THE UNIVERSITY OF MELBOURNE

DEPARTMENT OF ECONOMICS
SEMESTER 2 ASSESSMENT, 2013
ECON10004 INTRODUCTORY MICROECONOMICS
Solutions
Time Allowed: TWO hours
Reading Time: 15 minutes

This examination paper contributes 60% to the assessment in ECON10004.

The Response Sheet for the multiple-choice questions should be inserted in the back of
the examination script book at the end of the examination. For the multiple-choice
questions, you may use the examination script books to make notes or calculations. These
notes will NOT be taken into account for your assessment.

SECTION A: ANSWER ALL QUESTIONS

This section is worth 25% of the total exam marks.

Answer all questions. Fill in the small circle in the appropriate place with a 2B pencil on
the Response Sheet provided. An incorrect answer, no answer, or more than one answer,
will receive a zero mark.

SECTION B: ANSWER ALL QUESTIONS

This section is worth 25% of the total exam marks.

Answer all questions. Each question is worth equal marks.

SECTION C: ANSWER ALL QUESTIONS

This section is worth 50% of the total exam marks.

Answer all questions. Questions are worth different marks.

The following item is authorised in the examination room:

A print dictionary that translates English into a foreign language
A calculator is not allowed.

This exam paper cannot be removed from the examination room.

A copy of this exam paper will be held in the Baillieu Library.

This exam paper has 8 pages

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SECTION A

ANSWER ALL QUESTIONS IN THIS SECTION

This section is worth 25% of the total exam marks.

All questions in this section are worth the same number of marks.
For each question select the one BEST answer. Incorrect answers, multiple answers,
or no answer, will receive zero.
Mark your answer on the Response Sheet.

Question A1

In the Ice-cream corner, Homer, Marge and Akira can sell a cup of ice-cream at $2, $4 and
$6 respectively. Bart, Lisa and Maggie are willing to pay $1, $3 and $5 respectively for a
cup and each of them want only one cup of Ice-cream. How many cups of ice-cream will
be sold at the Ice-cream corner?

a) 1
b) 2*
c) 3
d) 4

Question A2

Sam has bought a pay- TV connection for which he has to pay $100 per month on a 24
months plan and there is a penalty of $600 if he discontinues any time before the plan date
expires. But this pay- TV connection offers his favourite sports channel with 3 other
channels which he never watches. After 6 months of this pay- TV connection there is an
offer by another company which charges $50 per channel per month including that sports
channel on a 24 months plan. What would be the opportunity cost for Sam to switch to the
new company?

a) $600
b) $100
c) $50
d) $0*

Question A3

Harry started a small business selling second hand books online. He can purchase these
books at $3 each from Cheap Books warehouse. To set up the website he had to spend
$350 for registration and banking facilities. The postage cost of distributing the books to

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the buyers is $2 each. The table below shows the demand for his books. How many books
should Harry sell to maximise profit?

Price Quantity Demanded

$25 50
$20 100
$15 150
$10 200

a) 50
b) 100
c) 150*
d) 200

Question A4

Blueberry muffins and coffee are sold as a combo in a perfectly competitive market. If
there is a good harvest of blueberries and increase in tariff on imported coffee beans then
which of the following is true?

a) Price of muffin and coffee combo will increase

b) Price of muffin and coffee combo will decrease
c) Price of muffin and coffee combo will remain same
d) Price of muffin and coffee combo will depend on the relative change in price of
blueberry and coffee beans.*

Question A5

The shut-down of all government managed national parks, museums, important exhibits in
Americana will have a major adverse effect on tourism in that country. If the exchange rate
in Australiana is defined as the amount of Americanas currency per $1 of Australianas
currency, then in upcoming summer season the exchange rate in Australiana will
a) Appreciate*
b) Depreciate
c) Remain same
d) It is not possible to say without more information

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Question A6

Consider the information below on short-run costs for a firm:

1. The current quantity of output is 20 units
2. Marginal cost is $15, variable cost is $14, average total cost is $16
3. The market price is $15
4. If the firm increases its output ATC decreases and marginal cost increases
What should the firm manager do about their output decision in the SR?

a) Produce more output as ATC decreases

b) Produce less output as MC increases
c) Shut down as they are making a loss
d) Continue to produce at 20 units*

Question A7

Suppose that the market for petrol is perfectly competitive and each firm in the industry is
making a positive profit in the short run. If this is a constant cost industry, we would expect
the long run market supply curve to be
a) More elastic than the short run supply curve
b) Less elastic than the short run supply curve
c) Perfectly inelastic
d) Perfectly elastic*

Question A8

Rosy sells roses such that her quantity supplied for bunches of roses is: QS = 2P. The
demand for her roses can be described as QD = 20 2P. Also the bees attracted to Rosys
garden helps her neighbours fruit tree for growing fruits is worth $4 per bunch of roses.
What will be the market equilibrium price, the quantity traded, the socially optimal price
and socially optimal quantity traded?

a) Market price and quantity traded are $15 and 10, socially optimal price and quantity
traded are $16 and 12.
b) Market price and quantity traded are $5 and 10, socially optimal price and quantity
traded are $6 and 12.*
c) Market price and quantity traded are $5 and 20, socially optimal price and quantity
traded are $6 and 30.
d) Market price and quantity traded are $6 and 12, socially optimal price and quantity
traded are $5 and 10.
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Question A9

Demand for and supply of packets of wheat crackers in Ozland are as follows:
Q=P
Q = 40 3P
The world price of wheat crackers is $12 per packet. If Ozland is free to trade with rest of
the world what will happen to consumers, producers and total surplus in Ozland?

a) Consumers surplus will decrease, producers surplus will increase and total surplus
will decrease.
b) Consumers surplus will increase, producers surplus will decrease and total surplus
will increase.
c) Consumers surplus will decrease, producers surplus will increase and total surplus
will increase.*
d) Consumers surplus will increase, producers surplus will increase and total surplus
will increase.

Question A10

Tom and Jerry are participating in a running competition to win the famous DisneyWalt
medal by reaching a goal at the shortest time possible. There are two tracks to run, Slow-
track and Fast-track. If they both are in the same track then their speed reduces by half
compared to running alone along one track. The times in minutes required by each of these
competitors to reach the goal are described in the following table. What are the Nash
equilibria for Tom and Jerry?
Jerry
Slow-track Fast-track
Tom Slow-track 50, 50 25, 20
Fast-track 20, 25 40, 40

a) {Tom chooses Slow-track, Jerry chooses Fast-track} and {Tom chooses Fast-track,
Jerry chooses Slow-track}*
b) {Tom chooses Slow-track, Jerry chooses Slow-track} and {Tom chooses Slow-
track, Jerry chooses Fast-track}
c) {Tom chooses Slow-track, Jerry chooses Slow-track} and {Tom chooses Fast-
track, Jerry chooses Fast-track}
d) {Tom chooses Fast-track, Jerry chooses Fast-track} and {Tom chooses Fast-track,
Jerry chooses Slow-track}

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SECTION B
ANSWER ALL QUESTIONS IN THIS SECTION
This section is worth 25% of the total exam marks.
All questions in this section are worth the same number of marks.
For each of the following questions:
Consider the statements. State whether you believe each statement is correct or
incorrect. Briefly explain your answer and use diagrams where appropriate. Note
that most of the marks will be given for your explanation.

Question B1

Demand for tickets to a Monet Art exhibition is price elastic and the supply of the Monet
Art exhibition tickets is price inelastic. In order to restrict the number of people coming to
the exhibition Monets art collection authority should use a demand side policy.

Answer: False. Demand side policy will not work as supply is inelastic, if demand
decreases there will not be much reduction in quantity traded. A supply side policy will be
more effective.

$ Supply 2
Supply Supply 1

Demand 1 Demand
Demand 2

If authority uses a demand side policy, such as restricted time for showing, which shift
demand curve to the left, given an inelastic supply curve there will be little reduction in
quantity traded. On the other hand if there is a policy to reduce supply, such as issuing
fewer permits for exhibitions, which will shift the supply curve to the left then give the
elastic demand curve the quantity traded will be reduced by much bigger amount.

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Question B2

A firm has two production techniques to choose from: 1) High fixed cost and constant
marginal cost; 2) Low fixed cost and increasing Marginal cost. The firm should use
technique 1 at low levels of output and use technique 2 at high levels of output to minimise
cost.

Answer: False. As AFC is decreasing, with constant MC, ATC will also be decreasing.
Hence at the higher level of output ATC will be lower and minimize cost.
$
SRATC 2

SRATC 1

Q
Production method 1: Large investment in physical capital required and capacity
constraints are less binding on marginal product (For examples: electricity generation; on-
line sale of books) => high FC and constant SRMC. FC has larger proportion in ATC at
lower level of output and VC has larger proportion in ATC at higher level of output. ATC
will be decreasing at higher level of output.
Production method 2: No large investment in physical capital required and capacity
constraints affect marginal product (for example: small-scale retail activity) => low FC and
increasing SRMC. FC has larger proportion in ATC at lower level of output and VC has
larger proportion in ATC at higher level of output. ATC will be increasing at higher level
of output.

Question B3

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Mickey and Minnie are two profit-maximising suppliers of supercheese where they
compete strategically by choosing a quantity of supercheese to supply to the market.
Their choices of quantities and profits are described by the following game table:

Minnie
20 40
Mickey 20 1000, 1000 750, 1500
40 1500, 750 300, 300
Playing either simultaneously or sequentially it will always be the case in equilibrium
that their profit will differ.

Answer: False. It will not always be different. There is a first mover advantage when
playing simultaneously and sequentially will give them the same profit whoever moves
first.
In this game, playing simultaneously none of the players have a dominant strategy. The
Nash equilibria are: {Mickey chooses 40, Minnie chooses 20} and {Mickey chooses 20,
Minnie chooses 40}

Playing sequentially, if Mickey moves first, the rollback equilibrium is {Mickey chooses
40, Minnie chooses 20} as shown in the game tree below. If Minnie moves first then Minnie
will receive the higher payoff.

1000, 1000
20
Minnie
20 40
Mickey 750, 1500
1000, 1000
40 20 20 1500, 750
Minnie
40
300, 300

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 Mickey
20 40
Minnie 750, 1500
40 20 1500, 750
Mickey
40
300, 300

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SECTION C

ANSWER ALL QUESTIONS IN THIS SECTION

This section is worth 50% of the total exam marks.

Question C1 (15 marks)

The Indonesian allocation of import permits will limit Australian exports to the market
during 2013, with shipments forecast to decline 15% year-on-year, to 23,000 tonne.
Despite historically tight supplies due to a lack of imported product, resulting in reportedly
higher domestic livestock and retail prices, import permits are again forecast to remain
severely restricted throughout 2013. (www.mla.com.au/Prices-and-markets/Trends-and-
analysis/Beef/Forecasts/MLA-cattle-industry-projections-2013/878-beef-exports-
Indonesia-and-SE-Asia)

(a) Consider the beef market in Australia. Using an international trade model analyse the
economic well-being of Australians including consumers and producers following
increased restriction on import permits in Indonesia. (10 marks)
(b) Discuss what government policy can help beef producers and show the overall effect
on total well-being in Australia. (5 marks)

Answer: a) Indonesian reduction in imports of Australian beef can be represented as a

reduction in world price that Australian beef producers are facing. This will mean export
will decrease, hence PS will decrease, CS will increase due to the lower price, but total
surplus will decrease.

P Exports2
SAUS
Exports1
A
World price G
H I J
B C D
P*
F

E
DAUS

QD Q* QS

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 Before import restrictions After import restrictions Change
CS A A+G+H +(G+H)
PS G+H+I+J+ B+C+D+E+F B+C+D+E+F -(G+H+I+J)
Total surplus A+G+H+I+J+ B+C+D+E+F A+G+H +B+C+D+E+F -(I+J)

b) Government can help Australian producers by giving a subsidy equal to the reduction in
price. Total well-being in Australia will go down as the cost of subsidy to the government
will not be recovered by gain in PS.

P Exports2
SAUS
Exports1
A World price +
G subsidy
World price H I J
B C D
P*
F

E
DAUS

QD Q* QS

Before import restrictions After import restrictions+ Change

subsidy
CS A A 0
PS G+H+I+ B+C+D+E+F G+H+I++ B+C+D+E+F 0
Govt. - -( G+H+I) -( G+H+I+J)
Revenue
Total surplus A+G+H+I+J+ B+C+D+E+F A+G+H+I+J+ -( G+H+I+J)
B+C+D+E+F-( G+H+I+J)

Question C2 (20 marks)

Lily Lee is the owner of Fair Fitness which is a small centre for various fitness activities
in the market for physical exercise. Lily faces increasing marginal cost and a u-shaped

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 average total cost with the increase in the number of patrons. Assuming that the market for
physical exercise centres is perfectly competitive.
a) Draw the long run equilibrium for the market and Lilys firm. Explain the output
level and profit made by Lilys firm.(6 marks)

b) Suppose there is an increase in demand for physical fitness. What will be the effect on
the market outcome and in Fair Fitness output in the short run and long run? What will be
the effect on the output level and profit made by Lilys firm in the short-run and long-run?
Suppose all other firms in the physical exercise industry are identical to Lilys Firm. In
long-run equilibrium, what will be the effect on the number of firms operating in the
industry? What is the welfare effect in the long run?(10 marks)
c) Assume that the physical exercise industry is actually monopolistically competitive.
Would your answer to part b) change for Lilys Fair Fitness? Why or why not? Explain. (4
marks)

Answer: a) The long run equilibrium output will be at the minimum ATC level of output
and Lily will be earning zero profit. At this point there is no incentive entry or exit.
Equilibrium for the market at E1 in the figure below.

$ $
SR supply
1
SR supply 2

P*2 P*2
E1 E2
P*1 P*1

Demand 2

Demand 1
Q
Q*1 Q*2 Q*3 q*1 q*2

Market Firm

b) Increased demand will increase market equilibrium price. Lilys firm will earn
positive profit in the short-run. New firms will enter the industry, supply increase,
price will go down, until profit is driven down to 0 again. In the long-run, number
of firms will increase. The new market equilibrium is E2 in the above diagram.

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 Economic well-being will improve since we get a bigger consumer and producer
surplus area for increased efficiency meaning increased quantity traded.
c) With monopolistically competitive market output will not reach the minimum
efficient point as they face a downward sloping demand curve. So maximum
efficiency will not be achieved, there will be an excess capacity in the long-run.
See the diagram below.

$ Demand for $
$ original firm P= ATC at q** *Not reaching the
before entry => Zero profit efficient point at
of new firms minimum ATC
MC MC *There are quantities
profit demanded at lower MC
than MB but trade is not
occurring => loss of
P* ATC societys well-being.
ATC
P*

D
D D1 M
q* q q q** q
Demand for
original firm
after entry
of new firms

Question C3 (15 marks)

StarJet and Origin are the only two airlines for domestic aviation in the country of Skyland.
Both the airlines offer two types of seats, business seats at $100 each and economy seats
at $60 each. The marginal cost of supplying any seat is $20. Suppose that economy seat
travellers have to make a prior booking whereas business pre-booking is not required.
When StarJet sells out all of its economy seats, Origin airlines reduces the price of business
seats to $80 each to attract 20 more travellers. If Origin reduces its price, StarJet offers free
inflight entertainment for business seat travellers which cost them an extra $20 per seat and
sells 20 more of these seats.
(a) If StarJet sells out all economy seats, consider a game where the two airlines competing
as described above for the business travellers and decide simultaneously whether to
reduce price and offer free entertainment. Draw a game table that describes the
available strategies and expresses the payoffs as profit of the two airlines for each
possible outcome in the game. (5 marks)
(b) What is the dominant strategy equilibrium? What is the Nash equilibrium? (2 marks)

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(c) Suppose StarJet reduced its price to $80 per business seat as well as offering free
entertainment to attract 10 more travellers away from Origin. What is the dominant
strategy equilibrium now? What is the Nash equilibrium?(5 marks)
(d) Using the information in part (c), what is the rollback equilibrium if Origin moves first?
Would StarJet also have an incentive to try to move first? Why or why not? (3 marks)

Answer: a)

Origin

Reduce price Same price

StarJet Free 1200, 1200 2400, 0

Entertainment
No free 0, 2400 0, 0
entertainment

b) DS equilibrium: StarJet chooses Free Entertainment, Origin chooses Reduce Price

Nash equilibrium: StarJet chooses Free Entertainment, Origin chooses Reduce Price

c)

Origin

Reduce price Same price

StarJet Reduce price 1200, 600 1600, 0

with Free
Entertainment
Same price 0, 2400 0, 0
with no free
entertainment

DS equilibrium: StarJet chooses Reduce Price, Origin chooses Reduce Price

Nash equilibrium: StarJet chooses Reduce Price, Origin chooses Reduce Price
Reduce 600, 1200
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 Reduce SJ
d) Not red. 2400, 0
Origin
Not red. Reduce 0, 1600
SJ
Not red.
0, 0
Rollback equilibrium: Origin chooses Reduce Price, StarJet chooses Reduce Price

Nash equilibrium: StarJet chooses Reduce Price, Origin chooses Reduce Price
1200, 600
Reduce

Reduce Ori
Not red. 1600, 0
SJ
Not red. Reduce 0, 2400
Ori
Not red.
0, 0

StarJet will not want to move first as there is no first mover advantage.

END OF EXAMINATION

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