Microeconomics BE 501

October 21, 2022

9.00-13.00

Instructions

o Number of questions: 4+1 extra as replacement for dugga (midterm)

o Total max point on the exam: 83 (+10 for dugga replacement)
o Use of a calculator as specified on the SSE portal is allowed
o Use answer sheets as provided by the school.
o Do not use blank papers or your own sheets of paper as answer sheets.
o Write your Student ID number on each answer sheet.
o Please answer each question on a separate answer sheet (a, b, c etc can be
on the same sheet however).
o Write clearly and legibly
o All questions must be answered in English
o No aids except calculator are permitted on this examination (apart from
the obvious: pencil, eraser and ruler)
o You can keep the exam questions after finished examination.
 Exam in Microeconomics, course BE 501
(also exam for courses 404 and 410 for those that started before 2020)
October 21 2022, 9-13

Use terms and models that you’ve learnt during the course to answer questions.
Well structured and well motivated answers are rewarded.

Question 1
a) Zap is a new game for smartphones that is sold on Apple’s app store. It is a game
where you solve puzzles and there is no interaction with other users of the game.
Zap is free to download and to play, but Zap sell a number of helpful hints and tools
within the game, a so called “freemium” strategy. Can this type of pricing be seen
as a form of price discrimination? If so explain how and how it might increase
profits for the firm. (4 p)

b) Now assume that a change is made so that players in Zap interact with other players
of the same game. Can network effects be an additional motivation for the freemium
strategy? If so explain how. (2 p)

c) Sellers of mobile apps in Apple’s app are not free to set any price for their game or
for downloads bought within the game. The lowest price that can be charged is 99
cents. Some economists argue that this lowest price is a way to keep profits up for
the producers of the apps, and avoid a situation that we associate with Bertrand
competition with homogeneous products. Explain how such an economist might
reason using terms from the course. (4 p)

d) Together with a friend you are starting a platform geared at people renting outdoor
sports equipment such as mountainbikes. Explain what a platform is and explain
some of the key elements that are likely to be needed to make the platform
successful. (6 p)

e) The Lerner index, (price-marginal cost)/price, is linked to the elasticity of demand

for a product. Briefly explain the link and show how the Lerner index can be derived
from the profit maximization problem of a monopolist. (4 p)

Question 2

a) The inhabitants of Fargo contemplate installing an open wifi system so that all
inhabitants can use it to surf. We can view the open wifi system as a public good, briefly
explain what characterizes a public good. (4 p)

b) The cost of an open wifi system depends on transmission speed that costs 1500 for each
speed unit Q. Each of Fargo’s 300 inhabitants has a valuation of the speed of the wifi-
system given by p=10-Q. What is the socially efficient solution in this case? (4 p)
 c) Economic theory points to difficulties in achieving the efficient level of wifi speed in
b). Briefly explain those difficulties. (2 p)

d) Assume that demand for wheat in Indonesia is given by p=80-Q and domestic supply
of wheat by p= 20+Q, where p is price in rupiah and Q kilos of wheat. Assume that the
world market price of wheat is 30 rupiah per kilo. What is the price of wheat in
Indonesia if there is free trade? How much wheat is imported? (4 p)

e) Assume now that Indonesia imposes a tariff of 10 rupiah per kilo of wheat. What is the
effect on consumer surplus and on domestic producer surplus of the tariff? How high
are tariff revenues? What is the deadweight loss of the tariff? Calculate the solutions
and also use a figure to illustrate. (6 p)

Question 3

a) In standard economic theory a monopolist sets a lower quantity than a firm that faces
competition. Briefly discuss the welfare consequences of monopoly if we measure
welfare as the sum of producer and consumer surplus. (3 p)

b) Assume that the firm Tuttle has a monopoly on selling heating pumps. Demand is given
by p=26-2Q and costs are given by C(Q)=2Q where p is price in kronor and Q number
of heating pumps. There is also a per unit tax of 4 kronor per heating pump sold that is
paid by Tuttle. What is the profit maximizing monopoly quantity and price if Tuttle
can’t price discriminate? Is there a deadweight loss? If so calculate how large the
deadweight loss is and illustrate it in a diagram. (6 p)

c) Would it matter for equilibrium quantity if tax instead was paid by consumers? Explain
clearly why or why not. (4 p)

d) Now instead assume that there is no tax but that the heating pumps are sold by two
firms (denoted by 1 and 2) that set quantity (Cournot competition). Demand is still
given by p=26-2Q where Q=q1+q2 and C(q1)=2q1 and C(q2)=2q2. What are equilibrium
quantities and what is price? (5 p)

e) Now assume that the two firms in d) also have to pay a unit tax of 4 kronor per unit.
Show how equilibrium quantities will be affected by the tax using reaction functions.1
You don’t need calculate the new equilibrium. (5 p)

Question 4
a) You just bought a small hotel and need to hire a carpenter to renovate parts of the
building. You believe that the work will take 200 hours but realize that it is hard to
know in advance. One model for remuneration (”fixed”) is that the carpenter receives
100 000 kronor irrespective of how long she works. Another model for remuneration
(”hourly”) is that the carpenter charges 500 kronor per hour but with no fixed time limit.
Explain the concept moral hazard and discuss whether considerations related to moral
hazard should affect which model for remuneration that you prefer. (4 p)

1
These can also be called reaction curves or best-response functions.
 b) Use the information in a) and assume that you choose between two carpenters that are
equally honest and skilled. One has many other clients at this time whereas the other
has plenty of time. Does this affect the model for remuneration that should be offered
to the respective carpenters? Discuss. (4 p)

c) As you think about pricing for the hotel you think back to your microeconomics course
and try to remember how to think of profit maximization. The supply curve for a price
taking firm is given by its marginal cost curve (as long as price is above average variable
cost). As market demand curves shift and/or rotate, the optimal quantity shifts and each
price is associated with a unique optimal quantity. Does a monopoly have a supply
curve as well, where there also is a similar one-to-one match between price and quantity
supplied? Explain why or why not. (6 p)

d) At the hotel you foresee having two types of customers, Gourmets and Snoozers, in
about equal numbers. You know that these types exist but you can’t observe if a given
person is a Gourmet or a Snoozer. The willingness to pay for dinner and hotel room for
each of these types are given by the matrix below. You are contemplating whether to
only sell package deals where both dinner and hotel room are included for one price or
whether to only sell them separately, such that a person for instance can choose to buy
a hotel room but not buy dinner. What is the profit maximizing choice – only selling
package deals or only selling dinner and hotel rooms separately? Be careful in
motivating your reasoning. (6 p)

Dinner Hotel room Package deal

(dinner+hotel room)
Gourmets 100 50 150
Snoozers 80 70 150

Question 5 Answer this question only if you haven’t written the part exam (dugga)
this year, or if you don’t want to use your points from the part exam. Note
that if you answer question 5 the points from the part exam will not be
used.

Question 5

I. Define the following terms without using ”technical” terms, that is in plain english.

a) Cross-price elasticity of demand (1 p)

b) Increasing returns to scale (1 p)

c) Marginal rate of substitution (1 p)

d) Indifference curve (1 p)

e) Perfect substitutes (1 p)
II. Sweden gives foreign aid to Guinea-Bissau. Assume that we can represent preferences
of people in Guinea-Bissau by a representative individual and that this individual cares only
about consumption of food and of other goods. Assume that we at present give foreign aid in
the form of subsidy on food such that the price of food that this individual faces is lower.
Consider a change in policy, such that food prices faced by this individual increased, but that
she received sufficient money to buy her current consumption basket. Would this individual
be better off with this alternative policy if indifference curves have the usual, convex, shape?
Use a diagram to explain.
(5 p)