Time Allowed: TWO hours
Reading Time: 15 minutes

This examination paper contributes 60% to the assessment in ECON10004.

The Response Sheet for the multiple-choice questions should be inserted in the back of the examination script book at the end of the examination. For the multiple-choice questions, you may use the examination script books to make notes or calculations. These notes will NOT be taken into account for your assessment.

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SECTION A: ANSWER ALL QUESTIONS

This section is worth 25% of the total exam marks.
Answer all questions. Fill in the small circle in the appropriate place with a 2B pencil on the Response Sheet. An incorrect answer, no answer, or more than one answer, will receive a zero mark.

SECTION B: ANSWER ALL QUESTIONS

This section is worth 25% of the total exam marks.
Answer all questions. Each question is worth equal marks.

SECTION C: ANSWER ALL QUESTIONS

This section is worth 50% of the total exam marks.
Answer all questions. Questions are worth different marks.

Other Instructions

Foreign/English language dictionaries are allowed into the examination room. No other materials are allowed.

This exam paper may be removed from the examination room.
A copy of this exam paper will be held in the Baillieu Library.

This exam paper has 9 pages.
SECTION A

ANSWER ALL QUESTIONS IN THIS SECTION

This section is worth 25% of the total exam marks.
All questions in this section are worth the same number of marks. For each question select the one BEST answer. Incorrect answers, multiple answers, or no answer, will receive zero. Mark your answer on the Response Sheet.

1. The market for wheat is in equilibrium. Then a new technology is developed that improves production efficiency for wheat. We should expect that: a) Supply of wheat will decrease, so that at the original equilibrium price there is excess demand which will cause the price to decrease towards a new equilibrium price. b) Supply of wheat will increase, so that at the original equilibrium price there is excess supply which will cause the price to decrease towards a new equilibrium price. c) The quantity supplied of wheat will increase, and this will cause a decrease in equilibrium price and an increase in demand. d) Demand for wheat will increase, so that at the original equilibrium price there is excess demand which will cause the price to increase towards a new equilibrium price.

2. Suppose that Australian and US dollars are traded in a perfectly competitive market. Treat the price in this market as the amount of $US that can be traded for $1AUS (referred to as the US/AUS exchange rate), and the quantity traded as the quantity of $AUS traded. Suppose that the expected future profitability of US businesses improves so that the expected future return earned on owning shares in US businesses increases. The predicted effect would be: a) A decrease in the US/AUS exchange rate.

b) An increase in the US/AUS exchange rate.
c) A decrease in the supply of $AUS in the US.
d) An increase in the demand for $AUS in the US.

Q3 The government introduces a price ceiling on the price of a litre of milk. Assume that the price ceiling is less than what the equilibrium price would be if there was no government intervention in the market. We would expect that the effect of the price ceiling would be to:

a) Decrease the quantity traded of milk.
b) Cause no change in the equilibrium price of milk.
c) Increase the total surplus to society in the market for milk. d) Increase the well-being of producers, and lower the well-being of consumers.

Q4 Steph Social Planner knows that the PMB for acquiring a university degree is 250 – Q (where Q is the total number of persons obtaining a university degree). The SMB is 500 – Q. Also PMC = SMC = 100. Steph knows that to have the efficient number of persons obtain a university degree it will be necessary to:

a) Set a maximum limit on the number of persons obtaining a university degree equal to 400. b) Impose a tax of 250 on each individual who obtains a university degree. c) Provide a subsidy of 250 to each individual who acquires a university degree. d) Require that at least 150 persons obtain a university degree.

Q5 Daniel’s Deepdish Pizza has costs as follows:

Quantity of pizzas per day
FC
MC
1
10
1
2
10
1
3
10
2
4
10
2
5
10
3
6
10
3
7
10
4
8
10
4
9
10
5
10
10
5

Daniel knows that – over the range from 1 to 10 pizzas per day – his ATC will:

a) Continuously increase.
b) Continuously decrease.
c) Increase and then decrease.
d) Decrease and then increase.

Q6 Joy’s Superwash Carwash can use two alternative methods of production. The FC and VC of each of these methods are shown below:

Method 1

Method 2

Output
FC
VC
FC
VC
1
1
1
10
1
2
1
3
10
2
3
1
6
10
3
4
1
10
10
4
5
1
15
10
5
6
1
21
10
6
7
1
28
10
7
8
1
36
10
8

In the long-run Joy should choose:

a) To only use production method 1
b) To use production method 1 if output is less than or equal to 4 units, and production method 2 if output is 5 units and above c) To use production method 2 if output is less than or equal to 4 units, and production method 1 if output is 5 units and above d) To use production method 1 if output is less than or equal to 5 units, and production method 2 if output is 7 units and above

Q7 Mac’s Luxury Boat Co. has to decide on the profit maximising price to charge for its boats, and on whether to operate. Mac knows that demand for his firm’s luxury boats is:

Quantity
Price ($m)
8
1
7
2
6
3
5
4
4
5
3
6
2
7
1
8

The MC of making each boat is $1m, and there is a fixed cost of $10m. Mac should decide:

a) To set a price of $4m, and that the business should operate both in the SR and LR. b) To set a price of $5m, and that the business should only operate in the SR. c) To set a price of $4m, and that the business should only operate in the SR. d) To set a price of $5m, and that the business should operate both in the SR and LR

Q8 The potential market for going to Sam’s City Cinema includes 30 adults each of whom has a willingness to pay of $20, 20 seniors each of whom has a willingness to pay of $15, and 10 children each of whom has a willingness to pay of $10. The FC of supplying the service of watching movies at the cinema is $10, and the MC is $5 for each person who attends the movies. The cinema is able to charge a maximum of two different prices (but not three different prices). The profit maximising set of prices for Sam to choose will be:

a) $15 for seniors, and $20 for adults
b) $10 for children and seniors, and $20 for adults
c) $10 for children, and $15 for seniors and adults
d) $10 for children, seniors and adults.

Q9 Consider the following game table:

Player 2

Left
Right
Player 1
Up
0,10
10,5

Down
0,5
0,10

Which of the following statements is correct?

a) Player 1 has a strict dominant strategy, and player 2 does not have a dominant strategy. b) Player 1 has a weak dominant strategy, and player 2 does not have a dominant strategy. c) Player 1 does not have a dominant strategy, and player 2 has a strict dominant strategy. d) Player 1 does not have a dominant strategy, and player 2 has a weak dominant strategy.

Q10 Consider the following game table which describes a simultaneous game where two banks must decide whether to change their interest rates charged for home loans:

SouthPac

Increase
Don’t change
Decrease
OzBank
Increase
10,10
5,10
0,15

Don’t change
10,5
5,5
10,5

Decrease
15,0
5,10
-5,-5

What are the set of Nash equilibria for this game? (In each strategy combination the strategy for OzBank is listed first.)

a) (Increase; Increase), (Don’t change; Don’t change), (Decrease; Decrease) b) (Increase; Don’t change), (Don’t change; Decrease)
c) (Decrease; Don’t change), (Don’t change; Decrease)
d) (Increase; Decrease), (Decrease; Increase)

SECTION B

ANSWER ALL QUESTIONS IN THIS SECTION

This section is worth 25% of the total exam marks.
All questions in this section are worth the same number of marks. For each of the following questions:
Consider the statements made by Alan Accountant and Edwina Economist. Say whether you believe each statement is correct or incorrect. Briefly explain your answer. Note that most of the marks will be given for your
explanation. Question B1

Alan Accountant and Edwina Economist are discussing the government’s recent decision to stop paying subsidies to home-owners who buy solar panels to provide a source of power to their homes. Alan says: ‘This change in policy will not have a big effect. Because supply of solar panels is price-elastic, therefore removing the subsidy only causes a small decrease in the quantity of panels sold.’ Edwina disagrees. She says: ‘The fact that supply is price-elastic means that the change in policy will cause a relatively large decrease in the quantity of panels sold.’

Question B2

Alan Accountant and Edwina Economist are advising their friend Mardi Manager on operating her business. Mardi sells ice-creams, and because of their distinctive flavours, the business has a high degree of market power. Mardi is trying to decide whether to increase her daily sales as a way of earning higher profits. Alan says: ‘Mardi can produce the extra ice-creams at the same marginal cost as the ice-creams she is already producing. Hence she will definitely earn higher profits by increasing her sales.’ Edwina disagrees. She says: ‘That Mardi has a constant marginal cost of supply does mean that her ATC will decrease when she sells more. But we would need more information to know that her profits would increase when she sells more ice-cream.’

Question B3

Alan Accountant and Edwina Economist are advising their friend Gerry Gameplayer who is going to play in the World Championship of ‘Scissors, Paper, Rock’. Gerry will be playing a sequence of games against each opponent in the contest. Edwina Economist says: ‘My advice is to choose randomly between the three strategies in each game you play.’ Alan Accountant disagrees. He says: ‘If you choose randomly you will only have a one-third chance of winning each game. But I have a better strategy. Noone ever makes the same choice two games in a row. So I advise you in each game
to choose the best response to one of the two strategies that your opponent did not choose in the last game. That way you will always have at least a one-half chance of winning each game.’ ANSWER ALL QUESTIONS IN THIS SECTION

This section is worth 50% of the total exam marks.
Question C1 (15% of total marks)

In the market for bananas in Australia demand for and supply of bananas are as follows: QD = 12,000 – 6000P
QS = 2,000 + 4000P
(where QD = Kilograms of bananas demanded by Australian consumers, QS = Kilograms of bananas supplied by Australian suppliers, and P = price (in dollars) per kilogram of bananas).

a) (2 marks) What will be the equilibrium price per kilogram of bananas and total kilograms of bananas traded?

Suppose now that Australian consumers can buy bananas from international suppliers at a price of 50cents per banana.

b) (5 marks) What will be the effect of introducing the possibility of buying bananas from international suppliers on: i) The equilibrium price of bananas in Australia?
ii) The total quantity of bananas supplied by Australian suppliers? iii) The total hours of bananas demanded by Australian consumers? iv) The quantity of bananas imported?

Now suppose that there is a cyclone that adversely affects supply of bananas by Australian suppliers. The supply becomes:

QS = -3,000 + 4000P

c) (2 marks) In the case where there is no international trade, what will be the effect on the equilibrium price per kilogram of bananas and total
kilograms of bananas traded? d) (3 marks) In the case where international trade is allowed (still at the price of 50 cents per kilogram of bananas) is there any effect on the equilibrium price of bananas? What about on the total quantity demanded by Australian consumers, and total quantity supplied by Australian suppliers? e) (3 marks) Will the effect of the cyclone on the well-being of Australian consumers be worse where there is international trade or no international trade? What about the effect on the overall well-being of society in Australia?

Question C2 (20% of total marks)

Part A (10 marks)

‘Many Victorian private schools will raise their fees by more than four times the rate of inflation with principals claiming that a boost to government teacher salaries has forced independent schools to play catch-up [with their own teachers’ salaries]. The average fee increase at private schools was about 5 per cent, compared to 8 per cent last year, with the impact of the economic downturn tempering fee rises.’ ‘Teacher pay blamed for private school fees hike’, The Age, January 7 2010, page 3.

Use the model of a profit-maximising firm with market power to explain why private schools would want to increase school fees in response to an increase in teacher salaries.

Part B (10 marks)

Stanley has begun planning for selling hamburgers at the 2012 Grand Final. He thinks that there are two types of consumers, StKilda fans who are willing to pay $5 for a hamburger, and Collingwood fans who are willing to pay $3. The MC of making a hamburger is $2. At the same time, Theonie, who is planning to sell Pepsi and chips at the Grand Final, suggests to Stanley that they should form a partnership. Preferences of StKilda and Collingwood fans for these items are described in the table below. There are 200 StKilda fans and 50 Collingwood fans who are potential customers. Pepsi
costs $1 for Theonie to obtain, and hot chips cost her $1 to make.

Hamburger
Pepsi
Hot chips
StKilda fans
$5
$3
$2
Collingwood fans
$3
$2
$3

a)(5 marks) Suppose Stanley and Theonie were to sell hamburgers, Pepsi and hot chips as separate items. What would be the profit maximising price to charge for each item? b) (5 marks) Could Stanley and Theonie choose to bundle just two items and make higher profits? What explains this result?

Question C3 (15% of total marks)

Part A (7 marks)

‘To spruik or not to spruik, that is the question…The spruikers of Carlton’s Little Italy have long been considered a blight by many Melburnians, and recently the restaurant owners who employ them have come to think they might have a point…So on Tuesday afternoon the owners of eight Italian restaurants on the eastern side of Lygon street…met to discuss what to do about a practice that is both a tradition and a millstone. The informal gathering decided unanimously to put an end to spruiking. But by yesterday afternoon, one restaurant, Sale e Pepe, was back on the street, selling its own merits.’ (‘Lygon street hustle dances on for now’, Karl Quinn, The Age, June 3 2010, page 3). [Note: A spruiker is a person who stands outside a restaurant and advertises for customers.]

Suppose that there are two restaurants in Lygon Street. On each day they operate they must each make a choice between ‘Spruik’ or ‘Not spruik’. Neither restaurant observes the choice made by the other restaurant prior to making its own choice.

a) (3 marks) Draw a game table showing this game including payoffs so that it is a strict dominant strategy for each restaurant to choose to ‘Spruik’. b) (2 marks) Suppose the restaurants planned to be in operation for two days. (So that they therefore need to play the game you have shown for part (a) twice.) Is it possible that this would lead to a different outcome on either day? c) (2 marks) Suppose the restaurants think it is possible they will be operating indefinitely. Why might it be an equilibrium of the ‘infinitely repeated’ version of this game that each restaurant would choose to ‘Spruik’ on every day it operates?

Part B (8 marks)

In the Envelope game there are 2 players and 2 envelopes. One of the envelopes is marked ‘player 1’ and the other is marked ‘player 2’. At the beginning of the game, each envelope contains $1. The game has three stages. In the first stage player 1 must decide whether to ‘Stop’ or ‘Continue’. If he chooses ‘Stop’ then each player receives the money in their own envelope and the game stops. If he chooses ‘Continue’ then the $1 is removed from his envelope, and $2 is added to player 2’s envelope. In the second stage, player 2 must continue whether to ‘Stop’ or ‘Continue’. If she chooses ‘Stop’ then each player receives the money in their own envelope and the game stops. If she chooses ‘Continue’ then $1 is removed from her envelope, and $2 is added to player 1’s envelope. In the third stage, player 1 must again decide whether to ‘Stop’ or ‘Continue’. If he chooses ‘Stop’ then each player receives the money in their own envelope and the game stops. If he chooses ‘Continue’ then $1 is removed from his envelope, and $2 is added to player 2’s envelope. After this the game ends.

a) (4 marks) Draw the game tree that represents the Envelope game. b) (4 marks) What is the rollback equilibrium of the game?

End of Examination

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