OPEN-BOOK EXERCISE

for
ECONOMICS VISITING STUDENT APPLICANTS
To be completed by all candidates applying to
take courses in Economics

Lady Margaret Hall

University of Oxford

Please carefully follow the directions about which questions to attempt, according to your
course choices.

We recommend that you spend no more than one hour attempting each question.

You are welcome to make use of your course notes and textbooks, but you should not seek
assistance from any other person. You are welcome to use a calculator.

This is not an examination: the main purpose of this exercise is to assess whether you meet the
prerequisites for the Oxford economics courses that you have requested, at the point of
application. We may be able to offer suitable alternatives if you do not, and will take into
account the courses that you plan to take between application and admission. Please attempt
each question to the best of your ability, given the courses that you have studied thus far. If you
are not familiar with a concept or topic, please write a note to that effect and we will take that
into account. You are welcome to attempt questions on topics that you have not previously
studied, but there is no need to spend time learning new material.
All applicants should attempt Q1.

Q1. Please attempt each part of this question.

(i) Solve the simultaneous equations 𝑦 = 𝑥 2 + 1 and 2𝑦 − 3𝑥 = 4.
(ii) Find all roots of the equation 𝑥 3 − 2𝑥 2 − 9𝑥 + 18 = 0.
(iii) Simplify 12 ln 𝑥 4 + 3ln(2𝑦).

Any applicant who wishes to take course #3 but not course #1 should attempt Q2.

Q2. Please attempt each part of this question.

(i) Evaluate 2 + 1 + 0.5 + 0.25 + 0.125+. .. .
(ii) Find all stationary points of the function 𝑓(𝑥, 𝑦) = 𝑥 3 − 𝑦 3 − 3𝑥 + 12𝑦, and classify
them.
(iii) Find the maximum and the minimum of the function 𝑓(𝑥, 𝑦) = 2𝑥 + 𝑦 2 subject to
the constraint 𝑥 + 𝑦 = 4, where 𝑥 and 𝑦 are both non-negative real numbers.
Any applicant who wishes to take any course numbered #4 or above, but not course #3,
should attempt Q3, Q4 and Q5.

Q3. Please attempt each part of this question.

(i) If the interest rate is 4%, find the present value of a bond that pays £200 every year
in perpetuity (a ‘perpetuity’).
(ii) Find all roots of the equation 𝑥 3 − 2𝑥 2 − 9𝑥 + 18 = 0.
(iii) A monopolist faces demand 𝑞(𝑝). Find the elasticity of demand at the revenue-
maximising quantity.
(iv) Find and classify all stationary points of the function 𝑓(𝑥, 𝑦) = 𝑥 3 − 𝑦 3 − 3𝑥 + 12𝑦.
(v) Find the maximum and the minimum of the function 𝑓(𝑥, 𝑦) = 2𝑥 + 𝑦 2 subject to
the constraint 𝑥 + 𝑦 = 4, where 𝑥 and 𝑦 are both non-negative real numbers.

Q4. Arthur lives in a world in which there are just two goods: nutmegs and pears. In his
garden there is a tree which yields eight nutmegs and one pear every day. He has no income
other than from his nutmegs and pears. Arthur's preferences over nutmegs and pears may
be represented by the utility function 𝑢(𝑛, 𝑝) = 2 ln 𝑛 + 3 ln 𝑝, where 𝑛 is the number of
nutmegs that he consumes and 𝑝 is the number of pears.
(i) Show that Arthur's preferences may, alternatively, be represented by a utility
function of the form 𝑣(𝑛, 𝑝) = 𝑛𝛼 𝑝𝛽 and explain why this is the case.
(ii) People in Arthur's world are prepared to trade one pear for two nutmegs. Describe
the relationship between the prices of pears and nutmegs and draw a carefully
labelled graph of Arthur's budget constraint.
(iii) Arthur maximises his utility, subject to his budget constraint. Show that his gross
demands are 4 nutmegs and 3 pears. Mark the gross demands on your diagram and
sketch in one or two of his indifference curves. What are his net demands?
(iv) There is a shortage of nutmegs in Arthur's world, so the relative price of nutmegs
increases. (Arthur's tree still produces the same yield every day.) Illustrate on your
diagram what happens to his budget constraint. Will he be better off or worse off
after the price change? What can you say about how his gross demands will change?
(v) Consider the effect of the change in the price of nutmegs on Arthur's demand for
nutmegs. This may be decomposed into a substitution effect, an ordinary income
effect and an endowment income effect. Explain what is meant by these terms and
draw a diagram to illustrate this decomposition. (Please draw a new graph for this
part of the question.)

Q5. Please write an essay of up to two pages in length in response to part (i) OR part
(ii) of this question.
(i) How can all the oligopoly models be right, when their predictions are so different?
(ii) Why do perfectly competitive firms produce when they don’t make any profit in the long
run?
Any applicant who wishes to take any course numbered #5 or above, but not course #4,
should attempt Q6 and Q7.

Q6. Suppose that consumers live for 2 periods (the present and future). Each consumer has
income y1 in the present and y2 in the future, can borrow and save at the real interest
rate r and has well-behaved preferences over current and future consumption, c1 and
c 2.
(i) Write down the consumer's budget constraint and draw a diagram to illustrate
the optimal choice of consumption over the two periods.
(ii) Explain carefully why, according to this model, changes in the interest rate may
have little effect on saving.
(iii) Discuss how a temporary increase in income, in the present period only, has
different effects from an increase in the same size that is expected to be
permanent. What would be the effect of a temporary rise in income if there were
many periods in the model? What are the implications of your findings for the
marginal propensity to consume?
(iv) Suppose the government levies a tax T on each consumer in the present, invests
the proceeds in bonds paying interest at r and returns the amount T plus interest,
to the consumer in the future. How will this affect c1 and c2? Would the answer
be different if consumers faced borrowing constraints?
(v) Compare the policy implications of this model of consumption with those of the
Keynesian consumption function.

Q7. ‘When expectations are formed adaptively there is a short-run trade-off between
unemployment and inflation, but when expectations are formed rationally there is no short-
run trade-off between unemployment and inflation.’ Discuss. (Please write
an essay of up to two pages in length in response to this statement.)
Any applicant who wishes to take course #7, #8, #10, #12, #13 or #14, should attempt Q8.

Q8. Give concise answers to all parts of this question.

(i) Derive Bayes’ Theorem from the definition of conditional probability.
(ii) Alice the meteorologist determines that the probability of rain on Saturday is 50%,
and the probability of rain on Sunday is also 50%. Bob the presenter sees Alice’s
forecast and summarises it as follows: “According to Alice we’re in for a wet
weekend. There’s a 100% chance of rain this weekend: 50% on Saturday and 50% on
Sunday.” Is Bob correct? Why or why not?
(iii) Approximately what is the probability that a standard normal random variable will
take on a value between -1 and 1?
(iv) True or false? The following statements are equivalent:
a. Variables A and B are independent
b. The covariance and correlation between variables A and B are zero.
(v) Suppose that 𝑋1 , . . . , 𝑋𝑛 are iid draws from a population with mean 2 and variance 9
1
and define 𝑋̅ ≡ ∑𝑛𝑖=1 𝑋𝑖 . Calculate 𝔼(𝑋̅) and Var(𝑋̅) in terms of 𝑛.
𝑛
(vi) Define and explain what it means for an estimator to be “consistent” and “efficient”.
(vii) Using the potential outcomes framework, explain what is meant by selection bias.

Any applicant who wishes to take course #8, #10, #12, #13 or #14, should attempt Q9 and
Q10.

Q9. Give concise answers to all parts of this question.

(i) Show that the residual 𝑒𝑖 in the identity Y𝑖 = 𝐸[Y𝑖 | X𝑖 ] + 𝑒𝑖 is mean independent of X𝑖.
(ii) Explain how measurement error causes attenuation bias in the linear regression
model.
(iii) “Most regression studies rely on the conditional independence assumption in order
to argue that the estimated coefficients represent causal effects.” Explain and
discuss.
(iv) Consider the following AR(1) time-series model: 𝑦𝑡 = 𝛼 + β𝑦𝑡-1 + 𝜀𝑡 . What
econometric problems arise if β = 1? What if β < 1 but close to 1?
(v) Suppose we had some time-series data and estimated an AR(1) model, obtaining the
following:

where standard errors are reported in parentheses. Can you reject that β = 1 at the
5% significance level?
(vi) What problems are caused by structural breaks in time series? How would you test
for a structural break?
Q10. Answer both parts of this question.
Part A

Part B