Assignment Group Number 25

Name SNR

Student 1 Virginia Mirabile 2100718

Student 2 Juan Diego Basurto A 2106631

Student 3 Federico Bohl 2107187

Student 4

ANSWER TABLE

Answer (A/B/C/D)

Question 1 C

Question 2 C

Question 3 B

Question 4 A

Question 5 D

Question 6 C

Question 7 B

Question 8 D

Question 9 B

Question 10 C

Question 11 A

Question 12 A

Question 13 B

Question 14 B

Question 15 B
Question 1

The option C is true, as by fixing the price of a taxi ride, taxi drivers are not incentivized to take longer
routes or to drive more slowly to increase the price of a ride from the airport to the city. The
behaviour described above can be seen as moral hazard.

Question 2

Option C is true for this question. As quality is observed by buyers and sellers we can conclude that
there is no information asymmetry hence, at the competitive equilibrium, the price range within
which all cars will be sold is going to be between the value of the sellers 1.2q and the value of the
buyers 3q. As the amount of buyers and sellers is not specified, we can conclude that the price could
be any between the interval 1.2q and 3q which includes the 2.7q of answer C, making it the correct
one.

Question 3

The correct answer is B. As buyers observe the price 1, they know that it must be higher or equal than
the value of a seller:
5
𝑝 ≥ 𝑉𝑠 −> 1 ≥ 1. 2𝑞 −> 𝑞 ≤ 6

The expected quality of cars on offer, as buyers do not know how many “good” or “bad cars”, is given
by:
5 5
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 (𝑄) = 0. 5 * 0 + 0. 5 * 6
= 12

Question 4

Answer A is the correct one, as workers have no incentive to deviate. Both H and L have utility equal
to 23 by education e=7, and if they deviate from this equilibrium their utility will be reduced to 20.

Answer B is not an equilibrium as workers would be incentivized to deviate to education level 5 as it

guarantees a higher wage and utility.

Answer C is not a pooling equilibrium as workers are incentivized to deviate from the proposed
equilibrium because by choosing e=0 they can increase their utility to 20 instead of 16.

Answer D is also not an equilibrium because firms would not offer a wage higher than their estimated
value of the product of workers.

Question 5

D is the correct answer as the players in this scenario are symmetric, meaning that they have the
same cost of education, hence no separating equilibrium is possible as the low type will pretend to be
of high type to earn the higher wage.

Question 6

The correct answer is C. Making leisure travellers indifferent between travelling in second class or not
travelling at all means charging their willingness to pay. This will leave no choice to leisure travellers
but to self-select second class. Furthermore, the monopolist can attract business travellers by
charging less than their willingness to pay on first class tickets but making them indifferent between
choosing second class or first class, which can be obtained by foregoing an informational rent that
allows business travellers to self select the product designed for them.

Question 7

The correct statement is B. By computing the utility of the third group of consumers and setting it
greater or equal than zero we find the maximum W at which these consumers will be willing to buy
the 5900X. The equation is as follows:
636 10435
𝑈𝑡ℎ𝑖𝑟𝑑;5900𝑋 = 𝑊 * 2
+ (1 − 𝑊) * 15
− 549 ≥ 0

𝑊 ≤ 0. 39

This result represents the upper bound for W, and as 0.3 is lower, the third group of consumers will
be willing to purchase the 5900X.

Question 8

Answer D is the correct one. To better explain our point we start by proving that all other answers are
true.

Answer A is true as the utility for the high type of buying the second contract is higher than the one
of buying the first contract.

𝑈𝐻; 𝑓𝑖𝑟𝑠𝑡 = 2 𝑈𝐻; 𝑠𝑒𝑐𝑜𝑛𝑑 = 2. 45

Answer B is true as the utility of not buying an insurance contract for the low type is higher than both
buying the first and second contract offered.

𝑈𝐿; 𝑓𝑖𝑟𝑠𝑡 = 2. 5 𝑈𝐿; 𝑠𝑒𝑐𝑜𝑛𝑑 = 2. 44 𝑈𝐿; 𝑛𝑜 𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡 = 3

Answer C is also true as the company is making positive profits when the high types purchase the
second contract and low types do not enter, but this can not be an equilibrium as we are in a
competitive insurance market and firms will be incentivized to enter and profits will be reduced to
zero.

Answer D is false as the company manages to screen consumers as high types enter the market and
purchase the contract designed for them whereas low consumers don’t.

Question 9

Answer B is correct. If the new contracts are offered, through calculation, we can see that both high
and low types will choose the second contract offered by the entrant firm as their utilities are the
highest among all contracts. This implies that there will be a unique market, making B false.

Answer A is true as an entrant offering the same coverage but a lower premium than the previous
contract (the one offering coverage 16 and premium 10) will attract H-type consumers.

Answer C is true as it can be seen by plugging in the numbers in the first best equation which states
that wealth in the good state with insurance must be equal to wealth in the bad state without
insurance which must also be equal to the expected value of endowment.

𝐶 + 𝑝𝐶 = 16 − 𝑝𝐶 = 0. 25 * 0 + 0. 75 * 16 → 𝐶 = 16 𝑎𝑛𝑑 𝑝𝐶 = 4
Answer D is also true. This can be verified because the utility in the separating equilibrium for the low
type must be between the utility in the case with no insurance 𝑈𝐿; 𝑛𝑜 𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡 = 3 and the first best
utility which is 𝑈𝐿; 𝑓𝑎𝑖𝑟 𝑜𝑑𝑑𝑠 = 3. 46.

Question 10

The false statement is C because at equilibrium the utility curve of the high risk customer matches
the zero profit line for the low risk customer. We can find the utility function from the first best:
1 2
3
22000 + 3
22000 = 22000

At the same time the zero profit line for the low risk customer is:

0. 1𝑋 + 0. 9𝑌 = 24100

Using substitution we have that:

𝑋 = 16702. 5 𝑌 = 24921. 9

So then we can calculate the premium paid for the low type:

24921. 9 = 25000 − 𝑃 · 𝑐 ⇒ 𝑃 · 𝑐 = 78. 1 ≠ 78. 06

Question 11
2
The correct answer is A. We know that 𝐹(𝑣) = 𝑣 and consequently 𝑓(𝑣) = 2𝑣.
𝑛−1 4
The probability of winning for one player is 𝐹(𝑣)) = 𝑣 , the expected payment in case of winning
is 𝑣. The expected revenue of the auctioneer, ex-ante, is given by:
1 1
4 6 2
∫ 𝑣 * 𝑣 * 2𝑣 = ∫ 2𝑣 = 7
As players are symmetric, the total expected revenue is the expected
0 0
6
revenue for one player times the number of players which in this case gives 7
.

Question 12

The correct answer is A, bids in an English auction are increasing.

Question 13

The correct answer is B, as it is a second price auction, the revenue of the auctioneer is the second
highest bis which in this case is 12.

Question 14

𝑇ℎ𝑒𝑟𝑒 𝑎𝑟𝑒 2 𝑝𝑜𝑠𝑠𝑖𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑡ℎ𝑎𝑡 𝑎 𝑏𝑖𝑑𝑑𝑒𝑟 𝑤𝑖𝑡ℎ 𝑣𝑎𝑙𝑢𝑒 𝑉 𝑤𝑖𝑙𝑙 𝑠𝑢𝑏𝑚𝑖𝑡 𝑡ℎ𝑒 𝑠𝑒𝑐𝑜𝑛𝑑 ℎ𝑖𝑔ℎ𝑒𝑠𝑡, 2𝑉 .

𝑠𝑜 𝑤𝑒 𝑛𝑒𝑒𝑑 𝑡𝑜 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑦 2 𝑝𝑙𝑢𝑠 𝑡ℎ𝑒 [𝑃𝑟𝑜𝑏(𝑤) = 𝑉] * [𝑃𝑟𝑜𝑏(𝑙) = 1 − 𝑝𝑟𝑜𝑏(𝑤)] 𝑖𝑛𝑑𝑒𝑒𝑑 𝑤𝑒 ℎ𝑎𝑣𝑒

2 * 𝑉 * (1 − 𝑉)

Question 15
Using the revenue equivalence theorem, we know that the expected payment by one bidder is the
same regardless of the auction type.
First we derive the expected payment of a first price auction with 2 players and distribution of 𝑉 [0, 2]
1 1
, to do that we must first find the pdf which is 𝑓(𝑣) = 2
which leads to 𝐹(𝑣) = 2
𝑣.
1
The probability of winning for a player is 2
𝑣. The next step is calculating the expected payment 𝑇(𝑣)
as a difference between the expected value and the information rents:
𝑣
1 1
𝑇(𝑣) = 𝑣 * 𝑣 -∫ 2 𝑣 𝑑𝑣
2
0
2
𝑣
= 4
2
𝑣
We can infer that the expected payment of a bidder in the all-pay auction is 4
, the same as in the
first price auction, thanks to the revenue equivalence theorem.