Question 1

Assume you paid $3,000 for your notebook computer.The probability of the computer being stolen is .02 if you are careful and .05 if you are not.How much (in dollar terms)are you willing to expend in caring for the computer? If you had purchased insurance that replaced the computer if it were stolen,how much would you be willing to spend in taking care of it (ignore the "costs" of lost data and time in getting a replacement)? Why?

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Question 2

You start an insurance company as your first entrepreneurial venture after graduation.Your main product line is malpractice insurance for dentists.After exhaustive research,you learn that settling malpractice claims against careful dentists costs $2,000 and settling malpractice claims against reckless dentists costs $7,500.Individual dentists know whether they are reckless or careful,and your research shows that approximately 20% of dentists are reckless.How much do should you charge for malpractice insurance to break even? Why?

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Question 3

Research has shown that the majority of strategic alliance joint ventures between companies are not successful.Provide an adverse selection and moral hazard explanation for this lack of success.

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Question 4

You are considering launching a strategic alliance with a competitor to join your separate skills to develop a new jointly owned technology.Both you and your partner have the option of fully or partially supporting the alliance.Complete the payoff diagram to make this a Prisoner's Dilemma.
 $$\begin{array} { | l | l | l | } 
\hline & { \text { You fully support alliance } } & \text { Youpartially support alliance } \
\hline \begin{array} { l } 
\text { Partrer fully } \
\text { supports alliance }
\end{array} & \text { You: 100 } & \text { You: 150 } \
& \text { Partner: 100 } & \text { Partur: 50 } \
\hline \begin{array} { l } 
\text { Partrer partially } \
\text { supports alliance }
\end{array} & \text { You: 50 } & \text { You: } \
& \text { Partner: 150 } & \text { Partne: } \
\hline
\end{array}$$

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Question 5

You take a position with a large real estate development company as your first job after graduation.Your first big assignment is to sell an office building - you have been informed the company's cost into the building (and the bottom line price it is willing to accept)is $400,000.You have identified a likely buyer and you assess that his top price is either $500,000 with a probability of .3,$600,000 with a probability of .5,or $1,000,000 with a probability of .2.You have to commit to a posted price - what price will maximize your profitability?

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Question 6

Suppose there are 9 sellers and 9 buyers in a market, each willing to buy or sell one unit of a good.  Their values are {$15, $14, $13, $12, $11, $10, $9, $8, $7}.  That is, there is one buyer and one seller each valuing the good at $15, one buyer and one seller each valuing the market good at $14, etc.
a)	Assuming no transactions costs and a competitive market, what is the equilibrium price and quantity of goods traded in this market?
b)	Suppose there is a single market maker in this market and no price controls.  Calculate the bid-ask prices that maximize the market maker's profit when the marginal cost of a transaction is $1.
c)	If the government imposes a maximum spread of $2 (i.e., controlling the market maker's per transaction profit), what are the bid-ask prices that maximize the market maker's profit when the marginal cost of a transaction is $1?  What number of goods will be traded?

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Question 7

The following represents the potential outcomes of your first salary negotiation after graduation:
  Assuming this is a sequential move game with the employer moving first,circle the most likely outcome.Does the ability to move first give the employer an advantage? If so,how? As the employee,is there anything you could do to realize a higher payoff?

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Question 8

You are considering an investment that will enable you to produce a new product.Your market research has indicated that the probability that the new product will be extremely successful is .6 and the probability that it will only be moderately successful is .4.The estimated demand curve if the product is extremely successful indicates 100 units per week at a price of $10 and 300 units per week at a price of $8.If it is only moderately successful your demand curve indicates 50 units per week at a price of $10 and 70 units per week at a price of $8.Your fixed costs are $200 per week and your marginal costs are constant at $5 in this production range.Should you invest in the new product? If so,how should you price? What quantity do you expect to sell at that price? What is the expected profit?

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Question 9

Your company manufactures a high-efficiency natural gas furnace.  The current price is $2000 per unit.  The price elasticity of demand is -2.5 for prices between $1500 and $2500.  Your CEO has asked you to predict the net effect on demand for various scenarios.  You have determined that there are three major factors that will affect your demand: the price of competitors' products, income, and the price of natural gas.  You have hired a consulting company to estimate the effects of these factors.  The results are as follows: (1) the cross price elasticity of demand between your product and your competitors' products is constant at +.5, (2) income elasticity of demand for your products is constant at +1.6, and (3) the cross price elasticity of demand between your product and natural gas is constant at +.3.
a)	By what percent would your demand change if you increased price by 5% and all other factors remained constant?
b)	By what percent would your demand change if you did not increase price but your competitors increased their prices by 8% and all other factors remained constant?
c)	By what percent would your demand change if you did not increase price but income decreased by 2% and all other factors remained constant?
d)	By what percent would your demand change if you did not increase price but the price of natural gas fell by 20% and all other factors remained constant?
e)	What is the net effect on your demand of all changes taken together (you increased price by 5% and competitors increased price by 8% and income decreased by 2% and the price of natural gas fell by 20%)?  Assume the effects of each change are independent and cumulative.

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Question 10

Universities ask students to complete evaluations of professor performance at the end of classes.Provide both an adverse selection explanation and a separate moral hazard explanation for the practice and identify information asymmetry.

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Question 11

In the Oct 29,2005 NY Times Article,Wal-mart's Health Care Struggle is Corporate America's too,an internal Wal-Mart Memo,suggested redefining jobs to require physical activity,and to offer health care insurance plans that allowed workers who have low medical costs to spend the unused benefits on other items,like housing or education.Give an adverse selection explanation and a moral hazard explanation of how these actions can help reduce Wal-Mart's health care costs.

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Question 12

Botulinum toxin,marketed under the brand name "Botox" is a drug that paralyzes muscles into which it is injected.It is one of the few promising treatments for migraine headaches,which affect about 10% of the population.Migraine headaches are debilitating,but there is no objective way to diagnose them.Thus migraine headaches are relatively easy to fake.Botox is also very popular as a cosmetic treatment to get rid of wrinkles.If you are a small business,should you offer insurance coverage for Botox treatments for migraine headaches? (HINT: moral hazard.)

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Question 13

You have an opportunity to invest in a new plant.The fixed costs are $100,000 per year.The marginal cost of production is $2 for a quantity up to 10,000 units per year.The marginal cost of production is $4 for a quantity between 10,001 and 30,000 units per year (an additional 20,000 units per year)and $10 for production above 30,000 per year.What is the break even quantity if the market is competitive and the market price is $8 per unit? Show all calculations.

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Question 14

When China reformed state-owned enterprises,it tried a new approach to choosing managers: it put managerial jobs up for auction.The bids for the jobs consisted of promises of future profit streams that the managers would generate and then deliver to the state.A simple regression analysis showed that in cases where the incumbent manager was the winning bidder,firm productivity tended to increase dramatically.When outside bidders won,there was little productivity improvement.How can we explain this surprising result?
[The above question is inspired by McMillan,J.(1996).Games,Strategies,and Managers: How Managers Can Use Game Theory to Make Better Business Decisions.New York: Oxford University Press,USA]

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Question 15

You are running an oral auction,and you know the six bidders place the following values on the auction item:
Joe: $150&ensp;&ensp; Jack: $149&ensp;&ensp; Jim:$148
Jane: $147 &ensp;&ensp;Jill: $146 &ensp;&ensp;Jean: $145
What winning bid should you expect? If the winning bid turns out to be $146.01 because of a bid cartel,which bidders must have participated?

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Question 16

In 1997 America Online (AOL)started charging "rent" (a fixed fee for a "space" in its electronic store)to its electronic retailers,instead of a share of their sales revenue.
a.What is the adverse selection problem that is solved by this change?
b.What is the moral hazard problem that is solved by this change?
In answering this question,identify distinct moral hazard and adverse selection problems and the source of the information asymmetry.Describe only the problems,not the solutions.Assume also that AOL can easily monitor sales by its retailers so there is no way to "cheat" on the sales commission by,for example,diverting sales from AOL to another outlet.

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Question 17

Suppose that you are a seller bargaining with a buyer.Your bottom line is zero,and you think the buyer's top dollar is either $5 with probability .25,or $6 with probability .75.Suppose further that you can commit to a posted price.What is the price that maximizes expected profitability?

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Question 18

You and a competitor are both considering the launch of a new product line,which could be made of either plastic or glass.
 $\begin{array}{|ll|l|l|}
\hline & & {\text { You useplastic }} & {\text { You use glass }} \
\hline \begin{array}{l}
\text { Competitor } \
\text { plastic }
\end{array} & \text { uses } & \text { You: 25 } & \text { You: } 100 \
& & \text { Competitor: 25 } & \text { Competitor: 50 } \
\hline \begin{array}{l}
\text { Competitor } \
\text { glass }
\end{array} & \text { uses } & \text { You: } 50 & \text { You: 25 } \
& & \text { Competitor: } 100 & \text { Competitor: } 25\
\hline
\end{array}$ Are there one or more Nash equilibria to this game? If so,indicate by circling the cell(s).What is the main lesson to be learned from this game?

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Question 19

Referring to the question above: If the symphonies were also offered as a complete set of 9 CDs and the price of the entire set was $79.00,would he rather buy the individual CDs or the box set? HINT: WHICH OPTION GIVES HIM MORE CONSUMER SURPLUS?

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Question 20

You have 10 individuals with values {$1,$2,$3,$4,$5,$6,$7,$8,$9,$10},and suppose you find a way to charge one price to the consumers whose values are {$1,$2,$3,$4,$5},and a different price to those consumers whose values are {$6,$7,$8,$9,$10}.MC of production is $2.50.
a.What price should you charge to the second group?
b.What are your expected profits from selling to the second group?
c.What price should you charge to the first group?
d.If it costs $5 to implement this price-discrimination scheme (to identify the two groups and prevent arbitrage between them),should you do it?

Accepted Answer

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Quiz 1: Managerial Economics

Research has shown that the majority of strategic alliance joint ventures between companies are not successful.Provide an adverse selection and moral hazard explanation for this lack of success.

Universities ask students to complete evaluations of professor performance at the end of classes.Provide both an adverse selection explanation and a separate moral hazard explanation for the practice and identify information asymmetry.

Suppose that you are a seller bargaining with a buyer.Your bottom line is zero,and you think the buyer's top dollar is either $5 with probability .25,or $6 with probability .75.Suppose further that you can commit to a posted price.What is the price that maximizes expected profitability?

Referring to the question above: If the symphonies were also offered as a complete set of 9 CDs and the price of the entire set was $79.00,would he rather buy the individual CDs or the box set? HINT: WHICH OPTION GIVES HIM MORE CONSUMER SURPLUS?