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SINGAPORE INSTITUTE OF MANAGEMENT

UNIVERSITY OF LONDON
PRELIMINARY EXAM 2019

MODULE CODE : EC2066

MODULE TITLE : Microeconomics

DATE OF EXAM : 26/02/2019

DURATION : 3 hours

TOTAL NUMBER : 7 pages


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INSTRUCTIONS TO CANDIDATES :-
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Candidates should answer ELEVEN of the following FOURTEEN questions: all


EIGHT from Section A (5~marks each) and THREE from Section B (20 marks each).

A calculator may be used when answering questions on this paper and it must comply
in all respects with the specification given with your Admission Notice. The make and
type of machine must be clearly stated on the front cover of the answer book.

If more questions are answered than requested, only the first answers attempted will be counted.

DO NOT TURN OVER THIS QUESTION PAPER UNTIL YOU ARE TOLD TO
DO SO.

Candidates are strongly advised to divide their time accordingly.

EC2066 Microeconomics Page 1 of 7


SECTION A

Answer all EIGHT questions from this section (5 marks each).

1. You don’t know your neighbour, but you can see his garden from your living
room window. Your neighbour enjoys gardening and you enjoy the view of
his garden. It follows that your neighbour is working too little on the garden
compared to the social optimum. Is this true or false? Explain your answer.

2. There are 50 firms in a competitive industry. Each firm has the production func-
tion q = ln L, where q denotes firm output and L denotes the quantity of labour
employed by the firm. The wage rate is w = 2 and each firm can sell its output
at price p = 10. What is the total labour employment in the industry?

3. In a perfectly competitive industry with constant input prices and constant re-
turns to scale, the burden of any tax will fall only on the consumers in the long

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run. Is this true or false? Explain your answer.
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4. Pip derives all of his utility from consuming only chocolate bars. He spends his
entire weekly allowance of 10 on chocolate bars. Suppose the price of chocolate
bars rises from 1 to 2. Compute Pip’s Compensating Variation (the amount of
extra income needed after the price change to return Pip to the original utility
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level) and Equivalent Variation (the maximum amount of money that Pip would
pay to prevent the price increase).
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5. Under first-degree price discrimination, a monopolist’s marginal revenue is equal


to average revenue. Is this true or false? Explain your answer.

6. Consider the following game. For what values of x does each player have a
dominant strategy? Explain your answer.

Player 2
A2 B2 C2
A1 3,3 3,0 1,2
Player 1 B1 2,3 1,2 0,1
C1 0,1 2,0 x, x

7. If the long-run average cost is decreasing in output, the long-run marginal cost
must be decreasing in output as well. Is this true or false? Explain your answer.

EC2066 Microeconomics Page 2 of 7


8. There are 3 consumers of a public good. The demand functions of the con-
sumers are as follows:

P1 = 60 − Q (Consumer 1) (1)
P2 = 100 − Q (Consumer 2) (2)
P3 = 140 − Q (Consumer 3) (3)

where Q is the quantity of public good and Pi is the price consumer i is willing
to pay, i ∈ {1, 2, 3}. The public good can be produced at a constant marginal
cost of 180, and there are no fixed costs. Find the efficient level of production of
the public good.

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EC2066 Microeconomics Page 3 of 7


SECTION B

Answer THREE questions from this section (20 marks each).

9. (a) Find the pure and mixed strategy Nash equilibria of the following game.
[8 marks]
Player 2
A2 B2
Player 1 A1 2,7 3,2
B1 0,0 4,1

(b) Consider the following extensive-form game with two players. Player 2
moves after player 1. Each player can produce a high output or a low
output. Player 1’s payoff is additionally influenced by an exogenous event
which occurs with probability p ∈ [0, 1].
The payoffs are written as ((Payoff to 1), Payoff to 2).

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L1 H1
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2 2
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L2 H2 L2 H2

((4 − 2p), 1) ((3 − 2p), 4) ((2 + p), 2) ((1 + p), 1)

i. Suppose p > 1/3. Find the subgame perfect Nash equilibrium of the
game above. [6 marks]
ii. Suppose, before the start of the game, player 2 has the option of com-
mitting to produce a high output (H2 ). Making such a commitment
requires player 2 to incur a cost of 1. Find the range of values of p for
which it is optimal to make such a costly commitment.
[6 marks]

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10. A competitive firm produces according to the following production function:

Q = 2L1/2 K1/2

where Q denotes the firm’s output, K denotes capital and L denotes labour. The
price of labour is 4 and the price of capital is 16. Let P be the price at which the
firm can sell its output. In the short-run, capital is fixed at some level K. In the
long run both labour and capital are variable.

(a) Write down the total short run cost of the firm as a function of the output
Q and the fixed level K. [5 marks]
(b) What is the minimum average cost in the short run? [5 marks]
(c) What is the short-run supply curve of the firm? In answering this question,
be careful to check whether there is a P below which the firm would shut
down in the short run (so that supply would be zero for such prices).
[5 marks]
(d) Now consider the long-run scenario in which both labour and capital are
variable inputs. Derive and explain the shapes of the long-run marginal

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and average cost curves of the firm. [5 marks]
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11. (a) Consider a labour market with two types of workers: high ability and low
ability. The ability of a worker is known only to the worker himself. Ex-
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plain the conditions necessary for education to be a credible signal of abil-
ity even when education does not enhance ability. [12 marks]
(b) An employer has two types of jobs available: high difficulty and low dif-
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ficulty. There are two types of workers: high ability and low ability. The
ability is known only to the worker himself.
The utility of a worker is w − c where w denotes salary and c denotes the
cost of doing the job. The salary is w H for the high difficulty job and w L
for the low difficulty job. Further, c varies across worker types and jobs, so
that the utilities are as follows:

Utility from Utility from


High Difficulty Job Low Difficulty Job
High Ability Worker w H − 100 w L − 50
Low Ability Worker w H − 150 w L − 100

Suppose w L = 100.
Since the employer cannot observe the ability level of a worker directly,
how should he set w H so that the low ability workers take only the low
difficulty jobs and high ability workers take only the high difficulty jobs?
[8 marks]

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12. Rai spends her income on fuel for heating her house (H) and a composite of all
other goods (Y). Her preferences are represented by the utility function

u( H, Y ) = H α Y1−α

The price of the composite good is 1, and the price of heating fuel is p. Let M
denote Rai’s income.

(a) Derive Rai’s demand for H and Y. [5 marks]

(b) Suppose M = 300 and α = 2/3. Also suppose currently the unit price of
fuel is p = 20. The energy company offers Rai the option to switch to a
different tariff. Under the new tariff, Rai must pay a fixed fee of 100 and
then she can buy fuel at a unit price of 10. Would Rai switch to the new
tariff? Explain. [8 marks]

(c) The government decides to give Rai a heating fuel subsidy of s per unit.
This results in an increase in utility from u0 before the subsidy to u1 after
the subsidy. Could the government follow an alternative policy that would

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result in the same increase in utility for Rai, but cost the government less?
Explain using a suitable diagram. [7 marks]
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13. You are advising the minister responsible for housing. The minister is con-
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cerned that rents are too high and wants to reduce the rent payments by tenants
without causing too much inefficiency.

(a) Using appropriate diagrams explain the circumstances under which you
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would advise the minister to impose rent control. [7 marks]

(b) Using appropriate diagrams explain the circumstances under which you
would advise the minister to give a rent subsidy to tenants. [7 marks]

(c) Using appropriate diagrams describe a case in which issuing more build-
ing permits would not be an effective policy. [6 marks]

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14. A monopolist has two customers with the following demand functions:

Q1 = 70 − P1 (Demand of customer 1)
Q2 = 110 − P2 (Demand of customer 2)

Here Pi is the price charged to customer i, i ∈ {1, 2}. The monopolist has a
constant marginal cost of 10, and no fixed costs.

(a) Suppose the monopolist can differentiate between the customers, and the
customers cannot trade between themselves, allowing the monopolist to
engage in third-degree price discrimination. What is the price charged to
each consumer? [5 marks]

(b) Now suppose the monopolist cannot differentiate between the customers
and must charge them the same price. Calculate the monopolist’s optimal
single price P as well as the quantity sold to each customer. [5 marks]

(c) Is the total surplus (consumer surplus plus profit) higher under a single
price or under price discrimination? Explain. [5 marks]

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(d) Suppose, as in part (b), the monopolist cannot differentiate between the
customers. However, in addition to a per-unit price P, the monopolist can
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also charge a fixed fee F. A customer must pay this fee irrespective of
the quantity purchased when a positive amount is purchased. Derive the
monopolist’s optimal price and fee. [5 marks]
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END OF PAPER

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