EC2066 ZA

BSc DEGREES AND GRADUATE DIPLOMAS IN ECONOMICS, MANAGEMENT, FI-

NANCE AND THE SOCIAL SCIENCES, THE DIPLOMAS IN ECONOMICS AND SO-
CIAL SCIENCES AND THE CERTIFICATE IN EDUCATION IN SOCIAL SCIENCES

Summer 2021 Online Assessment Instructions

EC2066 Microeconomics

The assessment will be an open-book take-home online assessment within a 6-hour

window. The requirements for this assessment remain the same as the closed-book
exam, with an expected time/effort of 3 hours and 15 minutes (inclusive of 15 minutes
reading time).

For this online assessment, your answers should be carefully explained and moti-
vated.

Candidates should answer EIGHT of the following NINE questions: all FIVE
from Section A (8 marks each) and THREE from Section B (20 marks each). Can-
didates are strongly advised to divide their time accordingly. If more than EIGHT
questions are answered, only the first EIGHT questions attempted will be counted.

You should complete your assessment using pen and paper. Please use BLACK INK
only.

Handwritten work then needs to be scanned, converted to PDF and then uploaded to
the VLE as ONE individual file including the coversheet. Each scanned sheet should
have your candidate number written clearly at the top. Please do not write your name
anywhere on any sheet.

The paper will be available at 15:00 BST on Friday, 07 May 2021.

You have until 21:00 BST on Friday, 07 May 2021 to upload your file into the VLE
submission portal. However, you are advised not to leave your submission to the last
minute.

If you think there is any information missing or any error in any question, then you
should indicate this but proceed to answer the question stating any assumptions you
have made.

© University of London 2021

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Page 1 of 6
The assessment has been designed with a duration of 6 hours to provide a more flexi-
ble window in which to complete the assessment and to appropriately test the course
learning outcomes. As an open-book exam, the expected amount of effort required to
complete all questions and upload your answers during this window is no more than
3 hours and 15 minutes. Organise your time well.

You may use any calculator for any appropriate calculations, but you may not use
any computer software to obtain solutions. Credit will only be given if all workings
are shown.

You are assured that there will be no benefit in you going beyond the expected 3
hours and 15 minutes of effort. Your assessment has been carefully designed to help
you show what you have learned in the hours allocated.

This is an open book assessment and as such you may have access to additional mate-
rials including but not limited to subject guides and any recommended reading. But
the work you submit is expected to be 100% your own. Therefore, unless instructed
otherwise, you must not collaborate or confer with anyone during the assessment.
The University of London will carry out checks to ensure the academic integrity of
your work. Many students that break the University of London’s assessment reg-
ulations did not intend to cheat but did not properly understand the University of
London’s regulations on referencing and plagiarism. The University of London con-
siders all forms of plagiarism, whether deliberate or otherwise, a very serious matter
and can apply severe penalties that might impact on your award.

The University of London 2020-21 Procedure for the consideration of Allegations of

Assessment Offences is available online at:

Assessment Offence Procedures - University of London

UL21/0052 Page 2 of 6
SECTION A

Answer all FIVE questions from this section (8 marks each).

1. The government wants to regulate health insurance companies requiring them

to provide insurance coverage not just for future health problems, but also for
pre-existing conditions. For such a policy to succeed, it is important to make
purchase of health insurance compulsory for individuals. Is this true or false?
Explain your answer.

2. Consider a competitive industry with several identical firms. The long run av-
erage cost of a firm producing q units of output is given by

AC(q) = 20 + 3q2 − 12q.

Suppose factor costs are constant and there is free entry and exit. Suppose mar-
ket demand is
Q D = 30 − P.
where P denotes market price. Determine the number of firms in the industry
in the long run equilibrium.

3. The following game has three Nash equilibria. Is this true or false? Explain your
answer.

Player 2
A2 B2 C2
A1 2,2 4,2 0,4
Player 1 B1 4,0 6,8 2,2
C1 6,4 4,0 8,6

4. Under Cournot competition, the equilibrium market price is higher compared

to a collusive equilibrium. Is this true or false? Explain.

5. A monopolist has a high set-up cost and produces at a small and fixed marginal
cost. Any regulation that forces the monopolist to set price equal to marginal
cost must also provide a subsidy to the monopolist if the monopolist is to stay
in the market. Is this true or false? Explain using an appropriate diagram.

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SECTION B

Answer THREE questions from this section (20 marks each).

6. Suppose the following game is repeated infinitely. The players have a common
discount factor δ, where 0 < δ < 1.

2
C D
1 C 2,2 0,3
D 3,0 1,1

(a) Show that for high enough values of δ, there is an equilibrium of the in-
finitely repeated game in which (C, C) is played in every period. Your
answer must state the strategies of the players clearly. [8 marks]

(b) For what values of δ is it possible to sustain playing ( D, D ) each period as

an equilibrium of the infinitely repeated game? [4 marks]
(c) Calculate the value δ∗ such that for δ > δ∗ , there is an equilibrium of the
infinitely repeated game in which players alternate between ( D, C) and
(C, D ), starting with ( D, C) in the first period. [8 marks]
[Hint: Player 1 has no incentive to deviate in period 0 or any other even pe-
riods when ( D, C) is being played. Similarly, 2 has no incentive to deviate
in odd periods when (C, D ) is being played. So the only possible devia-
tions are by player 1 in odd periods and by player 2 in even periods. Given
that the game is symmetric, if we can prevent a deviation by 1, that would
also work for preventing deviation by 2.]

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 7. In each of the following situations, identify the externality and explain whether
or not the Coase theorem would provide a basis for dealing with the externality.
You must define all relevant economic concepts clearly.

(a) The Ganges river in India receives industrial effluents from hundreds of
tanneries that operate along its banks. Further, millions of litres of raw
sewage are spilled into the river from hundreds of towns and villages.
[10 marks]

(b) Your neighbour has an electrical device that is costly to run, but kills in-
sects very effectively. The longer he keeps the device on, the fewer insects
appear in your garden. [10 marks]

8. Consider the following exchange economy. There are two goods, tea and coffee,
and two consumers, 1 and 2.
Consumer 1 has utility function

1 3
U1 (t1 , c1 ) = ln(t1 ) + ln(c1 )
4 4
where t1 and c1 are the amounts of tea and coffee (respectively) that Consumer
1 consumes. Similarly, Consumer 2 has utility function

3 1
U2 (t2 , c2 ) = ln(t2 ) + ln(c2 )
4 4
where t2 and c2 denote the amounts of tea and coffee (respectively) that Con-
sumer 2 consumes. Consumer 1 is endowed with 12 units of tea and 32 units of
coffee. Consumer 2 is endowed with 4 units of tea and 16 units of coffee.
Suppose the price of coffee is normalised to 1, and let p denote the price of tea.

(a) Derive the contract curve for this economy. [5 marks]

(b) Derive the competitive equilibrium price of tea in this economy. [5 marks]

(c) Derive the equilibrium allocation of tea and coffee. [5 marks]

(d) If we can redistribute endowments suitably, is it possible to sustain the

allocation t1 = 1, c1 = 18 and t2 = 15, c2 = 30 as an equilibrium? Explain,
using any relevant result from your course to support your arguments.
[5 marks]

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 9. Consider a second-hand car market with two kinds of cars:

• Type A cars work fine with probability 9/10 and break down with proba-
bility 1/10
• Type B cars work fine with probability 1/2 and break down with probabil-
ity 1/2.

Other than the difference in the probability of break down, types A and B cars
are identical. Each seller knows the type of their own car, but this information
is not available to the buyers. The buyers only know that 1/2 the cars are type
A and 1/2 are type B.
Sellers value a car that works fine at 800, while buyers value a car that works
fine at 1000. Both sellers and buyers have a zero value for a car that breaks
down. Both sellers and buyers are risk-neutral.
There are many sellers and even more buyers, and you can assume that in any
transaction the seller gets all the surplus.

(a) Given that quality is observable to sellers but not to buyers, which type(s)
of car(s) would be traded and at what price(s)? Is the market outcome
efficient? [5 marks]

[Hint: Note that the value of a type A car to a buyer is (9/10)1000 = 900.
Similarly derive other values.]
(b) Suppose any seller can offer a guarantee, which is a contract that promises
to pay the buyer R if the car breaks down (no payment is made if the car
does not break down).
Find the range of values of R for which there is a separating equilibrium
in which type A cars sell with a guarantee and type B cars sell without a
guarantee. [10 marks]

(c) Suppose the government forces all sellers to offer a guarantee that promises
a refund of 1100 if the car breaks down. Would such a policy promote
efficiency? Explain your answer. [5 marks]

END OF PAPER

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