MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

Final Exam for ΜΒΑ50

Economics for Managers
Saturday, July 1, 2023
Instructions: Please answer all 4 questions. The weight of each question is indicated as a percentage
of the entire exam. The maximum grade in the entire exam is 10. All sub-sections have equal weight,
unless it is denoted otherwise. You are welcome to use any examples and graphs you consider useful.
Cooperation among students and copying is prohibited and is penalized with exemption from the exams.
The use of mobile phones is banned. You are not allowed to borrow any device, e.g., calculator, mobile
phone, etc. The duration of the exam is two and a half (2.5) hours.

STUDENT LAST NAME ………………………………………………………………………

STUDENT FIRST NAME ………………………………………………………………………
STUDENT E-MAIL ………………………………………………………………………
GROUP …. MBA50…………………………………………………………..
TUTOR FULL NAME ………………………………………………………………………

QUESTION 1 (25%)
Water Solution S.A. is the only water provider in Waterland and observes that there are two
distinct relevant market segments: (i) industrial, and (ii) residential. The inverse demand
function for the industrial consumers is 𝑝𝐼 = 14 − 𝑞𝐼 , where 𝑞𝐼 measures the cubic liters of
water that industries consume per week, and 𝑝𝐼 is the price per cubic liter charged to the
industries. The inverse demand function for the residential market segment is 𝑝𝑅 = 16 − 𝑞𝑅 ,
where 𝑞𝑅 measures the cubic liters of water that households consume per week and 𝑝𝑅 is the
price per cubic liter charged to the households. Water Solution S.A. has a cost function equal to
𝐶(𝑞) = 2𝑞, where 𝑞 = 𝑞𝐼 + 𝑞𝑅 .
a) Assume that Water Solution S.A. can apply 3rd degree price discrimination between the two
market segments. Calculate the price it charges and the cubic liters of water it sells to each
group, as well as the company’s total profit. Explain your findings with reference to the price
elasticity of demand in each market segment. (Mark: 1.25)
b) Calculate the consumer surplus and the social welfare in Waterland under price
discrimination. (Mark: 0.50)
c) Assume that the government passes a law that forbids price discrimination. Solve again the
monopolist’s profit maximization problem. Is Waterland better off under uniform pricing
relative to price discrimination? Explain. (Mark: 0.75)
[Hint: Price discrimination requires perfect separation of the two markets. That means the
resale of services from one segment to the other is not possible.]
Round your answer to two decimal points

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Indicative Answer
a) Given 𝑇𝑅𝐼 = 𝑝𝐼 ∙ 𝑞𝐼 = (14 − 𝑞𝐼 ) ∙ 𝑞𝐼 , 𝑀𝑅𝐼 = 14 − 2𝑞𝐼 , and given 𝑇𝑅𝑅 = 𝑝𝑅 ∙ 𝑞𝑅 = (16 −
𝑞𝑅 ) ∙ 𝑞𝑅 , 𝑀𝑅𝑅 = 16 − 2𝑞𝑅 . Given (𝑞𝐼 , 𝑞𝑅 ) = 𝑞𝐼 + 𝑞𝑅 , 𝑀𝐶𝐼 = 𝑀𝐶𝑅 = 𝑀𝐶 = 2. The
monopolist will produce where 𝑀𝑅𝐼 = 𝑀𝐶𝐼 and 𝑀𝑅𝑅 = 𝑀𝐶𝑅 (from first-order conditions):
𝑀𝑅𝐼 = 𝑀𝐶 ⇔ 14 − 2𝑞𝐼 = 2 ⇔ 𝑞𝐼 = 6 cubic liters of water, and
𝑀𝑅𝑅 = 𝑀𝐶 ⇔ 16 − 2𝑞𝑅 = 2 ⇔ 𝑞𝑅 = 7 cubic liters of water.
Therefore, 𝑝𝐼 = 14 − 6 = 8 and 𝑝𝑅 = 16 − 7 = 9.
In the industrial sector, the own price elasticity of demand at the equilibrium point is given
as 𝜀𝑑𝐼 = (𝑑𝑞𝐼 ⁄𝑑𝑝𝐼 ) ∙ (𝑝𝐼 ⁄𝑞𝐼 ) = −1 ∙ (8⁄6) = − 4⁄3 = −1.33. Similarly, in the residential
sector, the own price elasticity of demand at the equilibrium point is given as 𝜀𝑑𝑅 =
(𝑑𝑞𝑅 ⁄𝑑𝑝𝑅 ) ∙ (𝑝𝑅 ⁄𝑞𝑅 ) = −1 ∙ (9⁄7) = −1.29. We observe that the price is larger (𝑝𝑅 = 9)
in the less elastic market segment (residential) and smaller (𝑝𝐼 = 8) in the more elastic one
(industrial).
b) Total profit is 𝜋 = 𝑇𝑅𝐼 + 𝑇𝑅𝑅 − (2𝑞𝐼 + 2𝑞𝑅 ) = (8 ∙ 6) + (9 ∙ 7) − [(2 ∙ 6) + (2 ∙ 7)] =
85. The consumer surplus in the industrial sector is the area of the triangle below the demand
curve 𝑞𝐼 and above the horizontal line at 𝑝𝐼 = 8. Similarly, the residentials’ surplus is the
area of the triangle below the demand curve 𝑞𝑅 and above the horizontal line at 𝑝𝑅 = 9. The
sum of the two surpluses is the consumer surplus (CS):
𝐶𝑆 = [(1⁄2) ∙ 6 ∙ (14 − 8)] + [(1⁄2) ∙ 7 ∙ (16 − 9)] = 18 + 24.5 = 42.5. The welfare
level is 127.5 (85 + 42.5).
c) In this case the monopolist follows uniform pricing. Using the demand functions we get:
𝑞 = 𝑞𝐼 + 𝑞𝑅 = 30 − 2𝑝 ⇒ 𝑝 = 15 − 0.5𝑞. The monopolist will produce where 𝑀𝑅 = 𝑀𝐶
(from first-order condition):
𝑀𝑅 = 𝑀𝐶 ⇔ 15 − 𝑞 = 2 ⇔ 𝑞 = 13 and 𝑝 = 8.5.
The quantity sold in each group can be calculated as:
𝑞𝐼 = 14 − 𝑝𝐼 = 14 − 8.5 = 5.5 and 𝑞𝑅 = 16 − 𝑝𝑅 = 16 − 8.5 = 7.5, since 𝑝𝐼 = 𝑝𝑅 under
uniform pricing. The CS for the two market segments will be:
𝐶𝑆𝐼 = (1⁄2) ∙ (14 − 8.5) ∙ 5.5 = 15.13 and 𝐶𝑆𝑅 = (1⁄2) ∙ (16 − 8.5) ∙ 7.5 = 28.13.
Therefore, 𝐶𝑆 = 𝐶𝑆𝐼 + 𝐶𝑆𝑅 = 15.13 + 28.13 = 43.26 and 𝜋 = (8.5 ∙ 13) − (2 ∙ 13) =
84.5.
The Waterland is worse-off because it is forced to set the same price in both segments. On
the other hand, society is better off after this change is introduced since the total (social)
welfare in this case (43.26 + 84.5 = 127.76 > 127.5) is (slightly) larger than the price
discrimination case.

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QUESTION 2 (25%)
Consider a homogeneous product market with an inverse demand function 𝑃 = 90 − 2𝑄,
where 𝑃 is the product price and 𝑄 is total quantity demanded. The market is served by an
incumbent firm 1 with cost function 𝐶 = 30𝑞1 . Currently, firm 2 is contemplating entry. Firm
2 has the same marginal cost as firm 1, but it also needs to pay a fixed entry cost 𝐹 that is sunk
upon entry. Hence, its cost function is 𝐶2 = 𝐹 + 30𝑞2 . Let 𝐹 = 100. Accommodation of entry
by the incumbent (i.e., a passive reaction from the incumbent) implies that quantity competition
will ensue. However, in case of entry, firm 1 threatens to produce the competitive output, so
that 𝑃 = 𝑀𝐶.
a) Find the monopoly profit in the case of no entry (Mark: 0.4)
b) Find both firms’ profit in the case of entry accommodation (Mark: 0.8)
c) Find both firms’ profit in the case of entry and aggressive reaction by the incumbent (Mark:
0.3)
d) Construct the game tree assuming that in case of entry, firm 2 enters producing the Cournot-
equilibrium quantity. Find the subgame-perfect Nash equilibrium and explain your thought
in no more than six lines (Mark: 1.0)

Indicative answer
a) In case of non-entry, the monopoly profit is: 𝜋1𝑀 = (90 − 2𝑞1 )𝑞1 − 30𝑞1 .
Maximizing the above yields: 𝑞1𝑀 = 15, 𝑃𝑀 = 60, 𝜋1𝑀 = 450.
b) To find the Cournot equilibrium that follows entry and passive reaction, let us start with the
incumbent, who’s profit function is: 𝜋1 = [90 − 2(𝑞1 + 𝑞2 )]𝑞1 − 30𝑞1 .
Maximizing the above we get the incumbent’s reaction function:
𝜕𝜋1 90 − 30 1 1
= 90 − 2𝑞1 − 𝑞2 − 30 = 0 ⟺ 𝑞1 = − 𝑞2 = 15 − 𝑞2 .
𝜕𝑞1 2×2 2 2
1
A symmetric reaction function holds for firm B: 𝑞2 = 15 − 2 𝑞1 .

Solving the two equations system we obtain: 𝑞𝐴𝐶 = 𝑞𝐵𝐶 = 10.

Replacing 𝑄 𝐶 = 𝑞𝐴𝐶 + 𝑞𝐵𝐶 = 20 in the demand function we obtain the equilibrium price:
𝑝𝐶 = 50.
Cournot-equilibrium profits are: 𝜋1 = (50 − 30) × 10 = 200, 𝜋2 = (50 − 30) × 10 −
100 = 100.

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c) In case of aggressive reaction we consider that the incumbent produces as much output as it
is needed to drive the price equal to marginal cost. Hence, total output in the market is found
by solving 30 = 90 − 2𝑄 ⇔ 𝑄 = 30.
The above is total output and it is irrelevant how it is divided between the two firms, since
at the end both firms are making no gross profit, so the net profit of the incumbent is zero
while that of the entrant −100, equal to its fixed cost which cannot be covered.
d) The game tree is the following

The incumbent’s threat to play aggressively is non-credible since by playing passively she
gets a profit of 200, while by playing aggressively she gets zero profit. Hence, the entrant
chooses the best for him between entering and staying out knowing that in case of entry his
profit will be that of Cournot equilibrium, i.e., 100. Obviously, the subgame-perfect Nash
equilibrium is (Entry, Accommodation).

QUESTION 3 (25%)
Assume a Swedish firm that sells product S in the local market and considers sales to the USA.
If the Swedish firm enters the American market, it will compete in prices against an incumbent
US firm that produces a similar (but not identical) product A. The Swedish (indicated by
subscript S) and the American (indicated by subscript A) firms face the following demand
functions: 𝑄𝑆 = 10 − 2𝑃𝑆 + 𝑃𝐴 and 𝑄𝐴 = 20 − 2𝑃𝐴 + 𝑃𝑆 , respectively, where 𝑄𝑆 (𝑄𝐴 ) and 𝑃𝑆
(𝑃𝐴 ) is the quantity and price of the Swedish (American) firm in the US market. Both firms have
no variable production cost. The Swedish firm has the option to either invest directly in
operating a plant in the US, bearing a fixed cost of 𝐹 = $6, or use its already existing production
facilities in Sweden, shipping its product to the US with a transportation cost of $1/unit.
a) Find the price of S and A in the US in each case: exporting and FDI. (Mark: 1.5)

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b) Examine whether the Swedish firm would prefer to export S or produce it domestically in
the US market. (Mark: 1.0)
Explain all the steps of your answers.

Indicative Answer
a) i. When the Swedish firm exports:

The profits of the Swedish firm is given by

Π𝑆 = (10 − 2𝑃𝑆 + 𝑃𝐴 ) × 𝑃𝑆 − (10 − 2𝑃𝑆 + 𝑃𝐴 ).
𝑃𝐴
We maximize profits w.r.t. 𝑃𝑆 to get Swedish firm’s best response: 𝑃𝑆 = 3 + .
4

Respectively, the US firm’s profits are: Π𝐴 = (20 − 2𝑃𝐴 + 𝑃𝑆 ) × 𝑃𝐴 .

𝑃𝑆
We maximize profits w.r.t. 𝑃𝐴 to get US firm’s best response: 𝑃𝐴 = 5 + .
4

Solving the system of the two best response functions gives: 𝑃𝑆 = 4.53 and 𝑃𝐴 = 6.13.
ii. When the Swedish firm proceeds with FDI
The profit of the Swedish firm is given by
Π𝑆 = (10 − 2𝑃𝑆 + 𝑃𝐴 ) × 𝑃𝑆 − 6
𝑃𝐴
We maximize profits w.r.t. 𝑃𝑆 to get Swedish firm’s best response: 𝑃𝑆 = 2.5 + .
4
𝑃𝑆
US firm’s best response function is identical to the ‘exporting case’: 𝑃𝐴 = 5 + .
4

Solving the system of the two best response functions gives: 𝑃𝑆 = 4 and 𝑃𝐴 = 6.
b) Substituting the two prices under exporting, 𝑃𝑆 = 4.53 and 𝑃𝐴 = 6.13, into the Swedish
firm’s profit equation gives Π𝑆 = 24.97 .
Also, substituting the two prices under FDI, 𝑃𝑆 = 4 and 𝑃𝐴 = 6, into the Swedish firm’s
profit gives Π𝑆 = 26.
Thus, the Swedish firm would prefer to invest directly in operating a plant in the US because
its profit is higher (26 > 24.97).

QUESTION 4 (25%)
A. You are planning to invest 5 million euros for one year either in a US asset with interest rate
5%, or in a Dutch asset with interest rate 4.2%. Today’s euro nominal exchange rate per $ is
0.92.

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a) If you expect annual appreciation of the euro by 4%, what will be your choice? (Mark: 0.8)
b) At what expected (future) exchange rate would you be indifferent between the two options.
(Mark: 0.7)
B. The national account system of a European Union country provides data on real Gross
Domestic output (GDP), private consumption (C), and government spendings (G). In 2022, the
GDP equals €230 billion, the private consumption is €140 billion, and the government
expenditure is €85 billion. Also, the country runs a current account (CA) deficit of €30 billion.
Calculate the amount of private investment (I) for 2022. Also, what will happen to CA if
domestic private savings (S) increase by 20%? (Mark: 1.0)

Indicative Answer
A.
a) Annual appreciation of the euro by 4% implies that the future (one-year) nominal exchange
rate will be 0.92 × (1 − 0.04) = 0.883 euros per US dollar. If you invest 5 million euros in
a US asset:
(i) Exchange them in the spot market for US dollars: 5 × (1⁄0.92) = 5.435 million US
dollars.
(ii) Invest them in a US asset for one year: 5.435 × (1 + 0.05) = 5.707 million US dollars.
(iii) Exchanging them for euros, in the future (one-year) expected exchange rate:
5.707 × 0.883 = 5.040 million euros (a net profit of 40 thousand euros).
On the other hand, if you invest in a Dutch asset, you will receive in one year
5 × (1 + 0.042) = 5.210 million euros (a net profit of 210 thousand euros). Thus, it is
preferable to invest in a Dutch asset.
b) For being indifferent between the two options, it must hold that 5.707 million dollars ×
𝐸€𝑒⁄$ = 5.210 million euros ⇒ 𝐸€𝑒⁄$ = 0.913. This means that the future (one-year)
0.913−0.92
exchange rate must change by = −0.008 or −0.8%. In other words, the euro must
0.92
be appreciated against the US dollar by 0.8%.
B. From the income identities we know that 𝐼 = 𝑌 − (𝐶 + 𝐺 + 𝐶𝐴) = 230 − (140 + 85 −
30) ⇒ 𝐼 = 35. Thus, 𝑆 = 𝐼 + 𝐶𝐴 = 35 − 30 = 5. If domestic private savings increase by
20%, their new level will be 𝑆 ′ = 5 × 1.2 = 6. Thus, the new level of current account will be
𝐶𝐴′ = 𝑆 ′ − 𝐼 = 6 − 35 = −29. This implies an improvement of the current account as its
deficit reduced by 1 billion euros.
Good luck!!