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UNIVERSITY OFTORONTOMISSISSAUGA
APRIL 2012 FINAL EXAl\lINATION
EC0206Y5Y
CarolynPitchik
Duration3 hours
No Aids Allowed
The University of Toronto Mississauga and you, as a student, share a commitment to aca-
demic 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 begun.
Instructions: Youhave 3hourstocompletethistest. Pleasewriteyouranswers inthespace
provided below each question. Make sure you justifyyour answers. A simple yes or no is
not sufficient. The number in parentheses beside each question is the worth of its correct
answer including explanation. Pleasefill intheinformation requested above. Thistest has
38 pages.
This examination consists of six questions which are equally weighted.
all questions.
For instructor'suseonly
#
1 2 3 4 5
You must answer
6
Grade
Outof 17 17 17 17 17 17
EC0206Y5Ypage2of38
Answer each of the following SIX equally-weighted questions below. You
must show your work.
1. (17 points) Answer each ofthefollowing questionsshov.ring all yourreasoning.
(a) Supposethat Gabriella's preferences over x and y are represented by the utility
function
U(x, y) =(x +15)2(y +10)3
which is defined over the positiveorthant and thata typical indifferencecurve
{x +15)2(y +10)3 =C
defines y =h(x) as a differentiable function ofx inthepositive orthant.
i. Use the Implicit Function Theorem to find out how a typical indifference
curve of this function looks like and describe the "better than" set in the
positive orthant. You do not have to graph the function y = h(x). You
just need to use the Implicit Function Theorem to infer whether the curve
y = h(x) implicitly defined above increases or decreases as x increases and
whether itis concaveor convex. Show your reasoning.
ii. Is Gabriella's utility function quasi-concave on the positive orthant? Show
your reasoning.
(b) IfXin's valuefunction satisfies
v(P 1) = 201
(OPy,Pz, 4 +20 +
Px 1Jy pz
then what is Xin's Marshallian demand x(Px,Py,Pz'!) for good x when Px =
py =pz =1and1 25?
(c) IfDeepa'svaluefunction satisfies
{
if 1 S 10(Px - Py)
PII
(I+lOp",+lOp 11)2
V (PX,PYl 1) if 1;:::: lOmax{px- Py,Py - Px}
4p",Pll
lO(I+10p",)
p",
if 1 S 10(py
Px)
andherexpenditurefunction satisfies
Pv(u-lOO)
10
if
U <.!.QQzk
- Pll
(p.,P., u) ; {
(4Pxp
y
U)1/2 - lOpx
lOpy if U 2:: max{l ~ l p r ,
} p",
p,,(u-100)
if U<
10 -
P:r:
thenwhatistheminimumthatDeeparequiresincompensationforapriceincrease
fromPx = 1toPx 4whenI =20, Py =I?
Examination continued on page3
EC0206Y5Ypage8of38
2. (17points) Demandfor hockeyticketsathockeymatchesinthePrairietownofSaska-
toon fluctuate withthe weather. Theeffect of the weather on a hockey rink's wealth
depends on theskill level ofthehockey rink's set ofteams. With probability 1/2the
wealth level ofa hockey rinkwith High level AAA players is 8100 dollars while with
probability1/2itis4900dollars. \Vithprobability1/3thewealthlevelofahockeyrink
with Funlevel B players is 8100 dollars while with probability 2/3 it is 4900 dollars.
1 2
The Bernouilli utility of any hockey rink owner is u(w) =w / . Half of the hockey
rink owners arethose with High level AAA players and halfare those with Fun level
B players.
(a) Wnatis theexpectedwealthofahockeyrinkov:.'1lerwithHighlevelAAAplayers?
(b) Rink-OpInsuranceofferscontractsthatpayoutY for a priceofb. If L represents
the value ofthe loss and 11" represents theprobabilityofa loss, then what is the
algrebraicrelationship betweengeneralY, b, Land11" ina fair contract? in afull
contract? For both types of hockey rink owners, using the actual probabilities
and losses given in thequestion, illustrateinone diagram, thefair contracts and
thefull contracts in statespacein which thehorizontalaxis representswealthin
good times and thevertical axis represents wealth in bad times. For each type,
illustratetheexpectedutilityindifferencecurvethroughtheno-insurancebundle.
(c) Illustrate the maximum Mh that a High-level AAA hockey rinkowner is willing
topayfor fullinsuranceinyourdiagramandstatewhetherandwhyA1h isgreater
orsmallerthanthefair priceoffull insurance? \\;nathappenstoMh iftheprob-
ability of good times decreases for H-Ievel AAA hockey rink owners? Illustrate
your answer andgive some intuition.
(d) Suppose that the contract A which pays out Y = 3200 and has price b = 1600
is currently on offer by every insurance firm. Show whether this contract A
wouldearnpositive, negative, orzeroprofits. Also, illustratewhetherthereexists
another contract B that would attract consumers away from A and would earn
thefirm offering B positiveprofits.
Examinationcontinuedon page9
EC0206Y5Ypage14 of38
3. (17 points) Tenyear old Krippahas a planninghorizon ofthreedays. Herpreferences
overdollarsspentonconsumptiontoday(denotedbyCo), dollarsspentonconsumption
tomorrow(denotedbyCd anddollarsspentonconsumptiononthedayaftertomorrow
(denotedbyC
2
) arerepresentedbytheutilityfunctionu(Co, C
1
, C
2
) = C
O
C
1
C
2
. Krippa
receives $A =$3
3
4
2
today, $0 tomorrow, and $A = $3
3
4
2
on theday after tomorrow.
There is no uncertainty in the model. Krippacan borrow and save from her brother
Marcin at aninterest rate fb = fs = 1/3. Inwhat follows, you may use thefact that
when preferences are representedbyu (XI, X2, X3) = XIX2X3 and pricesarerepresented
by the vector (PI, P2, P3) and income is I, Marshallian demand is xi (PI, P2, P3, 1)
I/3Pi.
(a) Write down Krippa's budget constraint over her consumption today, tomorrow
and thedayafter tomorrow.
(b) vvnat is her optimal consumption plan over today, tomorrow and the day after
tomorrow?
(c) Foreachday, statehow much sheborrows orsaves?
Examinationcontinuedonpage 15
EC0206Y5Ypage20 of38
4. (17 points) Steve's company Applenut is the only company that supplies gourmet
apples. SteveoV\.ns threeseparatetechnologiesthatcanbeusedtopreparehisgourmet
apples. Thecost ofpreparing ql kilos ofgourmet apples usingtechnology 1is
q2
C1(ql) = ~ + F
where F > 0is thefixed cost ofoperatingtechnology 1. Thecost ofpreparingq2 kilos
ofgourmet apples using technology 2is
q ~
20
Thecost ofpreparingq3 kilos ofgourmet apples usingtechnology 3is
Inverse demandfor gourmet apples is
78 - fa ifq ~ 780
P(q) = {
oifq ~ 780
where q is theaggregatequantityproduced.
(a) Explainyouranswerstothefollowingtwoquestions. (i) Vv'hat isSteve'saggregate
production ofgourmet apples ifhe produces qi 2: 0 units ofgourmet apples for
i 1,2,3? (li) \\,That is Steve'sprofit as a function ofqb q2 and q3?
(b) For each i = 1,2,3, suppose that Steve is producing qi ~ 0 units of gourmet
apples using technology i. Explainyour answers to the follo'\\ring two questions.
(i) What is Steve's marginal revenue ofselling another unit ofgourmet apples?
(ii) Foreachi = 1,2,3whatis Steve'smarginalcost ofproducinganotherunitof
gourmetapples using technology i?
(c) Suppose that F = O. Explain your answers to the following two questions. (i)
WhatareSteve'sshort-runprofit-maximizinglevels ofq!, q2 andq3? (li) Whatis
theshort-runprofit-maximizingpricethatStevecharges?
(d) Vvnat are Steve's short-run profit-maximizing levels qI, q2 and q3 if F = 3200?
Explainyouranswer.
Examination continued on page 21
EC0206Y5Ypage 26 of38
5. (17 points) Supposethat theaggregate inversedemandfor lentils is
220 - Q if0 $ Q $ 220
P(Q) {
oif220 $ Q
where Q is theaggregatequantityproducedbyall firms intheindustry. Supposethat
thereareexactlyn firms intheindustry. Firmi =1,...,n faces thecost function
The firms compete as in Cournot with each firm i = 1,...,n making its choice of qi
simultaneously. Explainyour answers tothefollowing questions.
(a) Assuming that all firms produce positive quantities, what is the Cournot-Nash
equilibrium as a function ofn?
(b) Given the firms produce positive quantities in the Cournot Nash equilibrium,
whatis theprice? \\That istheprofit ofeachfirm?
(c) As n increases to 00, what happens to the Cournot Nash equilibrium price and
profitsofeach firm?
Examination continued on page 27
EC0206Y5Ypage 32 of38
6. (17points) l\rpita,DominiqueandJinarebestfriends who areenrolled ina cornmon
programatUTM. UTM issues90 pointstoeachstudent tobe usedeithertopurchase
solution time (denoted by S) to search for on-line solutions to past tests or to pur-
chase personallesson time (denotedbyL) inswimming, basketball andchess at UTM
recreational clubs. AIpita, Dominique andJin sharetheirtest solutions but purchase
recreational lessons for personal use atUTM clubs. TheUTMper unitprice ofS is 3
pointsperunit. TheUTMpriceofL is 2pointsperunit. Eachstudenthaspreferences
over SandL that are represented bytheutilityfunction u(S, L) =SL +10L.
(a) \VhataretheNashequilibrium (orlaissez-faire) purchaseandconsumptionplans
ofAIpita, Dominique andJin? Make thecalculations and illustrateyour answer
ina diagram.
(b) \\;'hat are the socially efficient consumption plan levels? Make the calculations
andillustrateyour answer in a diagram.
(c) Use a diagram to indicate what effect a decrease in the number of individuals
wouldhaveon theNashequilibriumproductionofpublicand privategoods. You
do not have to actually make any calculations. \\7bat is the intuition for your
answer?
Examinationcontinuedon page33