a se EC311 OF HONG KONG August 2010 Examination INTERMEDIATE MICROECONOMICS (Apr 2010) 20 August 2010 Time Allowed: 2 hours 18:30-20:30 BE RETURNED [Material/Stationery [Material to be |Admissible/Inadmissible materials in this exai provided to Svgienreriie ena| standard items) _ lof the examination T, Caleulatorsare allowed. (Please referto the OUHK 1. 1 Examination |I. Examination Approved List.) Paper Paper l2. Dictionaries are NOT allowed. 2. 1 Answer Book |2. Answer Book Violation of the above may lead to disqualification from |3. 2 Graph Papers Ithe examination, Instructions: 1, Answer this examination paper in English. 2. 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. 3. 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 sheet as distributed by the invigilator. Failure to do so will mean that your work cannot be identified. 6, _Atthe 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 following five questions in this examination. Each question carries 25 marks. Total marks are 100. Question 1 Peter derives utility from only two goods, cakes (Q.) and donuts (Q4). His utility function is as follows: U(Qe.Qu) = QQu The marginal utility of a piece of cake (MU,) and the marginal utility of a piece of donut (MU) are given as follows: MU.=Qa = MUs=Qe Peter has an income (1) of $100 and the per unit price of cakes (P.) and donuts (Pa) are both $1. a. Derive Peter's budget constraint. (4 marks) b. What quantities of cakes and donuts will maximize Peter's utility? (6 marks) c. Suppose that a per-unit tax of $1 is levied on donuts, How will this alter Peter's utility maximizing market basket of goods? (5 marks) 4. Suppose that, instead of the per-unit tax in part (c), a lump sum tax of the same dollar amount is levied on Peter. What is Peter's utility maximizing market basket? (5 marks) e. The taxes in part (¢) and (4) both collect exactly the same amount of revenue for the government. Which of the two taxes would Peter prefer? Explain. (S marks) Question 2 a, Samuel Company produces televisions. Suppose Samuel Company can produce Q units of output by capital (K) and labour (L) according to the production function Q= 100L"*K"*, where Q represents annual output measured in units, K denotes capital input measured in machine hours, and L denotes labor input measured in person hours. The marginal products of labor (MP1) and capital (MPx) are as follows: MP, = 80L“"K°S MPx = 60L°*K*4 Samuel Company's employees earn $100 per hour. The rental charge of capital is $30 per hour. Samuel forecasts annual costs of $100,000. i. Does this production function exhibit the property of increasing return to scale, constant return to scale, or decreasing return to scale? Explain. ( marks) ii, Derive the isocost equation. (4 marks) iii, Determine the firm's optimal capital-labor ratio. (4 marks) iv. How much capital and labor should the firm employ, given the $100,000 budget? Calculate the firm's output. (6 marks) Distinguish between economies of scale and economies of scope. What is the relationship between them? (6 marks) C311 (2010-0) Page 2 of 4Question 3 a. Suppose the perfectly competitive market for good X can be described by the following equations: Demand: Q=10-P Supply: Q=P+4 where P is the per unit price and Q is the quantity. i. What are the equilibrium price and quantity? (4 marks) Suppose the gover ment imposes a $1 per unit tax on good X. ii, What will the new equilibrium quantity be? (2 marks) iii, What price (per unit) will the buyer pay? (2 marks) iv. What amount (per unit) will the seller receive? (2 marks) v. What is the tax revenue? (2 marks) b. Discuss whether it is true that market supply curve does not exist for the monopoly. (© marks) ¢. Explain whether the production possibility frontier and the production contract curve are the same. (7 marks) a. A monopolist is deciding how to allocate output between two geographically separated markets (Market 1 and Market 2). Demand and marginal revenue curves for the two markets are: Market 1: P,=15-Q,; MRi=15 -2Q; Market 2: P,=25-2Q; MR2=25 - 4Q2 where P; and P2 are the per unit price charged in Market 1 and Market 2 respectively, Q) and are the quantity demanded in Market I and Market 2 respectively, MR; and MR; are the marginal revenue curves in Market 1 and Market 2 respectively. ‘The monopolist’s total cost of production is C = 5 + 3(Q, + Q,) and marginal cost of production is $3. What are the marginal revenues, prices, outputs for these two markets and total profit if the monopolist can price discriminate? (8 marks) C311 (2010-0) Page 3 of 4b. Consider two identical firms (Firm 1 and Firm 2) that face a linear market demand curve. The marginal costs of production are the same for both firms at $2 per unit of output. The two firms together face the demand: P= 50 - 0.5Q, where Q= Qi + Qo where P is the per unit price, Q is the total quantity, Q; and Q: are the quantities for Firm 1 and Firm 2 respectively. i. Find the Cournot equilibrium quantity and price for each firm. (8 marks) ii, 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.) (4 marks) iii, Contrast the efficiencies of the markets in part (i) and (ii) above. (5 marks) Question 5 a. Firm A produces a home video game that has become very popular with children. Firm A’s ‘managers have reason to believe that Firm B is considering entering the market with a competing product. Firm A must decide whether to set a high price to accommodate entry or a low, entry deterring price. The payoff matrix below shows the profit outcome for each firm under the alternative price and entry strategies. Firm A's profit is entered before the comma, and Firm B's profit is entered after the comma. Firm B Enter Don’t Enter Firm A High Low Price i. What ou ‘ome, if any, is Nash equilibrium? Explain. (4 marks) ii. Firm A’s managers have vaguely suggested a willingness to lower price in order to deter entry. Is this threat credible in light of the payoff matrix above? Explain. (4 marks) iii, If the threat is not credible, what changes in the payoff matrix would be necessary to make the threat credible? What business strategies could Firm A use to alter the payoff matrix so that the threat is credible? (5 marks) b. Consider a game in which the prisoners” dilemma is repeated 5000 times and both players are rational and fully informed. Is a tt-for-tat strategy optimal in this case? Under what conditions would such a strategy be optimal? Explain, (6 marks) c. Suppose you eared the first class honours classification for your bachelor degree. Examine whether itis a strong signal to your future employer that you will be a highly productive worker. (G marks) [END OF EXAMINATION PAPER] EC311 20100) Page 4 of 4THEC APPROVED LIST G (Unable fling mel AMax sco ‘ATARA/AUHORA SITY OF HONG KONG “ORS FOR 2009/10 EXAMINATIONS Scene? Ibe HKEAHKEAA Approval” abel ae ai showed) is scans HOMET-PACKARO = Fe sapeees Consaart tsatw Fede tetituc cel 1 cr tie soar gue"