UNIVERSITY OF CAPE COAST

COLLEGE OF DISTANCE EDUCATION

Question 1
Assume that the market demand curve for diamonds is given by the following equation: P = 1000
- 2Q and the market supply curve, which is equal to the aggregated marginal cost curve of all
producers, is given by, P = 200 + 2Q. Diamond production, however, is associated with harmful
side effects on both workers and nearby households and firms. The total damage to the
surroundings is proportional to output according to: D = 50Q. (use a graph to demonstrate your
answers).
a) Without any government interference into diamond production, what is the market price
of diamonds? What is the equilibrium quantity consumed and produced? Assume that
prices are expressed in US $ per unit of diamonds.
b) What is the marginal social cost of diamond production at the equilibrium quantity? What
is the total surplus at market equilibrium?

c) What is the Pareto-efficient level of diamond production? What is the marginal social
cost at that level?
d) What is the total surplus at the Pareto-efficient level? What is the deadweight loss of
diamond production in an unregulated market?

Question 2
Two players, James and Dean play the game of matching pennies with the following rules: Each
player can either play head (H) or tail (T). If James puts down a head or a tail and Dean matches
James’ choice, then James loses $1 and Dean wins $1. If instead Dean fails to match James’
choice, them James wins $1 and Dean loses $1.
(a) How would you classify this game?
(b) Represent this game in extensive form, with James moving at the root node.
(c) Write down the normal (strategic) form of this game.
(d) Define the concept of Nash equilibrium.
(e) Show that this game possesses no Nash equilibrium in pure strategies. Give an intuition
why?

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Question 3

Mr. Asem, a risk-averse person, is required by law to buy theft insurance for his car. His total
wealth is 10000 $. His car, which is part of his total wealth, is worth 5000$ and his utility of
wealth function is U ( W )= √W , where W is his wealth. There are two insurance policies: (a) high
premium and low deductible (policy 1), and (b) low premium and high deductible (policy 2). A
deductible means that if Asem’s car is stolen, he incurs the first $D of the loss while the
insurance company pays him $(5000 – D), where 0 ≤ D≤ 5000. Let the premium be P . A car
theft will occur with probability α and will not occur with probability 1−α , where 0< α <1.
Consider the following information:
Policy 1: P=1200 , D=0, and Policy 2: P=800, D=700.
(i) Suppose α =0.9 . which policy will Asem choose?
(ii) Suppose α =0.1 . which policy will Asem choose?
(iii) Explain the intuition for any difference between your answers in (i) and (ii).
(iv)Now show that, in general, there exist a number α min such that if α >α min he chooses
policy 1 and if α <α min he chooses policy 2, where 0< α min <1.
(v) Will Asem buy the policy you found in (i) even if he is not required by law to do so?
Prove your answer and explain the economic intuition behind it.

Question 4

Two players, 1 and 2, voluntarily contribute g j to a public good, j=1 ,2. The aggregate quantity
of the public good is
2
G=∑ g j
j=1

Their utility function is U j=Gα x 1−α

Suppose w 1=w 2=w .

(i) Find the symmetric Nash equilibrium of this game.

Now suppose w 1> w2

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 (iv) Using math and game theory, show how you will verify the proposition that in societies
with very high levels of inequality, the poor contribute nothing to public goods.
Question 5

Anna and Betty are assigned to write a joint paper within 24-hours period about the Pareto
optimal provision of public goods. Let t A denote the number of hours that Anna contributes to
the to the project and t Bthe number of hours that Betty contributes. The numeric grade that Anna
and Betty earn is a function, 23 ln( t A + t B ), of the total number of hours that they contribute to the
project. If Anna contributes t A then she has (24−t A ) hours in the day for leisure
U A =23 ln ( t A +t B ) + ln ⁡(24−t A ) and Betty’s utility function is U B=23 ln ( t A +t B ) + ln ⁡(24−t B ). If
they chose the hours to contribute simultaneously and independently,

a) What is the Nash equilibrium number of hour that each will provide?
b) What is the number of hours each should contribute to the project t that maximise the
sum of their utilities?

Question 6

a) Explain the terms moral hazard and adverse selection. Explain why the presence of
asymmetric information can lead to inefficient equilibria, or no equilibrium at all.
(12marks)
b) Why is game theory useful in the analysis of situations in which there is asymmetric
information? (8 marks)

NOTE:

Submission Deadline: 30th September, 2023

Email to: [email protected]

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