Toronto Gold 2015

The final exam will be held on Friday, October 16 at 7 pm. The exam will consist of questions
taken from the list of potential questions below. The questions will be exactly the same as those
on the list below except that some of the numbers may change. Allowable exam aids are a
calculator. Answers to the exam must be hand written – no laptops permitted. Exam is 2.5 hours
long and consists of 6 questions (no choice).

Potential Final Exam Questions (each question is worth 20 marks)

1. (Profit maximization). The marketing department of Johnny Rockabilly’s record company

has determined that the demand for his latest CD is given in the table below. The record
company's costs consist of a $240,000 fixed cost of recording the CD, a $5 per CD variable
cost of producing and distributing the CD, plus the cost of paying Johnny for his creative
talent. The company is considering two plans for paying Johnny.

Plan 1: Johnny receives a zero fixed recording fee and a $5 per CD royalty for each CD that
is sold.

Plan 2: Johnny receives a $440,000 fixed recording fee and a zero royalty per CD sold.

Under either plan the record company will choose the price of Johnny's CD so as to
maximize its (the record company's) profit. The record company's profit is the revenues
minus costs where the costs include the costs of production, distribution and the payment
made to Johnny.

a) (5 marks) Fill in the revenue and marginal revenue columns of the table given below.

b) (5 marks) Use MR-MC analysis to find the record company’s profit maximizing price,
and quantity under Plan 1. Calculate record company profits and Johnny’s payment.

c) (5 marks) Use MR-MC analysis to find the record company’s profit maximizing price,
and quantity under Plan 2. Calculate record company profits and Johnny’s payment.

d) (5 marks) Use double marginalization to explain why both the record company and
Johnny are better off under Plan 2.

Price Quantity Revenues Marginal revenue

$26 0 Leave blank
$24 20,000
$22 40,000
$20 60,000
$18 80,000
$16 100,000
$14 120,000

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2. Supply, demand, elasticity and consumer spending

a) (10 marks). Apples and oranges are substitutes in consumption. What is the effect of a
crop failure in the apple industry on the equilibrium price of apples and the equilibrium
quantity of oranges. Use supply and demand diagrams to illustrate your answers. If the
demand for apples is inelastic then what happens to consumer spending on apples?

b) (10 marks). Cars and tires are complements. What is the impact of an increase in wages
paid to workers in the car industry on the price of cars and the quantity of tires. Use
supply and demand analysis to illustrate your answer. If the demand for cars is elastic
then what happens to consumer spending on cars.

3. Economic and accounting profits

a) (10 marks). (i) What are economic profits and how do they differ from accounting
profits? (ii) If accounting profits are positive then does this imply that economic profits
are positive and thus that firms should stay in an industry? (iii) If the owner of a firm
consistently earns zero economic profit then would they be better off if they were to exit
the industry?

b) (10 marks). A landlord decides to evict her tenants from a property that she owns so
that she can use the facility to run her own business. The annual rent on the property is
$120,000. In order to run the business she must give up her current job that pays
$50,000. She must invest $1,000,000 to buy equipment. The equipment does not
depreciate and lasts forever. Her cost of capital is 10%. Production costs are constant and
equal to $5 per unit and she can sell 100,000 units at $10 per unit. Calculate annual
economic profits and interpret what the number means.

4. Taxes and subsidies

a) (10 marks). Consider a labour market in which a payroll tax equal to $3/hr on each hour
of labour hired is levied on employers. (i) Use a diagram to explain how the elasticities of
demand and supply determine both the price that workers receive per hour labour
supplied (PS) and the price that employers pay per hour of labour demanded (PB). (ii)
Explain why the tax creates deadweight loss and illustrate the deadweight loss in a
diagram.

b) (10 marks). Suppose the government provides daycare providers with $100 per child
per week subsidy. (i) Use a diagram to explain how the elasticities of supply and demand
determine both the price that parents will pay for daycare (PB) and the subsidised price
that the daycare providers will receive for daycare (PS). (ii) Explain why the subsidy creates
deadweight loss and illustrate the deadweight loss in a diagram.

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 Toronto Gold 2015

5. (Deriving a supply function). Wolfgang is a typical producer in a perfectly competitive

piano market. His fixed costs are $1,000 per month in rent. The two variable inputs are
raw materials (wire, wood, ivory) which cost $1,000 per piano and Wolfgang’s time which
he values at $40 per hour. In 100 hours Wolfgang can make 1 piano, in 150 hours he can
make 2 pianos, in 250 hours he can make 3 pianos and in 400 hours he can make 4 pianos.

a) (5 marks). What is the marginal cost of each piano?

b) (5 marks). If the price is $6,000 per piano then use MR and MC analysis to determine
how many pianos Wolfgang should produce to maximize profits?

c) (5 marks). Derive Wolfgang’s short-run supply function by indicating for what set of
prices (if any) Wolfgang will (i) shutdown (ii) produce 1 piano (iii) produce 2 pianos (iii)
produce 3 pianos (iv) produce 4 pianos.

d) (5 marks).What will be the long-run competitive equilibrium price? How many pianos
will Wolfgang produce in the long-run?

6. (Economies of scale and scope). A firm produces two products, X and Y. The production
technology displays the following costs, where C(a,b) represents the cost of producing a
units of X and b units of Y

C(0,50) = 100 C(5,0) = 150

C(0,100) = 210 C(10,0) = 320
C(5,50) = 240 C(10,100) = 500

a) (6 marks). Does this production technology display economies of scale? Explain.

b) (6 marks). Does this production technology display economies of scope? Explain.

c) (8 marks). In the 1990s the car industry experienced a number of mergers (e.g. Daimler-
Chrysler, Volkswagen-Audi). What are the possible economies of scope that lie behind
these mergers?

7. Economizing.

a) (5 marks). Explain the technical efficiency versus agency efficiency economizing theory
proposed by Oliver Williamson.

b) (5 marks). Explain the main predictions of Williamson’s theory as they relate to (i) firm
size (ii) asset specificity and (iii) difficulties in measuring performance.

c) (5 marks). Explain how Williamson’s theory is supported by contracting relationships in

either automobiles or aerospace.

d) (5 marks). Explain how Williamson’s theory is supported by contracting relationships in

either electric utilities or electronic components.

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8. Vertical restraints.

a) (7 marks). Explain what resale price maintenance (RPM) is and why a manufacturer
would want to use it. Under what circumstances is RPM in the public interest? Discuss the
efficiency and market power effects of record companies effectively imposing RPM on
retailers of compact disks by punishing retailers that fail to sell at the retail price
suggested by the manufacturers (e.g. Sony and Warner Music).

b) (7 marks). Explain what exclusive territories (ET) is and why a manufacturer would want
to use it. Under what circumstances is ET in the public interest? Explain why Coke granted
its independent bottlers exclusive territories.

c) (6 marks). Explain what exclusive dealing (ED) is and why a manufacturer would want to
use it. Under what circumstance is ED in the public interest? Discuss the efficiency and
market power effects of beer producers imposing an exclusive dealing clause on retailers
(i.e. pubs) in the UK.

9. Property Rights Theory

a) (7 marks) Briefly explain the Property Rights Theory (PRT).

b) (7 marks) Use PRT to explain why the type of insurance (life, term/substandard)
determines whether insurance companies use an in-house sales force or a broker.

c) (6 marks) Use PRT to explain why stockbrokers are permitted to keep their client lists
(i.e. continue to contact and do business with clients) if they are dismissed from their jobs
and find employment with another brokerage house.

10. Make vs. Buy

a) (7 marks) Explain the reasons to ‘make’

b) (7 marks) Explain the reasons to ‘buy’
c) (6 marks). Explain why Coke chose to use independent bottlers in the early years and
then chose to buy out its bottlers in the latter years.

11. Macroeconomic measurement

a) (5 marks). Explain how the unemployment rate is measured. Explain what discouraged
workers are and how they affect the unemployment rate.

b) (5 marks) Explain how real and nominal GDP are measured. Briefly describe what your
firm does and how you would measure your firm’s contribution to GDP.

c) (5 marks). Explain how the CPI index is calculated and how inflation is measured using
the CPI index.

d) (5 marks). Explain (i) how the money supply is measured (ii) how money is created
when the central bank carries out an open market operation (iii) the money multiplier.

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12. (Comparative advantage). A worker in Spain can either produce 3 litres of wine or 1 kilo of
cheese. A worker in Portugal can either produce 4 litres of wine or 12 kilos of cheese.

a) (4 marks). Explain which countries have absolute advantages in which goods.

b) (4 marks). Explain which countries have comparative advantages in which goods.

c) (6 marks). Can the two countries gain from trade? Why or why not? If gains from trade
are possible then explain for what set of relative prices both countries gain from trade.

d) (6 marks). Use an example to show how both countries can increase their consumption
of both goods by trading with one another.

13. (Fiscal Policy). Suppose that for every $100 of income earned by the average household
the government taxes away $30. Out of the remaining disposable income of $70 the
average household saves $20 and spends $40 on domestically produced goods and $10 on
imports.

a) (8 marks). Use the above data to calculate the (i) marginal propensity to consume
(MPC) (ii) the spending multiplier and (iii) the tax multiplier. Use the rounds of spending
argument to briefly explain why the multiplier is greater than 1.

b) (6 marks). What is crowding out? Explain how fiscal policy causes crowding out? Is
crowding out factored into the spending multiplier? If so then explain how? If not then
explain which variables (e.g. price, interest rates, exchange rates) are held fixed when the
multiplier is calculated.

c) (6 marks). Use AD/AS analysis and the multiplier in a) to determine whether the impact
of a $10B increase in government spending on real GDP will be larger, smaller or the same
(in absolute value) as a $10B decrease in government spending.

14. (Monetary policy). Suppose an economy is experiencing an inflationary gap.

a) (4 marks). If the central bank does nothing then use the AD/AS model to explain how
wage adjustment will eliminate the gap.

b) (8 marks). Explain how under flexible exchange rates the central bank can eliminate the
gap by using contractionary monetary policy. Show the impact of this policy on interest
rates, investment, exchange rates, net exports, AD and AS.

c) (8 marks). Explain how under fixed exchange rates the central bank will be unable to
alter the money supply and thus will be unable to carry out the contractionary monetary
policy needed to eliminate the inflationary gap.

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15. Supply Management and Free Trade.

a) (10 marks). Search the internet to answer the following question. What are the
essential features and impacts of supply management in the Canadian egg, cheese,
poultry and milk markets?

b) (10 marks). If supply management were abandoned to satisfy the Trans Pacific
Partnership (TPP) trade deal then explain who would be the winners and losers. Use a
diagram to illustrate whether or not the winners could potentially compensate the losers
and still be better off.

16. Evolution of market structure.

a) (6 marks). In perfectly competitive markets explain why a doubling of market size

results in a doubling in the number of firms.

b) (6 marks). In markets that are not perfectly competitive explain why a doubling in
market size either results in (i) less than a doubling in the number of firms or in (ii) the exit
of firms. Give real world examples.

c) (8 marks). Use the replacement, efficiency and sunk cost effect to explain the
circumstances which determine whether innovation results in the persistence of
monopoly or in reduced concentration. Give real-world examples.

17. Strategic effects.

a) (8 marks). What is a strategic effect? What must a commitment involve in order to give
rise to a strategic effect? What does it mean for a strategic effect to be negative or
positive? What is the difference between the strategic effect and the direct effect?

b) (6 marks). What are possible direct and strategic effects of a merger between two car
companies? Assume that firms engage in Cournot competition.

c) (6 marks). Persuasive advertising serves to increase brand loyalty and reduce the price
elasticity of demand. What are the direct and strategic effects of persuasive advertising?
Assume that firms engage in Differentiated Bertrand price competition.

18. Factors which facilitate collusion

a) (10 marks). Discuss the factors which facilitate collusion. Wherever possible use real-
world examples from the text which illustrate how these factors apply.

b) (10 marks). Apply the concepts in part a) to determine whether collusion is likely to
occur in the commercial airline manufacturing industry.

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19. (Cournot). Consider two firms that compete in Cournot fashion and face an inverted
demand curve given by P = 120 – Q. Each firm can choose either old technology which has
constant MC = 60 and a zero fixed cost or new technology which has constant MC = 30
and fixed cost equal to F. [In the exam you will be given a number of F].

a) (5 marks). Find the Cournot Nash equilibrium outputs and profits of each firm if both
firms choose the old technology.

b) (5 marks). Find the Cournot Nash equilibrium outputs and profits of each firm if both
firms choose the new technology.

c) (5 marks). Find the Cournot Nash equilibrium outputs and profits of each firm if one
firm chooses the new technology and the other chooses the old technology.

d) (5 marks). If firms choose their technology prior to engaging in Cournot competition

then explain each firm’s Nash equilibrium choice of technology.

20. Sustainable competitive advantage

a) (10 marks). A firm has a 60 percent share of T3MP, a commodity chemical used to
make industrial solvents. Minimum efficient scale is thought to be 50 percent of current
market demand. Recently, a change in environmental regulation has dramatically raised
the price of a substitute chemical that indirectly competes with T3MP. This change
undermines the market for the substitute, which is about twice the size of the market for
T3MP. Is the firm early move in the T3MP market likely to be the source of sustainable
competitive advantage.

b) (10 marks). Under what circumstances can human resources and intellectual property
be a source of sustainable competitive advantage?

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