Microeconomics Final Exam Written Portion

Question Two - S2 (c)(iii) Which cell in the matrix will be the market result assuming no collusion between the firms? (1 mark)

(price war, price war) or (3,3) or bottom right cell (1 mark)

Question One -S1 (b)(i) Your friend wants to borrow $30,000 off you, and will pay you back $20,000 in one yearís time, and $12,000 in two years. Assume the current real interest rate is 5%, and that your decision to lend your friend the money will be based solely on the financial returns. What is the net present value of the future repayments from your friend? (Show your working).(2Marks)

20000/(1.05)1 (1/2 mark) + 12000/(1.05)2 (1/2 mark) = $19047.62 + $10,884.35 = $29931.97 (1 mark for correct final amount, allow for any minor rounding discrepancies)

Question Two - S1 (c)(ii) Assuming a demand function of QD = 75 ñ 3P, what is the price elasticity of demand at a quantity of 30? Be sure to state what type of price elasticity of demand your answer shows, and to Show your working. (3 marks)

30 = 75 - 3P 45 = 3P 15 = P (1 mark) PED = -3 x 15/30 PED = -1.5 (1 mark, still award if negative sign is missing) PED is elastic (1 mark)

Question One - S2 (b)(i) Explain the difference between a variable cost and a fixed cost, and give an example of each cost for a strawberry grower. (3 marks)

A variable cost changes with output (1 mark). Any correct example such as wages (1/2 mark). A fixed cost does not change with output (1 mark). Any correct example such as a lease (1/2 mark).

Question Two - S2 (a)(i) Copy the set of axis below into your answer booklets and show a profit maximising monopolist making positive economic profit. (6 marks)

AR drawn and labelled correctly (1/2 mark) MR drawn and labelled correctly (1/2 mark) MR x-axis intercept halfway between origin and AR curve intercept (1/2 mark) AC drawn and labelled correctly (1/2 mark) MC drawn and labelled correctly (1/2 mark) MC cuts AC at its lowest point (1/2 mark) AR at Q correctly identified on vertical axis (1/2 mark) AC at Q correctly identified on vertical axis (1/2 mark) Positive economic profit of areas 1, 2 and 3 correctly identified (1 mark) and labelled (1 mark)

Question Two - S2 (d)(vi) Explain what the substitution effect would be due to a decreased price of apples on the quantity of apples and all other goods. (2 marks)

An increase in the quantity demanded of apples (1 mark) and a decrease in the quantity demanded of all other goods (1 mark)

Question Two - S1 (b)(iv) Give one example of something that would cause a movement up the supply curve for labour, and one example of something that would cause the supply curve for labour to shift right. (2 marks)

An increase in the wage rate (1 mark) Any correct reason that increases supply apart from a wage increase such as higher retiring age, increased immigration etc (1 mark)

Question One - S2 (b)(v) Give two characteristics of a perfectly competitive market structure that do not exist for an oligopoly market structure. (1 mark)

Any two of many buyers, many sellers, perfect information, identical product, price taker, perfect knowledge (1/2 mark for each correct answer to a maximum of 1 mark).

Question Two - S2 (d)(v) Identify the area on your diagram which shows the increase in efficiency as a result of moving to the social equilibrium. Be sure to explain what the area of increased efficiency is (e.g. consumer surplus, producer surplus etc.). (3 marks)

Areas 1 and 2 identified as increase in efficiency (1 mark) Area 1 is positive externality (1/2 mark), consumer surplus (1/2 mark) and cost of the subsidy (1/2 mark). Area 2 is positive externality (1/2 mark)

Question Two - S2 (d)(iii) Explain why the quantity you did NOT choose in (ii) above is NOT allocatively efficient. (2 marks)

At Qp the quantity is too small (1 mark) as it does not account for the positive externality (1 mark for the idea)

Question Two - S1 (d) Copy the set of axes below into your answer booklet and show the effect on a utility maximising consumer of an increase in the price of a pizza on the quantities of pizza and all other goods consumed. Be sure to show and explain the income and substitution effects. (6 Marks)

BL1 drawn correctly showing a decrease on the pizza axis and no change on the all other goods & services axis (1 mark) New relative prices line shown parallel to BL, and tangent to I (1/2 mark) New quantities at point B shown on both axes (1/2 mark) I1 drawn at a tangent to BL1 (1/2 mark) New quantities shown on both axes at point C (1/2 mark) A to B identified as substitution effect (can be shown on the axes) (1/2 mark) B to C identified as income effect (can be shown on the axes) (1/2 mark) Substitution effect explained as being a movement around the existing indifference curve (1/2 mark) as a result of a change in relative prices (1/2 mark for idea) Income effect explained as being a shift to a new indifference curve (1/2 mark) due to decreased purchasing power/real income (1/2 mark for the idea)

Question One -S1 (c)(ii) Which cell in the matrix will be the market result assuming no collusion between the firms? (1 mark)

Both firms pricing normal (1 mark)

Question One - S2 (a)(iv) On your graphs in (iii) above, show the effect of an increase in the world price for strawberries caused by the increased demand mentioned in the article. Briefly explain your diagram. (8 marks)

Demand curve shifted right and labelled (1 mark), with new P (1/2 mark) and Q (1/2 mark) correctly labelled. MR1=AR1 curve correctly drawn at P1 (1 mark) and labelled (1/2 mark) New profit maximising quantity shown at Q1 where MC=MR1. (1 mark) Positive economic profit correctly shown at Q1 (areas 1, 2 & 3) (1 mark) and labelled (1/2 mark). Explanation that at the higher world price the revenue curves for the firm will shift upward (1/2 mark), resulting in a larger profit maximising quantity where MC=MR1, (1/2 mark) and a positive economic profit being made (1 mark).

New Zealand strawberry exports rise to meet new markets New Zealand strawberry growers have seen increased demand for exports as markets open up around the world. ìItís broader now, in terms of where we can go, so itís opened up opportunities for us a bit more," North Island grower Phil Greig says. "We definitely did more export this season. We always do a lot through Asia--Hong Kong, Thailand, Singapore -- and we also did a bit to the United States this year because itís opened up a bit more there. We also exported a bit to Canada and to the Middle East." The latest strawberry season has just wrapped up, and while Mr Greig said it was too early to give definite numbers, demand was up across the board. ìAll markets had increased demand. Asia is definitely a growing market and so is the Middle East, but all of them are growing,î he says. ìI think once a new market opens up, they get into a pattern and they just want more. Especially when the quality of the fruit is so good.î He says exports play a significant role for the major strawberry growers in New Zealand, particularly when it comes to pricing and affordability. ìIf we have a good export market, the main growers here can divert a certain amount of fruit across to other countries and helps keep prices reasonable across New Zealand.î Question One - S2 (a)(i) On a world supply and demand diagram, show the effect of an increased demand for strawberries on the price and quantity of strawberries. (3 marks)

Demand curve shifts right (1 mark) Original price labelled (1/2 mark) Original quantity labelled (1/2 mark) New price labelled (1/2 mark) New quantity labelled (1/2 mark)

Question One -S1 (a)(i)Copy the diagram below into your answer booklet and show the marginal perfectly competitive NZ dairy farm making a zero economic profit at the current world price. (4 marks)

MC correctly drawn and labelled (1 mark) AC correctly drawn and labelled (1 mark) MC cuts AC at its lowest point (1/2 mark) AR=MR correctly labelled (1/2 mark) Q correctly labelled where MC=MR (1 mark)

Question One -S1 (a)(v) Some dairy farmers will choose to leave the industry in the short run. Use a diagram to show a perfectly competitive firmís short run break even and shut down points. (51/2 marks)

MC curve correctly drawn and labelled (1/2 mark) AC curve correctly drawn and labelled (1/2 mark) AVC curve correctly drawn and labelled (1/2 mark) MC cuts AC at its lowest point (1/2mark) MC cuts AVC at its lowest point (1/2mark) AR=MR drawn at break-even point (1/2 mark) AR=MR drawn at shut-down point (1/2 mark) Shut-down point correctly identified (point B) (1 mark) Break-even point correctly identified (point A) (1 mark)

Question One - S2 (b)(ii) Explain what marginal cost is and how it is calculated. (2 marks)

Marginal cost is the cost of producing another unit (1 mark for the idea). It is calculated as the change in total cost when another unit is produced (or change in total cost over change in quantity) (1 mark)

Question Two - S1 (a)(iii) With reference to your diagram in (i) above, explain the impact of the tax on efficiency. (3 marks)

Market failure exists at the market equilibrium (1 mark) as the market has not accounted for the externality (1/2 mark) resulting in too big a quantity being produced/consumed (1/2 mark). The effect of the tax is to improve efficiency (1/2 mark) as it reduces the quantity (1/2 mark).

Question One - S2 (b)(iii) Explain why in the short-run, the marginal cost curve typically decreases then increases. As part of your answer, give the terms used to describe marginal cost increasing and decreasing. (3 marks)

The MC curve decreases when another unit of a variable input adds more to total output than the previous unit (1 mark). This is called increasing returns (1/2 mark). The MC curve increases when another unit of a variable input adds less to total output than the previous unit dis (1 mark). This is called decreasing/diminishing returns (1/2 mark).

Question Two - S2 (a)(iii) Explain why a monopolist would be happy to continue making zero economic profits in the long run. (2 marks)

The firm is still making an accounting profit/receiving a return on their investment (1 mark) which is equal to their opportunity cost (1 mark for the idea)

Question One -S1 (a)(vi) Use your diagram to explain when and why a firm would choose to leave an industry in the short-run.(3 marks)

The firm would leave the industry in the short run if their revenue/price does not cover any of their fixed costs and only some of their variable costs (1 mark) because they would lose less money by shutting down then remaining open (1 mark for the idea) as if they shut down they only have to pay their fixed costs (1 mark).

Question Two - S1 (b)(iii) Given the scenario described in (ii) above, what would QS ñ QE represent? (1 mark)

The labour that people were previously unwilling to supply but now are (1 mark for the idea)

Question Two - S2 (b)(i) Monopolists sometimes use price discrimination to increase profits. Explain what third degree price discrimination is and give an example a monopolist could use. (2 marks)

Third degree price discrimination is when the firm segments the market (1/2 mark for the idea) and charges a different price to each segment (1/2 mark for the idea) based on price elasticity of demand (1/2 mark for the idea). Any correct example such as student discount, senior citizen discount (1/2 mark)

Question Two - S2 (c)(i)Explain why firms in an oligopoly market structure would use non-price competition. (2 marks) Assume that Firm A and Firm B are both considering whether to use non-price competition or start a price war. The following pay-off matrix illustrates the profits (in $Mís) available to both firms arising from their joint actions. Firm Aís profits are written first.

To increase market share (1 mark for the idea) while not sparking a price war (1 mark for the idea)

Question One - S2 (b)(iv) In the long run, a firmís break-even point is also their shut down point. Is the above statement true or false? Explain why. (3 marks)

True (1 mark). In the long run all costs are variable (1 mark for the idea) so the AVC curve is also the AC curve (1 mark for the idea).

Question Two - S2 (b)(iv) What is the main difference between a monopolistic competitor and a perfect competitor that allows a monopolistic competitor to have a weak degree of control over price? (1 mark)

A perfect competitor has an identical product (1 mark for the idea)

Question Two - S2 (b)(iii) Why can't a perfect competitor use price discrimination? (1 mark)

A perfect competitor is a price taker/has no control over price (1 mark for the idea)

Question Two - S2 (c)(ii) Explain what a dominant strategy is and identify any dominant strategies that exist in the matrix. (3 marks)

A dominant strategy is one a firm plays regardless of the actions of the other player (1 mark for the idea). Firm A has a dominant strategy of price war (1 mark). Firm B has a dominant strategy of price war (1 mark)

Question One -S1 (c)(i) Assume that Firm A and Firm B are both considering whether to price normally or start a price war. The following pay-off matrix illustrates the profits (in $Mís) available to both firms arising from their joint actions. Firm Aís profits are written first. Explain what a dominant strategy is and identify any dominant strategies that exist in the matrix. (2 marks)

A dominant strategy is one that is followed regardless of the other party's actions (1 mark for the idea). Firm A has a dominant strategy of price normal (1/2 mark) and firm B has a dominant strategy of price normal (1/2 mark)

Question One -S1 (a)(iv) Using the concepts of accounting and economic profits, explain why a non- profit maximising dairy farmer may continue to stay in an industry making negative economic profit in the long run. As part of your answer, explain the difference between accounting and economic costs. (2 marks)

A farmer may stay in the industry whilst making a negative economic profit because they may still be making an accounting profit which is satisfactory to them (1 mark for any reasonable idea). The difference between economic costs and accounting costs is that economic costs include opportunity costs (1 mark for the idea).

Question One -S1 (a)(vii) Explain the difference between fixed and variable costs, and give an example for each that a dairy farmer may incur. (2 marks)

A fixed cost does not change when output changes while a variable cost does (1 mark for the idea). An example of a fixed cost for a dairy farmer would be a mortgage payment (1/2 mark for any correct answer). An example of a variable cost for a dairy farmer would be wages for casual workers (1/2 mark for any correct answer).

Question One - S2 (a)(ii) Copy the set of axis and table below into your answer booklets and show the effect on the graph and the table of an increase in the world price of strawberries. (7 marks)

New Wp1 correctly drawn above Wp (1 mark) S curve correctly labelled (1/2 mark) D curve correctly labelled (1/2 mark)

Question One -S1 (a)(ii) Show on your diagram the effect of a falling world price on the profit of the firm. Be sure to fully label your diagram. (4 marks)

New lower world price correctly drawn (1/2 mark) and labelled with P/Wp/Pw etc (1/2 mark) New world price labelled as AR1=MR1 or such like (1/2 mark) New Q identified where MR1=AR (1 mark) Area of profit correctly shown (1 mark) and identified (1/2 mark)

Question One -S1 (c)(iii) Is this game is an example of a prisonersí dilemma. Why/Why Not? (2 marks)

No (1 mark) as the outcome is not inferior (1 mark for the idea)

Question One -S1 (b)(ii) Should you lend the money to your friend? Explain your answer. (2 marks)

No (1 mark) as you would make a better return by putting your money in the bank (1 mark for the idea)

Question One - S2 (a)(iii) Copy the set of axis below into your answer booklets and show a strawberry grower in NZ making a zero economic profit at the current world price of strawberries. Assume the strawberry grower is a perfect competitor. (5 Marks)

P (1/2 mark) and Q (1/2 mark) correctly identified and labelled on market diagram Horizontal AR=MR correctly drawn at P (1/2 mark) and correctly labelled (1/2 mark). MC and AC correctly drawn and labelled (1 mark) with MC cutting AC at its lowest point. (1/2 mark) Profit maximising Q shown where MC=MR (1/2 mark) Zero economic profit being made at Q (1 mark)

Question Two - S2 (d)(iv) Assume the Government decides to subsidise the apple market producers to internalise the externality. On your diagram, show a subsidy being imposed on the producer side in the market. Be sure to label all prices, and relabel any curves as necessary. (2 marks)

Pe correctly labelled (1/2 mark) Pe correctly labelled (1/2 mark) Pe correctly labelled (1/2 mark) SMC=PMC+Subsidy correctly labelled (1/2 mark)

Question Two - S1 (b)(ii) If the diagram above was for a minimum wage (price) placed in the labour market, and the government didnít ëbuyí unsold labour, using the notation on the axis give the number of people who have lost their jobs as a result of the minimum wage? (1 mark)

QE - QD (1 mark)

Question Two - S2 (d)(ii) Which quantity on your diagram above represents the allocatively efficient quantity? (1 mark)

Qs (1 mark)

Question Two - S1 (a)(i) Read the article below and answer the questions that follow. Govt should raise tobacco taxes by up to 50 per cent: smoking opponents SAM SACHDEVA February 10 2016 Increasing tobacco taxes by as much as 50 per cent a year could form the "backbone" of efforts to make New Zealand smoke-free, politicians have been told. Tobacco taxes increased by 10 per cent at the start of the year, and academics and anti-smoking groups have encouraged Parliament's finance and expenditure select committee to support a bigger price hike. Otago University public health professor Nick Wilson, who has studied the best-value methods for reducing the impact of smoking, said politicians were "on extremely strong scientific ground" when raising taxes on tobacco. "It's one of the most powerful things that can be done to improve the health of the population ... tax can be the backbone of the strategy." Wilson said raising taxes would save money in the health sector within a year, due to a reduction in heart attacks and strokes, while it would also reduce the gap in smoking rates between Maori and non-Maori. "This is in some way a no-brainer public health intervention if you're actually gaining healthy years of lives and saving health costs." (a)(i) Copy the axis and table below into your answer booklet. On the set of axes, showing the market for tobacco with a negative externality of consumption. Be sure to fully label all curves, and show any quantities. (5 marks)

S=PMC=SMC correctly labelled (1 mark) D=PMB correctly labelled (1 mark) SMB correctly drawn and labelled (1 mark) Qp correctly identified and labelled (1 mark) Qs correctly identified and labelled (1 mark)

Question Two - S1 (a)(ii) EXPLAIN AND SHOW on your diagram in (ii) above the effect on price and quantity of an imposition of a tax on the cigarette market. You can show the tax being imposed on the demand side or the supply side. Be sure to fully label any new curves. (4 marks)

SMB=PMB + Tax or SMB=D + Tax correctly labelled (1 mark) Pc correctly labelled (1/2 mark) Pp correctly labelled (1/2 mark) Explanation that the consumer price rises (1/2 mark) and the producer price falls (1/2 mark) resulting in a smaller quantity (1/2 mark) at the social equilibrium (1/2 mark for the idea)

Assume the apple market contains a positive externality of production. Question Two - S2 (d)(i) Copy the diagram below into your answer booklets and complete the diagram to show the apple market with a positive production externality. Be sure to label all curves and quantities correctly. (4 marks)

SMC curve correctly labelled (may also be labelled PMC + Subsidy) (1 mark) PMB=SMB or D=PMB=SMB curve correctly labelled (1 mark) Qp correctly identified (1 mark) Qs correctly identified (1 mark)

Question Two - S2 (b)(ii) Give one characteristic discussed in class which is necessary for third degree price discrimination to operate correctly. (1 mark)

The market must be able to be segmented or one customer cannot sell to another customer (1 mark for the idea)

Question One -S1 (a)(iii) Given the type of profit being made in (ii) above, DESCRIBE (You do NOT need to draw a diagram) how this firm would return to zero economic profit in the long run in the absence of any cost changes (in other words, if the falling world price affected many firms in many countries). Be sure to explain any changes in the world dairy market. (51/2 marks)

The number of firms in the market would decrease (1 mark) causing the supply curve to shift left/a decrease in supply (1/2 mark) and the price to increase (1 mark) resulting in an increase in AR=MR (1 mark) until zero economic profit is made (1 mark) at a higher profit maximising quantity (1 mark)

Question Two - S2 (a)(ii) Explain why a monopolist faces a downward sloping demand curve, but a perfect competitor faces a horizontal demand curve. (2 marks)

The perfect competitor can sell as much as it wants at the current market price (1 mark) while the monopolist must lower its price to sell another unit (1 mark)