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Unformatted text preview: UNIVERSITY OF TORONTO
Faculty of Arts and Science AUGUST EXAMINATIONS 2006 ECONOMICS 200Y Duration: 2 hours
Aids Allowed: Non—Programmable Calculator STUDENT INFORMATION:
NAME (print)
FIRST LAST
STUDENT #
SECTION (circle): MartinezGerricho Slasor Wolfson INSTRUCTIONS: You MUST answer the Multiple Choice Question #4. Then select 4 other questions out
of the 6 remaining questions available to you on this exam paper. Each question is worth 20 marks. Be aware that every question spans more than one page. Note: Question I is for MartinezGorricho students only; Question 2 is for Slasor
students only; and Question 3 is for Wolfson students only. All answers are to be written on this examination paper. Page 2 0f23 1. THIS QUESTION IS FOR MARTTNEZGORRICHO STUDENTS ONLY. Javier owns a bookstore in London, England. The bookstore has a monetary value of
$10,000 (consider it his wealth level). Recently, there have been several vandalism acts
performed by hooligans throughout the city. Javier is aware of this risk and he estimates
that these teenagers will eventually damage his bookstore with probability 20%, in which case, he will suffer a loss of $6,000. Javier's utility function is U(W)=JW . a) (2) What is Javier's Expected Utility? Expected Utility = b) (4) Suppose that Javier has the option of installing a security system in the
bookstore. This security system costs $396 and if it were adopted, it would reduce
the probability that the bookstore is eventually damaged to 10%. Will Javier
install this security system? (Yes / No). Show your work. c) (4) Suppose now that Javier has a second option of buying full insurance
coverage (Full coverage means that in the event that the hooligans damage the bookstore, the
company will refund Javier the entire loss of $6,000). Ifthe insurance company offers him
a full insurance coverage at a price of $1 ,069, I conclude that Javier will buy
(the full insurance coverage / the security device / neither). Show your work. d) Page 3 0f23 (4) What is the maximum price (i.e., maximum premium) that Javier is willing to
pay for the full insurance coverage? Show your work. Maximum Premium = (6) In order to encourage Javier to purchase the security system and reduce the
probability of suffering a loss, the insurance company is studying the possibility
of also offering Javier partial insurance coverage of $2,000, so that in the event
that the hooligans damage the bookstore, the company will only refund Javier
$2,000. If this partial insurance coverage is offered at a price of $210, and the full
insurance coverage is offered at a price of $1,069, then I conclude that Javier will
buy: (both the partial insurance and the security device/ only the partial insurance / only the full insurance/ only the security device / none). Show your work, Page 4 0f 23 2. THIS QUESTION IS FOR SLASOR STUDENTS ONLY. Suppose that the price of consumer good X is held below its equilibrium level by
government price control (i.e., a price ceiling). Analyze the implications of this price
control for Pareto efﬁciency — making the usual assumptions that all markets in the
economy are perfectly competitive, there are no taxes or subsidies, and there are no externalities. Relate your answer to diagrams, of course.
(Two pages have been allocated for your answer.) more space to answer question 2 is on the following page Page 5 of 23 Solution to Q2 cont’d: Page 6 0f23 3. THIS QUESTION IS FOR WOLF SON STUDENTS ONLY. Davie has a fancy Porsche racing car worth $360,000. In any year, there is a 5% chance
that his car will be stolen, never to be found again. An insurance company offers to
insure his car for $50 for every $500 of coverage (i.e., full coverage would cost $36,000). 3.1 (1) What are the contingent commodities in this situation? 3.2 (3) On the diagram below, draw Davie’s Budget Line, labelled BL. Show the Fair
Odds Budget Line, labelled FOBL. Be sure to label the axes and to show the
slopes of the budget lines. [lfthe two budget lines are the same, label as BL. = FOBL.] 3.3 (4) Despite owning a very fast car, Davie is risk averse. On the diagram above,
Label the “Endowment Point” as Point E. (Davie’s only wealth in his fancy carl).
Show his equilibrium point when he can insure his car, labelled Point A. Show the amount of insurance coverage and the amount of premium paid on the diagram. [No
precise values required; just label clearly.] 3.4 (2) Will Davie buy full insurance coverage for his car? (Full coverage means that if
the car is stolen, he will receive $360,000). (Yes / N0) Brieﬂy explain your answer. 3.5 b) d) Page 7 0f 23 We move now to another model of Choice Under Uncertainty with Davie having
the following Utility Function: U = U(W) = 4* W A where W is his wealth. (Recall
this is just his car.) (2) What is Davie’s Expected Utility before purchasing any car insurance? [Show
your work in the space below and place your ﬁnal answer on the line below.] EU: (3) What is the maximum premium (“reservation price”) Davie would pay to get
ﬁlll insurance coverage for his car? Maximum Premium = (1) What additional amount is the insurance company charging above the
“actuarially fair” price for insuring the car for the full amount of $360,000? Additional Amount Over Actuarially Fair Price = (4) In the diagram below (freehand, not to scale), show Davie’s Utility of Wealth
Function, his Expected Utility, and his reservation price for full insurance
coverage. Page 8 0f23 4. MULTIPLECHOICE ******(All students must do this question) ****** .i Provide the best answer to the following multiplechoice questions by circling your response below. There are 12 questions; choose 10 to answer at 2 marks each. No penalty
for incorrect responses. If more than 10 questions are attempted, only the ﬁrst 10 will be marked. 1. Compared to a cash grant, a perunit subsidyI on clothing that costs the
government the same total amount a) results in more clothing and more of other goods being purchased b) results in less clothing and more of other goods being purchased 0) results in more clothing and less of other goods being purchased d) results in less clothing and less of other goods being purchased e) results in no difference in clothing and other goods being purchased. 2. In a two—year setting, if a higher interest rate causes consumption in year 1 to rise,
then a) the income effect associated with the higher interest rate is greater than the
substitution effect b) the substitution effect associated with the higher interest rate is greater than the
income effect c) the income effect of the higher interest rate is negative (1) the substitution effect of the higher interest rate on year 1 consumption is positive e) none of the above. 3. The income effect ofa higher wage rate a) encourages more hours of labour due to a higher opportunity cost of leisure time b) discourages more hours of labour because a higher real income encourages
greater leisure time c) encourages more hours of labour because a higher real income encourages greater
leisure time d) encourages more hours of labour and more hours of leisure since the opportunity
cost of both has fallen e) discourages fewer hours of labour due to a lower opportunity cost of leisure time. ' Assume that the consumer receives the full amount of this subsidy. Page 9 0f23 A carpenter hammers nails each day at work. The ﬁrst hour she can hammer 120
nails, the second hour 100 nails, the third hour 90 nails, the fourth hour 60 nails
and the ﬁfth hour 10 nails. The marginal product in the third hour is 10 nails
—10 nails
90 nails
310 nails
60 nails. With labour as the only variable cost, MC is inversely related to MPL
is constant is positively related to MPL
is not related to MPL must be rising. A ﬁrm employs 100 units of labour and 50 units of capital to produce 200
widgets. Labour costs $10 per unit and capital costs $21 per unit. For the
quantities of inputs employed, MPL = 3 and MPK = 3. In this situation, the ﬁrm is producing the 200 widgets at the lowest possible cost could lower its production costs by using more capital and less labour could increase its output at no extra cost by using more labour and less capital
should shut down none of the above. Jane Doe has her own law practice. She pays rent for ofﬁces of $1 ,500 a month,
pays salaries to secretaries and staff of $4,000 a month, pays utility bills of $500 a
month, and miscellaneous bills of $1,000 a month. She recently received an offer
to work for a legal ﬁrm for $8,000 a month. Her monthly total (economic) cost for
her law practice is the same as “accounting” total cost
$5,500 $6,000 $7,000 $15,000. Page 10 0f23 Suppose labor is on the horizontal axis and capital is on the vertical axis. Further,
the expansion path has shifted down and average cost curves have shifted up. A
possible explanation for what has happened is the wage rate decreased
the wage rate increased
the price of capital decreased
the price of capital increased. If the price elasticity of demand for a monopolist's product is equal to 2 and
marginal revenue is $10, what is the price? $20
$10
$0.50
$5 cannot be calculated from the information provided. At an output rate of 1000, a monopoly's average revenue is $40, its marginal
revenue is $30, its marginal cost is $30, its average variable cost is $35, and its
ﬁxed costs are $5000. The monopoly is maximizing proﬁts and profits are $5000 maximizing proﬁts and profits are zero not maximizing profits, but could if it increased output
not maximizing profits, but could if it decreased output. When a monopoly is maximizing proﬁts, which of the following conditions
generally holds? MC=MR<AC
MC=MR<AR MC=MR=AC=AR b)
MC = MR = P > MR (1)
none of the above. If a firm hires workers to a point where the wage exceeds the MRPL profits can be increased by employing fewer workers
proﬁts can be increased by employing more workers
total cost must be greater than total revenue proﬁts are maximized at that employment level it is using too much capital. Page 1] of 23 5. CONSUMER THEORY
5.1 (14) Equilibrium, Substitution Effect (SE) and Income Effect (IE) Asier is an undergraduate student who consumes only camera ﬁlms and DVD rentals. His
parents have provided him with an allowance of $200 per week. He has no other source
of income. Renting a DVD movie costs $5. A pack of camera ﬁlms usually costs $10 but
the camera store is currently running a promotion as follows: if Asier purchases more
than 10 ﬁlm packs, he will pay the regular price for the ﬁrst 10 packs and half the price
for the remaining purchased packs. a) (3) In the diagram below, carefully draw Asier's budget line (label axes and show
values for the intercepts and slope). Put ﬁlm packs on the horizontal axis. b) (2) Asier's indifference curves are smooth and convex. Moreover, we know that
Asier consumes both goods and that at the optimal consumption bundle, Asier's
marginal utility for ﬁlm packs is 6 “utils” and his marginal utility for DVD rentals
is 3 “utils”. For some set of indifference curves, show Asier's optimal
consumption bundle in the diagram above. Label Asier’s equilibrium as point
“A”. d) Page 12 0f23 (6) Quickly redraw the original equilibrium in the diagram below. Suppose now
that the camera store replaces the ﬁrst promotion with a different one: a 20%
discount on the price of all ﬁlm packs purchased (i.e., a price of $8 per ﬁlm pack _ irrespective of how many are purchased). In the diagram below, draw Asier’s new budget line (show the values of the intercepts). Show the substitution effect (SE)
and the Income Effect (IE) for the case in which both DVD rentals and camera ﬁlm packs are normal goods. You can use either the Hicks Method or the Slutsky
Method. (1) My diagram utilizes the (Hicks Method / Slutsky Method) of demonstrating
the SE and IE. (2) Using the infomiation above, I conclude that Asier is (better off / worse off /
equally well off/ cannot determine) under the second promotion when
compared to the ﬁrst promotion. Explain brieﬂy. Page 13 0f 23 5.2 (6) Joining a Club Consider now a different consumer, Tony the tennis player, who has a budget of $1,000
per period to spend on playing tennis games at the Tennis Emporium and on all other
things (the composite). The price of a game of tennis is $20. (The price of the composite
good is $1.) Tony has smooth, convex indifference curves. Tony is currently playing 15
games per period. The Emporium now offers Tony the opportunity to join as a member
for $400 per period. Members can play as many games as they wish at zero cost per
game (i.e., “for free” is the way the Emporium’s marketing materials state the
opportunity!). 0 Show the initial equilibrium for Tony, labelled as Point A, in both diagrams
below. 0 If it is possible that Tony will join as a member, show his equilibrium in the
diagram on the left below and label it as Point B. If such a result is not a
possibility, circle this statement: (There is no possible Point B). o If it is possible that Tony will NOT join as a member, show his equilibrium in the
diagram on the right below and label it as Point C. If such a result is not a possibility, circle this statement: (There is no possible Point C). Use the diagrams below as needed. For Points A and B For Points A and C ...
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This note was uploaded on 04/08/2010 for the course ECONOMICS ECO200 taught by Professor Leebailey during the Fall '10 term at University of Toronto Toronto.
 Fall '10
 LeeBailey
 Microeconomics

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