ETF2700/ETF9700

Sample Exam Solutions

Total: 11 + 12 + 12 + 15 + 14 + 12 + 9 = 85 marks
Question 1

(a)

(i)

(ii)

[(3+2) + 1 + (1+2+2) = 11 marks]

Discount rate: 8%.

NPV = -10 + (-5)(1.08)-1 + 8(1.08)-2 + 8(1.08)-3 + 8(1.08)-4
= -10 + -4.630 + 6.859 + 6.351 +5.880
= $4.459978... m
$4.460m

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NPV: Solar, $4.624m; wind, $4.460m.

The projects have different NPVs.
The difference: wind - solar = 4.624 - 4.460 = 0.164
A grant of $0.164m to the wind project would equalize the NPVs.

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(b)

Solar: because it has a higher NPV.

But, only a little higher and Solar requires a higher outlay.

(c)

(i)

IRR:

discount (interest) rate at which NPV = $0

OR
the actual rate of return expected to be yielded by the project.

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(ii)

Wind is preferable as it has higher IRR.

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Solar, 17.75%; wind farm, 19.5%.
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[Solar, 17.7169%; wind farm, 19.5945% electronically.]
IRR was estimated from Exhibit 1.1: the Discount Rate where NPV = $0,
ie, the point where each graph intersects the horizontal axis.
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(iii)

Compare answers for (b) and (c)(ii).

The choice of project was different:
- solar in (b)
because it had higher NPV.
- wind in (c)(ii)
because it had higher IRR.

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These answers differed because they were based on different criteria.

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The IRR calculations are based only on the cash flows of the projects,
while the NPV calculations rely on external data (i.e., discount rate).
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As Exhibit 1.1 shows, the result of a choice based on NPV depends on the
prevailing discount rate. With a different discount rate, (b) and (c)(ii) could
result in the same choice.

Question 2
(a)

[5 + (4+1+2) = 12 marks]

At equilibrium, supply = demand.

60e0.0025Q
= 180e-0.005Q
Multiply both sides by e0.005Q /60.
[e0.005Q /60]*60e0.0025Q = [e0.005Q /60]*180e-0.005Q
e0.0025Q + 0.005Q = (180/60)e0
e0.0075Q = 3

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ln[e0.0075Q]= ln(3)
0.0075Q = ln(3)
Q
= [ln(3)]/0.0075
Q
= 146.482
[ie, approximately 146 blocks.]

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P = 60e0.0025Q = 60e0.0025*146.482 = $86.535

[60e0.0025*146 86.431]
(b)

(i)

(ii)

(iii)

d
= (dQ/dP)(P/Q)
P
= 180e-0.005Q
dP/dQ = 180(-0.005)e-0.005Q
= -0.9e-0.005Q
= (1/180)(-0.9)180e-0.005Q
= -P/200
dQ/dP = -200/P
d
= (dQ/dP)(P/Q)
= (-200/P)(P/Q)
= -200/Q

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TB p350

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Q.E.D.

At Q = 146.482,
d = -200/Q = -200/146.482 = -1.36536 -1.365
Since |d| > 1, demand is elastic.
At equilibrium (price P = $86.535, demand Q = 146.482),
a point elasticity of -1.365 indicates
a 1% increase in price
1.365% decrease in demand.

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Question 3
(a)

Profit = TR TC
= P*Q
(TVC + TFC)
= Q(140 2Q) [(1/3)Q3 10Q2 + 188Q
= 140Q 2Q2 - (1/3)Q3 + 10Q2 - 188Q 200
= -(1/3)Q3 + 8Q2 48Q 200

(b)

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+ 200]

(i) Turning points occur when d/dQ = 0.

d/dQ = -3(1/3)Q2 + 16Q 48
= -Q2 + 16Q 48 = 0

(ii)

(iii)

(c)

[3 + (4+3+1) + 1 = 12 marks]

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Quadratic coefficients: a = -1, b = 16, c = -48.

Solutions are (1/2)(-1){-16 [162 4(-1)(-48)]}
= (-1/2){-16 64}
= {16 8}/2
=84
Answer: turning points at Q = 4 and Q = 12.

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d2/dQ2 = d(-Q2 + 16Q 48)/dQ

= -2Q + 16
At Q = 4, d2/dQ2 = 8 > 0.
Turning point is a (local) minimum.
At Q = 12, d2/dQ2 = -8 < 0.
Turning point is a (local) maximum.

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= -(1/3)Q3 + 8Q2 48Q 200

At Q = 12,
= -(1/3)(12)3 + 8(12)2 48(12) - 200
= -200
Answer: -200.

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If profit is -200 at most, this enterprise is not viable it runs at a loss!

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Question 4
(a)

[4 + (1+9+1) = 15 marks]

= MPL = AL-1K
> 0 because A, , L & K > 0.
So, with K held constant, as L increases, Q increases.
QL

Lect 7, Slide 5.

QLL
= ( - 1){Q}/L2
QLL
< 0 because , Q & L > 0, but ( - 1) < 0.
[0 < < 1]
So, the curve is concave to the origin.
With K held constant, as L increases, Q increases, but at a decreasing rate.
Therefore, MPL decreases (rate of change < 0) as L increases.
ie, as L increases, the marginal increase in Q diminishes.

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This illustrates the Law of Diminishing Returns to Labour.

(b)

(i)
(ii)

Budget constraint: 20L + 50K = 1,000.

L = 50L0.4 K0.6 + (1,000 20L 50K)
Step 1
LL = 50(0.4)L-0.6K0.6 20
= 20L-0.6K0.6 20
LK = 50(0.6)L0.4K-0.4 50
= 30L0.4K-0.4 50
L
= 1000 20L 50K
st
Step 2
Equate 1 derivatives to zero & solve.
-0.6 0.6
LL :
20L K 20 = 0 20 = 20L-0.6K0.6 = L-0.6K0.6 /1
LK:
30L0.4K-0.4 50 = 0 50 = 30L0.4K-0.4 = 0.6L0.4K-0.4
So, = L-0.6K0.6 = 0.6L0.4K-0.4
Multiply b.s. by L0.6K0.4
L0.6K0.4 L-0.6K0.6 = 0.6L0.4K-0.4 L0.6K0.4
L0K1 = 0.6L1K0
K = 0.6L
L:
1000 20L 50K = 0 1000 20L 50(0.6)L = 0
1000 -20L -30L = 0 50L = 1000
L = 20
1000 20(20) 50K = 0 1000 400 = 50K
K = 12
[BTW, = 0.736022]

(iii)

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= 50L0.4K0.6
= (50)200.4120.6 = 736.0219 736.022
736 shoes

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Question 5
(a)

(i)

(ii)

[(2+1+5) + 3 + 3 = 14 marks]
At market equilibrium, demand = supply.
Good X: 120 2PX + 3PY = -240 + 6PX
Good Y: 150 + 6PX 4PY = -150 + 6PY

[
[

360 = 8PX - 3PY

300 = -6PX + 10PY /1
150 = -3PX + 5PY

][ ] [ ]
][ ] [ ]

8 3 P X = 360
6 10 PY
300

or

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8 3 P X = 360
3 5 PY
150
ie, AX = B
(iii)

= 8*10 (-6)(-3) = 62

8 3
6 10

AX = B
X =(1/ 62)

=( 1/ 62 ) 10 3
6 8

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X = A-1B

[ ][ ]
10 3 360
6 8 300

PX = (10*360+ 3*300)/62 = 4500/62 = $72.58

PY = (6*360 + 8*300)/62 = 4560/62 = $73.55
NB, the solution required the use of A-1.
(b)

(c)

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Y = Xb + e
Pre-multiply b.s. by XT.
XTY = XTXb + XTe
= XTXb + 0
since XTe = 0
= XTXb
Since X: n(k+1), XT: (k+1)n
XTX: (k+1)(k+1)
T
So, X X is square and, by the assumption (given), it has an inverse.
XTXb
= XTY
Pre-multiply b.s. by (XTX)-1
(XTX)-1XTXb = (XTX)-1XTY
Ib
= (XTX)-1XTY
b
= (XTX)-1XTY

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AX = B
There are 5 equations and 5 unknowns 55 coefficient matrix.
This coefficient matrix has 2 identical rows, so its determinant = 0 and its rank < 5.
Therefore, it cannot have a unique solution.
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[Rank of coefficient matrix A is 4; rank of augmented matrix is 5.]
Alternatively, equations (1) and (3) have the same coefficients, but different constants on the
RHS. So, these equations are contradictory. So, there is no solution.

Question 6
dQ P 1
=
(a)
dP Q Q

[7 + 5 = 12 marks]

dQ/dP = (-1/Q)(Q/P)

dQ

= -1/P

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= (-1/P)dP

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1 dQ = - (1/P)dP

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General solution for Q:

Q
= -ln(P)
(We know that P 0. So, we dont need to write |P|.)
+c

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P = 120 when Q = 0. So, the particular solution for Q:

Q
= -ln(P) + c
0 = -ln(120) + c
So, c = ln(120) = 4.7875

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(b)

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= -ln(P) + c

Q = -ln(P) + ln(120)
Q = -ln(P) + 4.7875
Q = ln(120/P)

Evaluate
1

x ln x dx
Substitution: u = ln(x)
du/dx = 1/x
du = dx/x

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dx/[xln(x)]
= (dx/x)[1/ln(x)]
= du[1/u]
= du/u
= ln(u) + c
= ln[ln(x)] + c

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QUESTION 7 (Show all calculations)

(a)

(i)

(ii)
(b)

(c)

[(2.5+1) + 2.5 + (1+2) = 9 marks]

1970s: CPI rose by from 313 to 766.

100*(766 313)/313 = 144.728% increase.
1980s: CPI rose by from 844 to 1714.
100*(1714 844)/844 = 103.081% increase.
Answer: the 1970s.

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Purchasing power in 1980 is (1/844)*100 = $0.118 $0.12 (1945 $).

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Real growth rr = {(1 + r)/(1 + ri)} - 1

Money could be invested at r = 0.072 pa.
CPI increased by (107.6/105.8) 1 = 0.017013
So, ri = 0.0170132
rr
= {(1 + r)/(1 + ri)} 1
= {(1 + 0.072)/(1 + 0.017013)} 1
= {1.072/1.017013} 1
= 0.05406715
Answer: 5.41%.

(1.7013%)
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(i)

The ABS periodically surveys the Australian population and updates this pattern of
usage (weights).
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{The CPI is based on an average consumption pattern of goods and services. The problem
is that this pattern changes over time, so it has to be updated. So, every 5 years or so, the
ABS surveys the Australian population and updates this pattern of usage the goods and
services included in the basket may be changed, and their relative weights will be changed.}
(ii)

Purpose of the index: measure changes over time in prices.

If the quantities change over time (very likely),
then the index will reflect changes in prices and in quantities.
So, for the index to reflect only price changes,
it should use the same quantities at each time period.

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