Many laser-building companies are considering bidding for access rights to a lar

Question

Many laser-building companies are considering bidding for access rights to a large deposit of Thulium (atomic number 69). One-third (1/3) of the companies value this deposit at $600 million and two-thirds (2/3) at $900 million. The mining company will hold an oral auction to determine who gets the rights to the deposit. The mining company expects only two (2) firms to actually show up to the auction and bid on the deposit, and will set a reserve price of $300 million.

1. What is the expected revenue from this auction? [6 pts]

2. The laser-building companies themselves don’t bid, rather an employee of the companies bids. Sometimes, the employee gets really excited about the auction and overbids. Who is the principal and who is the agent? [1 pt]

3. Does this principal-agent relationship in (b) describe moral hazard, adverse selection or neither (ie, there is no principal-agent problem)? Justify your answer. [3 pts]

4. Suppose that half (1/2) of the high-value firms have employees who act in the way described in (b), and they do so by bidding up to $1,000 million, instead of $900 million. What is the new expected revenue from the auction, still assuming only two (2) bidders show up? [Note: This could be tricky, so think hard about this.] [6 pts]

5. Given your answers to (a) and (d), what is the expected amount of the agency costs to the laser-building industry? [2 pts]

Explanation / Answer

Expected Revenue = 1/3*600+ 2/3*900 = 600

b) Companies are principal and the companies agent are bidder because he is given the task to do successful auction .

c) Principal agent problem in part b represent moral hazard problem because as mentioned in question the companies bidder get overexcited and thus bids higher . Since at the time of appointing bidder and also at biding company can't watch agent action.

d) 1/3*600+ 2/3*{1/2(1000)+1/2*900} = 200+ 333.33 = 836.5

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