Economics 203, Fall 2003

Intermediate microeconomics
Instructor: Paul Schure

FINAL EXAMINATION
Saturday 6 December 2003, 9-11 am (2 hours)

This exam is four pages long and consists of two parts. Part 1 contains 5 short-
answer questions and carries a weight of 20 percent of your grade on this exam.
Part 2 has four longer questions, each of which is worth 20 percent. Before you
start, first fill out your details on your answer booklet. Good luck!

PART 1: SHORT-ANSWER QUESTIONS (20 percent)

The short-answer questions below are worth 4 percent each. Important notice:
your answer on each question may not exceed 50 words. If you feel that is
useful, please feel free to support your answer with a graph.

Question 1-1. In a game with n players, define what is meant by a Nash equilibrium.

Question 1-2. Rachelle is a rational agent. What do we know about her preferences?

Question 1-3. NotSoFancY Inc. is a corporation selling an inferior good to B.C.

consumers. The B.C. provincial government announces to cut (personal) income taxes.
Is this good or bad news for NotSoFancY Inc? Or do you need additional information to
make this judgment call? Explain your answer.

Question 1-4. Explain the relationship between costs in the short run and costs in the
long run. In your answer define what the “short run” means.

Question 1-5. Define what is a long-run equilibrium in a perfectly competitive market.

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PART 2 (80 percent)

Do each of the following four questions.

Question 2-1 (20 percent)

Consider the game tree below that describes a complicated (but fun) game two children
(A and B) sometimes play. The top entry of the payoff vector represents A’s payoff and
the bottom entry B’s payoff
A

up down
B
3
6 out in
A
4
2 over under

2 3
1 3

(a) Give the strategic form representation of the game above. Explain the strategies
of the players by an example.
(b) Find all the equilibria in dominant strategies.
(c) Find all the Nash equilibria.
(d) Find all the subgame perfect Nash equilibria.

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Question 2-2 (20 percent)

Elizabeth only cares for raspberries r and apples a. In fact, her utility function is given by
U (r , a ) = r 1 / 3 a 2 / 3 . Assume Elizabeth has a budget of M = 60 , and let the price of
apples be p a = 8 .

(a) Write down the consumer's problem that Elizabeth solves in case the price of
raspberries is p r = 1 . Explain in words what it says.

(b) Derive Elizabeth’s optimum bundle in case the price of raspberries is p r = 1 .

(c) Derive and draw Elizabeth’s individual demand function for raspberries.
(d) Consider Geoffrey with the following demand function for raspberries:
qGr = 10 − 2 pr . Derive the aggregated demand function in an economy of
Elizabeth and Geoffrey.

Question 2-3 (20 percent)

Suppose a monopolist has stores in two towns A and B. Assume demand in town A is
given by Q A = 55 − PA and demand in B by QB = 80 − 2 PB . The factory of the monopolist
is located in town A. Production of an amount Q costs C P (Q) = 15Q + 100 . In addition
to production costs, the monopolist faces costs to ship goods from A to B:
C S (Q S ) = 5Q S , where Q S represents the number of units shipped to B. The monopolist
can charge different prices in each city because arbitrage between the towns is
expensive.

(a) Compute the prices the monopolist charges in A and B.

(b) Compute the consumer surplus in each town, as well as the total profits of the
monopolist. [Hint: start your answer with a picture.]

The mayors of towns A and B meet one day and decide they will forbid the monopolist to
charge different prices in the two towns. As compensation, they offer the monopolist to
cover the shipment costs. [In (c) and (d) below total costs thus
become C P (Q) = 15Q + 100 !] The monopolist decides to hire a consultant. The
consultant advises the monopolist offer a two-part tariff T (Q) = vQ + F in both towns.
Since the two-part tariff is the same in both towns, the mayors are OK with this.

(c) Find the specific two-part tariff that the consultant suggests, that is, find the
optimum v and F. What quantities are sold in A and B, respectively? [Hint:
Assume that demand in each town stems from just a single (price-taking)
consumer.]
(d) Now assume that demand in town B shifts and becomes QB = 50 − 2 PB . Find the
new optimum two-part tariff. What quantities are sold in A and B, respectively?

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Question 2-4 (20 percent)1

Consider an exchange economy with only 2 agents, Arnold and Brigitte, and 2 goods, X
and Y. Arnold has utility function U A ( X A , YA ) = min{ X A , YA } and Brigitte
U B ( X B , YB ) = min{ X B ,2YB } . Here ( X A , YA ) and ( X B , YB ) represent the good bundles of
Arnold and Brigitte, respectively. Arnold has an initial endowment of ( X A , YA ) = (2,1) and
Brigitte has ( X B , YB ) = (1,2) .

(a) Draw a few indifference curves of Arnold and Brigitte in an Edgeworth box.
Indicate the set of individually rational trades. Is the initial endowment Pareto
efficient?
(b) Draw up a new Edgeworth box and indicate clearly the contract curve and the
core of this economy.
(c) Show, whether the prices p X = 1 and pY = 1 can form competitive equilibrium
prices. If not, then what are possible competitive equilibrium prices for X and Y?
[Hint: use again the Edgeworth box, but explain in words what you are doing.]

Now consider another exchange economy with 2 agents, Christine and Dermot, but with
the same goods X and Y. Christine has utility function U C ( X C , YC ) = X C1 / 3YC2 / 3 and
Dermot U D ( X D , YD ) = X D1 / 2YD1 / 2 . The initial allocation is ( X C , YC ) = (1,0) and
( X D , YD ) = (0,1) .

(d) Check whether the allocation ( X C , YC ) = (1 2 , 2 3) and ( X D , YD ) = (1 2 ,1 3) is

Pareto-efficient.
(e) Check whether the allocation of (d) and prices p X = 2 and pY = 3 can constitute
a competitive equilibrium. If not, then what are possible competitive equilibrium
prices for X and Y?

<end of exam>

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Your mark on this question will be based on your best 4 out of 5 answers on (a)-(e).