~~MN3028 ZA d0

This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON

MN3028 ZA

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the
Social Sciences, the Diplomas in Economics and Social Sciences and Access Route

Managerial Economics

Thursday, 16 May 2013 : 10.00am to 1.00pm

Candidates should answer SIX of the following TEN questions: FOUR from Section A (12.5
marks each) and TWO from Section B (25 marks each). Candidates are strongly advised to
divide their time accordingly.
A calculator may be used when answering questions on this paper and it must comply in all
respects with the specification given with your Admission Notice. The make and type of
machine must be clearly stated on the front cover of the answer book.

PLEASE TURN OVER

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SECTION A
Answer four questions from this section.

1.

N players simultaneously decide whether to enter a market or stay out. Market demand is d (<N).
If d or fewer players enter, entrants get 1; if more than d enter, entrants get zero. Staying out yields a
payoff of 0.5. Find all pure strategy Nash equilibria.

2.

Firm A and Firm B are duopolists. Firm A has constant marginal cost of 5 and annual fixed cost of 6.
Firm B has constant marginal cost of 3 and annual fixed cost of 6. Annual demand is given by
Q = 15 p/2. Firm A is the leader and Firm B is the follower. Find the Stackelberg equilibrium and
the corresponding annual profits.

3.

A manufacturer has to decide which (if any) of two plants to operate. Plant 1 has cost function
C1(q1) = + q12 and Plant 2 has cost function C2(q2) = + q22/2. Demand is given by p = 2 q/3.

4.

(a)

If both plants are used, how should output be divided between them? Calculate the
corresponding profit.

(b)

Verify that it is better to use both plants than to just use Plant 2.

Consider the following infinitely repeated alternating offers bargaining game. Player 1 offers the
division of a cake of size 1 to Player 2. Player 2 can either accept or reject. If he accepts, the proposed
division is realized. If Player 2 rejects, he can then propose a division which Player 1 accepts or
rejects. If Player 1 rejects, he again makes an offer and so on. Both players discount their payoffs after
each rejection by a factor (0<<1). Find the subgame perfect Nash equilibrium.

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SECTION B
Answer two questions from this section.
5.

Dingle Dongle is a profit maximising monopoly retailer of widgets in Wonderland. Dingle Dongle has
annual fixed costs of 100 and it pays the wholesaler 1 for every widget it sells. The price charged by
Dingle Dongle must be a whole number of pounds. Annual demand for widgets in Wonderland, as a
function of the price, is given in the table below.
Price
1
2
3
4
5
6
7
8
9
(a)

What price should Dingle Dongle charge? What are the corresponding annual profits?

(b)

A potential competitor, Gizmo Heaven, is considering opening a shop in Wonderland. If it does,

it will have the same cost structure as Dingle Dongle (same fixed cost, same wholesale price). If
there are two widget shops in Wonderland, customers will buy from whichever is cheaper and if
both charge the same price, each gets 50% of the market. Suppose Dingle Dongle can commit to
a price. What is the (profit maximising) price it should set to deter entry by Gizmo Heaven?

(c)

Now suppose the Gizmo Heaven entry threat has disappeared but Wonderland is considering
imposing a tax on widget sales. What is the effect of the following taxes on the price Dingle
Dongle will charge?
i.
ii.
iii.

6.

Number of widgets sold

100
90
80
70
60
50
40
30
0

A tax of 3 per widget sold.

An annual fixed tax of 100.
An annual fixed tax of 200.

A seller has one object for sale. There are two bidders and their valuations are independently and
uniformly distributed on [0,1]. The seller holds an all-pay auction: the bidders simultaneously submit a
sealed bid each. The bidder with the highest bid receives the object and each bidder has to pay his bid.
(a)

Show that it is not an equilibrium strategy for each bidder to bid half his valuation.

(b)

Assume that bidder 2 bids b2(v2) = fv22 (f>0). Show that if bidder 1 bids b1, his expected payoff
is v1(b1/f)1/2 - b1.

(c)

Show that the best response of bidder 1 to b2(v2) is b1 = v12/(4f). What is the equilibrium of the
all-pay auction?

(d)

Would you advise a seller to use an all-pay auction rather than a first or second price sealed
bid auction?

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7.

A customer buys a car from a used car dealer. The car may be sold with or without a warranty. With a
warranty, the dealer will pay for all repair expenses over the next year. Without a warranty, the
customer must pay for all repair expenses. The dealer may sell a good car or a mediocre car. The buyer
may treat the car well or badly. For a given level of care, a good car will incur less repair expense than
a mediocre car. A car will also incur less repair expense if it is treated well rather than badly. The
customer cannot tell the quality of the car when he buys it and the dealer does not know whether the
customer will treat the car well. The cost of first year repairs is given in the table below.

Treated well
Treated badly

Good car
100
800

Mediocre car
900
1600

The customer incurs an additional cost of 100 if he treats the car well.
A good car costs the dealer 300 more than a mediocre car. Assume that the customer can sell a good
car for 300 more than a mediocre car after one year.
Both the customer and the dealer are risk neutral.

8.

(a)

If the car is sold without warranty, which type of car will the dealer sell? Will the customer treat
it well or badly?

(b)

If the car is sold with a warranty, which type of car will the dealer sell? Will the customer treat it
well or badly?

(c)

What is the maximum additional amount the customer should be prepared to pay for a warranty?

(d)

What is the minimum amount the dealer would charge for a warranty?

(e)

Now suppose that there is a partial warranty: the dealer will pay a fraction p of the repair costs
(and the customer pays a fraction 1-p). For which values of p will the dealer sell a good car that
is treated well by the customer?

(a)

Explain the intertemporal choice model.

(b)

Show how an increase in interest rate affects period 1 consumption if consumption is a normal
good.

(c)

Show that the amount an individual saves can decrease if the interest rate rises.

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9.

Explain what is meant by transfer pricing. Show how optimal transfer prices are calculated.
Give worked out examples.

10.

(a)

Explain what is meant by certainty equivalent and how we can use this concept to indicate
whether a decision maker is risk averse.

(b)

Reducing all payoffs in a lottery by x reduces expected utility by x. True or false? Explain your
answer.

(c)

Reducing all payoffs in a lottery by x reduces certainty equivalent by x. True or false? Explain
your answer.

(d)

Explain the concept of expected value of perfect information.

END OF PAPER

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