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2nd midterm

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You are on page 1of 7

2

nd

Midterm

Instructions

1 Work on each question in a separate Bluebook: clearly indicate the

question number on the Bluebook cover

2 Read over the whole exam, and do the easier questions first.

3 Show your work. No credit will be given if work is not shown.

4 Make clear which subsection of the exam you are answering!

5 Write legibly!

6 Write your name and student I.D. number on every Bluebook and on

the first and last page of this exam

Your

Name:_____________________________________________________

Your

I.D. # _______________________________________________________________

Section number:_____________________________________________

DO NOT START UNTIL 6:00 PM

EACH QUESTION IN A SEPARATE

BLUEBOOK!

THIS PAGE INTENTIONALLY BLANK

Question 1 (20 points)

Steve Employments, the CEO of Pineapple Inc., is developing a new product: a black

turtleneck sweater that incorporates a microphone, ear buds, 4G coverage, an MP3

player, GPS, and a health monitoring system. The productcodenamed IHotis ready

to go into production. Unfortunately, Steve knows that his suppliers will eventually share

the production technology with a competitor: Swansong. Swansong is already developing

marketing materials for their copy-cat product: the MeSweats.

Fortunately for Steve, Pineapple is widely recognized as the leader in new consumer tech

products. Steve will make a decision as to how many IHots to produce first and thinks

that Swansong will just accept its secondary position upon entering the industry.

Since the product is outsourced to identical foreign suppliers, the marginal cost of

production will be the same for Pineapple and Swansong: $20 per unit. Assume that fixed

costs are zero.

Steve estimates that the overall demand for the indistinguishable IHots and MeSweats

follows the function:

1

300

2

P Q = .

a) (10 points) What should be the production target of Pineapple?

b) (3 points) What will be the likely retail price of the IHot?

Steve realizes that, rather than outsourcing the production of IHot, he could be producing

it in his Mugertino plants, at an estimated marginal cost of $150 per unit. The advantage

of in-house production is that it would not allow any competitors access to the IHot

technology, and Pineapple would be the sole producer in this market.

c) (7 points) Should Steve outsource production or produce the IHot in-house?

Briefly discuss.

Question 2 (20 points)

Brianna is an iPhone user, whose individual demand for hours of iPhone use is given by

q = 40 P, while her opportunity cost of time can be represented by P = 10 + 2q.

In this market, q represents Briannas hours of iPhone use, and P represents the amount

of money she would spend for the right to use her phone for an hour or the opportunity

cost of her time.

Briannas iPhone use affects the people around her on Penns campus: the more she uses

her iPhone, the more each hour of texting while walking, talking loudly, game-playing,

etc., annoys people around her. These additional costs can be written as MEC(q) = 3q.

a) (3 points) Compute the efficient quantity of Briannas iPhone use.

b) (5 points) Compute Briannas preferred quantity of iPhone use and the total

deadweight loss at that quantity.

c) (5 points) Suppose Penns administration recognizes the problem in this

market and charges each user a constant fee of $100 to register her phone

and consequently be permitted to use her phone on campus. How does this

affect your answers to (b)? Would Brianna pay the fee? Provide appropriate

calculations.

d) (5 points) Now suppose that instead of the policy in (c), Penn assesses each

user a per-hour fee of $3. How does this affect your answers to (b)? How

much revenue would Penn collect from Brianna? Provide appropriate

calculations.

e) (2 points) Describe a policy that yields the efficient quantity of iPhone hours

and generates revenue for Penn. Calculate the revenue Penn collects from

Brianna.

Question 3 (20 points)

You own a small company with only two workers: Eloi and Morlock. Eloi is hard-

working and highly motivated. His utility function is therefore independent of effort and

contingent on his wages:

E

U W = . Morlock, on the other hand, tends to display

inordinate narcissist tendencies and loathes working hard. If Morlock does not work hard,

his utility function is identical to Eloiss:

M

U (shirking) W = ; however, if Morlock must

work hard, he feels as if his wage were reduced by $5,000, and his utility function

therefore becomes ( )

M

U (working) W 5,000 = .

Union rules force you to pay your workers 50% of the companys gross profits, divided

equally between your workers (25% to Eloi, 25% to Morlock). Eloi will always work

hard, and so the chance of experiencing higher profits depends solely on Morlocks

attitude. The following table illustrates the probabilities of attaining high gross profits

($100,000) or low gross profits ($60,000) as a function of Morlocks effort:

Probability of Obtaining High

Gross Profits ($100,000)

Probability of Obtaining Low

Gross Profits ($60,000)

Morlock Shirks 0.1 0.9

Morlock Works Hard 0.7 0.3

a) (2 points) What is the expected wage for each worker if Morlock shirks?

b) (2 points) What is the expected utility of working hard for Morlock, given

that he obtains wages equal to 25% of profits?

c) (2 points) What is the expected utility of shirking for Morlock?

d) (3 points) What average net profits (after wages) should you expect?

The local union boss, Joe Breccabonni, has realized that you are risk-neutral and only

care about your expected profits whereas workers are risk-averse. He offers you a deal:

you can now pay one or both of your workers a fixed salary if you want to; however, you

have to make sure that the worker would agree to the fixed payment in lieu of his current

situation (25% profit sharing).

e) (5 points) What is the fixed minimum payment that Eloi will accept in lieu of

his share in the companys profit?

f) (6 points) How should you structure your wage payments now? What is your

expected net profit (after all wage disbursements)?

Question 4 (20 points)

Hana and Dave play the following simultaneous game:

a) (5 points) Find all Nash equilibria of this game

b) (2 points) Suppose this game is repeated 55 times, what would the Nash

equilibrium or equilibria be? Why?

Now suppose that Hana and Dave have altruistic preferences. Specifically, Hanas and

Daves new utilities are given by

v

H

(s

H

,s

D

)=u

H

(s

H

,s

D

) + yu

D

(s

H

,s

D

), and

v

D

(s

H

,s

D

)=u

D

(s

H

,s

D

) + yu

H

(s

H

,s

D

),

respectively, where y is a constant and s

H

, s

D

represent each players strategy.

For example, u

H

(Confess, Confess) = 1, u

D

(Confess, Confess) = 1, so Hanas utility from

playing (Confess, Confess) will be v

H

(Confess, Confess) = 1+ y.

c) (3 points) Draw a payoff matrix that represents this new game.

d) (5 points) Find the range for values of y such that the Nash equilibrium or

equilibria of this new game are the same as that or those found in (a).

e) (5 points) If y lies outside the range found in (d), find all possible Nash

equilibria.

Player D: Dave

Not Confess Confess

Player H:

Hana

Not Confess (3,3) (0,5)

Confess (5,0) (1,1)

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