THE UNIVERSITY OF NEW SOUTH WALES SCHOOL OF ECONOMICS SESSION 1, 2008 ECONllOl MICROECONOMICS I FINAL EXAMINATION TIME ALLOWED

- 2HOURS

THIS PAPER IS WORTH 60% OF THE TOTAL SUBJECT MARK

This examination paper consists of two parts - Part A and Part B Part A consists of 20 multiple choice questions each worth one (1) mark. Answer all the questions in Part A on the answer sheet provided, using pencil only: (a) Print your student number, name and initials in the space provided and mark the appropriate boxes below your student number, name and initials. (b) For each question, mark the appropriate response (a), (b), (c), or (cl). There is only one correct response to each question in Part A.

Part B consists of four (4) essay-type questions, each worth TWENTY (20) marks. Answer only TWO (2) questions from Part B. ANSWER EACH PART B QUESTION IN A SEPARATE EXAMINATION BOOKLET Answers to questions in Part B must be written in ink. Pencil may be used in answers to Part B for drawing, sketching or graphical work only.

This question paper may be retained by the candidate

PART A

This section is worth 20 marks Mark your answer on Answer Sheet provided Question 1
If

Output Average Total Cost Total Fixed Cost Marginal Cost

= 400 units = $70 = $12000 = $90

then
(a) $20 (b) $40 (c) $50

Average Variable Cost equals:

(d) $160

Question 2
In an imperfectly competitive market, in which a firm has some market power: (a) The demand curve faced by a typical firm is perfectly elastic at the current market price (b) Marginal revenue is greater than average revenue at all levels of production. (c) The demand curve faced by the typical firm is significantly less elastic for price increases than for price decreases. (d) For the typical firm, price is greater than marginal cost at the profit-maximising output level.

Question 3
At the level of production at which short run average cost is minimized: (a) Marginal cost equals average cost. (b) Marginal cost is decreasing. (c) Average cost is less than marginal cost. (d) Average cost is less than average variable cost.

Question 4
Which of the following has the "non excludability" characteristic that defines a pure public good? (a) A local council car park. (b) Suburban street lighting. (c) A toll road. (d) Primary school education.

Question 5
Which of the following statements is true? (a) A profit maximising monopolist will always set price and output at a level where demand is price elastic. (b) A profit maximising monopolist always produces where Average Revenue equals Average Cost (c) A profit maximising monopolist will, in long run equilibrium, always use a scale of plant that minimises Long Run Average Costs. (d) A profit maximising monopolist will always produce where Marginal Cost is greater than Price.

Question 6 Assessment of a financial investment opportunity for a merchant bank provides the following estimates of possible profit levels and corresponding probabilities; Profit $lAm $0.7m Probability 0.3 0.6 0.1

-$OAm

The Expected Value of profit for this opportunity is: (a) $0.70m (b) $0.80m (c) $0.84m (d) $0.88m

Question 7 Big&Beefy PIL produces frozen meat pies in packets of 20. Big&Beefy has the following

costs of production:
Packets Total Cost

(per hour) 0 1 2

($ per hour) 90

96
101 107 118 140 172

3
4 5

6
(only completed packets are produced)

At an output level of 5 packets per hour, Big&Beefy's average variable cost is:
(a) $10 (b) $18 (c) $22 (d) $28

Question 8

Refer to the data in Question 7 At an output level of 2 packets per hour, Big&Beefy's average fixed cost is: (a) $2.50
(b) $3

(c) $45 (d) $50.50

Question 9
Vesty PIL produces cotton shirts. Vesty is a price taker and must decide on its hourly
production rate. The costs of production are:

Shirts (per hour)

Total Cost (per hour)

o
1

20 26
31 35 48 70 102

2 3
4

5
6 (only completed shirts are counted)

If the market price of a shirt is $15, Vesty's profit maximising production rate is:
(a) 3 shirts per hour (b) 4 shirts per hour (c) 5 shirts per hour (d) 6 shirts per hour

Question 10
Consider the data of Question 9 The price below which Vesty should shut down operations in the short run (the "shut-down price") is:

(a) $3.00 (b) $5.00 (c) $5.50 (d) $7.00

Question 11 The following table gives the demand schedule for a monopolist Price ($) 24 20 16 12 8 4 0 Marginal Revenue from the sale of the 5th unit is:
(a) -$12 (b) -$4
(c) $4

Quantity Demanded 0 1 2

3
4
5

The Marginal Cost of production for the monopolist is constant at $5 per unit.

(d) $12

Question 12 Refer to the data in Question 11. The profit maximizing level of output is (a) 2 units (b) 3 units (c) 4 units (d) 5 units

Question 13 If the supply curve of a factor of production facing a competitive firm is perfectly elastic, then from the firm's point of view: (a) none of the factor's earnings is necessary transfer payment (b) all of the factor's earnings is producer surplus (c) none of the factor's earnings is rent (d) all of the factor's earnings is rent

Question 14

The table below presents data on the productivity of workers in a meat processing factory. The meat processing industry can be assumed to be competitive. Number of workers Quantity of meat processed per day (kg)

1
2 3

40
100 180

4
5

240 290 330 360 380

7
8
The market price of processed meat is $2.50 per kilo. The wage rate for meat processors is $90 per day The Marginal Revenue Product from employing the 4th worker is:
(a) $60 (b) 60 kg (c) $150

(d) 150 kg

Question 15

Consider the data for Question 14. To maximise profit the factory should employ: (a) 5 workers (b) 6 workers (c) 7 workers (d) 8 workers

Question 16

A seller in an oligopolistic market believes that rival firms will match a price cut, but rivals will maintain current prices if the seller raises price. Therefore both strategies will reduce profits. This means that: (a) Demand for the seller's product is perceived as significantly more elastic for price increases than for price decreases. (b) Demand for the seller's product is perceived as significantly less elastic for price increases than for price decreases. (c) Price cutting is a dominant strategy for the seller. (d) Raising price is a dominant strategy for the seller.

Question 17
If production of a commodity generates an unfavourable externality:

(a) marginal social cost of production is greater than private marginal cost of production. (b) marginal social benefit is greater than private marginal benefit. (c) the commodity will be over-priced and under-supplied in a competitive market. (d) the commodity will be over-priced and over-supplied in a competitive market.

Question 18

Which of the following statements about the Monopolistic Competition market model is true? (a) The market is characterised by a small number of rival firms each selling a slightly differentiated product (b) The typical firm tends to operate with excess capacity and unexploited economies of scale (c) In the long run, surviving firms charge a price which is higher than average cost and make economic profits. (d) The demand for each firm's product is infinitely elastic.

Question 19 Assume two rival car rental companies (Ace Rentals and Bob's Rentals) are considering whether to discount their rates as a method of increasing market share. The following pay-off matrix gives the expected monthly profits (in $'000) of each company (Ace, Bob's) under alternate strategies:

BOB'S
Discount Discount (12, 10) Do Not Discount (24, 6)

ACE
Do Not Discount (8, 20) (16, 14)

(a) The Nash equilibrium is for neither firm to discount. (b) The Nash equilibrium is for both firms to discount (c) The Nash equilibrium is for Ace to discount and Bob's to not discount. (d) The Nash equilibrium is for Bob's to discount and Ace to not discount.

Question 20 A government postal service charges a lower postage rate for cards than for ordinary letters. This price discrimination will be profitable for the postal service if (a) The demand for card postal services is less elastic than the demand for ordinary letter postal services (b) The demand for card postal services is more elastic than the demand for ordinary letter postal services (c) The demand curve for card postal services shifts to the right (d) The demand curve for ordinary letter postal services shifts to the left

PARTB Each question in this part is worth 20 marks Answer only TWO (2) questions from this part ANSWER EACH QUESTION IN A SEPARATE EXAMINATION BOOK Question B.l Consider a small firm which is operating in a perfectly competitive market and is a pricetaker in both the market where it buys its inputs and the market where it sells its product. (a) Explain the difference between the Short Run and the Long Run in the analysis of this (2 marks) firm's costs of production. (b) Explain why this firm's Short Run Average Cost Curve, depicting how per unit costs of production change as output is increased, is typically U-shaped. What is the significance of the output level at which Short Run Average Cost is minimized? (5 marks) (c) Explain the circumstances in which a profit-maximising firm would find it worthwhile to shut down operations in the short run. (4 marks) (d) What factors determine the shape of this firm's Long Run Average Cost Curve. (4 marks) (e) Explain why in the long run this firm will be unable to make more than a normal profit (5 marks)

Question B.2 (a) Explain what is meant by a "natural monopoly". (4 marks)

(b) Construct a diagram showing the average and marginal cost curves, and the demand and marginal revenue curves for a natural monopoly. Use your diagram to explain why profit maximising behaviour by the monopolist is inefficient from society's point of view. (8 marks) (c) Suppose the government seeks to regulate the behaviour of the monopolist by price regulation. Consider the advantages and disadvantages of alternative criteria for setting the regulated price. (8 marks)

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Question B.3

Consider an industry whose production process emits a gaseous pollutant into the atmosphere. (a) Use the simple Supply and Demand model to demonstrate that, in the absence of any regulation, the industry will overproduce from the point of view of allocative efficiency. (6 marks) (b) Explain the Coase Theorem. What are the limitations of the Coase theorem which might make its approach to resolving the externality problem inapplicable for this industry? (6 marks) (c) Discuss alternative forms of intervention by government aimed at correcting the externality problem in this case. (8 marks)

Question B.4

(a) What are the characteristics of an industry whose market structure is described as "oligopolistic"? (3 marks) (b) Explain why firms in an oligopolistic industry have an incentive to collude, but also the incentive to cheat on any collusive agreement. (6 marks) (c) Explain why, even in the absence of formal collusion, oligopolistic firms are unwilling to engage in competition on the basis of price. What forms of non-price competition do oligopolists typically engage in? (6 marks) (d) What are the advantages and disadvantages for society of these forms of non-price competition? (5 marks)

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