Microeconomics II (Fall 2017)

SECTION 1 (50 points)

In this section of the exam, for each of the following statements you have three possi-
ble answers: true, false or abstention. The number of attainable points is indicated in
brackets. For a correct answer the points are added. For a wrong answer the points are
subtracted. For an abstention you receive 0 points. If the total number of points for a
given problem ends up being negative, it will automatically be set to zero. Please enter
all your answers in the answer sheet enclosed (only the answer sheet will count for the
evaluation).

Problem 1. Consumer Behavior (8 Points)

A consumer has preferences over two goods X and Y that satisfy the assumptions of com-
pleteness, non-satiation, and transitivity. The consumer can choose among the following
consumption bundles A, B, C, and D:

consumption bundle X Y
A 1 1
B 1 2
C 2 1
D 2 0

(a) The consumer weakly prefers bundle C to bundle A, i.e. C % A. (2 Points)

(b) If B % C and C % D, then it must also be that B % D. (2 Points)

dY
(c) If the indifference curves have a constant slope of dX = −1, then the consumption
bundles B and C must lie on the same indifference curve. (2 Points)

(d) If MRSXY = 2, then it must also be that B ∼ D. (2 Points)

Problem 2. Production and Costs (8 Points)√ √

A firm has the production function Q(K, L) = K + 2 L. The price of one unit of
capital K is R, and the price of one unit of labor L is W .

(a) This production function has increasing returns to scale. (2 Points)

√
2√ L
(b) The marginal rate of technical substitution is MRTSLK = K
. (2 Points)

(c) If factor prices are equal (W = R), then the firm’s conditional demand for labor is
four times the conditional demand for capital. (2 Points)

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 √ √
(d) The production function Q(K, L) = K + 2 L cannot be represented by a CES
1
production function Q(K, L) = [aLρ + bK ρ ] ρ . (2 Points)

Problem 3. Perfect Competition and Monopoly (6 Points)

A firm has the cost function C(Q) = Q2 + 100.
100
(a) The marginal cost of the firm are M C(Q) = Q + Q
. (1.5 Points)

(b) Under perfect competition, in the long run the firm will stay in the market only if
the market price is P ≥ 20. (1.5 Points)

(c) If the firm is a profit-maximizing monopolist, then at quantity Q = 20 and price

P = 50, the Lerner index is L = 0.5. (1.5 Points)

(d) If the firm is a profit-maximizing monopolist, then it will always choose to offer a
quantity that minimizes its average cost. (1.5 Points)

Problem 4. Game Theory A (8 Points)

Consider the following payoff matrix of a game in normal form:

Player 2

C D

A 1, 1 1, 1
Player 1
B 1, 1 0, 1

(a) Iteratively eliminating strictly dominated strategies leads to the following four pos-
sible outcomes of the game {(A, C); (A, D); (B, C); (B, D)}. (2 Points)

(b) The game has exactly two Nash equilibria in pure strategies, namely {(A, C); (A, D)}.
(2 Points)

(c) This game has a unique Nash equilibrium in mixed strategies, in which both players
play each action with strictly positive probability. (2 Points)

(d) The game has infinitely many Nash equilibria, in each of which one of the two
players randomizes between the two actions, while the other plays a pure strategy.
(2 Points)

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Problem 5. Game Theory B (8 Points)
Consider the following decision tree of a sequential game:

A
l r
B
(5, 4)
l r

(6, 5) (4, 6)

(a) Solving the game using backward induction yields the payoffs (5, 4). (2 Punkte)

(b) Both players may benefit from a commitment mechanism that allows player B to
announce his strategy prior to the game. (2 Points)

(c) A commitment mechanism that allows player B to announce her strategy before the
game starts would increase her payoff by 2. (2 Points)

Assume that the game is played twice. The decision tree then looks as follows:

A
r
B
l

l r

A A A
l r l r l r
B B B
(10, 8) l r (11, 9) l r (9, 10) l r

(11, 9) (9, 10) (12, 10) (10, 11) (10, 11) (8, 12)

(d) Solving the game using backward induction yields the payoffs (10, 8). (2 Points)

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Problem 6. General Equilibrium (6 Points)
Consider a pure exchange economy with two consumers and two goods.

(a) No consumer strictly prefers his endowment to the allocation in the Walrasian equi-
librium. (1.5 Points)

(b) Every allocation on the offer curve of a consumer is Pareto efficient. (1.5 Points)

(c) Every allocation on the contract curve is Pareto efficient. (1.5 Points)

(d) If the endowments of both consumers with both goods are doubled, then relative
prices at the equilibrium must remain the same. (1.5 Points)

Problem 7. Selected Topics (6 Points)

(a) An individual is risk-averse if his utility of expected consumption is larger than his
expected utility of consumption. (1.5 Points)

(b) Suppose the utility function of an individual is U (w) = ln(w). Then the absolute
1
degree of risk aversion is r(w) = 2w . (1.5 Points)

(c) When the seller has an incentive to reduce costly quality we call this adverse selec-
tion. (1.5 Points)

(d) Assume the discount factor is δ = 0.8. An infinite payment stream of 1 in every
time period starts in period 0. Under hyperbolic discounting the present value of
this payment stream at the beginning of period 0 is smaller than 5. (1.5 Punkte)

SECTION 2 (40 Points)

In this section of the exam, you are given a list of five possible answers for each part
of each problem. Only one of these five answers is correct. Your task is to identify the
correct answer. The number of attainable points is indicated in brackets. For a correct
answer, the points are added. For a wrong answer you receive 0 points. For an abstention,
you receive 0 points. Please enter all your answers in the answer sheet enclosed (only the
answer sheet will count for the evaluation).

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Problem 1. Optimal Consumption (20 Points)
The preferences of a consumer are represented by the utility function U (X, Y ) = XY 2 .
His income is denoted by I. The price of good X is PX and the price of good Y is PY .

(a) Determine the marginal rate of substitution MRSXY . (4 Points)

X
A. MRSXY = Y
X
B. MRSXY = 2Y
Y
C. MRSXY = X
Y
D. MRSXY = 2X
E. None of the above answers is correct.

(b) Find the Marshallian demand X(PX , PY , I) if I = 12 and PX = PY = 2. (6 Points)

A. X(PX , PY , I) = 1
B. X(PX , PY , I) = 2
C. X(PX , PY , I) = 4
D. X(PX , PY , I) = 9
E. None of the above answers is correct.

The Hicksian demand can be found by solving the following optimization problem:

min L(X, Y, λ) = PX X + PY Y + λ[Ū − XY 2 ]

X,Y,λ

(c) The Lagrange multiplier λ above describes: (4 Points)

A. The marginal utility of X.
B. The marginal utility of I.
C. The marginal expenditure for Y .
D. The marginal cost of X.
E. None of the above answers is correct.

(d) Find the Hicksian demand Y (PX , PY , Ū ). (6 Points)

  31
A. Y (PX , PY , Ū ) = 2ŪPPY X
  32
2Ū PX
B. Y (PX , PY , Ū ) = PY
  13
2Ū PY
C. Y (PX , PY , Ū ) = PX
  23
2Ū PY
D. Y (PX , PY , Ū ) = PX

E. None of the above answers is correct.

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Problem 2. Cournot Competition (20 Points)
Firm 1 and firm 2 produce a homogeneous good. The inverse market demand function is
P (Q) = 6 − 12 Q, where Q = q1 + q2 is the aggregate market output. Firm 1 produces with
constant marginal cost of c1 = 1, firm 2 produces with constant marginal cost of c2 = 2.
The two firms are competing in quantities; there are no fixed cost.

(a) What is the reaction function of firm 1? (4 Points)

A. q1 = 6 − 12 q2
B. q1 = 5 − 21 q2
C. q1 = 4 − 21 q2
D. q1 = 3 − 12 q2
E. None of the above answers is correct.

(b) What is the quantity produced by firm 1 in the Nash equilibrium? (6 Points)
A. q1 = 2
B. q1 = 3
C. q1 = 4
D. q1 = 5
E. None of the above answers is correct.

The market price in the Nash equilibrium is P = 3 and industry profit is π1 + π2 = 10.

(c) Which of the following statements is correct? (4 Points)

A. Firm 1 produces less than firm 2.
B. The Herfindahl-Hirschmann-Index is smaller than 0.5.
C. The consumer surplus is less than 10.
D. The profit of firm 1 is strictly lower than the profit of firm 2.
E. None of the above answers is correct.

(d) Finally, assume that firm 2 exits the market and firm 1 acts as a profit-maximizing
monopolist. How does the sum of consumer and producer surplus (total welfare)
change? (6 Points)
A. It falls by 0.75.
B. It falls by 0.25.
C. It increases by 0.25.
D. It increases by 0.75.
E. None of the above answers is correct.

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