Feedback and Revision

Lecture Objectives

• To provide feedback on key learning outcomes way

before the exam

• To familiarise students with the exam structure.

How do I prepare for the exam?
Business Economics

Lecture notes, lecture

slides, exams from
previous years etc are
here!
Exam: 2016
Q1. Firms operating in a market have a constant marginal cost of
£5. Market price elasticity of demand is -1.5. We observe an
equilibrium price of £5. Which of the following statements is
correct:

A. It must be a perfectly
competitive market
structure.
B. It can be a Bertrand
Oligopoly.
C. It can be a single monopoly
firm.
D. It can be a Cournot
duopoly.
E. None of the above.
 Q1 - rationale (see Lecture 6)

• Process of elimination

• P = MC = £5 ➔ Not Cournot

• Does not have to be perfect competition

• Given the options, “can be Bertrand” is the one that is

always true
Q2. Paper Ltd. (PL) produces a paper-based product, which is sold in a
perfectly competitive market. PL has the following cost functions:
MC = 75 – 20Q + 1.5Q2,
AVC = 75 – 10Q + 0.5Q2

The price below which the firm should shut down its operation in the
short-run is:

A. 20/3
B. 10
C. 25
D. 50
E. 75
 Q2 – rationale (see lecture 4)

• Firm should never go below the min of the AVC

• Let us find Q that minimises AVC = 75 – 10Q + 0.5Q2

FOC: -10+Q=0  Q= 10 and the corresponding AVC = 25.

• The information about the MC not needed, although might

have remembered that MC intersects AVC in its minimum
point and set MC = AVC
Q3. A monopolist has two sets of customers, Group 1 and Group 2. The
demand for X of Group 1 is P = 10 - X, while for Group 2 it is given by P
= 50 – X. The monopolist faces constant marginal cost of 0. If the
monopolist has to offer a single price to everybody, it should:

A. charge 0
B. charge 25
C. charge 5
D. charge 7.5
E. None of the above.
Q3 – rationale (see Lecture 5, GSK case study)

•Group 1 is P = 10 - X ; Group 2 it is given by P = 50 – X. Hence

group 2 is much “larger” than group 1 (check intercept)
•Thus, it makes no sense to sell in Group 1. In Group 2:
– TR= 50X – X^2
– MR= 50 – 2X
– MR=MC=0 => X = 25 and P = 25
P2 P1
Group 2 Group 1

D2
D1
MR2 MR1
Q4. What is/are the Nash equilibrium/equilibria of this game?

Player 2
Player 1 L R
A (4,10) (4,10)
B (6,5) (0,1)
C (8,7) (3,2)

A. There are no Nash

equilibria.
B. (A, R)
C. (C, L) and (A, R)
D. (A, L)
E. (C, L)
 Q4 – rationale (see Lecture 7, first few slides)

4. What is/are the Nash equilibrium/equilibria of this game?

Player 2
Player 1 L R
A (4,10) (4,10)
B (6,5) (0,1)
C (8,7) (3,2)

Hence,

c) (C, L) and (A, R)

Q5. If a market is controlled by a monopolist who can practice first-
degree price discrimination, the level of consumer surplus will be:
A. the same as under perfect
competition.
B. the same as under single-
price monopoly.
C. the monopoly profit that a
single-price monopolist would
have received.
D. zero, since each consumer is
paying his or her reservation
price and receives no
consumer surplus.
E. This problem cannot be
answered without knowing the
cost of the monopolist.
 Q5 – rationale (see Lecture 5)

Price

p1
p2
p3

Marginal cost
Demand curve

Quantity
 Q5 – rationale (see Lecture 5)

Personalised pricing (1st degree p.d): no deadweight loss!

Price
Producer surplus increases

Consumer surplus disappears (completely expropriated)

Pm Deadweight loss also disappears (absorbed in PS)

Pc MC

MR D
Qm Qc Quantity
Q6. Alpha Co. and Beta Co. are the two identical firms operating in a
duopoly. The total cost functions of Alpha Co. and Beta Co. are TCA =
0.5QA2 and TCB = 0.5QB2 . If the demand function for the industry is Q =
100 – 2P, what is the Cournot equilibrium price for the industry?

A. 10
B. 20
C. 30
D. 40
E. None of the above.
Q6 – rationale (see Lecture 6 “soft competition” )

• Q= 100 - 2P  P = 50 – Q/2  P = 50 – Qa/2 – Qb/2

• Max Πa = Pqa – Tca = [50 – Qa/2 –Qb/2]Qa – 0.5Qa^2 =

= 50 Qa – Qa^2 – (QaQb)/2
FOC:
50 - 2Qa – Qb/2 = 0 => Qa = [50 – Qb/2]*1/2

• Thus, the reaction functions are

– Ra: Qa = 25 – Qb/4 and by symmetry Rb: Qb = 25 – Qa/4

• Solving for the Cournot equilibrium: Qa=Qb= Qc  Qc = 25 –

Qc/4
 Qc = 20 and (substituting into the overall demand) P=30
Q7. Domestic demand for a good is Q = 100 – P. It is traded on the
world market for a price of £5. The domestic supply curve is Q = P. The
government imposes a tariff on imports of £10. What is the revenue the
government receives from the tariff?

A. 950
B. 850
C. 700
D. 150
E. None of the above.
 Q7 – rationale (see Lecture 4, beginning)

•Domestic demand: Q = 100 – P ; P = £5

•Domestic supply: Q = P.
•International P = £5; tariff on imports = £10, hence new P = £15
•Thus:
– Total demand = 85,
– Domestic supply = 15
– Imports = 85-15=70
– Government makes 70x10=700

•Further details: see general discussion of trade tariffs in Lecture 4

Q8. A company has two plants (1 and 2), producing the same product,
but with different costs functions in each. For plant 1 we have at total
cost of TC1=20+12Q1, whereas for plant 2 it is TC2 = 20+4Q2. The
company’s demand function is described by P =100 - 2(Q1 + Q2). What
will be the optimal output if the company is a monopolist in this market?

A. 0
B. 15
C. 20
D. 24
E. None of the above.
 Q8 – rationale (see Lecture 4 and also Lecture 5
and respective problem set)

•Note that:
– C1=20+12Q1 and MC1= 12
– C2=20+4Q2 and MC2 = 4
•Factory 2 is much more efficient and, in the absence of capacity
constraints, Factory 1 should not be used

•Thus:
– P=100-2(Q1+Q2 )  P = 100 - 2(Q2), TR = 100Q2 – 2 Q2^2
and MR = 100 -4Q2
– Hence, MR=MC=4  100 – 4Q2 = 4 => Q2 = 24
Q9. Suppose the demand for Apple’s MacBook Air computer is Qd=
2400 − 4p. When the price elasticity of demand equals to -1, what is the
quantity demanded at that point?

A. 300
B. 600
C. 1200
D. 2400
E. None of the above.
 Q9 – rationale (see Lecture 2)

Qd P
Price = = − P = 600 – Q/4
P Q

600 DQd P
e= = -1
DP Q

DQd P
e= =0
DP Q

0
1200 2400 Quantity
In a linear demand curve the price elasticity is different at different points on
the curve
Q10. A firm has a marginal cost of £10 per unit, and has identified two
market segments between which it is able to discriminate. If it charges
prices of £15 per unit in segment A and £20 per unit in segment B, and
the own-price elasticity of demand in segment A is minus 3, what is the
own-price elasticity of demand in segment B?

A. Minus 2
B. Minus 3
C. Minus 4
D. Plus 3
E. None of the above.
 Q10 – rationale (see Lecture 3)

•MC = 10

•Pb = 20, εb?

•We know that MR = P[1 – 1/|ε|] and that MR=MC, hence:

10 = Pb[1 - 1/|εb|] = 20[1 – 1/|εb|] => εb = -2
Q11. A monopoly faces market demand Q = 30 – P and has a total cost
function C(q) = q2/2. Calculate the deadweight loss due to the
monopolist behaviour of this firm.

A. 12.5
B. 25
C. 30
D. 50
E. None of the above.
 Q11 – rationale – always sketch a graph!

• Demand: Q = 30 – P  P = 30 - Q and MR = 30 – 2Q
• Total cost: C(q) = Q^2/2 ; MC = Q
• So MR = MC => Q = 10, P = 20, MC = 10.

Price

• Loss in total welfare = Deadweight loss: area C+D = (10 x 5)/2

A
C+D= (5 x 10 )/2 = 25
20
B MC
15 C
Notes:
D
Welfare comparison: 10
• if we had P = MC then P =
15 and Q = 15
• So delta (change) q = 5 and
PM – MC = 10; MR D
10 15 Quantity
Q12. Suppose a monopolistic producer with positive marginal costs
faces a demand curve P=100 – Q and supplies 60 units to the market.
Which of the following statements must be correct?

A. 60 is the profit maximizing

supply.
B. The profit maximizing supply
is higher than 60.
C. The profit maximizing supply
is lower than 60 but higher
than 50.
D. The profit maximizing supply
is lower than 50.
E. We cannot decide between
the cases above without
information on costs.
 Q12 – rationale (see Lecture 5 and respective
problem set)

•Demand curve P=100 – Q and Q=60 units to the market.

•R = 100Q – Q^2 ; MR = 100 – 2Q

•MR = c => c = 100 - 2Q  c -100 = - 2Q, hence

Q = 50 – c/2

• Given that c >0, then Q <50

Q13. When the price of a good rises from 60 to 80 the quantity falls from
200 to 150. In this case, the arc elasticity of demand is:

A. -0.2
B. -0.75
C. -1
D. -1.33
E. None of the above.
 Q13 – rationale (see Lecture 2 – “arc
elasticity”)

•P 60 ➔ 80 => Q 200 ➔150.

•Arc Elasticity”= ΔQ/ΔP * P/Q
•What values for P and Q? Take mid-points, i.e. P = 70 and Q = 175
•Thus: -50/20 * 70/175 = -1 £

80
70
60

150 200
175
Q14. In an infinitely repeated game, the payoff from colluding is 10 per
period. A player can gain a payoff of 60 in the period in which they
defect, but the grim strategy would then give them a payoff of 5 per
period, forever. What is the highest interest rate for which collusion can
be sustained?

A. 0
B. 10%
C. 20%
D. 50%
E. None of the above.
 Q14 – rationale (see Lecture 6, Pablo Escobar’s
example, lecture notes and book, if needed)
• Payoff if collude: 10, 10, 10, (…)
• Payoff if defect: 60, 5 , 5, (...)

• Comparison made in terms of present values (PV)

– δ = 1/ (1 +r), where r is the interest rate.
– PV collude = 10 +10d +10d +10d +.... =10(1+ d + d + d +...) =10 /1- d
2 3 2 3

Note that (see Lec notes & book) (1+ d + d 2 + d 3 +...) =1/1- d

- PV defect = 60 +5d +5d +5d +.... = 60+5d (1+ d + d + d +...) = 60 +5d /1- d
2 3 2 3

• Thus, PV collude> PV defect  10/(1-δ)>60 + 5δ/(1-δ)  δ >50/55

• The question is asked in terms of r, not δ. Since δ = 1/ (1 +r), then:

– 1/(1+r)>50/55  r< 5/ 50  r <1/10
Q15. When the government installs a price support program that
requires the government to purchase all of a good not bought in the
private economy at the support price, which of the following statements
is true:
A. Changes in producer surplus are
negative.
B. Changes in producer surplus are
positive, but more than offset by
the cost to consumers and the
government.
C. Changes in producer surplus are
positive, and not offset by the cost
to consumers and the government.
D. Changes in both producer and
consumer surplus are both positive.
E. Changes in both producer and
consumer surplus are negative.
 Q15 – rationale ( see Lectures 2, 3 and
Hurricane Fran business case)
• Context: government sets price (above market price) and buys all excess
supply

• Process of elimination:

a) Changes in producer surplus are negative. FALSE (the scheme is meant to

support them)
b) Changes in producer surplus are positive, but more than offset by the cost
to consumers and the government. TRUE!
c) Changes in producer surplus are positive, and not offset by the cost to
consumers and the government. FALSE (ignores deadweight loss)
d) Changes in both producer and consumer surplus are both positive. FALSE
e) Changes in both producer and consumer surplus are negative. FALSE
Q16. A firm in a perfectly competitive market has a daily short-run total
cost of production equal to 20 + 10Q +0.1Q2, where Q is the number of
units produced per day. The prevailing market price is £20 per unit.
What is the firm’s daily maximum profit?

A. Zero as this is a perfectly

competitive industry.
B. 40
C. 100
D. 230
E. 250
 Q16 – rationale (see Lecture 4)

•Perfectly competitive market: P = £20

•C = 20 + 10Q +0.1Q^2 , hence MC = 10 + 0.2 Q

•Thus:
– P = MC => Q = 10/0.2= 50 ;
– R = 1000, cost = 20 + 500 + 0.1 x 2500 = 770
– Profit = 1000 – 770 = 230
Q17. The market for corn in country A is perfectly competitive. There
are no imports or exports. The demand curve is Q = 10 – Pb, when the
price buyers pay is Pb. The supply curve is Q = Ps when the price
producers receive is Ps. Suppose the government imposes an excise
tax of £2 per unit to raise government revenues. What is the deadweight
loss?

A. There is no deadweight
loss as the government
raises money.
B. 1
C. 8
D. 2
E. 4
 Q17 – rationale: sketch a graph!

S after taxP new (£6) is the price

(including
Price the tax) paid by buyers.
S PS (£4) is the price sellers
receive,
net of the tax.
Pnew= 6
A B Buyers lose A + B, and
Pold= 5
D C sellers lose D + C, and
Ps = Pnew – t= 4 the government earns A + D
in revenue. The deadweight
loss is B + C = (2x1)/2=1

4 5
Quantity
Q18. Consider a game with the following payoffs:
GM
Cut price Hold price
Cut price (-2, -1) (4, -3)
BMW
Hold price (-3, 3) (5, 2)

where the first payoff in the brackets is that of BMW, the second that of GM.
What, if any, is the equilibrium of the game?

A. {cut, cut}
B. {cut, hold}
C. {hold, cut}
D. {hold, hold}
E. There is no equilibrium in
pure strategies.
 Q18 – rationale (see Lecture 7)
GM
Cut price Hold price
Cut price (-2, -1) (4, -3)
BMW
Hold price (-3, 3) (5, 2)

where the first payoff in the brackets is that of BMW, the second that of
GM. What, if any, is the equilibrium of the game?

a) {cut, cut}
b) {cut, hold}
c) {hold, cut}
d) {hold, hold}
e) There is no equilibrium in pure strategies.
Q19. The long-run total cost function for producing mugs is given by
C(q) = 8 + 2q2. Any firm in this market will have access to the same
technology. The demand for mugs is given by P = 200 - 2Qd. How many
firms will there be in this market in the long run?

A. Indeterminate.
B. 8
C. 92
D. 48
E. None of the above.
 Q19 – rationale (see Lecture 4)

• Long-run total cost: C(q) = 8 + 2Q^2.

• Demand: P = 200 -2Q.

• Number of firms? In the long-run P= AC(min)

– AC = 8/Q + 2Q
– Determine min AC: FOC -> - 8/Q^2 +2 = 0  Q = 2
– Hence AC (min) = MC = P = 8

• Total quantity demanded?

– From demand: Q=100 – P/2; when P=8, Q=96.
– Hence there will be 96/2= 48 firms
Q20. A monopolist is serving a market with demand P = 200 - Q. The
monopolist has two production plants. For plant 1, total cost is TC1= Q12,
whereas for plant 2 total cost is TC2 =8Q2. How much is the monopolist
going to produce in plant 2?

A. Zero.
B. 98 units.
C. 96 units.
D. 92 units.
E. None of the above.
 Q20 – rationale (see Lectures 4 and 7)

• Demand P = 200 - Q.
• Two plants with cost:
– C1= Q1^2 ; MC = 2Q1
– C2=8Q2 ; MC = 8

• MC1=MC2 => 2Q1=8 =>Q1=4

• How to find Q2?

– MR=200-2(Q1+Q2)=200-2(4+Q2)=192-2Q2
– Finally set MR=MC=8  192 -2Q2 = 8 Q2 = 92
Q21. A monopolist faces a demand curve given by P = 46 – 2Q. The
monopolist has a marginal cost of 6. What is the optimal mark-up?

A. 1
B. -1
C. 10/13
D. 26/6
E. None of the above.
Q21 – rationale (see Lecture 3 and respective
problem set)

•Mark up = (P – MC)/P

•P = 46 – 2Q ; TR = 46Q – 2Q^2 ; MR = 46 - 4Q

•MR = MC  46 – 4Q = 6  Q = 10 , hence P= 26

•Thus, (P – MC)/P = (26 – 6)/26 = 10/13

 Q22

22. Consider the market represented in the Figure below. Suppose the
government imposes a price floor equal to Pmin. Which area or
combination of areas in the Figure consequently represents the loss in
consumer surplus generated by the price floor?

a) J
b) D+E+J
c) D+E J

d) E+F Pmin
D E
e) None of the above.
F
C G
Price

A H

Quantity
Q22. Consider the market represented in the Figure below. Suppose the
government imposes a price floor equal to Pmin. Which area or
combination of areas in the Figure consequently represents the loss in
consumer surplus generated by the price floor?

A. J J

Pmin
B. D+E+J D E

C. D+E C G

Price
B

D. E+F
A H

E. None of the above.

Quantity
Q23. A, B and C are three firms that provide identical laptop screens.
Market demand is given by P = 100 – 2Q, where Q is the total quantity
of screens bought. All firms have a constant marginal cost. However,
the marginal cost of A is £20, while at B it is £40 and at C it is £30.
Firms compete in prices. The equilibrium can be one where:

A. A prices at £20, B at £40,

C at £30.
B. A prices at £20, and B and
C at £40.
C. A prices at £29.99, and B
and C exit the market.
D. A prices at £29.99, B exits
the market, and C prices at
£30.
E. None of the above.
F. .
 Q23 – rationale (see Lecture 6)
PC
PA (PC)

PM
PC (PA)

£30 •
Bertrand NE
ΠA > 0,
ΠC = 0
0
PA
£20 PM
 FROM LECTURE 6: Both firms earn 0 profit, so each is indifferent
to exiting. Is it a Nash equilibrium for one firm to exit (and the other
remain)?

A. Yes
B. No
 FROM LECTURE 6: Price trap with no exit

• Since both firms earn 0 profit, each is indifferent to exiting

• But, is it a Nash equilibrium for one to exit?
– If one firm exits, the other charges the monopoly price ($600 is
the best reply of the remaining firm to a competitor that stays out)
– But, if one firm stays and charges $600, the other firm wants to
enter and charge slightly less
– This cannot be a stable situation (Nash equilibrium)
– Besides, who would “volunteer” to leave?

• It is only Nash for both firms to post P = MC

– Otherwise, either someone wants to enter
– Or, someone wants to cut price
Q24. Suppose the demand function for a fitness club can be expressed
as P = 100 – Q where P is £ per session and Q is the number of
sessions per year. The fitness club incurs a £20 marginal cost for each
session. If the club can charge both an annual membership fee and a
price per training session, what combination of prices maximises the
club's profit? (Interesting but not relevant for the exam)
A. Price per session = £60, annual
membership fee = 0.
B. Price per session = £50, annual
membership fee = £1,250.
C. Price per session = £20, annual
membership fee = £3,200.
D. Price per session = 0, annual
membership fee = £5,000.
E. None of the above.
 Q24 – rationale (interesting but this will NOT be
in the exam)
a) Price per session = £60, annual membership fee
= 0?

• Usually, we set MC = MR to set a price to

maximise profits. This would be:
MR = 100 - 2Q = MC = 20, so 2Q = 80, so Q = 40
Substituting back in demand gives P = 100 - 40 = 60
Profit = (60 - 20) (40) = £1600

• BUT, this is optimal only if you can charge a per

unit price p and no fixed charge F. Profits could
be much higher (like in first degree price
discrimination)

• Both F should be > 0 to extract Consumer

Surplus, and P should be lower to allow the whole
market to be exploited.
 Q24 - rationale
c) Price per session = £20, annual membership fee =
£3,200?

•Profit maximised by setting P = MC (so market price

reflects true cost as in a competitive market), and
then extracting ALL the consumer surplus via a fixed
charge.
•This would mean the fixed charge F = Area A + B +
C = Profit, but pricing is at cost. So P = MC = 20, so
Q = 80

•The intercept of the Demand function is 100,

So (A + B + C) = 1/2 (100 - 20) (80) = 1/2 (80)(80) =

1/2(6400) = £3200, which exceeds profit from just
setting a per unit price.

The Correct Answer is (c)!

 Q24 - rationale
b) Price per session = £50, annual membership fee =
£1,250?

•P = 50 implies Q = 50
consumer surplus area = 1/2 (50) (50) = 2,500/2 =
£1250
•While the Fixed charge in (b) would exactly extract the
Consumer Surplus, P = 50 leaves forgone opportunities!
•Profit = (P - MC)Q + F = (50-20)(50) + 1250 = 1500 +
1250 = £2750, which is less than £3200..
•Intuitively, P = 50 is too high...pays to drop price to
Marginal Cost to expand the market and adjust F to
extract all the consumer surplus at that point.
•Could drop price further and sweep up the CS by
expanding F!
 Q24 - rationale
d) Price per session = 0, annual membership fee =
£5,000?
•A price of zero would normally imply a demand of
100, with a consumer surplus of (1/2)(100)(100) =
5,000
•The fixed fee in (d) would exactly extract the
consumer surplus, but the profit of the firm is lower
than in (c) because a price below P = 20 is loss-
making at the margin.
•Think about it:
Profit = (P - MC)Q + F = (0-20)(100) + 5,000 = -
2,000 + 5,000 = £3,000 < £3,200

So, going beyond the P = MC point is inefficient and

reduces profit.
Q25. Consider the following sequential game played by three agents,
called 1, 2, and 3. Player 1 moves first, followed by player 2, and finally
by player 3 (if he gets a chance to play at all). The first payoff in the
brackets is that of 1, the second that of 2, and the third that of 3. What, if
any, is the subgame perfect Nash equilibrium of the game?

A. {U, R}
B. {U, R, B}
C. {D, J}
D. {UR, B, KX}
E. {U, RK, BX}
 Q25 – rationale (see Lecture 9)

a) {U, R}
b) {U, R, B}
c) {D, J}
d) {UR, B, KX}
e) {U, RK, BX}
 Q25 – rationale (see Lecture 9)

a) {U, R}
b) {U, R, B}
c) {D, J}
d) {UR, B, KX}
e) {U, RK, BX}
 Q25 – rationale (see Lecture 9)

a) {U, R}
b) {U, R, B}
c) {D, J}
d) {UR, B, KX}
e) {U, RK, BX}
 Q25 – rationale (see Lecture 9)

e) {U, RK, BX}