a06-part1 - UNIVERSITY OF TORONTO Faculty of Arts and...

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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): Martinez-Gerricho 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 Martinez-Gorricho 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 MARTTNEZ-GORRICHO 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 (free-hand, 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. MULTIPLE-CHOICE ******(All students must do this question) ****** .i Provide the best answer to the following multiple-choice 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 per-unit 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.

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a06-part1 - UNIVERSITY OF TORONTO Faculty of Arts and...

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