School of Arts and Social Sciences
ECON A231F Introduction to Microeconomics
Mid-term Test 2
Date: 1 December 2014
Time: 8:15pm – 9:30pm
9:00 – 10:00
10:00 - 11:00
11:00 - 12:00
12:00 - 13:00
13:00 - 14:00
14:00 – 15:00
15:00 - 16:00
16:00 - 17:00
Answer ALL questions.
Precise and concise answers are preferred to lengthy ones.
Relevant diagrammes are highly recommended.
(a) Kelly is a clerk and she earns $80,000 per annum. She thinks that her salary is too low. So she starts her own cake shop by using her savings of $100,000, which earns interest at 5 percent per annum. After one year, she earns an accounting profit of $80,000. What is Kelly’s economic profit? Show your calculation.
(b) Based on your answer in (a), is Kelly better off after running her own shop? Briefly explain.
An ECON A231F student argues: “The economic model of perfectly competitive market is very unrealistic because it predicts that firms in a perfectly competitive market earn zero profits in the long run. However, in reality, no firm would stay in business if it earned no profits.” Agree or Disagree? Explain.
Compared with perfect competition, quantity produced in monopolistic competition is inefficient as price is higher than marginal cost (i.e. allocative inefficiency). Why do some economists argue that even price is higher than marginal cost, it does not necessarily imply inefficiency?
(a) Consider trade relations between the United States and Mexico. They can choose either low tariffs or high tariffs. Refer to the following payoff matrix. The first entry in the bracket is the payoffs (in $billion) of Mexico and the second entry is the payoffs of the United States. What is the dominant strategy of Mexico? What is the dominant strategy of United States? Explain your answer.
(b) What is the Nash equilibrium?
United States’ decision
In general, monopoly creates inefficiency. Under what conditions will merger be justifiable from an efficiency point of view? Explain without using a diagram. (8 marks):
[END OF MID-TERM TEST]
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