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Business Economics Special Notes: 1

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Business Economics

Special Notes:

1. Never define any term by using the same words as the term itself.

2. Every graph that you draw must be fully labeled, and large enough to read without ambiguity.

3. When you are asked to give different reasons, do not make a subsequent reason a repeat of an earlier reason, simply re-written from the opposite perspective.

4. When you are asked for reasons, give the reasons that fit with our class' and textbook's material, not your own, because this is an exam about course material.

There are five questions. 20 points each:

1. It is illegal for any two firms that sell similar products to engage in price fixing agreements. Violating the anti-trust laws can bring both civil and criminal prosecutions. Nevertheless, price fixing does take place. Examples would be found at the service plazas along the NY State Thruway and the NJ Turnpike. Each location has a small number of fast food restaurants. Each fast food restaurant belongs to a different firm, which should create competition, yet at service plazas all restaurants have uncommonly high prices.

A. Draw a prisoner's dilemma type of game (2x2) to show the pricing choices and strategies of two competing fast food restaurants, located at one service plaza. Payoffs are daily profits. Create sensible numbers. Write a brief explanation for the different numbers that you have created.

B. Identify John Nash's equilibrium, as well as the optimal outcome for the two fast food outlets. Also find and label any strictly dominant strategies.

C. Actual long run pricing results at the service plaza may be contrary to the results predicted by the 2x2 diagram from part A. Explain why actual results may differ in the long run. Why is competition between different firms unable to bring lower prices to the consumer at the service plaza?

2. An auction website is listing a 1965 Ford Mustang convertible for sale. From the pictures, everything about the car looks good. However, this is a website and the auction ends in four days, so no bidder could inspect the vehicle in person, prior to submitting a bid. Instead, bidders only know the probability of getting quality vs. the probability of getting a lemon:

Probability (Quality) = 50 percent

Probability (Lemon) = 50 percent

The auction will be a sealed bid second price auction (Vickrey auction). Bidders know about the probabilities of getting quality vs. getting a lemon. Bidders do not know about the preferences of any of the other bidders when they make their own bids.

A. Andrew likes the car. If it is quality it would be worth $30,000 to him. If instead it turns out to be a lemon, it only will be worth $10,000 to him. Andrew's utility function is risk averse, represented by: U(Product received) = Square root of $ value of Product received

B. Betty really likes the car. If quality it would be worth $50,000 to her. Utility function is risk averse, represented by:

U(Product Received) = In($ value of Product received)

A. Charley also would like this car, but is not as enthusiastic as the others. If quality it is worth $25,000 to him. If a lemon, it only would be worth $5,000 to him. Charley's utility function is risk neutral: U(Product received) = $ value of the product.

i. What will be each of the three separate bids from each of the three bidders (Andrew, Betty and Charley), for this sealed bid, second price auction? Show your work to show how you reached each bid. Identify each bidder's certainty equivalent.

ii. Which one of these three people places the highest bid, thus winning the auction? Note that these three people do not know about each other. How much does the auction winner pay for the car?

iii. Draw the utility function for the auction winner (not for all three bidders). Identify probability results, the expected value, and the certainty equivalent on the utility diagram, as well.

3. The General Motors factory in Michigan manufactures at a cost disadvantage because its production workers are unionized. Wages are higher than at a typical non-union factory, and the union contract also specifies minimum staffing requirements.

The Honda factory in Ohio only has non-union employees. Honda's non-union cost advantages include lower hourly wages and no minimum staffing requirements.

A. Draw the total cost (TC) and total revenue (TR) diagram for the unionized General Motors factory in Michigan. Place both TC and TR ($) on the y-axis and total quantity of employees (Q_L) on the x-axis.

B. Draw the total cost (TC) and total revenue (TR) diagram for the non-union Honda factory in Ohio. Place both TC and TR ($) on the y-axis and total quantity of employees (QL) on the x-axis.

C. Verbally identify five (5) differences between the two separate graphs (GM and Honda). Along with each difference, also include a reason for each difference.

4. The demand for tax return preparation services is as follows: Q = 1800 - 4 P

The supply of tax return preparation services is as follows: Q = 2P

A. Find the equilibrium quantity supplied and price paid, initially assuming no taxes have been imposed. Draw the supply and demand diagram, and use numbers that you have solved, including for the endpoints of the supply and demand curves. Identify and calculate both consumer surplus and producer surplus. Make this graph large enough to be clear to the reader, including all numbers.

B. Impose a tax per unit sold of $30. Find the new quantity of sold, the price paid by the consumer, the price received by the seller, and the total tax revenue collected by government.

c. Impose a tax per unit sold of $60. Find the new quantity of sold, the price paid by the consumer, the price received by the seller, and the total tax revenue collected by government.

D. Impose a tax per unit sold of $90. Find the new quantity of sold, the price paid by the consumer, the price received by the seller, and the total tax revenue collected by government.

E. Draw Arthur Laffer's curve. Include the numbers for tax rates and total tax revenue collected that you have solved in parts A, B, C and D.