Microeconomics for MSc in Finance
WINTER EXAM DEMO
Section A [48 points total].
Pick a single correct answer to each question. Each correct answer is worth 4 points.
1) Which of the assumption combinations described below will be sufficient to guarantee that the indifference
curves slope downwards?
a. Transitivity
b. Completeness, transitivity
c. Completeness, transitivity, strict monotonicity
d. Completeness, transitivity, strict monotonicity, convexity
e. Completeness, transitivity, strict monotonicity, strict convexity
2) Consider the standard two-period intertemporal choice model. For a consumer with standard preferences, if
consumption in both periods is a normal good, a decrease in the interest rate…
a. Will make the person borrow more if she were a net borrower
b. Will make the person save more if she were a net lender
c. Will make the person save less if she were a net lender
d. Will make the person borrow less if she were a net borrower
3) Nikita’s preferences can be described by a von Neumann-Morgenstern expected utility function with a
diminishing marginal utility of wealth. We can be sure that…
a. Between any two lotteries, he will prefer the one with bigger expected value
b. He will never buy insurance at an actuarially fair price
c. He will never invest in any risky assets as long as there are risk-free assets available
d. His certainty equivalent of any risky lottery is always smaller than the expected value of this lottery
e. All of the above
4) Anna and Boris are two consumers with zero wealth and preferences described by von Neumann-Morgenstern
expected utility functions. Anna has a ticket for a lottery that yields a prize of $90 with a probability of 1/3 or a
prize of $60 with a probability of 2/3. Boris has a ticket for lottery that yields a prize of $150 with a probability of
1/3 or a prize of $30 with a probability of 2/3. The current allocation of lottery tickets is NOT Pareto-optimal if…
a. Anna and Boris are risk averse and their utility-of-wealth functions are positive linear transformations of each
other
b. Anna and Boris are risk averse and their utility-of-wealth functions are NOT positive linear transformations of
each other
c. Anna is risk averse and Boris is a risk lover
d. Anna is a risk lover and Boris is risk neutral
e. Anna and Boris are risk neutral
5) A perfectly competitive firm’s technology has decreasing returns to scale at all output levels. Its long-run
marginal cost curve will be…
a. U-shaped, intersecting the LAC curve twice: first at output level q = 0 and then at the level of output where
the LAC reaches its minimum
b. Horizontal for any q > 0
c. Upward-sloping and lying above the LAC curve for any q > 0
d. Upward-sloping and lying below the LAC curve for any q > 0
e. Downward-sloping and lying below the LAC curve for any q > 0
6) A perfectly competitive firm produces a positive amount of output q0 > 0 with a production function
q = f(K, L), where the quantity of capital services K is fixed. The law of diminishing marginal returns holds for
any L > 0. Which of the following events will induce this firm to produce more?
a. A decrease in the unit price of output, “p”
b. A decrease in the unit price of labor services, “w”
c. A decrease in the unit price of capital services, “r”
d. An increase in the unit price of capital services, “r”
7) Market demand was given by QD(P) = 60 – P, market supply was given by QS(P) = P. A per unit subsidy
equal to 10 will create…
a. An increase of sellers’ price by 10 and an increase in social surplus by 350
b. An increase of sellers’ price by 5 and a decrease in social surplus by 25
c. A decrease of buyers’ price by 5 and a decrease in social surplus by 162,5
d. A decrease of buyers’ price by 10 and a decrease in social surplus by 325
8) A museum with constant marginal cost of $1 charges a price of $5 to local visitors and a price of $10 to
foreign visitors. We can infer that…
a. Price elasticity of demand is “ – 5” for locals and “ – 10” for foreigners
b. Price elasticity of demand is “ – 1/5” for locals and “ – 1/10” for foreigners
c. Price elasticity of demand is “ – 5/4” for locals and “ – 10/9” for foreigners
d. Price elasticity of demand for locals is twice as high as price elasticity of demand for foreigners
e. None of the above
9) Consider a market served by two identical firms competing by simultaneously choosing quantities. If one of
these firms got the opportunity to choose its output level first, in the new Nash equilibrium…
a. The first-moving firm would necessarily produce less
b. The first-moving firm would necessarily produce more
c. Both firms would produce less
d. The first-moving firm would necessarily have a profit which is the same as in the initial equilibrium, or higher
10) A honey farm with a cost function CH(H, A) = 0,01H2 – 2A is located next to an apple orchard with a
cost function CA(H, A) = 0,01A2 where H and A are the quantities of honey and apples produced respectively. The
price of honey is $6 and the price of apples is $3 per unit. Let A1 be the output of apples if the firms operate
independently, and A2 be the output of apples if the firms are operated by a single profit-maximizing owner. Then:
a. A1 = 75 and A2 = 150
b. A1 = A2 = 150
c. A1 = 125 and A2 = 150
d. A1 = 150 and A2 = 250
e. A1 = 300 and A2 = 150
11) A man and his wife annually earn 24H where H is the number of hours they work per year. Their
utility functions are, respectively, UM(CM, H) = CM – 0,02H2 and UW(CW, H) = CW – 0,01H2 where CM and CW
denotes their spending on private consumption. If they find a Pareto optimal choice of hours of work and income
distribution, it must be that the number of hours they work per year is:
a. 500
b. 600
c. 400
d. 150
e. 250
12) Which of the following would be an example of adverse selection?
a. purchasing a new car without going to see it based on the recommendation of a neighbor.
b. high health insurance premiums resulting from the poor health of people who buy policies.
c. suppliers who charge more for better quality clothing than for lower quality clothing.
d. being talked into buying a low-quality item because the price is lower.
Section B [52 points total]
Answer the questions below
1. In a small country of Panem-et-circences, a typical consumer spends all of his monetary income m on food (F) and
theater performances (T), with theater performances being a luxury good. Preferences among bundles of F and T are
standard and homothetic1. The unit prices of food and theater performances are pF and pT, respectively, and we will
assume both goods are perfectly divisible. After the elections, the Art Lovers party, whose motto was "ars longa, vita
brevis", tries to promote public interest towards art by giving people free tickets for Tf > 0 theatre performances (these
free tickets can’t be resold).
a) Using a properly labeled graph, illustrate the typical consumer’s (i) budget set, (ii) optimal consumption bundle (F0,
T0), and (iii) the indifference curve running through it (Ū0) before receiving the free tickets.
b) On your graph from (a), illustrate the typical consumer’s (i) budget set, (ii) optimal consumption bundle (F1, T1),
and (iii) the indifference curve running through it (Ū1) after receiving the free tickets.
b) Will a typical consumer attend more theater performances after getting the free tickets? Will he buy more food?
Use your graphs from (a) and (b) to help you answer this question.
c) Some liberal economic advisors suggest that replacing the free tickets with a lump-sum transfer of equivalent
monetary cost can actually make people at least as happy as the free tickets – and possibly happier. Do you agree with
them? Prove your claim using a separate graph, showing the typical consumer’s budget set and optimal bundle with
the free tickets and his budget set and optimal bundle with the lump-sum transfer (do these budget sets on the same
graph!).
d) The proposal to replace the free tickets with a lump-sum transfer has been rejected, but now the Art Lovers party
comes up with another idea. To further stimulate public interest towards art, they want to introduce a per unit tax on
food, arguing that once food becomes relatively more expensive, people would be willing to replace it with theater
performances. However, their economic advisors warn that income elasticity of demand for theatre performances may
actually be very high - and because of this, the proposed tax won’t be as effective in promoting theatre attendance as it
was thought to be. Do you think their opinion is right or wrong? Prove your point of view by discussing the possible
sign and magnitude of substitution and income effects that the tax on food will generate, and illustrate the possible
changes in the quantity of theatre performances demanded due to substitution and income effects.
e) Suppose that a typical citizen’s demand for theatre performances is given by TD(pT) = 20 – pT, where pT denotes the
price of attending a theater performance. Currently, pT = 10, but the government announces a program, under which
you can buy personalized tickets to 20 theater performances for a reduced price of 𝑝 = 5. These tickets have your
name on them, and cannot be resold to anyone else. Would a typical citizen participate in this program? Back up your
answer with calculations.
2. Citizens of Bjornland are very proud of their pickled herring, and would only eat the variety produced inside their
own country. After a report about the herring population being endangered, the government decided to discourage
excessive herring fishing by banning all herring exports.
a) Suppose Bjornland’s herring industry is a perfectly competitive, increasing cost one. Using a side-by-side graph
(one for the whole market, another for a typical firm operating in it), illustrate the initial long-run equilibrium with
export restrictions in place.
b) Financial crisis led the country to remove exports restrictions. Producers begin exporting, and consumers
worldwide like the product, but they don’t think there’s anything special about it (so in the world herring market,
Bjornland is just one more tiny producer, like everyone else). Describe the short-run effect of export restrictions’
removal on the (i) equilibrium buyers’ price, (ii) total quantity of herring produced, (iii) the quantity of herring
produced by an individual firm, (iv) consumers’ surplus and (v) and producers’ surplus that citizens of Bjornland get
from buying and selling herring. Illustrate your answers on your graph from (a).
1
This implies that MRS is constant along any ray from the origin.
c) Replicate the graph that you used to illustrate the short-run equilibrium in (b), and use it to describe and illustrate
the changes in (i) equilibrium buyers’ price and (ii) total quantity of herring produced, as the industry moves from
short-run to long-run equilibrium.
d) Suppose that costs of operating one herring fishing boat in Bjornland are $5000 per month, and each company is
only allowed to have one such boat. Total monthly revenue of this industry is 1000(21x – x2), where x denotes the total
quantity of operating boats. What is the number of fishing boats in the long run perfectly competitive equilibrium, if
all companies make their decisions independently?
e) How many fishing boats would Bjornland have, if the goal of fishing companies was to maximize total, not
individual, profit from fishing? Was the outcome in (d) Pareto efficient? Explain intuitively (no algebra!).
