York University Final Examination Course Director: S.H. Chiang Course Number: ECON 2300.03A I.

Consider a two-person economy (persons A and B). Both A and B consume only two goods, x and y and their utility functions are given by: U A = U A (x, y) = min[x, 2y] and U B = U B (x, y) = min[2x, y]. Further, assume that As initial endowment (x,y) = (0,10) and Bs initial endowment (x,y) = (10,0). (a) If they decide to consume whatever they have, what will their utilities be? (b) Obtain price oer curves for A and B. (c) From their preferences and initial endowments, are you able to tell whether A and B can benet from trade? If they do, who is the buyer in markets x and y? What will the exchange ratio be? (20 points) II. You have$2500, which can buy you a projection TV ($1600) and a VCR ($900). You plan to take them home with your own car. Due to the snowy weather and your driving skill, the probability of having an accident is 0.5. When the accident occurs, both TV and VCR will be totally damaged (i.e., their residual values = zero). The transportation costs (money as well as time) are assumed to be relatively minor and can therefore be ignored. For simplicity, assume that your preference function is U = w, where w is the total value of these two products. (a) You can bring them home in one trip or in two separate trips. Which one do you prefer? (b) There is an insurance that you can purchase. The full coverage insurance may cost you as much as $1250. Are you better o in buying this insurance? Draw a diagram to prove your assertion. (c) The other option is to buy a partial coverage insurance. It pays 50 percent of your losses at a cost of $625 (half of what you pay under the full coverage insurance). Compare this with the full coverage insurance and with no insurance. (d) The insurance company from which you purchase the insurance can go bankrupt with a probability of 25%. Bankruptcy would make it impossible for you to claim the loss, if incurred. What happens to your results above? (20 points) III. Answer two related questions: (a) Over the past few years, college and university administrators have been increasing intuition rates, even though there have been declines in student enrolment, Is this a rational decision on the administrators part? What assumptions do they make about the price elasticity of demand for higher education? 1

(b) Suppose the universities provide not only education but also housing to their students. The university administrators determine that at current prices the demand for education has a price elasticity (i.e., (dQ/dP )(P/Q)) of the demand for education is -2, while the price elasticity for housing is -0.5. If the administrators wish to raise the price of both products by 10 percent, what will happen to their revenues for each product? Can you tell from the available information whether more revenues will be generated for the universities? If yes, why? If not, what additional information would you need? (20 points) IV. Short Questions: (40 points) (a) It is known that the Laspeyres index uses the base-year quantity as weighs pt xb +pt xb to calculate the price index (specically, Lp = p1 x1 +p2 x2 ). If the relative b b b b 1 1 2 2 t t b b price increases over time (i.e., p1 /p2 > p1 /p2 ), what would the the relatiopt xt +pt xt ship be between Lp and the total expenditure index M = p1 x1 +p2 x2 (where b b b b xj and pj are the consumption and the price of i in period j; i = 1, 2 ; i i j = t, b)? (b) What is the compensating variation? What is the equivalent variation? Illustrate. (c) A consumer, who is initially a lender, switches to be a borrower after an increase in ination rates. Is this consumer better o or worse o after the change in ination rates? (d) Assume that your utility is given by U(C, L), where C = consumption and L = leisure. You have v dollars non-labour income and 24 hours to spend per day. Thus, your budget constaint can be written as C = w(24 L) +v, where w= wage. Identify the substitution, income, and endowment eects in your diagram, as w increases. (e) Assume that demand for gasoline is Qd = 150 100P and the supply of gasoline is Qs = 10 + 100P. Establish the equilibrium output and price. Calculate the consumers surplus (CS) and producers surplus (PS). To protect the consumers, the Government is considering to set the gasoline price at $0.50 per liter. However, the Government is not prepared to buy or sell if demand and supply are in disequilibrium.due to limited resources. What eect does this have on CS and PS?
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