IIM-K, 2012-13

Microeconomics

Name____________________________________________________ Section______

End Term Examination

Roll No. PGP/16/__________________

Time: 120 minutes. Maximum points: 60.

Please PRINT your name, section and roll number.
Answer all questions.
Each multiple-choice question has one best answer.
The point value of each question and part is mentioned in parentheses on the right margin.
There may not be any partial award of part points.
Clearly show your reasoning and calculations for all non multiple-choice questions.
In the answer book, any part of any question must start from the left margin. Anything not started
from the left margin shall not be graded.
This is a closed-book examination. No notes, no calculators, no neighbors.
Good luck!

1) Discrimination based upon the quantity consumed is referred to as __________ price discrimination.
A) second-degree
B) group
C) third-degree
D) first-degree
[2]
2) Two firms operating in the same market must choose between a collude price and a cheat price. Firm A's
profit is listed before the comma, B's outcome after the comma.

If each firm tries to choose a price that is best for it, regardless of the other firm's price, which of these
statements is correct?
A) Both firms should charge a collude price.
B) Firm A should charge the collude price, Firm B should charge a cheat price.
C) Firm A should charge a cheat price, Firm B should charge a collude price.
D) Both firms should charge a cheat price.
[2]

3) A third-degree price discriminating monopolist can sell its output either in the local market or on an internet
auction site (or both). After selling all of its output, the firm discovers that the marginal revenue earned in the
local market was Rs.20 while its marginal revenue on the internet auction site was Rs.30. To maximize profits
the firm should
A) sell less in both markets until marginal revenue is zero.
B) do nothing until it acquires more information on costs.
C) have sold more output in the local market and less at the internet auction site.
D) sell more in both markets until marginal cost is zero.
E) have sold less output in the local market and more on the internet auction site.
[2]
Consider the following game:

4) Which of the following is true regarding the game above?

A) Both companies have a dominant strategy: expand South.
B) Only Deer Meat has a dominant strategy.
C) Both companies have a dominant strategy: expand West.
D) Only Bull Meat has a dominant strategy.
E) Neither company has a dominant strategy.
[2]
5) In the game above
A) there are two equilibria: either can expand in the West, and the other expands in the South.
B) there is one equilibrium: for both to expand West.
C) there is one equilibrium: for both to expand South.
D) all four outcomes are equilibria.
[2]
6) A monopolistically competitive firm in short-run equilibrium:
A) will make positive profit.
B) will make negative profit (lose money).
C) will make zero profit (break-even).
D) Any of the above is possible.
[2]

7) For a perfect first-degree price discriminator, incremental revenue is

A) greater than price if the demand curve is downward sloping.
B) the same as the marginal revenue curve if the firm is a non-discriminating monopolist.
C) equal to the price paid for each unit of output.
D) less than the marginal revenue for a non-discriminating monopolist.
[2]

Figure 1
All producers in the corbomite industry dump wastes in the river in the production of their output.
8) Given the information in Figure 1, the competitive output in the corbomite industry is:
A) Q0.
B) Q1.
C) Q2.
D) any level as long as price is P0.
[2]
9) Given the information in Figure 1, the efficient output in the corbomite industry is:
A) 0.
B) Q0.
C) Q1.
D) Q2.
[2]

10) Your local grocery store offers a coupon that reduces the price of milk during the coming week. The regular
retail price of milk in the store is Rs.3.00 per gallon, and the coupon price is Rs.2.00 per gallon for the next
week. If the store maximizes profits and the price elasticity of demand for milk is -2 for coupon users, what is
the price elasticity of demand for non-users?
A) -0.67
B) -1.5
C) -1.0
D) We do not have enough information to answer the question.
[2]
11) Suppose your neighbor likes to repair motorcycles in his front yard during evenings and on weekends, and
he earns Rs.400 per week from this work. However, the sight of piles of greasy motorcycle parts and the
additional noise and traffic caused by his customers reduces your value of living in this neighborhood by Rs.300
per week. If your neighbor has a right to operate this business, what is the efficient outcome?
A) You can pay him to move the business to another location.
B) He continues to operate the business.
C) He pays you to let him continue working on motorcycles at his home.
D) There is no efficient outcome from this situation.
[2]
12) A lighthouse is a public good
A) because it doesn't cost any more to light the way for 105 ships than it does to light the way for 104 ships.
B) because there is no way to prevent those who haven't contributed to the lighthouse from seeing better
because of it.
C) because the government produces it.
D) for the reasons in A and B together.
E) for the reasons in A, B, and C together.
[2]
13) Suppose your neighbor likes to repair motorcycles in his front yard during evenings and on weekends, and
he earns Rs.400 per week from this work. However, the sight of piles of greasy motorcycle parts and the
additional noise and traffic caused by his customers reduces your value of living in this neighborhood by Rs.500
per week. If your neighbor has a right to operate this business, how can you achieve the efficient outcome?
A) You cannot afford to pay him enough money to stop working on motorcycles, and he continues to operate the
business.
B) You pay him some value between Rs.400 and Rs.500 to close his home business.
C) You pay him at least Rs.500 to close his home business.
D) You pay him some value between Rs.0 and Rs.100 to close his home business.
[2]

14) Assume that a particular state has decided to outlaw the sharing of individuals' credit histories as an illegal
invasion of privacy. As a result of this action we would expect the
A) problems of asymmetric information to become more severe.
B) number of loans to unworthy credit risks to rise.
C) cost of borrowing money to rise.
D) all of the above
E) none of the above
[2]
15) Over the past several years, the US government has rescued a few financially distressed banks and other
large private companies, and the key reasons for these actions is to stabilize financial markets and to prevent
additional business failures that may arise from the original problem. However, critics of these interventions
argue that these actions generate perverse incentives. Why?
A) Managers have more information about the financial strength of their firm than US government officials, so
the rescue attempts may be unnecessary.
B) Managers may be more likely to invest in risky projects if they believe the US government will save the firm
in case of failure.
C) The US government oversight of rescued firms is typically based on limited information, so the outcome is
economically inefficient.
D) Rescued firms will have a difficult time buying insurance in private markets, so the US government will also
have to insure the firm against losses from fire, theft, etc.
[2]
Consider the game below:

16) a. What is the equilibrium in the game above?

b. In the game above, each firm has a strategy that would not be chosen under any circumstances. What is
it?
c. When, in the game above, the strategy that would not be chosen under any circumstances is removed,
what kind of game are we left with?
d. If player R moves first in the game above, what would the equilibrium of the game be? Relative to a
simultaneous-move situation, what are the gains and losses for R and C?
[2 + 1 + 1 + 4 = 8]

17) The local zoo has hired you to assist them in setting admission prices. The zoo's managers recognize that
there are two distinct demand curves for zoo admission. One demand curve applies to those ages 12 to 64, while
the other is for children and senior citizens. The two demand and marginal revenue curves are:
PA = 9.6 - 0.08QA
MRA = 9.6 - 0.16QA
PCS = 4 - 0.05QCS
MRCS = 4 - 0.10QCS
where PA = adult price, PCS = children's/senior citizen's price, QA = daily quantity of adults, and QCS = daily
quantity of children and senior citizens. Crowding is not a problem at the zoo, so that the managers consider
marginal cost to be zero.
a. If the zoo decides to price discriminate, what are the profit maximizing price and quantity in each market?
Calculate total revenue in each sub-market.
b. What is the elasticity of demand at the quantities calculated in part a for each market? Are these elasticities
consistent with your understanding of profit maximization and the relationship between marginal revenue and
elasticity?
[4 + 2 = 6]
18) As president and CEO of MegaWorld industries, Priya must decide on some very risky alternative
investments. Consider the following:
Project
A
B
C
D
E

Profit if Probability of
Loss if
Probability of
Successful
Success
Failure
Failure
Rs.10 million
.5
-Rs.6 million
.5
Rs.50 million
.2
-Rs.4 million
.8
Rs.90 million
.1
-Rs.10 million
.9
Rs.20 million
.8
-Rs.50 million
.2
Rs.15 million
.4
Rs.0
.6

If Priya is a risk-neutral executive, which investment alternative would she choose?

[3]
19) Hari just bought a house for Rs. 250,000. Earthquake insurance, which would pay Rs. 250,000 in the event
of a major earthquake, is available for Rs. 25,000. Hari estimates that the probability of a major earthquake in
the coming year is 10 percent, and that in the event of such a quake, the property would be worth nothing. The
utility (U) that Hari gets from income (I) is given as follows:
U(I) = I0.5.
Should Hari buy the insurance?
[2]

20) A certain firm can hire two types of workers: Group A workers who have high productivity and Group B
workers with low productivity. Group A workers will add Rs. 27,500 to the firm's revenues per year, while
Group B workers will increase the firm's revenues by Rs. 15,000 per year. The firm's managers expect workers
to be employed for eight years. The differences in the workers' productivity levels are reflected in their costs per
year of education. Each year of education (which includes the psychic costs of study effort) costs an A worker
Rs. 12,500, while each year costs a B worker Rs. 25,000.
a. Under competitive conditions (where information is perfect), how much would A and B workers earn?
b. Assuming that the firm is unable to distinguish A from B workers and that it is equally likely that a worker is
of either type, what pay scale will the firm offer?
c. Suppose that the firm decides to use education as a market signaling device to distinguish A workers from B
workers. What education requirement could the firm set?
[2 + 1 + 4 = 7]
21) Consider the following information:
Income to the firm from workers who sell door-to-door
Low Effort (e = 0)
High Effort (e = 1)

Bad Luck
Rs.5,000
Rs.7,000

Good Luck
Rs.7,000
Rs.13,000

Cost of effort: c = Rs.2800e

Probabilities: Bad luck = 0.75; Good luck = 0.25
a. Suppose the worker is risk-neutral, then if a fixed wage of Rs.3000 is given to the worker, would the
worker exert high effort? Explain.
b. Suppose the worker is risk-neutral, provide at least two payment schemes where the worker would
indeed exert high effort. Among the payment schemes you found, explain which one the firm should
prefer.
[1 + 3 = 4]