ECON90015
Semester 2, 2020
Final exam
19 Nov 2020
Managerial Economics (ECON90015) final exam
ˆ You have 3 hours for this exam and an additional half hour of reading time.
ˆ Please, keep track of the time and budget enough time to submit your answers in
LMS.
ˆ This exam paper has 4 problems and 5 numbered pages (including this one).
ˆ Answer all questions to the best of your ability, showing your work and providing
sufficient explanation. No credit may be given to an answer without an explanation.
Partial credit will be given to partial or partially correct answers.
ˆ Start each problem on a new page and make sure your answers to all subparts of
every problem are next to each other in the file you submit. You do not need to start
every (a), (b), (c). . . subpart on a new page.
ˆ When you are done, submit a single file within LMS.
ˆ You MAY NOT discuss this exam with anyone from within or from outside the
subject. (This excludes any questions you ask me through the Exam Support tool.)
Doing so would be a severe violation of the University’s academic-integrity policy, and I
would make sure every occurrence is investigated and punished.
ˆ The exam total is 100 marks. Each problem is worth 25 marks. The point value of each
sub-problem is indicated next to it.
ˆ Good luck!
Page 1 of 5
1. You are a manager at Sievert Devices, Inc., a manufacturer of scientific instruments.
You are attending an executive meeting when Rolf, another manager at your company,
announces:
(a) (4 marks) “Our marketing department has estimated the own-price elasticity of
demand for our Geiger counter at its current price of $10. We are confident that the
coefficient of elasticity is 0. This means that if we slightly increase our price above
$10, the quantity demanded would not change and this would increase our revenue
and our profits.” Evaluate Rolf’s claim. Is he correct? If not, explain which parts
of his statement are incorrect.
(b) (4 marks) “This is nothing!” Rolf adds, “Why should we limit ourselves to small
price changes? Clearly, if the coefficient of price elasticity of demand is zero, then
increasing the price above $10 by any amount is going to increase revenue and profits
without changing the quantity demanded.” Evaluate Rolf’s claim as in part (a).
(c) (4 marks) “But this is not all, ladies and gentlemen!” Rolf continues, “As you are all
well aware, Sievert Devices Inc. is also the proud manufacturer of the world-famous
Curie radiometer. We have also estimated the cross-price elasticity of demand for
our Geiger counters with respect to the price of the Curie radiometer, and we have
found that it equals 3. Naturally, this means that the two goods are complements
and that if we increase the Curie radiometer’s price by 1%, the quantity demanded
for our Geiger counter will go up by 3%.” Evaluate Rolf’s claim as in part (a).
(d) (4 marks) “Of course, this gives me another idea about how to increase profits,”
concludes Rolf, “If we increase the price of the Curie radiometers, we will see an
increase in demand for our Geiger counters and higher profits from the sale of Curie
radiometers. Overall, this would guarantee an increase in the profits of the firm as
a whole.” Evaluate Rolf’s claim as in part (a).
(e) (4 marks) Consider a good with demand represented by the inverse demand function
P = 10−0.5Qd. Using the point elasticity method, find the price elasticity of demand
for this good when price equals $3 and again when price equals $8. In each of these
cases, state whether demand is elastic or inelastic.
(f) (5 marks) Consider a good with demand represented by the demand function Qd =
A/P for some positive parameter A > 0. Using the arc elasticity method, find the
price elasticity of demand for this good when price increases from $1 to $4. Then,
using the same method, find the price elasticity of demand for this good when price
drops from $10 to $5. Discuss the results you observe. What kind of demand does
this good have?
Page 2 of 5
2. Consider the market for DVDs of the movie Alien. Inverse demand in the market is given
by P = 20 − 2Qd, and the quantity supplied is Qs = P − 5, where price is measured in
dollars and both quantities are measured in thousands of units. The state government
has grown increasingly concerned about the negative effects that viewing fictional alien
xenomorphs has on the psyche of the movie-viewing public and is strongly considering
an intervention into the market. You have been brought on to help with your analytical
skills.
(a) (7 marks) “I think we should impose a strict limit on how many DVDs manufac-
turers can produce,” says state premier Andrew Danielson. “I propose we make
it illegal to produce more than 6,000 units of this dreadful DVD across the entire
market.” What is the proposed policy called and will it have any effect on the mar-
ket outcome? Analyse this policy: draw the resulting supply and demand graphs,
calculate the equilibrium price, quantity traded, and find the exact numerical values
for deadweight loss, consumer surplus, and producer surplus under this policy.
(b) (7 marks) “Wait, no,” continues Mr Danielson, ”6,000 is not good enough. That
would be enough to give a DVD to every denizen of Collingwood and have some
left over. That cannot stand, this movie is just too scary. Let’s limit production to
4,000 instead of 6,000.” Analyse the proposed policy as in part (a).
(c) (7 marks) “Now I hear that my approval rating with small-business owners is very
low. Let’s consider something else instead. I think 4,000 is a good number, not too
scary. But instead of making it illegal to produce and sell more than 4,000 units, let’s
make it illegal to buy more than 4,000 units across the entire market. We can even
issue rationing cards to make sure the policy is enforced.” Analyse the proposed
policy as in part (a). What do you think this policy should be called?
(d) (4 marks) Using the concepts introduced in the subject this semester, discuss whether
it is possible for a government intervention in a market to lower or eliminate ineffi-
ciency rather that increase it. If so, give an example.
Page 3 of 5
3. Computronium Interactive (CI)’s business model is to rent out computing time on its
super computers. CI has two types of potential customers of equal number: 10 aca-
demic and 10 business clients. CI charges each customer a monthly subscription fee F
in exchange for the right to purchase any amount of computing time at a usage fee of P
cents per second of computing time. Each academic customer has the demand function
QA = 8 − PA, where PA is the usage fee that academic institutions are charged; each
business customer has the demand QB = 10−PB, where PB is the usage fee that business
institutions are charged. The quantities QA and QB are measured in millions of seconds
per month. The marginal cost to CI of additional computing time is constant at 2 cents
per second, and CI has no fixed cost.
(a) (5 marks) First, suppose that CI can distinguish between academic and business
customers and can successfully charge them different usage fees PA and PB but the
subscription fees for both types are fixed to zero (i.e. FA = FB = 0). What usage
fees PA and PB would maximise CI’s profits? What would its profits be in this case?
(b) (6 marks) Now consider the same situation as in part (a) but without the assumption
that the subscription fees FA and FB have to be zero. So now CI can set different,
potentially positive subscription fees for each customer type. What subscription fees
FA and FB and what usage fees PA and PB should CI charge each group to maximise
its profits? What would its profits be in this case?
(c) (7 marks) For this part and the next, suppose instead that CI cannot distinguish
between the two types of consumers and cannot successfully price discriminate: i.e.
CI has to charge the same subscription fee F and usage fee P to both types of
customers. What usage fee P would maximise CI’s profits if F = 0? What would
its profits be in this case?
(d) (7 marks) Now consider the same situation as in part (c) but without the assumption
that the subscription fee F has to be zero. If P = 2, what subscription fee F should
CI charge to maximise its profits? What would its profits be in this case?
Page 4 of 5
4. The market for gizmos have two firms operating in it. The demand curve in the market
is Q = 10− 0.2P , where Q = Q1+Q2. The firms’ cost functions are C1(Q1) = 20+ 10Q1
and C2(Q2) = 20 + 12Q2.
(a) (2 mark) What are the firms’ marginal-cost functions?
(b) (7 marks) First, assume that the two gizmo producers are behaving noncooperatively.
Using the Cournot model, find how much each firm would produce and what its
profits would be? Draw the firms’ reaction curves and show the equilibrium.
(c) (6 marks) Now assume that firm 1 announces its output decision publicly before
firm 2 decides on its output level. Find the rollback equilibrium of the game that
represents this strategic situation. How much would each firm produce and what
would its profits be?
(d) (3 marks) Discuss how the profits of each of the two firms change between parts (b)
and (c). Explain why you are seeing these differences. What is this an example of?
(e) (7 marks) Finally, assume that the two gizmo producers are colluding instead of
competing. They can freely share their profits so they are attempting to maximise
their joint profit (i.e. their total combined profit). Given the firms’ cost functions,
would both firms produce positive quantities? Why or why not? What is the joint-
profit-maximising level of output? How much would each firm produce and what
would its profits be?