THE UNIVERSITY OF NEW SOUTH WALES SCHOOL OF ECONOMICS ECON2101 MICROECONOMICS 2 FINAL EXAMINATION - JUNE/JULY 2006

TIME ALLOWED:

2 HOURS

TOTAL NUMBER OF QUESTIONS: THREE (3) THIS EXAMINATION IS WORTH 60% OF THE TOTAL MARKS FOR THE SUBJECT.

ANSWER ALL QUESTIONS

QUESTIONS ARE OF EQUAL VALUE THIS PAPER MAY BE RETAINED BY CANDIDATES CANDIDATES MAY BRING DRAWING MATERIALS TO THEIR DESK

ANSWER EACH QUESTION IN A SEPARATE BOOK WITH THE QUESTION NUMBER

INDICATED ON THE COVER.
~ AT THE END OF THE EXAM YOU SHOULD HAYE AT LEAST THREE

BOOKLETS~

Indicate on the space provided at the front of the answer book the question number. Be sure to

print your name and student number on the front of each answer book in the space provided.
CALCULATORS MAY ALSO BE USED. ALL ANSWERS MUST BE WRITTEN IN INK. PENCILS MAYBE USED ONLY FOR DRAWINGS, SKETCHING OR GRAPHICAL WORK.

QUESTION 1 (ANSWERS BOTH PART A AND PART B. BOTH PARTS MAY BE ANSWERED IN THE SAME BOOKLET) PART A (10 MARKS) EITHER (Each part 2 marks)

1.

In the following cases show appropriate indifference curves, and where relevant, budget constraints which illustrate the following statements: (a) "I like peanuts a lot, but ifI eat too many, I feel really ill." (Put peanuts on the Y axis; all other goods on the X axis.) "Howard is a real snob. If the price of a wine falls, he drinks less of it." (Put wine on the X axis; all other goods on the Y axis.) "I would love to buy some champagne, but at that price, it's just too expensive. If the price fell, however, I would buy some." (Put champagne on the X axis; all other goods on the Y axis.) "Liver is disgusting. I wouldn't buy it at any price." (Put liver on the X axis; all other goods on the Y axis.)

(b)

(c)

(d)

(e)

"Cola all tastes the same to me. I only drink cola for the caffeine in it, and Lightning Cola has twice as much as Burpsi Cola." (Put Lightning Cola on the Y axis; Burpsi Cola on the X axis.)

OR

11.

Fred is deciding whether to buy a lottery ticket. Each ticket costs $1, and the probability of the payoffs is: Probability Return 0.5 $0.00 0.25 $1.00 0.2 $2.00 0.05 $7.50 What is the expected value of the gamble if Fred buys a ticket? (2 Marks) Fred's utility function is U = Wo. s : (i) Is Fred risk-averse, a risk-seeker or risk-neutral? Cl mark) (ii) What is his expected utility? Cl marks) (iii) Would he take the gamble? Explain. (2 marks) Suppose Fred was offered insurance against losing any money. Ifhe buys 1,000 tickets, how much would he be willing to pay to insure the gamble? In the circumstances, would he insure? Explain. (4 marks)
2

(a) (b)

(c)

PART B (10 MARKS)

EITHER:
I.

a) What is a cartel? (2 marks) b) Why are cartels inherently unstable? (4 marks) c) What factors may make them stable? [Use examples of actual cartels to support your argument] (4 marks)

OR

H.

"Companies will often offer discounted software to students and staff at school and university levels. These may be labeled as academic versions, but perform the same as the full price retail software. Academic versions of the most expensive software suites may be priced as little as one fifth or less of retail price." a) With the aid of diagrams explain the economic rationale for this pricing policy. (6 marks) b) What is the effect of the pricing policy on efficiency? (4 marks)

QUESTION 2

(20 Marks)

EITHER

The market for Pickled Gizmos is perfectly competitive and is characterized by decreasing costs. Currently firms in the market are suffering losses as tastes have changed and Boiled Widgets have become a good substitute for Pickled Gizmos. If, before the change in tastes, the Pickled Gizmo market was in long run equilibrium, for the market, and for a representative firm in the market, show and describe the possible process of adjustment from the initial long-run equilibrium, to a new long-run equilibrium.

OR

11.

Ruritania is completely isolated from the rest of the world. In Ruritania there are only 2 factors of production, labour and capital, producing only 2 goods, guns and wheat. The endowment of labour in Ruritania is 40 units and the endowment of capital is 20 units. Currently the Marginal Rate of Technical Substitution oflabour for capital in wheat production is 1/3 and in gun production 3/1. Is this an efficient allocation of factors? Show and explain why, or why not. If not, show the possible process of adjustment towards an efficient equilibrium. Is it possible to efficiently produce only one of these commodities? What are the three 'marginal conditions' for an efficient allocation of resources in the economy? In answering these questions, conduct your analysis using both an Edgeworth Box and a corresponding Production Possibility Frontier (PPF), in the process showing the relationship between the contract curve and the PPF.

QUESTION 3

(20 Marks) EITHER

I. Empirical studies in Australia suggest that, while there is still a significant wage gap between males and females, the gap has been declining since the 1980s. What are the main explanations for the wage gap? What factors may explain its decline?

OR

n.

Assume that there are two types of drivers on the road. "Bad" drivers and "good" drivers who are distinguished simply on the basis of the likelihood of their having an accident. Bad drivers are 10 times more likely to have accidents than good drivers, and represent 20% of the population. The average cost of an accident is the same for both types of drivers. This information is summarized in the table below:
Type
% of Population

Risk of Accident

Average Cost of Accident

"Bad" Drivers "Good" Drivers

20% 80%

0.01 0.001

$1,000 $1,000

(a) If an insurance company can only charge a single price, what is the "fair" price for car insurance? (2 marks) (b) What are the problems and likely consequences for the insurance company of providing car insurance under these conditions? (10 marks) (c) What options are open to the insurance company to overcome these problems? (8 marks)