HRMS EC311 “THE OPEN UNIVERSITY OF HONG KONG August 2009 Examination INTERMEDIATE MICROECONOMICS (Apr 2009) 25 August 2009 Time Allowed: 2 hours 18:30-20:30 [Material/Stationery [Material to be provided to lreturned to the lcandidates linvigilator at the end| |(standard items) _|of the examination Admissible/Inadmissible materials in this examination: T. Calculators are allowed. (Please refer to the OUHK [1.1 Examination [1. Examination Approved List.) Paper Paper 12. Dictionaries are NOT allowed. l2. 1 Answer Book |2.. Answer Book |Violation of the above may lead to disqualification from |3. 2 Graph Papers ithe examination. J Instructions: 1, Answer this examination paper in English. 2. Read the rubrie(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 ona 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. 4, Write clearly. It may not be possible to award marks where the writing is very difficult to read. 5. 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 shect as distributed by the invigilator. Failure to do so will mean that your work cannot be identified. 6. At the end of the examination, hand over the answer book and examination paper to the invigilator. 7. Do NOT open this examination paper until you are told to do so, otherwise you may be disqualified. © The Open University of Hong Kong‘You should answer any FOUR of the five questions in this examination. Each question carries 25 marks. Total marks are 100. Question 1 a. Nancy derives utility from consuming raisin (r) and from cofive (c) as follows: Ulen) = cr" The marginal utility ofa cup of coffee (MU.) and the marginal utility of a pound of raisin (MU,) are given as follows: MU. = 0.9071! MU, =0.10"°r®? The price of a cup of coffee (P.) is $1 and the price of a pound of raisin (P,) is $30. Nancy's income is $300. i, Derive Nancy's budget constraint, (GB marks) ii, How many cups of coffee and pounds of raisin should Nancy buy to maximize utility? (6 marks) iti, Suppose that the sellers of raisin require each consumer to buy 4 pounds of raisin or none at all. How many cups of coffee and pounds of raisin should Nancy buy to maximize utility? (4 marks) iv. Is Nancy better off under the conditions in (ii) or (ii)? Explain intuitively. (5 marks) b. Explain why an insurance company is likely to behave as if it were risk neutral although the managers are risk-averse. (7 marks) Question 2 a, Suppose the School Press produces A4 papers in its local shop. The company can rent its equipment and hire workers at competitive rates. Equipment needed for this operation can be rented at $52 per hour, and labor can be hired at $12 per worker hour. The company has allocated $150,000 for the initial run of A4 papers. The production function using available technology can be expressed as: Q=0.25K°2510%, where Q represents A4 papers (boxes per hour), K denotes capital input (units per hour), and L denotes labor input (units of worker time per hour). ‘The marginal products of labor and capital are as follows: MP, = (0.75)(0.25)K°5L 025 MPx = (0.25)(0.25)K°"5L"75 EC311 (2009-0) Page 2 of 4i. Derive the isocost equation. (G marks) ii, Determine the appropriate input mix to get the greatest output for an outlay of $150,000 for a production run of Ad papers and the related level of output. (9 marks) iii, Explain intuitively what would happen to the appropriate input mix in the short run (keeping capital fixed) if production were changed to 1,500 boxes of A4 papers per hour? Would the input combination be different in the long run? If so, how would it change? (Note: Calculation is not required in this part of question.) (7 marks) b. Discuss whether economies of scale and returns to scale are the same. (6 marks) Question 3 a. The perfectly competitive market for unskilled labor can be represented by the following supply and demand curves: Ly =32000- 4000W Ls =-8000 + 6000W, where L = millions of person hours per year, and W = the wage in dollars per hour. i. Calculate the equilibrium price and quantity that would exist under a free market. What impact does a minimum wage of $3.35 per hour have on the market? (6 marks) ii, ‘The government is contemplating an increase in the minimum wage to $5.00 per hour. Calculate the impact of the new minimum wage on the quantity of labor supplied and demanded, Does it cause any unemployment? (6 marks) iii, Calculate producer surplus (labors’ surplus) before and after the proposed change in minimum wage (from $3.35 per hour to $5.00 per hour). Comment on the net effect of the proposed change upon workers as a whole and on individual workers. (7 marks) b. What is the relationship between the production possibilities frontier and the production contract curve? Explain. (6 marks) Question 4 a. Suppose that the market demand curve for mountain spring water is given as follows: P=1200-Q Mountain spring water can be produced at no cost. i. What is the profit maximizing level of output and price of a monopolist? (Note: The ‘marginal revenue curve is MR = 1200 -2Q.) (6 marks) ii, What level of output would be produced by each firm in a Cournot duopoly in the long run? What will the price be? (6 marks) iii, What will be the level of output and price in the long run if this industry is perfectly competitive? (6 marks) EC311 (2009-0) Page 3 of 4b, Bookstores often offer annual memberships that allow customers to purchase books at a 10% discount. Explain why this may increase profits of the bookstore. (7 marks) Question 5 a. Suppose the semiconductor market is controlled by two firms: Firm A and Firm B. The structure of the market makes secret price cutting impossible, Each firm announces a price at the beginning of the time period and sells semiconductors at the price for the duration of the period. There is very little brand loyalty for semiconductor buyers so that each firm's demand is highly elastic. Each firm's prices are thus very sensitive to inter-firm price differentials. The two firms must choose between a high and low price strategy for the coming period. Profits (measured in thousands of dollars) for the two firms under each price strategy are given in the payoff matrix below. (Firm B's profit is before the comma and Firm A's profit is after the comma.) Firm A Low Price High Price Firm B Low Price 60, 60 250, -20 High Price |__-20, 250 130, 130 i. Does either firm have a dominant strategy? What strategy should each firm follow? Explain. (5 marks) ii, Suppose the game is to be played an infinite number of times. Would the tit-for-tat strategy be a reasonable choice? Explain. ( marks) iii, Suppose the game is to be played a very large (but finite) number of times. What is the appropriate strategy if both firms are always rational? Explain. (5 marks) b, Explain the nature and consequences of asymmetric information for each of the following cases, What options are available in each instance to reduce the problem? i, Professional athletes (5 marks) ii, Markets for used appliances (S marks) [END OF EXAMINATION PAPER] EC311 (2009-0) Page 4 of 4