Answers to Problem Set 1

Q1 To answer this question, we need to calculate the amount of future savings into present value
and subtract the additional amount spent on the more expensive refrigerator.
$45 $45 $45 $45 $45
𝑁𝑒𝑡 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 = + + + + + $1500 − $1700 = −$10.44
1.06 1.062 1.063 1.064 1.065
The negative value indicates that the conventional model without energy saving is cheaper in
present value by more than $10.

Q2 a. Jamie’s accounting costs are the overhead costs and operating expenses, which are
$145,000. Her implicit costs are the money she loses by leaving her current job that pays
$75,000$. Jamie therefore has total opportunity costs of $145,000 + $75,000 = $220,000.

b. For positive accounting profits, her revenues need to be higher than $145,000. For
economic profit her revenues must be higher than the opportunity costs of $220,000.

Q3 Traditional IRA: $2,500 per year, profits taxed, 7% ROI per year, setup fee $50.
($2,500 ∗ 1.071 + $2,500 ∗ 1.072 + $2,500 ∗ 1.073 + $2,500 ∗ 1.074 ) ∗ (1 − 0.19)
= $9.620.25
Roth IRA: $2,025 per year, profits tax-free, 7% ROI per year.
$2,500 ∗ (1 − 0.19) ∗ 1.071 + $2,500 ∗ (1 − 0.19) ∗ 1.072 + $2,500 ∗ (1 − 0.19) ∗
1.073 + $2,500 ∗ (1 − 0.19) ∗ 1.074
= ($2,500 ∗ 1.071 + $2,500 ∗ 1.072 + $2,500 ∗ 1.073 + $2,500 ∗ 1.074 ) ∗ (1 − 0.19)
= $9,620.25
As can be seen from the equations, both scenarios have the same result. Because of the $50
set-up fee for the traditional IRA, the client should choose the Roth IRA.

Q4 a. Player 1 is the first one to move, and he has only two options: to choose A or B.

Player 2 has more options, depending on what a chooses. He can set out strategies
before he knows if player 1 is deciding for A or B.

1. W if A, Y if B
2. X if A, Z if B
3. W if A, Z if B
4. X if A, Y if B

b. A,W -> (60,120) if player 1 goes for A and player 2 for strategy 1 or 3.

B,Z -> (100,150) if player 1 goes for B and player 2 for strategy 2 or 3.

c. B,Z -> (100,150)

Q5 To create the normal form the profits are calculated first.

Projected Revenues, Costs and Profits for Different Combinations of Mobile Technology
Standards (in billion dollars)
Qualcomm T-Mobile
Standard Revenue Costs Profit Standard Revenue Costs Profit
CDMA 13.5 1.2 12.2 GSM 9.7 1.1 8.6
CDMA 17.2 1.2 16.0 CDMA 15.6 2.7 12.9
GSM 16.7 2.0 14.7 CDMA 10.1 2.7 7.4
GSM 15.5 2.0 13.5 GSM 19.8 1.1 18.7

Qualcomm
CDMA GSM
CDMA

12.9 , 16.0 7.4 , 14.7

T-Mobile

GSM

8.6 , 12.2 18.7 , 13.5

Economic forces that give rise to the structure of the payoff:

- Additional research costs for implementing the different standard. Shared fixed costs
when using the same standard (economies of scale). Therefore, the companies have less
costs when implementing their currently used standard in the new market.
- In sum the revenue is less when both companies have different standards Or, in other
words, having the same standards brings more benefit to both companies.

Nash Equilibria

- Qualcomm CDMA and T-Mobile CDMA

- Qualcomm GSM and T-Mobile GSM

The problem is that while trying to maximize profit, both companies might go for their
current standard. Qualcomm can make the most profit by choosing CDMA (16 billion) and T-
Mobile can make the most profit with GSM (18.7 billion). Both companies have their
“preferred” Nash Equilibrium.

Q6 $10,000 each is not a Nash Equilibrium, because by lowering you value by $1, you will gain
$500 from the reward. Nash Equilibrium is therefore if both choose $500, because none of
the two would benefit by moving from that number. The result of the Nash Equilibrium is far
from optimal, because the total refund would amount to only $1,000. By choosing $10,000
both, the outcome could be $20,000.