Management Engineering - Business & Industrial Economics

Full exam

BIE Exam Garrone - Rizzuni 21 June 2023 Multiple-choice questions (10 points) 1. Which one is the correct statement related to vertical integration decisions, according to the efficiency trade-off model? • Agency efficiency is always higher for hierarchy • Agency efficiency is always higher for markets • Technical efficiency is always higher for hierarchy • Technical efficiency is always higher for markets 2. A signal • Is effective in overcoming moral hazard, when it requires more informed parties to bear a part of the costs for their opportunistic behaviour • Is effective in overcoming moral hazard, when it is credible because it would be too costly to be emitted by lower-quality actors • Is effective in overcoming adverse selection, when it is credible because it would be too costly to be emitted by lower-quality actors • Is effective in overcoming adverse selection, when it requires the more informed parties to bear a part of the costs for their opportunistic behaviour 3. Which of the following applications of circular economy in agriculture is a “Recovery” strategy? • Selling fruits and vegetables with aesthetic defects on secondary markets • Producing biogas from biomass • Extracting nutrients from grape pomace for the pharmaceutical industry • Using meat processing residuals to produce animal feed 4. Consider a duopoly in the smartphone market with two firms, Firm A and Firm B. B is the market leader, setting its quantity first, while A is the follower, observing B’s quantity before determining its own. Cost functions are symmetric and equal to TC(i) = 10q(i). The market demand function is given by P = 100 – Q, where P represents the market price and Q is the aggregate quantity of smartphones sold. The equilibrium is given by • None of the options • q(A) = 22.5, q(B) = 45, P = 55 • q(A) = 22.5, q(B) = 45, P = 32.5 • q(A) = 30, q(B) = 30, P = 40 Explain your answer to the previous question (Max 8 lines) This is an example of Stackelberg duopoly. The costs are symmetric, MC(A) = MC(B) = 10, while the revenues are equal to Rev(i) = 100q(i) – q(i)q(j) – q(i) 2. In the second period, the follower A acts according to its reaction function R(A) = q(A) = 45 – q(B)/2, obtained from MC(A) = MR(A), which is 10 = 100 – q(A) – 2q(B). Substituting R(A) = q(A) = 45 – q(B)/2 in the first-period problem for the leader B, we obtain that Rev(B) = MC(B) is equal to 100q(B) – (45 - q(B)/2)q(A) – q(B) 2 = 10, which gives q(B) = 45, from which q(A) = 22.5 and P = 100 – (22.5+45) = 32.5. 5. Web-based food delivery services and apps work by connecting businesses (mainly restaurants and bars) and customers. The value of such applications for customers increases the higher the number of businesses that join the platform. In turn, the value of such applications for businesses increases the more potential customers use that platform • this is an example of direct network effects • this is an example of indirect network effects • this is an example of economies of scale • this is an example of creative accumulation 6. Natural monopoly price regulation that follows a “competition for the market” approach • recreates the outcome of second best regulation, provided that certain conditions are met • recreates the outcome of first best regulation, provided that certain conditions are met • recreates the outcome of second best regulation, in any case • recreates the outcome of first best regulation, in any case 7. When the providers of software applications for the corporate market design the offer of a product, they are able to gather detailed information on the main characteristics of all the possible prospect customers. A strategy of group price discrimination • Is always more profitable than a uniform pricing strategy • Is always more profitable than a perfect price discrimination strategy • Sometimes is more profitable than a uniform pricing strategy • Sometimes is more profitable than a perfect price discrimination strategy 8. Undertaking clinical trials for new pharmaceutical products is a fixed cost necessary to enter the market. Costs of clinical trials are higher for drug A than for drug B, while the demand and variable costs are similar, and entry barriers for the producers of A and B are negligible. The number of firms that will enter the market • Will be higher for B • Will be higher for A • Will be very similar for A and B • Will cause concentration for B to increase 9. Which of the following is a good example of a commitment to stay in a market (not to exit)? • Large investment to develop the soft skills and foreign language abilities of personnel • Rationalization of productive capacity, and divestment from excess plants • Practicing aggressive pricing (limit pricing strategies) • Large investment in advertisement with local media to promote own products 10. Citizens and policymakers agree that the country’s infrastructure systems such as such as highways, railways and bridges need significant refurbishment and renewal projects. Important funds from the public budget are allocated to that goal, and the local authorities announce that over 100 projects will be contracted out through tenders in the next 2 years. Several well-known local and international operators are showing their interest in the projects. The Antitrust is likely to be concerned about the risk of • Efficiency tradeoffs caused by an increase in concentration • Bid rigging between the companies that could submit their offer to the tenders • Predatory pricing behaviour of the dominant operator • Failure of most projects according to the No Economic Sense test Structured Question (10 points) A country’s regulatory authority for the energy sector is setting the tariff scheme for the next regulatory period. In particular, it is now in the process of setting the tariff that energy utilities will charge for electricity distribution services to households. If the regulatory authority decided to set an access fee, it would consider N = 500,000 [households] as the relevant number of households. The total costs related to electricity distribution to households may be expressed as follows TC = 10,000,000 + 0.05Q where TC [€/year] is the total yearly cost sustained by an energy utility to distribute electricity to households, and Q [kWh/year] represents the yearly quantity of electricity distributed to households in. The demand for electricity by households has been estimated to be equal to T = 100 – 0.00002Q where Q [kWh/year] represents the yearly quantity of electricity distributed to households, and T [€/kHh] represents the unitary tariff for electricity distribution charged to household users. Taking into account the information provided: 1. Demonstrate that electricity distribution services are a natural monopoly in the country [3 points] 2. Assume a fully informed regulator. Illustrate the options available to the regulatory authority to set the tariff for the service, and compute unitary tariffs (prices) and quantities for each of them [3.5 points] 3. Select, among the solutions found in point 2, the most appropriate tariff scheme, motivating your choice [2.5 points] 4. You have answered to point 2 assuming a fully informed regulator. Explain which information asymmetries arise for regulators in a real-world setting [1 point] Solution 1. To answer the first question, it is necessary to look at the average cost function to find the Minimum Efficient Size (the Q that minimizes the AC). In this case, AC = TC/Q = 10,000,000/Q + 0.05. Minimizing the AC curve (setting the first derivative equal to 0), we find that ∂AC/∂Q = -10,000,000/Q 2 = 0, which gives MES = +∞. This means that the sufficient condition for natural monopoly (Q < MES) holds for any Q < +∞, and therefore water distribution services are a natural monopoly. Other factors which could have been mentioned, although not sufficient for a complete answer, as they are characteristics of natural monopolies and not sufficient conditions: very large fixed (probably sunk) costs, presence of a network infrastructure, utility, essential service. 2. A fully informed regulator has three main alternatives to regulate a private enterprise I. First-best regulation with subsidy: In first-best regulation with subsidy, the unitary tariff is set equal to the marginal cost, and a subsidy is set to cover the fixed costs. In this case, MC = ∂TC/∂Q = 0.05, therefore T FB = 0.05 [€/kWh], and S = F = 10,000,000 [€/year]. The corresponding quantity is found by substituting T FB in the demand curve, 0.05 = 100 – 0.00002Q FB, which gives Q FB = 99.95/0.00002 = 4,997,500 [kWh/year]. II. First-best regulation with access fee (two-part tariff): In first-best regulation with access fee, the unitary tariff is set equal to the marginal cost, and an access fee is set to cover the fixed costs F. The access fee is shared among N customers which high willingness to pay. In this case, MC = ∂TC/∂Q = 0.05, therefore T FB = 0.05 [kWh], and A = F/N = 10,000,000/500,000 = 20 [€/household*year]. The corresponding quantity is found by substituting T FB in the demand curve, 0.05 = 100 – 0.00002Q FB, which gives Q FB = 99.95/0.00002 = 4,997,500 [kWh/year] III. Second-best regulation: In second-best regulation, the unitary tariff is set equal to the average cost and allows the firm to breakeven. In this case, T SB = AC = 10,000,000/Q SB + 0.05. Looking at the demand function, we also know that T SB = 100 – 0.00002Q SB, therefore 10,000,000/Q SB + 0.05 = 100 – 0.00002Q SB, which gives 0.00002Q SB2 – 99.95Q SB + 10,000,000 = 0 The two solutions are Q SB’ = 4,895,362.52 [kWh/year] and Q SB’’ = 102,137.48 [kWh/year]. The first solution Q SB’ is the one that should be taken into account because it is the one that maximizes allocative efficiency. So, T SB = 100 – 0.00002Q SB = 100 – 97.91 = 2.09 [€/kWh]. 3. All options could have been chosen and be considered correct, provided that they were properly motivated. One could have chosen the first-best regulation option. There are two motivations to cite. 1) Equity: a lower price for a service without alternative options means including lower-income citizens. 2) Efficiency: a larger social welfare is ensured. In general, two- part tariffs (access fees) are preferred to subsidies and motivations may have been illustrated (refer to lecture on Natural monopoly regulation). One could have preferred the second-best regulation. There are two motivations to cite. 1) Issues with transfers from the public budget (subsidies to cover the fixed costs), mitigated by the possibility of a two-part tariff. 2) Not substantially large allocative efficiency loss: it may be argued qualitatively and / or quantitatively, or through a graph thanks to results obtained. First-best two part tariffs are probably the most appropriate solution in this case, given the nature of the service and the high tariff increase under second-best. However, properly motivated arguments for second-best are also accepted as a correct solution. 4. Real world regulators face two types of information asymmetry: I. Adverse selection: information asymmetry related to not knowing the monopolist’s “efficient costs. II. Moral hazard: information asymmetry related to not knowing whether the monopolist is making effort to operate efficiently. Real-world Questions (10 points) This document summarizes a few keywords and concepts that could be used in the 3 rd exercise. Take the present notes as a reference point and a set of hints / examples, more than as “the solution”. Assessment criteria: Linkages with the BIE course concepts, Clear statements supported by logical arguments and / or data, Questions addressed comprehensively. Originality of arguments and data is also welcome, provided that the mentioned quality characteristics are met. 1. Explain shortly the overfishing problem, and model the sustainable rate of fish catch (i.e. capture, exploitation). Overfishing occurs when marine and inland fish animals are caught (at a level beyond the sustainable exploitation rate, inducing a progressive reduction of the stock of overfished species and the jeopardization of the production capacity itself. Let’s call Q_t the stock of a given fish species at year t. The species dynamics over time may be modeled as Q_t+1=Q_t+ q_t –d_t – y_t +a_t with q birth, y catching, d death, a farmed production (aquaculture), expressed as annual rates with respect to Q. The basic formula for sustainable catching rate sy is sy_t=q_t–d_t +a_t, the catch limit not to trespass in order for the stock to be steady over time and not to decrease. One can also note that this is a simplified expression, since the sustainable rate sy should be computed making explicit the dependence of q and d from Q. 2. How does aquaculture contribute to the sustainability of fish production? Given the formula of point (1), a broader adoption of aquaculture techniques means increasing the farmed production rate, a, which brings sy rates up. This in turn expands the Aquaculture has established as a supply-side response to the emerging scarcity of several fish species in some regions, caused by increasing demand from a few markets and high catching rates in the past. 3. Which type of policy fishing quotas are? Allowable catches and related country-level fishing quotas are performance standards for marine and inland fisheries aimed at preventing fish scarcity and depletion of fish stocks, with far-reaching implications for natural environment and human nutrition. In detail, they are caps on the maximum catch allowed for many commercial species. Both catches of these species and by-catches should be landed and are counted by authorities against the caps. Regulation of by-catches stimulates fishing efficiency.