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Economics, Organization, and Management Examination Set (February 17th, 2014) (Paolo Bertoletti) Time: 90 minutes. I) Consider the problem of providing an input to a firm division, and suppose that only the slope of the (linear) marginal benefit of such an input is known to the planning division, which overestimates it. Assuming that the (linear) marginal cost is perfectly known to be almost constant, discuss graphically which is the best instrument to be used (either a quantity constraint or a price signal). The situation is described in the following Figure. MR* MR B P MC D C E A Q Q* QP The welfare loss induce by the use of the price signal P is equal to the area CDE, while on the contrary the use of Q as a quantity constraint creates a welfare loss given by the larger area ABC. Accordingly, the price signal should be preferred. II) Consider the business problem of introducing a new product for which N essential input need to be used, starting from a launch date that is has to be chosen. Suppose that the expected Revenue is given by the following formula: R[Min{y1, …, yN}, Max{t1, …, tN}], where R(y, t) increases wrt its first argument and decreases wrt its second argument, and yi is the amount of input i that will be ready at date ti. Explain why this is an example of a problem with design attributes. yi = y and ti = t, i = 1, …, N, and this is the first element which defines a problem with design attributes: a lot is known a priori about the optimal solution. The second element, which is the fact that the most serious mistakes come from lack of fitness among variable, is also present. In particular, it is pretty obvious that choices of yi < Min{y1, …, yi-1, yi+1, …, yN} and/or ti > Min{t1, …, ti-1, ti+1, …, tN} cause very large profit losses, implying large waste of input provision and early readiness.Explain what a “hold-up problem” is. An hold-up problem is a contractual lack of commitment ability that opens the possibility of successive opportunistic behavior by a trade counterpart. It commonly arises in presence of specific sunk investments, and generally implies underinvestment with respect to the efficient level. Possible solutions, in presence of contractual incompleteness, are vertical integration or the establishing of long-term (implicit) contracts based on reputational mechanisms.