SCHOOL OF ECONOMICS

ECO2003F: INTERMEDIATE MICROECONOMICS

FINAL EXAMINATION
MAY 2012

Time:
Total marks:

3 hours and 15 minutes. Please read the paper first.

180 marks

Examiner:
Internal Moderators:
External Examiner:

Katherine Eyal
Catherine Kannemeyer
Gideon Du Rand

Instructions:
1. There are 30 multiple choice questions in this exam. MCQs that are correctly answered will 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 new books.

PART A Multiple Choice Questions

1. Less cheese please.

Mr. Mouse is lactose intolerant. What this implies is that while he likes cheese he
cant eat infinite amounts of it. The consumer theory assumption violated in this
situation is
(A) completeness
(B) transitivity
(C) non-satiation
(D) perfect information
2. Diminishing marginal rate of substitution can be seen when indifference curves
(A) dont cross
(B) are downward sloping
(C) are concave to the origin
(D) become flatter as we increase the quantity of the good on the x-axis
Consider the two graphs below, showing kinked budget constraints, when answering
question 3.

3. In relation to the two scenarios shown in A) and B) above, which of the following
statements apply?
(i) Good X increases in price if the critical threshold, X, is exceeded
(ii) Good X decreases in price if the critical threshold, X, is exceeded
(iii) Assuming X is exceeded, the new price is applied to the entire consumption
bundle in scenario A
(iv) Assuming X is exceeded, the new price is applied to the entire consumption
bundle in scenario B
(v) The absolute price of Y changes beyond X in scenario B

(A) (i) & (v) only

(B) (ii) & (iii) only
(C) (ii) & (iv) only
(D) (iv) & (v) only

4. The solution to a Lagrangian optimisation problem yields the following demand equation for Good X:
X =

mp2
where m is income, p1 is the price of Good X and p2 is the price of Good Y.
p1

Which of the following statements are true as regards the preceding demand equation?

(i) X & Y are substitutes

(ii) X & Y are complements
(iii) Good Y is a normal good
(iv) X is a normal good
(v) X is an inferior good

(A) (i) & (iv) only

(B) (ii) & (iv) only
(C) (iii) & (v) only
(D) (i) & (v) only

Use the diagrams below, showing indifference curves and budget lines, to answer
question 5.
5. Good X and Y are substitutes and good X is a normal good. Which of the graphs
below show good X to have these two characteristics when the price of good X is
increased?

(A) Graph A
(B) Graph B
(C) Graph C
(D) Graph D

Use the graph below, showing a Hicks decomposition, to answer questions 6 and 7.

6. If the initial budget constraint is BK, which of the following statements apply?

(i) The total change in demand for Y is the distance from I to J

(ii) The substitution effect increases the demand for Y from G to E
(iii) The total change in demand for X is from H to J
(iv) The substitution effect reduces the demand for X from I to H
(v) The income effect decreases the demand for X from J to I

(A) (i) & (iii) only

(B) (i), (iii) & (iv) only
(C) (ii) & (v) only
(D) (ii) & (iv) only

7. The graph shows

(A) that good Y is an inferior good, X is a normal good, and it decomposes the total
effect of a price increase of good Y
(B) that good Y is an inferior good, X is a normal good, and it decomposes the total
effect of a price decrease of good Y
(C) that good X is an inferior good, Y is a normal good, and it decomposes the total
effect of a price increase of good X
(D) that good X is an inferior good, Y is a normal good, and it decomposes the total
effect of a price decrease of good X
8. Regarding the distinction between Giffen and ordinary inferior goods, which of the
following statements hold?
(i) For all inferior goods, including Giffen goods, if price increases the quantity
demanded of that good increases
(ii) Only for Giffen goods if the price increases does the quantity demanded of that
good increase
(iii) For both inferior goods and Giffen goods, the income effect decreases the demand
for these goods if their prices rise
(iv) If a good is an inferior good but not a Giffen good the substitution effect is
always smaller than the income effect
(v) If a good is an inferior good but not a Giffen good the substitution effect is
always larger than the income effect

(A) (i) & (iii) only

(B) (ii) & (iv) only
(C) (i) & (v) only
(D) (ii) & (v) only

9. If goods X & Y
(i) are easily substitutable we expect a large income effect in response to any price
change
(ii) are easily substitutable and X becomes more expensive than Y, we expect a
large substitution effect
(iii) cost the same one would consume equal amounts of both
(iv) are perfect complements, they must be consumed in fixed proportions
(v) are salt and pepper, expenditure on which comprises a small share of total
income, we would expect both the income effect and substitution effect to be
small if the price of either good changed
Which of the following statements apply?
(A) (i) & (iii) only
(B) (ii) & (iv) only
(C) (iii) & (v) only
(D) (ii), (iv) & (v) only
10. Which of the following statements are true?
(i) It is possible that a consumer will pick the same market basket when faced
with a choice of a cash grant or a food voucher of equal value
(ii) Cash grants shift part of the budget line to the right but a food voucher would
shift the entire budget line to the right
(iii) A cash grant always allows the consumer more choices than a subsidized price
of equal value for one commodity
(iv) A cash grant always allows the consumer fewer choices than a subsidized price
of equal value for one commodity
(v) The government should provide cash grants if individual consumers know best
how to fulfil their most immediate needs
(A) (i) & (iv) only
(B) (ii) & (iii) only
(C) (i), (iii) & (v) only
(D) (ii), (iii) & (iv) only
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11. In the short run, a profit maximizing firm will respond to a reduction in the wage
rate by
(A) hiring more labour
(B) hiring more capital
(C) hiring less labour
(D) decreasing output
12. When we compare monopsony and perfect competition in the labour market, we can
say that

(A) under monopsony, wages are higher and employment is lower than the levels of
wages and employment seen under perfect competition
(B) under monopsony, wages are lower and employment is higher than the levels of
wages and employment seen under perfect competition
(C) under monopsony, wages are higher and employment is higher than the levels of
wages and employment seen under perfect competition
(D) under monopsony, wages are lower and employment is lower than the levels of
wages and employment seen under perfect competition

13. Tendai grows marijuana in his student flat. He hires students (labour) as employees
to tend the plants (from his very large group of friends), and the marijuana is grown
in a cupboard (capital). There is only one cupboard in the flat, and Tendai does not
currently have the funds to buy another one or to move to a bigger flat with more
cupboards. For him, the long run is equal to
(A) the amount of time it takes to buy another cupboard
(B) the amount of time it takes to acquire more customers
(C) the amount of time it takes to hire an additional employee
(D) the amount of time it takes to grow 1 kilo of marijuana

14. Thomas Malthus prediction of mass starvation resulting from diminishing marginal
returns to labour has not been fulfilled because
(A) the law of diminishing marginal returns did not hold in this case
(B) Malthus ignored other factors like technological change
(C) relative to Malthus day, a larger percentage of todays labour force works in
the agricultural sector
(D) All of the above

15. If there are three production processes to choose among, it is best to

(A) produce all the output with the process that has the lowest average cost for the
output needed
(B) divide up the production into thirds and have each process do one third of the
output
(C) divide up the output among the processes so that the marginal cost is the same
in each process
(D) use the process with the most fixed cost in order to use up the fixed capital

16. The vertical distance between the average total cost and the average variable cost
curves at any level of output will always be

(A) variable cost

(B) total cost less fixed cost
(C) fixed cost less variable cost
(D) average fixed cost

17. If Kahneman and Tversky are correct, I should

(A) buy individual stocks or shares rather than put my money into a mutual fund
(B) have different strategies depending on whether my investments are expected to
rise or fall in value
(C) put my money in a mutual fund instead of individual stocks or shares
(D) be indifferent to which type of investment I make

18. Some sports writers are sure that rookies of the year will not repeat their performance the following year. Which of the following are they relying on to make this
judgement?
(A) Bounded rationality
(B) Psychophysics of perception
(C) Anchoring and adjustment
(D) Regression effect
19. Nosiphos utility function is given by U = M 1/2 . Nosipho has a choice: take R100 in
cash or take a gamble based on the flip 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 gamble

Which of the above statements are true?

(A) (i) and (v) only
(B) (iv) only
(C) (ii) only
(D) (iii) only

20. Adverse selection is the process by which

(i) undesirable members of a particular market are more likely to participate in
the exchange
(ii) undesirable members of a particular market are less likely to participate in
the exchange
(iii) adversaries communicate negative messages
(iv) full-disclosure becomes impossible

Which of the above statements are true?

(A) (i) only

(B) (ii), (iii) and (iv) only
(C) (iii) and (iv) only
(D) (i) and (iv) only

21. Other things remaining the same, in the long run as compared to the short run

(A) the price elasticity of supply will decrease

(B) the price elasticity of supply will increase
(C) the price elasticity of supply will remain the same
(D) one cannot tell

22. Competitive markets result in allocative efficiency because they

(A) maximize the total benefits from exchange
(B) make sure goods are produced at the lowest cost
(C) generate the most benefits for consumers
(D) distribute resources in the most equitable way

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23. Suppose an industry has 30 firms each with supply curve P = 20 + 90Qi . What is
the industry supply curve?
(A) P = 2/3 + 3Q
(B) P = 20 + 90Q
(C) P = 20 + 3Q
(D) P = 3/2 + Q/3
24. If a firm could perfectly price discriminate
(A) the marginal revenue curve would be the same as the demand curve
(B) the marginal revenue curve would lie below the demand curve
(C) the marginal revenue curve would lie above the demand curve
(D) there would be no marginal revenue function
Use the graph below to answer Question 25.

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25. The above figure shows the demand and marginal cost curves for a monopoly. Under
monopoly, the dead weight loss to society equals

(A) a + b + c
(B) a + b + c + d + e + f
(C) c + f
(D) none of the above.

26. You are given the four payout options shown below for a toss of a coin. If you are
using a maximum strategy, which option do you choose?
(A) Heads you win R500, tails you lose R100
(B) Heads you win R1,000, tails you lose R110
(C) Heads you win R50, tails you lose R25
(D) Heads you win R5, tails you lose R0
Use the following information to answer Questions 27 to 30. In a simple Cournot
model, two firms A and B face an identical market demand curve: P = 75 3Q.
Total costs are zero.
27. The reaction curve of Firm B is given by

(A) QB = 75 3QA

(B) QB = 75QA 3Q2A 3QA QB

(C) QB = 12.5 0.5QA

(D) QB = 0.5 12.5QA

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28. The Nash equilibrium occurs where

(A) total industry output is 75 units
(B) each firm each produces 8.33 units of output
(C) both firms charge a price of R8.33 for each unit of output
(D) the contract curve intersects the reaction curve of firm A
29. If Firm A instead acts as the Stackelberg leader in this scenario, then
(A) firm B will produce 2.08 units less than it did at the Nash equilibrium
(B) firm A will produce 4.17 units less than it did at the Nash equilibrium
(C) firm A and firm B will both produce 6.25 units of output
(D) firm A will produce half as much as Firm B
30. In a cartel
(i) output quotas are allocated on the basis of firm size
(ii) firms face no incentive to cheat because they always achieve higher profits
through collusion
(iii) the cartel agreement can be costlessly and perfectly enforced
(iv) the goal of the cartel is to maximize the individual profits of each member firm
(v) member firms act as price setters
Which of the above statements are true?
(A) All of the above
(B) (i), (ii) and (iv) only
(C) (iv) only
(D) None of the above
END OF PART A: 90 Marks in Total

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PART B Written Questions

Please refer to the following diagrams when answering the questions in part B.

The first panel shows you the effects of the two policies superimposed on one another, and
the bottom panel illustrates the effect of each policy separately.
The South African government is considering two possible interventions in the education market in South Africa. Prior to any policy being implemented, schooling is initially
at s1 . The two proposals under consideration are outlined below.
For the representative individual, (i) illustrates the impact of option 1, and (ii) the impact of option 2, on schooling. Option 1 allows the representative individual an amount (s2 )
of free schooling tenable at public schools. Option 2 provides the representative individual
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with free schooling up to an amount s2 , which can be redeemed at any school (public or private). The amount of schooling can be thought of as the quality or quantity of education
(skills) obtained.
The following three questions are all intimately related - read all three carefully
before starting to avoid duplication of effort.
(a). Describe the type of policy being employed and the optimal amount of schooling in
(i) as shown by the budget constraint oppq.
[5 marks]
(b). Describe the type of policy being employed and the optimal amount of schooling in
(ii) as shown by the budget constraint opr.
[5 marks]
Reference to the prescribed reading, Hoxby (2009) would be advantageous in answering question c below.
(c). Please compare the final consumption of education in (i) to (ii). Why might the
observed difference in the optimal amount of schooling differ between the policies?
Do you expect to see this pattern for all individuals? How do the level of funding
(relative to the initial expenditure on schooling) and individual preferences influence
the outcome?
[20 marks]

END OF PART B: 30 Marks in Total

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PART C Written Questions

You have decided to fund your studies at UCT in 2012 by operating a marijuana grow house
in the leafy suburb of BishopsCourt. The next big party is coming up, and you would like
to produce as much marijuana as possible. You have limited funds (only R16 000) however
to rent a house which contains suitable cupboards in which to grow the marijuana, and to
pay students to tend the plants and harvest them.

(a). How many cupboards (K) should you rent, and how many students (L) should you
hire, given the following information:

Q(K, L) = 2 KL
PK = 2000, PL = 8000

[10 marks]

(b). How many kilos of marijuana do you end up producing for the party?

[2 marks]

(c). Describe the problem in (a). graphically. Please ensure you label all the relevant
parts of your graph.
[5 marks]
(d). Does your production function display increasing, decreasing or constant returns to
scale? Give reasons for your answer.
[3 marks]
(e). Is the concept of decreasing returns to scale more of a real world phenomenon, or an
academic concern? Give reasons for your answer.
[4 marks]
(f). Why might a firm see its marginal and average cost decline in the long run, as the
firm increases output? Give two brief reasons. What do we call this phenomenon
of falling marginal and average costs? Would we expect to see older or newer firms
more likely to exhibit signs of this phenomenon? Give reasons for your answer.
[6 marks]
END OF PART C: 30 Marks in Total
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PART D Written Questions

(a). Economists place much emphasis on the actual or potential role of perfect competition
in driving efficient market outcomes. Critically discuss, using examples, the four
conditions for perfect competition.
[6 marks]
(b). Segregating the airline passenger market according to the number of days between
the outbound and return flights is a well known source of price discrimination in
the airline industry. This is also apparently evident in pricing behaviour of South
African Airways. For example, as outlined in the table below, a flight departing
for Lusaka on 2 May 2012 and returning a day later (on 3 May 2012) is quoted at
R8 268. If you returned two weeks later on 17 May 2012, the flight cost is only R6 100.
Quote

Depart

Return

Cost

Quote 1

2 May 2012

3 May 2012

R8 268

Quote 2

2 May 2012

17 May 2012

R6 100

Use this example to answer the following questions

(i). Briefly discuss the conditions that are required for airlines to be able to effectively price discriminate. Give examples relevant to the airline industry.
[6 marks]
(ii). Discuss, using diagrams the pricing behaviour of South African Airways. Assume the marginal cost for all flights is the same.
[9 marks]
(iii). Discuss the possible outcomes if the airline industry was prohibited from price
discriminating, i.e., airlines are only allowed to charge a single price for a return
ticket to a given destination.
[3 marks]
(c). Assume South African Airways sells in two separate markets, with demand curves
given by P1 = 100 Q1 and P2 = 200 Q2 , respectively. Also assume that South
African Airways has a total cost function given by T C = 5 + 20Q where Q denotes
the total number of flights. What quantities and at what prices should South African
Airways sell in the two markets?
[6 marks]
END OF PART D: 30 Marks in Total
END: 180 Marks in Total
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