Sample Exam 1

Part1: MCQ

1. Suppose that the market for newspaper is initially in equilibrium. Further suppose that
there is both an increase in the price of ink and a decrease in the price of magazines,
which people may read in place of a newspaper. Which of the following accurately
describes the new equilibrium?
a) The equilibrium price will rise; the equilibrium quantity is ambiguous.
b) The equilibrium price is ambiguous; the equilibrium quantity will fall.
c) The equilibrium price will fall; the equilibrium quantity is ambiguous.
d) The equilibrium price is ambiguous; the equilibrium quantity will rise.

2. We often think of labor as a variable cost, even in the short run. However, some labor
costs may be fixed. Which of the following represents an example of a fixed labor cost?
a) a salaried manager who have a five-year employment contract
b) an employee who is paid by the hour
c) a temporary worker who is paid by his output
d) none of the above

3. In a simultaneous move game with two players,

a) if neither player has a dominant strategy, we successively eliminate each players
subordinate strategy.
b) a player chooses among two or more pure strategies according to pre-specified
probabilities.
c) if one player has a dominant strategy and the other doesnt, you cant reach a
Nash equilibrium.
d) if both players have a dominant strategy, these constitute their Nash equilibrium
strategies.

4. Price ceilings can result in a net loss in consumer surplus when the ______ curve is
_________.
a) Demand; very elastic
b) Demand; very inelastic
c) Supply; very inelastic
d) None of the above; price ceilings always increase consumer surplus

5. The likelihood of a cooperative outcome in a repeated prisoners dilemma type game

decreases when
a) they value payoffs in future periods much less than they value payoffs in the
current period.
 b) interactions between the players are frequent.
c) cheating is easy to detect.
d) the one-time gain from cheating is small in comparison to the eventual cost of
cheating.

Part 2: Structured Questions

6. James has the utility function U(x, y) = x(y+1). The price of x is $2 and the price of y is $1.
Income is $10.

a. How much x does James demand? How much y?

b. If his income doubles and prices stay unchanged, will his consumption of x and y double as
well?

7. China is gradually liberalizing the use of its currency, the Yuan, in international trade and
finance. However, the U.S. dollar still dominates international markets as a medium of exchange
and store of value. Consider trade between Renmin Trading, a Chinese company, and Peoples
International, a U.S. company. If they both use Yuan to settle transactions, Renmin would get
benefit of 2 while Peoples would get benefit of 1. If they both use U.S. dollars to settle
transactions, Renmin would get benefit of 1 while Peoples would get benefit of 2. If they use
different currencies, each would get zero benefit.

a. Write the above game in normal form and find each players dominant strategy, if it exists.
b. Find the Nash Equilibrium (or equilibria) of this game.
c. If Peoples can choose the currency before Renmin, does Peoples have a first-mover
advantage? What is the subgame perfect equilibrium of this game?

8. Consider an industry with 2 firms, each having marginal costs equal to zero. The inverse
demand curve facing this industry is: P = 100-Q. where Q = Q1 + Q2 is total output.

a. If each firm behaves as a Cournot competitor, what is the equilibrium price and quantity?
b. Calculate the collusive (cartel) output and profit for the industry.
c. If firm 1 behaves as a follower and firm 2 behaves as a leader, calculate the Stackelberg
equilibrium output of each firm.
Solution key:

MCQ: BADBA

6.

a. From the utility function U(x,y) = x(y+1) we have U(x,y) = xy+ x.

Then MUx = y+1, MUy = x

The optimal choice of x and y should satisfy the condition that the marginal utility per dollar
spent on either good is the same, or:

MUx/Px = MUy/Py

Thus: (y+1)/2 = x

The budget constrain suggests that 2x+y=10. Plug in x= (y+1)/2, then y=4.5, x=2.75

b. If his income doubles, the budget constrain becomes 2x+y = 20. The optimal condition still
follows that (y+1)/2 = x.

Now the optimal choice is x =5.25, y =9.5. The new bundle does not double.

7.

a.

Peoples
U.S. Dollar Yuan
Renmin U.S. Dollar 1,2 0,0

Yuan 0,0 2,1

For either of the player, there is no dominant strategy.

b. Nash Equilibrium is (US Dollar,US Dollar) and (Yuan, Yuan)

c. If Peoples is a first mover, the best strategy for the two companies is both of them use U.S.
Dollar. This is the subgame perfect equilibrium. From the above form, it can be seen that Peoples
gets more benefit(2) than Renmin(1). In contrast, if Renmin is a first mover, it can get more
benefits(2) than Peoples(1). Hence, Peoples has a first-mover advantage.

8.

a. Cournot competition: we first derive the reaction function for firm 1:

P = 100 Q1 Q2 TR1 = 100 Q12 Q1Q2 MR1 = 100 2Q1 Q2

Q2
MR = MC 100 2Q1 Q2 = 0 Q1 = 50
2

Similarly firm 2s reaction function is:

Q1
Q2 = 50
2

The cournot equilibrium is where the two reaction functions intersect:

Q1
50
Q1 = 50 2 = 25 Q1 Q = 100
1
2 4 3

As the two firms are symmetric, Q2 = 100/3 and Q = 200/3 , hence market price
P = 100 200/3 = 100/3
b. If they form a cartel, they will act as a monopoly and then split the profit:

P = 100 Q TR = 100Q Q 2 MR = 100 2Q

MR = MC 100 2Q = 0 Q = 50, P = 100 Q = 50

= 50 * 50 = 2500

c. As firm 1 is the follower, it will maximize its profit given firm 2s decision Q2 , the reacion function
is the same:

Q2
Q1 = 50
2

Now for firm 2, it takes into account firm 1s reponse when setting the quantity, that is:

Q2 Q
P = 100 Q = 100 (50 Q2 ) = 50 2
2 2

Q22
TR2 = P * Q2 = 50Q2 MR2 = 50 Q2
2

To maximize it profit, firm 2 will set MR = MC , or

50 Q2 = 0 Q2 = 50

From the reaction function of firm 1:

Q2
Q1 = 50 = 25
2