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UNIVERSITYOFTORONTOMISSISSAUGA
APRIL2012FINALEXAMINATION
EC0204Y5Y
MicroeconomicTheoryandApplications(forCommerce)
KathleenYu
Duration- 3hours
Aids: Non-ProgrammableCalculators
The University of Toronto Mississauga and you, as a student, share a commitment to
academic integrity. You are reminded that you may be charged with an academic
offence for possessing any unauthorized aids during the writing of an exam, including
but not limited to any electronic devices'with storage, such as cell phones, pagers,
personal digital assistants (PDAs), iPods, and MP3 players. Unauthorized
calculators and notes are also not permitted. Do not have any of these items in your
possession in the area of your desk. Please turn the electronics off and put all
unauthorized aids with your belongings at the front of the room before the
examination begins. If any of these items are kept with you during the writing of your
exam, you may be charged with an academic offence. A typical penalty may cause
you to fail the course.
Please note, you CANNOT petition to re-write an examination once the exam has
I begun.
PLEASE READ: You must show ALL your work to receive full credit. If mention of characters in the
problems reminds you of books you've read or movies you've seen, you should use ONLY THE
INFORMATION PROVIDED to s o ve 1 the pro biems.
I
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Question Points
(points Possible) Earned
1 (20)
2 (20)
3 (20)
i
4 (20)
I
5 (20)
6 (20)
7 (30)
Total (150)
1. (20points) Supposeanewtypeoftealeafis discoveredgrowinginaspecificmountainousregion.Tazo,
acompetitivecompanyknownfortheir"teaproducts,hasdecidedto incorporatethenewtealeafintheir
lineofexistingproducts,whoseproductionfunctioncanbedescribedasQ(L)= 80L- 4L2. Supposethat
initially,withveryfewemploymentopportunitiesinthemountainousregionwherethetealeafgrows,
Tazoessentiallyactsastheonlyemployerinthearea.Theworkers' laborsupplycurvecanbedescribed
asw(L)= 2L+ 20.SupposeeachboxofTazoteabagssellfor $2aboxandthattheindustrydemands
teaaccordingtoP(Q)= 160- Q.Aftersometime,theworkersbecomefed upwiththeirpoortreatment
anddecidetoformtheMountainousTeaLeafGrowerslaborunion.Determinethechangeinworkers'
economicrentsaftertheunionis formed, relativetotherentstheyenjoyedbeforethelaborunion. Note:
roundyouranswersfor Ltothenearestwholenumberandroundyouranswersforwtotwodecimal
places(example: 0.01). .
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2. (20points)Francescajustgotherdriver'slicenseandisreadytopurchaseacar.Asanewdriver, she's
-not interestedinpurchasingabrane-newcarsoshe'slimitingherpurchasetopreviouslyowned(used)
cars.Francescaunderstandsthatit'sprobablybettertobuyausedcarfromacardealershipbecausethey
aremorelikelytoofferwarranties,comparedtoprivatesellers.Butcardealershipssellbothhighand
lowqualitycars,soeven"lemons"cancomewithawarranty.Supposethefollowing: Francescais
willingtopay$18,000forahigh-qualityusedcar,and$3,000foralow-qualityusedcar. Sheknowsit
costsadealer$2,000eachyeartoofferawarrantyforahighqualitycar,but$5,000eachyeartooffera
warrantyforalow-qualitycar.Inorderforthewarrantytoserveasaneffectivesignal, firstdetermine
theoptimalnumberof yearsFrancescashouldrequirethewarrantytolastforhertobesurethatthecar
ishighqualityandthereforeworth$18,000. Second,fromtheperspectiveof thecardealership(the
seller),illustratetheseparatingequilibriuminone graphandexplainwhythisrepresentsaseparating
equilibriumandnotapoolingequilibrium.Finally,howmanyyearsof warrantyshouldyouexpect
sellersofhighqualitycarstoofferfortheircar?
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3. (20points)SupposeGraysonhasjustmovedtoCalifornia,whereheboughtacondominiumworth
$490,000.Hisutilitycurve-canberlescribedas!U(HV)= (HV)O.5, whereHVrepresentsthehousing -
valueof his condominium,measuredintenthousandsofdollars.GiventhatGraysonthinksan
earthquakewilloccurwith10%probability,heistryingtodecidewhetherornotheshouldbuy
earthquakeinsurance.If anearthquakedoesn'toccur,hiscondomaintainsitsvalueof$490,000.Butif
anearthquakeoccurs,theresultingdamagewillmakethecondoworthonly$250,000.Ifhisinsurance
agentoffershimaquoteof$3000,whichsaysthatthecompanywillcoveranydamagestothecondoin
thecaseofanearthquake,willGraysonbewillingtopurchasetheearthquakeinsuranceprotection?
Explain.
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4. (20points)Inapureexchangeeconomywithtwogoods,bread(B)andfish (F),KatnissandPeetahave
-Cobb-Douglasutility-funetions.-Asswnewearegraphingbread'onthehorizontalaxisandfishon"the "-
verticalaxis.Betweenthem,KatnissandPeetaown 100loavesofbreadchickenand 50fish. Thus,if
KatnissownBK andF
K
,PeetahasBp=100- BK andFp=50- F
K
.Derivetheequationfortheircontract
curve.Youshouldsimplifytheequationsothatintheend, itwillbeafunctionof thevariablesa, j1, FK
andB
K
.Note:Althoughthenamesmightremindyouofapopularbookormovie,youshoulduseonly
theinformationprovidedhereintheproblemtoderivethecontractcurveequation.
Katniss' utilityisUK (CKt(BK)I.a
Peeta'sutilityis Up=(Cp)I1(Bp)l-11
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5. (20 points) The uncertainty of your future career after graduating from UTM has not only kept you up at
-night;,but has also-caused you-{oexperience a high level of disutHity (like aHs-ituations'whereyCtu-face
uncertainty). One ofthe steps you've taken to insure against the possibility that you graduate without
any job offer has been to sign up for a summer internship with Ben and Jerry's to sell ice cream at
Toronto's most popular tourist locations. Ben and Jerry's has agreed to pay you a share of each day's
revenues you bring in, w i ~ hopes that this payment scheme will encourage you to work hard. You and
the firm have both agreed to split the revenues so that you keep 35%, Ben & Jerry's keeps the remaining
65%. On a cool day, your ice cream revenues are $300. Ifthe weather is hot, you earn $500. Suppose the
weather forecast has predicted that it will be a very mild summer, with 60% hot days, and 40% cool
days. Calculate the level ofrisk each party (you and Ben & Jerry's) must bear. Be sure to indicate who
bears more risk and decide whether this wage contract is efficient in risk bearing.
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6. (20points)BiancaandCatelynareplanningtheirbigtripaftergraduatingfromuniversity.They've
.-- .- - todivideupthe-responsibilities- ofmakingtravel wi-ll be-responsiblefol' '..
choosingadestinationandCatelynwillplantheactivitiesontheiritinerary.Theircombineddecisions
willyieldthefollowingpayoffslistedinthepayoffmatrix. Usingagraph, illustrateBianca'sand
Catelyn'sbestresponsefunctionsandindicatealltheNashequilibriumforthisscenario.AssignBianca
thehorizontalaxisandCatelyntheverticalaxis.
Catelyn
Snorkeling Zip-Lining
Bianca Brazil
I 5,8
Australia
9,2
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7. (5 pointseach/30 pointstotal)True,FalseorUncertain.Foreachofthesectionsbelow,carefullyread
thestatementaaddetermiae-whether-theent,ire(underlined)statementistrue; false-oruncertain."Inorder
to receivefull creditfortheproblem,youmustexplainthereasonforyouranswer.Answersthatare
givenwithoutan explanationwillnotreceiveanycredit.If theansweryougiveis basedonany
assumptions,besuretostatethemclearly.
a. Thepricepoint-elasticityof demandisconstantalongtheentirelengthofalineardemandcurve.
b. Theaveragecostcurveandthemarginal costcurvereachtheirminimaatthesamelevel of output.
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c. The finn's demand curve is downward sloping.
d. When a competitive industry's supply curve is perfectly elastic, then the sole beneficiaries of a reduction
in input prices are consumers.
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e. If neither player in a two-person game has a dominant strategy, then there is no Nash equilibrium for
that game. . '-", ...
f. According to the examples provided by Akerlof, adverse selection wiII cause the equilibrium market
price to decrease relative to the perfect information scenario.
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