BEM/Ec 146 Final Examination Fall 2003 Prof. Colin Camerer

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1 BEM/Ec 146 Final Examination Fall 2003 Prof. Colin Camerer This exam is open book. You can consult everything discussed or handed out in class, and in the textbook and readings. You have 5 hours to complete the exam. If you take breaks, don t consult anybody or any source (other than the textbook and readings, and class notes) which might provide information that will influence your exam performance. All questions are 10 points except as noted. (As a good practicing economist, you should of course allocate marginal time to gain marginal points to maximize your score and grade. Also read over all the questions first to get a sense of how to pace yourself.) If you write your answers by hand, confine your answers to the space below each question (for questions that end on page p, this includes space at the top of page t+1 before the next question begins). This also gives you a big hint about how much depth is expected in your answer. Furthermore, we want you to develop the ability to not just give a good answer, but to do so concisely (in a short amount of space) and clearly. You are encouraged to type your answers rather than handwrite them. If you do type, you do not need to retype the question (just give the question number), and type no more than the number of lines specified at the end of in each question (using a 12 point font). You can also use a bulletpoint format on some questions as long as they are clear and to the point. The exam is available 130 pm Monday, December 8 from Karen Kerbs in 332 (and also on the web at that time), and is due back 130 pm Thursday, December 11 (332 Baxter) or my mailbox (first floor Baxter, in the suite to your left as you enter from the quad, or the west). The usual lateness policy applies: There is a 50% penalty for every 24 hours of lateness. Have a good holiday break!

2 1. Service thrills & chills. Describe an unusually good or bad service experience you have had. Suggest why the incentive system or culture of the firm, its customer discipline (the firm s customers policing service by being demanding), personality traits of the person(s) who served you, etc., may have created the high or low quality of service you experienced. [16 lines] 2. Getting rich slowly. At my local dry cleaner the person who regularly serves me, or his wife, usually rounds off the bill to the nearest nickel (invariably rounding down and charging me less e.g., $21.31 becomes $21.25). This never happens at a typical retail establishment like the gap or Baja Fresh. Can you suggest why? [13 lines]

3 3. Getting old. United Airlines has lost billions since 2001 (a hemorrhage which began before the 9/11 terrorist attacks). As a result, the airline is in bankruptcy. If you flew on United Airlines before 2001, and recently in fall 2003, you will immediately notice that the flight attendants appear to be much older now (2003) than they used to be (2001). (a) Why do you think this change occurred? [6 lines] (b) Describe the possible reasons underlying the policies that caused the change you noted in (a). [19 lines] 4. (5 points each) Give a brief definition and example of each of the following terms. (2 bonus points per problem for original examples not used in the readings or discussed in class): [10 lines] a. Compensating differential

4 b. Statistical discrimination c. Good corporate governance d. Principal-agent relationship e. Shielding

5 f. Ratchet effect g. Matrix organization h. Stocklifting 5. Looking good. At a department store like Macy s, the people who work at retail counters in sporting goods, shoes, luggage, etc., are Macy s employees. However, in many department stores like Macy s, the people who work at cosmetics and perfume counters are not Macy s employees. Instead, they are employees of the cosmetics

6 companies whose products are being sold at their particular counter. (That is, the person working at the Shisheido counter is employed by Shisheido.) Using concepts from the class, and what you might know about cosmetics (keep in mind that the markup on cosmetics from marginal production cost to retail price is extremely high), suggest some reasons why it may be more efficient to have cosmetics-company employees working at these counters than Macy s employees. [22 lines] 6. McAgency. A fast-food franchisee, at a chain like McDonald s, usually pays an initial upfront fee, an annual flat fee, and a percentage of revenues to McDonald s. In addition, McDonald s pays for most of national advertising and supplies knowhow (franchisees attend Hamburger University to learn the ropes) and advice. At the same time, some McDonald s stores are owned and operated by the company. Suppose we loosely divide stores into those which are near the company headquarters (HQ) and those which are far away from HQ. Do you think franchised stores or company-owned stores are more likely to be those which are near HQ or far away? Why? [13 lines]

7 7. (5 points each) Analogies at AOL: (a) One reason for AOL s success in enrolling new subscribers was its famous policy of giving away free disks. Their marketing expert got the idea from a previous product promotion that succeeded by giving away free products. What was the product? [4 lines] (b) One reason Time Warner CEO Gerald Levin may have been enamored of the AOL online-subscription business was that it resembled a business he had been involved which was very successful. What was that business? [4 lines] 8. (5 points each) Game theory. Consider two general types of sports teams, high- lowcooperation (denoted H and L). An H team is one in which the team performance is determined by some kind of cooperative or complementary interaction among players, rather than just the sum of individual performances. An L team is the opposite; an L team's performance is closely related to the sum of individual performances. Among major American professional sports, the best examples of H and L teams might be football (or soccer) (H) and baseball (L). (Other sports are very much L-team by construction, like amateur bowling leagues and some golf tournaments, in which several players' scores are just added up to form the team score.) Assume teams pay workers their marginal revenue product, and design selection, retention, and separation practices to maximize value. Ignore differences in team size, the size of their local and TV markets, and the fact that the length of a productive lifetime might differ across different teams (e.g. baseball players have longer careers than football players). How would you expect H and L teams to compare on the following criteria? Explain your answer for each one. [10 lines each] (i) Labor mobility or turnover (the percentage of players who leave the team in an average year).

8 (ii) Volatility of turnover (i.e., is the turnover a steady percentage each year, or does it vary wildly from 0 some years to high percentages in other years?). (iii) Relative importance of coaching and general management (e.g. player selection) versus playing. (iv) The wage variation, for a single player, as he or she moves from team to team.

9 9. Getting old II: In the University of California retirement system, you basically receive retirement pay which is 2.4% times the number of years worked at UC, times your last annual pre-retirement salary. (For example, if you work 10 years and earn $100,000 in your last year, the UC will pay you $24,000 a year after you are retired.) Also, most faculty members are allowed to teach an extra course for a modest increase in annual salary (I think 20%). Discuss the advantages and disadvantages of this system from the UC s point of view and from a professor s point of view. [30 lines] 10. Bad chemistry: In 1988 the fiber division of a chemical company put a small fraction of employee salaries in an at-risk bonus pool. In 1990, if the division s real-earnings growth exceeded 4%, the at-risk pay would be recovered. If earnings growth was larger than 4% the employees stood to earn a multiple of the at-risk pay; but if earnings growth was too low the bonus pool money would disappear.

10 (a) What went wrong in 1990? [6 lines] (b) How could the incentive system have been modified to prevent what went wrong in 1990? [10 lines] 11. (5 points each) Fashion. Many retail clothing stores offers employee discounts to employees who buy the products the store sells. (a) Explain how the discount might help with adverse selection problems by getting desirable employees to self-select, or otherwise motivate employees. [15 lines] (b) Explain the moral hazard problems that might arise from offering employee discounts of this sort. [12 lines]

11 END HERE (c) In the case of retail clothing, can you think of a simple method to limit the moral hazard problems in (b)? [18 lines]

Economics in Sports. 1. The draft system exploits players so they get paid less than they would without the draft system.

Economics in Sports. 1. The draft system exploits players so they get paid less than they would without the draft system. Economics in Sports Sports Industry Let s use our knowledge of labor and product markets to analyze the economics of the sports industry (team sports only, not individual sports such as tennis, golf, race