Page 1 of 32

UNIVERSITY OF TORONTO
Faculty of Arts and Sciences
April Examinations 2013
ECO 204 Y1Y

Duration: 3 hours Total Points: 100 points

Examination Aid Allowed: Calculator.
Instructions:
- This exam consists of 7 questions in 32 pages, single-sided.
Please Write Your Name and ID # as these appear in ROSI
Last Name:
First Name:
9-Digit ID #:


YOU CANNOT LEAVE THE EXAM ROOM DURING THE LAST 10 MINUTES.
PLEASE REMAIN SEATED UNTIL THE PROCTOR ANNOUNCES THAT YOU CAN LEAVE THE ROOM.
PLEASE DONT DETACH PAGES. IF YOU DO, THEN ITS YOUR RESPONSIBILITY TO RE-STAPLE DETACHED PAGES BACK TO THE EXAM
KEEP ANSWERS AS BRIEF AS POSSIBLE

For Graders Use Only:
Maximum Possible Points Score
Short Questions
Question 1 3
Question 2 3
Question 3 12
Question 4 6
Question 5 4
Long Questions
Question 6 30
Question 7 42
Total Points = 100

In case of F grade, Final Exam checked by Instructor/Course Coordinator?

Yes

No


Page 2 of 32


QUESTION 1 [3 POINTS]
A recent study assumed that firms in U.S. manufacturing sectors produce output according to the Cobb-Douglas
production function

. The following table contains estimates of for some sectors:

Sector
Tobacco Products 0.18 0.33 0.51
Food and Kindred Products 0.43 0.48 0.91
Transportation equipment 0.44 0.48 0.92
Apparel and other textiles 0.70 0.31 1.01
Furniture and fixtures 0.62 0.40 1.02
Electronics and electric equipment 0.49 0.53 1.02
Paper and allied products 0.44 0.65 1.09
Petroleum and coal products 0.30 0.88 1.18
Primary metal 0.51 0.73 1.24

Which of these sectors have strictly convex cost functions (i.e.

() )? Briefly explain the basis of your argument.

Page 3 of 32


QUESTION 2 [3 POINTS]
The following graph for L-1011 aircraft production is reproduced from Learning and Forgetting: The Dynamics of
Aircraft Production (The American Economic Review, 2000):

True or false: this graph shows that there was learning by doing in the production of L-1011 aircrafts? The wavy line
is measured on the left scale while the step line is measured on the right scale. Give a brief explanation.


Page 4 of 32


QUESTION 3 [12 POINTS]
The following table is reproduced from the HBS Case The Aluminum Industry in 1994 (AL = Aluminum):
Average Primary Aluminum Smelter (1993)
All cost figures $/metric ton
Capacity (000s tpy) 133.02
Electricity usage (kWh/t) 15,800
Electricity price ($/kWh) $0.02
Alumina usage (t/t Al) 1.94
Alumina price ($/t Alumina) $190
Other raw materials $125
Plant power and fuel $10
Consumables $70
Maintenance $50
Labor $150
Freight $45
General and Administrative $75

(3.1) [2 Points] What is the difference between primary and secondary aluminum?





Page 5 of 32


(3.2) [2 Points] According to the case, which primary aluminum smelters are irrational producers and why? Explain
briefly.

Page 6 of 32


(3.3) [3 Points] This part is independent of all other parts below. Suppose the current price of AL is $1,100/ton. What is
the breakeven output of the rational average primary AL smelter? Show all important steps.

Page 7 of 32


(3.4) [5 Points] The following table contains actual and projected figures for Western consumption of AL, Rest of the
World consumption of AL, and secondary production of AL. Suppose that in 1996, 0.75m tons of AL inventory was
unloaded onto the AL market and from thereon inventory was unloaded at a compound annual growth rate of 5%.
Calculate the demand for primary AL in 1998. Show all important steps.
ALL FIGURES ARE MILLIONS OF METRIC TONS 1993 1994 1995 1996 1997 1998
Western Consumption of AL 20.4 21.1 21.8 22.5 23.2 24.0
Rest of World Consumption of AL 4.1 4.1 4.1 4.1 4.1 4.1


















WRITE DOWN YOUR FINAL ANSWER HERE 1998
Demand for Primary AL (mtpy)

Secondary Production of AL 6.00 6.22 6.45 6.69 6.94 7.20

Page 8 of 32


QUESTION 4 [6 POINTS]
(4.1) [3 Points] Give two examples of non-price mechanisms that companies use to prevent/stop arbitrage in 3
rd
degree
price discrimination.









Page 9 of 32


(4.2) [3 Points] Below is a simplified Profit Maximization Problem for a company selling its product through 3
rd
degree
price discrimination to segments 1 and 2 and having to set the price differential equal to the cost of arbitrage per
unit

because it cant stop arbitrage through non-price mechanisms:

) (

) (

) (

) (

) (

) (

) (

[(

) (

]
What is the interpretation of

? Explain briefly and show all important steps. Hint: You do NOT have to solve the PMP.


Page 10 of 32


QUESTION 5 [4 POINTS]
(5.1) [2 Points] Consider a firm with market power and a downward sloping demand curve (). Suppose the company
sells its product by charging a uniform price. Provide expressions for its total revenue and marginal revenue.









(5.2) [2 Points] Consider a firm with market power and a downward sloping demand curve (). Suppose the company
sells its product by charging 1
st
degree price discrimination prices. Provide expressions for its total revenue and marginal
revenue.

Page 11 of 32


QUESTION 6 [30 POINTS]
A-sad Inc. produces output by using variable labor and fixed capital according to the following production function:
[

]
The parameter Let

price of labor and

price of capital.
(6.1) [2 Points] A-sad cost function exhibits constant average variable cost. Given this fact argue that the parameter
(and use throughout Question 6). Show any calculations. Hint: You can answer this question without
solving A-sads cost minimization problem.


Page 12 of 32


(6.2) [3 Points] This part is independent of all other parts below. Compute: the elasticity of output with respect to
labor the elasticity of output with respect to fixed capital the elasticity of output with respect to level of
technology/management. Show all important steps. Hint: Elasticity can be calculated by two methods -- which method
is more convenient in this question?


Page 13 of 32


(6.3) [3 Points] Derive the equation, intercepts and slope of the iso-quant curve for an arbitrary output level and
graph the iso-quant curve below. Show all important steps.

Page 14 of 32


(6.4) [10 Points] Solve A-sads short run cost minimization problem. Show all important steps. You are expected to solve
this problem by using the appropriate constrained optimization method.

Page 15 of 32



Page 16 of 32


(6.5) [3 Points] This part is independent of all other parts below. True or false: A-sads is proportional to the











(6.6) [3 Points] This part is independent of all other parts below. True or false: A-sads cost function exhibits constant
economies of scale? Briefly explain your answer.
amount of fixed capital (i.e. as does )? Briefly explain your answer.

Page 17 of 32


(6.7) [3 Points] This part is independent of all other parts below. Does A-sads cost function exhibit economies of
scope? What are the practical implications of this for a hypothetical merger of two firms identical to A-sad? Show all
important steps and give a brief explanation.

Page 18 of 32


(6.8) [3 Points] True or false: learning by doing will lower A-sads and ? Show all important steps







Page 19 of 32


QUESTION 7 [42 POINTS]
THROUGHOUT THIS QUESTION YOU MUST ROUND ALL NUMBERS TO FOUR DECIMAL PLACES. THIS INCLUDES ROUNDING ALL FINAL ANSWERS
AND ALL NUMBERS DURING CALCULATIONS TO 4 DECIMAL PLACES. MAKE SURE TO ROUND FIGURES TO 4 DECIMAL PLACES AT EACH AND
EVERY STEP OF THE CALCULATIONS.
In Project 3 you worked with a super market scanner data set for two brands of soda X and Y sold in seven stores
(62 through 68) over 52 weeks, and where each brand of soda had two varieties reg and lit. Let:
quantity sold (ozs./100,000), price ($ per oz.), Total variable cost ($)
Assume that each brand of soda is managed by its own pricing manager at this supermarket chain. These pricing
managers do not cooperate with each other and choose optimal strategies to maximize their brands profits.
The following cost equations were estimated via regression analysis on all stores, all weeks, and both varieties of soda:

The following demand equations were estimated via regression analysis on all stores, all weeks, and both varieties of
soda
1
:

For your convenience, we have re-arranged demand models and to give you the following demand models:

HINT: WHICH DEMAND MODEL YOU WORK WITH DEPENDS ON THE QUESTION.
The following table contains average values of brand X and Y prices:

($/oz.)

($/oz.)
Average 0.0283 0.0286

THROUGHOUT THIS QUESTION ASSUME THAT THE SUPERMARKET HAS AMPLE CAPACITY AND UNLESS STATED OTHERWISE, YOU DONT HAVE
TO PUT THE CONSTRAINTS

1
In actuality, these demand models were estimated by including Hval_150 as an independent variable. We then entered mean value
for Hval_150 and added it to the regression intercept. As such, the intercepts in demand models and include Hval_150.
Page 20 of 32


(7.1) [3 Points] This part is independent of all other parts below. In Project 3, what assumption did you make which










allowed you to estimate the functions without intercepts? Give a brief explanation.

(7.2) [3 Points] This part is independent of all other parts below. True or false: the supermarkets production function
for selling Brands X and Y has diminishing returns to variable inputs? Give a brief explanation.

Page 21 of 32




(7.3) [5 Points] This part is independent of all other parts below. If the last digit of your ID # ends in 0, 2, 4, 6, 8 then
please answer this part for brand X, otherwise answer this part for brand Y. Suppose the supermarket carries your brand
of soda but not the other brand (i.e. your brand of soda is a monopoly). Next, suppose the supermarket charges the
average price of your brand of soda. How can the supermarket do a quick check to see if this (average) price is in fact the
optimal profit maximizing price? Show all important steps. Hint: You can answer this question without solving the Profit
Maximization Problem.

Page 22 of 32


(7.4) [5 Points] This part is independent of all other parts below. If the last digit of your ID # ends in 0, 2, 4, 6, 8 then
please answer this part for brand X, otherwise answer this part for brand Y. Suppose the supermarket were to only sell
your brand of soda (i.e. your brand of soda is a monopoly). Calculate the profit maximizing output and price of your

brand. Dont forget the hints about ample capacity and assume that output of your brand is . Show all important
steps.

Page 23 of 32


(7.5) [5 Points] Now suppose the supermarket carries both brand X and brand Y products. Calculate the profit
maximizing outputs and prices for the case when brands X and Y compete as Cournot rivals. Dont forget the hints about
ample capacity and

. Show all important steps.

Page 24 of 32



Page 25 of 32


(7.6) [5 Points] Now suppose the supermarket carries both brand X and brand Y products. Calculate the profit
maximizing outputs and prices for the case when brands X and Y compete as Bertrand rivals. Dont forget the hints
about ample capacity and

. Show all important steps.
Page 26 of 32



Page 27 of 32


Prices for each pricing strategy
Brand Y
Enter Bertrand Price below Enter Cournot Price below



Brand X
Enter Bertrand Price below


Enter Cournot Price below



Quantities for various pricing strategies
Brand Y
Bertrand Price Cournot Price
Brand X
Bertrand Price
Cournot Price

Contribution margins for various pricing
strategies
Brand Y
Bertrand Price Cournot Price
Brand X
Bertrand Price
Cournot Price

Gross profits for various pricing
strategies
Brand Y
Bertrand Price Cournot Price
Brand X
Bertrand Price
Cournot Price

Please write down brand X and brand Ys pure strategies Nash equilibrium:
Brand Xs Pricing Strategy Brand Ys Pricing Strategy






(7.7) [10 Points] Consider the following one-shot game. Suppose brand X and Y pricing managers can either charge the
Bertrand price or charge the Cournot price. Compute the pure strategies Nash Equilibrium of this one-shot game. For
your convenience, we have inserted tables to guide your calculations and given you lots of space below for calculations.

Page 28 of 32


FOR PART 7.7 CALCULATIONS


Page 29 of 32


FOR PART 7.7 CALCULATIONS

Page 30 of 32


FOR PART 7.7 CALCULATIONS



Page 31 of 32


(7.8) [6 Points] Is the one-shot game in part (7.7) a prisoners dilemma game? If so, what would you recommend to the
pricing managers if the game in part (7.7) is played repeatedly forever? Hint: Do your recommendations require the
pricing managers to value long term gains over short gains? If so, under what conditions will these managers value long
term gains over short term gains? Show all important steps.


Page 32 of 32