Exam 2017, questions and answers PDF

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SCHOOL OF ECONOMICS UNIVERSITY OF CAPE TOWN ECO2003F: INTERMEDIATE MICROECONOMICS

Supp Exam: January 2018

Examiners: Prof. Corne van Walbeek Ms. Refilwe Lepelle Prof. Justine Burns Internal moderator: Associate Professor Tony Leiman External examiner: Prof. Pierre de Villiers (University of Stellenbosch) Time allowed: 3 hour 15 minutes (includes appropriate reading time) Number of marks: 150 Note that this test consists of two sections. Section A consists of 40 multiple-choice questions and section B consists of three written questions. All questions are compulsory. Please answer the multiple-choice questions on the MCQ sheet provided. Please answer each of the three written questions in a separate answer book. For Section A the questions are marked as follows: Correct answer: 1.5 marks Incorrect answer: -0.5 marks No answer: 0 marks

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SECTION A (60 marks) Answer all of the questions below on the MCQ answer sheet. 1. Homo economicus (“economic man”) is the centre-point of analysis in A. the Classical School B. the Neoclassical School C. Institutional Economics D. Behavioural Economics 2. Transaction costs are an important point of analysis in A. Schumpeterian Economics B. New Institutional Economics C. Behavioural Economics D. Feminist Economics 3. John Maynard Keynes’s major contribution to the discipline of economics was to explain A. that the price of a product was not only determined by the labour content but also by the demand for it B. the causes of inflation C. how the government can stabilise an economy through the business cycle D. that microeconomic principles can easily be transferred to macroeconomics 4. If the demand curve is P = 100 – Q and the supply curve is P = 10 + 0.5Q, and the government imposes a lump sum tax of R10 on the buyer of the product, the (tax-inclusive) price that the buyer will pay A. is unchanged B. will increase by R3.33 C. will increase by R6.67 D. will increase by R10 5. In order to calculate the real price of petrol in 1990 (expressed in 2016 prices), the minimum information, other than the nominal price of petrol in 1990, that I require is the A. Consumers’ Price Index for 1990 only B. Consumers’ Price Index for 1990 and 2016 C. Consumers’ Price Index for all years between 1990 and 2016 D. inflation rate in 1990 and 2016 6. If the price of a product increases and as a result firms decide to produce more of that product, then we ascribe the increase in the quantity produced to the ……………………. function of prices A. allocative B. rationing C. predictive D. prescriptive

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7. Consider a world where only two products, X and Y, are consumed. If you solve a utility maximising problem by means of Lagrange multipliers, and the value of λ is 2, this means that total utility will increase by 2 units if A. income increases by one unit B. the price of X decreases by one unit C. the price of Y decreases by one unit D. all the above are true 8. The demand curve for a Giffen product has a positive slope, because the income effect as a result of an increase in the price of the product is A. in the same direction as a the substitution effect B. zero C. in the opposite direction to the substitution effect and is larger in absolute terms D. in the opposite direction as the substitution effect, but smaller than the substitution effect 9. If the utility function is U = X1/2 Y1/4, and the consumer consumes 6 units of X and 3 units of Y, the marginal utility of X (at X = 6) would be A. 0.0269 B. 0.0537 C. 0.3224 D. impossible to calculate 10. If the interest rate is strictly positive and the absolute value of the slope of the inter-temporal indifference curve is less than one across all values of current consumption then, A. the consumer is a spendthrift (i.e. a person who wants to spend his/her money as quickly as possible) B. the consumer has a neutral marginal rate of time preference C. the consumer is not bound by her budget constraint D. the point of equilibrium will be a corner solution on the vertical axis (future consumption) 11. Lambert’s conundrum aims to show that A. even if the tax system is regressive, the cash grants can equalize net incomes across households B. personal income tax is regressive C. personal income tax is more progressive than corporate income tax D. VAT is regressive if some strategic commodities are not zero-rated 12. Which of the following taxes are designed to change people’s behaviour? A. Personal income tax B. Value-added Tax C. Excise tax D. None of the above because a good tax system should not cause people to change their behaviour

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13. Which of the economic applications mentioned below illustrate the costly-to-fake principle? (i) Product quality assurance (ii) Regulating employment interviews (iii) Only choosing trustworthy employees (iv) Lemons principle The following are correct: A. i, ii, iii B. i, ii, iv C. i, iii D. ii, iv only 14. A doctor tells a patient that an operation has a 10% chance of failure, and the patient chooses not to have the operation. If he had said that the operation had a 90% chance of success, the patient would have chosen to have it. This apparent inconsistency is an example of the A. contrast effect B. framing effect C. representative heuristic D. availability heuristic 15. An election is held among four candidates A, B, C, and D. Using a voting method X, the winner of the election is candidate A. Due to an irregularity in the original vote count, a recount is required. Before the recount takes place, candidate B drops out of the race. In the recount, still using voting method X, candidate D wins the election. Based on this information, we can say that voting method X violates the A. rational choice theory B. independence of irrelevant alternatives criterion C. the ability to forecast correctly D. all of the above 16. Given a production function expressed as 𝑄 = 𝐾10.35 𝐾20.25 𝐿0.5 where 𝐾1 and 𝐾2 are two different types of capital, and L is labour, we can say that this production function shows A. increasing returns to scale B. decreasing returns to scale C. constant returns to scale D. unknown returns to scale because there are more than two inputs 17. A fisherman can fish in either Lake A o Lake B. The constant marginal cost of fishing at each lake is 𝑀𝐶 𝐴 = 4 and 𝑀𝐶 𝐵 = 3. If the fisherman has to catch 28 fish to feed his village, how should he allocate production between the two lakes? A. 𝑄 𝐴 = 12; 𝑄𝐵 = 16 B. 𝑄 𝐴 = 16; 𝑄𝐵 = 12 C. 𝑄 𝐴 = 0; 𝑄𝐵 = 28 D. there is not enough information to solve this problem

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18. A bakery employs bakers (labour) and uses ovens (capital) in order to bake bread (Q) to sell every day. The production function for bread baked each day is given as 𝑄 = 4𝐾𝐿. Assume that, in the short run, the bakery has a fixed stock of 6 ovens. If the cost of running an oven is R36 per unit and the cost of labour is R600 per unit, then the average variable cost for producing 72 loaves of bread is A. R3.00 B. R25.00 C. R50.00 D. R53.00 19. If a more efficient technology was discovered by a firm, there would be: A. an upward shift in the AVC curve B. a downward shift in the AFC curve C. an upward shift in the AFC curve D. a downward shift in the MC curve 20. When minimum efficient scale is low, relative to the size of the whole industry, a of firms can operate efficiently, and this indicates a industry structure. A. small; perfect competitive B. small; monopolistic C. large; naturally monopolistic D. large; perfect competitive

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21. Suppose an industry has 5 firms each with supply curve P = 10+45Q. What is the industry supply curve? A. P=5/9+10Q B. P=9+10Q C. P=10+9Q D. P=9/10+Q/5 22. Long-run equilibrium in a purely competitive industry is characterized by, (i) productive efficiency (ii) P < MC (iii) P = minimum ATC (iv) allocative efficiency The following are correct: A. (ii) and (iv) B. (i), (ii) and (iii) C. (i), (iii) and (iv) D. (i), (ii), (iii) and (iv) 23. The mobile phone industry in South Africa can best be described as a(n) A. perfectly competitive industry B. monopolistically competitive industry C. monopoly D. oligopoly

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Question 24 refers to the following table:

Output firm

1 2 3 4 Total industry output

Industry Industry Industry X Y Z 35 25 30 35 25 30 15 25 20 15 25 20 100 100 100

24. The Herfindahl index (HHI) would rank these industries as follows (from most concentrated to least concentrated): A. X – Y – Z B. Y – X – Z C. Y – Z – X D. X – Z – Y The following information is relevant for Questions 25 to 27. A monopolist has an inverse demand curve given by P = 20 – 2Q. Its marginal cost is constant at 4 and it has a fixed cost of 10. 25. What is the profit maximising output and price for the monopolist? A. Q = 4 and P = 12 B. Q = 8 and P = 4 C. Q = 10 and P = 0 D. Q = 5 and P = 10 26. What is the deadweight loss of this monopoly? A. 25 B. 36 C. 16 D. 4 27. If this monopoly had its fixed costs subsidised, and was then regulated, being instructed to use the optimisation condition for a perfectly competitive industry, the resulting optimal output and price would be: A. Q = 4 and P = 12 B. Q = 8 and P = 4 C. Q = 10 and P = 0 D. Q = 5 and P = 10 28. Competitive markets result in allocative efficiency because they A. maximize the net benefits from exchange B. make sure goods are produced at the lowest cost C. generate the most benefits for consumers D. distribute resources in the most equitable way

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29. If a monopoly producer practices perfect price discrimination, there is no A. short-run economic profit B. long-run economic profit C. transfer of consumer surplus to the producer D. deadweight loss 30. For a single-price monopolist, if the elasticity of demand at equilibrium is -4.0, then the selling price is …………… greater than the marginal cost of production. A. 125% B. 120% C. 33% D. 25% 31. If a monopolist sells products in two separate markets, with demand curves given by 𝑃 1 = 100 − 𝑄1 and 𝑃2 = 200 − 𝑄2 , and has 𝑇𝐶 = 5 + 20𝑄, then, ignoring what happens in the other market, the firm should sell A. 40 units in market 1 at a price of R60 B. 90 units in market 1 at a price of R60 C. 40 units in market 2 at a price of R110 D. 130 units at a price R85 32. Which if the following does not characterise a core industry (as defined by Crotty, 2000)? A. Non-credible threats of price wars by incumbent firms B. MC < ATC C. High capital investment required D. Entrance at minimum scale expands aggregate industry output 33. Crotty (2000) argues that under natural oligopoly A. only the most efficient firms survive competitive pressure B. maximum competition leads to dynamic efficiency gains C. firms must co-operate to maintain P > ATC D. firms collude to keep prices high 34. The potential benefits of co-respective competition are that A. firms respect their rivals B. price wars can be avoided C. firms are able to adopt low-road labour relations in order to maximise profits D. creative destruction is maximised 35. Marginal Revenue is A. the increase in total revenue from selling one more unit of output B. equal to P when the price elasticity of demand is infinite C. equal to P(1+1/e) D. all of the above 36. A second degree price discriminator A. charges lower prices to customers who buy greater quantities B. charges each buyer her reservation price C. eliminates deadweight loss to society through its pricing strategy D. charges different prices to each customer based upon different costs of delivery

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Consider the following information for questions 37 to 39: Two duopolists face a market demand curve of 𝑃 = 120 − 2𝑄 where Q is total market quantity. Each firm produces at a constant marginal cost of 40 per unit. 37. If these were Cournot duopolists, then the industry’s equilibrium price and output would be A. 𝑃 = 40; 𝑄 = 40 B. 𝑃 = 60; 𝑄 = 30 C. 𝑃 = 66.7; 𝑄 = 26.7 D. 𝑃 = 80; 𝑄 = 20 38. If these were Bertrand duopolists, then the industry equilibrium price and output would be A. 𝑃 = 40; 𝑄 = 40 B. 𝑃 = 60; 𝑄 = 30 C. 𝑃 = 66.7; 𝑄 = 26.7 D. 𝑃 = 80; 𝑄 = 20 39. If these duopolists were to behave according to the Stackelberg “leader-follower” model, then the industry equilibrium price and quantity would be A. 𝑃 = 40; 𝑄 = 40 B. 𝑃 = 60; 𝑄 = 30 C. 𝑃 = 66.7; 𝑄 = 26.7 D. 𝑃 = 80; 𝑄 = 20 40. The presence of price rigidities in oligopolistic industries means that it is possible that the firm’s A. marginal cost curve is discontinuous B. marginal cost can decrease and have no impact on the prevailing price C. demand curve has a gap at the prevailing price D. marginal revenue curve is kinked

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SECTION B (90 marks) Answer each question in a separate book. All questions are compulsory. QUESTION 1 1.1

Lerato consumes only two goods, X and Y, and has a utility function U = X2/3 Y1/4. The price of X is R40/kg and the price of Y is R15/kg. Her weekly allowance of R200 is fully spent on these two products. (a) Find the utility maximizing combination of C and R using the Lagrange multiplier approach. Show all you calculations. [9] (b) Calculate the value of U at the point of maximum utility. Show your calculations. [2] (c) What is the value of λ and how do you interpret this value? [3] (d) If Lerato wanted to buy 3 kg of X and 10 kg of Y, would this be possible, given the budget constraint? Explain briefly. [2] (e) Would this combination of 3 kg of X and 10 kg of Y given her more utility than the equilibrium point of consumption? [2]

1.2

Briefly explain: (a) How you can use the Engel curve to indicate whether a product is normal or inferior, and, if normal, whether the product is a necessity or a luxury. Use a diagram to illustrate your answer. [3] (b) How an excise tax on alcohol encourages beer producers to produce beer with a lower alcohol content. [3] (c) How you can subdivide the change in the quantity consumed of X, as a result of an increase in the price of X, into a substitution and income effect. Assume that the product is a normal product, and use a diagram to illustrate your answer. [6]

QUESTION 2 Please answer this question in a separate answer book. 2.1

Long-term insurance in the United States is a product sold to help provide for the cost of long term health care beyond a predetermined period, which is usually not covered by regular health insurance. (a) Long-term insurance sellers are beginning to charge women more for policies. Why would they do this? Name and explain this phenomenon. [3] (b) When long-term care insurance policies were first offered, with few restrictions, what type of individuals might have been more likely to buy these policies? Name and explain this phenomenon [2] (c) If one insurance company charges both men and women the same price, how would this pricing strategy affect the long-term care insurance market in terms of consumers and premiums that can be charged? [3] (d) What is the lemons principle? State where it is related to adverse selection or moral hazard and explain. [2]

2.2

Tebogo is starting a new restaurant in Cape Town. While Tebogo plans to do the cooking himself, he will need to employ workers and machinery to produce the food. He estimates his production function as 𝑄 = 15𝐿0.25 𝐾 . Tebogo is able to accumulate R10 000 to finance the business. Workers cost R10 and capital costs R50.

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(a) If Tebogo wishes to produce the most output with the finances available, how much labour and capital should he employ? [7] (b) Does this bundle of capital and labour also minimise costs? Explain. [3] (c) Sketch the relationship between total cost, variable cost, fixed cost, average total cost, average variable cost, average fixed cost and marginal cost in the short run. Be sure to explain the relationship between TC, AC and MC and how these costs curves change when output changes. [10]

QUESTION 3 Please answer this question in a separate answer book. 3.1

Using an appropriate labelled diagram, define what is meant by the term “natural monopoly”, describe the monopolist’s profit maximising output and pricing choices and explain why it is not possible to achieve allocative efficiency through regulation. [15]

3.2

Critically evaluate available public policy responses to a natural monopoly.

[15]

END OF EXAM

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Solutions to MCQs

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40.

B B C C B A A C A D A C C B B A C B D D C C D D A C B A D C A A C B D A B A B B

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