Fall 2008 (Session I)
November 28, 2008
Microeconomics I: Final Exam
1. True, False, and Uncertain: State whether the following statement is true, false, or
uncertain and explain why you think so. [7pts each]
1) Consumers with more elastic demand suffer a greater loss of consumer surplus
from any given price increase than those with less elastic demand.
2) Suppose the U.S. can produce a combination of 10 units of food (F) and 0 units of
clothing (C) or 0 units of F and 5 units of C (or any linear combination) and Canada
can produce 6 units of F and 0 units of C or 0 units of F and 3 units of C (or any
linear combination). Then, it would be mutually beneficial if the U.S. specialized
in food production and exported to Canada.
3) Policies that restrict supply could generate an increase in social welfare because the
increase in producer surplus could exceed the decrease in consumer surplus.
2. Welfare Effects of Policy Intervention:
Vespuccia is a small country that trades with the world. It can buy or sell as much as it
wants at the world price. Suppose the supply and demand functions are given as:
QDworld = 1,000,000 – 50,000P
QSworld = 100,000 + 40,000P
QDdomestic = 2,000 – 100P
QSdomestic = – 100 + 320P,
where Q is in pounds and P is in dollars per pound.
1) Based on the world demand and supply and the domestic demand and supply of this
good, draw the supply and demand curves that the domestic producers face and
determine whether this country imports or exports this good. Also compute the
volume of imports or exports. [8pts]
2) Compute the change in consumer surplus, producer surplus, and deadweight loss if
the government of this country banned any trading with the rest of the world.[10pts]
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3. General Equilibrium Analysis:
Consider a society consisting of just a farmer and a tailor. The farmer has 10 units of
food (F) but no clothing (C). The tailor has 20 units of C but no F. They only
exchange and do not produce more than what are already available in the society.
Suppose that each has the utility function of the form: U = F0.5C0.5. The price of F is
always $1. Suppose the price of C is $3 for now and answer the following questions.
1) Given the prices and their utility functions, what condition must hold at the
competitive equilibrium? [8pts]
2) What are the equations of their budget lines? [6pts]
3) With the given price of C, does a competitive equilibrium exist (i.e., is this price
feasible as a competitive equilibrium)? If so, how much F and C does each
consume? If not, what will happen to the price of C? [10pts]
4. Applying Competitive and Monopoly Equilibria:
Suppose that the production function of electricity is given as q=L0.5K0.5, where q is the
production volume, L is labor and K is capital. The wage (w) is $1 and the rental rate
of capital (r) is $9. Market demand for the electricity is given by Qd = 500 - 10P.
1) Derive the long-run expansion path that shows the cost-minimized combination of
input factors and draw it on a diagram. [6pts]
2) Derive the cost curve equation as a function of quantity, i.e., C(q). [8pts]
3) If this market is perfectly competitive and there are 100 firms with identical cost
function as you derived in 2), what will be the market equilibrium price and
quantity and the quantity that each firm supplies? [8pts]
4) If instead this market is dominated by a monopoly that has the same cost function
as you derived in 2), what will be the profit-maximizing monopoly equilibrium
price and quantity? [8pts]
5) Suppose that the monopoly instead has a cost function of C(Q) = 500 + Q and faces
the same market demand as above. If the government has enough power to
control the price offered by the monopoly, what is the lowest price that the
government can impose on this monopoly while keeping the monopoly operating?
Indicate it on a diagram or explain where you can find it in words (no need to
compute the actual price). [7pts]
[End]
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