Explain the meaning of the term elasticity. Use your results to report the elasticity of output with respect to changes in capital.

Part A Word limit: 600 words

Two garden centres, Green Grass and Bushy Shrubs, sell a similar range of plant pots, plants and plant food. Both are considering whether to discount or maintain their prices as spring approaches.

Their payoffs under different combinations of decisions are given below:

If Green Grass discounts and Bushy Shrubs does not, Green Grass receives a profit of £3500 per week and Bushy Shrubs receives a profit of £1000 per week.
If Green Grass does not discount and Bushy Shrubs discounts, Green Grass receives a profit of £1000 per week and Bushy Shrubs receives a profit of £2700 per week.
If both Green Grass and Bushy Shrubs discount, they will both receive profits of £1500 per week.
If both Green Grass and Bushy Shrubs maintain their prices, they will both receive profits of £2000 per week.

Draw a payoff matrix to show this as a one-shot simultaneous game in which each seller has to make a one-off decision without knowing what the other will do. (5 marks)

Assuming both firms are rational and fully informed about the payoffs of the game, describe any dominant strategies they might have and justify your answer in full. (5 marks)

What, if any, are the Nash equilibria strategies and outcomes of this game? Explain your answer in full. (5 marks)

Suppose both sellers were considering whether or not to discount prices on a daily basis, repeatedly, for the foreseeable future. How would this change the game and the possible outcomes? (5 marks)

Now suppose that Green Grass has the ability to unilaterally discount its prices before Bushy Shrubs can make its decision. Draw a diagram of the sequential game and use backward induction reasoning to explain the rational solution to this game. Is there any change in the outcome compared to the one-shot simultaneous game in Questions 2 and 3? (5 marks)

Part B Word limit: 600 words

To answer this question, you will have to analyse the dataset TMA02_data_2021J.gdt which can be found in the

Assessment section of the module website. The data in this set are derived from a recent sample of data of companies from the AMADEUS database. The firms’ output is measured by the variable ‘Turnover’.

Generate summary statistics for employee numbers, capital used in £1000s and firm turnover. Report and briefly describe the results. (5 marks)

Use a scatterplot and correlation coefficient to assess the linear relationship between log of output and log of capital. Explain your results. (4 marks)

a. Write the linear econometric model that represents a production function in which log of output is a linear function of log of capital. Estimate the coefficients using a simple (univariate) regression OLS model. Explain your results. (3 marks)

b. Explain the meaning of the term elasticity. Use your results to report the elasticity of output with respect to changes in capital. (3 marks)

Extend the model of the production function, that you wrote in your answer to Question 3(a), by adding log of labour into your equation and write down the extended (multivariate) model equation. Estimate its coefficients and explain the results using elasticities. (5 marks)

Compare the results for the two models estimated in Questions 3 and 4 and use them to explain the consequences of omitting relevant variables when using a simple (univariate) regression. (5 marks)

Part C  Word limit: 1200 words

Drawing on economic analysis from the module as well as at least one of the extracts below, write an essay of no more than 1200 words discussing this statement, ‘The pandemic has shown that high profits for pharmaceutical companies are vital for innovation; these companies should therefore not be regulated by the competition authorities.

Competition and Markets Authority. (2020) ‘CMA secures affordable supply of key bipolar drug’.

Competition and Markets Authority. (2020) ‘CMA fines Pfizer and Flynn £90 million for drug price hike to NHS’.

Neville, S. et al. (2020) ‘AstraZeneca’s $39bn Alexion deal marks shift from prey to predator’, Financial Times, 14 December.

Desmyter, S. (2020) ‘The ESG case for the Oxford/ AstraZeneca vaccine’, Financial Times, 23 December.

All articles and data sets for use with TMAs can be accessed in the Assessment tab of the DD309 website; see the ‘Files for use’ sections for each TMA.

 

Last Completed Projects