SCHOOL OF BUSINESS STUDIES
DEPARTMENT OF ECONOMICS AND FINANCE
ADVANCED MICRO ECONOMICS (BEC 3701)
Assessment
INSTRUCTIONS:
Check instructions below:
1) Let 𝑢(𝑞1 , 𝑞2 ) = 𝑙𝑛 𝑞1 + 𝑞2 be the (direct) utility function, where 𝑞1 𝑎𝑛𝑑 𝑞2 t h e two goods. Denote
𝑃1 𝑎𝑛𝑑 𝑃2 as the prices of those two goods and let M be per period m o n e y income. Derive each of
the following:
a) the ordinary or Marshallian demand functions 𝑞1∗ = 𝑑𝑖 (𝑃 , 𝑃 , 𝑀) 𝑓𝑜𝑟 ⅈ = 1, 2 [3 Marks]
1 2
b) the compensated or Hicksian demand functions 𝑞1∗ = ℎ𝑖 (𝑃1 , 𝑃2 , 𝑀) 𝑓𝑜𝑟 ⅈ = 1, 2 [3 Marks]
c) the Indirect Utility Function 𝑢0 = 𝑣(𝑃1 , 𝑃2 , 𝑀) [3 Marks]
d) the Expenditure Function 𝐸(𝑃1 , 𝑃2 , 𝑈 0 ) [3 Marks]
e) Draw a diagram of the solution. There should be two graphs, one above the other; the
first containing the indifference curves and budget constraint that characterize the
solution to the consumer’s choice problem; the second characterizing the demand
functions [3 Marks]
2) Consider the following information about Simon lungu’s choices; When prices are (4,6), lungu chooses
the bundle (6,6) call it observation A and when prices are (6,3), he chooses the bundle (10,0),
observation B. Based on this information,
a) Sketch (in a graph) each of lungu’s budget constraints and choices. [2 Marks]
b) Is the consumer's behaviour consistent with the model of maximizing behaviour? [2 Marks]
c) Is lungu’s behaviour consistent with the Weak Axiom of Revealed Preference? [2 Marks]
3) A chemical plant has the following production function: In the short run, capital, K, is 100. The rental
rate of capital is 20 and labour cost is 10.
i. Find the fixed cost, variable cost and total cost equations. [2 Marks]
ii. Find the average fixed cost, average variable cost, average total cost and marginal cost equations.
[3 Marks]
iii. At what quantity will average cost reach a minimum? [2 Marks]
iv. If a per unit subsidy of 10 is in place, will it affect your answer in (c)? If so, what is the new
level? [2 Marks]
4) An individual purchases a dozen eggs and must take them home. Although making trips home is
costless, there is a 50 percent chance that all of the eggs carried on any one trip will be broken during
the trip. The individual considers two strategies: (1) take all 12 eggs in one trip; or (2) take two trips
with 6 eggs in each trip.
a) List the possible outcomes of each strategy and the probabilities of these outcomes. Show that,
on average, 6 eggs will remain unbroken after the trip home under either strategy. [5 Marks]
b) Develop a graph to show the utility obtainable under each strategy. Which strategy will be
preferable? [5 Marks]
c) Could utility be improved further by taking more than two trips? How would this possibility be
affected if additional trips were costly? [5 Marks]
5) The game of Chicken is played by two macho teens who speed toward each other on a single -lane road.
The first to veer off is branded the chicken, whereas the one who doesn’t veer gains peer-group esteem.
Of course, if neither veer, both die in the resulting crash. Payoffs to the Chicken game are provided in
the following table.
Teen 2
Veer Don’t veer
Teen1 Veer 2, 2 1, 3
Don’t veer 3, 1 0, 0
a. Draw the extensive form [2 Marks]
b. Find the pure-strategy Nash equilibrium or equilibria. [2 Marks]
c. Compute the mixed-strategy Nash equilibrium. As part of your answer, draw the best-response
function diagram for the mixed strategies. [2 Marks]
d. Suppose the game is played sequentially, with teen A moving first and committing to this action
by throwing away the steering wheel. What are teen B’s contingent strategies? Write down the
normal and extensive forms for the sequential version of the game. [2 Marks]
e. Using the normal form for the sequential version of the game, solve for the Nash equilibria. [2
Marks]
f. Identify the proper subgames in the extensive form for the sequential version of the game. [2
Marks]
g. Use backward induction to solve for the subgame-perfect equilibrium. Explain why the other
Nash equilibria of the sequential game are “unreasonable.” [3 Marks]
Note: -
1. Questions 1-3 will count as test 1 while question 5 – 6 will count as test 2
2. The deadline for this submission of soft copy scripts is 20th December, 2024 @ 10:00 hrs.
3. hard copy scripts must be submitted by Monday, 23rd December, 2024.
4. Late submission will NOT be tolerated.
