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ECO2003F: Intermediate Microeconomics Examination
May 2009
TOTAL MARKS: 240
This exam comprises TWO sections and 16 pages.
SECTION A and B each count 50% of the examination mark.
SECTION A: MULTIPLE CHOICE This section comprises 30 MULTIPLE
CHOICE questions.
Please make sure you record your student number in pencil on
your MCQ sheet.
Negative marking applies. Each question counts 4 marks. 1 mark
will be deducted for each wrong answer.
Selecting more than one answer for the same question incurs a 1
mark penalty too.
If you leave a question blank, you will not be penalised.
Only use pencil to fill in your MCQ sheet, and erase all
unwanted marks thoroughly.
SECTION B: PROBLEM SET
Please answer each question of the problem set in a separate
booklet
Note question 4 requires only one option A or B to be
submitted.
TIME: 3 hours
The duration of this examination paper includes appropriate
reading time.
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Section A (120 marks):
ANSWER SECTION A ON THE MCQ SHEET USING PENCIL.
1. Bryan likes Pete Philly, a hip-hop artist, whose CDs (X) are
only available on import, but whose
music can be downloaded in lower quality mp3 format (Z) for a
price strictly above zero. For
Bryan:
A) Pete Philly CD tracks and mp3s are perfect substitutes B)
Pete Philly CD tracks and mp3s are perfect complements
C) =/
/< 0
D) =/
/> 0
E) The own price elasticity of mp3 format tracks is
2. Consider the graphs below.
In relation to the two scenarios shown in A) and B) above, which
of the following statements apply:
(i) Good X increases in price if the critical threshold, X is
exceeded (ii) Good X decreases in price if the critical threshold,
X is exceeded (iii) Assuming X is exceeded, the new price is
applied to the entire consumption bundle in
scenario A (iv) Assuming X is exceeded, the new price is applied
to the entire consumption bundle in
scenario B (v) The price of Y changes beyond X in scenario A
A) (i) & (v) only B) (i) & (iii) only C) (ii) &
(iii) only D) (ii) & (iv)only E) (iv) & (v) only
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3. The solution to a Lagrangian optimisation problem yields the
following demand equation for
Good X: =
12 where m is income, p1 is the price of Good X and p2 is the
price of Good Y.
Which of the following statements accord with the preceding
demand equation?
(i) X & Y are complements (ii) X & Y are substitutes
(iii) The demand for Good X is unrelated to the demand for Good Y
(iv) X is a normal good (v) X is an inferior good
A) (i) & (iv) only B) (ii) & (iv) only C) (iii) &
(v) only D) (i) & (v) only E) (iii) & (iv) only
4 . Which of the graphs below match the same type of good as
Good X in the preceding question?
A) Graph A B) Graph B C) Graph C D) Graph D E) None of the
above
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Consider the decomposition below for questions 5 & 6.
5. If the initial budget constraint is CL in the preceding
decomposition, which of the following
statements apply
(i) The total change in demand for Y is the distance from F to
E
(ii) The substitution effect reduces the demand for Y from D to
F
(iii) The total change in demand for X is from H to I
(iv) The substitution effect reduces the demand for X from H to
G
(v) The income effect reduces the demand for X from I to G
A) (i) & (iii) only
B) (i), (iii) & (iv)
C) (i), (iii) & (v)
D) (ii) & (iv) only
E) (ii), (iv) & (v)
6. The preceding graph shows
A) that good Y is an inferior good, X is a normal good and
decomposes the total effect of a price
increase of good Y
B) that good Y is a Giffen good, X is a normal good and
decomposes the total effect of a price
decrease of good Y
C) that good Y is an inferior good, X is a normal good and
decomposes the total effect of a price
decrease of good Y
D) that good X is an inferior good, Y is a normal good and
decomposes the total effect of a price
increase of good X
E) that good X is an inferior good, Y is a normal good and
decomposes the total effect of a price
decrease of good X
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7. If goods X & Y
(i) are perfect complements, they must be consumed in fixed
proportions
(ii) are easily substitutable we expect a large income effect in
response to price changes
(iii) are easily substitutable and x becomes more expensive than
y, we expect a large substitution
effect
(iv) cost the same one would consume equal amounts of both
(v) are salt and sugar, we would expect both the income effect
and substitution effect to be
small if either of their prices changed
A) (i) & (ii) only
B) (i) & (v) only
C) (ii) & (v) only
D) (i), (iii) & (v)
E) (iii), (iv) & (v)
8. Regarding Giffen and inferior goods, which of the following
statements hold
(i) With inferior goods if price increases the quantity demanded
of that good increases
(ii) With Giffen goods if price increases the quantity demanded
of that good increases
(iii) With both inferior goods and Giffen goods the income
effect increases demand for that good
if the price rises
(iv) If a good is an inferior good but not a Giffen good the
substitution effect is always smaller
than the income effect
(v) If a good is an inferior good but not a Giffen good the
substitution effect is always larger
than the income effect
A) (i), (ii) & (iii)
B) (ii) & (iii) only
C) (i) & (iv) only
D) (ii), (iii) & (iv)
E) (ii), (iii) & (v)
9. Which of the following statements are true? (i) It is
possible that a consumer will pick the same market basket when
faced with a choice
of a cash grant or a single product subsidy of equal value
(ii) Cash grants shift part of the budget line to the right but
single product cash subsidies shift
the entire budget line to the right
(iii) A cash grant always allows the consumer fewer choices than
a subsidized price of equal
value for one commodity
(iv) A cash grant always allows the consumer more choices than a
subsidized price of equal
value for one commodity
(v) The government should not provide cash grants because the
consumption of food does not
rise as people make poor decisions about how they should spend
unconditional grants
A) (i) & (iv) only
B) (ii) & (iv) only
C) (ii), (iii) & (v)
D) (i), (iii) & (v)
E) (i), (iv) & (v)
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10. Which of the following statements apply in relation to the
bias in typical CPI calculations?
(i) CPI tends to overstate increases in the cost of living
(ii) CPI tends to understate increases in the cost of living
(iii) CPI bias arises because of the income effect
(iv) CPI bias arises as a result of a failure to account for the
substitution effect
(v) CPI bias is larger the more substitutable consumption items
are
A) (i) & (iv) only
B) (ii) & (iii) only
C) (ii) & (iv) only
D) (i), (iv) & (v)
E) (ii), (iii) & (v)
11. Conspicuous consumption as an ability signal is
A) Completely different to the prisoners dilemma B) Stronger if
the nature of positional goods causes everyone to consume more
extravagantly
C) Likely to continue even if it is wasteful for all
concerned
D) Characterized by lower levels of consumption
E) Directly proportional to the amount of other information
available about the person.
12. The Lemons argument helps to explain why:
A) Physical depreciation is the only reason for the sharp price
differential between new and used cars
B) Physical depreciation is an insufficient reason for the sharp
price differential between new and
used cars
C) Used cars fail to satisfy consumer demands for
transportation
D) It is irrational to buy a new car
E) New and used cars sell for more than their intrinsic value
would suggest
13. Toms utility function is given by U = M1/2. Tom has a
choice: take R100 in cash or take a
gamble based on the flip of a (fair) coin. If Tom takes the
gamble, the outcomes are as follows:
heads, he wins R225; tails, he wins R49. Tom will
(i) Take the R100 in cash
(ii) Take the gamble
(iii) Be indifferent between the cash and the gamble
(iv) We cannot say as we do not know Toms initial value of M (v)
Tom is risk averse and will never accept a gamble
A) (i) and (v)
B) (iv) only
C) (ii) only
D) (iii) only
E) (v) only
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14. The Kahneman-Tversky value function is
A) A conventional utility function
B) Much steeper in losses than gains
C) Much steeper in gains than in losses
D) Not defined over changes in wealth
E) C) and D) are both correct
15. Adverse selection is the process by which (i) "Undesirable"
members of a particular market are more likely to participate in
exchange (ii) "Undesirable" members of a particular market are less
likely to participate in exchange (iii) Adversaries communicate
negative messages (iv) Full-disclosure becomes impossible
A) (i)
B) (ii), (iii) and (iv)
C) (iii) and (iv)
D) (iv)
E) (i) and (iv)
16. Suppose that at a firm's current level of production the
marginal product of capital is equal to
10 units, while the marginal rate of technical substitution
between capital and labour is 2. Given
this, the marginal product of labour must be
A) 5 B) 20 C) 0.2 D) 0.05 E) cannot be determined
17. Which of the following production functions exhibits
increasing returns to scale?
A) Q = K1/2L1/2 B) Q = K1/2L2/3 C) Q = K1/4L1/3 D) Q = K/L E)
None of the above
18. Output for a simple production process is given by Q = 2KL,
where K denotes capital, and L
denotes labour. The price of capital is R25 per unit and capital
is fixed at 8 units in the short run.
The price of labour is R5 per unit. What is the variable cost of
producing 80 units of output?
A) R200
B) R33
C) R25
D) R40
E) None of the above
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19. Joe is self-employed in a shop that has a rental value of
R500 a month which he pays. His
other expenses are R100 a month for maintenance. He makes
R25,000 a year on net sales (total
revenue minus the wholesale cost of the product). If he quit his
job and worked the same number
of hours elsewhere at a job he liked equally well, he estimates
that he could make R20,000 a year.
No one else can be hired to work in the store. Suppose that Joe
had a long term lease which
requires him to pay the rent even if he doesn't operate the
store. What should Joe do?
A) Quit immediately and take the alternative job B) Keep his
current job until circumstances change C) Keep his current job
until the lease expires D) He is indifferent between his current
job and the alternative job E) It is impossible to say with the
information given in the problem
20. Suppose an island has 1000 adults living on it. All are of
working age (16-64). 600 people are
working. 200 people actively searched for work in the last week.
100 would like to work, but have
given up hope of ever finding a job so no longer bother to
search. Which of the following
statements is/are correct?
(i) The narrow (ILO) unemployment rate is 25% and the narrow
(ILO) labour force
participation rate is 80%
(ii) The narrow (ILO) unemployment rate is 25% and the narrow
(ILO) labour force
participation rate is 89%
(iii) The narrow (ILO) unemployment rate is 20%
(iv) The broad/expanded unemployment rate is 30%
A) (i) and (iv) are correct B) (iii) and (iv) are correct
C) Only (i) is correct
D) Only (ii) is correct
E) (ii) and (iv) are correct
21. The strategic or normal form representation of a game
comprises:
(i) A list of participants (the players)
(ii) A list of strategies for each player
(iii) A list of payoffs for each player, associated with each
strategy profile (i.e. each combination
of strategies of each player)
Which of the following combinations is true? A) Only (i) is
correct B) Only (i) and (ii) are correct C) Only (i) and (iii) are
correct D) (i), (ii) and (iii) are correct E) Only (ii) and (iii)
are correct
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22. The prediction that a player (say, player 1 in a two-player
game) will not choose a strictly
dominated strategy requires that:
A) Player 1 is rational B) Both players are rational C) Player 1
is irrational D) Both players are rational and each players knows
the other is rational E) Both players are rational; each players
knows the other is rational; and each player knows that
the other knows that he/she is rational
23. Nash equilibrium as prediction of choices requires in a
two-player game requires that:
A) Player 1 is rational B) Both players are rational C) Player 1
is irrational D) Both players are rational and each players knows
the other is rational E) Both players are rational; each players
knows the other is rational; and each player knows that
the other knows that he/she is rational, etc i.e. rationality
and common knowledge of rationality
24. In an Edgeworth box of the production sector, the contract
curve in the interior of the box shows:
A) Where marginal rates of technical substitution of the two
producers are equal B) The fair allocation of output C) The unique
allocation of output that is best for the economy D) The initial
endowment of inputs in the economy E) The allocation where
producers outputs are equal
25. In a two-person, two-good economy, mutual beneficial
exchange will occur so long as:
A) the initial allocation of goods results in an uneven division
of the two goods between the two consumers
B) one person can be made off better than before C) the two
consumers are free to trade D) one consumer has the total amount of
one good and the other consumer has the total amount
of the second good E) the marginal rates of substitution are not
the same for both consumers
26. Use the following diagram of an Edgeworth exchange box to
answer the following question:
OB
OA
Z
V
Y
X ICA
ICB
Hot-Dogs
Apples
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Which of the following are Pareto improving equilibrium
positions given initial allocations Z?
A) Any point on part OAV of the contract curve B) any point on
part VY of the contract curve C) any point on entire contract curve
OAOB D) any point on part OBY of the contract curve E) any point
within the area enclosed by VXYZ
27. The diagram below presents a production possibility
frontier, various relative price curves and various community
indifference curves for an open economy. Use the diagram to answer
the following question:
Assume initial equilibrium is given by point A. Assume there is
an increase in world demand for
cloth. The new consumer equilibrium is given by:
A) A B) B C) C D) D E) E
28. Use the following diagram to answer the following
question:
An economy finds itself at point A where the relative price
(Px/Py) equals 5, the Marginal rate of Transformation (slope of the
Production possibility frontier) equals 1 and consumer equilibrium
is at B. Which of the following are correct?
(i) The opportunity cost of producing X at A is lower than the
relative price of X (ii) Production of X will decrease and
production of Y will increase (iii) At given relative prices (Px/Py
= 5) and production at A, consumers will consume more
X and less Y (iv) Production of X will increase and production
of Y will decrease
X
Y
A
Px/Py=5
IC
B
Cloth
E
Cars
B
A
C
D
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A) (i), (ii) and (iii) B) (i), (iii) and (iv) C) (iii) and (iv)
D) (i) and (iv) E) (ii) and (iv)
Use the table below to answer questions 29 & 30:
Table: Ricardian production conditions in Country A and Country
B
Countries Wine Cloth
Country A 1hr/bottle 2hr/metre
Country B 6hr/bottle 3hr/metre
29. The price of wine (Pw) relative to the price of cloth (Pc)
in autarky is:
A) Pw / Pc = in country A B) Pw / Pc = 1 in country A C) Pw / Pc
= 1/6 in country A and B D) Pw / Pc = 2/3 in country A and B E) Pw
/ Pc = 1/2 in country B.
30. Which country has comparative advantage in which
product?
A) Country A has a comparative advantage in cloth while Country
B has a comparative advantage in wine
B) Country A has a comparative advantage in wine while Country B
has a comparative advantage in cloth
C) Country A has a comparative advantage in both wine and cloth
D) Country B has a comparative advantage in both wine and cloth E)
Both countries have a comparative advantage in both goods
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Section B. Long questions (120 marks).
REMINDER ~ please answer each question in a separate answer book
and ensure that you write
the question number on the cover.
Question 1 (40 marks)
This question is comprised of parts A), B) and C). Parts A) and
B) each compare two policy options
for a government looking to intervene in the education
market.
Policies (i) & (ii) are each shown separately in the bottom
panels, whereas A) & B) (top panels)
show the effects of policies (i) & (ii) superimposed on one
another.
In both A) & B):
S1 shows the level of schooling prior to government intervention
in the education market.
The price of the mandated amount of government education is
pe
When asked to describe the type of policy being employed be sure
to comment on how and why the
price of education changes, and the amount of education consumed
as a result.
Part A
(i) Please describe the type of policy (oppq) being employed in
(i) (5 marks) (ii) Please describe the type of policy (opr) being
employed in (ii) (5 marks) (iii) Please relate the final
consumption of education in (i) to (ii). Do you always expect to
see
this pattern? How does the level of funding and individual
preferences matter? (10 marks)
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Part B
(i) Please describe the type of policy being employed in (i)
(uvvw) (4 marks) (ii) Please describe the type of policy being
employed in (ii) (uvw) (4 marks)
Part C
Please note (i)-(iv) require concise (one or two line)
answers!
(i) If you consider both A) & B) to how would the size of
voucher/fixed quantity subsidy/tax rebate on educational
expenditure affect the amount of schooling obtained? (3 marks)
(ii) According to Hoxby, which conditions are necessary if a
school choice programme is to produce general improvements in
educational quality? (3 marks)
(iii) Why does the difference between transferable vouchers and
forfeitable fixed-quantity subsidies/rebates arise? (4 marks)
(iv) Do transferable vouchers paid to students always result in
the same or more education being consumed than the provision of
fixed quantity subsidies paid to schools? (2 marks)
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Question 2 (40 marks).
Part A
The total cost function is TC = 10Q3- 50Q2+ 1000Q + 500.
(i) When does diminishing returns to production set in? (5
marks)
(ii) At what output is AVC = MC? (3 marks)
(iii) At what output does ATC reach its minimum? (5 marks)
(iv) Explain in words why the AVC reaches its minimum before the
ATC reaches its minimum.
(2 marks)
Part B
Sketch a perfectly competitive firm operating in short-run
equilibrium but making economic
losses. Put in all the functions necessary to show that the firm
should stay in business in the short-
run despite the losses. Shade in the area of loss.
(12 marks)
Part C
(i) Explain what is meant by the term reservation wage. (3
marks) (ii) Explain how changing levels of education may affect the
reservation wage in South Africa.
(4 marks) (iii) Discuss the affect of social assistance grants
on the reservation wage in South Africa.
(6 marks)
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Question 3 (20 marks)
Assume Home is a two-good (Cloth and Machinery), two-factor
(Capital and Labour) economy
characterised by constant returns to scale production
technology, perfect competition and identical
consumers. Home has a comparative advantage in the production of
Machinery.
(i) Briefly discuss the consumption, production and product mix
conditions required for the economy to be in general equilibrium
under free trade. (10 marks)
(ii) Use the production possibility frontier diagram to show the
effect on production, consumption, trade flows and national welfare
in the Home country if Foreign country growth is biased towards
machinery. (10 marks)
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Question 4 (20 marks)
ANSWER ONE OF THE FOLLOWING TWO QUESTIONS (4A OR 4B)
QUESTION 4 A (20 marks; 4 marks each)
(i) In the following game, find the only profile that survives
the iterated elimination of strictly dominated strategies.
L R
A )6,4( )2,5(
B )1,5( )3,8(
C )0,6( )3,6(
(ii) Find the unique Nash equilibrium of the following game:
C D
A )10,1( )3,5(
B )7,2( )6,8(
(iii) Indicate whether the statement is true or false; and very
briefly (one concise sentence, maximum) explain why, or why not. In
the basic Bertrand model (of price competition) with an homogeneous
good and no capacity constraints, the unique Nash equilibrium has
each firm setting price equal to marginal cost even if there are
only two firms in the market.
(iii) Indicate whether the following statement is true or false;
and very briefly (one concise
sentence, maximum) explain why, or why not: An action (or
strategy) ia is a best response for
player i to her opponents strategies ia if ),'(),( iiiiii aauaau
for all 'ia in iA .
OR QUESTION 4B (20 marks; 4 marks each)
Suppose the demand function faced by firm 1, in a two-firm
industry, is given by
211 2160 ppq . Its marginal cost is constant, and equal to
4.
(i) Write the firms profit function. (ii) Write the marginal
profit function for firm 1
(iii) Show that pricing decisions are strategic complements
(iv) Is the strategic effect of commitment positive or negative
in this case? Comment.