BUSINESS AND INDUSTRIAL ECONOMICS

A.Y. 2022/2023
BIE classroom exam – June 21st, 2023
Length of the exam: 90 minutes

NAME _____________________________________ SURNAME ____________________________________

STUDENT ID_(matricula)___________________________________________________________________

MULTIPLE-CHOICE QUESTIONS [10 points]

You do not need to provide explanations for your answers. However, if you want to add a note to a response
(e.g., an assumption, a clarification, an illustration), please write it in the paper sheets you will upload as a
unique .pdf file.

1. Which of the following statements on firms’ boundaries is FALSE?

a. According to the transaction cost theory, the likelihood of choosing market transactions rather than
vertical integration decreases as the scale of production increases
b. The Scandinavian School argues that internationalization is a step-by-step process. Firstly, firms enter
foreign markets by exporting products developed in their home countries. Then, they establish
subsidiaries abroad
c. A firm with significant market power in one market might be reluctant to expand further within the
same market for fear of alerting the competition authorities. Thus, it decides to diversify into other
markets
d. A manufacturing industry consists of two large and several small manufacturers selling their
products to many retailers. The two large manufacturers establish exclusive contracts with large
restaurants, fast foods, and ballparks. This is an example of downstream vertical integration

2. Concerning the free-riding problem, which of the following statements is TRUE?

a. The likelihood of free-riding increases when students work on a course's final project in pairs rather
than in large groups (e.g., 8-9 members)
b. All soda-producing firms advertise sodas without mentioning any specific brand, thus boosting the
overall demand for sodas. This practice involves free-riding
c. The free-riding problem is less likely when people involved in the private provision of a public
good (e.g., a kindergarten) care about their reputation
d. A group of neighbors hires a security guard to overwatch their neighborhood. All the neighbors but
one contributes to cover the guard’s salary. Since the guard’s salary is covered, the free-riding
problem does not occur

3. Which of the following statements is TRUE? All the else being equal, a potential user likely prefers
platform A to platform B if A
a. Has less substantial cross-side network externalities than B. The cross-side network externalities
undermine platform value
b. Charges higher transaction fees than B
c. Allows multi-homing with B and other platforms, while B does not

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 d. Offer a worse user experience than B, although both platforms have the same functionalities (e.g.,
how to store pictures)

4. Which of the following statements exemplifies strategic entry barriers?

a. The government has implemented strict regulations that require any firm willing to provide
telecommunications services to obtain a Telecommunications Service Provider License. This license
is granted by a regulatory authority responsible for overseeing the telecommunication industry
b. After the entry of a few firms from beverage-related industries, one of the incumbents in the
soda market decides to acquire some extant facilities to increase the number of its plants in the
upcoming months
c. A PC manufacturer allows customers to buy laptops directly from its website. However, customers
are allowed to purchase complementary products (e.g., printers, pen drives) from an online competitor
d. All the other statements are examples of strategic entry barriers

5. PC manufacturer A is merging with its competitor B. The German antitrust authority is analyzing the
merger and has commissioned a survey to assess the closeness of competition between A and B. It has
asked 10,000 consumers what they would do if A increased the prices of its PCs. The results of the survey
are as follows:
• 5,000 consumers said that they would switch and purchase a PC from B
• 2,000 consumers said that they would switch and purchase a PC from C (the only other competitor
in Germany)
• 3,000 consumers said they would continue purchasing a PC from A.
The German antitrust authority asks you to use the survey data to compute the diversion ratio from A to
B. You submit a report in which you conclude that the diversion ratio is
a. 28.6%
b. 50%
c. 37.5%
d. None of the other answers

6. Which of the following statements on possible remedies to the principal-agent problem is FALSE?
a. Establishing a solid relationship based on trust, mutual understanding, and shared values
between a manufacturer and a supplier does not facilitate the alignment of parties’ goals
b. Venture capital firms provide funds to startups in exchange for equity shares and membership on the
Board of Directors
c. Firms finance their growth by increasing their debt instead of equity
d. Investing in the firm-specific training of agents enhances their skills and knowledge. Agents with tools
and expertise are more likely to make informed decisions and act in the principal’s best interests

7. Which of the following statements on the relevance of policymakers’ intervention is FALSE?

a. In competitive markets, policymakers establishing intellectual property rights (IPRs) cause
adverse effects on innovation. Indeed, obtaining IPRs increases firms’ costs and forces firms to
raise prices; this has negative repercussions on firms’ survival

2
 b. Policymakers can directly provide public goods, thus solving the free-riding problem, which hampers
their provision
c. In highly competitive industries, policymakers can stimulate innovation by providing non-financial
support to firms engaging in innovation and by setting up institutional entry barriers
d. Antitrust authority can impede a merger between two firms active in the same relevant market because
of merging firms’ unilateral effect on the market

8. The table below reports data on the annual production value 2021 for the eight largest firms and additional
data on the other firms (i.e., competitive fringe) in the Italian software and footwear manufacturing industries
(source: Orbis).
Software industry Footwear manufacturing industry
Value of production Value of production
Firms Firms
2021 (million euros) 2021 (million euros)
1 1,950 A 557
2 1,845 B 381
3 912 C 379
4 839 D 208
5 577 E 180
6 544 F 167
7 460 G 150
8 384 H 143
The sum of the value of
production for all the other 18,219 7,212
firms
The sum of the squared
market shares of all the other 0.0019 0.0025
firms

Which of the following statements on concentration ratios C3, C4, and Herfindahl Index (HI) in 2021 is
TRUE?
a. According to the C4 index, the software industry was slightly more diversified than the footwear
industry
b. According to the C3 index, the footwear industry was slightly more concentrated than the software
industry
c. According to HI, both the software and the footwear industries were in a monopolistic
competitive regime
d. According to HI, the software industry is in a monopolistic competitive regime, while the footwear
industry is in an oligopolistic one

9. Which of the following statements is TRUE? In a price-based oligopolistic regime, it follows that
a. Firms always deviate from a collusive agreement when the competition takes place over time
b. Firms have low incentives to deviate from a collusive agreement when the expected growth of
demand is low
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 c. If competition is one-shot, collusion always emerges
d. If competition takes place over time, a price competition driving prices below marginal costs always
occurs

10. Which of the following statements is TRUE? In platform businesses,

a. Designing the interface through which participants interact is a critical technological and
competitive challenge
b. The exchange of products requires the ownership of these products by the firm running the platform
c. Platform owners can leverage only their private knowledge; therefore, they have no incentive to
facilitate the creation of complementary innovations by third parties
d. In a divide-and-conquer strategy, a platform owner should charge low prices to the group of
participants with the lower demand elasticity to get them on board and, in turn, to attract participants
from the other group

STRUCTURED QUESTION
OPEN QUESTIONS [10 points]
Please, read the short article “The value of freeing ideas, not just locking them up,” which appeared in The Economist on
November 8th, 20, and reported below.
We can have both innovation and equality, say Joshua Gans and Andrew Leigh. There is a growing view that technology
inherently increases inequality, be it from richly compensated software developers or giant web platforms that skim economic
rents from users or other firms. But it is a false dichotomy. Tech often isn’t responsible for the unfairness, and where problems
do exist, they are fixable. It is possible to have both scientific progress and fair societies.
This is the message of a new book aptly titled “Innovation + Equality” (MIT Press, 2019) by Joshua Gans, an economist at
the University of Toronto and Andrew Leigh, an economist and member of parliament in Australia. The pair are alarmed by
the winner-take-most phenomenon that characterises many parts of the tech industry. They call for a wide range of reforms,
from banning non-compete clauses in work contracts and easing the process for university loans, to reducing sexual
harassment in the workplace to boost the number of women in tech.
One of the book’s most powerful arguments is on intellectual property. It is a highly controversial issue that typically divides
into two superficial camps, caricatured as portly capitalists who claim expansive rights to pickpocket consumers and other
businesses on one side, and hippie software-developers and snowflakes on the other side, who want to open-source everything.
Messrs Gans and Leigh bring much-needed nuance and balance. Patents and copyrights are crucial for securing rights so that
firms can invest, they acknowledge, but those rights need to be more limited than they are today [...].

Using the concepts and notions of the BIE course, answer the following questions. Note that each answer cannot exceed
300/400 words.
Question 1: What are the main characteristics of giant web platforms? [2 points]
Question 2: Explain what is the winner-take-most phenomenon that characterizes many parts of the tech industry. [4
points]
Question 3: Do you agree with the sentence “patents and copyrights are crucial for securing rights so that firms can
invest, …, but those rights need to be more limited than they are today”? Explain why you agree or disagree. [4 points]

4
SOLUTIONS OPEN QUESTIONS
Question 1: What are the main characteristics of “giant web platforms”? [2 points]
Key concepts (Module E, slides 79-80)
Platform businesses are firms that enable transactions between two (or more) groups of participants. These types of
businesses have two main groups of characteristics:
• “Asset light”, meaning that they do not generate value by transforming inputs into outputs but by coordinating and
enabling transactions among two (or more) groups of participants. Accordingly, they must develop a suitable
interface, the development of the interface accounts for the bulk of their costs. Indeed, most costs relate to the design
of the interface and are therefore fixed whereas variable costs (cost per connection) are meager. Due to these
characteristics, there are economies of scale.
[1 point: the concept is properly identified and discussed clearly and comprehensively]
[0.5 point: the concept is properly identified but it is not discussed clearly and comprehensively]

• Characterized by same-side and cross-side network externalities. Specifically, as the size of one group increases,
the benefits for the other group increase as well (cross-side network externalities); likewise, the benefits of one group
vary if the size of the group itself increases. In this case, the benefits may increase or decrease (usually due to
increased competition among group members). Because of economies of scale and same and cross-side externalities,
platform businesses tend to grow larger. Eventually provide examples of negative externalities among the same side
(e.g., competition between buyers and sellers on eBay)
[1 point: the concept is properly identified and discussed clearly and comprehensively]
[0.5 point: the concept is properly identified but it is not discussed clearly and comprehensively]

Because of these characteristics, platform business can easily scaleup, however they face the chicken and egg problem, and
the need to achieve a balanced growth.

Eventually, we evaluate concepts which depart from the key ones but that may offer original and meaningful insights
- Provide a definition of platforms and examples of winning platforms (e.g., Alibaba, Uber, Airbnb)
- Cite other meaningful characteristics (e.g., winners-takes-it-all phenomenon, pricing /non-pricing strategies, divide
and conquer strategy, platform quality, chicken and egg problem, balanced growth)
- Difference between platform and network
[max +0.5]

Question 2: Explain what is “the winner-take-most phenomenon that characterizes many parts of the tech industry.”
[4 points]
Mandatory arguments are related to the clear description of the winner-takes-it-all phenomenon:
• Description of the phenomenon: the goods/services exchanged in many high-tech industries are often characterized
by network externalities. In a platform business, as users increases, the good/service becomes increasingly attractive
for other potential users; thus, the first business platform which attracts enough users is going to conquer the whole
market as its users prefer to join the larger network. Hence, competition is “for the market” instead of “within the
market.” Once the market leader has reached a winner-takes-it-all, it is difficult for the followers to gain users as
they suffer from switching costs related mainly to network effects or to the psychological and social dynamics costs
related to switching platforms.
[2 points: the concept is properly identified and discussed clearly and comprehensively]
[1 point: the concept is properly identified but it is not discussed clearly and comprehensively]

• Discuss the process leading to the winner-take-most phenomenon: growth from the start-up phase to Reaching
critical mass and maturity phase. Discuss eventually how to solve the challenges related to growth.
[1 point: the concept is properly identified and discussed clearly and comprehensively]
[0.5 point: the concept is properly identified but it is not discussed clearly and comprehensively]

• Point out that the winner-takes-it-all phenomenon does not always manifest, for instance, because firms
differentiate their offerings of (network) goods and operate in market niches
[1 point: the concept is properly identified and discussed clearly and comprehensively]
[0.5 point: the concept is properly identified but it is not discussed clearly and comprehensively]
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Eventually, we evaluate concepts which depart from the key ones but that may offer original and meaningful insights
- Refer to the start-up problem that firms must overcome to reach a leadership position in the market
- provide examples of platforms winning the competition” for the market
- Difference between platform and network
- Reference to prospect theory
[max +0.5]

Question 3: Do you agree with the sentence “patents and copyrights are crucial for securing rights so that firms can
invest, …, but those rights need to be more limited than they are today”? Please, explain why you agree or disagree. [4
points]
Mandatory arguments [Module F]:
• Definition of patent and objectives of IPs law: explain patents’ role in relation to creating firms’ incentives to
innovate and spur economic growth. To innovate, firms must invest many resources in R&D; in the absence of
patents protecting their innovation from imitation, firms would have difficulties in recovering these investments.
Anticipating these difficulties, firms would restrain from innovating. Links to the market failure issue and knowledge
spillovers. Conceptualize patents as institutional barriers.
[1.5 point: the concept is properly identified and discussed clearly and comprehensively]
[0.75 point: the concept is properly identified but it is not discussed clearly and comprehensively]

• Describe potential dark sides of patents: patents (and copyrights, and, in general, intellectual property rights) may
o Create a temporary monopolistic position for the patent holders, which reduces social welfare
o Impede other firms to innovate if the patent holders use them for competitive reasons
o Increase the cost of innovation
[1 point: the concept is properly identified and discussed in a clearly and comprehensive way]
[0.5 point: the concept is properly identified but it is not discussed clearly and comprehensively]

• Relate the discussion to the platform context and explain under which condition IPs protection should be more
limited. Of note, platforms benefit from same-side and cross-side network externalities; being asset-light, they do
not bear high costs once the interface is created. Thus, they can also reap large benefits from innovation because
these are significant entry barriers. The design of intellectual property rights should consider these aspects. Provide
examples of conditions under which the protection of patent could eventually be lighter and explain your reasonings
(e.g., grand challenges, pandemic, temporary IP waiver to speed up commercialization). Policy makers challenges
in setting proper competition policies and IP laws can be mentioned. Arrow vs. Schumpeter law can be included in
the discussion.
[1.5 points: the mandatory concept is properly identified and discussed in a clearly and comprehensive way]
[0.75 point: the concept is properly identified but it is not discussed clearly and comprehensively]

Eventually, we evaluate concepts which depart from the key ones but that may offer original and meaningful insights
- Market structure and innovation
[max +0.5]

EXERCISES [10 points]

EXERCISE 1 [6]
1
Consider a duopoly regime with two firms (firm 1 and firm 2) facing the demand curve Q = 90 − P, where Q =
2
q1 + q2. Both firms have the following cost function Ci(qi) = 20 qi, i=1,2. When doing the computations, round
to the second digit if necessary.
a.) Suppose that products are homogeneous and the two firms (1 and 2) set their quantity levels simultaneously.
Find the resulting Nash’s equilibrium (quantities, prices, profits). [1.5 points]

b.) Suppose that products are homogeneous and firm 1 sets its quantity before firm 2. Find the resulting Nash’s
equilibrium (quantities, prices, profits). [1.5 points]

c.) Suppose that firms 1 and 2 collude. Find the resulting Nash’s equilibrium (quantities, prices, profits). [1 point]
6
d.) Suppose you are the CEO of firm 2 (the follower in the b case); which competition regime would you choose?
[0.25 point] Explain why. [0.25 point]

e.) Calculate the total consumer surplus, total producer surplus, and the total welfare in the market in each of the
three competitive regimes (i.e., Cournot, von Stackelberg, and Collusion). If you were the State, which
competitive regime would you prefer? [1.5 points]

SOLUTION EXERCISE 1
a.) Compute the Cournot equilibrium. Starting from the inverse demand function P = 180 – 2 (q1 + q2),
firm 1 chooses the quantity q1 that maximizes its profit function:
𝛱1 (𝑞1 , 𝑞2 ) = (180 − 2( 𝑞1 + 𝑞2 ))𝑞1 − 20𝑞1 = 1650 − 2𝑞12 − 2𝑞1 𝑞2

From the first order condition, we get firm 1’s best reply function:
∂𝛱1 (𝑞1 , 𝑞2 ) 1
= 160 − 4𝑞1 − 2 𝑞2 = 0 → 𝑞1 = 40 − 𝑞2
∂𝑞1 2
1
Because of symmetry, firm 2’s best reply function is: 𝑞2 = 40 − 𝑞1
2

By solving the system with the two best reply functions, we obtain the following:

𝑞1 = 26.67 and 𝑞2 = 26.67

Hence, the quantity Q = q1+q2 = 53.34 is sold at the price pC = 73.33, which is the same for both firms, and the
two firms get the profits:

𝛱1𝐶 = 𝛱2𝐶 =P*q-Ci= 73.33 ∗ 26.67 − 20 ∗ 26.67 = 1955.71 − 533.4 = 1,422.31

b.) Compute the von Stackelberg equilibrium (quantities, prices, profits).

The game is solved via backward induction, starting from the second stage. In this stage, firm 2
chooses its quantity as in the simultaneous game (Cournot), so its best reply function is:
1
𝑞2 = 40 − 𝑞1
2
(For calculation, see the first-order condition of firm 2 in point a.)
Going to the first stage of the game, we find the optimal price for firm 1 by plugging the best reply function of
firm 2 into the profit function of firm 1:

𝛱1 (𝑞1 , 𝑞2 ) = ((180 − 2( 𝑞1 + 𝑞2 ))𝑞1 − 20𝑞1 = (180 − 2𝑞1 − 80 + 𝑞1 )𝑞1 − 20 𝑞1 = 80𝑞1 − 𝑞12

From the first order condition, we get firm 1’s optimal quantity:
∂𝛱1 (𝑞1 , 𝑞2 )
= 80 − 2𝑞1 = 0 → 𝑞1 = 40
∂𝑞1
From q1, it is possible to derive the optimal quantity for firm 2,
1 1
𝑞2 = 40 − 𝑞1 = 40 − ∗ 40 = 20
2 2
In equilibrium, the overall quantity is Q = q1 + q2 = 60, which is sold at the price P = 60
πS1=1600
πS2=800

c.) Suppose that firms 1 and 2 collude. Find the resulting Nash’s equilibrium (quantities, prices, profits). [1 point]
TR=(180 – 2Q)*Q
MR= 180-4Q
MR=MC 180-4Q=20
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 q1 q2 Q P Π1 Π2 Points
Cournot 26.67 26.67 53.34 73.33 1,422.31 1,422.31 1.5
VS 40 20 60 60 1,600 800 1.5
Collusion 20 20 40 100 1,600 1,600 1
For those that have used the formulas:
𝑞∗ 𝑄∗ 𝑝∗ 𝜋∗
Monopoly 𝑎−𝑐 𝑎+𝑐 (𝑎 − 𝑐)2
2𝑏 2 4𝑏
Cournot 𝑎−𝑐 𝑎−𝑐 2 𝑎 + 2𝑐 (𝑎 − 𝑐)2
3𝑏 𝑏 3 3 9𝑏
VS (𝑎−𝑐) (𝑎−𝑐)2
𝑞1 =
2𝑏
𝜋1∗ =
3(𝑎 − 𝑐) 𝑎 + 3𝑐 8𝑏
(𝑎 − 𝑐) (𝑎−𝑐)2
𝑞2 = 4𝑏 4 𝜋2∗ =
4𝑏 16𝑏

d.) Suppose you are the CEO of firm 2 (the follower in case of b.), which competition regime would you choose?
Explain why. [0.25 + 0.25]
• Firm 2 prefers a collusive agreement. However, between Cournot and VS, firm 2 would prefer
competing a’ la Cournot since it enables it to gain a higher profit
• In the Von Stackelberg game, firms 2 is the follower and can only respond to the quantity set by firm 1,
the leader, which benefits from the first mover advantage.

e.) Calculate the total consumer surplus, total producer surplus, and the total welfare in the market in each of the
three competitive regimes (i.e., Cournot, von Stackelberg, and Collusion). If you were the state, which
competitive regime would you prefer? [1.5 points]
CS PS TS
Cournot 2,844.89 2,844.62 5,688
VS 3,600 2,400 6,000
Collusion 1,600 3,200 4,800

The State would prefer the Von Stackelberg regime as it enables it to gain the highest total welfare. Additional
insights should be added about the economic rationale.

EXERCISE 2 [2]
A coal-fired power plant jointly produces electricity and air pollution. Air pollution adversely affects a nearby
farm producing agricultural products. Assume that pe = 20 is the price of electricity, pf = 8 is the price of the
agricultural products (both firms are price-takers), Ce (e, x) = e2 + (x2 – 5x) is the cost for the coal-power plant of
producing electricity (e) jointly with x units of pollution (pollution is a negative production externality), and Cf (f,
x) = f2 + fx is the cost for the farm of producing f units of agricultural products when the coal-fired plant emits x
units of pollution.

a.) Suppose that the two firms merge to internalize the negative externality. Calculate the produced amount of
electricity (e*), agricultural products (f*), pollution (x*), and the overall profit of the merged firm (π*). [2
points]

SOLUTIONS

a.) Suppose that the two firms merge to internalize the negative externality. Calculate the produced amount of
electricity (e*), agricultural products (f*), pollution (x*) and the overall profit of the merged firm (π*). [1
point]

8
 If the two firms merge, the merged entity produces both electricity and agricultural products (it can choose e,
f and x) and its profit is:
𝛱 𝑀 (𝑒, 𝑓, 𝑥) = 20𝑒 + 8𝑓 − 𝑒 2 − (𝑥 2 – 5𝑥) − 𝑓 2 − 𝑓𝑥
Starting from the first-order profit-maximization conditions, we obtain:
𝜕Π(e, f, x)
= 20 − 2𝑒 = 0 → 𝒆∗ = 𝟏𝟎
𝜕𝑒
𝜕Π(e, f, x) 𝑥
= 8 − 2𝑓 − 𝑥 = 0 → 𝑓 = 4 −
𝜕𝑓 2
𝜕Π(e, f, x) 5−𝑓
= −2𝑥 + 5 − 𝑓 = 0 → 𝑥 =
𝜕𝑥 2
5−𝑓 𝟏𝟏
𝑓 =4− → 𝒇∗ = =3.666
4 𝟑
11
5− 𝟐
𝑥= 3
→ 𝒙∗ = =0.666
2 𝟑

𝑃𝑟𝑜𝑓𝑖𝑡 = 116.33

EXERCISE 3 [2 points]

a.) Consider a second-hand market for cars. There are high-quality cars, which buyers value at most 10,000
euros, and low-quality cars, which buyers value at most 5,000 euros. Sellers of high-quality cars accept at
least 8,000 euros, while sellers of low-quality cars accept at least 3,000 euros. Assume that buyers cannot
observe quality before purchasing. The threshold fraction of low-quality cars which distinguishes between
the pooling equilibrium and the separating equilibrium is ______________________________[1 point]
b.) When climbing, people take more risks because they have insurance covering accidents when doing sports.
This is a case of
______________________________________________________________________________________[
0.5 point]
c.) Explain briefly your reasoning and name at least one remedy that can solve the case you have identified
above. _____________________________________________________________________________
__________________________________________________________________________________ [0.5
points]

SOLUTIONS
a.) Assuming q is the fraction of low-quality cars on the market, (1-q) is the fraction of good-quality cars.
The expected value (EV) for buyers of any car is:
EV = 5,000q + 10,000 (1-q) = 10,000 – 5,000q
To calculate the maximum fraction of bad-quality cars which can be on the market without causing the exit
of high-quality cars (i.e., equilibrium):
EV = 10,000 – 5,000q = 8,000
Where 8,000 is the minimum value of a high-quality car for the sellers. Thus, the threshold value of bad-
quality cars between pooling and separating equilibrium is:
q = 2/5

b.) Moral hazard (ex-post information asymmetry)

Do you want your submitted exam to be corrected?

a. Yes, I want
b. No, I withdraw
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