Exam 12: The Economics of Information

You are a bidder in an independent private values auction. Each bidder perceives that valuations are evenly distributed between $100 and $1,000. If there is a total of three bidders and your own valuation of the item is $900, what is your optimal bidding strategy in: a. A first-price, sealed-bid auction? b. A Dutch auction? c. A second-price, sealed-bid auction? d. An English auction?

A peach farmer must decide how many peaches to harvest for the world peach fair. He knows that there is a 25 percent chance that the world price will be $3, a 50 percent chance that it will be $3.50, and a 25 percent chance that it will be $4. His cost function is C(Q) = 0.05Q². The farmer's maximum expected profit is:

You are the manager of a firm that has just created a new and improved version of a product you know to be superior to every other product on the market. To signal your quality, you have instructed your marketing department to change the label of your firm's product to include the phrase, "New and Improved." Based on this information, do you think it is prudent to contact your production department and instruct them to significantly expand capacity? Explain.

Your firm is planning to hold an auction to sell its mining facility. Your boss has asked you to determine the best type of auction to hold to maximize expected profits from selling the facility. Based on your knowledge of auctions, provide your boss with a suggestion.

OJ's Orange Juice produces orange juice to sell in a competitive market. Given uncertainty in weather patterns, OJ has to determine how much juice to produce before knowing the competitive price. It is estimated that there is a 10 percent chance the competitive price will be $5 and a 90 percent chance the price will be $2. If the marginal cost of producing orange juice is MC(Q) = 2Q, then to maximize expected profits, OJ should produce:

Why do life insurance policies have clauses stipulating that the company will not pay benefits for suicide within one year from the policy date?

A risk-averse manager is considering two projects. The first is to introduce a new product; the second is to revamp the production facilities at the existing plant. There is a 20 percent chance a rival will enter the market and an 80 percent chance it will not. If the rival enters, the firm will lose $20,000 if it introduces the new product, whereas revamping the production facilities will earn it $50,000 in profits. If the rival does not enter, the firm will earn $15,000 if it introduces the new product, and revamping the production facilities will earn net profits of $60,000. What should the manager do? Why?

When each bidder in an auction knows what the item is worth to that bidder, but does not know the valuations of other bidders, the auction exhibits:

Fli-By-Nite Airlines has 1,000 customers. These customers are of two types. Day customers are willing to pay $700 for a flight that has a daytime departure and arrival but only $200 for a flight on the red-eye. Night customers will pay $500 for a flight that has a daytime departure and $300 for a flight on the red-eye. You are the manager for Fli-By-Nite and are unable to determine whether any given individual is a day customer or a night customer. Can you think of a self-selection mechanism that would permit you to identify day and night customers?

The optimal bid for an individual participating in a first-price, sealed-bid auction with independent private values is to bid:

Based on the following table, what is the highest price that risk-neutral buyers will offer for a used car if they recognize adverse selection?

Consider 45 risk-neutral bidders who are participating in a second-price, sealed-bid auction. It is commonly known that bidders have independent private values. Based on this information, we know the optimal bidding strategy for each bidder is to:

You are the manager of a new computer company that manufactures PCs to order. Devise a plan that will convince potential customers your quality is the best in the business.

Which of the following is a means of eliminating the undesirable effects of adverse selection?

Joe's search costs are $7 per search. He wants to buy a video player for his wife for Christmas, and the lowest price he's found so far is $200. Joe thinks one-third of the stores charge $300 for a video player, one-third charge $200, and one-third charge $185. Should Joe continue to search or should he buy a video player at a price of $200?

An apple farmer must decide how many apples to harvest for the world apple market. He knows that there is a one-third probability that the world price will be $1, a one-third probability that it will be $1.50, and a one-third probability that it will be $2. His cost function is C(Q) = 0.01Q². The farmer's maximum expected profit is:

John is a seller in an independent private-values auction environment where bidders are risk neutral. Which auction yields John the greatest expected revenue?

You are a hotel manager considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. If a manager adopted both project A and project B simultaneously, the expected value of this joint project would be:

Which of the following phenomena shows that risk aversion is the characteristic of many people?

As the manager of We Do It Right Construction, you need to make a decision on how many homes to build in a new residential area. There is a 20 percent chance of a recession, a 60 percent chance the economy will remain as it is, and a 20 percent chance there will be an economic upturn. If a recession hits, your inverse demand curve for new homes will be P = 100,000 - 4Q. If things remain as they are, your inverse demand curve will be P = 115,000 - 3Q. If economic growth occurs, your inverse demand curve will be P = 130,000 - 2Q. Your cost function in all three scenarios is C(Q) = 70,000 + 2Q + 0.5Q². If you are risk neutral, how many homes will you start?