MN7402: Business Economics Seminar 6

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MN7402: Business Economics

Seminar 6 (Lectures 8 & 9)

Part A (Comprehension)

1.  “Creative destruction” is the process by which:

(a) Old buildings are demolished and new ones are build in their place. (b) Old sources of competitive advantage are displaced by new ones.

(c) Old skills become obsolete and new ones develop in their place.

(d) Old technologies are replaced by new ones.

2.  If a firm is a monopolist in its market, then it may innovate faster than poten- tial entrants because of the:

(a) Efficiency effect.

(b) Sunk-cost effect.

(c) Level of innovation risk.

(d) Replacement effect.

3. If there is a negative supply shock in an economy, then we should expect:

(a) GDP to go up.

(b) Prices to go up.

(c) Inflation to go down.

(d) All of the above.

4. Which of the following is NOT an element of the PECS framework?

(a) Politics.

(b) Economics.

(c) Culture.

(d) Society.

Part B (Problems and Discussion)

5.   Larroch´e and Silkline are cosmetics companies that compete for a new genera- tion of anti-ageing skincare products.  They are currently in a patent race and each one of them needs to pick a research approach. There are two available approaches to creating the new product.  The first one (A1), is fully deterministic and it will take 3 years to complete.  The second one, (A2) is probabilistic and it has a probability of 50% to complete in 30 months time and a probability of 50% to complete in 40 months. Both approaches are available to both companies, and if they both select approach A2, then the outcome for each company is independent of the outcome for the other, i.e. A2 is an uncorrelated approach. Moreover, if one company achieves the innovation before the other then it will enjoy the advantage of being a monopoly for some period of time and it will generate expected profit of £8bn. The other company gets nothing in this case. Finally, if the two companies complete the innovation at the same time, they will have to share the market and, due to price competition, each one will generate expected profit of £3bn for the same time period.

a.  Suppose that Larroch´e selects A1.  Which approach does Silkline prefer to take?

b.  Suppose that Silkline selects A2.  Which approach does Larroch´e prefer to take?

c. Are the above choices consistent with each other? What does this imply for the selection of approaches that the two companies will make in the end?

d.  Suppose now that A2 is a perfectly correlated approach.  That is, if both companies select A2 and one of them completes the innovation in 30 months, then the other one also completes in 30 months. Would this change your answer in part c above?

6. With the use of verbal arguments and a graph, explain what is likely to happen to a major wheat-exporting economy in terms of GDP and inflation if a massive draught destroys 30% of its agricultural production.


2023-01-12