ECO2003F: Intermediate Microeconomics Examination

May/June 2011
TIME: 3 hours
TOTAL MARKS: 160

This exam comprises TWO sections and 9 pages.

SECTION A: MULTIPLE CHOICE

This section comprises 25 MULTIPLE CHOICE questions [75
marks].
Please make sure you record your student number in pencil on your
MCQ sheet.
Negative marking applies. Each question counts 3 marks. 1 mark
will be deducted for each wrong answer.
Selecting more than one answer for the same question also incurs a
1 mark penalty.
If you leave a question blank, you will not be penalised.
Only use pencil to fill in your MCQ sheet, and erase all unwanted
marks thoroughly.

SECTION B: PROBLEM SET [85 marks]

This section has 3 parts. Please answer each part of the problem
set in a separate booklet.

Section A: Multiple choice questions (3 marks each)

1. Consider the demand function Qd = 150 - 2P. The effects of other
determinants of Qd are reflected in:
a. The intercept of the function ***
b. The slope of the function
c. Neither the slope nor the intercept of the function
d. Both the slope and the intercept of the function
2. If an individual workers labour supply curve slopes upward, which of
the following is true?
a. The substitution effect of a wage change is greater than the
income effect of a wage change.***
b. The substitution effect of a wage change is equal to the income
effect of a wage change.
c. The substitution effect of a wage change is less than the income
effect of a wage change.
d. The worker is not maximizing utility.
3. When Peters income rises, he buys more peanut butter but the share
of his budget spent on peanut butter falls. For Peter, peanut butter is:
a. A necessity ***
b. A luxury
c. A Giffen good
An inferior good

Use this graph for question 4.

4. The above figure shows four different markets with changes in either
the supply curve or the demand curve. Which graph best illustrates the
market for computers after technological advances in making
computers occur?
a.
b.
c.
d.

Graph
Graph
Graph
Graph

A
B ***
C
D

5. An upward movement along an upward-sloping Engel curve

corresponds to
a.
b.
c.
d.

upward-sloping indifference curves

an inward rotation of the budget constraint
an outward rotation of the budget constraint
a parallel shift in the budget constraint ***

6. An Engel curve for a good has a positive slope if

a.
b.
c.
d.

The
The
The
The

good is an inferior good

good is a Giffen good
good is a normal good ***
demand curve slopes downwards

7. In her article entitled School Choice, Caroline Hoxby does NOT argue
that:
a. Government should regulate the number of schools ***
b. Schools should have to compete with one another
c. Learners benefit from being able to choose between schools that
use a variety of teaching methods
d. Money should follow students

The following diagram pertains to questions 8 and 9

8. The regulation illustrated in the diagram above is

a. An import tariff
b. A sales tax
c. A floor price with surplus removal
d. A licensing scheme, for example for taxis

9. The welfare implications of the regulation depicted in the diagram is

a.
b.
c.
d.

A deadweight loss of triangles C+E

A deadweight loss of block E
B+D (gains) E (expenditure)
Depends on whether there are enough domestic producers to
capture F (producer surplus)

10. As the number of firms in an industry increases, the residual

demand curve becomes
a.
b.
c.
d.
11.

Vertical
Larger
More elastic ***
Less elastic

Marginal Revenue is
a. the increase in total revenue from selling one more unit of
output.
b. equal to P when the price elasticity of demand is infinite.
c. equal to P(1+1/e)
d. All of the above ***

12. If the inverse demand curve a monopoly faces is p = 100 - 2Q, and
MC is constant at 16, then profit maximization
a.
b.
c.
d.

is achieved by setting price equal to 21.

is achieved only by shutting down in the short run.
is achieved when 21 units are produced. ***
cannot be determined solely from the information provided.

13. A monopoly sets a price of $50 per unit for an item that has a
marginal cost of $10. Assuming profit maximization, the implicit
demand elasticity is
a. -0.2.
b. -0.8.
c. -5.0.
d. -1.25. ***
Use the following diagram to answer question 14.
14. The above figure shows the demand and marginal cost curves for a
monopoly. The deadweight loss of this monopoly equals
a.
b.
c.
d.

c + d + e + f.
c.
c + f. ***
h.

15. A flour mill holding exclusive contracts to 95% of the wheat in a

large geographic area may operate as a flour producing monopoly
locally because
a. the government will declare it a monopoly.
b. the mill controls a key input. ***
c. the mill has a very inelastic supply curve.

d. the mill is a natural monopoly.

16. If the government attempts to force a natural monopoly to charge a
price equal to marginal cost
a.
b.
c.
d.
17.

the natural monopoly's marginal cost curve will shift up.

the natural monopoly will shut down. ***
Total welfare is maximized.
the natural monopoly will still make high profits.

A perfect price discriminator

a.
b.
c.
d.

charges lower prices to customers who buy greater quantities.

charges each buyer her reservation price. ***
generates a deadweight loss to society.
charges different prices to each customer based upon different
costs of delivery.

18. The deadweight loss generated by a perfect-price-discriminating

monopoly
a.a.
equals the deadweight loss of a single-price monopoly.
a.b.
equals the sum of all lost consumer surplus.
a.c.
equals zero. ***
a.d.
is greater than the deadweight loss of a single-price
monopoly.
19. When a firm has a monopoly in a market and also perfectly price
discriminates, total welfare
a.
b.
c.
d.

is
is
is
is

lower than in a perfectly competitive market.

minimized.
maximized. ***
higher than in a perfectly competitive market.

20. If the demand for air travel were to change so that business
travellers and vacationers have the same price elasticity of demand for
air travel,
a. airlines would charge the same price to each type of flyer. ***
b. airlines would still charge business flyers a higher fare since the
traveller's employer pays anyway.
c. airlines would counter by charging vacationers a higher fare.
d. airlines would be driven out of business.
21. Many theme parks charge an entrance fee and a per-ride fee equal
to zero. This is an example of
a. a two-tier tariff. ***
b. bundling.

c. perfect price discrimination.

d. multi-market price discrimination.
22. Oligopoly differs from monopolistic competition in that an oligopoly
includes
a.
b.
c.
d.

no barriers to entry.
barriers to entry. ***
downward-sloping demand curves facing the firm.
product differentiation.

23. In the Cournot model, the output that a firm chooses to produce
increases as
a.
b.
c.
d.

the number of firms in the market increases.

its marginal cost increases.
the total output of other firms increases.
the number of firms in the market decreases.***

24. One firm previously operated as a monopoly. Now, one potential

entrant enters the market. Consumers would prefer
a. entry, and the firms to split the output equally.
b. entry, and for the incumbent to produce the Stacelberg leader
level of output. ***
c. no entry, and for the incumbent to produce the Stackelberg
leader level of output.
d. no entry, and the monopoly to continue.
25.

Monopolistically competitive firms

a.a.
have market power because they can set price above
marginal cost. ***
a.b.
have no market power because price equals marginal
cost.
a.c.
have no market power because they earn zero economic
profit.
a.d.
have no market power because of free entry.

Section B [85 marks]

This section consists of three questions. Please
answer all questions.
NB! Answer each question in a separate answer
book.
Question 1
[20
marks]
[Please round your answers for amounts of utility to 2 decimal places and
for the number of books and CDs to the nearest integer]
Thulani uses all his pocket money to buy books (B) and CDs (C). His utility
function is U = 10B0.5C0.5. The price of a book is R10 and the price of a CD
is R10. He currently spends his R200 budget buying 10 books and 10
CDs. When the price of CDs rises to R15, he chooses to buy 10 books and
5 CDs.
a. What was Thulanis initial utility level (when books and CDs both
cost R10)?
[2]
b. What is Thulanis utility level when the price of CDs rises to R15?
[2]
c. Calculate the compensating variation for this price increase.
[12]
d. Explain in words what your answer to (c) means.
[4]
Question 2
marks]
[NB! Start a new answer book]

[30

a. Sketch the relationship between Total Value Product, Average Value

Product and Marginal Value product of input i, for a product sold at a
constant price p, assuming that input j is held constant at level . Be
sure to indicate the stages of production, as well as explain the
relationship between AVP, TVP and MVP as well as how these
change if the level of changes.
[20 marks]
b. In terms of your diagram, briefly explain how the firm identifies the
optimal levels of inputs and output?
[5 marks]
c. Briefly explain what would happen to your diagram if there is
technical progress [5 marks]
NB QUESTION 3 IS ON THE FOLLOWING PAGE

Question 3
marks]
[NB! Start a new answer book]

[35

Assume SA Airways is a monopoly in the South African domestic airline

market. The inverse market demand per week for flights by passengers
(Q) is given by of p=1500 Q. The airline has a constant marginal and
average cost of $30 per passenger.
a. Calculate the (i) profit-maximising level of output, (ii) the optimal
price and (iii) the profits of SA Airways
[10]
Assume Kululatoo.com enters the market offering identical flight services
with constant marginal and average costs of $30 per passenger.
b. Compute each firm's best response function. Plot each of these
functions on a graph with q1 on the horizontal axis and q2 on the
vertical. Clearly show where equilibrium output will be determined.
[10]
c. Compute the Cournot equilibrium quantities, prices and profits for
each firm. Has consumer welfare increased, decreased or remained
unchanged in comparison to situation when SA Airways was a
monopolist?
[5]
d. In response to the increased competition, SA Airways promises in an
advertising campaign that it intends to increase its flights. Explain
intuitively (and with reference to the best response function diagram
if needed) why SA Airways will not keep this promise if both firms
announce their output decisions simultaneously.
[5]
e. SA Airways and Kululatoo.com decide to form a cartel. Calculate the
output and profits of each airline. Do you think this will be a stable
equilibrium? Explain.
[5]

10