SCHOOL OF ECONOMICS

ECO2003F: INTERMEDIATE MICROECONOMICS

SUPPLEMENTARY EXAMINATION
JANUARY 2014

Time:
Total marks:

3 hours and 15 minutes.

180 marks

Examiner:
Katherine Eyal
Internal Moderators: Leonard Smith
External Examiner: Gideon Du Rand

Instructions:
1. There are 30 multiple choice questions in this exam. MCQs that are correctly answered
earn you 3 marks, while each incorrectly answered question attracts a penalty of 1 negative
mark.
2. All questions are compulsory.
3. Please answer part B, C and D in 3 separate answer books.

Part A:
Multiple Choice Questions

(1).

Nosiphos utility function is given by U = M1/2. Nosipho has a choice: to take R100 in
cash or to take a gamble based on the flip (toss) of a (fair) coin. If Nosipho takes the
gamble, the outcomes are as follows: heads, she wins R225; tails, she wins R49.
Nosipho will

(i)

take the R100 in cash

(ii)

take the gamble

(iii)

be indifferent between the cash and the gamble

(iv)

we cannot say as we do not know Nosiphos initial value of M

(v)

Nosipho is risk averse and will never accept a fair gamble

Which of the above statements are true?

(A)

(i) and (v) only

(B)

(iv) only

(C)

(ii) only

(D)

(iii) only

(2).

You are trying to guess the average age of a group that walks across a stage in a
guessing contest, and you are influenced by anchoring and adjustment bias. You will
guess a higher age estimate if the group

(A)

walks across the stage in ascending order of age

(B)

walks across the stage in a randomly selected fashion

(C)

walks across the stage in descending order of age

(D)

has bald rather than grey-haired senior citizens

(3).

A firm is operating in a perfectly competitive labour market, and an imperfectly

competitive product market. In the short run, the firm hires labour until the wage
equals _____, and it is _____ to change the product price by changing its output level.
Fill in the blanks.

(A)

the marginal revenue product; able

(B)

value of marginal product; unable

(C)

marginal revenue product; unable

(D)

value of marginal product; able

(4).

If the marginal product of the fifth person employed is 15 units and the product price
is R10, then the VMPL (value of marginal product of labour) of the fifth person
employed is

(A)

R15.

(B)

R150 if the product market is perfectly competitive.

(C)

R25.

(D)

more than R150 if the product market is monopolistically competitive.

(5).

If we minimise the cost function C = 20K + 10L subject to the constraint

K1/4L1/2 = 200, using the Lagrangian method, and round our answers to whole
numbers, we obtain L* = _____ and C* = ________. Fill in the blanks.

(A)

1857; 27850

(B)

464; 1857

(C)

464; 27850

(D)

465; 27850

(6).

Long-run cost functions that exhibit increasing returns to scale over the entire relevant
output range lead to

(A)

intensive competition among firms because low costs mean high potential profits

(B)

minimal competition and often a monopoly because the market cannot support
numerous large firms taking advantage of the economies of scale

(C)

many small firms producing at high cost in a regulated market because of the high
risk of investing heavily in one venture

(D)

none of the above, since such a cost condition is a theoretical construct not observed
in the real world

(7).

If you were to behave according to the rational choice model when confronted with a
loss of R25 on the same day in which you receive an unexpected gift of R25 you
would

(A)

value the loss of R25 more heavily than the gain of R25

(B)

discount the loss and value the gain so that you feel you have gained welfare

(C)

see the two events as exactly off setting each other and thereby of no consequence in
determining your overall welfare

(D)

value the gift of R25 more than the loss of R25

(8).

A risk loving person has a utility function which is ________, and an example of such
a utility function could be __________. This sort of person is _________ to take a fair
bet. Fill in the blanks.

(A)

concave; U = M2; unlikely

(B)

concave; U = M1/2; likely

(C)

convex; U = M1/2; unlikely

(D)

convex; U = M2; likely

(9).

The production function Q = 3KL with capital fixed at 2 is ________and has a slope
(in L) that is ______the slope of the same function with a fixed capital stock of 1. Fill
in the blanks.

(A)

linear, the same as

(B)

linear, twice

(C)

linear, three times

(D)

non-linear, one-third

(10).

Isoquants that are spaced equidistant from each other will

(A)

depict constant returns to scale across the entire production surface.

(B)

show decreasing returns to scale, since equidistant means that they are closer to each
other in proportion to the entire distance from the origin as they move out to the
northeast.

(C)

be inaccurately drawn.

(D)

not show any scale relationships unless there are output numbers put on the isoquants.

(11).

For equivalent homes, property purchase prices are higher in Cape Town than in
Johannesburg, while it is more expensive to rent property in Johannesburg. These
differences in prices and rents are expected to continue into the future. These
differences imply that at present

(i)

it would be more profitable to buy in Cape Town

(ii)

it would be more profitable to buy in Johannesburg

(ii)

cheap rentals might be explained by relatively lower incomes on average for the
population who are renting property in Cape Town

(iv)

relative to local demand, the supply of rentals is lower in Johannesburg than in Cape
Town

(v)

relative to local demand, the supply of rentals is higher in Johannesburg than it is in

Cape Town

Which of the preceding statements are most correct?

(A)

(i) and (iv) only

(B)

(ii) and (iii) only

(C)

(iv) and (v) only

(D)

(ii), (iii) and (iv) only

(12).

The average cost of living in Johannesburg is higher than the average cost of living in
Cape Town, which implies that

(A)

one should live in Cape Town if the average wage in Cape Town exceeds the
marginal cost of living in Cape Town

(B)

one should live in Johannesburg if the average wage in Johannesburg exceeds the
marginal cost of living in Johannesburg

(C)

one should live in Johannesburg if the marginal benefit of ones Johannesburg wage
exceeds the marginal cost of living in Johannesburg

(D)

None of the above options hold

(13).

Assume that the consumption of craft beer results in bandwagon effects. This implies
that

(i)

an individuals preferences are independent of other individuals consumption habits

(ii)

a consumers demand for craft beer is dependent on everyone elses demand for craft
beer

(iii)

the price elasticity of demand for craft beer is lower if it is a good with snob effects
than if it is not a good with snob effects

(iv)

the price elasticity of demand for craft beer is greater if it is a good with snob effects
than if it is not a good with snob effects

(v)

the income elasticity of demand for alcohol is higher than for other goods in general

Which of the preceding statements are true?

(A)

(i) and (iii) only

(B)

(ii) and (iv) only

(C)

(i), (iii) and (v) only

(D)

(ii), (iv) and (v) only

Use the indifference maps below to answer question 14.

(14).

Assume that both consumers, Justin and Camilla, get the same level of total utility
from the higher of their two indifference curves.

(i)

The absolute value of the slope of Justins indifference curve for the segment given by
the values on the X and Y axes is 0.5

(ii)

The absolute value of the slope of Justins indifference curve for the segment given by
the values on the X and Y axes is 2

(iii)

Justin likes salt relatively more than Camilla

(iv)

The preferences depicted graphically above violate the assumption of non-satiation

(v)

The preferences depicted graphically above conform to the assumption of transitivity

Which of the preceding statements are true?

(A)

(i) & (iii) only

(B)

(i), (iii) & (v) only

(C)

(ii) & (iv) only

(D)

(ii), (iii) & (v) only

(15).

Upward sloping indifference curves violate the assumption of

(A)

non-satiation

(B)

continuity

(C)

transitivity

(D)

completeness

(16).

Sugar and food are complements, and sugar and salt are substitutes to preserve food,
this implies that

(i)

salt and sugar will have L-shaped indifference curves

(ii)

sugar and food will have straight line indifference curves

(iii)

salt and food are complements

(iv)

we can expect the quantity demanded for sugar and food to be equally sensitive to
changes in price

(v)

only if salt and sugar are the same price can we expect the quantity demanded of each
good to be equally sensitive to changes in price

(A)

(i) and (iii) only

(B)

(ii) and (iv) only

(C)

(i), (iii) and (iv) only

(D)

(iii) and (v) only

Use the Hicks Decomposition below to answer questions 17 to 19.

(17).

In the Hicks Decomposition illustrated above the price of

(A)

Good X is decreasing

(B)

Good Y is decreasing

(C)

Good X is increasing

(D)

Good Y is increasing

(18).

For good Y, the change in demand due to the income effect is _____ and the change
in demand due to the substitution effect is _____. Fill in the blanks.

(A)

EF, GE

(B)

HI, IJ

(C)

IJ, FE

(D)

EF, FG

(19).

What type of goods are goods X and Y?

(A)

Good X is a normal good and so is Good Y

(B)

Good X is an inferior good and so is Good Y

(C)

Good X is an inferior good and Good Y is a normal good

(D)

Good X is a normal good and Good Y is an inferior good

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(20).

For a signal between two adversaries to be credible, it must

(A)

be verified by a third party

(B)

be costly to fake or duplicate

(C)

be part of a sequence of transactions

(D)

have both a good news and a bad news component

(21)

The expansion of the car manufacturing industry resulted in an improvement in

assembly line technology, so reducing the costs of production for each firm in that
industry. This is an example of

(A)

constant returns to scale

(B)

a decreasing-cost industry

(C)

decreasing returns to scale

(D)

an increasing-cost industry

(22)

Ceteris paribus, in the long run, a specific tax on the production of output in a
perfectly competitive industry

(A)

increases the price of the good by an amount equal to the tax/unit

(B)

increases the price of the good by an amount less than the tax/unit

(C)

is borne by both the producer and the consumer

(D)

is borne entirely by the consumer

(23)

The profit maximizing mark-up (over marginal cost) is given by

(A)

1/(price elasticity of demand)

(B)

price elasticity of demand

(C)

(price elasticity of demand)2

(D)

(price elasticity of demand) + 1

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(24)

The supply curve for a monopolist

(A)

is upward sloping

(B)

is vertical

(C)

does not exist

(D)

is downward sloping

(25)

If a monopolist has no costs, its profit maximising price occurs where demand is

(A)

infinitely price elastic

(B)

relatively (but not perfectly) price elastic in demand

(C)

unitary price elasticity in demand

(D)

relatively (but not completely) price inelastic in demand

(26)

Suppose you own a monopoly firm that produces cars. The inverse market demand is
given by the equation P = 100 - 2Q, where P is the price of cars and Q is the quantity
of cars sold per week. The firm's marginal costs are given by the equation MC = 16Q.
When the monopolist maximizes profits the price elasticity of demand for cars is

(A)

(B)

36

(C)

0.5

(D)

0.02

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Use the payoff matrix below to answer question 27.

Payoff Matrix
Firm B
Low price

High price

B = 10
Low price
Firm A

A = 10

B = 5
A = 25

B = 25
High price

A = 5

B = 20
A = 20

(27)

The above figure shows a payoff matrix for two firms, A and B. The firms must
choose between a high-price strategy and a low-price strategy. A denotes profit of
Firm A and B denotes profit of Firm B for each of the four possible outcomes. The
Nash equilibrium is that

(A)

Firm A sets low price, and Firm B sets high price

(B)

Firm A sets high price, and Firm B sets low price

(C)

Firm A sets high price, and Firm B sets high price

(D)

Firm A sets low price, and Firm B sets low price

(28)

Cournot duopolists face an inverse market demand function given by P = 90 - Q,

where Q is total market demand. Each firm can produce output at a constant marginal
cost of 30 per unit. If the duopolists collude then the market equilibrium price and
quantity are

(A)

Q = 30, P = 60

(B)

Q = 60, P = 30

(C)

Q = 40, P = 50

(D)

Q = 45, P = 45

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(29)

If the duopolists in question 28 behave according to the Stackelberg Leader-Follower

model, the market equilibrium price and quantity are

(A)

Q = 30, P = 60

(B)

Q = 60, P = 30

(C)

Q = 40, P = 50

(D)

Q = 45, P = 45

(30)

One would expect the demand curve facing a monopolistically competitive firm to be

(A)

more price elastic than for a perfectly competitive firm in the same industry

(B)

less price elastic than for a monopoly firm in the same industry

(C)

more price elastic than for a monopoly firm in the same industry

(D)

as price elastic as for a monopoly firm in the same industry

END OF PART A: 90 Marks in Total

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Part B
Please answer this question in a new answer book.

Suppose the supply and demand for tea at the University of Cape Town depends on the price
of tea, , the price of coffee, , and average student income, . The equations for the supply
( ) and demand ( ) curves are given by:

(a) Sketch a graph of the supply and demand curves for tea. Explain how each of the demand
and supply curves shift (if at all) if there is an increase in the price of coffee. Go on to
discuss the effect of any shift in either of the demand or supply curves on the equilibrium
price and quantity (increase/decrease)?
[10 marks]
(b) Sketch a second graph of the supply and demand curves for tea. Explain how each of the
demand and supply curves shift (if at all) if there is an increase in consumers income. Go
on to discuss the effect of any shift in either of the demand or supply curves on the
equilibrium price and quantity (increase/decrease)?
[10 marks]
(c) Use the supply and demand equations for tea to solve for the equilibrium price and
equilibrium quantity as functions of and .
[5 marks]
(d) Take your answers to part(c) and use calculus to determine:(i) how the equilibrium
quantity and equilibrium price change when income changes, ceteris paribus, and (ii) how
the equilibrium quantity and equilibrium price change when the price of coffee changes,
ceteris paribus. Are coffee and tea substitutes or complements?
[5 marks]

END OF PART B: 30 Marks in Total

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Part C
Please answer this question in a new answer book.

(a)

Long-term insurance in the United States is a product sold to help provide for the cost
of long-term care beyond a predetermined period, which is usually not covered by
regular health insurance.
Referencing the article by Jane Gross, February 2013, is advised when answering the
following questions.

(i)

Profits in the market for long-term care insurance in the US have fallen in
recent years. Why do you think this has happened? Has this impacted on
current sales?
[2 marks]

(ii)

Long-term insurance sellers are beginning to charge women more for policies.
Why would they do this? What is this phenomenon called?
[3 marks]

(iii)

What else could long-term care insurance sellers do (besides gender

discrimination) to reduce their losses? Explain your answer .
[3 marks]

(iv)

When long-term care insurance policies were first offered, with few
restrictions, what types of individuals might have been more likely to buy
these policies? What do we call this phenomenon?
[2 marks]

(v)

What action could the government take to make long-term care insurance
profitable once again? Why would this work?
[4 marks]

(vi)

Betty buys a long-term care insurance policy, knowing that she has the genes
for breast cancer and Alzeimers. What do we call this behaviour? [1 mark]

(vii)

In general, is buying an insurance policy a fair gamble? Why or why not?

[2 marks]

16

(b)
(i)

Determine mathematically whether the production function Q = 2K0.6L0.7 has

increasing or decreasing returns to scale. Explain your answer.
[3 marks]

(ii)

Define the law of diminishing marginal returns to the variable factor, and the
concept of decreasing returns to scale, making reference to the production
function Q = F(K,L).
Which of diminishing marginal returns to the variable factor and decreasing
returns to scale is a short-run concept?
In practice, it seems unreasonable to ever expect to ever see decreasing returns
to scale. Why?
What type of returns at a minimum might we expect to get?
[10 marks]

END OF PART C: 30 Marks in Total

17

Part D
Please answer this question in a new answer book.

You are granted permission to open a stand selling hotdogs at Newlands stadium. Your
market research indicates that the demand for hotdogs during cricket games at Newlands
stadium is p = 29 2Q where Q is the number of hotdogs. The cost of producing hotdogs is
represented by a linear function C(Q) = Q.
(a).

Calculate your (i) profit maximizing quantity, (ii) profit maximizing price and (iii) the
maximum profits
[3 marks]

(b).

After the first season, you realize that you are able to charge each consumer the price
that they are willing to pay. What are the conditions under which perfect price
discrimination can be practiced? Explain each condition.
[6 marks]

(c).

Assuming that the conditions for perfect price discrimination hold, what would your
profits be if you could perfectly price discriminate? What would be the consumer
surplus and the deadweight loss to society? Show your workings.
[5 marks]

(d).

Suppose the Newlands stadium managers allow a second hotdog outlet with the same
cost function to enter the market. The Newlands stadium managers require each
hotdog outlet to simultaneously specify the number of hotdogs that they will offer
during each cricket game, and imposes that the price be chosen according to the
market demand function given above. The hotdog outlets are unable to price
discriminate.
(i)

Calculate each hotdog outlets best response function. Plot each of these
functions on a graph with output of your outlet (q1) on the horizontal axis and
output of the competing outlet (q2) on the vertical. Clearly show where
equilibrium output is determined.
[6 marks]

(ii)

Calculate the Cournot equilibrium quantities, prices and profits of each hotdog
outlet.
[4 marks]

18

(e).

The Newlands stadium managers change the terms of the contract. Hotdog outlets are
now required to simultaneously specify the price at which they will sell their hotdogs.
Derive and discuss the new equilibrium outcome for each firm.
[6 marks]

END OF PART D: 30 Marks in Total

END OF EXAM: 180 Marks in Total

19