Examination for Managerial Economics Term Paper

Examination for Managerial Economics Term Paper

Examination for Managerial Economics Term Paper

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Examination for Managerial Economics May 2021 Guidance for Students and Outline Solutions

Overall the standard was good. The key point in answering these questions was to show that you understood the economic principles and could apply them to practical problems. Thus an ideal answer would contain a clear exposition of the theory followed by a short case study. Extra marks were awarded for originality.

The division of marks between Section A and Section B was intended to be indicative of the time needed to answer these Sections. On average answers to part 1 were longer than justified by this rule while some answers to Section were slightly shorter than expected.

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Can I emphasise that it is important to answer the correct number of questions as described in the rubric.

Question 1 1a,b. Straightforward bookwork C. The key point is relative performance evaluation is a less risky way to pay the agent. This reduces the wage bill if the agent is risk averse. D. Large corporations are owned by diversified shareholders who have little control over managers who make the decisions.

This creates an agency problem. E. If two firms in a supply chain simultaneously attempt to impose monopoly markets this results in a situation where both consumer and producer surplus are less than they could be. F. Any relevant signal, e.g oil prices,

state of the national economy, should be incorporated into an incentive scheme if it reduces the variance of the agent’s pay. This reduces total wages if the agent is risk averse. G. describe the main components of executive pay and show they are a potential solution to the agency problem described in part d.

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Question 2 A) The key point here is that the franchise system controls moral hazard by the outlet manager.

The franchise owner receives every pound of extra profit generated by his her/effort. B) salaried mangers are used to prevent distortion of effort between maintaining the brand image and increasing profit at a particular outlet. C). Franchising is unsuitable when the agent is risk averse, or if the agent has insufficient capital to pay the franchise fee.

Question 3 A good way to answer this was to use the lemons model as an example of adverse selection and the Spence education model as an example of signalling. Most answers took this approach. Some candidates discussed adverse selection in the context of insurance which is a valid approach.

Question 4. There is no unique answer here. It is relevant to discuss Freidman’s arguments in favour of shareholder value and the opposing views of the American Business Roundtable.

The relevant theory is the Fisher Separation Theorem which says that if markets are undistorted shareholder will be unanimous and agree that profit maximisation should be the objective of the firm. One can then consider likely market distortions and how these may justify stakeholder involvement. For instance, cooperatives may be formed to mitigate monopoly distortions.

Question 5. There are two key points: • The Hubris hypothesis. Overconfidence can lead raiders to neglect the winner’s curse. As a result

they will overvalue takeover targets. This results in eventual losses. • In Cournot oligopoly firms which do not participate in a merger can exploit the resulting price

rise by expanding output. As a result, mergers will not increase profits unless they include at least 80% of the firms in an industry.

Question 6 This is a question on Hart and Moore’s property rights theory of the firm. If there are specific assets needed to produce widgets which are complementary with your own assets then it is best to make widgets in-house. This gives investments the best protection from hold-ups. In contrast if the two assets are independent then outsourcing is best.

Conglomerate mergers are undesirable according to this theory. They involve independent assets and thus make the assets of both firms more vulnerable to hold-up. Such mergers have a high failure rate in practice.

Question 7 A key point is the repeated games effect. In a long run relationship good/bad behavior can be punished in future time periods. This makes cooperation easier to sustain in a long run relationship.

Also relevant are that long-run relationships are less vulnerable to hold-ups.

Efficiency wages are more effective in a long run relationship.

Examination for Managerial Economics Term Paper

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