YSGOL BUSNES BANGOR

BANGOR BUSINESS SCHOOL

Arholiadau Diwedd Semester 1 2018/19

End of Semester 1 Examinations 2018/19

ASB- 2307 Microeconomics

Amser a ganiateir: 2 ½ hours

Time allowed: 2 ½ hours

Cyfarwyddiadau / Instructions:
No programmable calculators are permitted

This exam is split into two sections:

Section A (30 marks): ANSWER ALL QUESTIONS

Section B (70 marks): ANSWER TWO QUESTIONS

Trowch y dudalen drosodd pan ddywedir wrthych / Please turn over when instructed
SECTION A: ANSWER ALL QUESTIONS (3 marks per question, 30 marks total)

A1 A competitive price-taking firm will produce as long as its economic profit is strictly above
zero. [true/false]

A2 A mixed strategy can be a best response to another player’s strategy only if the expected
payoff from playing the pure strategies is the same. [true/false]

A3 A monopolist would not produce at all if the intersection of marginal revenue and
marginal cost occurs at a quantity at which the average cost lies above the demand curve.
[true/false]

A4 An increase in wage will cause the supply curve in the one-input model to shift in unless
labour is an inferior input [true/false]

A5 Assuming interior solution, a production plan is maximising if and only if all marginal
revenue products are equal to the input prices. [true/false]

A6 Bundle A is worse than bundle B, and bundle C is an average of bundles A and B. Then,
our usual assumptions about tastes imply that bundle B is at least as good as bundle C.
[true/false]

A7 A firm that is the only firm in the industry may not behave like a monopolist in order to
deter entry of other firms. [true/false]

A8 Cartels tend to be short-lived because of the Prisoner’s Dilemma. [true/false]

A9 Monopoly power can last only if there are legal barriers to entry for other firms.
[true/false]

A10 Assuming convex producer choice sets, the marginal technical rate of substitution is
equal (in absolute value) to the ratio of prices of inputs at any profit maximising production
plan. [true/false]

Turn over
SECTION B: ANSWER TWO QUESTIONS (35 marks per question, 70 marks
total)

Question B1

Suppose our price-taking and wage-taking firm can produce a single output 𝑥 using inputs
labour (𝑙) and capital (𝑘) according to the production function:

𝑥 = 𝑓(𝑙, 𝑘) = 70𝑙 0.3 𝑘 0.5

Assume the we operate in a short-run environment where capital is fixed at 100 units:

a) Sketch the firm’s short-run production frontier, clearly indicating the feasible set of
production plans. Is it convex?
[7 marks]

The market wage paid to labour (𝑤) is £90 per unit of labour employed, and the price the
firm receives for each unit of its output (𝑝) is £10.

b) If the firm is maximising its profit in the short-run, how much labour (𝑙) does the firm
employ?
[11 marks]

c) What is the firm’s profit maximising output at this level of labour (where output is
divisible)?
[5 marks]

d) How much profit (𝜋) does the firm make in the short-run?
[5 marks]

e) Moving to the long-run where the firm can also vary the amount of capital it employs.
Assuming that the firm must pay a rent (𝑟) of 120 for each unit of capital it employs
(but all other prices and factor-prices remain the same), would the firm employ more
or less than the 100 units of capital it employed in the short-run? Use any appropriate
method to support your answer.
[7 marks]

Turn over
Question B2

Consider an industry with 2 firms, each having marginal costs equal to 0. The (inverse)
demand curve facing this industry is

𝑃(𝑌) = 100 − 𝑌

where 𝑌 = 𝑦1 + 𝑦2 .

a) What is the competitive equilibrium level of industry output?

[6 marks]

b) If each firm behaves as a Cournot competitor, what is the firm 1’s optimal choice
given firm 2’s output?
[6 marks]

c) Calculate the Cournot equilibrium output for each firm.

[6 marks]

d) If the firms would form a cartel, what is the amount of output for the industry?
[6 marks]

e) If firm 1 behaves as a follower and firm 2 as a leader, calculate the Stackelberg

equilibrium output of each firm.
[7 marks]

f) What is the Cournot equilibrium level of industry output if the number of firms were
𝑛 → ∞?
[4 marks]

Turn over
Question B3

Two teenagers are playing Chicken. Bill drives his car south down a one-lane road, and Ted
drives his car north along the same road. Each has two strategies: Stay or Swerve. If one
player chooses Swerve he loses face; if both Swerve, they both lose face. However, if both
chose Stay, they are both killed. The payoff matrix for Chicken looks like this:

Stay Swerve
Stay -3 ; -3 2;0
Swerve 0;2 1;1

a) Find all pure strategy equilibria.

[9 marks]

b) Find all mixed strategy equilibria.

[9 marks]

c) What is the probability that both teenagers will survive?

[7 marks]

d) Comment on the two following statements:

(i) In a finitely repeated Prisoner’s Dilemma game, the Subgame Perfect

Nash equilibrium is to defect every round.
[5 marks]

(ii) In an infinitely repeated Prisoner’s Dilemma game, as long as the

discount rate is not too high, there exists a Nash equilibrium pair of
strategies such that each player finds it profitable to cooperate at each
stage.
[5 marks]

Turn over
Question B4

Suppose two agents are deciding how fast to drive their cars. Agent 𝑖 chooses speed 𝑥𝑖 and
gets utility 𝑢𝑖 (𝑥𝑖 ) from his choice, where 𝑢𝑖′ (𝑥𝑖 ) > 0. However, the faster the agents drive, the
more likely it is that they are involved in a mutual accident. Let 𝑝(𝑥1 , 𝑥2 ) be the probability of
an accident, assumed increasing in both arguments. Let 𝑐𝑖 > 0 be the cost faced by each 𝑖 in
case of accident.

a) Show that each agent has incentive to drive too fast from the social point of view.
[10 marks]

b) If agent 𝑖 is fined an amount 𝑡𝑖 , in the case of accident, how large should 𝑡𝑖 be to

internalize the externality?
[10 marks]

c) If the optimal fines are being used, what are the total costs, including fines, paid by
the agents? How does this compare to the total cost of the accident?
[10 marks]

d) Suppose each agent 𝑖 gets utility 𝑢𝑖 (𝑥) only if there is no accident. What is the
appropriate fine in this case?
[5 marks]

The end