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BPUB 250: Fall 2010

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)