Arab Academy Graduate School of Business

Final Exam
Course Name: Micro & Macro Economics – Priority Setting & Resource Allocation.
Student Name: Mennat allah Mohamed Mohamed EL-Arabi

Answer the following questions:

1. Gillette and Schick are two of the dominant manufactures

of disposable razors worldwide. Each firm can either sign or
not sign an exclusive contract with Russell Crowe to appear
on their TV ads. If both companies manage to sign with
Crowe, they will each make $7 million in economic profit. If
only one of them signs, it earns $10 million in economic
profit and the other firm incurs an economic loss of $1.5
million. If neither firm sign, they only make normal profit.
Build the pay-off matrix for the above game and identify
“Nash Equilibrium”, if any.

Gillette
Nash equilibrium
Sign Not sign
Sign +7 million dollars -1.5 million dollar

Schick
+7 million dollars +10 million dollar

+10 million dollar Normal profit

Not sign
-1.5 million dollar Normal profit
2. In the late 1970s, Prof. Michael Porter began publishing
articles on strategy that would have a profound impact on the
study of this subject. In his infamous “Five Forces Model”, Porter
introduced the generic strategy options for competition; namely
the “differentiation” approach and the “cost-leadership”
approach. Explain the rationale for Porter’s generic strategy
options in the light of the monopolistic competition market
structure.

Answer:

Professor porter illustrates that for a firm in order to successful

and make a profit in a competitive market it needs a clear
strategy. Each firm relative position within its market
determines whether a firm’s profitability is above or below the
market average.
Porter identifies three strategies for achieving competitive edge.
These are cost leadership, differentiation strategy and focus
strategy.
1) Cost leader ship strategy:

 this strategy focuses on increasing profits by reducing operating costs and

changing lower prices

 in order to implement this strategy successfully the firm will need to be

able to invest in new technology and has efficient logistics

 Making sure also, that spending on items such as labour, materials, and

facilities is kept low. I.e. become the low cost producer in the market .

2) Differentiation strategy:

 This strategy focuses on making the firm’s products or services attractive

and unique be renowned of its excellent customer services or having a

highly valued brand image.

 The firm has to be creative, innovative and has the ability to provide high

quality products or services for this strategy to work.

 Sales and marketing play have an important role in this strategy success.

 The firm must be up to date with the new trends in the market.
3. Mergers and Acquisitions (M&A) activities in the
pharmaceutical industry are most probably larger than any
other industry, in terms of both the number of deals and the
volume of funds invested. Provide a strategic analysis for this
statement highlighting the trends, motivations and
consequences of these activities. Support your answer with real
examples

Answer:
 In the last years pharmaceutical companies stared to redefine

themselves in a new way through merger and acquisitions

activities.

 Reasons forces pharma-companies toward M&A:

1. The most important driver for changes in the pharma activity

is the increasing cost of new product development as R&D of

new products is both expensive and risky. The most quoted

study of drug development costs states that on average, the

development of a new pharmaceutical ingredient costs

around $1.4billion. it usually takes 10 years from synthesis to

 approval and $1.2billion capital cost with average total cost

of $2.6 billion to develop new drug.

2. Increasing marketing opportunities.

3. Achieving the scale economies.

4. Synergy effect as the value of merger of two independent

companies under a single roof is much more than the values

that companies may obtain independently.

 Trends:

 Among 2015 mergers and acquisitions (M&A) in the

pharmaceutical industry were 468 announced deals involving

therapeutic drug assets, devices, diagnostics and insurance

companies, according to data from Thomson Reuters,

representing a 10% increase over 2014 and a 90% increase

over 2012, when deal making hit a 10-year low (Fig. 1). This

extends a trend of an increasing number of deals, beginning

 in 2013 after a sustained decrease during the economic

downturn around 2008.

 Of the healthcare M&A deals announced in 2015, there were

123 deals for which a core therapy area could be identified

(Fig. 2). Of these deals, the largest proportion (38%) were for

diversified assets, meaning the acquired company is active in

two or more core therapeutic areas, none of which

predominate. Examples of these companies include generics

 companies with broad portfolios, and some specialty

pharmaceutical companies, which focus their portfolios on

drugs for clinical specialties or grow by merging with or

acquiring other specialty pharmaceutical companies.

 Cancer was the therapeutic area with the greatest number of

deals (15% of the total), reflecting the large current interest

and focus in this area, most notably in immuno-oncology

approaches. With recent breakthroughs, such as the approval

of immune checkpoint inhibitors, demonstrating the power of

harnessing the immune system to attack tumours, leading

pharmaceutical companies are highly active in both M&A and

other deals for immuno-oncology assets (March 2016

Biopharma Dealmakers Biopharma Dealmakers, pB2). Other

therapy areas with significant deal numbers included

infectious diseases (9% of the total), central nervous system

disorders (7%), endocrine and metabolic disorders (7%) and

inflammation (6%) (Fig. 2).

 Examples:
4. What are the most common measures of market
concentration? Describe how these measures can be used to
identify the extent to which sales in a market are dominated by
one or more businesses. Highlight the major problems
associated with market concentration measures. Apply these
measures to the following industries in Egypt: steel, cement and
ceramics.

Answer:
The most common measures of market concentrations are:

1. The four firm concentration ratio:

 Is the percentage of the total industry sales accounted

for by the four largest firms in the industry .

 It is calculated based on the market shares of the largest

firms in the industry.

 A four-firm concentration ratio above 90% (meaning that

90% of industry output is produced by the four largest
firms) is a good indicator of oligopoly and that these
four firms have significant market control but if the
four-firm ratio equal for example 10% this is an
 indication that the market is a competitive market and
that the four largest firms have little market control.

 Disadvantage: only provide an indication of the

oligopolistic nature of a firm and suggest the degree of

competition but it doesn’t provide a lot of details about

competiveness of the market. May also provide a

misleading results.

2. The Herfidahl-Hirschman index (HHI):

 Is the sum the squared market shares of the 50 largest

firms in the industry.

 Is used to determine market competitiveness.

 According to HHI the larger the measure of market

concentration the less competition that exist in the

market.

If HHI>2500 so the market is highly concentrated and

uncompetitive.
 If 1800< HHI <2500 the market is moderately

concentrated

If HHI <1800 it is a highly competitive market.

 Disadvantage: it is a simple measures that fails to take in

to account the complexities of various markets in a way

that allows for a genuinely accurate assessment of

competitive or monopolistic market conditions.

 Therefore we cannot come to a conclusion on the market situation

based only on the results of the concentration ration without more

information.

Steel production in Egypt: is an oligopoly market where:

 I. Al Ezz Dekhela steel company market share = 53%

II. Egyptian iron and steel = 23%

III. Ezz flat steel market share= 13%

IV. Kandil steel= 11%

Four-firm conc. Ratio= 53+23+13+11 =100 *100 = 100%

100 100

HHI= (53)2 + (23)2 + (13)2 + (11)2

 = 2809 + 529 + 169 + 121 = 3628

This prove that it is a highly concentrated market

Cement production in Egypt

I. Suez cement= 23%

II. Lafarge = 19%

III. CEMEX=11%

IV. Cimpor= 8%

V. Titan = 7%

VI. Vicat = 7%

VII. National cem = 7%

 VIII. Other= 18%

Four-firm conc. Ratio= 23+19+11+8 = 61 *100 = 61%

100 100

HHI= (23)2 + (19)2 + (11)2 + (8)2

= 529 + 361+ 121 + 64 = 1075

This is a highly competitive market.

5. The pie-chart given above shows the annual global market

share of Pepsi and Coke for the last five years on average.
Under what market structure do Pepsi and Coke operate? Justify
your answer. What economic model can best describe the
behaviour of Pepsi and Coke? Briefly highlight the main theme
of this model. Given the obvious market share of both Pepsi and
Coke, on what grounds would you justify the multi-billion-dollar
annual advertising spending by those two companies?

Answer:

 Market structure of Pepsi and coke is Oligopoly as

 a) There is a small number of firms to compete.

b) They produce similar or slightly differentiated products.

c) Calculating HHI = (50)2 + (46)2 + (4) 2 = 4632 so it is a highly

conc. Market (no entry for new firms).

 It is a kinked demand model where each firm believes that if it

raises its price, its competitors will not follow, but if it lowers its

price all of its competitors will follow.

  They use advertising to signal the high quality of their products

(provide information about quality & consistency) none of the ads

need to mention the products they just need to be flashy and

expensive.

6. Kristi, a pharmacist, is planning on opening her own

pharmacy. Kristi Pharmacy is expected to generate yearly
revenue of $500,000. Kristi will run the pharmacy herself on full-
time basis. Kristi’s alternative employment options are as
follows:
- Continue to work as a senior medical representative for
$50,000 per year.
- Accepts a research position in another company for $70,000
per year.
Kristi expects to spend $350,000 per year on purchasing drugs
and cosmetics for resale to her customers. She will also need to
hire three employees: an assistant, an accountant and a
custodian, for whom the total salaries to be paid are expected
to be $48,000 per year. Kristi owns the building in which her
pharmacy is supposed to be; however, she could rent the
pharmacy-store space out for $42,000 per year. Calculate Kristi’s
accounting profit and economic profit. In your opinion, should
Kristi proceed with opening her own pharmacy? Justify your
answer.

Answer:
Total Revenue = $500,000
Explicit cost = $350,000+$48,000 = $ 398,000

Implicit Cost = interest forgone + opportunity cost (forgone wage)

= $ 42,000 + $ 70,000 = $112,000

Accounting profit = TR - Explicit cost

= $ 500,000 - $ 398,000 = $ 102,000

Economic profit = TR – (explicit cost + implicit cost)

= $ 500,000 – ($ 398,000 + $ 112,000)

= $ 500,000 - $ 510,000 = - $ 10,000 (loss)

Kristi should not procced with opening her own pharmacy as she will

encounter an economic loss of $ 10,000.

7. Suppose you are hired to work as economic advisor to His

Excellency the Prime Minister of Xanadu, an imaginary country
that suffers from a deep recession. In order to stimulate the
economy of Xanadu, what would be your recommendations for
an economic-reform program? What government policy actions
are required (fiscal, monetary, trade, foreign exchange rate, …)?
Explain to His Excellency the possible drawbacks of your
recommended course of actions.
Answer:

 In times of recession the government must influence an economic

activities which is expansionary polices through two main polices

fiscal policies and monetary policies.

a) Fiscal policies by increasing government spending rate and

decreasing tax rate which will lead to increase of money in

hands of both businesses and consumers encouraging

business to expand and consumers to buy more goods and

services also help in decreasing unemployment as businesses

will take the money they would spend in taxes and use it to

hire more workers.

Drawback of expansionary fiscal policies is that it will lead

to an increase in the size of government deficit and inflation

because of the higher demand. When the expansionary fiscal

policy is pursued when the economy is close to full capacity,

then the increased government borrowing is likely to cause

 crowding out and contribute to higher inflation with little

increase in GDP.

b) Monetary policies by increasing public banks money supply

and decreasing interest rates which courage the investors to

borrow money from banks and expand in production so

hiring more workers and the consumers will also take loans

for higher prices products such as cars and houses.

Drawback of expansionary monetary policies when

proceeded there will be more falling in foreign exchange rate

which will increase aggregated demand so real GDP growth

and inflation speed up.