001: Microeconomic Theory

Department of Economics, Delhi School of Economics

Midterm exam: January 31, 2022
Time: 2:00 - 4:30 p.m

INSTRUCTIONS

Answer all questions.

Write your full name and roll number clearly on the rst page of your answer sheet.

Create a single pdf le by scanning all your answers.

Upload the pdf le by 4:30 p.m via Google forms using the following link:
https://forms.gle/HgW6zJwtV5ptTvut6.

In case you have di culty uploading, you can email your pdf le to the following
email address: ec001midterma@gmail.com by 4:30 p.m.

Follow this lename convention: \FirstnameLastname.pdf".

PWD (persons with disabilities) category students have 40 min extra time. You
can upload your answers with a latest time stamp of 5:10 p.m. Students claiming
PWD status should additionally attach a signed self declaration letter attesting to
such status.

You can look at your books and notes during the exam but you cannot consult
another person. It is expected all students will adhere to this honour code.

Best of luck!

1
1. A household spends its income y on two goods with market price p1 and p2 . Its
preferences are represented by

u(x1 ; x2 ) = (x1 + a1 ) (x2 + a2 )1

where x1 ; x2 are the quantities of the two goods consumed; a1 ; a2 > 0 and 2 (0; 1)
are parameters.

(a) Derive the Marshallian demand functions for the two goods.
(b) Write down parametric conditions under which the solution is interior.
(c) Let a1 = a2 = 0 and = 43 . Also, let y = 100, p1 = 15 and p2 = 5. The
government starts a subsidy programme under which the household is given a
subsidy of Rs. 5 per unit on its purchase of good 1. If the subsidy programme
was replaced by a cash transfer programme that allowed the household to
reach the same level of utility as the former, how much money will it save the
government?
(d) Continue using the same values for preference parameters and income as in
part (c) above. The government can provide a subsidy of Rs. s per unit on
good 1, but it has to be nanced by a lump sum tax T on the consumer so that
the government's budget is balanced, i.e., its net payment to the consumer is
0. The government is paternalistic and measures the welfare of the consumer
by the following utility function:

v(x1 ; x2 ) = min fx1 ; 3x2 g

Find the optimal values of (s; T ) from the government's perspective.

(10 + 5 + 10 + 15 = 40)

2. The market for widgets has a single price-taking consumer. The inverse demand
function is p = 6 2q, where p is price and q is quantity demanded. Widgets are
supplied by two rms, 1 and 2. The rms can produce in their respective factories

2
using the following production functions:
q
q1 = min fL1 ; 4K1 g
1 2
q2 = L2 K23 3

where qi is rm i's output, Li is the amount of labour used by rm i and Ki is the

amount of capital used by rm i. The cost of labour is 1 per unit and the cost of
capital is 2 per unit.

(a) Suppose there is perfect competition in the widget market, i.e., both rms
act as price takers. Derive the cost and supply function of each rm.
(b) Find the equilibrium price and quantity.
(c) Suppose rm 1 has bought up rm 2 and has emerged as a monopolist. The
monopolist can allocate its production across the two factories as it wishes.
Derive the cost function of the monopolist.
(d) Find the optimal monopoly price and quantity if the monopolist can only
charge a constant per unit price.
(e) Suppose the government can impose a tax t per unit on the monopolist (t
can be negative, in which case it is a subsidy). What value of t maximizes (i)
tax revenue (ii) social surplus?
(f) Set t = 0. Suppose the monopolist can use a two-part tari , i.e., charge a xed
fee f and a per unit price p from the consumer. Find the pro t maximizing
values of f and p.

(10 6 = 60)