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Mock Exam

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Title of Paper

EC2002: Intermediate Microeconomics II

Time Allowed

Two Hours (2h)

Instructions to candidates Answer all questions. The use of a non-programmable calculator is allowed.

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This section carries 50% of the exam mark.

Question 1
The price elasticity of demand for oatmeal is constant and equal to 1. When the price of oatmeal is 10 per unit, the total amount demanded is 6, 000 units. Part 1 (5 points) Write an equation for the demand function. Solution:

q = 60, 000/p.
Part 2 (5 points) If the supply is perfectly inelastic at 5,000 units, what is the equilibrium price?. Solution:


Question 2
Banana Computer Company sells Banana computers in both the domestic and foreign markets. Because of differences in the power supplies, a Banana purchased in one market cannot be used in the other market. The demand and marginal revenue curves associated with the two markets are as follows:

Pd = 20, 000 20Q Pf = 25, 000 50Q M Rd = 20, 000 40Q M Rf = 25, 000 100Q
Bananas production process exhibits constant returns to scale and it takes 1, 000, 000 to produce 100 computers. Part 1 (5 points) If Banana is maximizing its prots, how many computers and at what prices will it sell in both markets? Solution: it will sell 250 computers in the domestic market at 15, 000 dollars each and 150 computers in the foreign market at 17, 500 dollars each.

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Part 2 (5 points) What are Bananas total prots? Solution:

2, 375, 000

Question 3
Dean Foster Z. Interface and Professor J. Fetid Nightsoil exchange platitudes and bromides. When Dean Interface consumes TI platitudes and BI bromides, his utility is given by UI (BI , TI ) = BI + 2 TI . When Professor Nightsoil consumes TN platitudes and BN bromide, his utility is given by UN (BN , TN ) = BN + 4 TN . Dean Interfaces initial endowment is 12 platitudes and 8 bromides. Professor Nightsoils initial endowment is 4 platitudes and 8 bromides. Part 1 (5 points) If Dean Interface consumes TI platitudes and BI bromides, and Professor Nightsoil consumes TN platitudes and BN bromides, what will there marginal rates of substitution be? Solution:



and 2TN


Part 2 (5 points) On the contract curve, Dean Interfaces marginal rate of substitution equals Professor Nightsoils. Write an equation that states this condition. Solution:

TI =

TN /2

Question 4
Consider a pure exchange economy with two consumers and two goods. At some given Pareto efcient allocation it is known that both consumers are consuming both goods and that consumer A has a marginal rate of substitution between the two goods of 3. Part 1 (5 points) What is consumer B s marginal rate of substitution between these two goods? Solution:


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Part 2 (5 points) In a competitive equilibrium, what should be the ration between the prices of both goods if initial endowments where (3, 4) and (1, 2) for consumers 1 and 2 respectively? Solution:


Question 5
A chemical works makes 1, 000 prot but pollutes a sh farm. The sh farm makes 400 prot but would make 600 without the pollution. The production process could be made clean by installing a certain technology at a cost of 300. The chemical works could move elsewhere at a cost of 600. Assume that negotiation is possible and that the Coase Theorem applies. Part 1 (5 points) Assume that the chemical works has the right to pollute, will the sh farm install the clean technology? Solution: No, cost of clean technology is greater than the benet from installing it. Optimal outcome is the status quo. Part 2 (5 points) Assume that the chemical works does not have the right to pollute, will the chemical works install the clean technology to avoid paying compensation to the sh farm? Solution: As optimal outcome is the status quo, if the chemical works does not have the right to pollute then it is better off by paying 200 compensation and continue to pollute.

This section carries 50% of the exam mark.

Question 6
Consider a Cournot setting where there are n > 1 identical rms producing with constant marginal cost M C = c. The inverse demand is given by

P = a bQ
where Q is the aggregate demand and a and b are two positive numbers.

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Part 1 (5 points) Show that the best response of each rm is given by

qi = (a c b(q1 + . . . + qi1 + qi+1 + . . . + qn ))/2b

where qi is the quantity produced by rm i. Solution: Each rm solves

max a b
qi i=1

qi qi cqi

which results in the equation given. Part 2 (5 points) Consider the symmetric equilibrium: i.e. q1 = q2 = . . . = qn = q . What is the quantity produced by each rm q as a function of the number of rms n? Solution: Substitute qi for q for all i {1, . . . , n} in the equation from part 1 and solve to obtain:

q =

ac . b(n + 1)

Part 3 (5 points) Assume now that n = 1, i.e. there is only one rm. What is the optimal quantity the rm will produce? How does this quantity compare with the quantity a monopolist would produce? Solution: Substitute n = 1 in part 2 to obtain q = maximizing quantity as expected.
ac , 2b

which equals the monopolist prot

Part 4 (5 points) What happens to the price if n tends to innity? Is this result surprising? Solution: If n then P c. With innity many rms price equals marginal cost, as expected given that innitely many rms imply perfect competition. Part 5 (5 points) Assume that n = 2. Does an asymmetric equilibrium (i.e. and equilibrium with q1 = q2 ) exist?

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Solution: Substitute n = 2 in part 1 to nd a linear system of two equations, two unknowns and a unique solution with q1 = q2 . Hence, the answer is no.

Question 7
Jim and Tammy are partners in Business and in Life. As is all too common in this imperfect world, each has a little habit that annoys the other. Jims habit, we will call activity X , and Tammys habit, activity Y . Let x be the amount of activity X that Jim pursues and y be the amount of activity Y that Tammy pursues. Due to a series of unfortunate reverses, Jim and Tammy have a total of only 1, 000, 000 a year to spend. Jims utility function is UJ = cJ + 500 ln x 10y , where cJ is the money he spends per year on goods other than his habit, x is the number of units of activity X that he consumes per year, and y is the number of units of activity Y that Tammy consumes per year. Tammys utility function is UT = cT +500 ln y 10x, where cT is the amount of money she spends on goods other than activity Y , y is the number of units of activity Y that she consumes, and x is the number of units of activity X that Jim consumes. Activity X costs 20 per unit. Activity Y costs 100 per unit. Part 1 (5 points) Suppose that Jim has a right to half their joint income and Tammy has a right to the other half. Suppose further that they make no bargains with each other about how much activity X and Y they will consume. How much of activity X will Jim choose to consume? Solution:

25 units.
Part 2 (5 points) How much of activity Y will Tammy consume? Solution:

5 units.
Part 3 (5 points) Because Jim and Tammy have quasilinear utility functions, their utility possibility frontier includes a straight line segment. Furthermore, this segment can be found by maximizing the sum of their utilities. Notice that

UJ (cJ , x, y ) + UT (cT , x, y ) = cJ + 500 ln x 20y + cT + 500 ln y 10x = cJ + cT + 500 ln x 10x + 500 ln y 10y.
But we know from the family budget constraint that cJ + cT = 1, 000, 000 20x 100y . Therefore we can write

UJ (cJ , x, y ) + UT (cT , x, y ) = 1, 000, 000 20x 100y + 500 ln x 10x + 500 ln y 10y = 1, 000, 000 + 500 ln x + 500 ln y 30x 110y.

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Let us now choose x and y so as to maximize UJ (cJ , x, y ) + UT (cT , x, y ). Setting the partial derivatives with respect to x and y equal to zero, we nd the maximum is achieve at what values of x and y ? Solution:

x = 16.67 and y = 4.54

Part 4 (5 points) If we plug these numbers into the equation UJ (cJ , x, y ) + UT (cT , x, y ) = 1, 000, 000 + 500 ln x + 500 ln y 30x 110y , Show that the equation of the utility possibility frontier is given byUJ + UC = 1, 001, 163.86. Solution:

UJ + UC = 1, 001, 163.86.
Part 5 (5 points) Along this frontier, what is the total expenditure on the annoying habits X and Y by Jim and Tammy given by? Solution:



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