LUBS242001

Separate script books

must be provided for
sections A and B

This question paper consists

of ....3.... printed pages,
each of which is identified by
the Code Number
LUBS242001

LUBS242001
UNIVERSITY OF LEEDS
May/June 2014

Examination for the degree of

BA and BSc
BUSINESS ECONOMICS

Time allowed 2 hours

Answer ALL questions in SECTION A and
TWO questions from SECTION B
Section A carries 40 marks
Section B carries 60 marks

Please answer Section A and Section B in separate script books

Please Turn Over

1

LUBS242001
SECTION A - Answer ALL QUESTIONS in this section
A1

A firm uses capital and labour to produce a single output. The prices of
capital and labour are given. The firms product market is perfectly
competitive, and the market price is P. Draw the firms short-run cost
curves and show the profit-maximising output for a particular value of P,
at which profit is strictly positive.
(10 Marks)

A2

Give an example of profit-maximising firm that is Pareto- (or allocatively)

inefficient in an economy with perfect information and no uncertainty.
Please give the definition of Pareto efficiency, and illustrate your answer
with a graph showing the inefficient profit-maximising firms price and
output; the Pareto-efficient price and output; and why the firm is not
Pareto efficient.
(10 Marks)

A3

Your only possession is a painting worth 50,000. However, there are

thieves in your neighbourhood, and in any given year, there is a 10%
chance the painting will be stolen and cannot be recovered.

(a)

What is your expected wealth if you do not get any insurance?

(b)

You can buy insurance to be compensated for the full value of the
painting if it is stolen. The cost of insurance (the value of the insurance
premium) is 5,000. What is your expected wealth if you get insured?

(c)

Will you get insurance if you are risk averse? Please explain your
answer with the help of a graph.

(d)

Please show on the graph the maximum insurance premium you would
be prepared to pay.
(10 Marks)

A4

You own a prosperous business and live in the UK, and have a shop in
New York. To manage the shop, you hired an impoverished business
school graduate. However, you had not designed her contract carefully,
and there seem to be problems.

(a)

She has just moved the shop to much larger, expensive premises. She
says she has studied the New York market and this is the best strategy
for the shop, but you are afraid this is not true. Thinking of yourself as
the principal and of her as your agent, how would you describe what
you fear has been happening?

(b)

Suppose you agree with her that she will be paid with a share of profit
from now on. You are both risk averse. Why would this optimal
contract be a second best optimum? Explain.
(10 Marks)
Total 40 Marks
Please Turn Over
2

LUBS242001
PLEASE ANSWER THIS SECTION IN A SEPARATE ANSWER BOOKLET
SECTION B - Answer TWO questions in this section
B1

Economies of scale and specialisation explain the existence of firms

but not the existence of risk-taking entrepreneurs. Discuss.
(30 Marks)

B2

What are transactions costs and what do they have to do with the
existence of firms? Explain.
(30 Marks)

B3

Corporate governance is not really a problem. What matters is to

have an efficient capital market and to reward managers for success.
Discuss.
(30 Marks)

B4

The best way to pay employees in order to make them work hard is
not always the same. It depends on the circumstances. Discuss,
assuming that employees only derive utility from income and leisure.
(30 Marks)

B5

Compare and contrast the factors that motivate employees in Akerlofs

efficiency wage (gift-exchange) theory with the conditions under which
intrinsic motivation is thought to flourish.
(30 Marks)

B6

The reason why there are so few employee-owned firms is that they
perform poorly and cannot survive. Discuss. Is there empirical
evidence on the issue?
(30 Marks)
Total 60 Marks

END