BUSINESS AND INDUSTRIAL ECONOMICS

A.Y. 2020/2021
BIE classroom exam – February 02nd, 2022

NAME _____________________________________ SURNAME ____________________________________

STUDENT ID_(matricula)___________________________________________________________________

MULTIPLE-CHOICE QUESTIONS [10 points]

You do not need to provide explanations for your answers. However, if something is not clear in the text
and you want to add a note to an answer (e.g., an assumption, a clarification, an explanation), please write
it in the paper sheets that you will upload as a unique .pdf file.

1. Which of the following statements is TRUE? According to the theory of public goods
a. The probability of free riding is independent on the number of participants
b. Two agents are willing to buy a public good independently from each other reservation price since
they share the use of the good
c. Non-profit organizations may satisfy the demand for public goods that is left unsatisfied by
governments (e.g., rural health care programs)
d. All the other statements are FALSE

2. Consider a market with ten firms: two with a market share of 30%, two with a market share of 10%, two with
a market share of 5%, and four with a market share of 2.5%. The two firms with a market share of 10% decide
to merge. As a reaction, one of the firms with a market share of 30% merges with one of firms with a market
share of 2.5%. Which of the following statements on concentration ratio (CK) or Herfindahl index (HI), before
and after the mergers, are TRUE?
Of note, more than one statement can be true
a. C3 after the mergers is lower than C4 before the mergers
b. C4 after the mergers is higher than C5 before the mergers
c. C5 before the mergers is higher than C3 before the mergers
d. HI is equal to 0.243 before the mergers and 0.208 after the mergers

Firms (before merge) Market share HI C3 C4 C5 Firms (after merge) Market share HI C3 C4 C5
A 0,3 0,090 0,7 0,8 0,85 A+G 0,325 0,106 0,825 0,875 0,925
B 0,3 0,090 B 0,3 0,090
C 0,1 0,010 C+D 0,2 0,040
D 0,1 0,010 E 0,05 0,003
E 0,05 0,003 F 0,05 0,003
F 0,05 0,003 H 0,025 0,001
G 0,025 0,001 I 0,025 0,001
H 0,025 0,001 L 0,025 0,001
I 0,025 0,001
L 0,025 0,001
Total 1 0,208 Total 1 0,243

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3. If two firms (1 and 2) produce a homogeneous good with the same technology and compete à la Cournot, then
a. They choose the quantity to produce; the choice of each firm is simultaneous and independent; in
equilibrium, profits of firm 1 are usually lower than its profit in a von Stackelberg competition
b. They choose the quantity to produce; the choice of each firm is independent, but one firm (the leader)
chooses before the other (the follower); in equilibrium, leader’s profits are higher than follower’s
profits
c. They choose the price at which they sell the good; the choice of each firm is simultaneous and
independent; in equilibrium, firms’ profits are usually higher than those in a Bertrand competition
d. None of the other statement is correct

4. In platforms business, it usually occurs that

a. Cross-side and same-side network externalities are negative
b. Cross-side network externalities are negative, while same-side network externalities are positive
c. Cross-side network externalities are negative, while same-side network externalities may be positive
if, for instance, there is competition among the participants of the same group
d. Cross-side network externalities are positive, while same-side network externalities may be
negative if, for instance, there is competition among the participants of the same group

5. According to industrial economists, which of the following is NOT a typical obstacle to innovation?
a. The existence of managerial firms, where ownership and control are separated
b. Uncertainty about consumers’ preferences
c. Information asymmetries in financial markets
d. All the other statements are TRUE

6. Which of the following statements is TRUE? Entrepreneurial ventures have difficulties in attracting external
financing because they usually
a. Have a more flexible organisational structure than established firms
b. Have difficulties in proving their commitment to develop their entrepreneurial idea
c. Do not signal their quality in the product-market; indeed, they profit from their innovations by
licensing their patents
d. All the other statements are FALSE

7. Which of the following statements are FALSE?

Of note, more than one statement can be false
a. In principal-agent relations, designing incentive contracts for the principal reduces agency
problems
b. Defining property rights is a remedy to negative externalities
c. In case of a monopoly upstream and a monopoly downstream, market transactions between
the two monopolists are preferable to vertical integration
d. If relational-specific investments of firm B are more important for value creation than relational-
specific investments of firm A, it is more efficient that B owns A

8. A merger between firms active in the same “relevant market” can significantly hamper effective competition
because of “unilateral effects” when

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 a. The merged entity enjoys larger economies of scale than its rivals and can drive its competitors out of
the market by charging lower prices
b. The definition of “relevant market” is based on firms’ marketing and technological strategy
c. The merged entity combines different products/services that are weak substitutes
d. None of the other statements is TRUE

9. Which of the following statements is TRUE? In a highly competitive industry, potential entrants enter the
industry when incumbents gain economic profits. This happens when the price is
a. Higher than the long run minimum average cost. However, the entry of new firms causes an increase
in price and the exit of firms that make losses
b. Lower than the short run minimum average cost. In this case, new entrants can quickly attract
customers
c. Lower than the short run marginal costs. In this case, new entrants can quickly attract customers
d. None of the other statements is TRUE

10. Which of the following situations encompass an externality?

Of note, more than one statement can be true
a. George lives in an apartment above a restaurant, and his apartment always smells like burgers
and onions. He has tried unsuccessfully to get the restaurant owner to solve the problem
b. Mary graduated from college with a high mark, she is looking forward to including this achievement
in her CV as she thinks that this will help her in finding a good job
c. After following a workshop on the opportunities stemming from cutting-edge technologies, three
students decide to found a new venture that provides digital payment services (based on
Blockchain) to online retailers
d. A venture capital investor decides to finance a new venture based on the recent increase in the citations
of the patents of the venture

EXERCISE 1 [4.5 points]

Consider a duopoly situation with two firms (1 and 2) facing the demand curve Q(P) = 250 – 5P, where Q= q1+q2.
The two firms employ different technologies, which means that they have different cost functions: specifically,
C1(q1) = 10+2q1 and C2(q2) = 5+5q2
a.) Suppose that products are homogeneous and that the two firms (1 and 2) set their produced quantity
simultaneously. Find the resulting Nash equilibrium (quantities, prices, profits) [2 points]
b.) Suppose that products are homogeneous and that firm 1 is the follower, while firm 2 is the leader. Find the
resulting Nash equilibrium (quantities, prices, profits) [2 points]
c.) Suppose you are the CEO of firm 2 (the leader in case of b.), which competition regime would you prefer?
[0.25 point]. Explain why [0.25 point]

Solution

a.) Starting from the inverse demand function P = 50 – (1/5)*(q1 + q2), firm 1 chooses the quantity q1 that
maximizes its profit function:
𝛱 (𝑞 , 𝑞 ) = ( 50 − (1/5)( 𝑞 + 𝑞 ) 𝑞 − 10 − 2𝑞 = 50𝑞 − (1/5) 𝑞 − (1/5) 𝑞 𝑞 − 10 − 2 𝑞
= 48𝑞 − (1/5)𝑞 − (1/5) 𝑞 𝑞 − 10

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From the first order condition, we get firm 1’s best reply function:
∂𝛱 (𝑞 , 𝑞 ) 1
= 48 − (2/5)𝑞 − (1/5)𝑞 = 0 → 𝑞 = 120 − 𝑞
∂𝑞 2

Firm 2 chooses the quantity q2 that maximizes its profit function:

𝛱 (𝑞 , 𝑞 ) = ( 50 − (1/5)( 𝑞 + 𝑞 ) 𝑞 − 5 − 5𝑞 = 50𝑞 − (1/5) 𝑞 − (1/5) 𝑞 𝑞 − 5 − 5 𝑞
= 45𝑞 − (1/5)𝑞 − (1/5) 𝑞 𝑞 − 5

From the first order condition, we get firm 2’s best reply function:
∂𝛱 (𝑞 , 𝑞 ) 1
= 45 − (2/5)𝑞 − (1/5)𝑞 = 0 → 𝑞 = 112.5 − 𝑞
∂𝑞 2

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

𝑞 = 112.5 − 120 − 𝑞 = 52.5 + 𝑞 → 𝑞 = 70

𝑞 = 120 − ∗ 70 = 85

The Cournot equilibrium quantities are 𝑞 = 85 and 𝑞 = 70

Hence, the quantity Q = q1+q2 = 155 is sold at the price pC = 19, which is the same for both firms. The two firms
will get the following profits:

𝛱 =P*q1-C1= 19 ∗ 85 − 10 − 2 ∗ 85 =1,435
𝛱 =P*q2-C2= 19 ∗ 70 − 5 − 5 ∗ 70 = 975

b.) The game is solved via backward induction, that is, starting from the second stage. In this stage, firm 1
chooses its quantity as in the simultaneous game (Cournot), so its best reply function is:
1
𝑞 = 120 − 𝑞
2

(For calculation, see the first order condition of firm 1 in point a.)
Going to the first stage of the game, we find the optimal price for firm 2 by plugging in the best reply function of
firm 1 into the profit function of firm 2:

𝛱 (𝑞 , 𝑞 ) = ( 50 − (1/5)( 𝑞 + 𝑞 ) 𝑞 − 5 − 5𝑞
= 50𝑞 − (1/5) 𝑞 − (1/5) (120 − 𝑞 /2) 𝑞 − 5 − 5 𝑞
= 45𝑞 − (1/5)𝑞 − (1/5)(120𝑞 − 𝑞 /2) − 5
= 45𝑞 − (1/5)𝑞 − 24𝑞 + 𝑞 /10 − 5 =
= 21 𝑞 − (1/10) 𝑞 − 5

From the first order condition, we get firm 2’s optimal quantity:
∂𝛱 (𝑞 , 𝑞 )
= 21 − (1/5)𝑞 = 0 → 𝑞 = 105
∂𝑞
From q2, it is possible to derive the optimal quantity for firm 1,

1 1
𝑞 = 120 − 𝑞 = 120 − ∗ 105 = 67.5
2 2

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In equilibrium, the overall quantity is Q = q1 + q2 = 67.5+105 = 172.5, which is sold at the price P = 50-34.5 =
15.5

πS1=P*q1-C1= 15.5*67.5 – 10-2*67.5=901.25

πS2=P*q2-C2= 15.5*105 – 5-5*105=1097.5

c.) The CEO of firm 2 (the leader in case of b.) should choose between two competitive regimes, as follows:

q1 q2 Q P 𝛱 𝛱
Cournot 85 70 155 19 1,435 975
Von Stackelberg 67.5 105 172.5 15.5 901.25 1,097.5

Firm 2 would rather choose to play a Von Stackelberg’s regime that enables to gain a higher profit.
 In the Cournot game, firm 2 has higher (variable) costs
 In the VS game firms 1 is the follower and can respond to the quantity set by firm 2, the leader which
benefit from the first mover advantage.

EXERCISE 2 [2.5 points]

Suppose that there are two types of workers on the labor market: half are high-skill workers, and the other half are
low-skill workers. For the sake of simplicity, assume that firms hire workers to participate on a specific project
and this is a one-time interaction.
A high-skill worker’s productivity in the project is aH=8,500, while a low-skill worker’s productivity is aL=3,000.
Workers know their type, but firms do not.
Assume that the labor market is perfectly competitive, so when a firm hires a worker, it pays a wage equal to the
worker’s expected productivity.
Suppose that a local college offers a certificate program, whose completion has no impact on workers’
productivity. High-skill workers’ cost of obtaining the certificate (e.g., tuition fees and workers’ effort in term of
time) is cH=1,500$, while the cost of obtaining the certificate for low-skill workers is cL=4,500$.

a.) Suppose that firms consider having a certificate a credible signal of a worker being high-skilled. Then, the
firms will offer wage wH=8,500$ to workers who obtain it and wL=3,000$ to those without the certificate.
Which types of workers will get the certificate? [1 point]
b.) What would be the wages if the firm revises its wage scheme by using the average expected productivity of
the two types of workers? [0.5 point]
c.) Using the data provided (aH=8,500, aL=3,000, cH=1,500, cL=4,500), find the level of education eH that allows
high-skilled workers to credibly signal their skills on the labor market [1 point]

Solutions
a.) Let e =1 if worker obtained the education and e=0 if not.
Compute the payoff of both types of workers.
High-skill workers:
πH(e = 1) = 8,500− 1,500 = 7,000 > πH(e = 0) = 3,000.
High-skill workers find it in their interest to choose e = 1.

Low-skill workers:
πL(e = 1) = 8,500 – 4,500 = 4,000 > πL(e = 0) = 3,000
Low-skill workers find it in their interest to choose e = 1 as well.
Therefore, both types of workers have incentives to get the certificate.

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b.) The compensation scheme based on the expected productivity of the two types of workers is:
0.5*8,500 + 0.5*3,000=5,750

c.) (aH-aL)/cL< eH< (aH-aL)/ cH

(8,500-3,000)/4,500< eH<(8,500-3,000)/1,500 → 1.2 < eH< 3.6

EXERCISE 3 [3 points]

Consider a second-hand market for motorbikes. There are high-quality motorbikes, which buyers value at most
12,000 $, and low-quality motorbikes, which buyers value at most 8,000$. High-quality sellers accept 9,500 $,
while low-quality sellers accept 4,000 $. Assume that buyers cannot observe quality before purchasing.

a.) What is the maximum fraction of low-quality motorbikes up to which sellers will still have incentives to sell
high quality motorbikes? [1 point]
b.) Based on the fraction of low-quality motorbikes you computed at point a.), what is the buyers’ expected
value for motorbikes? [0.5 point]
c.) Assume the fraction of low-quality motorbikes is 0.5. Explain whether the sellers have incentives to stay or
exit the market by calculating the buyers’ expected value [0.5 point]. What type of equilibrium is reached?
[0.25 point]
d.) Assume the fraction of low-quality motorbikes is 0.7. Explain whether the sellers have incentives to stay or
exit the market by calculating the buyers’ expected value [0.5 point]. What type of equilibrium is reached?
[0.25 point]

Solution
a.) Assume that q is the fraction of low-quality cars and 1-q is the fraction of good quality cars. Then
the EV of buyers of any motorbike is:

EV= $8,000q + $12,000(1-q) = $12,000 - $4,000q

EV= $12,000 - $4,000q= $9,500 (the minimum value that sellers accept for high quality motorbikes)

Solving for q we obtain that q*= 5/8 = 0.625

The fraction of bad quality motorbikes is 0.625 which implies that 1-q is the fraction of good quality motorbikes,
that is 0.375.

b.) Based on the fraction of low-quality motorbikes you computed in point a.), buyers’ EV is:
EV= 0.375*$12,000 + 0.625 * $8,000 = 9,500$

c.) If the fraction of low-quality motorbikes is equal to 0.5, buyers’ EV is:

EV= 0.5*$12,000 + 0.5 * $8,000 = 10,000$ (>$9,500 is the minimum that sellers accept for high quality
motorbikes)
As q = 0.5 is lower than the q* (0.625), there is a pooling equilibrium, a market equilibrium in which both types
of motorbikes (bad and high quality) are traded

d.) If the fraction of low-quality motorbikes is equal to 0.7, buyers’ EV is:

EV= 0.3*$12,000 + 0.7 * $8,000 = 9,200$ (<$9,500 is the minimum that sellers accept for high quality motorbikes)

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As q = 0.7 is higher than the q* (0.625), there is a separating equilibrium, a market equilibrium in which only one
type of motorbike (bad quality) is sold. High-quality sellers will exit the market.

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