Financial Economics – Extra Practice for Final Exam

1. Using general equilibrium analysis, and taking into account feedback effects, analyze the
following
 The likely effects of increase in insurance price on the market for cheap cars which is the
car for low-income people.
 The effects of increased taxes on petrol on using air tickets for travelling to holiday
destinations.

2. Explain the difference between adverse selection and moral hazard in insurance markets.
Can one exist without the other?

3. Contract curve shows all efficient allocations of goods between two consumers or of two
inputs between two production functions. With the help of graph and hypothetical example,
derive the contract curve.

4. You have seen how asymmetric information can reduce the average quality of products sold
in a market, as low-quality products drive out high-quality products. For those markets in
which asymmetric information is prevalent, would you agree or disagree with each of the
following? Explain briefly:
a. The government should subsidize Consumer Reports.
b. The government should impose quality standards—for example, firms should not be
allowed to sell low-quality items

5. Assume that scientific studies provide you with the following information concerning the benefits and
costs of dirt emissions of a cement factory
Benefits of reducing dirt emissions: MB = 400 - 10A
Costs of reducing dirt emissions: MC = 100 + 5A
where A is the quantity abated in millions of tons and the benefits and costs are given in dollars per ton.
a. What is the socially efficient level of emissions abatement?
b. What happens to net social benefits (benefits minus costs) if you abate one million more
tons than the efficient level? One million fewer?

6. Prove that that contract curve will be a straight line if the utility function for both consumers
is U=3x2i yi