BUSINESS AND INDUSTRIAL ECONOMICS [A-L]

A.Y. 2018/2019

Final exam – July 12th, 2019

NAME _____________________________________ SURNAME ____________________________________

STUDENT ID (Matricola)____________________________________________________________________

MULTIPLE-CHOICE QUESTIONS [15 points]

Please, indicate your answers in the following table. We will consider and evaluate only answers reported
in this table. You do not need to provide explanations for your answers. However, if you want to add a note
to an answer (e.g., an assumption, a clarification, an explanation), please write “YES” in the last column.

Question A B C D Notes
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1. Which of the following statements is NOT true about economic analysis of mergers?
a. If there exists a positive external effect, a profitable merger is welfare-increasing
b. A relatively small percentage cost reduction will usually offset a relatively large price increase
when one evaluates welfare changes after mergers
c. The anti-trust authorities usually adopt total surplus standards when examining merger cases
d. In a Cournot industry, a merger may be profitable but decrease consumer surplus

2. Two firms, 1 and 2, produce non-homogeneous goods and compete on prices, by playing their strategy
simultaneously and independently. They have the following demand functions: 𝑞𝑞1 (𝑝𝑝1 , 𝑝𝑝2 ) = 400 − 𝑝𝑝1 +
1 1
𝑝𝑝 and 𝑞𝑞2 (𝑝𝑝1 , 𝑝𝑝2 ) = 400 − 𝑝𝑝2 + 𝑝𝑝1 . The two firms produce with identical total costs: TC(qi)=200qi,
2 2 2
with i=1,2. The equilibrium prices and quantities are
a. p1*=p2*=400, q1*=q2*=200
b. p1*=p2*=200, q1*=q2*=300
c. p1*=400, p2*=200, q1*=200; q2*=300
d. None of the answers above is correct
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3. Two firms, 1 and 2, produce the same good and have different total costs: TC(q1)=10q1 and TC(q2)=20q2.
The two firms compete on prices, the demand is 𝑞𝑞(𝑝𝑝) = 5000 − 50𝑝𝑝. In the Bertrand equilibrium, firm
1 sets
a. A price slightly lower than its marginal cost: p1*=10-ε
b. The monopoly price: p1*=55
c. A price slightly lower than 20: p1*=20-ε
d. None of the answers above is correct

4. Four firms compete in the industry by choosing simultaneously the quantity to produce. The four firms
produce with identical total costs: TC(qi)=0.2qi (i=1,…,4). The demand function is P(Q)=1-Q. The
equilibrium quantities in the industry are
a. qi=0.16
b. qi=0.2
c. qi=0.24
d. Impossible to compute

5. A coal-fired power plant jointly produces electricity and air pollution. Air pollution adversely affects a
nearby farm. Assume: pe = 24 the price of electricity, pf = 20 the price of the agricultural product of the
farm (both firms are price-taker), ce(e,x) = e2 + (x - 8)2 the cost for the coal-power plant of producing
electricity e jointly with x units of pollution (there are no external costs of pollution), and cf(f,x) = f2 + fx
the cost for the farm of producing f units of agricultural products, when the coal-fired plant emits x units
of pollution. Suppose that property rights on air are created and assigned to the farm, which can now sell
pollution rights at price px. It results that
a. e* = 12, f* = 4, x* = 12, px=4
b. e* = 12, f* = 8, x* = 4, px=8
c. e* = 12, f* = 8, x* = 12, px=8
d. None of the answers above is correct

6. 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 high quality bike on the market is 0.4.
We conclude that
a. Both kinds of bikes are sold on the market
b. Only low quality bikes are sold on the market
c. Only high quality bikes are sold on the market
d. Information asymmetries do not pay any role in this market, because buyers evaluation is always
higher that the amount of money sellers are willing to accept (namely, 800>700 and 400>300)

7. The divide-and-conquer strategy

a. Prescribes that a platform owner charges low prices to the group of participants with the highest
demand elasticity so as to get this group on board and thus attract participants from the other group
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 b. Is a way to solve the chicken-egg-problem
c. Consists in subsidizing participation of one group in order to attract participants of the other group
d. All the answers above are correct

8. Which of the following is NOT a situation in which market mechanisms fail to efficiently allocate
resources?
a. In an industry, fixed costs are very high, while variable costs are very low
b. A good has a value, but there is no market in which it can be exchanged
c. Sellers are better informed than buyers on the characteristics of a good
d. In managerial firms, owners and managers may have non-aligned goals

9. Which of the following statements is NOT specifically in the realm of the Scandinavian School? The
Scandinavian School
a. States that FDIs are a way for reducing transaction costs
b. Does not explain the phenomenon of the born global firms
c. Views internationalization as a step-by-step process
d. States that firms start their internationalization path by exporting in neighboring countries

10. Which of the following is NOT a way to reduce principal-agent problems?

a. Shareholders engage in monitoring by auditing managers
b. Venture capital firms provide funds to startups in exchange for equity and membership on the
board of directors
c. Firms issue equity instead of debt because principal-agent problems are smaller with equity
d. Governments impose firms to follow standard accounting principles and punishes accounting
frauds

11. Which of the following statements is false? According to the transaction cost approach to vertical
integration
a. Transaction efficiency is always positive, while agency efficiency may be positive or negative
b. The likelihood of integration increases as the scale of production increases
c. Asset specificity influences both transaction efficiency and agency efficiency
d. Transaction efficiency is low when market specialists benefit from high economies of scale

12. Firm i is active in five diverse industries. The table reports i’s shares of sales in each industry j (Pij, with j
= 1,…,5). The Entropy Index (EI) and the Herfindal Index (HI) are
Industry Pij
1 0.40
2 0.30
3 0.15

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 4 0.10
5 0.05
a. EI=0.605; HI=0.285
b. EI=0.605; HI=0.715
c. EI=4.046; HI=0.285
d. EI=4.046; HI=0.715

13. Which of the following statements is false? According to industrial economists

a. Information asymmetries in capital markets make it difficult to finance innovation
b. Firms do not have enough incentives to innovate because the private benefits of innovation are
lower than its public benefits
c. Innovation benefits the whole economic system and thus policymakers should support innovation
d. There is consistent evidence that innovation is negatively related to firm size

14. Which of the following situations encompasses an externality?

a. Elisabeth lives in an apartment above a restaurant, and her apartment always smells like burgers
and fries. She has tried unsuccessfully to get the restaurant owner to remedy the problem
b. Mary graduated from college with a very good mark, she is looking forward to put this
achievement in her CV as she thinks that this will be very helpful for finding a good job
c. Three friends of Mary have installed WhatApp on their cellphones. Now Mary can communicate
with each of them in a quick and unexpansive way
d. Both a and c are correct

15. Which of the following statements is NOT specifically in the realm of incomplete contract theory?
a. An owner of an asset has residual control rights over that asset
b. The ownership of physical capital can lead to control over human capital
c. Relational-specific investments cause asset-specificity: the assets of A, which made the
investment, are usable just in a transaction with B
d. The allocation of property rights affects the bargaining power of the two parties and thus how they
share the surplus, which may in turn affect their incentives to make relational-specific investments

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STRUCTURED QUESTION

Exercise [8 points]
a) Consider two firms having the same marginal cost of production MC = 0, but producing slightly different goods.
Specifically, firm 1 faces the demand y1 = 27 - 0.5p1 + 0.7p2, while firm 2 faces the demand y2 = 27 - 0.5p2 + 0.7p1.
Find the equilibrium when the two firms compete on prices and play their strategies simultaneously and
independently. Does the Bertrand paradox arise in this case? Explain. [3 points]
b) Pamela owns a restaurant and hired Andres as a worker for her kitchen. The daily revenue can be either XH =
80 or XL = 40. The revenue depends on two things: demand and Andres’ effort. Andres can work hard e = 1 or be
lazy e = 0. If Andres works hard the probability of success is 0.7; if Alfred is lazy the probability of success is 0.2.
Pamela, who is the principal, is risk-neutral and maximizes her (expected) profits πP = X − w, where w is the wage
she will pay to Andres. Andres (agent) is risk-averse and has payoff πA = √𝑤𝑤−e (notice that this is his utility of
wealth net of the cost of exerting the effort). Instead of working in the restaurant Andres could work in a bar for
36 dollars a day which would involve effort (e=1).
Suppose that the effort is observable. Find the profit-maximizing wage if (i) Pamela wants Andres to be lazy (ii)
Pamela wants Andres to work hard. Which level of effort would Pamela choose? [2.5 points]
c) Assume a homogeneous good market for cellular phones with only five firms present in the market, in which
each firm acts as if it has a “share-of-the-market” demand curve of 20 percent of the market demand. The market
demand is Q=100-P. All cellular phone producers have constant marginal and average costs of $50. Initially the
price is $50.
Firm 1 and 2 have decided to merge. They can lower their costs of production from $50 to $48 because of
economies of scale of combined operations. They expect that as the market leader they can lead the industry to a
price of $60. If social benefits and costs are computed on an “industry-wide” basis, should the merger be approved?
[2.5 points]

PLEASE REPORT THE SOLUTION BELOW

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Mini-case [7 points]

Read the following mini-case and answer the following questions basing on the concepts and models that
we have studied in class.
Despite the fact that Internet companies IPOs have decreased over the past year, many new companies that just
went public continue to play a central role in shaping the new economy. The health of these companies
depends to a large degree on the strength of their leaders, including their boards of directors. Unfortunately,
the composition of many of their boards is deeply flawed, compromising their ability to provide independent
oversight and to act in the best long-term interests of the companies and their public shareholders. In our
review of 50 of 1999's largest Internet IPOs, we found that the typical board has seven directors: two
members of management, two venture capitalists, one other significant shareholder, and only two
independent, "outside" directors. No doubt, there are advantages to this lean structure. The small size and
cohesiveness of such a board, together with the high level of commitment and industry knowledge of its
directors, can help a start-up move with the speed and flexibility that the new economy demands. But that
advantage comes at too high a price. For one thing, these boards lack the independence from management
that's critical to effective oversight. When there are less outside directors than insiders - company
executives and venture capitalists – a board cannot be trusted to monitor management's decisions and
actions objectively. This is particularly true when insiders are in control of the board's compensation and
audit committees, and that's often the case at newly public, venture-backed companies today.
From Lorsch J.W., Zelleke A.S., Pick K. (2001) Unbalanced boards. Harvard Business Review
1. Why, in board of directors, is it crucial to have a good balance between insiders and outside directors? [3
points]?
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2. What are the advantages and disadvantages of having venture capitalists sitting in the board of directors
of startups? [3 points]
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3. Provide one example for the following statement “the board of directors can signal the quality of the firm”
[1 points]
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