UBC

Managerial Economics: Commerce/ FRE 295

October 25, 2018


Maximum Score: 100. Time Available: 2 hours.

Answer Key and Marking Guide;

The exam consists of:

Multiple Choice: 20 questions worth 2 pts each = 40 pts.
Fill-in-the-blanks: 12 blanks worth 2 pts each = 24 pts.
Numerical Answer: 4 questions worth 4 pts each = 16 pts.
Short Answer: 4 questions worth 5 pts each = 20 pts.

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PART I
Multiple Choice Questions

Instructions: Please choose the correct answer for each question. There are 20 multiple
choice questions worth 2 pts each, for a total of 40 pts.


1. Economic models

A. Are not very useful if they incorporate simplifying assumptions.
B. Cannot be tested if they are based on assumptions.
C. Allow managers to consider hypothetical situations.**
D. None of the above.

2. Consider the market for gasoline in Metro Vancouver as shown in the following
diagram. Gasoline is a normal good. Which of the following events might have caused
the demand curve to shift to the left (from D1 to D2)?

$
S

P1

P2

D2 D1

Q2 Q1 Q

A. An increase in the price of gasoline.

B. An increase in consumer incomes.
C. An increase in the price of hybrid cars (which use less gasoline than other cars).
D. A decrease in the price of rapid transit.**

3. Thomas Malthus described the law of diminishing marginal returns and predicted that,
as land is in fixed supply, increases in population would cause increasing
undernourishment. Yet, in the past seventy years, population has risen substantially
but undernourishment has fallen. The most important reason is

A. Increases in the amount of agricultural land.
B. Increasing returns to scale in agriculture.
C. Technological progress causing the production function Q(L) to shift up. **
D. All of the above.

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 4. The following diagram shows an estimated cost function.

A. The average cost curve is U-shaped.
B. Marginal cost is well-approximated by a quadratic function.
C. In the underlying data, factors other than quantity have little effect on cost.
D. All of the above.**

5. Figure 3.6 from the textbook illustrates the effect of different levels of advertising
expenditure A on quantity demanded. Two different regressions are illustrated.

A. The R2 statistic is smaller for the quadratic regression, indicating a better fit to
the data.
B. We would expect that the coefficient on A2 in the quadratic regression is
statistically significant. **
C. The linear regression line illustrates the saturation effect of advertising.
D. All of the above.
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6. Limited liability for the shareholders of publicly traded corporations:

A. Ensures that banks which lend money to these organizations will always be
fully repaid in the event of bankruptcy.
B. Allows the shareholders to pay income tax at the corporate rate rather than at
their own personal rate.
C. Ensures that shareholders cannot lose more than the amount they paid for
their shares.**
D. Allows these organizations to provide senior managers with stock options.

7. Anne and Frank are CEOs of two publicly traded corporations. The two corporations
have the same revenues and costs, as illustrated in the diagram below. Anne’s annual
compensation is a base salary plus 3 percent of revenues, and Frank’s compensation is
a base salary plus 6 percent of profits. Assuming that Anne and Frank have complete
control over the choice of quantity, q, the theory of managerial incentives tells us that:

$
revenue cost




q

A. Anne’s firm will have higher total cost than Frank’s firm. **
B. Frank’s firm will have higher revenue than Anne’s firm.
C. The difference in output for the two firms will depend on the difference in the
base salary for Anne and Frank.
D. Neither CEO will choose the q that maximizes their company’s stock price.

8. The cost function for a perfectly competitive firm is C(q) = 100 + 8q + 2q2. In the short
run the $100 fixed cost must be paid even if the firm shuts down. Let p* denote the
short-run shut-down price (i.e. the firm would shut down if p < p*).

A. Average variable cost is equal to marginal cost when p = p*.
B. As price p falls toward p*, output q falls toward 0.
C. p* = 8.
D. All of the above.**

9. Which of the following is an accurate description of producer surplus?

A. Revenue minus variable cost. **
B. Revenue minus variable cost minus sunk cost.
C. Revenue minus consumer surplus.
D. The area between a downward sloping demand curve and an upward sloping
supply curve and to the left of the equilibrium quantity.
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P 1
10. A monopoly maximizes profit when output is chosen according to = ,
MC 1 + (1 / ε )
where ε is the price elasticity of demand. This equation demonstrates that:

A. A monopoly always sets price in the inelastic portion of its demand curve.
B. A decrease in a monopoly’s fixed cost results in an increase in the monopoly’s
profit maximizing quantity.
C. The price elasticity ε remains constant if the firm changes price in response to
change in marginal cost.
D. None of the above.**

11. A profit-maximizing monopolist sells to 100 identical consumers, each of whom has
demand given by p = 100 – Q. Marginal cost is constant and equal to 40.

A. Uniform pricing is more profitable than two-part pricing.
B. Nonlinear pricing with price equal to 80 for the first 20 units and price equal to
60 for all subsequent units maximizes total surplus.
C. Total surplus is maximized when Q = 60.**
D. All of the above.

12. Each student is willing to pay $3 for a first cup of coffee and $1.50 for a second cup.
Each faculty member is willing to pay $4 for a first cup of coffee and $3 for a second
cup. Nobody is willing to pay for more than two cups. The marginal cost of providing
coffee is $1 per cup. There is only one coffee shop in the relevant area.

A. If the coffee shop were able to charge different prices to students and faculty, it
would charge $1.50 to students and $3 to faculty.
B. The pricing strategy in A above is an example of nonlinear pricing.
C. A profit-maximizing two-part pricing system with a different monthly
subscription fees for faculty and students would maximize total surplus. **
D. A and C.

13. QuickieFood sells small fries (70g) for $2, large fries (150g) for $3, hamburgers for $4,
and a combination of large fries and a hamburger for $6.

A. QuickieFood uses a nonlinear pricing strategy.
B. QuickieFood uses a mixed bundling strategy.
C. QuickieFood uses individual price discrimination.
D. A and B.**

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 14. This diagram compares perfect competition, perfect price discrimination, and uniform
monopoly pricing. Which statement is correct?

A. Under uniform monopoly pricing, consumer surplus is A + B + C.
B. Under perfect price discrimination, total surplus is A + B + C + D + E.**
C. Under perfect competition, producer surplus is zero.
D. Only perfect price discrimination eliminates deadweight loss.

15. A car-sharing company charges an annual membership fee of $20 and a fee per minute
of $0.40. The marginal cost per minute (for gas, wear and tear, etc.) is $0.20.

A. This pricing structure is an example of two-part pricing.**
B. The pricing structure suggests consumers in this market are close to identical.
C. Consumers who buy one or more hours for any given trip get a discount on the
per-minute price. This is best described as group price discrimination.
D. A and B.


16. Consider the Bertrand model with two firms producing identical products. Firm A’s
marginal cost of production is $5 while that of Firm B is $10. Neither firm has fixed
costs. The market demand for the product is given by Q = 60 – 2P. Assuming that firms
must charge prices that are whole numbers, what is the market equilibrium quantity?

A. Q = 42. **
B. Q = 50.
C. Q = 60.
D. Q = 38.

17. Which of the following statements about cartel is TRUE?

A. A cartel can be more successful when demand is more elastic.
B. A cartel may fail when fringe firms (non-members) produce a significant
fraction of the market output.**
C. When two firms each with marginal cost of production equal to $2 collude and
form a cartel, the MC of the cartel = $4.
D. Once two or more firms collude to form a cartel, there is no incentive for
cheating as the firms make higher profits in the cartel than by acting
independently.
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18. Consider an airline route with only two firms: Sky Airlines (SL) and Fly Airlines (FL).
The two firms produce identical products and each firm has a marginal cost of $100.
There are no fixed costs.

A. The Bertrand-equilibrium profits are higher than Cournot-equilibrium profits.
B. If the two firms collude and form a cartel, the profit-maximizing cartel price is
$100.
C. If SL’s marginal cost increases to $120 while FL’s marginal cost remains $100,
SL cannot earn positive profits in the Cournot equilibrium.
D. If SL’s marginal cost increases to $120 while FL’s marginal cost remains
$100, SL cannot earn positive profits in the Bertrand equilibrium.**

19. In the following payoff matrix, Coke and Pepsi have two choices available to them
regarding advertising. In each cell the number on the left is the profit of Coke and the
number on the right is the profit of Pepsi.


Pepsi
Don’t Advertise Advertise
Don’t Advertise 20,20 15, 15
Coke Advertise 25,15 30, 20


A. This is a prisoners’ dilemma game.
B. Neither firm has a dominant strategy.
C. The Nash equilibrium is for both firms to advertise.**
D. There are multiple Nash equilibria in this game.

20. Consider a monopolistically competitive market with symmetric firms. The following
diagram illustrates the current situation of a typical firm in the market.

Quantity
A. The market is in long run equilibrium.
B. In the long run, the demand curve for a typical firm remaining in the market
shifts to the right.**
C. In the long run, the demand curve facing a typical firm remaining in the market
shift to the left.
D. The long run equilibrium price equals the minimum average cost of production.

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 PART II
Fill in the Blank Questions

Each blank should be filled in with one of the following words or terms: average variable cost,
competition, complements, confidence level, differentiated, discrimination, downward-sloping,
elastic, higher, identical, inelastic, linear, lots of competitors, losses, lower, marginal cost, market
power, Nash equilibrium, normal goods, normative, perfect substitutes, positive, prisoner’s
dilemma, producer surplus, resale, residual, standard error, substitutes, sunk costs, unavoidable
fixed cost, upward-sloping, variable cost, zero. Some terms may be used more than once. Each
question is worth 2 pts.

21. If a decrease in the price of good A causes the demand for Good B to shift out, then these
goods are complements.

22. A t-statistic is a coefficient divided by its standard error.

23. A proposed cause-and-effect relationship is a positive statement.

24. Suppose a perfectly competitive industry is in a long run equilibrium in which each firm
earns zero economic (above-normal) profit. This zero profit condition implies that each firm
is producing at the point where its marginal cost is equal to its average cost. (marginal cost)

25. Suppose market demand in a perfectly competitive industry permanently shifts to the left
due to a consumer health scare. Assume that fixed costs are unavoidable in the short run. The
firms in this industry will continue operating in the short run provided that each firm’s
revenue equals or exceeds its variable cost.

26. Marginal revenue for a monopoly is related to the elasticity of demand. If revenue and
price move in the same direction when the monopoly adjusts its level of output then the
monopoly is pricing in the inelastic portion of its demand curve.

27. Price discrimination is possible when firms have market power, they can prevent resale,
and they can distinguish among different consumers. (resale)

28. A firm employing profit-maximizing multi-group price discrimination will charge a lower
price to the group with more elastic demand. (lower)

29. In a monopolistically competitive market firms face downward-sloping demand curves
because, in such a market, products are differentiated.

30. Suppose that two firms produce identical goods, set prices, and have different marginal
costs. The firm with the lower marginal cost undercuts its rival’s prices and capture the entire
market. In this case, the deadweight loss in the market is positive.

31. A dominant strategy solution must be a Nash equilibrium.

32. A manager should consider opportunity costs and ignore sunk costs.

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PART III
Numerical Questions

Each question is worth 4 pts. Most questions have four components worth 1 pt each. Use
numbers (like 10), not words (like ten). Do not use commas in numbers (i.e. type 2000, not
2,000). Do not use dollar signs.

33. The inverse demand function for blueberries is p = 100 – 2Q and the inverse supply
function is p = 10 + Q. Assume the market is in equilibrium.
The quantity is 30.
The price is 40.
Consumer surplus is 900.
Excess demand is 0.

34. The following table provides willingness to pay information (i.e. reservation prices) for
three consumers who are considering taking a holiday in the Okanagan. The consumers
may book hotel rooms and one possible activity is a wine-tasting tour. These are the only
consumers. Marginal cost is zero for both products and there are no fixed costs. A travel
agency is considering whether to use stand-alone pricing (selling the products separately),
pure bundling, or mixed bundling.

Wine Hotel
Tour
Xavier 400 50
Yolanda 350 300
Zara 50 400

The maximum profit under stand-alone pricing is 1300.
The maximum profit under pure bundling is 1350.
The maximum profit under mixed bundling is 1450.
Under mixed bundling, the bundle discount is 150.


35. An airport sets profit-maximizing landing fees for airlines. The period 8am to 8pm is the
peak period and the period 8pm to 8am is the non-peak period. The inverse demand function
for the peak period is p = 10 – 0.1Q. The inverse demand function for the non-peak period is
p = 5 – 0.1Q. The marginal cost per landing for the airport is 1. The maximum number of
landings the airport can handle (capacity) is 30.

The profit-maximizing price for a landing slot in the non-peak period is 3.

The profit-maximizing price for a landing spot in the peak period is 7.

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36. Intel and AMD are the only two firms that produce central processing units (CPUs). The
output of Intel is QI and the output of AMD is QA. Assume that the CPUs produced by the two
firms are identical. The market demand for CPUs is given by p = 340 – Q, where Q (= QI + QA) is
the market quantity. The marginal cost of production for each firm is constant and is equal to
$40. The industry is a Cournot duopoly.

If AMD produces an output of 60, the best response of Intel is an output of 120.
If AMD produces 60 and Intel makes its best response, the market price is 160.
The Cournot equilibrium quantity for each firm is 100.
The Cournot equilibrium price is 140.

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 PART IV
Short answer
Each question is worth 5 pts. Confine your answers to the available space.

37. A well-known telecommunications company hires employees to respond to consumer
problems. Most such employees do not stay long. The company has kept records on education
levels and length of service for a group of workers all earning the same wage. The company
has also experimented with different wage rates and has tracked the relationship between
wages and length of service for a group of employees with the same education level. One
finding is that length of service generally increases as wages rise. These two different data
sets are illustrated below. In each case, the vertical axis shows length of service.

Chart A Chart B

Which chart illustrates the education data and which chart illustrates the wage data? Explain
your reasoning briefly. What functional form would you use for regression analysis for each
data set? Explain your reasoning. State two ways in which the company could increase length
of service.

Chart A is the education data and Chart B is the wage data (1 pt for both). The question says
that length of service increases as wages rise so that must be B and chart A must show the
effect of education (1 pt for both).We would use a linear regression for wages (1 pt) and a
quadratic function for education (1 pt). The company could increase length of service by
paying higher wages and hiring employees with intermediate education levels. (1 pt for both).
Some students did not refer to the data in the question but gave an explanation based on
economic incentives for what Chart A shows education data and Chart B shows wage data,
Also, some students described measures other than wages and education levels that could be
used to increase length of service. Very good answers of these types received some credit or
possibly even full credit.

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 38. A CBC Marketplace investigation found that the online travel agent expedia.ca was
charging different prices to different consumers based on their browsing history.

State the type of pricing strategy expedia.ca was using, state what expedia.ca is likely
interested in estimating from consumers’ browsing history, and briefly explain the likely
effect of this pricing strategy on consumer surplus and on total surplus.

Expedia is using individual price discrimination (1 pt). Expedia is likely to trying to infer the
willingness to pay of consumers. (1 pt for saying “willingness to pay”). Relative to uniform
pricing, the likely effect on consumer surplus is a decline in consumer surplus (1 pt) OR it is
okay to say consumer surplus could go up or down. Total surplus would likely rise (1 pt). The
reason total surplus would likely rise is that individual price discrimination would likely lead
to more output, reducing the deadweight loss from monopoly power (or market power.) (1 pt
for saying something about output increasing.) Some credit could be obtained for alternative
answers.

39. The graph below shows the current situation in Canada’s dairy industry. Canadian
producers are regulated to produce Q0 units of dairy products, and Canadian importers are
regulated to import X units of dairy products from the U.S. and other countries. These
regulations have resulted in a price of Canadian dairy products, PC, above the world price, PW.




Canadian Supply

a

PC

b d f
World Price
W
P
e
c
Canadian Demand

Q0

Given the current situation, identify the letters in the above diagram that represent the
following concepts. (1 pt for each correct response.)
Consumer surplus is a.
Surplus for Canadian dairy producers is b + c.

Deadweight loss (DWL): Everyone received 1 pt for this. It is not clear what happens if “the
regulation is removed”. It could mean that imports fall to zero or it could mean free trade. If it
means free trade (no quota limit) the correct answer would be e + f + the unlabeled triangle
under and beside f.

The imported quantity is X.
Profit for the importers who are allowed to buy at the world price, PW, and sell at the Canadian
price, PC is d

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40. Consider following network scheduling payoff matrix. In each cell, the first payoff is for
CNN and the second for FOX. (Note: To specify a Nash equilibrium, state the strategies chosen
by each network.)

FOX
Wednesday Thursday
Wednesday 10, 10 12, 12
CNN Thursday 15, 15 X, X

If X = 16, what is the Nash equilibrium in the simultaneous-move game? Is this Prisoner’s
Dilemma game? Explain briefly.

If X = 16, the Nash equilibrium is for each network to choose Thursday. (1 pt). It is not ok to
say 16,16 is the solution as the question states that strategies should be specified. This is not a
prisoners’ dilemma because there is no other outcome that is better for both parties. (1 pt for
saying no AND for saying why.)

Now assume X = 8. Identify any Nash equilibria. Are there any things the networks can do so
they will be confident of getting the highest possible payoffs?

If X = 8, there are two Nash equilibria. One is for CNN to go on Wednesday and FOX to go on
Thursday. The other is for CNN to go on Thursday and FOX to go on Wednesday. (1 pt for
both. It is ok to say just “one network goes on Wednesday and one goes on Thursday”. ) One
way of getting to the highest possible payoff is pre-play communication (cheap talk is ok). (1
pt.) Another way is for the networks to apply the Pareto criterion (1 pt): each firm chooses the
strategy corresponding to the equilibrium that is better for both. (Just saying Pareto criterion
is good enough for 1 pt).

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