Question A1 Abbey plans to start a coffee shop. Her rental costs are $450 per day but these costs have been paid for the month and are non-recoverable. Based on market research, she is expected to sell the following number of cups of coffee (see table below) if a cup of coffee is priced at $4. Courtney’s best alternative use of time is to work at the local convenience store which pays her $22 per hour. Assume that there are no other costs associated with selling coffee. How many hours should she run the coffee shop for? Number of hours Total coffee sold (cups) 0 0 1 20 2 35 3 45 4 50 5 52 (a) 0. (b) 1. (c) 2. (d) 3. (e) 4.
Answer: D



Question A2 The markets for strawberries and blueberries are perfectly competitive. Strawberries and blueberries are complements. Suppose that adverse weather destroys 30% of the domestic strawberry crop. Which of the following statements is correct?
(a) The price of strawberries will rise and the quantity of blueberries will fall. (b) The price of strawberries will rise and the quantity of strawberries will rise. (c) The price of blueberries will rise and the quantity of blueberries will rise. (d) The price of blueberries will rise and the quantity of blueberries will fall. (e) None of the above.
Answer: A



Question A3 Bob runs a book-binding business, and the production of bound books requires two inputs: the binding machine and labour. The production function exhibits diminishing returns to labour. Which of the following statement is incorrect in the short run? (a) The production function is concave in the labour input. (b) Average total cost is increasing in output. (c) Short-run total cost is convex in output. (d) Variable cost is convex in output. (e) Marginal cost is increasing in output.
Answer: B

Question A4 The local animal shelter sets the adoption price for kittens, cats, and dogs who are rescued from the surrounding area. Over time, they have experimented with their adoption prices. The table below shows the percentage change in quantity demanded of kittens, cats, and dogs from a one-percent increase in each adoption price (holding all other prices constant): Effect on quantity of:
Change in
adoption
price of:
Kittens Cats Dogs Kittens -0.8 -0.1 0 Cats -0.5 -3 0.5 Dogs 0 0.1 -0.5 Which of the following statements is true? (a) The quantity demanded for Kittens and Dogs are inelastic. Cats and Kittens are substitutes. (b) The quantity demanded for Cats is elastic. Cats and Kittens are complements. (c) The quantity demanded for Kittens and Dogs are inelastic. Dogs and Cats are complements. (d) The quantity demanded for Kittens and Dogs are elastic. Dogs and Cats are complements. (e) The quantity demanded for Kittens and Dogs are elastic. Cats and Kittens are substitutes.

Answer: B




Question A5 When the government imposes a per unit tax on producers in a perfectly competitive constant-cost industry, in the long run the incidence of the tax: (a) Will fall mostly on producers. (b) Will be split between consumers and producers. (c) Will fall exclusively on consumers. (d) Will fall exclusively on producers. (e) Cannot be determined without further information.
Answer: C


Question A6 Lionotica is a biotech firm who has discovered a drug that reduces the symptoms of Covid-19 and is considering switching from its current policy to setting a single uniform price for all consumers to a third-degree price discrimination strategy based on geographic region. If Region A is more price elastic than Region B at the current single uniform price and Lionotica is a monopoly, what would we expect would happen when third-degree price discrimination is introduced? (a) The price of Lionotica’s drug to rise in Region A and rise in Region B. (b) The price of Lionotica’s drug to fall in Region A and fall in Region B. (c) The price of Lionotica’s drug to rise in Region A and fall in Region B. (d) The price of Lionotica’s drug to fall in Region A and rise in Region B. (e) No change in prices for either region.
Answer: D

Question A7 A profit-maximising monopolist firm facing a downward sloping demand will not select an output where: (a) Demand is elastic. (b) Marginal revenue is falling. (c) Average total cost is rising. (d) Average revenue is equal to marginal cost. (e) Marginal cost is rising.

Answer: D

Question A8 Aaron and Bob run mattress shops across the street from each other. At the start of each month, they independently and simultaneous choose prices for their mattresses, which will result in profits as depicted below:
Bob Low price Medium price High price Aaron Low price $200, $300 $400, $200 $800, $700 Medium price $500, $900 $200, $600 $200, $400 High price $400, $1000 $700, $200 $100, $800 Which of the following statements is correct? (a) There are two pure strategy Nash equilibria. (b) Both players have a dominated strategy. (c) There is no pure strategy Nash equilibrium that would result in Aaron having higher profits than Bob. (d) Aaron playing “low price” cannot be part of a pure strategy Nash equilibrium. (e) Bob has a dominant strategy of playing “low price”.
Answer: A

Question A9
Adam’s Jewelry Store and Brian’s Cafe are located next to each other at a local mall. They are considering whether to hire security guards for their business. Their choices and profits are depicted below:
Brian’s Cafe Don’t Hire Hire Adam’s Jewelry Store Don’t Hire -$200, $0 $-100, $50 Hire $400, $100 $600, $0
Prior to making their decisions, Brian claims that he will hire a security guard no matter what Adam does. Which of the following statements is correct?
(a) In equilibrium, the socially efficient number of security guards will be hired. (b) In equilibrium, no security guards will be hired. (c) There are two pure strategy equilibria. In each equilibrium exactly one security guard will be hired. (d) Brian’s claim is not credible. (e) There is no pure strategy Nash equilibrium in this game.
Answer: D





Question A10
Serge Koros, a high net worth individual, is approached one day at his country club by Lenny Waldorf, hedge fund manager. After introducing himself, Lenny tells Serge that he would be willing to manage some of Serge’s wealth in exchange for a fixed fee of $1,000,000. Which of the following strategies is likely to have the biggest impact in mitigating moral hazard and improving Lenny’s management of Serge’s wealth? (a) Serge offers to pay Lenny a lower fee of $500,000. (b) Serge offers to pay Lenny a higher fee of $2,000,000. (c) Instead of a fixed fee, Serge offers to pay Lenny 20% of the profits that Lenny generates from managing his wealth. (d) Serge offers to pay Lenny a fixed fee equal to 5% of the wealth he entrusts Lenny to manage. (e) Serge refuses Lenny’s offer and asks him for stock tips instead.
Answer: C

Question B1 [10 points] When producing steel, a small amount of pollution is emitted into the atmosphere that has a negative impact on the health of people in the surrounding area. The government has calculated that the private and social marginal benefits of steel are given by: PMB = SMB = 110 – Q While the private marginal cost and social marginal costs are PMC = 10 + Q SMC = 50 + Q Answer the following questions: B1.1: In the absence of regulation, what level of output will the economy produce? (2 points) Solution: The market equilibrium is the point where PMB=PMC or: 110-Q = 10 + Q Rearranging yields: Q* = 50, P* = 60 B1.2: What is the efficient (welfare-maximizing) level of output? (2 points)
Solution: The efficient outcome is the point where SMB=SMC or: 110-Q = 50 + Q Rearranging yields: Q* = 30, P* = 80 B1.3: What is the dollar value of the net gain to society from `correcting’ the externality? (4 points) Solution: The deadweight loss due to the externality is based on the two points found above and a third point at {Q,P} = {Q = 50, P = 100}. The total DWL is thus equal to .5*(50 – 30)*(100-60) = 400 B1.4: Suppose the government wishes to correct the market failure using a tax. What size of the tax should the government choose if it wishes to induce the efficient (welfare-maximizing) level of effort? (2 points) Solution: A Pigouvian tax of $40 will lead to the socially efficient level. Based on the equations: T = P_{D} – P_{S} P_D = 110 – Q P_S = 10 + Q Thus, the equilibrium point will occur when P_D = 110 – Q P_D = 10 + Q + T This coincides with the efficient outcome when T = 40.
Question B2 [10 points] Huntingon’s disease (HD) is an inherited disorder that has symptoms that develop when individuals are between 30 and 50 years of age. You are the owner of a non-profit startup that has discovered a treatment for the disease. The marginal cost for offering the treatment is $100,000 and many individuals who may be at risk to the condition are interested in purchasing an insurance contract that will cover the treatment.

Question B2.1: Currently, all individuals can take a free genetic test that can identify whether they are at risk of HD. If an individual receives a positive test result, they have a 45% chance of getting sick while an individual who receives a negative test result has a 0% chance of getting sick. How much would you expect to pay on average if everyone who tests positive purchases the insurance you offer? (2 points) Solution: This is a expected value calculation: .45*100000 = $45,000
Question B2.2: Suppose that a biotech firm called Lionotica has discovered a new testing procedure that can give an individual better information about their risk. In particular, the test can place individuals into five “groups” that differ in the probability of getting sick. An individual who has tested positive to the initial test is equally likely to fall into each of the five groups shown in the table below. Test Result Probability of Getting Sick “Group 1” 10% “Group 2” 25% “Group 3” 35% “Group 4” 70% “Group 5” 80% Suppose that you charge the expected payment that you calculated in part B2.1 and that all individuals who are considering the insurance are risk neutral. Which groups would take up the original insurance offer? What are your expected losses per individual who buys the insurance if they can take the test privately and do not have to disclose it to you? (4 points) Solution: The expected value of the contract of the five groups are $10,000, $25,000, $35,000, $70,000, and $80,000. Thus, only individuals in group 4 and group 5 will purchase the contract. The expected cost is $.5*70,000 + .5*80,000 = $75,000. The expected loss per individual is thus $45,000 - $75,000 = -$30,000.
Question B2.3: Suppose that you need to cover the expected cost of treatment with the premium that you charge. If all individuals have access to Lionotica’s test and can keep the results private, what price will you charge for insurance? Who
will continue to buy it? (4 points) Solution: At a price of $75,000, only group 5 will purchase, thus the market will unwind. The only price where this does not occur is $80,000. At this price, only group 5 will purchase.

Question B3 [10 points] For this question, refer to the figure below, which shows the average total cost curve of a firm that faces demand curve D. We have marked the point on the demand curve where the elasticity of demand is equal to 1. As done in class, you may assume that the ATC includes both variable costs and fixed costs but does not include sunk costs.



Question B3.1: Would we ever observe a profit maximizing monopolist produce a quantity of QA and charging price PA? If not, explain why (2 points) Solution: No. The price here is below the average total cost curve. Thus, the firm would be losing money on each unit offered and would shut down.
Question B3.2: Would we ever observe a profit maximizing monopolist produce a quantity of QB and charging price PB? If not, explain why (2 points)
Solution: Yes.
Question B3.3: Would we ever observe a profit maximizing monopolist produce a quantity of QC and charging price PC? If not, explain why (2 points) Solution: No. Revenue is maximized at an elasticity of 1, but if this was an equilibrium it would imply the marginal cost was zero. This cannot be the case based on the drawn ATC curve.
Question B3.4: Would we ever observe a profit maximizing monopolist produce a quantity of QD and charging price PD? If not, explain why (2 points) Solution: No. This is part of the inelastic portion of the demand curve. Monopolists never produce here.
Question B3.5: Based on the graph, what can we say about the marginal cost curve of the firm? Where does it intersect the average total cost curve? (2 points) Solution: Based on the graph, the marginal cost curve must pass through the minimum of the ATC curve and will be to the right of this point and to the left of the rest of the ATC curve.

Question C1 [20 marks] To produce honey, beekeepers raise bees in hive boxes that are specifically designed to allow for easy access to honey. Hives can be co-located near apple orchards or near orange groves:
• When beekeepers keep their hives near apple orchards, their bees will pollinate the apples, increasing the output of the orchard.
• When beekeepers keep their hives in orange groves, the sticky nectar in orange blossoms helps the bees to produce more honey.
Question C1.1: Suppose that the beekeepers have property rights over their beehives but can only place their beehives next to an apple orchard or an orange grove if they are granted permission to the land. Beeswax Beehives has already been paid to locate its bees at Amy’s Apple Orchard when it is contacted by Groovy Groves who is willing to allow Beeswax to move its bees to its orange grove instead. Beeswax is negotiating with Amy’s Apples to break its current contract. The two companies have determined
that their economic profit for staying in the Apple Orchard and or moving to the Orange Grove are: Beeswax Beehives Profit Amy’s Apples Profit Bees Stay at Amy’s Apple Orchard $400 $300 Bees Move to Groovy Groves Orange Grove $900 $100 Assume that there are no transaction costs for bargaining. Based on the Coase Theorem, would you predict that the bees stay or move? Let P be the price paid by Beeswax Beehives to Amy’s Apple Orchard to break its contract. What is the lowest possible P that would lead to this outcome? What is the highest possible P that would lead to this outcome? [4 marks] The beehives should move to the orchard generating a total (additional) surplus of $300. Under the status quo, Amy can force Beeswax bees to stay and receive a profit of $300. Thus, to break the contract, it must receive at least $200, the difference in economic profits between the two actions. The maximum price that Beeswax will be willing to pay is $500. Thus, P is between $200 and $500.

Question C1.2: In the last 10 years, there has been a dramatic fall in bee populations due to the spread of Varroa mites, which infect and kill the larvae of bees and can cause bee colonies to collapse. Beeswax Beehives and its competitor Candlewax operate hives in the same area and must decide on whether to transport their bees to different spots in the orchard in the season or to keep them stationary. Transporting bees can be privately lucrative but potentially exposes both operators to the mite. Based on the actions of both parties, the payoffs are as follows: Candlewax Profit Beeswax
Beehives
Profit Keep Stationary Transport Keep Stationary 600, 700 250, 500 Transport 500, 250 700, 400 Suppose that the two companies simultaneously choose whether to transport their bees or not transport their bees. What are the pure strategy Nash Equilibrium of this game? [4 marks] The Two Nash Equilibria are {Keep, Keep} and {Transport, Transport}
Question C1.3: Suppose that instead of the game being played simultaneously, Beeswax Beehives can commit to an acting before or after Candlewax.

• If it commits to acting before Candlewax, the game is played sequentially with Beeswax Beehives choosing its action, Candlewax observing this action, and then choosing its own action.
• If it commits to acting after Candlewax, the game is played sequentially with Candlewax its action, Beeswax Beehives observing this action, and then Beeswax Beehives choosing its own action. Write down the strategies of both players in the sequential game that would arise if Beehives chooses to act before Candlewax. Write down the strategies of both players in the sequential game that would arise if Beehives chooses to act after Candlewax. Should Beeswax Beehives commit to acting before or after Candlewax? [6 points]
• Beehive first: Beehive Strategy: [Transport], Candlewax Strategy [Keep, Transport], where the first action is in the case of Beehive choosing action “Keep” and the second action is the case where Beehive chooses “Transport.”
• Candlewax first: Candlewax Strategy: [Keep], Beehive Strategy [Keep, Transport], where the first action is the case of Candlewax choosing “Keep” and the second action is the case where Candlewax chooses “Transport.”
• Beeswax should commit to be the first mover.
Question C1.4: Groovy Groves has written into its contract that it has the right to prevent bee owners from transporting their bees in the orchard. However, it cannot force the owners to transport bees if they do not wish to. Assume that there are no transaction costs for bargaining and that without an agreement, Beeswax’s preferred outcome from question C1.3 will occur. Based on the Coase Theorem, would you predict that the bees will be allowed to be transported? Let P be the price paid by Candlewax to Groovy Groves to prevent owners from transporting bees in the orchard. What is the lowest possible P that would lead to this outcome? What is the highest possible P that would lead to this outcome? [6 marks] The socially efficient outcome is for transportation to be banned. Thus, this is the outcome we would expect to occur. The lowest possible P that would be charged is $100. For lower prices, Beeswax would be willing to counter-offer and pay to remove the restriction from the contract. The highest possible P that could be charged is $200. For any higher price, Beeswax would be happy to sign its own agreement with Candlewax and ban the movement of bees.

Question C2 The Australian Competition and Consumer Commission (ACCC) has opened an investigation regarding collusion between the two major firms producing fire protection gear for bush firefighters. The firms – Azure Associates and Blue Guard – contend that they are quantity competitors and that the prices they are charging
are a result of an increase in price by their suppliers. As part of the case, the ACCC has noted that the Australian firefighters typically purchase their own protective gear and are thus price takers in the market. Both the ACCC and the two firms under investigation agree that the market demand can be described by the inverse demand function:
( ) 240 ,DP Q Q= − where Q is the total quantity provided by the two firms (i.e., A BQ q q= + , where Aq is the amount produced by Azure Associates and Bq is the amount produced by Blue Guard).
All parties also agree that the two firms have identical production technologies and that the two firms have the same constant marginal cost of production of c. In court, however, the firms argue that their marginal costs are high while the ACC argues that they are low.

Question C2.1 Azure Associates and Blue Guard contend that the two firms are competing as an oligopoly and that they compete by simultaneously choosing quantity. They argue that their marginal costs of production are equal to c = 75. Based on this marginal cost, the two firms have the following profit functions:
( , ) (240 ) 75
( , ) (240 ) 75
A A B A B A A
B A B A B B B
q q q q q q
q q q q q q
π
π
= − − −
= − − −
Using these profit functions, find the best-response function for each firm based on the other firm’s quantity choice. Use these best-response functions to calculate the equilibrium price and quantity that would arise in the market. (8 points) Solution: Taking the first-order conditions of firm A, we have:
(240 2 75) 0A Bq q− − − =
Rearranging this yields the reaction function:
75( ) 120
2 2
B
A B
qq q = − − By symmetry (or by solving for the other reaction function:
75( ) 120
2 2
A
B A
qq q = − − Noting that the problem Is symmetric, we can use one of the reaction functions to solve for each q:
75 2 75120 120 55
2 2 3 3
A
A A
qq q+ = − → = − = Thus, 55; 130.A Bq q P= = =
Question C2.2 The ACCC maintains that the two firms are acting in a collusive agreement and that the marginal cost of production is 10. Using these assumptions, calculate the predicted market price and the total quantity offered if the two firms collude and act as a monopolist. If the two firms agree to split the surplus evenly, how much profit does each firm earn? (6 points) Solution: If the two firms are colluding, they will maximize:
( ) (240 ) (240 )DP Q Q cQ Q Q cQ Q c Qπ = − = − − = − − Taking the first order condition, the profit maximizing choice would be:
(240 2 ) 0
120
Q c
Q c
− − =
= −
Thus, when c = 10, Q* = 115, P* = 125. Each firm would produce 57.5 and would receive a profit of (125-10)*57.5 = 6612.5.

Question C2.3 Suppose that the court hearing the case cannot tell whether the assertion made by the ACCC or the firms is correct. However, it notes that in 2019, the Australian government offered a subsidy of $120 to all firefighters who purchased gear during the peak of the fire season. Thus, the demand in this time period was:

( ) 360 .DP Q Q= − Explain how this information might be used to Identify whether the ACCC or the firms are correct in their arguments. (6 points) Based on the earlier analysis, the quantities under competition would be equal to:
2 75180 95
3 3A
q = − = Thus, total quantity would be 190 and the equilibrium price would be 170. Under the monopoly problem, we would have Q = 175. Thus, P* = 185. It follows that we would see the colluding firms raise their prices by more than the competing firms. Thus, we could use the response to the subsidy to identify whether the ACCC or the firms were correct.