FHGMKE EC311 ‘THE OPEN UNIVERSITY OF HONG KONG August 2008 Examination INTERMEDIATE MICROECONOMICS (Apr 2008) 13 August 2008 Time Allowed: 2 hours 18:30-20:30 |Admissible/Inadmissible materials in this examination: [Material/Stationery [Material to be provided to returned to the lcandidates invigilator at the end| |(standard items) _|of the examination. 1. Calculators are allowed, (Please refer to the OUHK [1.1 Examination I. Examination Approved List.) Paper Paper |2. Dictionaries are NOT allowed. I2. 1 Answer Book |2. Answer Book |Violation of the above may lead to disqual ithe examination. ication from |3. 2 Graph Papers Instructions: 1. 2. ‘Answer this examination paper in English. Read the rubric(s) in the examination paper carefully and write your answers in the answer book, ‘graph papers as specified. Answers recorded elsewhere will not be marked. Begin each question on a new page and write the question number at the top of each page you have worked on. Write any rough work in the answer book or this examination paper and cross it through afterwards. Rough work will not be marked. Write clearly. It may not be possible to award marks where the writing is very difficult to read. After the invigilator has announced that the examination has started, write your examination number, student number and course code on the cover of the answer book or other sheet as distributed by the invigilator. Failure to do so will mean that your work cannot be identified. ‘At the end of the examination, hand over the answer book and examination paper to the invigilator. Do NOT open this examination paper until you are told to do so, otherwise you may be disqualified. (© The Open University of Hong Kong31 1G - 0) Aug 2008 ‘You should answer any FOUR of the five questions in this examination. Each question carries 25 marks. Total marks are 100. Question 1 a, Janice consumes two goods, X and Y. Janice has a utility function given by the expression: U=4x*y* ays 0s | Spr and MU, =oe~. The current prices of X and Y are $25 and 850, respectively. Janice currently has an income of $750 per time period. i, Derive Janice's budget constraint. G marks) ii, What is the optimum quantities of X and Y that Janice should choose, given her budget constraint? (6 marks) iii. Suppose that the goverment rations purchases of good X such that Janice is limited to 10 units of X per time period. Assuming that Janice chooses to spend her entire income, how much Y will Janice consume? (G marks) iv. Calculate the impact of the ration restriction on Janice’s utility. (5 marks) . Suppose an insurance company charges a premium above the expected loss for an individual, Explain why this person may still want to buy the insurance. (8 marks) Question 2 ®. Suppose the production function of ABC company is Q = 500L"°K®, where Q= annual level of output, L K = capital measured in machine hours. labor measured in person hours, ‘The marginal products of labor and capital are: MP, =300LK°* ~— MPx = 400L°SK*? ABC’s employees carn $15 per hour. The firm estimates a rental charge of $50 per hour on capital. ABC forecasts annual costs of $500,000 per year, measured in real dollars. i. Determine the company’s optimal capital-labor ratio, given the information above. G marks) ii, _ How much capital and labor should the company employ, given the $500,000 budget? Calculate the company's output, (6 marks) iii, ABC is currently negotiating with a newly organized union. The company's personnel manager indicates that the wage may rise to $22.50 under the proposed union contract. C311 (2008-0) Page 2 of 4% $-0) Avy Io Exam & Analyze the effect of the higher union wage on the optimal capital-labor ratio and the firm's employment of capital and labor. What will happen to the firm's output? (6 marks) b. “Diminishing returns to a single factor of production and constant returns to scale ate not inconsistent”, Explain. (10 marks) Question 3 a. Suppose the cost of production for a firm operating in the perfectly competitive market is given by C 2 = 200 +2 q’, where q is the level of output and C is total cost. The marginal cost of production is 44, i. If the price of the good is $100, how many units of output should the firm produce to maximize profit? (5 marks) ii, Whats the profit? (4 marks) ‘What js the minimum price that the firm will produce a positive level of output in the long. run equilibrium? (6 marks) b. Explain why goods will not be distributed efficiently among consumers if the marginal rate of ‘transformation (MRT) is not equal to the consumers’ marginal rate of substitution (MRS). (10 marks) Question 4 Consider two identical firms (Firm 1 and Firm 2) that face a linear market demand curve. Each firm has a marginal cost of zero and the two firms together face demand: P= SO - 0.5Q, where Q = Qi + Qo where Q, Q; and Q» are the total output, Firm 1°s output and Firm 2’s output respectively, and P is the price, Find the Coumot equilibrium quantity and price for each firm. (marks) b. Find the equilibrium quantity and price for each firm assuming that the firms collude and share the profit equally. (Note: The marginal revenue curve is MR = 50—Q) (6 marks) ¢. Find the Bertrand equilibrium quantity and price. (6 marks) 4. Contrast the efficiencies of the markets in (a), (b) and (¢) above. (7 marks) 311 (2008-0) Page 3 of 4Question 5 a. Joanna has a credit card account with Card Bank. Card Bank's available strategies are “raise Joanna's credit card interest rate” or “do nothing”. Joanna's available strategies are “transfer her Card Bank account balance to another creditor” or “do nothing”. If Card Bank raises Joanna's interest rate and Joanna does nothing, Card Bank increases profits by $1,000 while Joanna receives $-1,000. If Card Bank raises Joanna's interest rate and Joanna transfers her account to another creditor, Card Bank receives $-300 while Joanna receives $-100. If Card Bank does nothing and Joanna does nothing, each player receives $0. If Card Bank does nothing and Joanna transfers her account to another creditor, Card Bank receives $-300 while Joanna receives $-150. i. Draw the game tree diagramme for this sequential game. (6 marks) ii, Whatis the Nash equilibrium (if any)? (3 marks) i. Why might a seller find it advantageous to signal the quality of a product? How are guarantees and warranties a form of market signaling? (8 marks) ii. Suppose a civil servant is retiring from his job and are given two options, He can accept a Jump sum payment from the government, or he can accept a smaller annual payment that will continue for as long as he lives. How would he decide which option is the best? What information does he need? (8 marks) [END OF EXAMINATION PAPER] C311 (2008-0) Page 4 of 4‘THE OPEN UNIVERSITY OF HONG KONG APPROVED LIT OF CHLCULATORS FOR SV RMEAMINATIONS eo (inaddition to the following models, calculators bearing the “HKEAJHKEAA Approved” labels ae also allowed.) ro war = = on Be eh ‘es an _ S one Ee tein. eee EB a Biiee ES = 3 ey em ee em ee we _— — eave, ey Fim = ERK Eten a en. Igysnsmomens oe Be eum a PEE rezmrannrst MAIEMPLORER Heduzowre Re Bex ieee ae Pet ae. way we 2, 2s. He BS as