ECON 201 MICROECONOMICS

Study Questions 2014

Note:
The following are a sample of questions drawn from assignments, tests, and
final exams.
Please recognize that assignment questions are typically harder than exam
questions.
ECON!" has #een taught #y a num#er of indi$iduals in recent times and the
questions should not #e attri#uted to any particular lecturer. %uestions may
also ha$e #een drawn from the recommended texts.
Please use the questions as a study guide. &f you ha$e difficulty with the
question then, #y all means, as' for assistance. (ut & will not pro$ide answers)
it is for you to attempt the question and chec' the answer out.
Consumer choice and demand
1. *raw the following indifference cur$es+
,a-.hen ma'ing slurp & always com#ine / grams of lemonade ,L- with " gram of
0ungle 0uice ,J-.
,#-(1 li'es #eer #ut hates ham#urgers. 2he always prefers more #eer no matter how
many ham#urgers she has.
,c-22 is indifferent #etween #undles of either three #eers or two ham#urgers. 3is
preferences do not change as he consumes any more of either.
,d- 41 eats one ham#urger and washes it down with one #eer. 3e will not consume
an additional unit of one item without an additional unit of the other.
,e-2uppose (ill $iews #utter and margarine as perfectly su#stituta#le for each other.
*raw a set of indifference cur$es that descri#es (ill5s preferences for #utter and
margarine.
,f- 6ollowing on from ,e- a#o$e, (ill has 7! to spend each month. (utter costs 7
per pac'age and margarine costs 7". .hat is (ill5s optimal consumption #undle8
&llustrate your result using a suita#ly la#eled diagram. *escri#e a representati$e
indifference cur$e for each of the following situations.
,g- The two goods are right glo$es ,R- and left glo$es ,L- and the consumer has
two hands.
,h-The two goods are wine ,W- and lo#ster ,L- tails. Eating more than a certain
num#er of lo#ster tails ma'es the consumer sic'.
,i- The two goods are Co'e ,C- and Pepsi ,P- and the consumer percei$es no
difference #etween the two soft drin's.
,0- .hen optimizing his consumption o$er two periods 9ac decides to sa$e money
in the first period. &f the interest rate increases, what has happened to the price of
consumption in period one8 .ill 9ac remain a sa$er8 .hy or why not8 1ustify
your answer using a suita#ly la#eled diagram.
2. 4 consumer deri$es utility from consuming X and Y according to the function
-

, min,
Y
X U = .
,a- The consumer faces prices P
X
and P
Y
and has income I.
1
,#- 2'etch the a#o$e utility function for U : "!, with X on the horizontal axis and
Y on the $ertical axis. 2how the income consumption cur$e in your graph.
,c- *eri$e the Engel function for good Y. &llustrate the Engel function using a
suita#ly la#eled diagram with Y on the horizontal axis.
,d- *eri$e the demand functions for both X and Y. ;sing the demand function for
X, descri#e the impact of a rise in the price of Y on the demand for X. (riefly
explain why this relationship exists.
3. <et X measure the amount of chocolate and Y measure the amount of a composite
good 21 #uys. .e represent 215s preferences with the following utility function
Y X 2 = Y) U(X, + . The price of the composite good is " per unit, let P
X
represent the price of X per unit. 21 has a #udget of 7"! per day.
,a- *eri$e 215s demand function for chocolate.
,#- 2uppose the price of chocolate is initially 7!.=! per unit. 3ow many units of
chocolate and how many units of the composite good are in (15s optimal
consumption #as'et8
,#- 2uppose the price of chocolate drops to 7!.! per unit. 3ow many units of
chocolate and how many units of the composite good are in the optimal
consumption #as'et8
,c- &llustrate the su#stitution and income effects that result from the fall in the price
of chocolate.
4. 4 consumer has a utility function
3Y 5X Y) U(X, + =
, income of 7!, and faces P
X
: > and P
Y
: =.
,a- 6ind the consumer5s optimal consumption #undle (X
*
,Y
*
). &llustrate your answer.
,#- <et income : &. *eri$e an equation for the Engel cur$e. &llustrate your answer.
. 2uzie purchases two goods, food ,X- and clothing ,Y-. 3er utility function is
U(X,Y) = XY and she has income I. <et the price of food and clothing #e gi$en #y
P
X
and P
Y
respecti$ely.
,a- *eri$e the demand functions for X and Y.
,#- &s clothing a normal good8 *raw her demand cur$e for clothing when the le$el
of income is I : !!. <a#el this demand cur$e *
"
. *raw the demand cur$e
when I : ?!! and la#el this demand cur$e *

. Note+ your graph need only show

the general shape and position of the demand cur$es.
,c- .hat can #e said a#out the cross@price elasticity of demand of food with
respect to the price of clothing8
,d- Now assume that there are n consumers. Each consumer i has the same utility
function U
i
(X,Y) = XY as defined a#o$e #ut different income I
i
. *eri$e the
mar'et demand function.
!. 4 consumer with utility function,
2 1 2 1
) 100 ( ) , ( C C C C U =
, has an initial
endowment of
1
M
and
2
M
to allocate #etween consumption in period "
) (
1
C
and consumption in period
). (
2
C

3er inter@temporal #udget constraint is+
) 1 ( ) 1 (
2
1
2
1
r
M
M
r
C
C
+
+ =
+
+
, where r is the
interest rate for #orrowing and lending.
,a- *eri$e expressions for
1
C
MU
,
2
C
MU
and MRS and hence deri$e a general
expression for the first order condition for utility maximization for this consumer.
2
,#- *eri$e the demand functions for
1
C
and
2
C
.+
,c- &f
800 , 10 $
1
= M
,
016 , 11 $
2
= M
and % 8 = r +
i. 6ind the optimal consumption #undle and determine the le$el of utility
associated with this consumption #undle.
&s the consumer a #orrower or a lender at this interest rate8
3ow much does the consumer #orrow or lend in equili#rium8
;se a s'etch to illustrate this consumption #eha$iour.
ii. &f the interest rate increased to % 10 = r would you expect the consumer to
#e a #orrower or a lender in equili#rium8 .ould you expect her utility to #e
higher or lower than the utility calculated in c.i.8 Explain.
iii. Calculate the interest rate at which the consumer neither #orrows nor lends
in equili#rium.
". *1 deri$es utility from always consuming > units of X to " unit of Y. No utility is
gained from not following this rule. *1 has income I, and faces P
X
and P
Y
.
,a- *eri$e the demand function for X and Y.
,#- 4ssume that I : "! and P
X
= 1 and P
Y
: A. Calculate *15s optimal consumption
#undle (X
*
,Y
*
). Now assume that the price of X falls P
X
= 0.5 and the price of Y is
unchanged. &llustrate the income and su#stitution affects associated with the fall in
the price of X8
#. Baty is a model whose diet consists solely of soup ,2- and nuts ,N- and whose
preferences are represented #y her utility function, u,2, N- : 2

N. 3er wee'ly
food #udget is & ,7-) the prices of soup and nuts are P
2
,7 per litre- and P
N
,7 per
'ilo-.
,a- .rite down Baty5s food #udget constraint.
,#- 6ind Baty5s demand functions for soup and nuts. Comment on how these
demand functions relate to the particular type of utility function that Baty has.
$. 9oC is a student and she drin's caffeine #efore ECON !" ,the lecturer isn5t all
that greatD-. 3er preferences are such that she always trades@off the drin's at the
rate of+ one glass of redo! ,let this drin' #e X- for half a glass of boost ,let this
drin' #e Y-. 9oe has a daily income of 7! and faces prices P
X
: > and P
Y
: =.
,a- .hat is 9oC5s optimal choice8 &llustrate your answer.
,#- <et income : &. *eri$e an equation for the Engel cur$e. &llustrate your answer.
Ris% & in'ormation
10. (1 is planning a s'iing trip to (ig 2'y Eontana. The utility from the trip is a
function of how much she spends ,"- and is gi$en #y ;,y- : log ". (1 has 7"!,!!!
to spend on the trip. &f she spends it all, her utility will #e ;,"!,!!!- : log "!,!!! :
>. , we are using logarithms to #ase "!-.
,a- &f there is a =F pro#a#ility that (1 will lose 7",!!! of her cash on the trip,
what is the trip5s expected utility8
,#- 2uppose (1 can #uy insurance against losing the 7",!!! at an actuarially fair
premium of 7=!. .ill (1 #uy the insurance8
,c- .hat is the maximum amount that (1 would #e willing to pay to insure her
7",!!!.
,d- 2uppose that people who #uy insurance tend to #ecome more careless with their
cash than those that don5t, and assume that the pro#a#ility of their losing 7",!!!
3
is ?!F. .hat will #e the actuarially fair insurance premium8 .ill (1 #uy
insurance at the actuarially fair price8
11.T*5s utility depends on his wealth, !, according to the utility function, #(!) = $!.
T* owns 7=!,!!! worth of safe assets and he also owns a house that is located in
an area where there are lots of forest fires. 3is house and land are currently $alued
at 7!!,!!!. 3owe$er, if his house #urns down, the remains of his house and the
land it is #uilt on would #e worth only 7>!,!!!. The pro#a#ility that his home will
#urn down is estimated to #e !.!".
,a- Calculate T*5s expected utility if he doesn5t #uy fire insurance.
,#- Calculate the certainty equi$alent of the gam#le he ta'es if he doesn5t #uy fire
insurance. 6ind the ris' premium in this situation.
,c- 2uppose that T* can #uy insurance at a price of 7" per 7"!! of insurance
co$erage. &s this insurance actuarially fair or not8 Explain.
,d- &f T* decides to fully insure against the ris' of fire, what will his wealth #e8
.hat will #e his expected utility with full insurance8
12. Gou ha$e 0ust mo$ed into a new apartment. Gour assets are worth 7"!,!!!. &f
your apartment is #urgled you will lose e$erything except the clothes you wear to
uni$ersity, reducing your wealth to 7H!!. (ased on historical records, the local
police estimate the pro#a#ility of a thief #rea'ing into your apartment and stealing
your assets is !.". Gour utility function is W U= where W is the $alue of your
assets.
,a- Calculate and illustrate in a suita#ly la#eled diagram+ the expected $alue of ris')
utility of expected $alue) expected utility
,#- &f an insurance company offered you a fair contract to insure against #urglary
would you accept8 (riefly 0ustify your answer.
,c- .hat is the maximum price you would #e willing to pay for insurance8 &llustrate
this price in the diagram presented in ,a- a#o$e.
,d- Now assume that a new alarm system is a$aila#le on the mar'et. The new system
does not alter the pro#a#ility of #urglary #ut it is might scare #urglars away if
they do #rea' into your apartment. &nsurance is still a$aila#le at the fair price
used in your answer to ,#- a#o$e. .hat would the pro#a#ility of scaring #urglars
away ha$e to #e in order for you to switch from the fair contract to #uying the
new alarm system8 .hat is the maximum you would #e willing to pay for the
new alarm system8
13. Gou ha$e #een hired to ad$ise the Einistry of 6isheries on its policy on illegal
fishing. Thie$es ma'e money ,W- out of illegal fishing. The existing pro#a#ility of
apprehending a fisheries thief is % & 0.5. &f caught, they are fined ' and their wealth
is (W('). The Einistry is proposing to deter illegal fishing #y either dou#ling the
fine ,'- for illegal fishing ,holding pro#a#ility constant- or dou#ling the pro#a#ility
,%- of catching the fish thie$es ,holding the fine constant-. 4s an economist, you are
well aware of the rele$ance of an indi$idual5s attitude to ris' and suggest analysing
the pro#lem in terms of a ris' a$erse fisher and a ris' lo$ing fisher
,a-&f fish thie$es are ris% a(erse, what policy ,dou#ling the fine or dou#ling the
pro#a#ility of getting a fine- will do #etter in deterring illegal fishing8
4
,#-3ow does your analysis change if fish thie$es are ris% )o(in*8 .hich has the
greater deterrence effect in this case, dou#ling the fine or dou#ling the
pro#a#ility of getting a fine8
+roduction & Costs
14. The production of wheat is represented #y the following production function
= . ! = . !
W ' )= where ' is fertilizer and W is water
,a-.hat returns to scale are e$ident8
,#- 2how one isoquant for wheat with water ,W- on the
horizontal axis and fertilizer ,'- on the $ertical axis. *oes the a#o$e function
exhi#it diminishing returns to scale8 .hat is the marginal rate of technical
su#stitution of water for fertilizer when W : "! and ' : "!.
,c- Now assume that genetic engineering has changed the
production function to
I . ! = . !
W ' )= . 3ow has genetic engineering impacted
returns to scale8 ;sing this new production function, what is the marginal rate of
technical su#stitution of water for fertilizer when W : "! and ' : "!8
,d- ;se two isoquants @ one representing the old wheat $ariety
and the other representing the genetically enhanced wheat $ariety J to illustrate
the impact of genetic engineering. (riefly discuss your conclusions.
1. 4 truc' dri$er has an input #undle of "! hours and "! litres of diesel. <et q :
'ilometres tra$eled, h : hours, and d : litres of diesel. The tra$el production
function is

"
- "!! , hd q=
.
,a- .hat is maximum num#er of 'ilometers her truc' can #e dri$en8 .hat
a$erage speed is required to achie$e this result8 Ki$en the same input #undle,
how far can the truc' #e dri$en at /! 'ph8 4t "A! 'ph8
,#- 6ind the total product function for d : ", d : I, d : >/. &llustrate the total
production functions with h on the horizontal axis and ) on the $ertical axis.
,c- 2uppose d : ". 6ind the a$erage product function.
1!. The production function for an industry is gi$en as
- " ,
= L K q where * is
capital and L is la#our.
,a- Kraph an isoquant for this production function, with la#our ,L- on the
horizontal axis and ,*- on the $ertical axis. *eri$e the rate of technical
su#stitution and illustrate your result in the graph for a gi$en quantity of la#our
and capital
L- L, , K L
. .hat happens to output if la#our and capital are now
L- L, , K L
8 *oes the rate of technical su#stitution change, 0ustify your
answer.
,#- 4n inno$ation in the industry has now
changed the production relationship to
- " ,
= L K q where
>
. &llustrate
the impact of this inno$ation using a suita#ly la#elled graph.
1". The production function of <ightning *irect Courier 2er$ice ,<*C2- is gi$en #y+
( ) LG q "!! = where ) : 'ilometres of ser$ice, L : la#our and + : litres of
petrol. <et ! : price of la#our and , : the price of petrol.
5
(a) 2uppose the price of la#our is 7A and the price of petrol is 7. 6ind the cost@
minimising com#ination of la#our and petrol for "! 'ilometres of ser$ice.
&llustrate your result.
(b) *eri$e <*C25s input demand functions for la#our and petrol. (riefly comment
on the relationship #etween input demand and the price of each input.
(c) *eri$e <*C25s long run cost, a$erage, and marginal, cost functions.
1#. The production function for #i'es requires capital ,*- and la#our ,L- and is
characterized #y L * ) . = .
,a- .hat is the a$erage producti$ity of la#our and capital for #i'e production8
Kraph the a$erage producti$ity of la#our cur$e for B : "!!.
,#- 2'etch the ) : "! isoquant for this production function. .hat is the EMT2 on
the ) : "! isoquant at the points+ * : L : "!) * : =, L : >) and * : >, L :=.
*oes the function exhi#it diminishing EMT28 (riefly 0ustify your answer.

1$. 2uppose that a firm5s production function is gi$en #y
- "! , = min, L * )=
and the
rental rates for capital and la#our are , : " and ! : ? respecti$ely.
,a- 2'etch the q : "!! isoquant for this production function. .hat is the
relationship #etween capital and la#our regardless of the le$el of production8
,#- Calculate the firm5s long run total, a$erage, and marginal cost functions.
,c- 2uppose that * is fixed at "! in the short@run. Calculate the firm5s short@run
total a$erage, and marginal cost cur$es.

20. 2uppose a firm5s production function is a Co##@*ouglas production function of
the form . * 50L -
0.5 0.5
= 4ssume that the price of la#our is gi$en #y ! and the
price of capital is gi$en #y r.
,a- 2uppose that the firm5s capital is fixed at B . .hat amount of la#our will the
firm hire to sol$e its short@run cost minimization pro#lem8
,#- Now suppose that that the price of la#our ! is 7= per unit and the price of
capital r is 7! per unit. .hat is the cost@minimising input com#ination if the
firm wants to produce ",!!! units per year8 &llustrate your result using a
suita#ly la#eled diagram.
,c- *eri$e the long@run total cost function. ,3int+ find the factor demand functions
first.- &llustrate the total cost cur$e when ! : = and r : "!!. .hat are the
long@run a$erage and marginal cost cur$es associated with the long@run total
cost cur$e8 (riefly explain the relationship #etween the long@run total cost
cur$e and the long@run a$erage and marginal cost cur$es.
,d- ;sing a suita#ly la#eled diagram, explain why total costs are higher in the short
run than in the long run.
21. *eri$e the production function for each of the following production relationships,
construct an isoquant for the le$el of output indicated, and deri$e the cost function.
a. 41 uses a furnace and fuel to produce heat. The furnace can use either coal or
wood for fuel. One tonne of coal produces = 'ilo0oules of heat and one tonne of
wood produces 'ilo0oules. <et ) : 'ilo0oules of heat, .
1
: tonnes of coal and .
2
: tonnes of wood. Construct, and illustrate using an appropriately la#eled
diagram, an isoquant for ! 'ilo0oules. ;sing !
1
and !
2
as the price of coal and
wood respecti$ely, deri$e the cost function.
#. TC wor's at a city nightclu#. 3er rum@and@Co'e recipe calls for "! millilitres of
rum and ?! millilitres of Co'e. <et ) : num#er of drin's, .
1
: millilitres of rum
and .
2
: millilitres of Co'e. Construct, and illustrate using an appropriately
6
la#eled diagram, an isoquant for drin's. ;sing !
1
and !
2
as the price of rum
and Co'e respecti$ely, deri$e the cost function.
22. 2uppose that a firm5s production function is gi$en #y
- "! , = min, L * )=
and
the rental rates for capital and la#our are , : " and ! : ? respecti$ely.
,a- 2'etch the q : "!! isoquant for this production function. .hat is the relationship
#etween capital and la#our regardless of the le$el of production8
,#- Calculate the firm5s long run total, a$erage, and marginal cost functions.
,c- 2uppose that * is fixed at "! in the short@run. Calculate the firm5s short@run total
a$erage, and marginal cost cur$es.
23. The production function for #i'es requires capital ,*- and la#our ,L- and is
characterized #y L * ) . = .
,a- .hat is the a$erage producti$ity of la#our and capital for #i'e production8 Kraph
the a$erage producti$ity of la#our cur$e for B : "!!.
,#- 2'etch the ) : "! isoquant for this production function. .hat is the EMT2 on the
) : "! isoquant at the points+ * : L : "!) * : =, L : >) and * : >, L :=. *oes
the function exhi#it diminishing EMT28 (riefly 0ustify your answer.
24. (15s is a small #usiness that operates in the perfectly competiti$e residential
window washing mar'et. The short@run total cost function is

" . ! "! >! - , ) ) ) /0C + + = where q is the num#er of windows washed per day.
The pre$ailing mar'et price is 7! per window.
,a- 3ow many windows should (1 wash to maximise profit8 .hat is (15s maximum
daily profit8
,#- Kraph 2EC, 24C, and show the profit@maximising daily profit. ,= mar's-
,c- .hat is (15s short@run supply function, assuming that all of the 7>! per day fixed
costs are sun'8
,d- .hat is (15s short@run supply function, assuming that if he produces zero output,
he can rent or sell his fixed assets and therefore a$oid all his fixed costs8
,emand and Su--)y
2. The demand ,-
d
- and supply ,-
s
-functions for wine are

P -
d
= . ! "! =
and

!

=
+ =
P !hen
P !hen P -
s
,a- .hat are the equili#rium price and quantity8
,#- 4t the equili#rium in part ,a-, calculate the consumer surplus and producer
surplus8
,c- 2uppose go$ernment imposes an excise tax of 7A per unit. .hat will the new
equili#rium quantity #e8 .hat price will consumers pay8 .hat price will the
sellers recei$e8
,d- 4t the equili#rium with the tax in part ,c- a#o$e, calculate the consumer and
producer surplus8 Calculate the go$ernment re$enue generated from the tax8
&llustrate your results using a suita#ly la#eled diagram.
7
2!. The mar'et supply functions for one of the 'ey components of a drilling rig
are+
P Q
D
5 000 , 1 =
and
80 4 = P Q
S
where
Q
is measured in units
and P is measured in 7 per unit.
a. *etermine the mar'et equili#rium price and quantity.
#. *etermine the own price elasticity of demand and the own price elasticity of
supply at the mar'et equili#rium.
c. 2uppose the go$ernment imposes a 7>= per unit tax on this component. 3ow
would this tax affect the mar'et equili#rium8 3ow would the tax #urden #e
shared #etween #uyers and sellers of the component8
2". 4ssume that the price per #arrel of crude is a#out ;2*= and world output
was I! million #arrelsNday. The short@run demand and supply functions are+
%
*
: /! @ !.>P
%
2
: == O !.AP
,a- Calculate the mar'et equili#rium price P quantity) and the short@run supply and
demand price elasticities.
,#- This demand cur$e is a Qnet5 demand cur$e @@ net of the taxes paid #y oil
consumers. These $ary around the world, #ut are quite high compared with most
other goods. <et us ta'e 7= to #e the a$erage tax paid per #arrel. Then we can
construct the gross or retail demand cur$e which relates the demand for oil to
the ,tax@inclusi$e- actual price paid per #arrel. 2how that the formula for this
demand function is+
%
*
: H! @ !.>P
r
.here P
r
is the price actually paid.
,c- Calculate the retail mar'et demand elasticity and explain in words why it is
larger in a#solute $alue than the net demand elasticity of @!."=. -
,d- Calculate the Rwithout the taxS equili#rium price and output .
,e- Carry out a welfare analysis ,changes in surpluses) deadweight loss- of the oil
tax ,compared to no tax- from the perspecti$e of an oil@importing economy
such as New 9ealand.
,f- The ma0or player on the supply side of the world oil mar'et is the OPEC
,Organization of Petroleum Exporting Countries- cartel, which coordinates the
supply of most of the world5s largest oil producers. OPEC is often accused of
Qmonopolising5 the world mar'et. Explain why OPEC cannot #e maximising short@
run profits.
,g- 3owe$er, list some longer@run supply and demand considerations which may
explain why OPEC would not want to set a price to maximise short@run profits
.
Com-etiti(e E.ui)i/rium
2#. Consider an industry in which there are "! identical firms and ",!!! identical
demanders. Each 1 demander has the following demand function
% )
d
1
!!= . ! " =
.
Each of the i firms has the following short@run cost function

"! - , ) ) ) /0C
i
+ = .
,a- *eri$e the short@run supply function for one of the firms.
,#- *eri$e the short@run mar'et supply function.
,c- Calculate the short@run mar'et equili#rium price and quantity.
,d- ;sing an appropriately la#elled graph+ illustrate the firm5s supply function)
calculate and illustrate the firm5s profit.
8
2$. 4 perfectly competiti$e mar'et has a demand function
2
- % !? . ! ?! = . &f
e$ery firm in the mar'et has an a$erage cost function
) ) 3C + = N ?A
.
,a-Calculate the equili#rium price and quantity in the mar'et.
,#-Calculate the long@run equili#rium num#er of firms.
,c-*eri$e the mar'et supply function.
,d-Calculate the total surplus for this competiti$e equili#rium.
30.
4ll firms ha$e identical a$erage cost functions 4C,q- : >! T q O !.!"q

and long run marginal cost functions EC,q- : >! T q O !.!?q

. Ear'et demand is
*,p- : =, !!! T ", !!!P.
,a- 6ind the long run equili#rium quantity per firm, price and num#er of firms.
31.
Baya's are produced #y a num#er ,many- of identically sized firms. Total ,long
run- monthly costs for each firm are gi$en #y !!! , / "!! !
?
+ + = ) ) ) 0C where
) is the num#er of 'aya's produced and demand is
P - ? =!! , =
.
,a- 6ind the monthly output of 'aya's #y each firm and their mar'et price.
,#-.hat is the equili#rium num#er of firms8
,c-.hat if demand increased to
P - ? !!! , ? =
8 4ssuming entry into the mar'et is
free and does not alter costs, recalculate the equili#rium price, total num#er of
'aya's and the num#er of new entrants into the mar'et.
Mono-o)y
32.
4 firm is a monopolist with demand
) % ="!!
and total costs H!!

+ =) C .
,a-*eri$e the profit maximising le$el of output for the monopolist. 4t what price will it
sell this quantity8 .hat are the profits of the firm8
,#-&llustrate your results using a suita#ly la#elled graph.
,c-Calculate the optimal mar'@up expressed as a percentage of price.
,d-2uppose the go$ernment imposes a price ceiling of 7A=. .hat is the monopolist5s
profit maximising output8 .hat is the monopolist5s profit8
,e-&llustrate the results o#tained in ,d- a#o$e using a suita#ly la#elled graph8
33. 4 monopolist can produce at a constant 4C : EC : 7=. &t faces a mar'et
demand cur$e gi$en #y
P - ==?
.
,a- Calculate the profit@maximising price and quantity for this monopolist. 4lso
calculate its profits. ,= mar's-
,#- Now suppose that a second firm enters the mar'et. Ear'et demand is now gi$en
#y P ) ) - = + = =?
"
. 4ssume that their costs are identical and 4C : EC : 7=.
6ind the Cournot equili#rium. .hat are the resulting mar'et price and profits for
each firm. ,"! mar's-
,c- 2uppose there are N firms in the industry, all with the same constant marginal cost,
EC : 7=. 6ind the Cournot equili#rium. 3ow much will each firm produce, what
will #e the mar'et price, and how much will each firm earn8 4lso, show that as N
#ecomes RlargeS, the mar'et price will approach the price that would pre$ail under
perfect competition. ,"! mar's-

9
34. Consider a monopolist who faces a linear demand cur$e
) % > "!! =
.
The monopoly5s total cost is a linear function of output
) C ! =!+ =
.
,a- Calculate the monopolist5s profit maximizing output, mar'et price, profit, and
consumer surplus. &llustrate your results in a suita#ly la#elled graph.
,#- Calculate the dead weight loss.
,c- Now assume that the monopolist can perfectly discriminate so that each successi$e
unit of q is sold for the maximum amount that consumers are willing to pay.
Calculate the monopolist5s profit maximizing output, mar'et price, profit, and
consumer surplus. &llustrate your results in a suita#ly la#elled graph.
,d- Now assume that aggregate demand and total cost remains unchanged #ut the
monopolist can new separate consumers into two distinct mar'ets, thus
" "
= /! ) % =
and

! /! " ) % =
Calculate the monopolist5s profit maximizing output, mar'et price, profit, and
consumer surplus. &llustrate your results in a suita#ly la#elled graph.
3. 2uppose a text#oo' monopoly can produce any le$el of output it wishes at a
constant marginal cost of 7= per unit. 4ssume that the monopolist sells its #oo's in
two different mar'ets that are separated #y some distance. *emand in the first
mar'et is gi$en #y
" "
== P - =
*emand in the second mar'et is gi$en #y

I! P - =
,a- &f the monopolist can maintain separation #etween the two mar'ets, what le$el of
output should #e produced in each mar'et and what price will pre$ail in each mar'et8
.hat are the total profits in this situation8
,#- 3ow would your answer change if it only cost demanders 7= to mail #oo's
#etween the two mar'ets8 .hat would #e the monopolist5s new profit le$el in this
situation8
,c- 3ow would your answer change if mailing costs were ! and the firm was forced to
follow a single@price policy8
O)i*o-o)y and 0ame 1heory
3!. 4 homogeneous product industry has a mar'et demand cur$e+
P : "= @ !."%
The technology is represented #y a cost function+
TC : 6 O ?q
for any firm producing q units of output. 4ssume 6 : !.
,a- 2how that the reaction function of some firm 4, gi$ing its optimal output as a
function of the output of other firms is+ q
4
: A! @ !.=%
1
where %
1
is the total
output of the other firms in the industry.
,#-2uppose the industry is a duopoly. 2how that the Cournot@Nash equili#rium has
each firm producing >! units, mar'et price : 7I, and profitsNfirm : 7"A!.
,c- ;se the reaction function to deduce that monopoly output
would #e A!.
,e- 2uppose that the two firms were a#le to cooperate to set the 0oint@profit
maximising price and split the mar'et equally #etween them. 2how that price : 7H
and profitsNfirm : 7"/!.
10
,f- Now show that the cooperati$e outcome is not a Nash Equili#rium, #y
calculating firm 45s optimal output if the other firm ,call it firm (- produces only its
half share of the 0oint@profit maximising industry output.
,g- 2et out the a#o$e scenarios in the form of a payoff matrix, with each
firm5s possi#le actions #eing Qcooperate5 or Qdon5t cooperate5.
,h- 2uppose firm 4 ad$ertises a Qprice protection promise5, under which it
promises its customers that should they purchase the product from firm 4, and then
find it a$aila#le from another supplier at a lower price, then firm 4 will refund the
difference plus 7". 2uppose that firm ( ma'es a similar promise. .ithout #eing
precise or technical a#out it, modify the payoff matrix to suggest how these
promises may actually #e used to con$ert the cooperati$e outcome into the Nash
Equili#rium.
,i- Now assume that fixed costs, 6 : !!. Explain why the industry is now a Qnatural
monopoly5 and explain why a regulator might wish to set a maximum price of 7=.
3". 2uppose .ai5s and 3!5s demand functions are gi$en #y
" " "
= - =! , > - A> , P P - 4nd P P - + = + = respecti$ely. .ai5s marginal cost is
7= per unit and 3!5s marginal cost is 7> per unit.
,a- .hat is .ai5s profit maximising price when 3!5s price is 7/8
,#- .hat is the equation of .ai5s price reaction function8
,c- .hat are .ai5s and 3!5s profit maximising prices and quantities at the
(ertrand equili#rium8
3#. Consider a duopoly. The demand for spring water is gi$en #y
P ) ) - + = "!
"
and the marginal cost of o#taining the water is zero.
,a- 4ssume a cartel com#ines the interests of #oth firms. .hat is the profit
maximising price, output, and profit8
,#- Now assume the firms #eha$e as Cournot duopolists. *eri$e the reaction
function for each firm and deri$e the Cournot solution.
,c- On a graph, with price on the $ertical axis and quantity on the horizontal axis,
show the cartel ,monopoly- solution, the Cournot solution, and the competiti$e
solution
3$. 2uppose a mar'et consists of N identical firms, that the mar'et demand
function is
b- 4 P =
and the each firm5s marginal costs is .
,a- .hat is the Cournot equili#rium quantity per firm8
,#- .hat are the equili#rium mar'et quantity and price8
,c- .hat to the equili#rium quantity and price as the num#er of firms N gets
#igger8
40. The following ta#le shows payoffs in millions of dollars associated with the
release of new fashion designs #etween Bates Clothes ,BC- and Mu#y5s 6ashions
,M6-.
BC
M6
Melease *on5t release
Melease "A,"A !,"=
*on5t release "=,! "/,"/
11
,a-4ssuming simultaneous mo$es, what is the Nash Equili#rium outcome for this
game8 *oes the Nash Equili#rium maximise 0oint profits8
,#-Now assume that #oth BC and M6 include a third strategy and BC gets to mo$e
first. That is BC gets to decide what to do #efore M6. Construct a game tree for
fashion game and identify the Nash Equili#rium.
BC
M6
Melease <imited release *on5t release
Melease !,! ",/ "/,H
<imited release /," "A,"A !,"=
*on5t release H,"/ "=,! "/,"/
41. RTragedy of the CommonS relates to o$eruse of a resource where players ha$e
open access. 4ssume two farmers 4 and ( are deciding how many cows to graze
on the $illage common. The $illage common is quite small and can easily #e o$er@
grazed. <et the payoff in mil' per cow #e gi$en #y

- , !! - , ,
5 3 5 3
Y Y Y Y 6 + = where Y
3
and Y
5
represents the num#er of cows
#rought to the commons #y 4 and ( respecti$ely.
,a- 6ind the Nash equili#rium for this game and the return each famer ma'es.
,#- *oes the Nash Equili#rium maximise returns8 &f not how many cows does8 &s
this equili#rium sta#le i.e. does the re$enue maximising solution pro$ide an
incenti$e to cheat8
+ure E2chan*e E.ui)i/rium
42. Person 45s utility function gi$en #y
A A
A
Y X U
= . !
= and person (5s is

B B
B
Y X U = . Their initial endowments are
"A "A = =

A
Y and
X
A
) and
">> > = =

B
Y and
X
B
respecti$ely.
,a- ;sing an Edgeworth (ox, with person 45s origin at the Rsouthwest cornerS show
their respecti$e endowments of U and G. Put U on the horizontal axis and G on the
$ertical axis. 2'etch in their respecti$e indifference cur$es ,note, a RroughS s'etch is
fine- at their initial endowments. Calculate their marginal rates of su#stitution at the
initial endowment. 4re they equal8
,#- 6ind an equili#rium set of prices using P
x
as the numeraire. Ki$en your equili#rium
prices find the quantity of U and G each person consumes. ;se the Edgeworth (ox
drawn in ",a- a#o$e to illustrate the equili#rium consumption of U and G. Calculate
the EM2 for each person at the equili#rium. 4re they equal8 &s the equili#rium
efficient8 (riefly 0ustify your answer.
,c- Can you find another initial endowment, using the same set of prices you disco$ered
in ",#-, that will result in the same equili#rium le$el of consumption8 &llustrate your
answer.
43. Kinger has a 'ilogram of sausages " =
+
s
e and no potatoes
! =
+
%
e
, and 6red
has a 'ilogram of potatoes
" =
'
%
e
and no sausages ! =
'
s
e . 4ssume Kinger has the
12
utility function

=
"
+ + +
P / U and 6red has the same utility function

=
"
' ' '
P / U ,
and the parameter

is the same for Kinger and 6red.

,a- *eri$e the contract cur$e and illustrate your result using the Edgeworth #ox.
,#- *eri$e the competiti$e equili#rium.
44. 4manda has > #ottles of wine and loa$es of #read - , > , - , , =
3
5
3
!
e e and 2ue
has #ottles of wine and / loa$es of #read - / , , - , , =
/
5
/
!
e e . Their respecti$e
utility functions are
A . > . . A .
5 W U 4nd 5 W U
/ 3
= = .
,a- &llustrate the initial endowments using an Edgeworth #ox. &s the initial
endowment efficient8
,#- *eri$e the competiti$e equili#rium and show that the equili#rium prices are
Pareto efficient.
4. The total amount of food a$aila#le on an island is "! units and the total
amount of energy a$aila#le is "! units. Mo##ie has " unit of food and = units of
energy and (onnie has H units of food and = units of energy. Their respecti$e
utility functions are
. / . > . A .
7 ' U 4nd 7 ' U
5 R
= = .
,a- &s the initial endowment efficient8
,#- *eri$e the contract cur$e.
,c- *eri$e the competiti$e equili#rium using the price of energy as numeraire.
4!. There are two goods in the world, mil' ,X- and honey ,Y- and two consumers
&chi and Ni. &chi got in first and cornered the total endowments of mil' and honey,
his endowment is - > , > , - . , =
I
Y
I
X
e e and his utility function is
?
X8 U
I
= . Ni5s utility
function is X8 U
9
= . ;se P
X
as the numeraire.
,a- &s the original endowment Pareto optimal8 Explain.
,#- Now suppose a #ene$olent dictator sets &chi5s lump@sum tax at > =
I
0 and
Ni5s lump@sum transfer at
> =
9
0
. .rite down the new #udget constraint for #oth
&chi and Ni. 2ol$e for the competiti$e equili#rium
8 9 9 I I
P 4nd 8 X 8 X - , , , - , ,
L L L L
.
+u/)ic 0oods and E2terna)ity
4". There are three consumers of a pu#lic good. The demand for each consumer+
P
"
: A! J %
P

: "!! J %
P
?
: ">! J %
.here P
i
is the price ,marginal $alue to person i- in dollars and % measures the
num#er of units of the good. The marginal cost of the pu#lic good is 7"/!.
,a- .hat is the economically efficient le$el of production of %8 &llustrate your
answer on a clearly la#elled graph.
,#- .hat if the producer of % pri$ately contracted with person and ? o$er the
supply of %. .hat would they agree to8 &s the contracted quantity of %
economically efficient8 1ustify your answer.
,c- 3ow would your answer change if the marginal cost of producing the pu#lic
good is 7A!8 .hat if the marginal cost is 7?=!8
4#. There are two groups of citizens on .aihe'e &sland. The first type is willing to
pay - P ="!!
"
for a marine reser$e where % is measured in hectares. The other
13
group is willing to pay - P =/!

. The opportunity cost of setting aside the

reser$e is 7! per hectare.
,a- .hat is the optimal area of the reser$e8
,#- 4ssume that a pri$ate organisation is granted the rights to acquire the reser$e
,at 7! per hectare- and charge an entry fee. .ould this result in a different sized
reser$e8 .hat pricing strategy would optimise the firm5s profit8
4$. 2uppose that a #ee'eeper is located next to a !@hectare apple orchard. Each
hi$e of #ees can pollinate V hectare of apple trees, there#y raising the $alue of apple
output #y 7=.
a. 2uppose the mar'et $alue of the honey from one hi$e is 7=! and that the #ee@
'eeper5s marginal costs are gi$en #y

- :C = . ! ?!+ =
where - is the num#er of hi$es employed. &n the a#sence of any #argaining, how
many hi$es will the #ee'eeper ha$e and what portion of the apple orchard will #e
pollinated8
#. .hat is the maximum amount per hi$e the orchard owner would pay as a su#sidy to
the #ee'eeper to prompt her to install extra hi$es8 .ill the owner ha$e to pay this
much to prompt the #ee'eeper to use enough hi$es to pollinate the entire orchard8
0. Two types of firms emit a nasty pollutant ,we will call the pollutant z-. There
are ten firms of each type. The firms thin' of pollution emissions as a producti$e
input much li'e any other input. The primary difference is that the price of pollution
emissions is currently 7!. Their input demand functions for pollution emissions are+
!
1
= 100 ; <
1
!
2
= 150 ; <
2
,d-Ki$en the current price of pollution emissions, how much does each firm emit, and
what are total emissions8
,e-2uppose that we want to reduce pollution emissions to "!!! units in total and we
must use an emission tax ,T- per unit emited. .hat $alue of T will induce firms to
reduce emissions to the target le$el8
Re'erences
(esan'o, *. and M.M. (raeutigam. !!=. :iroeono=is, 1ohn .iley P 2ons,
3o#o'en, N1.
Nicholson, .. "HH/. :iroeono=i 0heor", 3arcourt (race P Company, Orlando,
6lorida.
Perloff, 1.E. Eicroeconomics with Calculus, Pearson, Essex, England.
2errano, M. and 4.E. 6eldman. !"?. 4 2hort Course in &ntermediate Eicroeconomics
with Calculus, Cam#ridge ;ni$ersity Press, NG.
14
15