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EC2380

2019/20

Economics 2: Microeconomics


Section A: Answer BOTH questions

1. Answer true, false or uncertain and provide an explanation.

(a) The following diagram shows a rise in the price of good X, when X is an inferior good and consumers have been compensated using Slutsky compensation. (The original budget constraint is BL1, the new one is BL2 and the compensated one is BL3.)

(6 marks)


(b)  Insurance companies can completely deal with the problem of moral hazard by raising premiums. (6 marks)

(c)   The First Welfare Theorem says that a competitive equilibrium will be Pareto optimal. (6 marks)


(d)   Consider a Cournot model of competition, where there are two identical firms (A and B), which each have a constant marginal cost of 30 and zero fixed costs. The inverse    market demand function is: = 150 − . The Cournot reaction functions for

each firm will be given by: = 60 − and = 60 − (6 marks)


2. There are many models of oligopolistic competition, with firms competing sequentially or simultaneously and competing on price or quantity or acting as a profit maximising   monopolist (collusion). Consider an oligopolistic market structure, with two firms. By    considering the five main ways of competing for these firms (price or quantity and         simultaneously or sequentially, or lastly colluding), briefly compare the outcomes for    these firms in terms of price, output, profits and efficiency under each model.

(16 marks)


Section B: Answer ONE question

3. Assume that the price of housing, 1, is currently increased by a government tax. The government is intending to remove this tax on housing consumption by lowering the price from (1 + ) to 1 . At the same time, the government is planning to remove a

subsidy on other consumption, 2, raising its price from (2 ) to 2 . Suppose that the following utility function captures your tastes:

1

(1, 2) = 1 + 2

and suppose = 10,000; 1 = 4; 2 = 2; = 1; = 6

(a) Set out the consumer’s utility maximisation problem and determine how much housing and other goods this consumer will choose prior to any policy change.

(8 marks)

(b) When the policy change comes into effect, will this consumer still be able to afford the original bundle? (4 marks)