Assignment Econ 2021

Assignment on Microeconomics I (Econ 2021)
Academic Year: 2022/23

Weight: 20%
Submission Deadline: February 24, 2023.
______________________________________________________________________________
Instructions:
Each section is expected to form five groups with a maximum of 10-12 students per group.
Each group should work independently (plagiarism will not be tolerated).
All group members should participate in doing the questions.
The stated deadline must be respected.
Answers to the questions must be written legibly.
______________________________________________________________________________
1. A) Explain the substitution and the income effects of increasing price for a normal, inferior
and Giffen goods using diagrams. Show the sign of the substitution effect, the income
effect and the total effect in the case or normal, inferior and Giffen goods, B) Explain the
income and substitution effects when the two goods are i) perfect substitutes and ii) perfect
complements.
2. Derive the relationship between marginal revenue and price elasticity of demand, and
explain the change in revenue with respect to quantity when demand is elastic, inelastic
and unitary elastic.
3. Explain why the absolute magnitude of the difference in marginal utility from the ordinal
utility function have no intrinsic behavioral content.
4. Compare the risk-premium of a risk averse, risk seeking and risk natural persons.
5. Suppose Hanna’s utility function is U(m) = m0.5, where m is her income in thousands.
a) Is Hanna a risk-neutral, risk-loving or risk-averse person?

b) Suppose Hanna is earning an income of $10,000 this year, she can also earn $16,000
with a probability of 0.5 and $5000 with a probability of 0.5. Would she take the new
job? Why?
c) Would Hanna be willing to buy insurance to account for the risk associated with the
variability in income in b? If so how much?
1
6. If Eden has a utility function given by U(m) = em, where m is income in thousands;
a) Is Eden a risk averse, risk seeking or risk neutral person?

b) Suppose Eden is earning an income of $10,000 this year, she can also earn $10,000
next year with certainty. She is offered a new job that gets her $16,000 with a
probability of 0.5 and $5000 with a probability of 0.5. Would she take the new job?
Why?
7. Suppose the demand function of a consumer for a product X per month X= m/2p; his
income per month is Birr 500 and the initial price of the product was Birr 5 per unit.
Calculate the income and substitution effect if price increases to Birr 10 per unit.
8. The utility that Abebe gains by consuming food (F) and clothing (C) is given by U(F, C) =
FC.
a) Draw the indifference curve associated with a utility level of 12 and the indifference
curve associated with a utility level of 24. Are the indifference curves convex?
b) Suppose that food costs 1 Birr per unit, clothing 3 Birr per unit, and Abebe has 12 Birr
to spend on food and clothing. Graph the budget line that he faces.
c) What is the optimal level of consumption of food and clothing?
d) At the optimal choice, calculate the marginal rate substitution of food for clothing and
interpret it.
9. Suppose a consumer is confronted with three commodities X, Y, and Z. The respective

prices are Px=1, Py=3 and Pz=5. Using the hypothetical data given below, find the
optimum of the consumer when income is; a) 65 and b) 43Birr.
Unit of goods MUx MUy MUz

1 12 60 70
2 11 55 60
3 10 48 50
4 9 40 50
5 8 32 30
6 7 24 25
7 6 21 18
8 5 18 10
9 4 15 3
10 3 12 1
10. Discuss the laws of variable proportions and returns to scale in relation to technology and
cost curves of the firms and explain the causes of increasing and decreasing returns to scale.
Explain by giving examples.
2
11. The production function for the personal computers of DELL Co. is given by Q =
10K0.5L0.5, where Q is the number of computers produced per day, K is the number of units
machines, L is the number of units of labor. DELL’s competitor, IBM Co. is using the
production function 10K0.6K0.4. Assume that capital is limited to 9 units. In which company
is the marginal product of labor greater. Explain.
12. Suppose a radio firm operates in a competitive market. The firm’s cost of production is
given by C = 200 + 10Q – Q2 + (1/3)Q3 where Q is the level of output and C is the total
cost.
a) If the price of a radio is Birr 90, how many radios should the firm produce to maximize
profit?
b) Derive the firm’s short run supply curve
c) If the minimum of long run average cost is Birr 75, then what will be the long-run
equilibrium price? Explain.
13. Suppose a monopolist has total cost and demand schedules given in the table below.
a) What price should the firm charge?
b) Derive the marginal revenue schedule.
c) What will be the maximum profit of the firm?
P Q Total Cost
8 5 20
7 6 21
6 7 22
5 8 23
4 9 24
3 10 30
14. Given the following production function, Q = f(L,K) = KL2 and unit prices of labor and
capital Birr 15 and 10 respectively, what combinations of labor and capital minimize the
cost of producing and given level of output.
15. A firm operating under a competitive market has a total long-run cost (TC) = Q3 – 5Q2 +
60Q. At what price are the firm and the industry equilibrium? The industry demand and
supply intersect at a price equal to 3 per unit of output. If the firm operating with excess or
under capacity at such a price?
16. A company in a perfectly competitive market has a total cost function given as: TC = 50 +
4Q + 3/2Q2. The price of a unit of output of this company is Birr13. A student working on
his senior essay (on this firm) argues that, the firm would better off by closing down. Do
you agree? Explain.
3
17. What is price discrimination? Under what condition is it feasible for a firm to practice price
discrimination? Under what circumstances is it profitable for the firm to practice price
discrimination? Explain by giving examples.
18. A frim has two plants with following marginal cost functions: MC1 = 20 + 2Q1 and MC1 =
10 + 5Q2. Where MC1 is the marginal cost in the first plant, MC2 is marginal cost in the
second plant, Q1 is output in the first plant, Q2 is output in the second plant. If the firm is
minimizing its costs and if it is producing 5 units of output in the first plant, how many
units of output is it producing in the second plant? Explain.
19. Assume that a monopolist has two markets, 1 and 2, such that the demands for the firm’s
product in the two markets are, P1 = 100-2Q1 and P2 = 80-Q2. The cost function of the firm
is C = 10 + 40Q + 2Q2 where Q = Q1 + Q2. Find the output level that should be sold in each
of the markets for the firm to maximize profit. Also find the price that the firm should
charge in each market and the amount of profit earned by the frim. Why is the firm charging
different prices in the two markets? Show that the monopolist is charging prices greater
than the marginal cost. Calculate the mark-up at the firm’s equilibrium. For which market
is the mark up higher and why? State at least two conditions required for a monopolist to
practice price discrimination.
20. Discuss the social cost of monopoly and how it can be reduced. Support your discussion
with graphical illustration and appropriate examples.

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Assignment on Microeconomics I (Econ 2021)

Academic Year: 2022/23

a) Is Hanna a risk-neutral, risk-loving or risk-averse person?

a) Is Eden a risk averse, risk seeking or risk neutral person?

9. Suppose a consumer is confronted with three commodities X, Y, and Z. The respective

Unit of goods MUx MUy MUz

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