ECON20022 Microeconomics 4 Final Exam 2021-22
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ECON20022
Microeconomics 4
Final Exam
2021-22
Section A
(Answer all parts of Question 1 to get full credit)
Question 1 (Please note that part a, b, and c are independent questions. Answer all parts) [Word limit: 1300]
a. What do you mean by ‘Information Rent’ in contract design? If agents are boundedly self-interested (i.e., they have social preferences), instead of self- interested, what would happen to the volume of information rent and why? Explain with an example. [Word limit 500] [15 marks]
b. Write a brief summary of the following paper. In the summary, you should include the main research questions, motivation, research designs, and main findings of the paper. Next explain how the findings of this paper are
relevant/useful in reality by providing one real-world example [Word limit 600] [15 marks].
Rao, G., 2019. Familiarity does not breed contempt: Generosity, discrimination, and diversity in Delhi schools. American Economic Review, 109(3), pp.774-809.
c) Vedica (V) has the following utility function of wealth:
uV = y4/3
Vedica is a potential international immigrant to the United States. She works out that she faces the following lottery if she tries to travel to the US to work or to become a student. She starts with wealth of $20 000 . She is told that if she goes to the US, she could end up gaining additional wealth of $100 000 with probability (p) and that she could lose all of her $20 000 with probability ( 1 − p) . Vedica believes that she will be successful with a probability of 10%.
Read the following statement. Do you think the statement is true or false? Explain your answer mathematically and intuitively.
As a member of the government of the state from which Vedica originates, you evaluate Vedica’s case and work out that Vedica is risk-loving and you would need to compensate Vedica the equivalent of approximately $1340 for her to remain in your country and not emigrate. [Mark 10] [Word limit: 200]
Section B
(Answer all parts of any TWO of the following questions.)
Question 2 [Word limit: 500]
Consider the following game, called a voluntary contribution mechanism (VCM), as we discussed in the lecture. In this game, n players are each given an endowment y. Each player simultaneously selects an amount, ci, to contribute to provision of a public good, and 0 ≤ ci ≤ y; i = 1, 2, . . . .,n. Each player's payoff is:
几i = y − ci + m 
cj,wℎere m indicates tℎe marginal return from tℎe public good
The game may be one-shot or repeated. We shall assume the following parameters for the game: n = 8; m = 0.4; y = $15.
a. Why, assuming rational self-interested preferences, is the best response to contribute nothing and for all players not to contribute? Explain your answer with numerical numbers, given the parameter values, and intuitively. [2 marks]
b. Why are payoffs maximized if all players (1 to n) contribute? Explain your answer with numerical numbers given the parameter values. [2 marks]
c. Given your explanations to a. and b. above, why, then do we call this a public goods game and what other kind of game does it resemble? [2 marks]
d. Why, given the rational self-interested best response you proposed above, do we find empirically that many subjects contribute in one-shot public goods games and in public goods game repeated for many rounds? [3 marks]
e. Why, given your answer to c., might contributions decline over repeated games? Why does this not reflect ‘learning’? [3 marks]
f. What role does punishment play in promoting or inhibiting cooperation in public goods games? [3 marks]
g. Why might non-contribution be a rational and self-interested best response to the existence of punishment? What would a rational and self-interested player who has the ability to punish do in a VCM with punishment? [4 marks]
h. What are the best responses in a VCM if the parameter m > 1? Why? [3 marks]
i. If the m in the game above increased to 0.6, what would we predict if players had self-interested preferences? If players had social preferences? Why? [3 marks]
j. What are the Pareto-efficient outcomes in a VCM when mn < 1? Why? [3 marks]
k. How does ‘leadership’ affect contribution to public good? Give an example. [2 marks]
Question 3 (Please note that part a, b, and c are independent questions. Answer all parts)
Part A [Word limit: 400]
Consider a two-firm model with a negative production externality. Let xi denote firm i’s output, with i = 1, 2 . Suppose that two firms operate in two different competitive markets and each firm sells its product in its respective competitive market, at the prices p1 = 100 and p2 = 150 , respectively, and that they face the same direct production cost ci (xi ) = 
. Let e(x1, x2 ) = x1x2 be the external cost on firm 2’s activity generated by the production of firm 1.
a. Find each firm’s best response function to the output set by the other firm and compute the Nash equilibrium assuming that firms choose their output non-cooperatively and independently. Illustrate the equilibrium in an appropriate graph. [10 marks]
b. Calculate each firm’s equilibrium profits and the total external cost imposed on firm 2. [5 marks]
Part B [Word limit: 600]
c. Rational choice theory assumes that economic agents are rational and self-interested. Based on the evidence from behavioural laboratory experiments (e.g., dictator games), behavioural economists suggest that people are not always self-interested, rather they have intrinsic preferences for others’ well-being (e.g., altruism, inequity aversion). However, some other studies in behavioural economics investigate this further and disentangle the intrinsic preferences into several other factors. Following the discussion in the lecture, state two such studies that try to disentangle the true intrinsic preferences based on dictator games in the lab. Explain clearly and briefly the following: (i) what each study addresses; (ii) brief description of the experimental design; and (iii) intuitive explanations. [15 marks]
Question 4 (Please note that part a, b, and c are independent questions. Answer all parts)
Part A [Word limit 500]
Candice and Dominica are engaged in exchange over two goods: boxes of pens (x) and boxes of paper (y). They both have inequality averse preferences as defined by the following equation.
?i [ui (xi , yi ), uj (xj , yj )] = ui − 6i max[uj − ui , 0] − ai max[ui − uj , 0]
We assume that ai and 6i are identical for Candice and Dominica. In this interaction, the two players each treats themselves as player i and their co-participant as player j . The two players have the following initial endowments. Candice has 16 boxes of pens and 4 of paper. Dominica has 4 of boxes pens and 46 of paper.
a. Graph the Edgeworth box for the exchange between Candice and Dominica when they each have utilities that are Cobb-Douglas and take the following form:
1 1
ui = Xi(2)yi2
Candice knows Dominica's utility takes this form, and vice versa. They use this information when constructing their ?i functions. Derive the equation of the contract curve. In your Edgeworth box, show their initial allocations, their initial indifference curves, and the contract. [10 marks]
b. Referring to your Edgeworth box, explain the shape of the indifference curves and how we determine a Pareto efficient allocation in the Edgeworth box. [4 marks]
c. What would happen if ai increased? Explain by referring to your Edgeworth box. It is useful to think about what happens to marginal utility with changes in the consumption of pens and paper when ai changes. [6 marks]
Part B [Word limit: 500]
d. Leaving for holidays, Emma’s luggage may be lost with probability p = 0. 1. The luggage and its content are estimated to be worth £316.05. Emma’s utility function over monetary payoffs is given by u(X) = √X . Suppose Emma can insure against the loss of the luggage, what is the maximum insurance premium I that Emma would be willing to pay? [5 marks]
e. Using a diagram show and explain that a risk loving individual would decline the offer of full insurance coverage on actuarially fair terms. [5 marks]
2023-05-24