# HEC Montréal

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```					51-851-02 - MANAGERIAL ECONOMICS                                       FALL 2007

PROFESSOR ROBERT CLARK

Final Exam

There are 5 questions, totalling 18 marks. Read each question carefully and show all
relevant calculations, graphs, and/or verbal reasoning you use in arriving at your
solutions. The last page contains a list of formulas which you may or may not find
useful.

Question 1 (3 marks):

Consider a retail industry composed of three different large chains with similar cost
structures. In different cities, different numbers of these chains are present. It was
observed that prices for a sample product follow a general pattern based on the number of
chains that are present in any city:

With one chain,                prices for the sample product are:    \$20
With two chains,               prices for the sample product are:    \$16
With three chains,             prices for the sample product are:    \$15

Based on this observation would you think that the chains are offering homogeneous
products or differentiated products? Explain.

Question 2 (3 marks):

In November 1998, the major tobacco companies settled multi-state litigation with an
agreement to pay nearly \$250 billion to the states over the next 25 years as compensation
for smoking-related health care costs. They also agreed to abide by significant restrictions
on the nature of cigarette marketing and promotional activity. While this settlement was
being negotiated but before it was signed, firms engaged in intense price competition as
well as extensive advertising and marketing activity. Briefly sketch a rationale for this
behaviour.
Question 3 (6 marks):

In order for a sparkling wine to bear the name of Champagne (or to be referred as
produced by the Champagne Method), it must be produced within a strictly defined
geographical region and adhere to strict guidelines defined by the Appelation d’Origine
Contrôlée. Within this region, almost every square-inch of the usable 32 000 hectares is
farmed for the production of champagne. Among the many varieties of champagnes,
there is a select group of top champagnes known as the cuvée de prestige that compete
against each other and that can be considered relatively close substitutes. They include
such champagnes as LVMH’s Krug Vintage and Dom Perignon, Pol Roger’s Sir Winston
Churchill, Taittinger’s Compte de Champagne, and Veuve Clicquot’s La Grande Dame.
An important characteristic of this market is that the production of champagne is decided
many years before the product actually hits the market (for example, the latest vintage of
Dom Pérignon currently available at the SAQ is 1999). Finally, the demand for these
cuvée de prestige is notoriously cyclical. That is, demand for these products increases
with global income and wealth (and during certain years like 1999 because of the
millennium celebration).

a) How would you characterize the structure (economic environment) in this
market? (3 marks)
b) Given your answer to part (a), what can we expect to happen to prices in this
market as global demand rises and falls? (3 marks)

Question 4 (3 marks):

The recent fall in the value of the U.S. dollar has made it such that it is much cheaper for
an American to buy a particular automobile in the U.S. than it is for a Canadian to buy

What factors should Canadian automobile retailers consider when deciding whether or
not to decrease their prices in an effort to move closer to American prices?

Question 5 (3 marks):

Traditional vehicle insurance contracts do not offer protection against the replacement
value of a vehicle. A replacement cost endorsement gives the opportunity to get a new
vehicle in the case of a total theft or in the case of total destruction of the car in a road
accident. This type of protection was introduced in Canada in the late 1980’s.

A recent study found that holders of car insurance policies with a replacement cost
endorsement have a higher probability of theft near the end of this additional protection
(usually this protection expires 24 months following the acquisition of a new car).
Explain this phenomenon.
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Some formulas that might be helpful:

Note: Just because the formulas are listed does not necessarily mean that they must be
used to answer questions on this exam. Also, the fact that other formulas are not listed
does not mean that they might not be useful for answering the questions. The formulas
listed are provided in case you think you need them.

Present value:

The present value of a stream of future payments can be written as:

PV=FV1/(1+i)+FV2/(1+i)²+FV3/(1+i)³+……

Elasticities:

Own price elasticity of demand= (%∆Qdx)/(%∆Px)
Cross price elasticity of demand= (%∆Qdx)/(%∆Py)
Income elasticity of demand= (%∆Qdx)/(%∆I)
Own price elasticity of supply= (%∆Qsx)/(%∆Px)

Arc elasticity = (∆Qdx/∆Px)*(average P/average Q)

Marginal revenue:

Monopolist:
If demand is linear, such that the inverse demand curve is of the form: P=a+bQ
Then MR=a+2bQ

Cournot oligopolist:
If demand is linear, such that the inverse demand curve is of the form: P=a+bQ1+bQ2
Then MR1=a+2bQ1+bQ2 and MR2=a+bQ1+2bQ2

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