MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

Resit Exam for ΜΒΑ50

Economics for Managers
Saturday, July 15, 2023
Instructions: Please answer all 4 questions. The weight of each question is indicated as a percentage
of the entire exam. The maximum grade in the entire exam is 10. All sub-sections have equal weight,
unless it is denoted otherwise. You are welcome to use any examples and graphs you consider useful.
Cooperation among students and copying is prohibited and is penalized with exemption from the exams.
The use of mobile phones is banned. You are not allowed to borrow any device, e.g., calculator, mobile
phone, etc. The duration of the exam is two and a half (2.5) hours.

STUDENT LAST NAME ………………………………………………………………………

STUDENT FIRST NAME ………………………………………………………………………
STUDENT E-MAIL ………………………………………………………………………
GROUP …. MBA50…………………………………………………………..
TUTOR FULL NAME ………………………………………………………………………

QUESTION 1 (25%)
There are 20 identical firms in a perfectly competitive industry. The cost function of the
individual firm is 𝐶(𝑞𝑖 ) = 5𝑞𝑖2 , 𝑖 = 1,2, … ,20. The market demand function is 𝑝(𝑄) = 100 −
2𝑄, where 𝑄 stands for the aggregate quantity available.
a) Find the individual firm’s supply function and the industry supply function. (Mark: 0.5)
b) Find the equilibrium price and quantity of this industry. (Mark: 0.5)
c) Suppose that the government imposes a tax 𝑡 = 5 per unit of product that will be paid by the
consumers. Find the industry equilibrium with the tax. (Mark: 0.5)
d) Compute and explain the tax incidence. (Mark: 0.5)
e) Find the deadweight loss that results from the imposition of the tax. (Mark: 0.5)

Indicative Answer
a) 𝑀𝐶𝑖 = 10𝑞𝑖 . Setting price equal to 𝑝 and solving for 𝑞𝑖 leads to 𝑠𝑖 (𝑝) = 𝑝⁄10. Therefore,
the aggregate supply function is 𝑆(𝑝) = 20 ∙ (𝑝⁄10) = 2𝑝.
b) The direct demand function is 𝑄 = 50 − (𝑝⁄2). Equating aggregate supply to aggregate
demand leads to 𝑝 = 20 and, then, from either of the two aggregate functions 𝑄 = 40.
c) Let 𝑝 be the consumer price with the tax. Then 2(𝑝 − 5) = 50 − (𝑝⁄2), which implies 𝑝 =
24. The price the producers receive is 𝑝 𝑆 = 24 − 5 = 19. The aggregate quantity in the
market is 38.
d) The tax incidence – i.e., the percentage of the tax burden that goes to consumers – is
[elasticity of supply / (elasticity of supply – elasticity of demand)], where elasticities are
calculated in the market equilibrium. Here, elasticity of supply is 2 ∙ (20⁄40) = 1 and
elasticity of demand is (−1⁄2) ∙ (20⁄40) = − 1⁄4, suggesting that the tax incidence equals

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 MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

1⁄[1 + (1⁄4)] = 4⁄5. The less flexible part of the market (consumers) undertakes the
largest part of the burden.
e) Deadweight loss is [(24 − 19) ∙ (40 − 38)]⁄2 = 5.

QUESTION 2 (25%)
Consider a homogeneous product market with inverse demand function 𝑃 = 100 − 2𝑄, where
𝑃 is the product’s price and 𝑄 is the total quantity demanded. The market is served by two
symmetric firms, A and B, competing in quantities, each having cost function 𝐶 = 50 + 40𝑞𝑖 .
a) What is the equilibrium quantity per firm and the equilibrium price in this market? (Mark:
1.0)
b) Assume that firm A wants to acquire firm B. What is the minimum payment offer that the
owner(s) of firm A can make to the owner(s) of firm B so the latter are willing to sell the
firm? (Mark: 0.5)
c) Assume that after the acquisition Firm A is able to produce with cost function 𝐶̂ = 50 +
40(1 − 𝑥)𝑄, with 0 < 𝑥 < 1. Find the values of x that make the acquisition of firm B
beneficial for consumers. (Mark: 1.0)

Indicative answer
a) We must find the Cournot equilibrium in this market. Each firm’s profit function is
𝜋𝐴 = [100 − 2(𝑞𝐴 + 𝑞𝐵 )]𝑞𝐴 − 50 − 40𝑞𝐴
Maximizing the above we get firm A’s reaction function
𝜕𝜋𝐴 100 − 40 1 1
= 100 − 2𝑞𝐴 − 𝑞𝐵 − 40 = 0 ⟺ 𝑞𝐴 = − 𝑞𝐵 = 15 − 𝑞𝐵 .
𝜕𝑞𝐴 2∙2 2 2
1
A symmetric reaction function holds for firm B: 𝑞𝐵 = 15 − 𝑞𝐴
2
Solving the two equation system we obtain
𝑞𝐴𝐶 = 𝑞𝐵𝐶 = 10.
Replacing 𝑄𝐶 = 𝑞𝐴𝐶 + 𝑞𝐵𝐶 = 20 in the demand function we obtain the equilibrium price:
𝑝𝐶 = 60.
b) Firm B will not accept anything less than its net profit, hence the minimum payment that its
owners may consider is 𝜋𝐵𝐶 = (𝑝𝐶 − 40)𝑞𝐵𝐶 − 50 = 150.
c) To find the critical value 𝑥̂ we must calculate the monopoly price as function of x and equate
it at 𝑝𝐶 = 60, i.e.,
max 𝜋𝑀 = (100 − 2𝑄)𝑄 − 50 − 40(1 − 𝑥)𝑄, 𝑄𝑀 = 15 + 10𝑥, 𝑃𝑀 = 70 − 20𝑥.
Q
Hence:
𝑝𝑀 ≤ 𝑝𝐶 ⟺ 70 − 20𝑥 ≤ 60 ⟺ 𝑥 ≥ 1/2.

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QUESTION 3 (25%)
Two countries, A and B, produce rice and meat. Each country has 200 units of labor. The labor
requirements for the production of one unit of each product in the two countries are given in
the following table:
Rice Meat
A 2 5
B 4 20

a) Which country has an absolute advantage and which a comparative advantage in the
production of rice? Meat? (Mark: 0.5)
b) Over which range of the relative price of meat will free trade between the two countries take
place? (Mark: 1.0)
c) Suppose the world relative price of meat price is 3. What are the gains from free trade for
each country? (Mark: 1.0)
Explain all your answers.

Indicative Answer
a) Since 2 < 4, country A has an absolute advantage in rice. Also, since 5 < 20, country A has
an absolute advantage in the production of meat as well. Next, we calculate the opportunity
cost of each product:
Rice Meat
A ⁄ ⁄
2 5 = 0.4 5 2 = 2.5
B 4⁄20 = 0.2 20⁄4 = 5

Since 0.2 < 0.4, country B has a comparative advantage in the production of rice. Also,
since 2.5 < 5, country A has a comparative advantage in the production of meat.
b) Under free trade the relative price of met will be between the two opportunity costs (=
autarky prices). That is,
2.5 < 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑚𝑒𝑎𝑡 ⁄𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑟𝑖𝑐𝑒 < 5.
c) The gains from trade for each country are the extra units it can acquire of the good at which
it exhibits comparative disadvantage, by completely specializing in the good where it holds
comparative advantage.
Country A has a comparative advantage and specializes completely in meat, producing
200⁄5 = 40 units. At a world price of meat equal to 3, this corresponds to 120 units of rice.
On the other hand, the maximum quantity of rice that A can produce under autarky is
200⁄2 = 100. Thus, by entering into free-trade and completely specializing in meat, A
gains 20 units of rice.

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 MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

Country B has a comparative advantage in rice and specializes in it, producing 200⁄4 = 50
units. At a world price of rice equal to 1⁄3, this corresponds to 50⁄3 units of meat. On the
other hand, the maximum quantity of meat that B can produce under autarky is 200⁄20 =
10. Thus, by entering into free-trade and completely specializing in rice, B gains 20⁄3 units
of meat.

QUESTION 4 (25%)
A. Given the following exchange rate in Paris and New York: 𝐸€⁄$ = 0.833 (Paris), 𝐸€⁄𝐶𝐴𝐷 =
0.666 (Paris) and 𝐸$⁄𝐶𝐴𝐷 = 0.700 (New York). Assume that you have an initial amount of
$1,000,000.
a) Can you make a profit via a triangular arbitrage? (Mark 0.5)
b) If so, show the steps and calculate the amount of profit in US dollars. (Mark 1.0)
B. The inflation rate in the UK is expected to be 4% per year, and the inflation rate in France is
expected to be 6% per year. If the current spot rate is 𝐸€⁄£ = 1.12, what is the expected spot
rate in one year? (Mark 1.0)

Indicative Answer
A.
a) The cross rate €⁄$ can be calculated as follows:
𝑆€⁄$ = 𝐸€⁄𝐶𝐴𝐷 ⁄𝐸$⁄𝐶𝐴𝐷 = 0.666⁄0.700 = 0.951 €⁄$
Since 𝑆€⁄$ = 0.951 ≠ 0.833, we can conclude that there is room for arbitrage.
b)
i. Sell $ to buy CAD: Sell $1,000,000 to get $1,000,000 × (1⁄0.700) =
𝐶𝐴𝐷1,428,571.43.
ii. Sell CAD to buy €: Sell 𝐶𝐴𝐷1,428,571 to buy 𝐶𝐴𝐷1,428,571 × 0.666 = €951,428.57.
iii. Sell € to buy $: Sell €951,428.57 to buy €951,428.57 × (1⁄0.833) = $1,142,171.15.
This shows a profit of $1,142,171.15 − $1,000,000 = $142,171.15.
B. Based on the relative PPP, the change in the current spot rate will be:
Δ𝐸€⁄£
= 6% − 4% = 2%.
𝐸€⁄£
This means that the euro will depreciate by 2%. Thus, the expected spot rate in one year will
be 1.12 × 1.02 = 1.142.

Good luck!!