Exercises in Advanced Micro Economics
Milgram & Roberts, chapter 2
Question 1
Why do firms exist in markets? Try to answer this question using the syllabus for this examination.
Question 2
Transaction Costs are crucial for propositions based on The Coase Theorem. Explain the main proposition of
this theorem using the notion of Transaction Costs.
Question 3
Apply the Transaction Cost Approach and discuss if it is reason to expect that agriculture in developing
countries is organized in a way that maximizes the wealth of farmers and workers employed by farmers.
Question 4
According to one of the major approaches to analyzing organizations , a firm is considered as a nexus of
contracts. Explain this notion of firms.
Frank, chapter 17
Question 1
A village have five fishermen, each of whom has a wealth of 100. They can save this wealth on a bank
account and after one year they have 115 on their accounts. Alternatively, they can use their wealth to rent
a boat with all the tools needed for one year’s fishing. All of them go to the same fishery implying that they
utilize the same commonly owned resource. The yearly average revenue of fishing depends on the number
of fishermen using the fishery:
Number of fishermen
Average revenue
1
2
3
4
5
125
122
120
116
113
What is the social optimal number of fishermen that should go to the fishery? Does this number differ from
a situation where the fishermen ignore the externalities involved? Give reasons for your answer.
Question 2
A and B are neighbors. In A’s compound there is a house for rent. The rent is 20. B earns 40 from poultry
but need a dog to protect the hens. The barking of the dog harms A who, therefore, is unable to get any
tenants. It is in the interest of A to negotiate a private agreement with B, where A pays B for a safety guard,
who will completely eliminate the need of a dog. The cost of a guard is 10. In addition, there are
negotiation costs of the private agreement, which are paid by A. What are the highest negotiation costs
that will give A incentives to pay B for a safety guard? Would the outcome be more efficient if B is made
liable for the barking damage, i.e. if B is required to compensate A for any damage caused by the dog?
Varian, chapters 27.2, 28
Question 1
Define the Nash Equilibrium. Also determine the number of Nash Equilibriums in a game between players A
and B choosing between strategies 𝑆1 and 𝑆2 with payoffs depicted in the table below. Give reasons for
your answer.
Player B
Player A
S1
S2
Player B
S1
4,2
1,1
S2
1,1
2,4
Question 2
Define “Dominant Strategy”. Also examine if there is an equilibrium in dominant strategies in a game
between players A and B choosing between strategies 𝑆1 and 𝑆2 with payoffs depicted in the table below.
Give reasons for your answer.
Player B
Player B
Player A
S1
S2
S1
8,4
2,2
S2
2,2
4,8
Milgram & Roberts, chapters 5-6
Question 1
Since contracts are incomplete, various kinds of opportunism arise. Describe principal types of opportunism
and the incentive problems they create.
Question 2
Employers are unable to discipline employees against bad behavior only by using cash penalties (conditions
of no wealth effects not satisfied). To terminate an employee´s employment is the only effective means
available. What determines whether the threat of termination of employment is an efficient hindrance
against cheating?
Varian, chapters 18 - 19
Question 1
A profit maximizing firm produces one output using one variable input 𝑥1 and one fixed input 𝑥2 with given
factor prices 𝑤1 and 𝑤2 . Show in a graph the short run profit-maximizing point by using isoprofit lines and a
production function characterized by decreasing returns to scale. Also show how output changes when
𝑤1 increases.
Frank, chapter 18
Question 1
Two compounds use the same road. One of the compounds is prepared to pay 80 to improve the cleaning
of the road, and the other compound is prepared to pay 50 for the same improvement. Two possibilities
are considered: 1) the level of cleaning is unchanged, 2) a local farmer carries out the improved cleaning at
a cost of 90. Which alternative would be social optimal and how should the costs be shared between the
compounds? Give reasons for your answer.