Note of caution for students:

 The actual question paper is not going to be a subset of this question bank. This
is just to serve as a general outline of how the questions in the actual paper will
be.

QUESTION BANK

1. Rahul has a utility function of the formu ( w )=√ w . He has an initial wealth of Rs 16.
He is offered the opportunity to bet on the flip of a fair coin and will get Rs 20 if
head comes and zero if tail comes. Calculate for Rahul, the Certainty Equivalent of
this gamble.
2. Why lemon problem exists, at least minimally, in every market transaction?
Describe how and in which way information asymmetry breeds inefficiency resulting
in situation where bad quality drives out good. Is it advisable to use this conceptual
framework while transacting in insurance market.
3. State and describe an efficient strategy for job hiring in a situation where attributes of
potential employees can’t be observed perfectly by the employers but the market is
competitive and the productivity of the employee matters. Suppose some of the
potential employees behave differently in order to have a particular high paid job,
which is, perhaps, beyond their ability. As an intelligent employer, what would be
your preferred choice variable that will ensure market-clearing solution? Please
explain with suitable example.
4. Explain the concept of IRRA, DRRA.
5. What is the relation between Certainty Equivalent and expected value of a lottery if a
person is i) risk lover, ii) risk averse
6. Explain the usefulness of Roy’s safety index
7. State and prove Hoteling’s lemma
8. Show that input demand curve will be unambiguously negatively sloped even for an
“inferior input”.
9. State True or False, with proper explanation (4 marks each)

i. Decreasing absolute as well as relative risk aversions are the desirable properties
of utility function.
ii. Purchasing insurance coverage is a rational response under the presence of risk
and uncertainty.
iii. The demand curve for a normal good is always negatively sloped.
iv. Producers in a competitive industry will prefer the stabilized price at average level
than fluctuating price.
v. According to Prof Arrow any utility function should satisfy DARA.
vi. Consumer A will accept any gamble that consumer B accepts means consumer A
is more risk averse than consumer B
vii. When the agent’s “effort” is not observable, the “First best contract” can’t work.
viii. While purchasing insurance, the risk averse individual will always go for full
coverage
ix. Isolation effect violates expected utility theory.
x. Expected utility theory with concave utility function implies probabilistic
insurance is more attractive than full coverage insurance.
 10. Show that if the insurance industry is perfectly competitive the insurer may get full
coverage.
11. What is a minimax regret criterion? When is it useful?
12. Do you think the modified Domar Musgrave Index is an improvement over the
earlier one?
13. What is reflection effect? Does it violate expected utility theory?
14. What is relative risk aversion? Explain CRRA with example.
15. How can passive choice and intertemporal choice made by economic agents create a
wedge between normative and revealed preference?
16. Suppose Lib has the option of taking a job as an executive assistant that pays
$62,000 with certainty or choosing a career in law. If Lib chooses the career in law,
there is a 50% chance she will not make partner and will only earn $45,000. On the
other hand, if Lib chooses a career in law, there is a 50% chance she will make
partner and will earn $80,000 annually. Lib's utility function is U(I) = I 2, where I
represents annual income.
i) Is Lib risk-averse, risk-neutral or risk loving?
ii) Should she become an executive assistant or choose a career in law?
17. Explain the difference between “passive profit function” and profit function.
18. Suppose John’s utility function is given by u(I)={100-(100,000/I)}, where I
represents annual income. Suppose John is currently earning an income of Rs 20,000
and can earn that income next year also. He is offered to take a job that offers a 50%
chance of offering Rs 25,000 and 15% chance of offering Rs 15,000. Should he take
the new job? In (a) would John be willing to buy insurance to protect against variable
income associated with the new job? If so what is the maximum amount he would be
ready to pay for insurance?
19. Show that irrespective of the nature of agent (risk averse or risk neutral) the “first
best contract” between principal and agent can’t work under asymmetric information
and in the absence of one to one relation between input and output.
20. Explain the following Concepts/Short Notes:-
a. Convexity of Indifference curve
b. Product differentiation
c. Price discrimination
d. Cost Function
e. Excess capacity

21. Can a prudent individual exhibit Increasing Absolute Risk Aversion (IARA)? What
do you think?
22. a) Show that under “Fair Premium” a risk averse individual will go for purchase of
full coverage from an Insurance company.
b) What are the important assumptions you have to take here?
23. Explain how the presence of “Asymmetric information” can lead to inefficiency ?
24. What is meant by weak and strong axioms of revealed preference? Explain with
example.
25. Z shows the following preference: When Price of X and price of Y are Rs 2 and Rs
4 the quantity purchased of X and Y are 10 and 20 respectively and when the price
of X and Y change to Rs 3 and Re1 the quantity purchased become 15 and 40. Is the
preference pattern consistent as per revealed preference theory?
 26. Show how does a market under perfect competition will reach long run equilibrium
from short run equilibrium.
27. What is common ratio effect? Does it satisfy expected utility theory?
28. a) What is meant by efficient incentive scheme?
b) “The presence of Hidden action and hidden information jointly stand in the way of
first best contract between employer and employee.”-justify.
29. a) Does quadratic utility function satisfy DARA?
b) What is the relation between risk attitude and risk premium?
c) Do you think prospect theory overcomes some limitations of expected utility theory?
30. “Baumol’s risk index truly emphasizes on expected return of an investment without
ignoring the chances of deviation from yet, hence it’s an useful index for investors”-
do you agree?
31. Explain the concept of value at risk as a risk measure
32. How can an efficient signal produce separating equilibrium?
33. Explain the concept of Roy’s safety index.
34. Do you think prospect theory is an improvement over expected utility theory?
35. Explain the concept of CRRA, DARA
36. What is certainty effect? Does it violate expected utility theory?
37. Show that input demand curve will be negatively sloped. (using the property of cost
function
38. Show that if the insurance industry is having imperfect completion the insurer may
get partial coverage.
39. Describe the properties of profit functions
40. Explain the concept of opportunity cost of holding an asset.
41. What is “limits to arbitrage”?
42. Show by Revealed Preference Theory Substitution effect is always negative.
43. How can passive choice and intertemporal choice made by economic agents create a
wedge between normative and revealed preference?
44. Show that labour supply curve is more likely to be backward bending at a higher
level of hours of work
45. In the context of intertemporal choice can we give revealed discount rate the
“normative” status?
46. When there is a change in the scale of operation the cultivator uses tractors instead of
rototiller.
a. How can you classify rototiller as an input?
b. If price of rototiller increases, what will happen to its demand?

47. In reality a rational insurer can be reluctant to offer full coverage”- Why?
48. a) Explain the concept of common ratio effect with example.
b) How can the reflection effect be explained by prospect theory. (Hint: prospect
theory talks on risk seeking for negative returns and risk avoidance for positive
returns.)
49. In the context of intertemporal choice can we give revealed discount rate the
“normative” status?

Guided by:
Dr. Atreyee Sinha Chakraborty