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EXAM DETAILS Course Code: Course Des$ription:

ECON !"# %ri$e Theory

27/10/201 1
Start time o& exam:

Date o& exam:

13:4 5

Duration o& exam:

2hr 15min

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Exam 7 page

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SECTION A Students are to attempt any two (2) questions from the six (6) questions contained in this section.

1.

(a) ( )

Briefly outline the four assumptions underlying indifference curves. Your answers should include diagrams where appropriate. !uliette consumes two goods" food (#) and clothing ($). %er utility function is given y the expression & ' #$. (he current mar)et price for food is *1 per unit" while the mar)et price for clothing is *+.,, per unit. !uliette-s current income is *1+. (i) (ii) .rite the expression for !uliette-s udget constraint. /etermine the food and clothing com ination which maximi0es !uliette-s utility" given her udget constraint.

(c)

1f the marginal utility per dollar spent on good 2 is less than the marginal utility per dollar spent on good Y" explain how the individual should ad3ust their consumption undle in order to achieve a higher level of utility. (6 4 + 4 5 4 6 ' 17 mar)s)

+.

(a)

8 price change has two conceptually separate effects 9 a su stitution effect and an income effect. &sing diagrams" explain the %ic)sian decomposition of a price increase. $ompare and contrast the effectiveness of decreasing the demand for a particular good y way of a constant per unit tax on a particular good versus an income tax. #or this comparison to e valid" the government:s revenue for each scheme must e the same. (6 4 ; ' 17 mar)s)

( )

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6.

(a)

8 new toll road was uilt in Southern $alifornia etween San !uan $apistrano and $osta @esa. =n average" drivers save 1, minutes ta)ing this road as opposed to the old road. (he toll is *+A the fine for not paying the toll is *B6. (he pro a ility of catching and fining someone who does not pay the toll is ;,C. Diven this information" for individuals who ta)e the road and pay the toll what must e the individual:s minimum valuation of the 1, minutes time saving. .hat does it mean for consumers to maximise expected monetary valueE /escri e a situation where a person might not want to maximise expected monetary value. .hat is a preferred conceptE Suppose that 1rma has an initial wealth of *5,. %er other option is to uy a vase. %er wealth is *B, if the vase is a genuine @ing vase and *1, if it is an imitation. (he pro a ility that it is a genuine @ing vase is 7,C. 1rma:s utility function is &(1) ' F1" where 1 is measure in dollars. (i) .ill 1rma purchase the vaseE Your answer should include the calculations that give rise to your decision and also whether or not this is a fair et. .hat is the maximum price 1rma would pay to insure against the vase eing an imitationE

( )

(c)

(ii)

(6 4 6 4 7 4 5 ' 17 mar)s)

(a)

1n a perfectly competitive mar)et let the mar)et supply and demand curves e as followsG @ar)et supplyG H ' I 4 + @ar)et demandG H ' +, J +I" (i) /etermine oth the consumer and producer surplus at the equili rium price and quantity. (ii) 8ssume that the government has imposed a price ceiling at *6 per unit. .hat is the si0e of the shortage in the mar)et with the price ceilingE (iii) .hat is the deadweight loss associated with the implementation of the price ceilingE

( )

"The shape of the industry long run supply curve depends on the extent to which increases and decreases in industry output affects the prices that the firms must pay for the inputs into the production process." .ith the aid of diagrams explain this statement in the context of an increasing cost industry. =utline six reasons for the consideration of competitive mar)ets.

(c)

(+ 4 + 4 + 4 6 4 6 ' 17 mar)s)

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7.

(a)

8 monopolist is deciding how to allocate output etween two mar)ets. (he two mar)ets are separated geographically. /emand for the two mar)ets is as followsG Hx ' 1,, 9 Ix Hy ' 7, J ,.7Iy @arginal costs are estimated at a constant *+,. (i) (ii) (iii) 1f the monopolist decides to price discriminate" what should the price and quantity e in each mar)etE 1f the monopolist decides to charge a single price across oth mar)ets" what price and quantity will e set in the mar)etE 1n which of the a ove situations" (i) or (ii)" does the monopolist earn the greatest profitE

( ) (c)

1f the gains to producers from monopoly power could e redistri uted to consumers" would the social cost of monopoly power e eliminatedE /iscuss. =utline the two conditions necessary for third degree price discrimination to e practiced. (5 4 5 4 + 4 6 4 + ' 17 mar)s)

6.

(a) ( ) (c)

Briefly outline the four general characteristics of monopolistic competition. .hy does 8verage (otal $ost equal price at that output level where marginal revenue equals marginal cost in the long run for the monopolistically competitive firmE 1t is argued that monopolistic competition is inefficient. .ith the aid of diagrams" explain this statement. 1n addition" riefly outline the arguments in favour of monopolistic competition. 8dvertising is widely used y monopolistically competitive firms. /iscuss the advantages and disadvantages of advertising from oth the firm:s and consumer:s perspective. (5 4 6 4 7 4 6 ' 17 mar)s)

(d)

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SECTION B Students are to attempt any two (2) questions from the four (5) questions contained in this section. B. (a) (he )in)ed demand curve model of oligopoly offers some possi le insights into why prices in oligopolistic industries appear to e slow to change. /iscuss. Your discussion should also include an outline of the wea)nesses of this model. (wo large diversified consumer products firms (#irm 8 and #irm B) are a out to enter the mar)et for a new pain reliever. (he two firms are very similar in terms of their costs" strategic approach" and mar)et outloo). @oreover" the firms have very similar individual demand curves so that each firm expects to sell one9half of the total mar)et output at any given price. (he mar)et demand curve for the pain reliever is given asG H ' + J ,.,,,6+7I where I ' I8 4 IB Both firms have constant marginal costs of *,.7, per ottle. Hatent protection insures that the two firms will operate as a duopoly for the foreseea le future. Hrice and quantities are per ottle. (i) (ii) 1f the firms act as $ournot duopolists" solve for the firm and mar)et outputs and equili rium prices. 1f #irm 8 is successful in advertising and captures a greater share of the mar)et i.e. it ecomes the Stac)el erg leader" solve for the firm and mar)et outputs and equili rium prices. (? 4 5 4 6 ' 17 mar)s)

( )

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(a) ( )

.hy is mar)et conduct in oligopolistic industries li)ened to a gameE 8s an experiment two psychologists placed two pigs J a little one and a ig one J into a pen that had a level at one end and a trough at the other. .hen the lever was pressed a serving of pig feed would appear in a trough at the other end of the pen. 1f the little pig would press the lever" then the ig pig would eat nearly all of the pig feed and )eep the little pig from getting much pig feed at all. 1f the ig pig pressed the lever there would e time for the little pig to get some of the pig feed efore the ig pig was a le to run to the trough and push the little pig away. (his situation can e represented y a game as followsG Big Pig .ait at the trough

Hress the lever L i t Hress the t lever l e .ait at the P trough i g

1A ;

1A 15

6A 5

,A ,

(i) (ii)

/oes each pig have a dominant strategyE <xplain what is meant y the term -dominant strategy-. #ind the >ash equili rium for this game" assuming that oth pigs ma)e their decisions at the same time. Briefly outline the limitations of the >ash equili rium concept. 8 sequential game is a multi9period game in which players move one at a time rather than simultaneously. .e can descri e such a game y its extensive form. 8ssuming Kittle Hig moves first" show the extended form of the a ove game. .hat is the li)ely solution to the gameE %ow might Big pig react in order to achieve a more desira le solution (from its perspective)E (+ 4 5 4 5 4 7 ' 17 mar)s)

(iii)

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(a)

The industry demand curve for labour is more inelastic than the demand schedule for the firm that would be obtained if the product prices were assumed to be unchanged. .ith the aid of a diagram discuss this statement" paying particular attention to the ad3ustment process. 8ssume that a monopoly firm faces a demand curve given y the expressionG H ' 1,, J +Y. (he firm-s production function is given y the expression Y ' +2 and the factor costs *5 per unit. (i) (ii) .rite an expression for the firm:s marginal revenue product. <xplain why the firm:s @LHK can also e considered the firm:s demand curve for la our. /etermine the profit maximising level of employment and output.

( )

(c)

8 num er of countries have a history of legal settlements of the M asic wage: i.e. minimum wages. .hat are the economic arguments against minimum wagesE (6 4 5 4 5 4 5 ' 17 mar)s)

1,

(a) ( ) (c)

.hy is the efficient level of pollution not equal to 0eroE Hu lic goods are oth non9rival and non9exclusive. <xplain each of these terms and provide examples. #irms located at different points on a river dump various quantities of pollutants into it. (he pollutants adversely impact the quality of swimming for home owners who live downstream. 8s a policy adviser for a regional planning organisation" how would you compare and contrast the following options for dealing with the harmful effect of the pollutantsG (i) (ii) (iii) 8n equal rate fee on firms located on the river. 8n equal standard per firm on the level of pollutants each firm can dump. 8 transfera le effluent permit system" in which the aggregate level of effluent is fixed and all firms receive identical permits.

(+ 4 5 4 6 4 6 4 6 ' 17 mar)s)

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