Microeconomics–Final.

Time: 2 hours

Answer any five of six questions. The exam is for two hours. Please hand your
question paper back to the invigilator after the exam.
Each questions carries 20 marks. The marks for each subpart is indicated in brackets after the
statement of the question.

1. Suppose the market demand curve of a particular product in a country is Q = 10 − P . The

domestic market supply curve in that country is Q = P .

(a) Find the equilibrium price and quantity in this market. Calculate consumer and producer
surpluses. (4)
(b) Assume the world price for this product is 3 and the country in question is a small one.
Suppose the country now opens up to imports. What is the equilibrium price in the
domestic market now? What is the equilibrium level of consumption? Calculate the
level of domestic production and import. (4)
(c) Find the consumer and producer surplus in the market after it opens up to imports.
Compared to part (a), who gains and who loses? Is aggregate surplus higher or lower
after imports? (5)
(d) Now suppose an import tariff of 1 per unit of import is imposed. Find the new equi-
librium price, consumption, domestic production and import. Also find new consumer
surplus and producer surplus? Compared to part (c), who benefits and who loses? Is
aggregate surplus higher or lower compared to (c)? (7)

2. Consider a monopolist who serves two types of markets. One market has a high willingness to
pay. The demand curve of high-willingness type (say group 1) is Q1 = 100 − P . The demand
curve for the low willingness to pay (say group 2) is Q2 = 50 − P (Note that for any Q, group
1 consumers are willing to pay a higher price). Suppose the monopolist’s total cost function
is C(Q) = 10Q.

(a) Suppose the monopolist cannot distinguish between the two markets so that he needs to
charge the same price in both markets. What price must he charge in order to maximize
profits? (8)

1
 (b) Now suppose the monopolist cannot distinguish between the two markets. Hence, he
cannot price discriminate on the basis of observable characteristics. He now decides to
follow a damaged goods strategy.
The monopolist releases a lower quality version of the same product. The demand curve
for consumers in group 1 (high willingness to pay) for the damaged version is Q1 = 60−P .
The demand curve for consumers in group 2 (low willingness to pay) for this version is
Q2 = 40 − P . Suppose the cost function of the low quality version is C(Q) = 12Q. (The
low quality version costs more because the monopolist first produces the high quality
version and deliberately “damages” it. This adds to total cost.)
Show that by targeting the high quality version at group 1 and the low quality version
at group 2, the monopolist can earn a higher profit compared to (a). (12)

3. Player 1 has two strategies; top (T) and bottom (B). Player 2 also has two strategies; left (L)
and right (R). The payoffs of the two players are summarized in the following matrix; with
the first numbers being player 1’s payoffs. (5+5+5+5)

L R
T 7, 4 2, 2
B 1, 4 4, 9

(a) Suppose the two players play simultaneously. Find the Nash equilibria of this game.
(b) Now, suppose player 1 moves first. Draw the extensive form of the game and show that
the outcome is (T,L).
(c) Player 2, however, prefers the outcome (B,R). Suppose player 2 threatens to play R
irrespective of what player 1 does. Is such a threat credible?
(d) What measure can player 2 take to ensure that the outcome of the game is (B,R)?

4. Consider the following two questions on game theory.

(a) Consider two corporations A and B. They can choose between two levels of advertising:
high level (H) and low level (L). The payoffs from the two actions are given below with
the rows standing for corporation A’s actions.
 
H L
 H 12, 12 15, 10 
 

L 10, 15 13, 13

i. Will corporation A engage in high or low level of advertising? What about corpo-
ration B? (6)
ii. What is the predicted outcome of this strategic situation? Is the outcome socially
efficient? (4)

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 (b) Two firms, X and Y, are searching for locations to establish themselves. Each firm has
a choice of two locations; L1 and L2. The payoffs in the location game are as follows.
The row player is firm X.  
L1 L2
 L1 10, 10 60, 40 
 

L2 25, 55 20, 20

i. Find the Nash equilibria of this game. (5)

ii. Firm X launches an advertising campaign declaring that it will establish itself in
location L1. Explain the rationale behind this action. (5)

5. Suppose there are two firms, A and B, in a duopoly market for a homogeneous good. Suppose
the cost of production of both firms is zero. The market demand curve is

P = 30 − Q,

where Q = Q1 + Q2 . (5+5+5+5)

(a) Suppose both firms decide their quantity choice simultaneously. What is the output and
profit of each firm?
(b) Now suppose the two firms collude. What is the profit maximizing output level and the
associated profit?
(c) Suppose the two firms interact only once. Can such collusion be sustained? Why or why
not? Give a precise quantitative answer.
(d) Suppose the two firms interact repeatedly. In this situation, can collusion be sustained?
Describe in words the nature of a strategy that can sustain the collusion.

6. Consider a river flowing through a village. The river is a common resource for the village.
Villagers can catch fish in the river using fishing boats. If the number of boats is x, the
√
amount of fish caught is x. Assume that the cost of a fishing boat is 1. (8+8+4)

(a) What is the optimal number of boats that should be used for fishing in the river? Assume
that the number of boats is a continuous variable.
(b) What is the number of boats that will be actually used in the river?
(c) Explain the difference between the optimal and the actual number of boats.