Midterm Exam
Instructor: Alex P. Arsenault
ECON 348 – Law and Economics
April 15, 2020
• Follow the instructions carefully.
– There are two sections to this exam.
∗ The first section contains short questions. Your answer should fit on one to three
lines for each question.
∗ The second section contains long questions. Show your calculations or provide
an explanation for your answer.
– There are 100 possible points.
– For an answer in the long question section to get full marks, the answer must:
∗ Be complete. Show your calculations or explain the logic behind your answer. One
part of one long question might require more than one element for the answer to
be complete.
∗ Be precise. Keep your answers brief and to the point. Calculations or explanations
that are unnecessary or not relevant to the question will be penalized.
– The exam is open book.
– The exam is individual. Do not talk about the exam with other students before the
deadline.
– Hand in the exam through the dropbox on OnQ before 11:59 pm, (so the very end of
the day) Kingston time, on Thursday the 16th.
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1 Mandatory Short Answer [30]
Answer all of the following short questions. Only provide explanations if the question asks
you to explain. Each question is worth 5 points for a total of 30 points.
1. Give an example of a contract that is legitimately formed without consideration or
give an example of a contract that is legitimately formed without legal intent.
2. True or False. According to the Coase theorem, bargaining is only possible when
transaction costs are either zero or very close to zero. Explain.
3. Orla was given a small piece of land 30 years ago. She paid the relevant taxes and
ignored the land since. Lewys owns land right next to this piece of land and he has
lived there for the last 20 years. Lewys uses the piece of land that Orla was given as
if it was his and have been doing so for the last 15 years. This land is right next to a
busy street and Lewys does not try to hide his use of the land. Orla and Lewys never
discussed the situation in any way. Who owns this piece of land? Explain
4. The liability regime is strict liability. Both the victim and injurer can exert precaution
if they so choose. There is an accident where the injurer exert a level of precaution
that is a lot higher than what would be optimal but the victim exerted no precaution
at all. Who is liable?
5. Are the cases where the Competition Bureau in Canada is involved civil cases or
criminal cases?
6. True or false: it is common for people to be found guilty in a criminal case but not
liable in a civil case for the same infraction. Explain briefly.
2
2 Mandatory Long Answer [70]
Answer all of the following questions. Each part of each question is worth 7
points for a total of 70 points.
1) Monopolies, Duopolies and Collusion
Firm 1 can produce a good. It faces a private cost of q22 where q is the number of units
produced.
a) Suppose that Firm 1 is a monopoly and that demand is given by Q=a-bp. There is
only one period. Since the firm is a monopoly, the firm can choose a quantity or a
price. Should the firm choose a price or a quantity? What is the equilibrium price and
quantity if the firm makes the optimal decision?
b) Suppose now that another firm is in this market. Both firms have the same cost function and the product they create is homogeneous. There are no capacity constraints.
No collusion is possible. Firm 1 can decide if both firms should compete on price
or on quantities. Both firms will compete on prices if Firm 1 chooses to compete
on price and both firms will compete on quantity if Firm 1 chooses to compete on
quantity. What should firm 1 choose and what is the equilibrium price and quantity
in that market?
c) Suppose now that firms can collude. There are infinitely many periods in which firms
can collude. Firm 1 will make an offer about a collusive price to Firm 2. They can
only make this offer once and the collusive price needs to be the same for every period.
Firm 2 can accept or reject the deal. If firm 2 rejects the deal or cheats on the deal
at any time, firm 1 sets the competitive price forever after. What price should Firm
1 offer to collude on? For what values of the time-preference parameter β is the
collusive deal stable?
d) Suppose now that collusion is only possible for 10 periods. What price should Firm 1
offer? For what values of β is the collusive deal stable?
3
2) Patents and Trade Secrets
A firm can invent a new product. That firm is the only entity in that world that can
invent the product and the firm faces a research cost of 20$ to create that product. The
monopoly price for this new product is 4$ per unit and the firm can produce this good, if
research have been done, at a cost of q22 where q is the quantity of good produced. Time
is discrete and the firm faces the same price and cost function every period. Without a
patent, other firms can produce the product more efficiently, therefore without a patent (or
a trade secret) the firm makes 0 profit. Assume a β of 0.9.
a) The firm can choose to maintain a trade secret at a cost of c, to be paid in every
period. The firm can also get a 20-year patent at a cost of 60$. This amount is to be
paid on top of the research cost, it is paid to the government to purchase the patent.
For what values of c should the firm choose a trade secret over a 20 year patent?
b) Suppose now that there are no trade secrets. The government can choose a price for
a 20-year patent. What price should the government choose to maximize it’s revenue?
c) Suppose now that there are no research costs and the government only cares about
the surplus of the consumers. The government can choose a duration for a patent
that is given to the firm at no cost if the firm did research. What duration should the
government choose in that case?
4
3) A Model of Rational Crime
Suppose that the world is populated entirely with rational but amoral individuals that only
get utility from wealth. An individual’s utility function is U(W)=ln(W+1) where W is the
wealth of the individual. Some individuals start with 0 initial wealth while other individuals
start with a wealth of w>0. Everyone can decide whether or not to steal x units of wealth.
The individual know their wealth when they take the decision to steal or not. Stealing has
two consequences: first the individual gains x$ of wealth up to 2$ of wealth. Second, with
probability p=0.6 the individual gets caught and has to pay back 2x$ , that is twice the
amount stolen. The penalty is capped by the individual’s wealth: the individual can never
get less than 0$ of wealth in that world.
a) How much should the individual steal if they have an initial wealth of w>>0?
b) How much should the individual steal if they started with no initial wealth?
c) Now suppose that there is no limit to the amount that can be stolen and that the
penalty when caught is simply to pay back the amount that was stolen. What amount
should an individual with a large intial wealth steal? What about an individual that
starts with w=0?
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