THE UNIVERSITY OF NEW SOUTH WALES SCHOOL OF ECONOMICS SESSION 1, 2010 ECON1101 MICROECONOMICS I Sample FINAL EXAMINATION

1. Time Allowed - 2 Hours 2. This Paper is Worth 50% of The Total Subject Mark

3. This examination paper consists of three parts Part A, Part B and Part C 4. Part A consists of 20 multiple choice questions each worth one (1) mark. 5. Answer all the questions in Part A on the answer sheet provided, using pencil only: Print your student number, name and initials in the space provided and mark the appropriate boxes below your student number, name and initials. For each question, mark the appropriate response (a), (b), (c), or (d). Choose the most correct response to each question in Part A. There is no negative marking. 6. 7. Part B consists of one written answer question, worth FIFTEEN (15) marks. You must answer this question. Part C consists of 5 questions each worth FIFTEEN (15) marks. You must answer one (1) only of these questions.

8. Answers to questions in Part B and C must be written in ink. Pencil may be used in answers to Part B and C for drawing, sketching or graphical work only. 9. This question paper may be retained by the candidate. 10. Students may bring non-programmable hand held calculators. 11. There are twelve (12) pages in this paper

Part A - Multiple Choice Answer all 20 questions in Part A on the answer sheet provided as per instructions on front cover.
Question 1 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. 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 2 Assume two rival car rental companies (Ace Rentals and Bobs 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, Bobs) under alternate strategies: BOBS Discount Discount ACE Do Not Discount (8, 20) (16, 14) (12, 10) Do Not Discount (24, 6) X (b) A profit maximising monopolist always produces where Average Revenue equals

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

Question 3 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) School education Question 4 A monopolist estimates that at the current price being charged for the product, marginal revenue is less than marginal cost, and price elasticity of demand is 1.4. To increase profit the monopolist should: (a) Increase price and sell less (b) Increase price and sell more (c) Decrease price and sell less (d) Decrease price and sell more X Question 5 Use the following figure to answer the question.
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A m a n d a s c a k e p r o d u c t io n p e r d a y

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r 1 2 1 4 d u c t i o n

6 n d

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Amandas maximum production of pies per day is represented by point: (a) J. (b) l. (c) n. (d) r X

Question 6 The major implication of__________________ is that individuals can solve many externalities if they can buy and sell the right to commit the externality. The Coase Theorem X (b) Market based instruments (c) The prisoners dilemma (d) The tragedy of the commons
(a)

Part B
Answer the following Question. This question is worth 15 % of the total marks for this course. This Question is Compulsory. This means that you must answer it. Question 1 B
(a) Explain what is meant by the term natural monopoly. (3 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 societys point of view. (6 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. (6marks)

Part C
Answer any one (1) of the Questions below. Each of these questions is worth 15 % of the total marks for this course. Answer only one of these questions. Where you mistakenly answer more than one of the questions below the first one you answer will be marked.
Question 1C Clearly state the nature of economic costs: that is what do economic costs represent? Distinguish between explicit and implicit costs, giving examples of each. What is the importance of the distinction between implicit and explicit costs to the calculation of economic and accounting profit? Explain this clearly. (7 marks) Koby operates his own business (a surfing school) at a local beach where he teaches tourists how to ride surfboards. If he were not running this business he would be employed by the local council as a beach inspector and paid $45,000 per year. His annual revenue from the school is $75,000 per annum. His costs are advertising $3,000 per year and an annual license fee which he pays to the Council for the use of the beach of $5,000. In addition he pays insurance of $7,000 per annum against injuries to his clients. He provides surfboards which cost him $30,000; he paid for these by using his savings of $15, 000 which he had in the bank where it received interest of 3%p.a the remaining $15, 00 he borrowed form a credit union at an interest rate of 10% per annum. Calculate his: Accounting profit, his economic profit and his normal profit, Will he stay in business? (8 marks) Question 2C Use a normal downward sloping demand curve and an upward sloping supply curve to illustrate and explain the deadweight loss from the imposition of a tariff on the imported substitute for a domestically produced product. (10 marks) Use your diagram to compare the effect of the tariff with a policy of providing the same benefits to domestic producers by means of a taxpayer funded per unit subsidy. (5 marks) Question 3C The Urban Transit Authority receives the following two pieces of expert advice: You should cut rail fares in order to encourage greater use. Raising fares will mean fewer customers and lower revenue. You cannot afford to cut fares as this will reduce your revenues

(a) What does each of these pieces of advice assume about the elasticity of demand for rail use? (6 marks) (b) How might an economist seek to resolve the conflict of opinion? (5marks) (c) What factors determine the elasticity of demand for rail use? (4 marks) Question 4 C Suppose Netscape and Microsoft each develop their own versions of an internet browser that is not only much more efficient and powerful for the user, but also allows advertisers to better target potential customers. Each firm must decide whether to sell the browser (for say $30) or give it away free. Giving the browser away free means more people will use it and will bring in increased advertising revenue. However, selling the browser will generate substantial sales revenue. Since the browsers are almost perfect substitutes, if one firm gives theirs away free, the other firm will sell none if they charge a price, thus making a loss equal to their development costs. Assume the development costs are $2b for each firm The estimated outcomes for each firm are as follows: If Microsoft and Netscape both charges $30, they share the market and each makes $3b in sales revenue and $4b in advertising revenue. If Microsoft and Netscape both gives the browser away free they share the larger market and each makes $5b in advertising revenue If one firm gives the browser away free, while the other tries to charge a price, the former makes $10b in advertising revenue and the latter makes zero revenue. (a) Construct the pay-off matrix showing each firms profit under different strategies. (6 marks) (b) Assuming the situation can be modeled as a single competitive game, is there Nash equilibrium? What is it? (2 marks) (c) Does this situation provide any incentive for collusion by the two firms? Explain your answer. (3 marks) (d) How does your analysis change if development costs are assumed to be $6b? (4 marks)