THE AUSTRALIAN NATIONAL UNIVERSITY
Semester Two, 2019: Final Examination – 1 November 2019
Microeconomics 2
ECON 2101
Reading Time: Fifteen Minutes.
Writing Time: Three Hours.
Permitted Materials: Non-programmable Calculator.
Page 1 of 6 – Microeconomics 2 (ECON 2101)
Instructions
1. The exam consists of four questions, each of which is worth twenty-five marks. As
such, there are a total of one-hundred marks available on this exam.
2. The division of marks between parts of a question is indicated within each question
itself.
3. Please attempt as many questions as you can in the allotted time for this exam.
4. Answer each question in the script book (or books) provided.
5. Please start each question on a new page of the script book.
6. A copy of the “Some useful formulae” document that was provided during this
course can be found at the end of this exam.
7. Good luck!
Page 2 of 6 – Microeconomics 2 (ECON 2101)
Question 1 (25 marks)
1. Ted describes his preferences over combinations of hamburgers and glasses of scotch
as follows. “I like both hamburgers and scotch up to a point, but after that point
further consumption of either of them makes me feel increasingly ill.” Draw a family
of representative indi↵erence curves that illustrate Ted’s preferences. Indicate the
direction(s) of increasing satisfaction for Ted in your diagram. Are Ted’s prefer-
ences locally non-satiated? You should include a brief explanation that provides a
justification for each of your answers. (5 marks.)
2. “If a consumer doesn’t consume any snails but does consume Big Macs, then his
marginal rate of substitution between snails and Big Macs when his snail consump-
tion is zero must be equal to the ratio of the price of snails to the price of Big Macs.”
Is this claim true, false or ambiguous? Justify your answer. (5 marks.)
3. Is the following claim true, false, or ambiguous? Justify your answer.
“A consumer has the utility function U (x1, x2) = x1 + 2
modity one is $2 and the price of commodity two is $1. The consumer’s income is
$20. If the price of commodity two rises to $2, then entire change in demand for
commodity two is due to the substitution e↵ect.” (7 marks.)
4. Describe and illustrate the derivation of the optimal choice of health status, health
care, and the composite “all other consumption” commodity in the Wagsta↵ model
of the demand for health care.1 Analyse the impact of an increase in the price of
health care on the optimal choice of health status, health care, and the composite
“all other consumption” commodity in the Wagsta↵ model. (8 marks.)
1Wagsta↵, A (1986), “The demand for health: Theory and applications”, The Journal of Epidemiology
and Community Health 40(1), March, pp. 1–11.
Page 3 of 6 – Microeconomics 2 (ECON 2101)
Question 2 (25 marks)
where x1 is the amount of co↵ee he consumes per week and x2 is the amount of tea
he consumes per week. Herbie has $200 a week to spend. The price of co↵ee is $1
per cup. The price of tea is currently $4 per cup. Herbie has received an invitation
to join a club devoted to the consumption of tea. If he joins the club, Herbie can
get a discount on the purchase of tea. If he belonged to the club, he could buy tea
for $1 per cup. What is the largest membership fee that Herbie would be willing to
pay to join this club? (8 marks.)
2. Bernice’s preferences can be represented by the utility function
U (x1, x2) = min (x1, x2). The price of commodity one is one dollar, the price of
commodity two is two dollars, and her income is twelve dollars. Suppose that an
economic shock results in the price of commodity one rising to three dollars and the
price of commodity two falling to one dollar. What is the the compensating varia-
tion measure of the impact of this shock on her welfare? What is the the equivalent
variation measure of the impact of this shock on her welfare? Illustrate your answers
using diagrams involving indi↵erence curves and budget lines. (8 marks.)
3. Rosalie is a von Neumann-Morgenstern expected utility maximiser whose initial
wealth is $1, 000. She is o↵ered the chance to invest all of this wealth in a project
which has a fifty percent chance of making $200 and a fifty percent chance of losing
$100. The utility that she derives from various wealth levels is shown in the table
below. Will Rosalie invest in the project? What is the risk premium that Rosalie
associates with the project? Justify your answers. (9 marks.)
A Brief Comment on Terminology
In this document, a function has been very loosely (and perhaps even slop-
pily) described as taking the form “y = f(x)”. Strictly speaking, this is the
equation that describes the graph of the function f(x). All coordinates of
the form (x, y) that satisfy the equation y = f(x) belong to the graph of the
function f(x), with x being the independent variable and y the associated
dependent variable.