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ECON20022
Microeconomics
Answer the Question in Section A and TWO QUESTIONS in Section B
Section A counts for 40% of the exam mark; Section B counts for 60 % of
the exam mark.
You are required to submit typed responses. Your exam responses will not be
accepted if it is not typed. You can include images of algebra or graphs if you
wish.
Where relevant, questions include word limits. These are limits, not targets.
Excellent answers can be shorter than the word limit. If you go beyond the word
limit the additional text will be ignored. Where a question includes a word limit
you HAVE to include a word count for your answer (excluding formulae).
Candidates are advised that the examiners attach considerable importance to
the clarity with which answers are expressed
You must correctly enter your registration number and the course code on your
answer.
P.T.O
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Section A (This section counts for 40% of the exam mark)
Question 1
a) Consider a two-person, two-commodity, pure-exchange economy: consumer A
and consumer B consume only two goods, X and Y, available in the economy.
Assume A’s preferences are described by =
and B’s preferences are
described by =
, where , , , and are the consumption of X and
Y by consumers A and B, respectively. Also consider that + = 0 and
+ = 0, where 0 and 0 are aggregate endowments. Derive the contract
curve as an implicit function of and . What condition on the coefficients,
and , will ensure that the contract curve is a straight line? [Word limit: 100
word] [ 15 marks]
b) Consider two representative individuals, individual A and individual B, in a pure
exchange economy with two goods. Individual A has an advantageous position
in compared to B in terms of initial allocations of resources. Using the First
Welfare Theorem and with an Edgeworth box diagram, explain intuitively how
this economy could still achieve the Pareto efficient exchange equilibrium,
assuming a competitive market and no other distortions in the market. Such an
equilibrium may not be desirable (e.g. not equitable). Explain (intuitively and
with an Edgeworth box diagram) the role of the Second Welfare Theorem in
making this Pareto equilibrium more equitable. [Word limit 200] [15 marks]
c) Discuss whether and how the Coase mechanism (as proposed in the article
below and as discussed in the lecture) can be useful in reality by providing one
real-world example. [Word limit 300] [10 marks]
Coase, R. (1960). The Problem of Social Cost. The Journal of Law and
Economics 3: 1-40.
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Section B
(Answer TWO from this section. Section B counts 60% of the exam mark.)
Question 2
Consider the following Public good game. There are 4 players in a group and each
player has £y as an endowment. Player i’s pay-off function is given by: = − +
∑
4
=1 , where is player i’s voluntary contribution to the public good, is the
marginal per capita return from a contribution to the public good and 0 < < 1 < 4.
Following rational choice theory, if it is common knowledge that every player is rational
and self-interested and they can do backward induction, the dominant strategy of each
player is to give zero to the public good (i.e. = 0). Suppose, a researcher conducts
a finitely repeated anonymous public good game with the randomly chosen players in
each group over all rounds and the same pay-off function described above.
a) What results would the researcher expect based on the results from the
existing literature (e.g. Fehr and Gächter 2000, see reference below)?
[Word limit: 100] [5 marks]
b) Explain intuitively whether an institution with ‘punishment’ (i.e. punishing
non-cooperative behaviour) can improve the outcome? Briefly state how
one can conduct an experiment to test this. [Word limit: 500] [15 marks]
c) Explain intuitively, with example, whether ‘leadership’ of individuals can help
improve contributions to a public good. [Word limit: 300] [10 marks]
Question 3
a) As we discussed in the lecture, Vickrey auction (1961) is demand revealing as
each rational bidder’s dominant strategy is to bid their true value. However,
experimental studies document overbidding behaviour as bidders could
increase the probability of winning the auction by overbidding with very little
additional costs to them (as they pay the second highest bid). Some people
criticise such results from lab experiments as they claim that the participants
are not sincere in choosing their actions in the lab because they receive the
monetary endowment for free. To address such a concern, propose an
experimental design that can examine bidders’ sincere biding behaviour, given
induced and independent private values and Vickrey auction in the lab. [Word
limit: 400] [15 marks]
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b) Write a brief summary of the following paper (see reference below). In the
summary, you may want to 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
(choose a different example than the one used in the paper). [Word limit 400]
[15 marks]
Fehr, E. and Leibbrandt, A., 2011. A field study on cooperativeness and
impatience in the tragedy of the commons. Journal of public
economics, 95(9-10), pp.1144-1155.
Question 4.
Consider a model of contract design under asymmetric information. A regulator (or
policy maker) wants to provide a subsidy, by designing a voluntary incentive
contract, to a firm (who is a regulated monopolist) for exerting effort to reduce
pollution from its production process. The regulator is the principal and the firm is an
agent.
A firm’s utility is: = − (),
where
() is the cost function of taking efforts with ′(. ) > 0 and ′′(. ) > 0
is the monetary transfer from the regulator to the firm
assume the firm has social preferences toward environmental protection and
captures such social preferences ( > 0)
define as the firm’s intrinsic valuation of money (i.e. how much a firm loves
money over environment)
a firm with low means that the firm’s cost of per unit of exerted is less than
a firm with high
is a firm’s private information
A firm’s effort has social value and social cost = − , where is the
efficiency parameter of the firm and is effort. The efficiency parameter, , is
fixed and common knowledge. The regulator observes the cost ex-ante.
The regulator cannot observe . She knows the firm is one of two types depending
on two levels of . Assume a firm can be one of two types depending on their
social preferences toward environmental protection, ∈ (, ), and < .
The consumers’ value, if the firm exerts effort, is, = − (1 + )( + ), where
> 0 is the social value of public funds used by the regulator to compensate the
firm.
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END OF EXAMINATION
A firm suffers a monetary loss when it exerts efforts to reduce pollution. It will
voluntarily participate if it gets monetary transfer from the regulator to compensate
its loss. The regulator is going to offer up a monetary transfer, t, to the firm in
exchange for effort by the firm, i.e. she designs a contract to maximize social
welfare from pollution reduction subject to the firm’s participation constraint.
Social welfare is the utility of private firms and consumers, and cost of monetary
compensation scaled by social value of public funds.
a) Set up the objective function of the regulator and the constraint under
complete information about and . Show and explain the optimal
conditions. [Word limit: 100 words] [10 marks]
b) Under asymmetric information, however, the regulator only knows that a firm
could be one of two types but does not know which type it is. Construct and
explain the constraints that the regulator must consider under asymmetric
information. Compare the constraints with the complete information case
and explain intuitively. Using the constraints, identify the volume of
‘information rent’, if any. Give a roadmap how to solve the problem (no need
to solve, you need to explain the steps). [Word limit: 250 words] [20
marks]