Tuesday 16 August 2011

Exam paper June 2011 Hand written solutions

The first page :

http://www.scribd.com/doc/62387625/June-2011-page-1 - this has the solutions 2a - 2bi)
http://www.scribd.com/doc/62389656/June-2011-page  This has the solutions for 2bii) - 5

Apologies that its not all nicely written out .... and in 2 attachments, but I hope that it helps you somewhat.

Saturday 13 August 2011

Externalties - try out these websites and trial questions


Possible questions:
Explain why negative externalities lead to inefficient overproduction and how property rights, emission charges, marketable permits, and taxes can be used to achieve a more efficient outcome.
Explain why positive externalities lead to inefficient underproduction and how public provision, subsidies, vouchers, and patents can increase economic efficiency.

CA2: Solution

Generally you all did a huge effort here and it paid off well.  If you were a little unsure of some of the answers, check them against this "model" that I have built from your submissions!

For those of you who might have received a little "help" from others. Make sure you've got it in YOUR head!

Thursday 11 August 2011

Solutions to Topic 12: Externalities

Exercise 12.1
If the equilibrium quantity is less than the socially optimal quantity, one can infer that
        A)           the supply curve for the activity is below the socially optimal supply curve.
        B)            the demand curve for the activity is above the socially optimal demand.
        C)            the production of this good has a positive externality.
        D)           the production of this good has a negative externality.
        E)            firm are not maximizing profits.
The correct answer is (C). When there is positive externality, the external benefits enjoy by outsides make the society prefer to have a larger quantity of output. But the market equilibrium quantity will not consider this external benefit and will produce a smaller quantity.
Exercise 12.2
Assume that reading economics produces a positive externality.  It will be the case that the __________ than the socially optimal amount.
        A)           supply curve for reading will be greater
        B)            price of reading will be greater
        C)            supply curve for reading will be less
        D)           demand curve for reading will be greater
        E)            demand curve for reading will be less
The correct answer is (E). With positive externality, there is external benefit and the marginal social benefit exceeds marginal private benefit. The demand curve for reading is marginal private benefit will be less than the social optimal amount.

Exercise 12.3
Suppose coal mining produces a negative externality in the form of polluted streams.  One can deduce that the unregulated
        A)           price of coal is too high.
        B)            quantity is too small.
        C)            quantity is too large.
        D)           supply curve is lower than the regulated supply curve.
        E)            demand curve is higher than the regulated demand curve.
The correct answer is (C). Producers will ignore the external cost and produces where MPC = MPB.
The society as a whole incur a higher cost and prefer a smaller quantity of output. Thus the market quantity is too large

Exercise 12.4
After correcting an externality, the equilibrium price and quantity both rose. What type of externality is this and what are the likely actions that are implemented to correct this externality?
Solution
This is a positive externality. When there is external benefit, the marginal social benefit exceeds marginal private benefit. The marginal social cost intersects the marginal social benefit at a larger quantity and a higher price compared to the market outcome. When the positive externality is corrected, both price and quantity rise.
The action needed is a government subsidy to increase the marginal private benefit to be the same as marginal social benefit.

Exercise 12.5
Consider the benefit and cost of industrial production, is the ideal amount of pollution equals zero?  Explain.
Solution
The ideal amount of pollution is not zero but the amount where marginal social benefit equals marginal social cost.  Production of goods and services are beneficial to society but bound to create some pollution.  So long as the benefits of having output exceeds the cost of pollution it is efficient to have a small amount of pollution

Excercise - Practice your Micro's skills with this, solutions are included

Monday 8 August 2011

Topic 4 Elasticity Solutions from Class Notes

Tuesday, 12 July 2011

Solutions for Elasticity Questions from Handouts

Question 4.1   When the price of cars is $15,000 each, 10,000 cars are sold every month. After increasing the price to $16,500 each, 9,380 cars are sold every month.  At the original price, what is the price elasticity of demand for cars?

Solution 4.1
The correct answer is (D)
Change in quantity of car demanded = 620
Average quantity of car demanded is (10000 + 9380)/2 = 9690
Change in price of car = $1500
Average price of car is ($15000 + $16500)/2 = 15750
The price elasticity of demand is (620/9690)/(1500/15750)= 0.67

Question 4.2  To increase total revenues, firms with ______ demand should lower price and firms with ______ demand should increase price.
A)   elastic; elastic
B)   inelastic; inelastic
C)   elastic; inelastic
D)   elastic; unit elastic
E)   inelastic; elastic
Solution 4.2 The correct answer is (C)
       If demand is elastic, consumers are sensitive to price change.  So firms should reduce price to sell a lot more and hence earns higher revenue.
       If demand is inelastic, consumers are not sensitive to price.  A higher price will only reduce quantity demanded by a small amount and hence total revenue increases.

 Question 4.3 The price elasticity of demand for apartments is 2.8 while the price elasticity of demand for soft drinks is 0.3.  The likely reason for the difference is because
A)      There are few substitutes for soft drinks
B)      It is easy to produce soft drinks but difficult to build apartments
C)      The fraction of income spent on soft drinks is very small
D)      Soft drinks are a necessity
E)      Apartments are a luxury
Solution 4.3 The correct answer is (C).
•          The price of apartment is very high compared to that of soft drinks, relative to consumers’ income.
•          If price of both products increase by 10%, it is a small amount of money for soft drinks but a large amount of money for apartment.
•          Hence consumers are more sensitive to the changes in the price of apartment and less sensitive on soft drinks.

4.4 Question
 (a)       An instant noodle manufacturer observes that when the mean income of his consumers is $2000 per month, he can sell 5000 packets of instant noodle per day.  But with economic growth and average income of his consumers increase to $2500, he can sell 4500 packets of instant noodle.  Calculate the income elasticity of demand of the instant noodle.  What will happen to his revenue when the economy enters a recession?
 (b)       A seller of a product Z discovered that when the price of another product W is $5 per unit, he can sell 750 units of Z.  When the price of W increases to $6.50, he can sell 580 units of Z.  Calculate the cross elasticity of demand between Z and W.  What will happen to his revenue when price of W decreases?
4.4 Solution
a) The income elasticity of demand is (-500/4750) /(500/2250) = -0.474.  Since the income elasticity of demand is negative, instant noodle is an inferior good and the seller will be able to earn higher revenue when the economy enters a recession.
(b) The cross elasticity of demand between Z and W is (-170/665)/(1.5/5.75) = -0.98.
Since the cross elasticity of demand between Z and W is negative, Z and W are complements.  When the price of W decreases, the revenue from selling Z will increase.
4.5 Question: Given that a product X has income elasticity of demand equals -2.5, its cross elasticity with another product W is -1.8, and its price elasticity of supply is 2.6, what can you comment about the nature of this product?
       Solution to 4.5 The product X is an inferior good since the income elasticity of demand is negative
       The product X is a complement to the product W since the cross elasticity of demand is negative
       The product X is price elastic in supply since the price elasticity of supply is greater than 1

Sunday 7 August 2011

Solutions to Class questions Topic 11 - Oligopolies

Questions and Solutions for Topic 11: Oligopolies
1.       What does the Kinked demand curve model tell us about prices in an Oligarchic market?
Prices are rigid, tend not to change frequently
2.       Do Ologopolies optimize output where MC=MR? Draw a diagram to support your answer.
Yes, draw diagram from slide 9 in your notes
3.       How might an Oligopoly increase its market share?
By using non-price competitive strategies .e.g product innovation, marketing, quality enhancements

Game theory – steps
1.       Understand the rules
2.       Identify the choices/strategies
3.       Tabulate the pay-off matrix
4.       First: column outcomes, then row outcomes
5.       Look for a common choice / strategy

4         Prisoner’s Dilemma Question
Soapy Inc. and Suddies Inc. are the only producers of soap powder. They collude and agree to share the market equally. If neither firm cheats on the agreement, each makes $1 million profit. If either firm cheats, the cheat makes a profit of $1.5 million, while the complier incurs a loss of $0.5 million. If both cheat, they break even. Neither firm can monitor the other’s actions.
a)      What are the strategies in this game?
Both agree: Soapy = $1 m and Suddies = $1 m
Both cheat: Soapy = $0 profit and Suddies = $0
Soapy cheats and Suddies agree :  Soapy = $1.5 million profit, and Suddies = $0.5 million loss;
Suddies cheats and Soapy agree :  Suddies = $1.5 million profit, and Soapy = $0.5 million loss.
Construct a payoff matrix


Soapy Inc


Agree
Cheat
Suddies Inc
Agree
$1 m      S1m
-$5m           $1.5m
Cheat
$1.5m     -$5m
$0                $0

b)      Is the equilibrium a dominant strategy/ Nash equilibrium? Explain.
Yes, The equilibrium is a dominant strategy equilibrium because for each firm, regardless of the opponent’s choice, the best strategy is to cheat.
If Suddies agrees, the best strategy for Soapy is to cheat = $1.5 million rather than $1 million.
If Suddies cheats, the best strategy for Soapy is to cheat = $0 rather than incur a loss of $0.5 million.
5         How does Prisoner’s dilemma substantiate the kinked demand curve model?
Prisoner’s dilemma shows the difficulty of cooperating. Firms need trust eachother if they are to get the best outcome.  The dilemma or nash equilbiruim is not the best solution for each of the firms, if they cooperated with and trusted each other they could select an outcome which was better for both of them.
The kinked demand curve also shows how, in an interdependent oligarchic market, the firm selects a strategy erroneously, believing that they know what the other firms’ response will be.  E.g. Firm does not raise prices, because no-one will follow.

Wednesday 3 August 2011

Solutions to Topic 11: Oligopoly

Question 11.1              
The common feature in monopoly, oligopoly, and monopolistic competition is
        A)           the absence of close substitutes.
        B)            blocked entry.
        C)            interdependent decision making by firms.
        D)           price discrimination.
        E)            downward sloping demand.
          The correct answer is (e).
          In monopoly, monopolistic competition and oligopoly, firms have at least some market power and can set price over a range of output.
          Thus the demand curve is downward sloping.
Question 11.2
Refer to the table (in your notes) which shows the payoff matrix of two firms, Firm A and Firm B, each has two strategies, to set high price or low price. The figures in the matrix show the profits earned by each firm.
(a)  Solve for the Nash equilibrium in this game.
(b)  Is this game a prisoner’s dilemma game?  Justify your answers.
(a)  The Nash equilibrium is both firm set high price and that the payoff to Firm A is $100 and pay off to Firm B is $75.
(b)  This is a prisoner’s dilemma game. The reason is that the Nash equilibrium is not the best outcome.  The best outcome is in fact both firms set low price so that Firm A gets $150 and Firm B gets $300
Question 11.3
The table (in your notes) shows the payoff matrix for players A and B to strategies X and Z.
Player A finds that
        A)           strategy Z is a dominated strategy.
        B)            strategy X is a dominant strategy.
        C)            strategy Z is a dominant strategy.
        D)           he has no dominant strategy.
        E)            his best strategy depends on what player B chooses.
The correct answer is (c)
If Player B chooses X, Player A will choose Z since $500 is better than $300.
If Player B chooses Z, Player A will choose Z since $1000 is better than $200.
Thus strategy Z is a dominant strategy for Player A.
Question 11.4
(1) Why is there no incentive for a firm in the kinked demand curve model to change its price?
(2) Is the price always remain rigid in the kinked demand curve model

(1) In the kinked demand curve model, the price is stabilized at the kink level.  If the firm charges a higher price, its demand becomes elastic and its revenue drops.  If it charges a lower price, its demand becomes inelastic and its revenue drops.  Thus it has no incentive to change the price.
(2) If there is a large change in the marginal cost such that the MC shifts by a larger amount than can be accommodated by the gap of MR, then the equilibrium price will change.