Final Exam

Microeconomics for AE
Academic Year 2023/2024

1. (23 points) Production. In a perfectly competitive market, a firm uses an amount

of capital K and a number of workers (or labour) L to produce Q units of a certain
good. The firm’s factory operates according to the following production function:

Q = F (K, L) = (K ρ + Lρ )1/ρ , 0 < ρ ≤ 1.

The rent the producer has to pay on each unit of capital is given by r = 2 and the
wage the firm pays to each worker is given by w = 1.
(a) (3 points) Determine for all ρ, whether this firm faces decreasing, constant or
increasing returns to scale.

From now on you may use that ρ = 12 , i.e., you may use that
√ √
Q = F (K, L) = ( K + L)2 .

(b) (8 points) Derive this firm’s conditional factor demands K(Q) (demand for cap-
ital) and L(Q) (demand for labour).
(c) (2 points) Derive this firm’s cost function C(Q).
(d) (4 points) What is the equilibrium price in this market and what are the firm’s
equilibrium profits? If you did not find a solution for part (b), you may use that
C(Q) = cQ with a constant c > 0.

The workers have decided to form a labour union, so that it is now impossible for the
firm to fire or hire any workers in the short-run. As a consequence, the firm’s labour
input is fixed at L̄ = 9.
(e) (4 points) What is the new short-run demand for capital K s (Q) and the short-
run cost function C s (Q)?
√
Let the demand for the good be P D (Q) = 2 − 61 Q.
(f) (4 points) What is the new equilibrium price and what are the firm’s profits?
Microeconomics for AE 2

2. (26 points) Taxes. Consider the competitive market for wheat. The market demand
function for wheat is given by D(p) = 64
p
. The wheat industry’s cost function is
3
c(q) = 23 q 2 .
(a) (2 points) Derive the inverse demand function for wheat P D (q).
(b) (2 points) Derive the inverse supply function for wheat P S (q).
(c) (4 points) Find the competitive market equilibrium price for wheat p∗ . What
quantity of wheat q ∗ is traded?

The government imposes a value-added-tax of t% on the sale of wheat.

(d) Draw a diagram with the quantity q on the x-axis and the price p on the y-axis.
i. (3 points) Sketch the market supply and demand functions, the market
equilibrium without taxes (p∗ , q ∗ ).
ii. (3 points) Construct the equilibrium with taxes (pt , q t ).
iii. (3 points) For the equilibrium with taxes, indicate the the areas correspond-
ing to the tax revenue, the consumer surplus and the producer surplus.
(e) (5 points) Show that, at the market equilibrium with taxes, the market price
that the consumer pays is pcons = P D (q t ) = 4(1 + t/100)2/3 .
(f) (2 points) What is the price pprod that the producer receives?
(g) (4 points) Determine the producer surplus with and without taxes. To simplify
calculations set t = 50.

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Microeconomics for AE 3

3. (26 points) Congestion 10 000 commuters in a suburb have to make a daily decision
on whether to drive to their work in the city or to work from home. Unfortunately,
the only road to the city where they work, suffers considerable congestion. Driving to
work involves a time cost, cW (n), which depends on n, the total number of commuters
driving to their work. This cost function is given by
 n 2
cW (n) = 40 + .
1000
Working from home involves an efficiency cost of cH = 65. The total costs of com-
muting are given by

C(n) = n · cW (n) + (10 000 − n) · cH .

(These costs only involve the costs to commuters driving to work and working at
home, and do not include taxes, subsidies or surpluses from any other parts of the
economy.)
(a) (4 points) What is the number of commuters that drives to work n∗ ? Explain.
(b) (2 points) What are the total costs of commuting C(n∗ )? Explain.
The city government is considering two options to resolve the congestion problem.
The first option is to construct a N ew road. This changes the cost of driving to work
to  n 2
N
cW (n) = 40 + .
2000
The second option is to impose a toll t. This changes the cost of driving to work to
 n 2
ctW (n) = 40 + t + .
1000
Let us first consider the first option.
(c) (2 points) Show that, after constructing the new road, all commuters will choose
to drive to work.
(d) (2 points) What are the total costs of commuting after building the new road?
Explain.

Now consider option two.

(e) (3 points) For a given toll t ∈ [0, 25], derive the number of commuters driving
to work. Call this number n(t).
(f) (5 points) What toll t∗ will maximise the municipality’s toll revenue? Explain.
Here, you may assume that the second order condition for toll revenue maximi-
sation is satisfied and that the solution is interior.
(g) (2 points) How many commuters will drive to their work after the introduction
of the revenue maximizing toll t∗ ? Explain.
(h) (2 points) What will be the total costs of commuting with toll t∗ ? Explain.
(i) (4 points) Which option is better in terms of total welfare? Constructing a new
road or introducing a toll? Explain.

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Microeconomics for AE 4

4. (23 points) Multiple Choice questions

(a) (3 points) Consider the two goods milk (m) and coffee (c) and a consumer named
Frank. Suppose that Frank’s preferences over the two goods are characterized by
the following utility function u(c, m) = min 6c, 23 m . Which of the following
relationships between c and m needs to hold in Frank’s optimal consumption
bundle? Choose one answer.
A. m=c
B. m = 2c
C. m = 4c
D. m = 6c
E. m = 8c
F. m = 10c
G. m = 12c
(b) (4 points) Consumer’s problem. This Figure shows an old budget line BC,
a new budget line BC and the two tangent indifference curves. The price of
good 2 is fixed: p2 = 1. which statement is true? Choose one answer.

(A) price p1 went up and good 1 in an Inferior good

(B) price p1 went up and good 1 is a Normal good
(C) price p1 went down and goods 1 and 2 are complements
(D) price p1 went down and is an Ordinary good
(E) the budget m went up and goods 1 and 2 are substitutes
(F) the budget m went up and good 2 is a Normal good
(G) the budget m went down and good 2 is an Inferior good
(H) the budget m went down and good 2 is a Normal good
(c) (4 points) A government wants to help its citizens to make their houses sustain-
able. In particular, the government wants it to be cheaper for its citizens to buy
solar panels. To accomplish this, the government gives a subsidy of a certain

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Microeconomics for AE 5

percentage per solar panel bought. Which of the following figures discribes ac-
curately how the price the supplier receives changes as a result of this subsidy?
Choose one answer.

P P
S′ S′
S S
pS ′ pS ′
pS pS

D D
Q Q
(a) (b)

P P

S S
pS ′ pS ′
pS pS

D′ D′
D D
Q Q
(c) (d)

(d) (4 points) Monopoly. A monopolist has a marginal cost function M C(q). The
monopolist faces an inverse demand function P D and an implied marginal rev-
enue M R(q). These functions are depicted in the figure below.
Let CS be the consumer surplus and P S be the producer surplus. What state-
ment is true?

(A) CS = A, PS = B + C + D + E + F
(B) CS = A, PS = B + D + F

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Microeconomics for AE 6

(C) CS = A + B, PS = D + E + F
(D) CS = A + B, PS = D + F
(E) CS = A + B + C, PS = D + E
(F) CS = A + B + C, PS = D + E + F
(G) CS = A + B + C + D + E, P S = F
(e) (3 points) Which of the following statements is true? Choose one answer.
A. The Nash equilibrium price of Cournot competition lies between the monopoly
price and the Bertrand price.
B. The deadweight loss of Cournot competition can be mitigated by a Pigou-
vian tax.
C. Under Bertrand competition, Firm 1 first decides on its price p1 and then
Firm 2 decides on its price p2 .
D. In the Stackelberg competition model, the first mover’s advantage means
that the leading firm can set higher prices than the following firm.
(f) (5 points) Nash equilibrium Consider the following bi-matrix game of two
players.
Player 2
L M H
L 20, 16 17, 18 11, 16
Player 1 M 22, 13 18, 14 10, 10
H 20, 7 14, 6 2, 0
What is the set of Nash equilibria N E? Choose one answer.
(A) NE = {(L, L)}
(B) NE = {(M, L)}
(C) NE = {(L, M )}
(D) NE = {(M, M )}
(E) NE = {(L, H)}
(F) NE = {(H, L)}
(G) NE = {(H, L), (L, H)}
(H) NE = {(M, M ), (L, H), (H, L)}
(I) NE = {(M, M ), (M, H), (H, M )}
(J) NE = {(M, L), (L, M ), (L, M ), (M, L)}

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