BUSINESS AND INDUSTRIAL ECONOMICS

A.Y. 2022/2023
BIE classroom exam – September 7th, 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 vertical integration is FALSE?

a. When markets are small, there is a tendency to integrate the various value chain stages. As markets
grow, benefits from specialization and economies of scale at the different stages may reduce this
tendency
b. Accumulation of experience in coordination facilitates the integration of specialized production
knowledge within firms’ boundaries. These differential competencies also explain cost differences
between firms and affect their decisions in internalizing activities rather than outsourcing them
c. If a producer and a retailer are both monopolists, the outcome is a lower price and lower output than
in the case the two firms are vertically integrated
d. The relationships among firms in subsequent stages of production and distribution are subjected to
uncertainty arising from incomplete and asymmetric information. Vertical integration can help reduce
such uncertainty

2. Which of the following statements on externalities is FALSE?

a. The increasing adoption of lithium-ion batteries for electric vehicles (EVs) has led to positive
externalities since the wider adoption of EVs contributes to reducing greenhouse gas emissions
b. The divide-and-conquer strategy states that a platform owner should charge lower prices to the group
of participants with the higher demand elasticity to bring both groups of users on board
c. If a network industry converges toward one technological standard, it is possible that a later entrant
with a superior technology will fail
d. Innovation generates only positive externalities that do not go beyond the direct benefits reaped by
firms

3. Which of the following statements on diversification is TRUE?

a. A firm that has already achieved a high market power in one market might be reluctant to expand
further within the same market for fear of alerting antitrust authorities
b. Firms tend to diversify to exploit over-utilized resources, which usually are interchangeable and/or
non-tradeable on the market

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 c. It is more likely that firms achieve superior performance by diversifying into unrelated markets than
in related ones
d. Manager-controlled firms are as likely as owner-controlled firms to pursue mergers and acquisitions
to diversify their business portfolio

4. Firms 1-6 are active in industries A, B, and C. The table reports firms’ shares of sales in each industry (pij,
where i is the i-th firm and j is the j-th industry). Which of the following statements is TRUE?
Firm Industry A Industry B Industry C
1 0.335 0.450 0.000
2 0.100 0.200 0.150
3 0.200 0.200 0.400
4 0.200 0.035 0.200
5 0.140 0.095 0.050
6 0.025 0.020 0.200

a. According to C3, industry C is more concentrated than the other industries

b. According to C4, industry C is more concentrated than the other industries
c. According to HI, industry B is less concentrated than the other industries
d. According to HI, all the industries are in a perfect competitive regime

5. Which of the following statements on internationalization is TRUE? According to the Vernon model,
a. Internationalization is less likely in the growth phase of a product life-cycle since new firms imitate
competitors’ new products
b. Firms tend to internationalize when they grow larger. However, born global firms challenge this view
c. Locating production in a foreign country is worth if the cost of producing abroad is lower than the
cost of producing domestically, especially in the mature phase of a product life-cycle
d. All the other statements are FALSE

6. Which of the following statements on the relationship between innovation and market structure is TRUE?
a. The public benefits of innovation are always lower than the private benefits, independently of the
market structure
b. Some scholars concur that competition incentivizes innovation because firms in a highly competitive
market have abundant resources to innovate and protect their innovation.
c. Some scholars concur that innovation rates are higher in concentrated markets than in competitive
ones as large oligopolistic firms have many resources to invest in innovation
d. All the other statements are FALSE

7. Which of the following statements on public goods and innovation is TRUE? Open-source software (OSS)
a. Is an example of a collective good in which individual programmers’ willingness to signal their talent
to employers does not mitigate free-riding problems

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 b. Is not an example of a collective good since firms can continuously release new software under OSS
license capturing value from their software
c. Is an example of a collective good as firms can fully reap the benefits from their investments using
OSS license and hiring a community of code developers
d. All the other statements are FALSE

8. In the market, there are ten large firms engaging in a collusive agreement. If the firms play the trigger strategy
and the discount factor of future profits is δ, each firm has an incentive to deviate from the collusive
agreement if
a. δ > 0.9
b. δ < 0.9
c. δ > 0.10
d. All the other statements are FALSE

9. The definition of a relevant market is mainly based on

a. Supply-side complementarity
b. Firms’ marketing strategies
c. Technology of production
d. Demand-side substitutability

10. Which of the following statements on industries characterized by network externalities is TRUE?
a. Critical mass is independent of the price charged by a firm for launching a network good because the
firm leverages in any case network effects to attract further users
b. In traditional network industries (e.g., telecommunication, railway transportation) where high
investments in infrastructures are needed, it is crucial to reach critical mass as soon as possible
c. If firm A’s network good has reached the critical mass of users, firm B just needs to launch its new
network good at a lower price to win the competition
d. All the other statements are FALSE

STRUCTURED QUESTION
OPEN QUESTIONS [10 points]
Please, read the section reported below from the article “Price-bots can collude against consumers”, appeared in The
Economist, on May 6th, 2017.

Martha’s Vineyard, an island off the coast of Massachusetts, is a favorite summer retreat for Americans. A few
years ago, visitors noticed that petrol prices were considerably higher than in nearby Cape Cod. A price-fixing suit
was brought against four of the island’s petrol stations. The judges found no evidence of a conspiracy to raise
prices, but they did note that the market was conducive to “tacit collusion” between retailers. In such
circumstances, rival firms tend to come to an implicit understanding that boosts profits at the expense of
consumers.
No one went to jail. Whereas explicit collusion over prices is illegal, tacit collusion is not—though trustbusters
attempt to forestall it by, for instance, blocking mergers that leave markets at the mercy of a handful of suppliers.

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But what if the conditions that foster such tacit collusion were to become widespread? […] As more and more
purchases are made online, sellers rely increasingly on sophisticated algorithms to set prices. And algorithmic
pricing is a recipe for tacit collusion of the kind found on Martha’s Vineyard.
Consider the conditions that allow for tacit collusion. First, the market is concentrated and hard for others to enter.
The petrol stations on the Vineyard were cut off from the mainland. Second, prices are transparent in a way that
renders any attempt to steal business by lowering prices self-defeating. A price cut posted outside one petrol station
will soon be matched by the others. And if one station raises prices, it can always cut them again if the others do
not follow. Third, the product is a small-ticket and frequent purchase, such as petrol. Markets for such items are
especially prone to tacit collusion, because the potential profits from “cheating” on an unspoken deal, before others
can respond, are small.
[…] In principle, the launch of, say, a smartphone app that compares prices at petrol stations ought to be a boon
to consumers. It saves them the bother of driving around for the best price. But such an app also makes it easy for
retailers to monitor and match each other’s prices. […] The rapid reaction afforded by algorithmic pricing means
sellers can co-ordinate price rises more quickly. Price-bots can test the market, going over many rounds of price
changes, without any one supplier being at risk of losing customers. Companies might need only seconds, and not
days, to settle on a higher price.
[..] An algorithm set up to mimic the prices of rival price-bots is carrying out a strategy that any firm might
reasonably follow if it wants to survive in a fast-moving market. Online sellers’ growing use of self-teaching
algorithms powered by artificial intelligence makes it even harder for trustbusters to point the finger.
[…] The way online markets work calls for new tools and unfamiliar tactics. But remedies have to be carefully
tested and calibrated—a fix for one problem might give rise to new ones. For instance, the more consumers are
pushed to deal directly with price-bots (to thwart the transparency that allows rival sellers to collude), the more
the algorithms will learn about the characteristics of individual customers. That opens the door to prices tailored
to each customer’s willingness to pay, a profitable strategy for sellers.

Using the concepts and notions of the BIE course, answer the following questions. Note that each answer cannot
exceed 300/400 words.
Question 1: “Rival firms tend to come to an implicit understanding that boosts profits at the expense of
consumers” Relate this notion to the mainstream theories discussed in class. Explain the main market
characteristics leading firms to reach an implicit agreement in the Martha’s Vineyard case. In so doing, include
examples that support your reasonings and arguments. [6 points]
Question 2: “Algorithmic pricing is a recipe for tacit collusion of the kind found on Martha’s Vineyard”.
Taking steps from this sentence, explain the possible implications of the increasing use of advanced information
technologies (e.g., price-bots, algorithms, blockchain) on collusion (e.g., facilitate collusion among firms, enable
policymakers to easily detect collusion). [2 points]
Question 3: Based on the notions studied in class, what do you think is the role of the critical discount factor in
collusive agreements? [2 points]

SOLUTIONS OPEN QUESTIONS

Question 1: “Rival firms tend to come to an implicit understanding that boosts profits at the expense of
consumers” Relate this notion to the mainstream theories discussed in class. Explain the main market
characteristics leading firms to reach an implicit agreement in the Martha’s Vineyard case. In so doing, include
examples that support your reasonings and arguments. [6 points]
Key concepts
• Identify the correct theory and definition: reference to the competition models and in particular to
collusion (tacit collusion). Briefly discuss the notion of tacit collusion and possible implications in terms
of social welfare.
[1.5 point: the concept is properly identified and discussed clearly and comprehensively]
[1 point: the concept is not fully addressed]

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 • Illustrate the general conditions that facilitate collusion (e.g., alleged deviations, repeated interactions) and other
case-specific factors for example structural elements (e.g., industry concentration, evolution of the demand,
consumer bargaining power, and degree of product diversification) and information availability. In particular, the
case highlights how information availability, price transparency and price signalling are key factors facilitating the
tacit collusion among the petrol stations in the island. The case also points out the role of the geographical location
as facilitator of tacit collusion because the petrol stations are located in an island cut off from the mainland.
[3.5 point: the concept is properly identified and discussed clearly and comprehensively]
[2 point: the concept is not fully addressed]

• Provide real-world examples of tacit collusions like for instance in the airlines industry or in case of the use of
information technologies in demand forecast.
[1 point: the concept is properly identified and discussed clearly and comprehensively]
[0.5 point: the concept is not fully addressed]
Eventually, we evaluate concepts which depart from the key ones but that may offer original and meaningful
insights:
- Implications of collusion
[max +0.5]

Question 2: “Algorithmic pricing is a recipe for tacit collusion of the kind found on Martha’s Vineyard”.
Taking steps from this sentence, explain the possible implications of the increasing use of advanced information
technologies (e.g., price-bots, algorithms, blockchain) on collusion (e.g., facilitate collusion among firms, enable
policymakers to easily detect collusion). [2 points]
Key concepts
• Explain how the use of information technologies facilitates tacit collusion because for example of the large
amount of data that algorithms can collect, process and store. The increasing use of information technologies (e.g.,
price-bots, algorithms, machine learning and blockchain) can influence the firms’ ability to establish, monitor and
enforce collusive agreements. Explain the possible advantages and disadvantages of price-making and deviation
monitoring enabled by algorithms on colluding firms’ profit functions and consumers’ welfare.
[1 point: the concept is properly identified and discussed clearly and comprehensively]
[0.5 point: the concept is not fully addressed]

• Explain the implications on the policy makers side: how the use of information technologies at the disposal of
policy makers can help to detect collusive agreements.
[1 point: the concept is properly identified and discussed clearly and comprehensively]
[0.5 point: the concept is not fully addressed]
Eventually, we evaluate concepts which depart from the key ones but that may offer original and meaningful
insights, for example:
- Explain how the use of information technologies can facilitate collusion in comparison to human interactions.
Human interactions make it more difficult to reach and maintain collusion without explicit communication
- Provide examples
[max +0.5]

Question 3: Based on the notions studied in class, generally speaking, what do you think is the role of the
critical discount factor in collusive agreement? [2 points]
• Discuss the role of the critical factors in collusive agreement. Explain the role of the discount factor
especially in relation to the propensity and incentives of firms to deviate from the collusive agreement.
[2 points: the concept is properly identified and discussed clearly and comprehensively]
[1 point: the concept is not fully addressed]
Eventually, we evaluate concepts which depart from the key ones but that may offer original and meaningful
insights
[max +0.5]

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EXERCISES [10 points]
EXERCISE 1 [5 points]
Consider a duopoly regime with two firms (firm 1 and firm 2) facing the demand curve P = 250 − 1/3Q, where Q
= q1 + q2. The two firms employ the same technology, that is, they have the same linear cost function
C1(q1) = C2(q2) = Ci(qi)= 4qi. If needed, round to the second digit after the decimal point.

a.) Suppose that products are homogeneous and that consumers buy from the firm charging the lower price. There
are no switching costs and the two firms (1 and 2) set their price levels simultaneously. Find the resulting
Nash’s equilibrium (quantities, prices, profits). [1 point]

b.) 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]

c.) 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]

d.) Suppose that firms 1 and 2 collude. Find the resulting Nash’s equilibrium (quantities, prices, profits). [1 point]

EXERCISE 2 [2 points]
A coal-fired power plant jointly produces electricity and air pollution. Air pollution adversely affects a nearby
farm producing agricultural products. Assume that pe = 15 is the price of electricity, pf = 10 is the price of the
agricultural products (both firms are price-takers), Ce (e, x) = e2 + (x – 3)2 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 + xf 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]

EXERCISE 3 [3 points]

a.) Consider a second-hand market for bikes. There are high-quality bikes, which buyers value at most 800
euros, and low-quality bikes, which buyers value at most 400 euros. High-quality sellers accept at minimum
700 euros, while low-quality sellers accept at minimum 300 euros. Assume that buyers cannot observe
quality before purchasing, but they know that the share of low quality bikes on the market is 0.4. Which
type of sellers will exit the market? [1.5 points]
______________________________________________________________________________________

b.) The example provided above best represents a problem of

_______________________________________[0.5 point]
c.) Explain briefly your reasoning and name at least three remedies that can solve the problem you have
identified above in the second-hand market for bikes. [1 point]
______________________________________________________________________________________
______________________________________________________________________________________
____________________________________________________________________________________

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SOLUTION EXERCISES
EXERCISE 1 [4.5 points]
a.) Compute the Bertrand equilibrium [1 point]
In the (Nash) equilibrium of a Bertrand duopoly, the two firms charge the same price, which equals the marginal
costs, therefore p = MC thus p=4
The total quantity produced on the market is Q = 738
Firms share equally the market, thus q1 = q2 = Q/2 = 738/2 = 369, and they get zero profit, π1 = π2 = 0

b.) Compute the Cournot equilibrium [1.5 points] Starting from the direct demand function P = 250 – 1/3
(q1 + q2), firm 1 chooses the quantity q1 that maximizes its profit function:
1 1
𝛱1 (𝑞1 , 𝑞2 ) = 246𝑞1 − 𝑞12 − 𝑞1 𝑞2
3 3

From the first order condition, we get firm 1’s best reply function:
∂𝛱1 (𝑞1 , 𝑞2 ) 2 1 1
= 246 − 𝑞1 − 𝑞2 = 0 → 𝑞1 = 369 − 𝑞2
∂𝑞1 3 3 2
1
The game is symmetric, therefore the best reply function of firm 2 is 𝑞2 = 369 − 𝑞1
2
By solving the system:
𝑞1 = 246 𝑎𝑛𝑑 𝑞2 = 246 → 𝑄𝐶 = 𝑞1 + 𝑞2 = 492
By plugging the quantities in the inverse demand function the price is P=86
The two firms earn the same profit, equal to 𝜋1𝑐 = 𝜋2𝑐 =20,172

c.) Compute the von Stackelberg equilibrium (quantities, prices, profits). [1.5 points]
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 = 369 − 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:
1 1 1
𝜋1 (𝑞1 , 𝑞2 ) = 246𝑞1 − 𝑞 21 – 𝑞1 ∗ (369 − 𝑞1 ) =
3 3 2
1 2 369 1 1 2
246𝑞1 − 𝑞 1 − 𝑞1 + 𝑞 21 = 123𝑞1 − 𝑞 1
3 3 6 6
Applying the first order condition:

∂1 1 1
= 123 − 𝑞1 = 0 → 𝑞 = 123 → 𝑞1 = 123 ∗ 3 = 369
∂𝑞1 3 3 1

We derive the optimal quantity for firm 2 based on its best reply function:
𝑞2 = 369 − 184.5 = 184.5

In equilibrium the overall quantity is 𝑄𝑉𝑆 = 553.5 sold at 𝑝𝑉𝑆 = 250 − 184.5 = 65.5

𝜋1𝑉𝑆 = 65.5 ∗ 369 − 4 ∗ 369 = 22693.5

𝜋2𝑉𝑆 = 65.5 ∗ 184.5 − 4 ∗ 184.5 = 11346.75

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d.) If the two firms collude, they will charge the monopoly price:
1
𝑝 = 250 − 𝑄
3
1
𝑇𝑅 = (250 − 𝑄) ∗ 𝑄
3
2
𝑀𝑅 = 250 − 𝑄
3
3
MR=MC therefore 𝑄 = 246 ∗ = 369 and P=127
2
𝜋1𝐶𝑜𝑙𝑙 = 𝜋2𝐶𝑜𝑙𝑙 = 127 ∗ 184.5 − 4 ∗ 184.5 = 22693.5

q1 q2 Q P π1 Π2
Bertrand 369 369 738 4 0 0
Cournot 246 246 492 86 20,172 20,172
Von Stack 369 184.5 553.5 65.5 22,693.5 11,346.75
Collusion 184.5 184.5 369 127 22,693.5 22,693.5

EXERCISE 2 [2 points]

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]
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) = 15𝑒 + 10𝑓 − 𝑒 2 − (𝑥 − 3)2 − 𝑓 2 − 𝑓𝑥
Starting from the first-order profit-maximization conditions, we obtain:
𝜕Π(e, f, x)
= 15 − 2𝑒 = 0 → 𝒆∗ = 𝟕. 𝟓
𝜕𝑒
𝜕Π(e, f, x) 𝑥
= 10 − 2𝑓 − 𝑥 = 0 → 𝑓 = 5 −
𝜕𝑓 2
𝜕Π(e, f, x) 𝑓
= −2(𝑥 − 3) − 𝑓 = 0 → 𝑥 = 3 −
𝜕𝑥 2
𝑓 = 4.67 , 𝑥 = 0.67, 𝑃𝑟𝑜𝑓𝑖𝑡 = 72.58

EXERCISE 3 [3 points]

a.) Only low quality bikes will be sold on the market. Sellers of high quality bike will exit the market.
b.) This is a case of ex-ante information asymmetry leading to a problem of adverse selection. Possible examples
are inspection, certification of components like brakes, warranties.

Do you want your submitted exam to be corrected?

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