ECO2003F: Intermediate Microeconomics

Examination
May 2010
TIME: 3 hours
TOTAL MARKS: 180

This exam comprises TWO sections and 10 pages.

SECTION A and B each count 50% of the examination mark.

SECTION A: MULTIPLE CHOICE

This section comprises 30 MULTIPLE CHOICE questions.
Please make sure you record your student number in pencil on your MCQ sheet.
Negative marking applies. Each question counts 3 marks. 1 mark will be deducted for
each wrong answer.
Selecting more than one answer for the same question incurs a 1 mark penalty too.
If you leave a question blank, you will not be penalised.
Only use pencil to fill in your MCQ sheet, and erase all unwanted marks thoroughly.

SECTION B: PROBLEM SET

This section comprises 3 parts, A, B and C. Please answer each part of the problem set in
a separate booklet.

Section A (90 marks)

ANSWER SECTION A ON THE MCQ SHEET USING PENCIL
1. If q1 is on the horizontal axis then the slope of the budget line is
a)
b)
c)
d)

p1/ p2
p2/ p1
m/p2
upward sloping for a Giffen good

This diagram applies to questions 2 to 6

Good 2

C
D
B

Good 1
2. If the compensated budget line is tangent to the lower indifference curve at B, the diagram
above illustrates a
a)
b)
c)
d)

price decrease for a normal good

price increase for a normal good
price decrease for an inferior good
price increase for an inferior good

3. For a price increase, the quantity change from D to C is a

a)
b)
c)
d)

positive substitution effect

negative substitution effect
positive income effect
negative income effect

4. In the diagram above, if the price of Good 1 rises, the compensated budget line should be
tangent to the indifference curve at
a)
b)
c)
d)

A
B
C
D

5. If, due to a price increase, B is the final tangency, Good 1 is

a)
b)
c)
d)

an inferior good
a normal good
a Giffen good
indeterminate (due to too little information)

6. For Good 1 to be a Giffen good in the case of a price increase, the final tangency must be
a)
b)
c)
d)

Between C and D
Left of C
Right of D
At D

7. What is the marginal utility of x1 if utility is given by U = x1 x22 ?

a)
b)
c)
d)

x22
x1 x2
x1-1 x22

8. The Lagrange method sets the first order conditions of the Lagrange function equal to zero
because
a)
b)
c)
d)

the constraint is binding

we assume the more is better condition for preferences
MRS = MRT
The slope of a function is zero at a maximum or a minimum

9. In the Lagrange method, is

a)

MU 1
MU 2

MU 1
MU 2
MU 1
c)
p1
b)

d) x 2

p2
p1
MU 2
p2
p1
x1
p2

10. If the utility function is given by U = x1 x22 the demand for x1 is

m
a) x1
2 p1
m
b) x1
3 p1
p1
x1
c) x1
p2
d) indeterminate
11. A movement along an upward-sloping Engel curve corresponds to
a)
b)
c)
d)

Upward-sloping indifference curves

Indifference curves crossing incorrectly
A parallel shift in the budget constraint
A rotation in the budget constraint towards a lower price of good one

12. Average productivity will fall as long as

a)
b)
c)
d)

marginal productivity is falling.

it exceeds marginal productivity.
it is less than marginal productivity
the number of workers is increasing

13. Suppose the production of DVD players can be represented by the following production
function: q = L0.4 K0.4. Which of the following statements is (are) TRUE?
(i)
(ii)
(iii)

The production function has decreasing returns to scale

The marginal productivity of labour falls as labour increases in the short run
Capital and labour can be substituted for one another

(a) Only (iii) is true

(b) (ii) and (iii) are true
(c) (i), (ii) and (iii) are true
(d) (i) and (iii) are true
14. Average total cost is R100 for a given output, total fixed cost is R120 and average variable
cost is R70. What is the quantity being produced?
(a)
(b)
(c)
(d)

3
4
6
It cannot be determined from the information given

15. If a firm buys a building so as to have office space for its workers, the monthly
opportunity cost of the building is best measured as
(a) the monthly bond (mortgage) payment the firm must pay
(b) the price the firm paid divided by twelve
(c) zero
(d) the rent the firm could earn if it rented the building to another firm
16. Suppose the total cost of producing T-shirts can be represented as TC = 50 + 2q. The
average cost of the 5th T-shirt is
(a) R2
(b) R12
(c) R52
(d) R60

17. Suppose the short-run production function is q = 10L. If the wage rate is R10 per unit of
labour, then AVC equals
(a) q
(b) q/10
(c) 10/q
(d) 1
18. If the marginal rate of technical substitution for a cost minimizing firm is 10, and the wage
rate for labour is R5, what is the rental rate for capital?
(a) R0.50
(b) R1
(c) R2
(d) R10
19. Consider the following properties
i. Economies of Scale
ii. Inclusive Control
iii. Exclusive Contracting
iv.
Registration/Licensure
v. Patents
vi.
Government Ownership
Which of the above are not sources of private monopoly power?
a)
b)
c)
d)

ii. and iv. only.

i., iii., iv., and v. only.
ii. and vi only.
None of the above

20. Consider the following characteristics discussed by Paul David in his article, Clio and the
Economics of Qwerty.
i. System scale economies.
ii. Quasi-irreversibility of investment.
iii. Technological interunrelatedness.
iv.
Ex ante predictability.
v. System compatibility.

Which of the above do not characterize positive feedback or lock-in systems as detailed by
David?
a)
b)
c)
d)

i., ii., and iii. only

i., ii., and v. only
ii., and iv. only
iii., iv. and v. only

For the next few questions consider the market for fashion magazines.
Lets assume that the fashion magazine industry is dominated by one firm,
Elle (l). Elle faces the following demand and cost structures.
Inverse Demand:
(D)
Firm Cost:
(C)
Remember that because there is a monopoly, market output
, the
monopolists output.

21. Facing demand and cost structures D and C, at what level would the monopolist, Elle, set
its output when it maximises profit?
a)
b)
c)
d)

22. Assume now that c=400 and that ql = 150. What would Elles profit be at the optimal
quantity?
a) 90 000
b) 150 000
c) 0
d) It cannot be calculated with the information provided.

23. Continue to assume that c=400 and that ql = 150. What is the value of the deadweight loss
(DWL) of monopoly when Elle charges its monopoly price?
a) DWL = 180 000
b) DWL = 90 000
c) DWL = 45 000
d) DWL = 0 because marginal costs are constant

24. Continue to assume that c=400 and that ql = 150. Elle realises that it has the ability to price
discriminate perfectly in its market by charging each reader the price they are willing to
pay for its magazines. Assuming that Elle is able to execute its price discrimination
perfectly, what is the total value of Consumer Surplus that Elle absorbs from its
consumers relative to if Elle operated in a perfectly competitive market?
a) CS = 360 000
b) CS = 180 000
c) CS = 90 000
d) Elle does not absorb any consumer surplus.
25. Which of the following must be true for Elle to be able to price discriminate?
a) There are no other firms in the market.
b) The good is non-durable.
c) The good cannot be easily resold.
d) All of the above must be true.
Now assume that the incumbent firm, Elle (l), is joined by another firm, Kay (k) and that
they form a two firm oligopoly a duopoly. Inverse demand is that same as previously,
defined by (D). Assume also that Kay faces the same cost structures as Elle, that
is
. Remember that total market output
.

26. Assume that Kay and Elle choose their outputs simultaneously. What would their
respective reaction functions be?
a)

b)
c)
d)

,
,
,

27. Now assume that Kay and Elle act sequentially and maximize profit with respect to
output. Assume that Elle, as the incumbent, is the market leader. Assume, also, that you
are given the value of costs, which are the same for both firms, c = 400. What would
Elles output be?
a) ql = 300
b) ql = 600
c) ql = 75
d) ql = 150

28. What condition ensures that Kay and Elle operate in an oligopoly and not in some form of
monopolistic competition?
a) Oligopoly includes barriers to entry.
b) Oligopoly includes product differentiation.
c) Oligopoly includes no barriers to entry.
d) Oligopoly includes firms facing downward-sloping demand curves.

29. Assume that Kay and Elle wanted to form a cartel in the fashion magazine industry and
that they cannot monitor each other. What will happen?
a) Kay and Elle will act as price setters.
b) Kay and Elles cartel will fail.
c) Kay and Elles cartel will prosper.
d) Kay and Elles actions will ensure the market becomes a monopoly.

30. Consider that Kay and Elle, instead of setting quantities simultaneously set their prices
simultaneously. Assume that they continue to operate in an oligopoly, and they continue
to face Demand (D) and Costs (C). What would the total industry output be?
a)
b)
c)
d)

Section B. Long questions [90 marks]

REMINDER ~ please answer each question in a separate answer book and ensure that you
write the question number on the cover.
Part 1 [30 marks]
Use indifference analysis to identify the conditions under which the compensating demand
curve is steeper than the uncompensated demand curve, and vice versa. Assume a price
increase and use two sets of diagrams to illustrate your answer.

Part 2 [30 marks]

2(a) Carmelas pasta factory employs workers and pasta machines according to the following
production function f(L,K) = L.5K.5. The hourly cost of capital is R10 and the hourly cost of
workers is R40. Suppose Carmela wishes to produce 1000 units of pasta. How much labour
and capital should she employ? How much will it cost to produce this amount?
[15]

2.(b) All firms in a perfectly competitive industry have the following identical long-run cost
curve: C(q) = q3-10q2+36q. where q is the output of the firm. The industry has a market
demand of Q = 111-p.
Determine the long run number of firms in this industry.

[15]

Part 3 [30 marks]

In his article The Limits of Markets Robert Kuttner says the following:
In markets where the consumer is not effectively sovereign or where the reliance on
market verdicts would lead to socially intolerable outcomes, a recourse purely to
ineffectual market discipline would leave both consumer and society worse off than the
alternative of a mix of market forces and regulatory interventions. While advocates of
laissez faire presume that the regulation characteristic of an earlier stage of capitalism
has been mooted by technology, competition, and better-informed consumers, they
forget that the more mannered capitalism of our own era is precisely the fruit of
regulation, and that the predatory tendencies persist.
What are the methods government can adopt to regulate a monopoly? Write an essay
explaining these methods, examining the circumstances when you think regulation is justified
or not, and commenting on the insights from the readings as they pertain to your justification.
In light of your explanation, say whether you agree or disagree with Kuttner's conclusion that
consumers and society should use a 'mix of market forces and regulatory interventions. Make
sure you answer the question and be sure to use paragraphs and complete sentences.

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