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BUSGR 510: Exam 2: Due Thursday August 8th 1. Suppose the US Dollar appreciates in its value against the Euro. (a) If you were exporting US made products to Europe, what would happen to the prices of your exports? Explain briefly (5 points) (b) If you were importing to the US products made in Europe, what would happen to the prices of your imports? Explain briefly (5 points) 2. What should you do to maximize profits with respect to prices after you acquire a substitute product. Which prices should you change more - Explain(5) 3. What should you do to maximize profits with respect to prices after you acquire a complement product.(5) 4. Briefly describe how these firms would price discriminate: department stores, airlines, movie theaters(5) 5. Give an example each of volume discounts and bundling as forms of price discrimination(5 points) 6. Suppose an airline flying on the New York - Chicago route has estimated the demand curves for three different types of customers: business (no advance purchase), leisure (7 day advance puchase), and discount (14 day advance purchase) travellers. They are: Business: P = 600 − Q and MR = 600 − 2Q Leisure: P = 500 − 2Q and MR = 500 − 4Q; Discount: P = 400 − 3Q and MR = 400 − 6Q. Assume there is only one class of service, hence the marginal cost of providing the service is equal for all customers and is $200. What prices will the airline charge to each of the three different segments of customers. (10 points) 7. Suppose you have a negotiation situation between Mangement and Labor concerning Labor wages. Management and Labor do well when they each do the opposite of what the other does i.e. the best situations for both are: (i) for management to bargain hard (offer low wages) and Labor to accomodate (accepts the contract offered) and (ii) for Management to accomodate (offer generous wages) and Labor to bargain hard (threatens to strike). 1 (a) If Management moves first what would you expect the equilibrium of this sequential game to be. (4 points) (b) If Labor moves first what would you expect the equilibrium of this sequential game to be. (4 points) (c) Is this a game with a first mover or last mover adavantage? Explain briefly (2 points) 8. Briefly describe the difference between the mechanism of an oral or English auction and a Vickrey or second price auction. Is there any difference between the winning bidders in the two auctions, and the winning payments made in the two auctions? Briefly explain.(7 points) 9. Give 2 examples each of screening and signalling that are used in businesses to get rid of the adverse selection problem. (8 points) 10. Suppose a bank is faced with two types of borrowers - a high risk borrower that should be charged an interest rate of 9% and a low risk borrower that should be charged an interest rate of 4%. There is a 30% chance of getting a high risk borrower and a 70% chance of getting a low risk one. What is the expected interest rate that will be charged by a bank that cannot exactly distinguish between the two types but knows the probabilities of each type. In this market for loans what would be the result. (5 points) 11. Suppose you have hired a new worker, unfortunately you do not know if the worker is a shirker or a hard worker. Suppose working hard raises the probability of making a sale from 40% to 80% (thus raises the probability of making a commission C by the same percentage). If the cost of working harder is $150,what commission C should you offer the worker to provide an incentive to work hard. (5 points) 12. Suppose as a manager of a profitable department store you are confronted with a pricing problem. You have two types of customers: a high-end type that are willing to pay a price of $20 for a pair of Levis Jeans, and a low-end type customer that are willing to pay a price of $13 for the same pair of jeans. Your supplier provided you with the jeans at MC of $11 per jeans. Your survey of your customers for jeans tells you that 50% of your customers are of the high end type and 50% are of the low end type. 2 (a) If you decided to price high, what would be your expected profits per unit.(5 points) (b) If you decided to price low, what would be your expected profits per unit.(5 points) (c) Suppose your store attracts 1000 customers for these jeans: will you price high or low? Explain briefly.(5 points) 13. The following is a case study using a recent event: CVS versus Walgreens: An interesting recent case involves two pharmacists CVS and Walgreens. Rather than a situation where the two indulge in a competitive battle against each other over advertising or a price war, they battle against each other on the services offered. In early June 2010, Walgreens announced that it would “no longer participate in new and renewed benefit plans from its rivals (CVS) drug benefits unit” (CNN Money, June 7 2010). The main grievance of Walgreens was CVS Caremark’s Maintenance Choice Plan which started requiring patients that have chronic medical conditions to fill their prescriptions at CVS pharmacies only rather than giving them the choice to fill it at Walgreens (or other pharmacies). As a result of this announcement both companies shares fell — CVS fell 8% and Walgreens fell 2.7%. As a response CVS in a couple of days decided to drop Walgreens from its pharmacy benefits plan, which would force some of its benefits customers to pay a much larger amount to get their drugs from Walgreens, leading to a potential loss of customers for Walgreens. As a result CVS shares fell 1.5% and Walgreens fell 3%. Eventually, about a week later the two pharmacies decided to end their war, coming to a compromise agreement the financial terms of which were not disclosed. As a result both firms saw their stock values increase. Briefly comment on this example as an application of the Prisoners Dilemma game (10 points)