ECOS2001 Practice exam no.

1. Consider the market for drug Y. The patent for Drug Y held by a firm Pharmagoods, and
there are no close substitutes. Drug Y was developed over ten years and cost Pharmagoods
$10,000 to develop. Market research shows that the price elasticity of demand for Y (in
absolute terms) is 2. The marginal cost of production of the drug is $1 per unit. What price
should Pharmagoods set for drug Y?

a. $3
b. $1.5
c. $2
d. $5
e. None of the above

The next three questions relate to the following example. Consider a perfectly competitive
industry in which each of the 100 firms in the industry have a cost function of Ci(qi) = 25 +qi2,
where qi denotes the quantity of output produced by firm i, for i= 1, … , 100. The marginal
cost for the each firm is MC(qi) = 2qi, where the firm is producing qi. Demand in the industry
is given by D(p) = 440 – 5P, where D(p) is the total quantity demanded and p is the price.

2. What is the short-run industry supply curve?

a. Q = 0.5p
b. Q = p
c. Q = 25p
d. Q = 50p
e. None of the above

3. In the short run, what is the competitive market equilibrium?

a. The market price is p = $6; each firm produces 4.1 units and total market output is 410
units.
b. The market price is p = $8; each firm produces 4 units and total market output is 400
units.
c. The market price is p = $10; each firm produces 3.9 units and total market output is 390
units.
d. None of the above.

4. In the long-run market equilibrium, what is the number of firms in the industry?

a. 100
b. 120
c. 50
d. 78
e. None of the above

ECOS2001 Practice exam no.3 1

The following information applies to the next two questions.

In the used-car market in Winton are two types of cars: bad cars and good cars. Owners of the
cars know what sort of car they have, but to potential buyer all cars look alike (until after they
have already been bought).

Owners of bad cars are willing to sell their cars for $400. Owners of good cars are willing to
sell their cars for $600.

Buyers have a maximum willingness to pay for a bad car of $500 and a maximum willingness
to pay for a good car of $1000. Buyer are risk neutral, so they maximise their expected return
when considering their purchase.

5. If the proportion of bad cars in the market is (1 – q) and the proportion of good cars is q,
what is a buyer’s expected value (EV) from buying a car.

a. EV = (1 – q).500 + q.1000
b. EV = (1 – q).1200 + q.700.
c. EV = (1 – q).700 + q.1200
d. EV = 900
e. None of the above.

6. What is the maximum proportion (1 – q) of bad cars in the market such that the owners of
the good cars are still willing to sell their cars?

a. (1 – q) = 0.2
b. (1 – q) = 0.4
c. (1 – q) = 0.6
d. (1 – q) = 0.8
e. None of the above.

7. Which statement is true?

a. Long-run marginal cost intersects short-run marginal cost at it minimum.

b. The short-run supply curve is the short-run marginal cost curve above the minimum
of average variable cost.
c. Long-run marginal cost is the lower envelope of the short-run average total cost curves.
d. The short-run supply curve is horizontal at the market price.
e. None of the above.

ECOS2001 Practice exam no.3 2

8. Let a consumer’s utility function be given by U ( x1 , x2 ) = x11/ 2 .x22 , where x1 is the quantity
of good 1 consumed and x2 is the quantity of good 2 consumed. What is the marginal rate of
substitution MRS 2→1 – that is, substituting good 2 for good 1 – for the consumer?

− x2
a. MRS 2→1 =
4 x1
− x22
b. MRS 2→1 =
x1
−4 x22
c. MRS 2→1 =
5 x11/ 2
d. MRS 2→1 = 2
e. None of the above.

9. Consider the short-run profit function of a competitive firm:

max pf ( x1 , x 2 ) − w1 x1 − w2 x 2 , where p is f ( x1 , x 2 ) is the production function, x1 is the
x1

quantity used of input 1 at cost per unit of w1 and the fixed input 2 of x 2 has a unit cost of
w2 .
If output price p falls:
a. there is no change to the vertical intercept for an isoprofit curve for a given level of profit,
however the output level falls and there is a decrease in the quantity demanded by the firm for
its variable input (there is a movement along its input demand curve)
b. in the short-run there is no change to the slope of the isoprofit lines, so there is no change
to the firm’s optimal choice input 1.
c. there is an increase in the slope of the firm’s isoprofit curves, the firm’s output level
falls (implying an upward-sloping supply curve) and there is a decrease in the firm’s use
of input 1 (implying the firm’s demand curve for the firm’s variable factor shifts in)
d. all of the above
e. none of the above

10. Assume that the production function for competitive firm is given by F ( L) = 6 L2 / 3 ,
where L is the number of units of labour used in the production process. Suppose that the cost
per unit of labor is $4 and the price of output is 3, how many units of labor will the firm hire?
a. 16
b. 27
c. 9
d. 24
e. none of the above.

ECOS2001 Practice exam no.3 3

11. Chris’s production function is 0.1L1/ 2 K 3/ 4 , where L and K are the units of labour and
capital used in the production process, respectively. Suppose that Chris can vary both labour
and capital. If labour costs $10 per unit and capital costs $20 per unit, then the cost-
minimising method of production requires using labour and capital in the ratio:
a. L/K = 4/3
b. L/K = 1/2
c. L/K = 2
d. L/K = 3/2
e. L/K = 4

12. A firm has a long-run cost function, C(q) = 8q2 + 200. In the long run, this firm will
supply a positive amount of output, as long as the price is greater than
a. $96
b. $80
c. $72
d. $200
e. None of the above

The following information applies to the next two questions. Harry is an expected utility
maximiser with an expected utility function represented by:

u (c1 , c2 , π ) = π .(c1 )1/ 2 + (1 − π ).(c2 )1/ 2

where c1 and c2 are his income in the two different states of the world and π is the probability
that his income is c1. Harry faces the following lottery: with probability 0.5 he receives 36 and
with probability 0.5 he receives 64; that is, c1 = 36, c2 = 64 and that π = ½.

13. What is Harry’s expected income (EI) and expected utility (EU) respectively?

a. EI = 50; EU = 6
b. EI = 50; EU = 7.
c. EI = 75; EU = 37.5
d. EI = 2.5; EU = 7.5
e. None of the above.

14. What is the certainty equivalent level of income (CE); that is, what is the level of income
that gives Harry the same level of expected utility as with the lottery detailed above?

a. CE = 62.5
b. CE = 75
c. CE = 50
d. CE = 56.25
e. None of the above.

the certainty equivalent is c = 49

U = 7 = c1/2; there c = 49

ECOS2001 Practice exam no.3 4

Extra questions

1. Review the following games: prisoners’ dilemma and a coordination game. What
are the characteristics of a prisoners’ dilemma? Practice solving for the pure strategy
and mixed strategy equilibria in a coordination game.

2. Following the lecture notes, work out the Nash equilibrium in a Cournot (quantity-
setting) game) with 2 firms with constant marginal costs of production of c. Also,
solving backwards, solve for the subgame perfect Nash equilibrium in a Stackelberg
game, when firm 1 sets their quantity first, firm 2 observes the quantity firm 1 has set
and then decides on its output.

3. Review every tutorial question throughout the semester.

ECOS2001 Practice exam no.3 5