The written exam in Intermediate Microeconomics

27-09-2017
The exam consists of 6 main problems accounting for total 75 points. This makes a total of 100 points
when the max 25 points are achieved from the assignment. If you choose not to do the assignment, there
will be additional questions of 25 points in the end of the exam. To pass, 50 or more credits are required.
No educational aids (except a calculator and a language dictionary) are allowed.

Good luck!

Anh Mai

Q1. Consumer theory (10p)

A. Erik’s utility function for goods X and Y is presented as U(X, Y) = 2X0.5 + Y. Assume his
income is $100 and the prices of X and Y are $10 and $20, respectively.

a. What is his optimal consumption bundle, given income and prices of the two goods? (2p)

b. Derive the uncompensated demand curves for good X and good Y. (3p)

B. Draw indifferent curves if two goods are perfect complements. How do indifference curves look
like if two goods are perfect substitutes? (2p)

C. What information is contained in the slope of an indifference curve? Why are these curves
typically convex to the origin? (3p)

Q2. Demand and supply (15p)

A. The demand of sugar is Qd = 12-P and the supply of sugar is Qs = 2P.

a. Find the market equilibrium price and quantity. (1p)

b. Calculate price elasticity of demand for sugar at equilibrium and interpret the result. Is sugar
demand elastic or inelastic? Explain. (2p)

c. The government becomes aware of diabetes so they reinforces the policy so that half of sugar
supply would be cut. Under this circumstance, find the new equilibrium price and quantity. (1p)

d. How does the consumer surplus changes between (a) and (c)? (2p)

e. Instead of cutting sugar supply, the government changes the policy. For every unit of sugar sold,
the seller has to pay the tax of $3. Calculate the incidence of the tax on consumers and the
incidence of the tax on producers. (2p)

f. In a competitive market, how is the incidence of the tax affected if the tax is collected from
consumers? Explain. (1p)

g. Compare the policies (c) and (e). Which policy do consumers prefer? Which policy does the
government prefer? Explain. (3p)
 B. Initially, electricity is sold in New York and in other states at a competitive single price. Now
suppose that New York restricts the quantity of electricity that its citizen can buy. What will
happen to the price of electricity and quantities sold in New York and elsewhere? (3p)

Q3. Government policies on Consumer Welfare and Labor supply (10p)

A. If an individual’s labor supply curve slopes forward at low wages and bends backward at high
wages, is leisure an inferior good or a normal good? Explain. (5p)

B. Is a poor person more likely to benefit from $100 a month worth of food stamps (that can be
used only to buy food) or a $100 cash a month? Explain. (5p)

Note: Please explain each question in Q3 with a graph and label everything clearly. Do not write
more than one page for each question.

Q4. Exchange and Edgeworth Box (15p)

A. Two individuals, Fred and Helen, are in an economy with no production. Initial endowments
for Fred are 10 units of X and 6 units of Y. Helen has 8 units of X and 12 units of Y.

a. Draw an Edgeworth box for this situation. Be sure to label everything clearly (including the
endowment point). (2p)

b. What is a set of Pareto improving allocations? Show and explain the set of Pareto improving
allocations in this economy in the graph. (4p)

c. Define the concept of contract curve and show it in your graph. (4p)

B. According to the first-fundamental theorem of welfare economics a general market equilibrium

in a perfectly competitive market economy will be Pareto-efficient. Explain the concept of
general market equilibrium. Why is it Pareto-efficient? Please, include a definition of Pareto-
efficiency in your explanation. When is it OK to use a partial equilibrium analysis? (5p)

Q5. Uncertainty (15p)

a. Assume that Emil faces an investment opportunity where he can earn $0 with a 25% probability,
$150 with a 25% probability, $250 with a 50% probability. Calculate the expected value and
variance of his earnings. (2p)
b. Explain the concept of a fair bet and relate your discussion to attitudes towards risk. (3p)
c. Using a graph, show that a person whose utility function is concave pick the less risky choice if
both choices have the same expected value. Be sure to label everything clearly and also show
risk premium. (5p)
d. Research show that some people’s choices contradict the expected utility theory. Framing and
certainty effects are two such classes of violation. Please explain these concepts and motivate
how/why they contradict the expected utility theory. (5p)
Q6. Externalities (10p)

Explain why negative externalities from production lead to market failures by using a graph. Please label
everything clearly. How could the government intervene and mitigate the effects of negative
externalities? Give two examples and discuss briefly. (10p)

------------------------------------------------------------------------------------------------------------ ---------------

The additional questions for who did not submit the assignment in the course web (25p)

If you already submitted the assignment, the answers for these questions will not be corrected.

Question A (10p)

For each of the following statements, state whether it is true or false or uncertain and explain your
answers. No point are given without explanation. Each correct answer will give you 2 points.

a. I bought three of these (identical) hats because the price was $10 each and that’s how much
each is worth to me.

b. Ann regards Pepsi and Coke as perfect substitutes. Therefore, Ann’s indifference curves will be
linear with a slope of −1.

c. The equilibrium price of pork is $5 per kilogram. The government has set a ceiling at $4 per
kilogram that cause a shortage in coffee market.

d. A double increase in income is equivalent to all prices decreasing by a half.

e. $500 would be the price of fair insurance for a $10,000 car for one year, assuming that during
that year there is a 10 percent chance that it will be destroyed in an accident, leaving a $300
salvage value and no chance of any partial loss. Assume that the owner keeps the salvage value.

Question B (10p)

A consumer has the following utility function for goods X and Y:

U(X,Y) = 5XY3 + 10

The consumer faces prices of goods X and Y given by px and py and has an income given by I.

a. Write out the conditions necessary for maximizing utility subject to the budget constraint. Provide
the economic (i.e. non-mathematical) interpretation of these conditions in a graph. Why are they
necessary for the consumer to be at the optimal bundle? (5p)

b. Solve for the Compensated Demand Equations for the goods X and Y. (5p)

Question C (5p)

Suppose the demand for antibiotics is Q = 100,000. What is the elasticity of demand? If a specific tax
of $1 per dose were levied, who would bear the burden of the tax?

End!