Economics 101 UCSC, Fall 2012

Practice Final Exam

Rules: Closedbook, no electronic devices, no notes other than one page of formulas. 180 minutes in class.Write your answers clearly on 8x11” paper in order (part I, then part II). Write your name on each page. Total Points = 100.

Part I. Short answers. 40 word maximum per question. “TFU?E” means “True, false or uncertain? Explain briefly.” 6 points each.

  1. Which (if any) of the following will encourage a firm to produce its own inputs:
  2. specialized labor and capital are required; and/or
  3. long-term contracts are easy to write; and/or
  4. the main inputs can be sold on the spot market.
  1. Price discrimination is a social evil held in check mainly by managers’ ethical principles and the force of law. TFU?E
  1. Gasoline prices could rocket 24 cents a gallon the next few days, as stations across the USA scramble to keep up with big jumps in the prices of oil, a veteran energy-price analyst forecast Thursday. –old USA Today story

This story illustrates the hold-up problem, for car drivers. TFU?E

  1. When a new search engine suddenly lowers your cost of searching camera prices, then you should immediately lower your reservation price for cameras. TFU?E
  1. Predatory pricing and penetration pricing are two different names for the same thing. TFU?E

Part II. Read the Wall Street Journal (WSJ) story excerpt below and answer the following questions. 30 word maximum and 4 points for each part.

  1. Why might it be profitable for Turkcell to charge a flat fee for Facebook access?
  2. Is Turkcell engaging in price discrimination? If so, what kind? If not, what Econ 101 terms describe what they are doing?
  3. What sort of new data plan would you expect from your cell phone carrier once they acquire the new equipment and software? Why?

"…Network technology companies are busy producing equipment and software that will allow mobile traffic to move at different speeds and be billed at different rates, so that carriers can create more complicated data plans.” For example, mobile operator Turkcell charges users a modest [$2/mo] flat fee for unlimited Facebook access, while access to rival Turkish social networks is charged by the minute. – A. Troianovski, WSJ, 3/1/12.

Part III. Problems. Show work. When information is insufficient to answer the question, write down a reasonable assumption and proceed. Generous partial credit will be awarded for relevant fragments, but not when the fragment is buried in irrelevancies. Points as marked.

PLEASE TURN OVER THE PAGE

1. A British publication once pointed out that iTunes prices vary by the customer’s currency. In terms of the British currency (£), the prices are: UK: £0.79; Germany & France: 99 Euro-cents (£0.68); US: 99 cents (£0.51); and Canada: 99 cents (£0.41). Evidence suggests that iTunes’ marginal cost is constant; you may suppose that it is £0.10.

a. Is there evidence of price discrimination here? If so, what kind? If not, what might be the reason for the differing prices? (3pts)

b. Estimate the (own-price) demand elasticity for one of the currency regions, say the US. Be sure to state the assumptions you use. (3pts)

  1. An industry consists of two firms, each of which can charge either a particular high price H or a particular low price L. Each earns annual profits of 10 if both charge H, and 5 if both charge L. A firm charging H earns 1 if the other firm charges L and thereby earns 15.
  2. Solve for Nash equilibrium if the firms choose price simultaneously once and for all. (3pts)
  3. Now assume that the firms choose simultaneously once each year. Describe a Nash equilibrium in which firms always choose H if one exists; if not, explain why not. (4pts)
  4. If the game instead is played once and for all, how much would a firm be willing to pay for the right to choose who moves first? Draw a “tree” diagram to explain. (4pts)
  1. The incumbent firm and all potential entrants in an industry make exactly the same product at exactly the same marginal cost, 4. Industry demand is well approximated by the function Q = 48 – p. All customers buy only from the lowest price firm.
  2. Before other firms can enter, what is the maximum profit for the incumbent? (3pts)
  3. After entry is possible, what is the maximum profit for the incumbent? (3pts)
  4. The incumbent has a unique option to lower marginal cost to 2 before entry is possible. How much would he be willing to pay to exercise this option? (5pts)
  1. You know there is a 90% chance that your car will survive your Spring Break driving plans, and a 10% chance that it will break down at cost $1000. You are slightly risk averse, with r=0.002.
  2. Compute your expected loss and its variance. (4pts)
  3. What is the maximum you would be willing to pay for Spring Break car insurance? (3pts)
  4. What is the expected cost per customer to an insurance company of providing such insurance to you and lots of other people in similar situations? (3pts)
  5. What problems would you anticipate for an insurance company seeking to profit from this line of business? (4pts)
  1. For Mother’s Day, you want to buy your mom a particular piece of kitsch, and you discover that it is sold on 4 different websites. Site A uses an English auction and typically has the most bidders. Site B uses a Dutch auction, and site C (with about the same number of bidders as B) uses a First price auction. Site D has the fewest bidders and uses a Second Price format.
  2. Where does auction theory suggest you can get the best deal on kitsch? (4pts)
  3. What other economic theories are relevant to your choice, and what do they say? (2pts)
  1. Rockets Inc is a manufacturer of spaceships. The company makes its own engines and refuses to sell them to competitors. One division of Rockets Inc manufactures the engines and another division assembles the body and sells completed spaceships. The inverse demand for Rocket’s spaceships is given by P = 80- 4Q, where P is the price in Megabucks, and Q is the annual output quantity. The cost of producing Q engines is 120 + 8Q and the remaining cost of assembling and selling Q spaceships is 80 + 4Q.
  2. What internal price for engines will maximize Rocket’s overall profits? (3pts)
  3. What is that maximum annual profit? How many spaceships do they sell? (4pts)
  4. Under what circumstances would you advise Rockets Inc to sell engines separately? (3pts)