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UNIVERSITY OF TORONTO
Faculty of Arts and Sciences
April Examinations 2012
ECO 204 Y1Y

Duration: 3 hours Total Points: 100 points

Examination Aid Allowed: Calculator.
Instructions:
- This exam consists of 6 questions in 39 pages, double-sided.
Please give your name and ID # as it appears in ROSI
Last Name: First Name:
Student ID #
_____________________________________________________________________________
Question Points Scores
1 (10 Short questions) 40
2 10
3 10
4 15
5 20
6 5
TOTAL SCORE =

YOU MUST STAY SEATED DURING THE LAST 10 MINUTES OF THE FINAL EXAM
WAIT UNTIL ALL EXAMS ARE COLLECTED
KEEP ANSWERS BRIEF
TO EARN CREDIT YOU MUST SHOW CALCULATIONS AND GIVE ARGUMENTS TO SUPPORT YOUR ANSWERS
FOR YOUR CONVENIENCE, THERE IS A WORKSHEET AT THE END OF THIS EXAM
Good luck!


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QUESTION 1 [40 POINTS] ALL SHORT QUESTIONS SHOULD BE ANSWERED INDEPENDENTLY OF EACH OTHER.
(1.1) [4 POINTS] Write down the Lagrangian objective function the first order conditions and (any)
Kuhn-Tucker conditions for the following profit maximization problem (do NOT solve the problem):

() ()

What are the possible signs of the Lagrange multipliers (i.e. positive, zero, negative)?







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(1.2) [4 POINTS] Write down the Lagrangian objective function the first order conditions and (any)
Kuhn-Tucker conditions for the following profit maximization problem (do NOT solve the problem):

() ()

What are the possible signs" of the Lagrange multipliers (i.e. positive, zero, negative)?

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(1.3) [4 POINTS] True or false: if a firm with market power is producing the revenue maximizing output at
a uniform price then the absolute value of the price elasticity must be equal to 1 (i.e. || )? Give a
brief explanation and use graphs to illustrate your answer. Do NOT solve the Revenue Maximization
Problem.

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(1.4) [4 POINTS] True or false: a firm with ample capacity and market power charging optimal 1
st
degree
price discrimination prices will produce the same total output as if it were charging the perfectly
competitive uniform price? Do NOT solve any profit maximization problems and use graphs to illustrate
your answer.

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(1.5) [4 Points] Give three ways to characterize (define) the following attitude towards risk in decision
making under uncertainty corresponding to the last digit of your ID# (use graphs to illustrate your
answer):
If your ID # ends in 0, 2, 4, 6, or 8 Risk averse attitude towards risk
If your ID # ends in 1, 3, 5, 7, or 9 Risk neutral attitude towards risk

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(1.6) [4 Points] True or false: solving a CMP with the production function

will yield identical
answers for

() as solving the CMP with the production function ( )?

Give a very brief explanation. Do NOT solve the Cost Minimization Problem.

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(1.7) [4 Points] Consider the following profit maximization problem:

() ()

What can be said about the firms capacity if at the optimal solution

? Give a brief explanation

and use graphs to illustrate your answer. Do NOT solve the Profit Maximization Problem.

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(1.8) [4 Points] The following table shows the as a % of market demand for some U.S. sectors.
What is the theoretical number of companies in each sector that can operate at the lowest cost per
unit? Show your calculations in the table below.
Industry
as % of Market Demand
Commercial Aircraft 10%
Beer 1.37%
Mineral water 0.08%
Source: Sutton, Sunk Costs and Market Structure, MIT Press


Industry
as %
of Market
Demand
Theoretical # of Companies Operating
at lowest cost per unit (show calculations)

Commercial
Aircraft

10%

Beer

1.37%









Mineral water

0.08%











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(1.9) [4 Points] Consider a company that has purchased (not leased) capital to produce a target output
. Assume straight line depreciation, zero salvage value, and constant opportunity cost rate of
return. What are: the lowest and highest values of owned capital the lowest and highest prices of
owned capital? Give a brief explanation and show all necessary calculations.

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(1.10) [4 POINTS] From The Aluminum Industry in 1994 case, recall that at the end of 1993 (AL =
Aluminum): Western consumption of AL = 20.4m tons; Rest of the world consumption of AL = 4.1m
tons; Production of secondary AL = 6m tons. Here are portions of Exhibit 4 from that case with 5 year
and 10 year CAGR (Compound Annual Growth Rate) forecasts:
5 year CAGR forecast 10 year CAGR forecast
Primary AL production 1.4% 3.6%
Secondary AL production 3.7% 3.4%
Western consumption of AL 2.0% 3.3%
Rest of the World consumption of AL -3.5% 0.2%

Assume that 1m/tpy of AL inventories will be unloaded onto the London Metal Exchange in each year
beginning with 1994. Predict the total supply of (new) primary AL in 1996 (up to 2 decimal places) by
using the following CAGRs corresponding to the last digit of your ID#:
If your ID # ends in 0, 2, 4, 6, or 8 use the 5 year CAGR forecast
If your ID # ends in 1, 3, 5, 7, or 9 use the 10 year CAGR forecast
State all assumptions and show all calculations.

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QUESTION 2 [10 POINTS]
The following table contains figures for Apple iPod units sold and price/unit from 2007 2011:
Apple iPod Units Sold and Price/unit ($)

2011 2010 2009 2008 2007
Unit sales 42,620,000 50,312,000 54,132,000 54,828,000 51,630,000
Price/unit ($) $174 $164 $149 $167 $161
Source: Source: Apple 10-K Annual Reports (2011 and 2009)

An analyst uses the data above to estimate the following demand function for iPods (here 000s of
units of iPods and price/unit):

(2.1) [1 Points] According to the demand function above, what is the elasticity of iPods? Give a brief
explanation.
(2.2) [1 Points] According to the demand function above what are the revenue maximizing uniform
price and output of iPods in 2011? Assume any number you like for capacity. State all assumptions and
show all calculations.

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(2.3) [2 Points] Assuming Apple chose the profit maximizing price and output in 2011, what was the
(upto 2 decimal places) of an iPod in 2011? State all assumptions and show all calculations.
(2.4) [2 Points] How would the price of an iPod in 2011 have changed due to a $5 quantity tax on iPods?
Assume Apple is charged with collecting the tax. State all assumptions and show all calculations.

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(2.5) [2 Points] Derive the utility function of the representative consumer for Apple iPods and
calculate the marginal utility of everything else. State all assumptions and show all calculations.

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(2.6) [2 Points] Use the demand curve for iPods to calculate the change in the representative
consumers utility from consuming iPods and everything else due to a $5 quantity tax on iPods in 2011.
State all assumptions and show all calculations.

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QUESTION 3 [10 POINTS]
(3.1) [3 Points] This morning ( ), the government of Geece issued a bond that will starting
tomorrow morning ( ) pay bondholders $100/day forever (the payment is made at the start of each
day). The price of the bond is $1,000 and the current (daily) interest rate is 5%. Will you buy this Geece
bond at ? Show all calculations and state all assumptions.

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(3.2) [2 Points] What is the internal rate of return at of the Geece bond in part (3.1)? Given the
current interest rate of 5%, will you buy this Geece bond? Show all calculations and state all
assumptions.

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Suppose that you have purchased the Geece bond on the morning of . Immediately afterwards,
you read a Boom-berg.com article on how Geece might default on its bonds: according to the article, the
market believes that there is a 20% chance that Geece will default on payments to bondholders, such as
yourself. In the following questions, assume you have the utility function .
(3.3) [5 Points] Right after you read the Boom-berg.com article on Geece bonds, you hop on to your red
tricycle and dash off to buy a credit default swap (CDS) policy on Geece bonds from Baldman Sucks, an
investment bank. Suppose you want to buy a CDS on Geece bonds which fully insures you against the
total present value of the outstanding Geece bond payments. What is the maximum dollar amount
youd pay to purchase this credit default swap policy? Assume CDS issuers are competitive. State all
assumptions, show all calculations, and you are strongly urged to draw a graph to illustrate your answer.

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QUESTION 4 [15 POINTS]
This table contains some figures for the High season in Exhibit 1 of the Container Transportation
Company case:
Select Figures from Exhibit 1 of the Container Transportation Company Case (High Season)
Port Price ($/TEU) High Season Demand (TEU) % in 20 Containers
Japan 940 320 30
China 878 68 40
Hong Kong 766 737 42
Indonesia 840 68 40
India 790 340 40
Korea 710 35 46
Malaysia 643 138 54
Singapore 649 43 39
Taiwan 702 41 41
Thailand 663 9 20

Please answer the following parts for the port corresponding to the last digit of your ID #:
If your ID # ends in 0, 1, or 2 Hong Kong
If your ID # ends in 3, 4, or 5 India
If your ID # ends in 6, 7, or 8 Malaysia
If your ID # ends in 9 Taiwan
(4.1) [2 POINTS] Calculate the number of 40 containers destined for the port corresponding to the last
digit of your ID # (see above). State all assumptions and show all calculations.

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(4.2) [2 POINTS] Suppose management feels that at the current prices and demands, raising price in each
port by 15% will decrease demand by 25%. Please derive the parameters of a linear demand curve for
the port corresponding to the last digit of your ID # (see above). State all assumptions and show all
calculations.
(4.3) [2 POINTS] Suppose management feels that at the current prices and demands, raising price in each
port by 15% will decrease demand in that port by 25%. Please derive the parameters of a constant-
elasticity demand curve for the port corresponding to the last digit of your ID # (see above). State all
assumptions and show all calculations.

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(4.4) [3 POINTS] Which type of demand curve (linear or constant elasticity) should CTC use to solve for
the optimal total revenue maximizing prices and outputs? Give a brief explanation.

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(4.5) [3 POINTS] From the CTC case, recall the following three constraints in the high season:
( )
( ) (tons)

The following table contains portions of the sensitivity report for CTCs high season total revenue
maximization problem:
CONSTRAINT FINAL VALUE LAGRANGE MULTIPLIER
1,547.46 0
22,800 30.11
TOTAL 40' TEU : TOTAL 20' TEU 1.514 0
TOTAL 40' TEU : TOTAL 20' TEU 1.514 0

Interpret the Lagrange multipliers on the TEU and weight constraints (you are expected to provide
numbers and recommendations in your explanation). State all assumptions and show all calculations.



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(4.6) [3 POINTS] Use the sensitivity report above to compute the optimal

ratio in the
high season. Show all calculations.

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QUESTION 5 [20 POINTS]
PART A
(5.1) [4 POINTS] A company with market power has constant returns. Setup, solve, and derive the
conditions for the various Kuhn-Tucker cases of the following general Profit Maximization Problem given
that the company can charge a uniform price or 1
st
degree price discrimination prices:

() ()

You must express all first order conditions and the conditions for the Kuhn-Tucker various cases in terms
of marginal revenue and marginal cost only. State all assumptions and show all calculations.

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PART B
In the paper Econometric Analysis of Collusive Behavior in a Soft-Drink Market published in the Journal
of Economics and Management Strategy (Summer 1992), Gamsi, Laffont and Vuong (GLV) estimated the
following demand functions for Coke and Pepsi concentrate syrup based on quarterly data 1968 1986:

The subscript is for Coke and is for Pepsi where:
= quarterly quantity of syrup sold
= price of syrup (1986 dollars)
= square root of quarterly advertising expenses (1986 dollars)
{



= real income (1986 dollars)
The average values of the variables in the data set (except season) were:

GLV also estimated Coke and Pepsis average variable cost to be (these are constant across seasons):

Assume Pepsis and Cokes costs stem from manufacturing concentrate syrup only (think of Pepsi and
Coke as producing syrup for gate delivery).
(5.2) [2 POINTS] What type of returns to variable inputs do Pepsi and Coke have? Give a brief
explanation.

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Answer the questions below for Pepsi and the season corresponding to the last digit of your ID # below:
If the last digit of your ID # ends in 0, 2, 4, 6, or 8 Pepsi in spring/summer
If the last digit of your ID # ends in 1, 3, 5, 7, or 9 Pepsi in winter/fall
(5.3) [2 POINTS] Derive Pepsis demand curve for the season corresponding to the last digit of your ID #
(see above). State all assumptions, show all calculations, and derive all figures up to two decimal places.

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PART C
(5.4) [2 POINTS] Assume Pepsi is a profit maximizer and charges a uniform price. What is Pepsis optimal
capacity in the season corresponding to the last digit of your ID # (see above)? State all assumptions,
show all calculations, and derive all figures up to two decimal places. Hint #1: If Pepsi were to build the
production facility for the first time, what capacity would it choose? Hint #2: When is the value of
expanding capacity zero?

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(5.5) [2 POINTS] Assume Pepsis actual capacity is 75% of the value you calculated in part (5.4). Use your
answers to part (5.1) to solve for Pepsis optimal uniform price and output in the season corresponding
to the last digit of your ID # (see above). State all assumptions, show all calculations, and derive all
figures up to two decimal places. Note: Only if you could not solve for optimal capacity in part (5.4) then
assume capacity of the maximum market size (this is not necessarily the optimal capacity and
you should only use this figure if you couldnt solve part (5.4)).

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(5.6) [2 POINTS] Assume Pepsis actual capacity is 75% of the value you calculated in part (5.4). What is
Pepsis optimal uniform price and output if the government requires Pepsi to behave as if it is perfectly
competitive in the season corresponding to the last digit of your ID # (see above)? State all
assumptions, show all calculations, and derive all figures up to two decimal places. Note: Only if you
could not solve for optimal capacity in part (5.4) then assume capacity of the maximum
market size (this is not necessarily the optimal capacity and you should only use this figure if you
couldnt solve part (5.4)).

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(5.7) [2 POINTS] Suppose that after Pepsi has produced but before any customers have purchased the
total output in part (5.5), Pepsi management finds out that the maximum willingness to pay for
concentrate syrup has fallen by 50%. If Pepsi wants to dispose the total output produced in part (5.5) by
charging uniform prices, how much syrup should it sell? Assume there is no secondary market for unsold
syrup. State all assumptions, show all calculations, and derive all figures up to two decimal places.

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PART D
(5.8) [2 POINTS] Assume Pepsi is a profit maximizer and charges 1
st
degree price discrimination prices.
What is Pepsis optimal capacity for the season corresponding to the last digit of your ID # (see
above)? State all assumptions, show all calculations, and derive all figures up to two decimal places. Hint
#1: If Pepsi were to build the production facility for the first time, what capacity would it choose? Hint
#2: When is the value of expanding capacity zero?

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(5.9) [2 POINTS] Assume Pepsis actual capacity is 75% of the value you calculated in part (5.8). Use your
answers to part (5.1) to solve for Pepsis optimal 1
st
degree price discrimination prices and total output
for the season corresponding to the last digit of your ID # (see above). State all assumptions, show all
calculations, and derive all figures up to two decimal places. Note: Only if you could not solve for optimal
capacity in part (5.8) then assume capacity of the maximum market size (this is not necessarily
the optimal capacity and you should only use this figure if you couldnt solve part (5.8)).

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QUESTION 6 [5 POINTS]
Below is Exhibit 1 from the Prestige Telephone Company case:
Exhibit 1: HBS case The Prestige Telephone Company

January 2003 February 2003 March 2003
Intercompany Hours 206 181 223
Commercial Hours 123 135 138
Total Revenue Hours 329 316 361

Service Hours 32 32 40
Available Hours 223 164 143
Total Hours 584 512 544

Recall that the Prestige Data Services commercial demand curve in March 2003 was:

And that the total cost function of Prestige Data Services was:

Here:

Price of commercial data services ($/hour)

Hours of commercial data services/month

Hours of intercompany data services/month

Hours of services/month
Recall that in March 2003:

price of intercompany data services ($/hour) = $400/hour and

$800/hour.
Solve for the profit maximizing uniform price and output in that month when Prestige Data Services
breaks even. You are expected to derive the demand curve in the breakeven month, make plausible
assumptions about the commercial capacity, solve the problem with the constraint that

capacity,
and use appropriate constrained optimization method. For convenience, you can assume that
State all assumptions and show all calculations.

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WORK SHEET
(DO NOT TEAR OFF)