SECTION A
Questions 1 to 5 of the examination question paper are PRACTICAL questions.
Please answer ALL five questions. Section A counts 55 marks out of a total of 100.
Please answer the questions by showing all the steps.
QUESTION 1 (15 marks)
In this question, write whether each statement is true or false. Fully explain your answer,
using a diagram if appropriate.
1.1 Michael only consumes two goods: X and Y. If X is a Giffen good for Michael, then Y must
be a normal good for Michael.
True. A Giffen good is an inferior good. Since Michael only consumes two
goods, they cannot both be inferior goods. Therefore, Y is a normal good.
(It is important to explicitly point out explicitly that Giffen goods are a special
kind of inferior goods, or the negative income effect of a Giffen good dominates
the substitution effect. Students who only say that the consumption of a Giffen
good decreases with income without an explanation lose partial points.)
(3 marks)
1.2 If S and F are perfect complements, you must be indifferent between these two bundles:
bundle one consists of one unit of S and one unit of F; and bundle two consists of two
units of S and one unit of F.
False. The line that goes through the kinks of the indifference curves does not
need to have slope 1. Consider a consumer that likes to consume both goods
in a ratio 2:1. In that case, the first bundle is in another indifference curve with
a lower level of utility associated.
(3 marks)
,1.3 In a perfectly competitive market, firms take the market price as a given, which implies
that the market demand is infinitely elastic.
False. In a competitive market, firms are assumed to be very small, therefore
they are assumed to have no influence on the market price – like if they faced
an infinitely elastic demand at the market price level. Nevertheless, the market
demand can be elastic or rigid.
(3 marks)
1.4 A risk averse individual that has to decide between two different lotteries will always prefer
a lottery with less risk.
False. A risk averse individuals dislike risk but not at “any price”. They will take
into account the expected value of each lottery in their decisions.
(3 marks)
1.5 A consumer finds two goods to be perfectly substitutable. Therefore, the optimal bundle
for this consumer will always be a corner solution.
False. Consider for example the utility function u = x + y. The optimal bundle will
be a corner solution if the prices of the two goods are different, if the prices are
the same, then any allocation is optimal.
(3 marks)
QUESTION 2 (5 marks)
Qd 10 2P
Suppose the demand function for corn is, , and the supply function is,
Qs 3P 5 . The government is concerned that the market equilibrium price of corn is too low
and would like to implement a price support policy to protect the farmers. By implementing the
price support policy, the government sets a support price and purchases the extra supply at the
support price. In this case, the government sets the support price at
ps 4 .
2.1 Calculate the original market equilibrium price and quantity in the absence of the price
support policy.
, Step 1
10 2P 3P 5
Thus
3P 2P 10 5
15
Pe
5
Pe 3
Step 2
Qe 10 2(3)
10 6
Qe 4
(2 marks)
2.2 Draw a diagram to show the change in the consumer surplus due to the implementation of
the price support policy. Calculate the change in the consumer surplus.
The loss to consumer is 2(4 −3) + (4 −2)(4 −3) / 2 =3, which is area A+B in the
following graph.
P
ps 4
A B
Pe 3
Q
(3 marks)
Government Purchase
Questions 1 to 5 of the examination question paper are PRACTICAL questions.
Please answer ALL five questions. Section A counts 55 marks out of a total of 100.
Please answer the questions by showing all the steps.
QUESTION 1 (15 marks)
In this question, write whether each statement is true or false. Fully explain your answer,
using a diagram if appropriate.
1.1 Michael only consumes two goods: X and Y. If X is a Giffen good for Michael, then Y must
be a normal good for Michael.
True. A Giffen good is an inferior good. Since Michael only consumes two
goods, they cannot both be inferior goods. Therefore, Y is a normal good.
(It is important to explicitly point out explicitly that Giffen goods are a special
kind of inferior goods, or the negative income effect of a Giffen good dominates
the substitution effect. Students who only say that the consumption of a Giffen
good decreases with income without an explanation lose partial points.)
(3 marks)
1.2 If S and F are perfect complements, you must be indifferent between these two bundles:
bundle one consists of one unit of S and one unit of F; and bundle two consists of two
units of S and one unit of F.
False. The line that goes through the kinks of the indifference curves does not
need to have slope 1. Consider a consumer that likes to consume both goods
in a ratio 2:1. In that case, the first bundle is in another indifference curve with
a lower level of utility associated.
(3 marks)
,1.3 In a perfectly competitive market, firms take the market price as a given, which implies
that the market demand is infinitely elastic.
False. In a competitive market, firms are assumed to be very small, therefore
they are assumed to have no influence on the market price – like if they faced
an infinitely elastic demand at the market price level. Nevertheless, the market
demand can be elastic or rigid.
(3 marks)
1.4 A risk averse individual that has to decide between two different lotteries will always prefer
a lottery with less risk.
False. A risk averse individuals dislike risk but not at “any price”. They will take
into account the expected value of each lottery in their decisions.
(3 marks)
1.5 A consumer finds two goods to be perfectly substitutable. Therefore, the optimal bundle
for this consumer will always be a corner solution.
False. Consider for example the utility function u = x + y. The optimal bundle will
be a corner solution if the prices of the two goods are different, if the prices are
the same, then any allocation is optimal.
(3 marks)
QUESTION 2 (5 marks)
Qd 10 2P
Suppose the demand function for corn is, , and the supply function is,
Qs 3P 5 . The government is concerned that the market equilibrium price of corn is too low
and would like to implement a price support policy to protect the farmers. By implementing the
price support policy, the government sets a support price and purchases the extra supply at the
support price. In this case, the government sets the support price at
ps 4 .
2.1 Calculate the original market equilibrium price and quantity in the absence of the price
support policy.
, Step 1
10 2P 3P 5
Thus
3P 2P 10 5
15
Pe
5
Pe 3
Step 2
Qe 10 2(3)
10 6
Qe 4
(2 marks)
2.2 Draw a diagram to show the change in the consumer surplus due to the implementation of
the price support policy. Calculate the change in the consumer surplus.
The loss to consumer is 2(4 −3) + (4 −2)(4 −3) / 2 =3, which is area A+B in the
following graph.
P
ps 4
A B
Pe 3
Q
(3 marks)
Government Purchase
