BUSINESS AND INDUSTRIAL ECONOMICS

A.Y. 2021/2022
BIE classroom exam – June 20th, 2022

NAME _____________________________________ SURNAME ____________________________________

STUDENT ID_(matricula)___________________________________________________________________

MULTIPLE-CHOICE QUESTIONS [10 points]

You do not need to provide explanations for your answers. However, if you want to add a note to a response
(e.g., an assumption, a clarification, an illustration), please write it in the paper sheets you will upload as a
unique .pdf file.

1. Which of the following statements about the incentives to invest in R&D for small firms is TRUE?
a. Firms with small market share have a lower incentive to invest in R&D than firms with high market
share because the former suffer from higher profit reductions than the latter
b. Small firms can easily access capital markets to finance their R&D investments. Indeed, capital
markets do not suffer from market frictions
c. Small firms can easily spread the risks of R&D investments by leveraging on their economies of scale
and flat organizational structures
d. All the other statements are FALSE

2. Three out of these four statements provide examples of market failures; pick the exception
a. In managerial firms, managers and owners may not have aligned goals
b. Sellers are better informed than buyers on the quality of their goods
c. In an industry, fixed costs are very high, while variable costs are meager; this cost structure enables
allocative efficiency
d. A firm mines coal and pollutes a nearby river where people bathe during summer

3. A manufacturing industry consists of two large and several small manufacturers, which sell their products to
many retailers. The two giant manufacturers establish exclusive contracts with large restaurants, fast foods,
ballparks, and other retail outlets. We conclude that it engages in
a. Downstream vertical integration
b. Vertical restraints
c. Diversification
d. Technological alliances

4. Which of the following statements on possible remedies to the principal-agent problem is FALSE?
a. Venture capital firms provide funds to startups in exchange for equity shares and membership in the
Board of Directors
b. Firms finance their growth by increasing their equity instead of debt
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 c. Governments impose firms to follow uniform accounting principles and punish accounting frauds
d. Because of negative long-term performance, the Board of Directors is considering accepting an
acquisition deal which will likely imply the CEO’s replacement of the acquired firm

5. Table reports data on the annual production value in 2020 for eight leading firms and additional data on the
other firms in the Italian software and footwear manufacturing industries (source: Orbis).
Software industry Footwear manufacturing industry
Value of production Value of production
Firms
2020 (mln EUR) 2020 (mln EUR)
1 1.950 A 557
2 1.845 B 381
3 912 C 379
4 839 D 208
5 577 E 180
6 544 F 167
7 460 G 150
8 384 H 143
Sum of the value of
production for all the other 18.219 7.212
firms
Sum of the squared market
0,0019 0,0025
shares of all the other firms

Which of the following statements on concentration ratio C3 and Herfindahl Index (HI) are TRUE? Consider that
more than one statement may be true
a. According to the C3 index, the software industry was slightly more concentrated than the
footwear industry in 2020
b. According to the C3 index, the footwear industry was slightly more concentrated than the software
industry in 2020
c. According to HI, both the software and the footwear industries were in a (monopolistic)
competitive regime in 2020
d. According to HI, both the software and the footwear industries were in an oligopolistic regime in 2020

6. Which of the following statements on firms’ boundaries is TRUE?

a. According to the transaction cost theory, the likelihood of choosing vertical integration rather than
market transactions decreases as the scale of production increases
b. The Scandinavian School argues that internationalization is a step-by-step process. Firstly, firms enter
foreign markets by establishing production subsidiaries and then by developing sales subsidiaries
c. Diversifying firms pursuing market entry in related industries through M&A do not face post-
acquisition implementation problems
d. All the other statements are FALSE

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 7. In a price-based oligopolistic regime, it follows that
a. If competition is one-shot, collusion always emerges
b. Firms have low incentives to deviate from a collusive agreement when competition unfolds over
time
c. Firms have high incentive to deviate from a collusive agreement when the expected growth of demand
is almost zero
d. If competition unfolds over time, a price war, which drives prices below marginal costs, always occurs

8. Which of the following statements on the free-riding problem is FALSE?

a. The free-riding problem is more likely when students work on a course’s final project in large teams
(e.g., 6-7 members) rather than in pairs
b. The free-riding problem is more likely when people involved in the private provision of a public
good (e.g., a kindergarten) do not care about their reputation
c. All firms producing sodas do some advertising for sodas without reference to any brand name; this
practice increases the market demand for sodas. In this market, there is no free-riding
d. Providing comfortable fitting rooms is an essential determinant of the demand for clothes. However,
consumers may try on shirts at one store and then buy from another store that have uncomfortable
fitting rooms but offers low prices. This is an example of free-riding among retail stores

9. All the else being equal, a potential user likely prefers platform A to platform B if A
a. Has more substantial cross-side network externalities than B
b. Charges lower transaction fees than B
c. Allows multi-homing, while B does not
d. All the statements above are correct

10. The laser-printer manufacturer “XP” is merging with its competitor “EXSON.” The Japanese antitrust
authority is analyzing the merger and has commissioned a survey to assess the closeness of competition
between XP and EXSON. In particular, it has asked 5.000 consumers what they would do if XP increased
the prices of its laser printers. The results of the survey are the following:
• 2,500 consumers said that they would switch and purchase a printer from EXSON
• 1,500 consumers said that they would switch and purchase a printer from KANON (the only other
company selling laser printers in Japan)
• 1,000 consumers said that they would continue to purchase an XP printer.
The Japanese antitrust authority is asking you to use the survey data to calculate the diversion ratio from XP to
EXSON. You submit a report in which you conclude that the diversion ratio is:

a. 25%
b. 62.5%
c. 40%
d. 37.5%

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STRUCTURED QUESTION
MINI-CASE [4.5 points]
Please read the following passage from the article “Secrets and agents; Information asymmetry”, which
appeared in The Economist, on July 23rd, 2016. Take inspiration from it and answer the following questions.
In 2007, the state of Washington introduced a new rule aimed at making the labour market fairer: firms were
banned from checking job applicants' credit scores. Campaigners celebrated the new law as a step towards
equality-an applicant with a low credit score is much more likely to be poor, black or young. Since then, ten other
states have followed suit. But when Robert Clifford and Daniel Shoag, two economists, recently studied the bans,
they found that the laws left blacks and the young with fewer jobs, not more.
[...] In the labour market, the textbooks mostly assumed that employers know the productivity of their workers--or
potential workers-and, thanks to competition, pay them for exactly the value of what they produce.
[...] Employers may struggle to tell which job candidates are best. Mr Spence showed that top workers might
signal their talents to firms by collecting gongs, like college degrees. Crucially, this only works if the signal is
credible: if low-productivity workers found it easy to get a degree, then they could masquerade as clever types.
Signalling helps explain what happened when Washington and those other states stopped firms from obtaining
job-applicants' credit scores. Credit history is a credible signal: it is hard to fake, and, presumably, those with
good credit scores are more likely to make good employees than those who default on their debts. Messrs. Clifford
and Shoag found that when firms could no longer access credit scores, they put more weight on other signals, like
education and experience. Because these are rarer among disadvantaged groups, it became harder, not easier,
for them to convince employers of their worth.

I. We can state that [1 point]:

More than one statement may be correct.
a. There is ex-ante information asymmetry; employers cannot distinguish employees’ abilities. Therefore,
employers pay every employee the expected marginal product. This generates, in turn, adverse selection
b. There is ex-ante information asymmetry; employers cannot distinguish employees’ abilities. Therefore,
employers pay employees their marginal product. This generates, in turn, a pooling equilibrium
c. There is ex-ante information asymmetry; employers cannot distinguish employees’ abilities. Therefore,
employers pay every employee the expected marginal product. This incentivizes employees to signal
their abilities
d. There is ex-ante information asymmetry; employers cannot distinguish employees’ abilities. Therefore,
employers pay employees their marginal product. Thus, the salary for high-ability employees is higher than
the salary of low-ability ones

II. From your own reading of the passage, you can conclude that the introduction of the new law in 2007 [1 point]
a. Distorted the labor market, enlarging the pool of potential candidates
b. Made the selection process fairer, disadvantaged candidates could quickly be hired
c. Distorted the labor market, restricting the pool of potential candidates
d. All other statements are FALSE

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III. Provide an example of a signal that employees can use to signal their abilities. In answering this question, try
to be original, specific, and synthetic (2 lines maximum) [0.5 points]
_______________________________________________________________________________________
_______________________________________________________________________________________

IV. Fill in the blank with a suitable word [0.5 points]

To be valuable a signal should be ___________ [credible, costly, objective, difficult to reach]

V. Suppose there are two types of English teachers in the labor market: half are high-skilled (aH), and the other
half are low-skilled (aL). English teachers know their type, but firms do not. Assume that the labor market for
English teachers is perfectly competitive. A high-skilled English teacher’s expected productivity is aH = 9,000,
while a low-skilled English teacher’s expected productivity is aL = 3,500. Suppose that firm Alpha intends to hire
English teachers to improve its employees’ English. Alpha considers having a training certificate from Cambridge
University a credible signal of being a high-skilled English teacher. Then, the firm will offer a wage of wH =
10,000 to all the English teachers with the certificate and wL = 3,000 to the English teachers without the certificate.
The cost (counting tuition fees and effort invested) of obtaining the certificate for high-skilled teachers is cH =
2,000, while the cost for low-skilled teachers is cL = 3,000. Who has incentives to get the certificate? [1.5 points]
a. Only high-skilled teachers
b. Only low-skilled teachers
c. None of the teachers
d. Both high-skilled and low-skilled teachers

SOLUTION
Let e =1 if the English teacher obtain the certificate and e=0 if not.
Compute the payoff of both types of teachers.
High-skilled English teachers’ payoff is:
πH(e = 1) = 10,000− 2,0000 = 8,000 > πH(e = 0) = 3,000.
High-skilled teachers find it in their interest to choose e = 1.

Low-skilled English teachers’ payoff is:

πL(e = 1) = 10,000 – 3,000 = 7,000 > πL(e = 0) = 3,000
Low-skill teachers find it in their interest to choose e = 1 as well.
Therefore, both types of English teachers have incentives to get the certificate.

EXERCISE [5.5 points]

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Consider a duopoly regime with two firms (firm 1 and firm 2) facing the demand curve Q = 90 − P, where Q =
2
q1 + q2. Both firms have the following cost function Ci(qi) = 15qi, i=1,2.
a. Find the Cournot equilibrium (quantities, prices, profits) [1.5 points]
b. Find the von Stackelberg equilibrium (quantities, prices, profits) [1.5 points]

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c. If you were firm 2 (the follower in case of b.), which competition regime would you prefer? [0.5 points]
d. Calculate the total consumer surplus, total producer surplus, and total welfare in the market in each of the two
cases above (under Cournot and von Stackelberg). If you were the policymaker, which solution would you
prefer? [2 points]

SOLUTION EXERCISE 1

a.) Compute the Cournot equilibrium. Starting from the inverse demand function P = 180 – 2 (q1 + q2), firm 1
chooses the quantity q1 that maximizes its profit function:
𝛱𝛱1 (𝑞𝑞1 , 𝑞𝑞2 ) = �180 − 2( 𝑞𝑞1 + 𝑞𝑞2 )�𝑞𝑞1 − 15𝑞𝑞1 = 165𝑞𝑞1 − 2𝑞𝑞12 − 2𝑞𝑞1 𝑞𝑞2

From the first order condition, we get firm 1’s best reply function:
∂𝛱𝛱1 (𝑞𝑞1 , 𝑞𝑞2 ) 1
= 165 − 4𝑞𝑞1 − 2 𝑞𝑞2 = 0 → 𝑞𝑞1 = 41.25 − 𝑞𝑞2
∂𝑞𝑞1 2

Similarly, firm 2 chooses the quantity q2 that maximizes its profit function. The results are symmetrical to those
of firm 1. From the first order condition, we get firm 2’s best reply function:

1
𝑞𝑞2 = 41.25 − 𝑞𝑞
2 1

By solving the system with the two best reply functions, we obtain:

1 1
𝑞𝑞1 = 41.25 − �41.25 − 𝑞𝑞1 � → 𝑞𝑞1 = 27.5
2 2
1
𝑞𝑞2 = 41.25 − ∗ 27.5 = 27.5
2

The Cournot equilibrium quantities are 𝑞𝑞1 = 𝑞𝑞2 = 27.5

Hence, the quantity Q = q1+q2 = 55 is sold at the price pC = 70, which is the same for both firms, and the two
firms get the profits:

𝛱𝛱1𝐶𝐶 = 𝛱𝛱2𝐶𝐶 =P*q-Ci= 70 ∗ 27.5 − 15 ∗ 27.5 = 1512.5

b.) Compute the von Stackelberg equilibrium (quantities, prices, profits).

The game is solved via backward induction, that is, starting from the second stage. In this stage, firm 2
chooses its quantity as in the simultaneous game (Cournot), so its best reply function is:
1
𝑞𝑞2 = 41.25 − 𝑞𝑞1
2

(For calculation, see the first order condition of firm 2 in point a.)
Going to the first stage of the game, we find the optimal price for firm 1 by plugging the best reply function of
firm 2 into the profit function of firm 1:

𝛱𝛱1 (𝑞𝑞1 , 𝑞𝑞2 ) = (�180 − 2( 𝑞𝑞1 + 𝑞𝑞2 )�𝑞𝑞1 − 15𝑞𝑞1 = (180 − 2𝑞𝑞1 − 82.5 + 𝑞𝑞1 )𝑞𝑞1 − 15 𝑞𝑞1 = 82.5𝑞𝑞1 − 𝑞𝑞12

From the first order condition, we get firm 1’s optimal quantity:
∂𝛱𝛱1 (𝑞𝑞1 , 𝑞𝑞2 )
= 82.5 − 2𝑞𝑞1 = 0 → 𝑞𝑞1 = 41.25
∂𝑞𝑞1
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From q1, it is possible to derive the optimal quantity for firm 2,
1 1
𝑞𝑞2 = 41.25 − 𝑞𝑞1 = 41.25 − ∗ 41.25 = 20.625
2 2

In equilibrium, the overall quantity is Q = q1 + q2 = 61.875, which is sold at the price P = 56.25

πS1=P*Q1-C1=
πS2=P*Q2-C2=

d.) If you were firm 2 (the follower), which competitive regime would you prefer?
q1 q2 P Π1 Π2
Cournot 27.5 27.5 70 1,512.5 1,512.5
Von 41.25 20.625 56.25 1,701.56 850.78
Stackelberg

• Firm 2 prefers competing a’ la Cournot since it enables it to gain a higher profit

• In the Von Stackelberg game, firms 2 is the follower and can only respond to the quantity set by firm 1,
the leader, which benefits from the first mover advantage.

e.) Calculate the total consumer surplus, total producer surplus, and the total welfare in the market in each of the
three competitive regimes (i.e., Cournot, von Stackelberg, and Collusion). If you were the state, which
competitive regime would you prefer?
CS PS TW
Cournot 3,025 3,025 6,050
Von 3,820.52 2,552.34 6,380.86
Stackelberg

The State would prefer the Von Stackelberg regime as it enables to gain the highest total welfare.

IV. Do you want your submitted exam to be corrected?

a. Yes, I want
b. No, I withdraw