Compiled by Jeka: 073 768 7330 /084 4995721 www.jekanomics .com 1 ECS4862 EXAM PREPARATION STUDY NOTES AND SOLUTIONS FOR PAST PAPERS. Table of contents. Unit 1. Choice under uncertainty -------------------- ---------------------------------- 2 Unit 2. Oligopoly Models and competitive strategy ------- ----------------- -------- 5 Unit 3. Inputs Market -------------------------------------------- ------------------------ 19 Unit 4. Neoclassical microeconomic theory ---------------------------------------- 24 Unit 5. Market Structure, Conduct and Performance Paradigm(SCP) -----27 Unit 6. Managerial theory of the firm ------------------------- ------------------------ 37 Unit 7. Behavioural theory ----------------------------------------- --------------------- 41 Unit 8. Old and new institutional economics ----------------- --------------------- -42 Unit 9. Government intervention in competitive markets ----------------------- 45 Unit 10. Competition Policy ------------------------------------------------------- -----48 Unit 11 . Regulation ------------------------------------------------------------ ----------- 52 Unit 12 . Past Exams solutions ------------------------ ------------------------ -------- 56 Compiled by Jeka: 073 768 7330 /084 4995721 www.jekanomics .com 2 Unit 1. Choice Under Uncertainty . Consumers and managers make decisions in which there is uncertainty about the future. UNCERTAINITY is characterized by the term risk, which applies when each of the possible outcomes and its probability of occurrence is known . RISK implies future uncertainty about deviation from expected earnings or expected outcome. Risk measures the uncertainty that an investor is willing to take to realize a gain from an investment. Consumers and investors are concerned about the expected value and the variability of uncertain outcomes. EXPECTED VALUE : is a measure of the central tendency of the values of risky outcomes. E(X) = P 1 X1 + P 2X2 + P 3X3+……………………+P nXn VARIABILITY: is frequently measured by the standard deviation of ou tcomes, which is the square root of the probability weighted average of the squares of the deviation from the expected value of each possible outcome. Var(X) = P 1 [X1 - E(X)]]2 + P 2[X2 –E(X)]2 +P3[X3-E(X)]2...............+P n [Xn-E(X)]2 STANDARD DEVIATION = √𝑽𝒂𝒓𝒊𝒂𝒏𝒄𝒆 Faced with uncertain choices, consumers maximize their expected utility i.e. an average of the utility associated with each outcome —with the associated probabilities serving as weights. RISK ARVERSE : Person who would prefer a certa in return of a given amount to a risky investment with the same expected return. The maximum amount of money that a risk -averse person would pay to avoid taking a risk is called the risk premium . Risk averse people are generally afraid of taking risks . -risk-
averse person has a diminishing marginal utility of income and prefers a certain income to a gamble with the same expected income . RISK NEUTRAL : Person who is indifferent between a risky investment and the certain receipt of the expected return on that investment is risk neutral. RISK -LOVING : Person would prefer a risky investment with a given expected return to the certain receipt of that expected return. The person is willing to take more risks in any given situation in return for little reward. A risk lover has an increasing marginal utility of income and prefers an uncertain income to a certain income. Consider the following example: Jan/Feb 2015 . QUESTION 1 a) What does i t mean to say that a pe rson is a risk lover or is risk averse ( 4)? Compiled by Jeka: 073 768 7330 /084 4995721 www.jekanomics .com 3 b) Suppos e that two projects have the same f our payoffs but the probability associated with each pay off differ as shown below. Payoff Project A Project B R100 0.3 0.2 R150 0.2 b R50 a 0.1 R200 0.1 0.2 i) What is the probability of getting a payoff of R50 under project A and a payoff of R 150 under project B [ Fill in the missing probability values] (2) ii) Find the expected return and standard deviation of each project ( 14)? iii) If Sam son's utility function is U = 2I , where I denote the payoff, which Investment Will S amson choose (5) SOLUTIONS : a) A risk lover is an individual who is willing to take more risks in any given situation in return for little reward whilst a risk averse person will only assume more risk if potential returns are high. Risk averse people are ge nerally afraid of taking risks. b) The missing values are shown in red: Payoff Project A Project B R100 0.3 0.2 R150 0.2 0.5 R50 0.4 0.1 R200 0.1 0.2 i) Missing values are as follows: Project A =0.4: Project B = 0.5 ii) Expected return and standard deviation are calculated as follows Project A Compiled by Jeka: 073 768 7330 /084 4995721 www.jekanomics .com 4 Expected return: E(Xa) = P 1 X1 + P 2X2 + P 3X3+……………………+P nXn = 0.3 x100 +0.2x 150 +0.4x50+0.1x200 = 100 Variance = P 1 [X1 =E(Xa) ]]2 + P 2[X2 –E(Xa)]2 +P3[X3-E(Xa)]2...............+P n [Xn-E(Xa)]2 = 0.3 x(100 -100)2 +0.2(150 -100)2 +0.4(50 -100)2 +0.1(200 -100)2 = 0.2x(50)2 +0.4( -50)2 +0.1(100)2 = 500 +1000+1000 = 2500 Standard deviation = 2500 ½ = 50 PROJECT B Expected return: E(Xb) = P 1 X1 + P 2X2 + P 3X3+……………………+P nXn = 0.2 x100 +0.5x 150 +0.1x50+0.2x200 = 140 Variance = P1 [X1 =E(Xb)]]2 + P 2[X2 –E(Xb)]2 +P3[X3-E(Xb)]2...............+P n [Xn-E(Xb)]2 = 0.2 x(100 -140)2 +0.5 (150 -140)2 +0.1(50 -140)2 +0.2(200 -140)2 = 0.2x( -40)2 +0.5( -10)2 +0.1( -90)2 +0.2(60)2 = 320 +50+810+720 = 1900 Standard deviation = 1900 ½ = 43.59 = 44 iii) The investment which Samson will choose will depend on the expected utility from each project. Project A E(U) = 0.3 x (2x100) + 0.2 x(2x150) + 0.4x (2x50) + 0.1 (2x200) = 0.3x200 + 0.2x300 +0.4x100 +0.1x400 = 200
averse person has a diminishing marginal utility of income and prefers a certain income to a gamble with the same expected income . RISK NEUTRAL : Person who is indifferent between a risky investment and the certain receipt of the expected return on that investment is risk neutral. RISK -LOVING : Person would prefer a risky investment with a given expected return to the certain receipt of that expected return. The person is willing to take more risks in any given situation in return for little reward. A risk lover has an increasing marginal utility of income and prefers an uncertain income to a certain income. Consider the following example: Jan/Feb 2015 . QUESTION 1 a) What does i t mean to say that a pe rson is a risk lover or is risk averse ( 4)? Compiled by Jeka: 073 768 7330 /084 4995721 www.jekanomics .com 3 b) Suppos e that two projects have the same f our payoffs but the probability associated with each pay off differ as shown below. Payoff Project A Project B R100 0.3 0.2 R150 0.2 b R50 a 0.1 R200 0.1 0.2 i) What is the probability of getting a payoff of R50 under project A and a payoff of R 150 under project B [ Fill in the missing probability values] (2) ii) Find the expected return and standard deviation of each project ( 14)? iii) If Sam son's utility function is U = 2I , where I denote the payoff, which Investment Will S amson choose (5) SOLUTIONS : a) A risk lover is an individual who is willing to take more risks in any given situation in return for little reward whilst a risk averse person will only assume more risk if potential returns are high. Risk averse people are ge nerally afraid of taking risks. b) The missing values are shown in red: Payoff Project A Project B R100 0.3 0.2 R150 0.2 0.5 R50 0.4 0.1 R200 0.1 0.2 i) Missing values are as follows: Project A =0.4: Project B = 0.5 ii) Expected return and standard deviation are calculated as follows Project A Compiled by Jeka: 073 768 7330 /084 4995721 www.jekanomics .com 4 Expected return: E(Xa) = P 1 X1 + P 2X2 + P 3X3+……………………+P nXn = 0.3 x100 +0.2x 150 +0.4x50+0.1x200 = 100 Variance = P 1 [X1 =E(Xa) ]]2 + P 2[X2 –E(Xa)]2 +P3[X3-E(Xa)]2...............+P n [Xn-E(Xa)]2 = 0.3 x(100 -100)2 +0.2(150 -100)2 +0.4(50 -100)2 +0.1(200 -100)2 = 0.2x(50)2 +0.4( -50)2 +0.1(100)2 = 500 +1000+1000 = 2500 Standard deviation = 2500 ½ = 50 PROJECT B Expected return: E(Xb) = P 1 X1 + P 2X2 + P 3X3+……………………+P nXn = 0.2 x100 +0.5x 150 +0.1x50+0.2x200 = 140 Variance = P1 [X1 =E(Xb)]]2 + P 2[X2 –E(Xb)]2 +P3[X3-E(Xb)]2...............+P n [Xn-E(Xb)]2 = 0.2 x(100 -140)2 +0.5 (150 -140)2 +0.1(50 -140)2 +0.2(200 -140)2 = 0.2x( -40)2 +0.5( -10)2 +0.1( -90)2 +0.2(60)2 = 320 +50+810+720 = 1900 Standard deviation = 1900 ½ = 43.59 = 44 iii) The investment which Samson will choose will depend on the expected utility from each project. Project A E(U) = 0.3 x (2x100) + 0.2 x(2x150) + 0.4x (2x50) + 0.1 (2x200) = 0.3x200 + 0.2x300 +0.4x100 +0.1x400 = 200
