1. Many fast food restaurant chains like McDonalds and others have some stores which are directly owned by the company (McDonalds) which hires a manager and staff to manage the restaurants, and some stores that they sell a franchise to an outside company/individual who operates the restaurants and pays the company (McDonalds) a franchise fee and keeps the rest of the profits. The franchise fee will have to be paid no matter what the profits of the restaurant may be.

(a) What is the principal - agent problem in the company owned restaurants? Please explain.

(b) What is the principal - agent problem in the franchised restaurant? Please explain. You may assume that the owner is still McDonalds as McDonalds can cancel the franchise agreement if they want to, in which case the former franchisee will no longer be able to use the McDonalds brand to sell their food.

(c) In which case will the principal-agent problem be more severe? Please explain.

2. (a) What is vertical integration? Please explain.

(b) Explain how Apple Inc. is a vertically integrated company. You must give an explanation.