilemmabecauseeachplayerthinkstheother playermightnotcooperate.

ANS: F Cooperationisdifficulttoachievebecausenotcooperatingisadominantstrategyforeachplayeri.e. regardlessofwhetherornottheotherplayercooperates,itisineachplayersinterestnottocooperate.

Question8 Dependingontheshapeofthemarginalcostcurve,amonopolistmightproduceanoutput levelontheelasticortheinelasticpartofdemand.

ANS: F Amonopolistalwaysproducesonthepriceinelasticpartofdemand.

Question9 Inthepresenceofpositiveproductionexternalities,amonopolistmightproducetheefficient outputlevel.

ANS: F Inthepresenceofpositiveexternalities,theefficientquantityislargerthanthequantityproducedif onlyprivateMCissettoMR.ThequantitywhereMC=MRisthemonopolistquantity.Introducinga positiveexternalitythenmovestheefficientquantityfurtheroutwithoutchangingthequantitythe monopolistwouldproduceimplyingthemonopolistwilldeviateevenfurtherfromefficiency.

Question10 Intheabsenceofthenegativeexternalityfromeachindividualscontributiontoroad congestion,roadswouldnotbecongested(asidefromcongestioncausedbyaccidents).

ANS: F Justastheoptimallevelofpollutionisnotzerotheoptimalamountofroadcongestionisnotzero.

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Question11 Achangeinthepriceofonegoodcannotleaveutilityunchangedunlessthepricechangeis accompaniedbyachangeinincome.

ANS: F Thereareseveraltypesofcounterexamplestothis.Forinstance,ifaconsumerisatacornersolution andthepriceofthegoodthatisnotconsumedincreases,theconsumersutilityisunchanged.Or,ifa consumerconsumesataninteriorsolution,anincreaseinthepriceofonegoodcouldbeaccompanied byadecreaseinthepriceoftheothergoodsuchthattheconsumersutilityremainsunchanged.

Question12 Iflaborandcapitalareperfectcomplementsinproduction,andcapitalisfixedintheshortrun, thenshortrunsupplycurvesarevertical.

ANS: T Ifcapitalcannotbevaried,thereisnowaytoincreaseproductionwhenoutputpricerises.

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