All tutorial problems here, with suggested

answers
BEE2024, David Reinstein, 2016

Contents
First tutorial

Discussion:

Second tutorial (chapters 2-3)

10

Tutorial problems from chapter 2

10

Additional suggested problems (between double lines)

13

Tutorial problems from chapter

16

Further suggested problems from text, 12th ed

24

Third tutorial (chapters 4-5, plus a few additional concepts covered

in lecture)
24
Fourth tutorial/homework (chapters 5-9)

44

Fifth tutorial/homework: Ch. 9Perfect competition . . . , 16

Public Goods, and 17Behavioural economics
53

First tutorial
Problem 1

***

1.1.A: Graph the points of these supply and demand curves

for orange juice. Be sure to put price on the vertical axis
and quantity on the horizontal axis.
(If this is tedious, just graph three points for each).

Ans:

1.1.B: Do these points lie along two straight lines? If so, figure out the precise algebraic equation of these lines. (Hint:
If the points do lie on straight lines, you need only consider
two points on each of them to calculate the lines.)
Ans: Yes, they do. The rise over run between any two points is the
same.
(Recall O-level maths formula for straight line: y = mx + b)
m=

y2 y1
x2 x1

Thus it is a linear function P = a + bQ (b may be negative)

For supply, increase P by 1 and Q increases by 200.
i.e, for
Thus

P
Q

P = 1,

Q = 200

1
200

We know the slope b =

Q
P = a + 200

1
200

What about the intercept a?

3

 at P = 2, Q = 300
2 = a + 300
200 = a +
so a = 12
Thus the equation is P =
or Qs = 200P 100

3
2
1
2

Qs
200

For demand, increase P by 1 and Q declines by 100.

Solves similarly to above:
P =8

Qd
100

or Qd = 800 100P

1.1.C: Use your solutions from part b to calculate the excess demand for orange juice if the (imposed) market price
is zero
Ans:
Draw these functions on the same graph to aid intuition
Qs (P ) = 200P 100, at P = 0, Qs = 100
We forgot to say we meant Qs (P ) = max(0, 200P 100), so Qs (0) = 0
Qd (P ) = 800 100P Qd (0) = 800

Excess demand at P = 0 is Qd (0) Qs (0) = 800 0 = 800.

Consider: does this make sense? If the government declared orange juice must
be free and imposed no subsidies, would you expect their to be excess demand?

1 Check: does this equation describe the graph? Is it intuitive? Supply upward-sloping in
price. Intercept: P>1/2 necessary for a positive quantity supplied.

1.1.D: Use your solutions from part b to calculate the excess supply for orange juice if the orange juice price is $6
per gallon.
Will probably skip in section because its basically the same task as part c
Ans: Excess supply at P = 6 is 900

Tutorial 1, second question

Marshall used the analogy of scissors to explain how demand and supply work
together in determining market outcomes.

T1Q2-A.Use this observation to explain why a shift outward in the demand for gold (which will have a nearly vertical supply curve) will have a greater impact on market
price than will a similar-sized shift outward in the demand
for flour (which will have a flat supply curve.)
Ans:

The figures above (gold on top, flour below) show different price responses
depending on the slope of the supply curve.

T1Q2-b) Explain your results from part a intuitively, by

focusing on the post-shift positions of suppliers and demanders in these two markets.
Ans:
Intuition for an equilibrium shift is difficult but I will try. If demand shifts out
this means consumers are willing to pay more for each unit, and are willing
to buy more units at a given price. To increase the quantity supplied of gold
involves a great cost it is hard to find new sources of gold. The consumers
thus bid up the price of gold, and the quantity only increases a little bit.
A similar shift out in demand for flour does not imply a large increase in costs
per unit; it is not so expensive to increase the amount of produced, diverting
fields and mills from other crops. Thus when consumers demand more flour at
the original price, the producers compete with one another to accommodate this
without raising price too much. 2

T1Q2-c) Devise an algebraic representation of these two

markets that illustrates what was shown in part a. (This
may be a challenge but its good to start thinking of modelbuilding.)
Ans:
For a good, quantity demanded must start positive (at p=0) and slope
downwards. Suppose, for each market, the demand curve is the same (in
some units):
QD,f = 3 pf
QD,g = 3 pg

Supply slopes upwards, and we need to consider a differing slope for the
supply curves in each market.
Suppose, for flour and gold, respectively:
QS,f = pf 1 pf = QS,f + 1

2 Note: this is *not* about the competitive nature of the industry; we are assuming perfect
competition throughout.

QS,g =

1
pg pg = 2QS,g
2

Note that gold has a steeper slope (of price in quantity), 2 rather than 1.
To make the comparison easy, I set this up so that the equilibrium price
and quantity start at the same point for both goods.
Flour: 3 pf = pf 1 4 = 2pf pf = 2 QD,f = QS,f = 1
Gold: 3 pg = 12 pg 3 = 32 pg pg = 2 QD,g = QS,g = 1
So price and quantity are initially the same (in different units) for both
goods.
I got this to occur by choosing the slope arbitrarily for flour and then
solving for the equilibrium flour price p = 2. Then I picked a zero
intercept for Gold, and solved for the value of the slope b such that
3 2 = b 2, which yielded slope b = 1/2.
More detail on this calculation in student forum HERE
Now suppose demand shifts out for both goods (but maintains the same slope),
to:
QD,f = QD,g = 6 p
Solving for the new equilibrium prices and quantities:
Flour: 6 pf = pf 1 7 = 2pf pf = 7/2 QD,f = QS,f = 5/2
Gold: 6 pg = 12 pg 6 = 32 pg pg = 4 QD,g = QS,g = 2
We see the price of flour has increased less than the price of gold, and the
quantity of flour has increased more than the quantity of gold.

Time permitting:

Discussion:
6. Gasoline sells for $4.00 per gallon this year, and it sold
for $3.00 per gallon last year.
But consumers bought more gasoline this year than they did last year.
This is clear proof that the economic theory that people buy less when the price
rises is incorrect. Do you agree? Explain.
8

Ans:
Other things may have changed, including tastes, income, the population; these
could shift the market demand curve. This does not invalidate the more general
proposition that people buy less when the price rises, all else equal.

8. Housing advocates often claim that the demand for affordable housing vastly exceeds the supply.
Use a supply-demand diagram to show whether you can make any sense out of
this statement.
In particular, show how a proper interpretation may depend on precisely how
the word affordable is to be defined.
Ans:
This is a tough one. A traditional economics interpretation suggests that the
price always adjusts until quantity demanded equals quantity supplied. But if the
good is affordable housing, the very definition of the good rules this out. If the
housing good rose in price then people would say it was no longer affordable.
As economists we generally separate the characteristics of the good (entering
the utility function directly) from its price. If the price is a characteristic, our
framework might not work.
Still, in a traditional interpretation we may have a price ceiling (e.g., rent control)
that caps the allowable price, leading to a shortage in the traditional economic
sense. Also, note that economic efficiency, and a market equilibrium doesnt rule
out great inequality, poverty and things people may find unfair. Hopefully we
will get to this later in the module.

Second tutorial (chapters 2-3)

Tutorial problems from chapter 2
2.5. Ms. Caffeine enjoys enjoys coffee (C) and tea (T) according to the function U (C, T ) = 3C + 4T
Parts a and b only
a. What does her utility function say about her MRS of coffee for tea? What
do her indifference curves look like?
Ans:
The picture illustrates both parts of this question

and solve for

To find the slope of an indifference curve set 3C + 4T = U
4

C = U /3 3 T . Thus the slope of C in T is -4/3.

The indifference curves here are straight lines with slope -4/3. Hence, the
MRS is a constant 4/3. The goods are perfect substitutes.
b. If coffee and tea cost $3 each and Ms Caffeine has $12 to spend on these
products, how much coffee and tea should she buy to maximize her utility?

10

Ans:
Because one unit of tea provides more utility than a unit of coffee, she will
spend all of her income on tea when the prices are equal.
In general, with perfect substitutes, choose the product for which MU/P
is higher. Here M PUC(C) = 3/3 = 1 and M PUT(T ) = 4/3 > 1
Thus T = 4, C = 0
2.3 Paul derives utility only from CDs and DVDs. His utility function is

U = (CD)

Parts a-c (Note,there is a video solution to this on the Cengage web site,
so we will not go over it in the tutorial)
a. Sketch Pauls indifference curves for U=5, U=10, and U=20

Ans
To graph the indifference curves, use U 2 instead of U. U = 10 means U 2 = 100 =
C D. Hence, indifference curves are hyperbolas. (Without knowing this you
would have to compute and plot a lot of points).

b. Suppose Paul has $200 to spend and that CDs cost $5 and DVDs cost
$20. Draw Pauls budget constraint on the same graph as his indifference
curves.
11

Ans:
See above graph
200 = 5C + 20D
Shortcut tip: find amounts of CDs he would buy if he only bought
CDs, and the amount of DVDs he could buy if he bought only DVDs
and connect these points
c. Suppose Paul spends all of his income on DVDs. How many can he buy
and what is his utility?
Ans:
D = 10, U =

10 0 = 0

Here each good is what might be called a necessity you will always
try to buy some of each good no matter the price
We extend this problem: Continuing this, note M RS = M UC /M UD in
general, and for this case:
M RS = M UC /M UD =

D 12 (CD)1/2
= D/C
C 12 (CD)1/2

I. With this information, determine how many CDs and

DVDs Paul will buy, and what his utility will be.
Ans:
These hyperbolas are certainly convex utility functions, so when he optimizes the M RS = price ratio condition will apply
Thus M UC /M UD = D/C = PC /PD = 5/20 = 1/4
Thus C = 4D
We can substitute 4D for C in the budget constraint:
200 = 5 4 D + 20D = 40D
D=5
C = 20
(Check this adds up to the total budget: 5 20 + 20 5 = 200)

Now plug D=5, C = 20 into the utility function

U = (20 5) = (100) = 10

12

II. Explain intuitively, graphically, and mathematically,

why we know this allocation will maximise his utility.
Intuitively, he wants to get the most bang for his buck. For every dollar he
spends, he wants to spend it on the thing that gives him the most utility.
This means he will choose at a point where the marginal utility of
DVDs per dollar (i.e., M U (D)/PD ) is the same as the marginal utility
of CDs per dollar (i.e., M U (C)/PC ). If it were otherwise then he
could do better by spending one less dollar on one good and one more
dollar on the other good.
Graphically, we see that this is the point where the slope of the price ratio
is equal to to the slope of the indifference curve at the point where this
indifference curve is tangent. The price trade-off is the same as the internal
utility trade-off.

2.7. Assume consumers are choosing between housing services. . .

All parts
We may not go over this in lecture as there is a video posted on the
textbook site.

Additional suggested problems (between double

lines)

13

2. How might you draw an indifference curve map that illustrates the following
ideas?
a.
b.
c.
d.
e.

Margarine is just as good as the high-priced spread.

Things go better with Coke.
A day without wine is like a day without sunshine.
Popcorn is addictive the more you eat, the more you want.
It takes two to tango.

Suggested answer to 2
Remember these questions are meant to be fun and get you thinking; there is not
always a single correct answer.
a. Margarine is just as good as the high-priced spread.
If true, these are perfect complements at a 1-1 ratio.
(But it is doubtful; if true, how could they profitably charge more for
the other spread).
b. Things go better with Coke.
If so, perhaps Coke is a complement to all goods? The more Coke you
have the more utility you get from other goods, so if Coke price declines,
you will buy more of other goods.
(But, holding utility constant, the substitution effect cannot be positive for all goods).
c. A day without wine is like a day without sunshine.
Not sure, but perhaps extreme diminishing marginal utility, so the first
unit of wine (or sunshine) is extremely valuable and you would be very
unwilling to give up a glass of wine for other goods if you only had the
one glass.
d. Popcorn is addictive the more you eat, the more you want.
Suggests a lack of diminishing marginal returns
14

 Or perhaps non-constant and inconsistent preferences (you first

thought you wanted a little bit, but then you realise you wanted a
lot).
e. It takes two to tango.

People tangoing are perfect complements in bundles of 2, 3 people tangoing

yields as much dancing as does 2 people. 5 as much as 4.
Or perhaps male role and female role dancers are perfect complements.
I thought you also needed a rose.
3. Inez reports that an extra banana would increase her utility by two
units and an extra pear would increase her utility by six units. What
is her MRS of bananas for pears that is, how many bananas would she
voluntarily give up to get an extra pear? Would Philip (who reports that
an extra banana yields 100 units of utility whereas an extra pear yields
400 units of utility) be willing to trade a pear to Inez at her voluntary MRS?

Suggested answer to 3
(At least at her current consumption. . . )
Inez would be willing to give up 3 bananas (utility given up = 3 2 = 6)
to get one extra pear (utility 6 units).
Thus her MRS is 3
For Phillip, giving up a pear costs him 400 units of utility; the same as 4
bananas
he would only be willing to give up a pear if he would get at least
4 bananas
But Inez would only be willing to offer him 3 bananas for a pear. So
this trade would not occur.
4. Oscar consumes two goods, wine and cheese. His weekly income is $500.
a. Describe Oscars budget constraints under the following conditions:

Wine costs $10/bottle, cheese costs $5/ pound;

Wine costs $10/bottle, cheese costs $10/ pound;
Wine costs $20/bottle, cheese costs $10/ pound;
Wine costs $20/bottle, cheese costs $10/ pound, but Oscars income
increases to $1,000/week.
15

b. What can you conclude by comparing the first and the last of these budget
constraints?

7. Most states require that you purchase automobile insurance when you buy
a car. Use an indifference curve diagram to show that this mandate reduces
utility for some people. What kinds of people are most likely to have their
utility reduced by such a law? Why do you think that the government
requires such insurance?
Also, problems 2.2 and 2.3 (2.3 has video) are relevant for understanding
the model, although 2.2 requires graphing this nonlinear function, so it is
a bit advanced (consult the text to see how this is done).
2.7 - 2.9 are good policy applications (2.7 has video) - these are somewhat on
the advanced side, (the upper-edge of what you might be examined on)

Tutorial problems from chapter

3.1: Elizabeth M. Suburbs makes $200 a week at her summer job and spends her entire weekly income on new running shoes and designer jeans, because these are the only
two items that provide utility to her. Furthermore, Elizabeth insists that for every pair of jeans she buys, she must
also buy a pair of shoes (without the shoes, the new jeans
are worthless). Therefore, she buys the same number of
pairs of shoes and jeans in any given week.
a. If jeans cost $20 and shoes cost $20, how many will Elizabeth buy of each?
Ans:xs
Assume by shoes we mean pairs of shoes
I = 200
S = J at optimum
16

 PS S + PJ J = 20S + 20J = 20S + 20S = 40S = 200

S=J =5

Note these are perfect complements.

Thus, we know she always buys bundles of a pair of shoes and a pair of
jeans (confusing use of plurals, sorry non-native speakers).
Each bundle now costs $40, and she has $200, so she can buy 5
bundles, or 5 pairs of shoes and 5 pairs of jeans.
b. Suppose that the price of jeans rises to $30 a pair. How many shoes and
jeans will she buy?
Ans:
Solve with similar algebra as above
Now a bundle costs 30 + 20 = 50 so she can afford only 4 bundles
So she buys 4 pairs of jeans and 4 pairs of shoes
c. Show your results by graphing the budget constraints from part a and part
b. Also draw Elizabeths indifference curves.
Ans:

Elizabeths indifference curves are L-shaped since she gains utility only when
shoes and jeans are purchased in a one to one proportion. 10 pairs of shoes and
5 pairs of jeans yield the same utility as 5 pairs of shoes and 5 pairs of jeans.
17

d. To what effect (income or substitution) do you attribute the change in

utility levels between part a and part b?
Ans:
The change from U2 to U1 is entirely attributable to the income effect. There is
no substitution effect due to Elizabeths insistence on a fixed proportion of jeans
and shoes.
In other words, there is no way to substitute shoes for jeans and maintain
the same utility
e. Now we look at Elizabeths demand curve for jeans. First, calculate how
many pairs of jeans she will choose to buy if jeans prices are $30, $20, $10,
or $5 (holding shoe prices constant at $20 a pair).
Ans:
The budget constraint yields:
20S + PJ J = 200
Note S = J throughout because of her preferences. Substituting this in. . .

20S + PJ S = 200
S(20 + PJ ) = 200
S=J =

200
20 + PJ

Plugging in each value of PJ as asked, we see that the following choices will be
made:
PJ

S=J

30
20
10
5

4
5
6 + 2/3
8

f. Use the information from part e to graph Ms. Suburbss demand curve for
jeans.
18

Ans:

(this figure is the answer to f and to g)

Note it is downward sloping but not linear
g. Suppose that her income rises to $300. Graph her demand curve for jeans
in this new situation.
Similar calculations as for part e yield:
S=J =

300
20 + PJ

Ans:
PJ

S=J

30
20
10
5

6
7.5
10
12

Note with a higher income (at least in this range), more J is demanded at
each price (curve d1 versus d)
19

 Here J is a normal good

h. Suppose that the price of running shoes rises to $30 per pair. How will
this affect the demand curves drawn in part b and part c?
Redo the above calculations, but with PS = 30.
200
This yields the demand functions S = J = 30+P
J
I.e., demand for both goods shifts inward
Intuition: they must be bought in equal proportions, so we know they
must be complements,
thus a rise in the price of one must reduce the quantity demanded
of each

3.9 (11th ed): In Chapter 3 we introduced the concept of

consumer surplus as measured by the area above market
price and below an individuals demand for a good. This
problem asks you to think about that concept for the market as a whole.
a. Consumer surplus in the market as a whole is simply the sum of the consumer
surplus received by each individual consumer. Use Figure 3.12 to explain why
this total consumer surplus is also given by the area under the market demand
curve and above the current price.

Because the market demand curve is the horizontal sum of each individuals
demand curve, the total consumer surplus area will just be the sum of each
individuals consumer surplus area
20

 Intuition: A vertical point on the market demand curve can be

interpreted as the price some consumer is willing to pay for that
next unit. Only one consumer can consume each unit. For each unit,
someone is getting a surplus equal to the distance between the vertical
value of the point on the demand curve and the market price. Thus
if we add up all of the surpluses some consumer is getting for each
unit, we get the total surplus all consumers get.
(Note: this is a simplification; there are some flaws in this logic
we will not discuss here).
b. Use a graph to show that the loss of consumer surplus resulting from a
given price rise is greater with an inelastic demand curve than with an
elastic one. Explain your result intuitively. (Hint: What is the primary
reason a demand curve is elastic?)
A demand curve is elastic (or has a shallow slope, quantity changes a
great deal in price) primarily because there are affordable close substitutes
for the product; or because people dont value the last few units of this
product much more than its price. So, when prices rise people easily switch
away from the product, or just stop buying it, and it doesnt hurt them
much.
When the demand curve is inelastic (or has a steep slope), people cannot
switch away so easily and value these last units a lot more than its price,
hence a price rise means that they buy nearly as much of the product but
pay a lot more in total. This means that as the price rises they get far
lower consumer surplus from this product (because the amount they must
pay moves much closer to the amount they were willing to pay, and they
now have a lot less to spend on other goods).
The graph below illustrates this, but needs some explanation:

21

 Both these demand curves meet at the same quantity-price point, but D1
is steeper, thus less elastic (quantity responds less to price).
We imagine price rises from P1 to P2 for either demand curve (either
because supply shifts, because of a price floor, or for whatever reason)
For each demand curve, the original consumer surplus is the area
between the demand curve and P1
For each demand curve, the new consumer surplus is the area between
the demand curve and P2
Thus the loss of surplus for each is the area between P2 , P1 , and
the demand curve.
For D2 relative to D1 there is the extra bit of loss given by the
shaded area.

22

Before price rise:

Consumer surplus with D1 is A+B+C+E
CS with D2 is A+C
After price rise:
CS with D1 is A+B; the consumer has lost C+E
CS with D2 is A; the consumer has lost C
E is lost under D1 but not under D2
c. SKIP
Note: the solution given in the recent textbook is to some old version of
the problem!
Note: these tutorial problems are not covering some key demand curve issues,
such as income and substitution effects, elasticities, etc.; make sure to revise
these as well

23

Further suggested problems from text, 12th ed

answers at back of text, some also have video answers on Cengage
- 3.3: Perfect complements, substitution effects etc
3.7: Demand and total expenditure
- all micro quizzes (answers also at the back)
- Be able to sketch and explain income and substitution effects of a price change

Third tutorial (chapters 4-5, plus a few additional

concepts covered in lecture)
Chapter 4 material
Suggested practice problems from Nicholson and Snyder Chapter 4
(12th ed)
Problems
4.1, (4.3), 4.5, 4.6, 4.7 (challenging)
Also see problem on next slide
In the tutorial we will probably have time to cover one problem from
chapter 4 and one problem on game theory.
Please let us know your preferences over what is covered
4.1

24

 Video solution available as well as solution at back of text (not covered in

tutorial)

25

4.6

26

4.7

(Briefly covered in tutorial)

27

Ans to a:
Note this is similar to buying a put option the right to sell an asset at
a particular price
If the prize is a worthless goat, the option to sell it for $8000 is worth
$8000. This happens half the time.
If the prize is the $15000 diamond ring, the option to sell it for $8000 is
worthless. This happens half the time.
Thus the option is worth 12 8000 + 12 0 = 4000 to Sophia.
If she is risk-neutral (only cares about expected dollar outcomes), she
would not pay $4500 for this option, as she only values it at $4000

Ans to b:
A risk-averse individual cares about more than just the expected monetary value
of the outcomes. She tends to prefer outcomes with less variability, even if they
have somewhat lower expected monetary values (they may yield higher expected
utility, as the utility function shows diminishing marginal returns).
The variability of income is lower with the option (ranging only between 3,500
and 10,500 rather than between 0 and 15,000), so a particularly risk-averse
contestant may choose the option even at an actuarially unfair price.
This could be illustrated with the utility-of-income diagram as in lecture and
the text and the next problem.

Tutorial 3, additional problem 0

Suppose there is a 50-50 chance that a risk averse individual with a current
wealth of 20,000 will contract a debilitating disease and suffer a loss of 10,000.
a) Calculate the cost of actuarially fair insurance in this situation and use a
utility-of-income graph to show that the individual will prefer fair insurance
against this loss to accepting the gamble uninsured.
(Part a to be covered in tutorial)

28

Ans:
The cost of actuarially fair insurance is equal to the expected monetary
value of the loss.
Here E(L) = .50 10, 000 = 5, 000

This implies that if she buys this insurance it will cost her 5,000, implying
that wealth with insurance is always 15,000.
Without insurance, wealth is either 10,000 or 20,000, each with 50
percent probability.
The individual will prefer actuarially fair insurance because the variability of wealth is lower, while the expected monetary value is the
same, as shown in the graph, and she has diminishing marginal utility
of income.
This is shown in the graph below (compare the utility at points a and
b)

b) Suppose two types of insurance policies were available: 1. A fair policy

covering the complete loss and 2. A fair policy covering only half of any
loss incurred.
Calculate the cost of the second type of policy and show that the individual will
generally regard it as inferior to the first.

29

Ans:
(Part b NOT to be covered in tutorial unless there is a strong demand and time
permits)
The cost of the second policy is 2,500. Now, if this individual buys policy 2, he
or she will have an equal chance of being well (having wealth 17,500) or being
sick (having wealth 12,500). This partial insurance is superior to no insurance
but inferior to complete insurance as shown in the previous figure.
c) Suppose individuals who purchase cost-sharing policies of the second type
take better care of their health, thereby reducing the loss suffered when ill
to only 7,000. In this situation, what will be the cost of a cost-sharing
policy? Show that some individuals may now prefer this type of policy.
(This is an example of the moral hazard problem in insurance theory.)
Ans:
(Part c NOT to be covered in tutorial unless there is a strong demand and time
permits)
Now, cost of the policy is (.5)(.5)(7,000) = 1,750. If he or she stays well,
wealth is 18,250; if he or she gets sick, wealth is 20,000 7,000 1,750 +
3,500 = 14,750 each with 50 percent probability. Utility of this gamble may
exceed utility of complete insurance since the expected value of wealth is now
16,500 reflecting the lower expected losses from ill health. This question part
provides a brief introduction to moral hazard in insurance.

Chapter 5 material+
Suggested practice problems from Nicholson and Snyder
Chapter 5 (12th ed)
Problems
5.1, 5.5, 5.6, 5.7, 5.10
Additional tutorial problems I-III

30

5.1

Ans:
(This question NOT to be covered in tutorial unless there is a strong demand
and time permits)
a. A plays Up; B plays Left.
b. As dominant strategy is Up. B does not have a dominant strategy.
Note: this problem should be easy for you to do. If you are struggling with
problems like these, you need to keep practicing and come to office hours if
necessary.
Note: There is a video solution on to this on the Cengage web site
5.5

31

(This question NOT to be covered in tutorial unless there is a strong demand

and time permits)

32

Ans:

Note: this problem should be easy for you to do, although translating from the
word problem to the matrix may take some thinking.
5.6

(There was supposed to be a video solution to this on the Cengage web site, but
it seems to be missing)

33

34

5.7

35

(Parts a and b to be covered in tutorial)

Ans to a:
Using the underlining method shows that Rat is a dominant strategy for
both and that both choosing Rat is a Nash equilibrium. (Show this)
Strategically, this is a prisoners dillemma, but the payoffs are somewhat
different than the payoffs you saw before
Ans to b:
Expected payoff if everyone follows the specified trigger strategy without deviation
is:

1 + (g)(1) + (g 2 )(1) + (g 3 )(1) + ... = (1((1 + g + g 2 + g 3 + ...) = 1/(1 g)

So his expected utility from following this trigger strategy is
36

1
1g

If a player deviates to Rat in the first period, his or her payoff is 3 in the first
period and 0 from then on.
So his expected payoff from deviating is simply 3.
Thus for the trigger strategies to be an equilibrium,

1
1g

I.e., g 23 .

Once again, cooperation is sustainable if the probability of continuing is

high enough.
(This problem was challenging but it is worth looking at closely)

Ans to c (NOT covered in tutorial):

The expected equilibrium payoff is the same as in part b, 1/(1 g). If a player
deviates from tit-for-tat, he or she earns 3 in the first period, 0 in the second,
and then the players return to the original equilibrium for an expected payoff of
3 + (g)(0) + (g 2 )(1) + (g 3 )(1) + ... = 2 + 1 + (g)(1 1) + (1)(g 2 + g 3 + ...) =
2 g + (1)(1 + g + g 2 + g 3 + ...) = 2 g + 1/(1 g)

For this payoff from deviating to be less than the equilibrium payoff, 2 g 0 ,
implying g 2 . This is impossible since g is a probability. So players cannot
sustain cooperation on Silent using tit-for-tat.
5.10

37

(Note,there is a video solution to this on the Cengage web site, so we will not
go over this problem in the tutorial. We may have the opportunity to cover a
similar problem in future tutorials.)
Ans:
a. Following the logic of equation (6.6), the marginal benefit of an additional
sheep for A is

300 2sA sB
Setting the marginal benefit equal to the marginal cost 0 gives
sA = 150 sB /2.
Similarly,
sB = 150 sA /2.
Solving simultaneously shows that the Nash equilibrium is
38

sA = sB = 100
b.

c.

39

Additional tutorial problem I (Game theory)

Teens A and B are smitten with each other but neither knows of the others
feelings. Suppose the teachers at their school organize a dance. The payoff
is based on whether their advances are rebuffed or accepted. If they both
Declare, they get positive utility but if they are Rebuffed they face humiliation
(significantly negative payoff). Rebuffing an advance slightly elevates the teens
standing with peers.
What is a teens dominant strategy, or is there no dominant strategy?
Ans:
There is no dominant strategy here
40

 It should be easy to see this; each players best response differs depending
on the other players action.
Find the pure-strategy Nash equilibrium or equilibria
Ans:
There are two: in one, both Declare, and in the other, both Rebuff/Ignore.
Use the underline best responses method
Find the mixed strategy equilibrium
Ans:
In addition to any pure-strategy Nash equilibrium, there is another one in mixed
strategies. In it, each teen chooses to declare with probability 0.526.
- Let the probability teen A declares be p and the probability teen B declares
be q - Consider: what probability of teen B declaring makes teen A indifferent
between declaring and ignoring? - Compute payoffs to teen A from declaring
and from ignoring as a function of q - set these equal, solve for q
EUA,declare = q 10 + (1 q) (10) = 10q 10 + 10q = 20q 10
EUA,ignore = q 1 + (1 q) (0) = q

Setting these equal and solving for q that makes A indifferent:

EUA,declare = EUA,ignore
20q 10 = q 19q = 10 q = 10/19 = 0.526
(approximately)
As this game is symmetric the value of p that makes teen B indifferent must also
be 10/19 (check it yourself if you doubt this).
Thus if A and B both plays declare with probability 10/19, both are indifferent
and thus best responding, and this is a Nash equilibrium.
(By the way, this is related to my research on Losing Face)
##Additional tutorial problem II (Game theory)

41

 Apply Iterated strict dominance to the above game, showing your steps
State the pure strategies that are rationalizable.
Ans:
i. B strictly dominates A
ii. X strictly dominates Y
iii. C strictly dominates D

This leaves X and Z for player 1 and B and C for player 2

Nothing else is strictly dominated for either player. Thus for player 1 X and Z
are rationalizable. And for player 2 C and B are rationalizable.

42

Additional tutorial problem III (Game theory)

Use backwards-induction to find the subgame-perfect Nash equilibrium

strategies, outcomes, and payoffs, of the above game.
Ans:
(This question NOT to be covered in tutorial unless there is a strong demand
and time permits)
Note: this problem should be easy for you to do. If you are struggling with
problems like these, you need to keep practicing and come to office hours if
necessary.
The one BWI outcome will be (In,Accommodate)
SPNE strategies are In for player 1 and Accomodate if player 1 plays In
for player 2 (dont worry too much about this)
Payoffs are 2 for player 1 and 1 for player 2.
Note the first-mover advantage in these entry games

43

Fourth tutorial/homework (chapters 5-9)

Game theory
Tutorial problem I a final question on game theory (Cover in 5-10
minutes max)

Consider a game where governments of countries A and B simultaneously choose

how many fishing boats to allow in the Arctic sea to allow from their country.
Country A gets a net benefit (benefits minus costs) sA (120 sA sB ) and B
gets a net benefit of sB (120 sA sB ), where SA and SB are the boats allowed
by countries A and B, respectively. This leads to the best response functions
depicted above.
Which statement below is True:
A. The more boats country A allows, the more boats country B wants to allow
B. There is a unique Nash Equilibrium
C. The Pareto Optimal, efficient outcome is for each country to allow 40 boats
D. There are multiple Nash Equilibria in this game
E. There are no Nash Equilibria in this game

Ans:
B. There is a unique Nash Equilibrium

44

. . . this is the unique point where the best response functions intersect, where
each country is best responding to one another. Bs best response when B allows
40 boats is to also allow 40 boats, and vice-versa.
False answers explained:
A is false because these BR functions are both negative sloping; this is also
intuitive as the benefit of allowing an additional boat declines the more
boats the other country allows.
C is false because it is not efficient in the Pareto optimality sense.
To compute this, for Pareto optimality here we would need that total
boats are at the point where the total net marginal benefit is zero.
If it were positive, more boats could be allowed. If it were negative,
fewer boats should be allowed. In either case the total surplus could
be increased and split between the two countries. If an improvement
can be made for both parties, the original situation is not Pareto
optimal.
But you do not need to compute this; each countrys boats are exerting
a negative externality on the others. We know each country will not
care about this, so they will choose too many boats from a total (both
countries) net-benefit context. This is a tragedy of the commons
situation; it is similar to a prisoners dillemma, but in the context of
continuous strategy space (any positive number of boats, rather than
Rat vs. Silent)
Also, if you know B is true, you can ignore C
D is false because B is true. (Note that I will never ask you to consider
mixed strategy equilibria in a continuous-strategy context, only perhaps in
a matrix game like BoS)
E is false because B is true

Chapter 6 - Production
6.1, 6.3, 6.5a - Note that I have cut problem 6.7 as we are not using Cobb-Douglas
right now
6.1 (Cover part c only in tutorial, 5-10 min)
Imagine that the production function for tuna cans is given by
q = 6K + 4L
where
q = Output of tuna cans per hour
45

K = Capital input per hour

L = Labor input per hour
a. Assuming capital is fixed at K = 6, how much L is required to produce 60
tuna cans per hour? To produce 100 per hour?
b. Assuming capital is fixed at K = 8 how much L is required to produce 60
tuna cans per hour? To produce 100 per hour?
Parts a and b are straightforward algebra; this does not need to be covered
in tutorial; answers in back of text.
Part c: Graph the q = 60 and q = 100 and isoquants. Indicate the points
found in part a and part b. What is the RTS along the isoquants?
Ans to 6.1.c

How do we know RTS is 23 ? Simple algebra works, or plot two point and
connect them; we know the production function is linear, these inputs are
perfect substitutes in production, so the slope will be constant.
q = 6K + 4L
6K = q 4L
q
4
K= L
6 6
So, for any value of q, if L increases by 1 unit, we can decrease K by
i.e., by 23 of a unit, and hold output constant
46

4
6

units,

 To find the intercepts of these isoquants, find the values of K that produces
the desired output (e.g., 60), if we are using 0 Labour. Next find the value
of L that produces this output if K = 0.
6.3 (Not covered in tutorial)

a.

Note: to graph this you must either plot a bunch of points and connect
them, or know the general shape of the square root function.
On an exam, I would let you know that it is increasing at a decreasing
rate. Multiplying it by 100 merely shifts the scale of the Y-axis.
b.

47


As L increases, so does L, so the denominator increases, thus APL
declines. Its only natural each unit becomes less and less productive, so
at higher levels of L we have less productive units on average.
Note that the APL never goes to zero even with a very large denominator,
this fraction is still positive.

6.5 (Cover part a in tutorial, 5-10 minutes)

Grapes must be harvested by hand. This production function is characterized by
fixed proportionseach worker must have one pair of stem clippers to produce
any output. A skilled worker with clippers can harvest 50 pounds of grapes per
hour.
a. Sketch the grape production isoquants for q = 500, q = 1000, and q = 1500
and indicate where on these isoquants firms are likely to operate.

48

 This is very much like the perfect complements indifference curves on

the consumer side. Consider whether you can do better than setting these
inputs in the proportions one clipper per worker. Increasing the number
of workers but not the number of clippers will increase costs but not
increase output. Boo. The same for increasing the number of clippers but
not workers. Thus, you always operate at these exact fixed proportions,
whatever output you produce.
Note, parts b-d are not assigned

Chapter 7 - Costs
Review questions 1-2,4
Review question 1 (Cover in tutorial; discussion, discussion of concise
bullet point answer - 10 min)
Q: Trump Airlines is thinking of buying a new plane for its shuttle service. Why
does the economists notion of cost suggest that Trump should consider the
planes price in deciding whether it is a profitable investment but that, once
bought, the planes price is not directly relevant to Trumps profit-maximizing
decisions? In such a case of sunk costs, which cost should be used for deciding
where to use the plane?
Ans to RQ1, ch 7
Note that the question sort of assumes the plane cannot be resold or rented
out; if it could, it wouldnt be a fully sunk cost
Economic costs consider the costs incurred as a result of the decision at
hand, to weigh against the likely benefits from that decision
Before buying the plane, consider whether the revenues resulting from that
choice outweigh the cost
After buying this plane (assuming it cant be resold/rented), when deciding,
e.g., how often to fly it, how much to charge passengers, which routes
to offer, he should consider only whether the revenue from these choices
(ticket sales etc) outweigh the cost of these choices (fuel costs, landing
rights costs, etc). Whatever he does, the cost of having purchased the
plane will be the same.
Note that if the plane could be resold, but only at the end of each
business year, it might represent a fixed cost but not a sunk cost
in the long run
49

Forty word answer

Assume plane cannot be resold

Economic costs: relevant to present decision only
Before buying plane: future revenues > cost of plane
After: Decisions maximize revenue minus economic costs
E.g., choose routes to max ticket revenue minus fuel costs; plane cost
cant be recovered

By the way, there was a Trump shuttle from 1989-92. It never turned a
profit.
Review question 2 (Cover in tutorial - 5 min, take questions)
Q: Farmer McDonald was heard to complain, Although my farm is still profitable,
I just cant afford to stay in this business any longer. Im going to sell out and
start a fast-food business. In what sense is McDonald using the word profitable
here? Explain why his statement might be correct if he means profits in the
accountants sense but would be dubious if he is referring to economic profits.
Ans to RQ2, ch 7 (short version)
Profitable in an accounting sense only. Revenues > accounting costs
(outlays)
Economic profits zero or negative:
Farmland an asset, could generate revenue (or rent) in other uses
Farmers time (labour, intelligence) also an input
Revenues < the true economic cost of these inputs

50

Review question 4 (Do not cover in tutorial)

Suppose a firm had a production function with linear isoquants, implying that
its two inputs were perfect substitutes for each other. What would determine the
firms expansion path in this case? For the opposite case of a fixed-proportions
production function, what would the firms expansion path be?
Linear isoquants: choose input that is more productive per . Prices
constant as output increases, expand this input only
Fixed proportions: Expand output according to these fixed proportions
expansion path a straight line

Micro quiz 7.1, part 1 (Do not cover in tutorial, unless

there are questions)
Young homeowners often get bad advice that confuses accounting and economic
costs. What is the fallacy in each of the following pieces of advice? Can you
alter the advice so that it makes sense?
Owning is always better than renting. Rent payments are just money
down a rat holemaking house payments as an owner means that
you are accumulating a real asset.
Ans to microquiz 7.1, part 1
Rent payments are for housing services. Someone who lives in his or her own
house similarly pays for such services in the form of forgone earnings on the
funds invested. So, the key question is which form of housing consumption
provides the services at lower costs (including opportunity costs). Paying off the
mortgage converts explicit interest costs into implicit ones (the forgone earnings
51

one could obtain by investing funds tied up in the house). If opportunity costs
are the same as mortgage costs, burning the mortgage has no significance.
Main point: Living in your owned house is not free it involves an implicit
cost: your investment in house principal could also generate a profit if you
sold the house and invested (e.g.) in a stock market index.

8.1 (cover in tutorial)

52

Fifth tutorial/homework:
Ch.
9Perfect
competition . . . , 16Public Goods, and 17
Behavioural economics
Ch. 9Perfect competition in a single market
Micro-quizes
9.2, 9.3, 9.4
Remember that short answers to these are at the back of the text
These are the sort of questions/answers I might ask for on the exam
(especially in the third section)

Problems 9.3a and b

These should be simple algebraic exercises, but helpful to get a feeling for
the firms SR supply curve and the industry supply curve as the sum of
these

53

9.9 a-d
16.7 all parts (Cover partially in tutorial; it is a bit advanced)

Ans to 16.7.a
The optimal level occurs where the social benefit less cost is maximised
With diminishing marginal benefit and constant marginal cost, as here,
this occurs where social marginal benefit equals marginal cost
Marginal benefit can be expressed as the price an individual is willing to
pay for the next unit; i.e., the price that comes from their demand curve:
Here, for person A, qA = 100 P P = 100 q = M BA (q) where
q < 100, otherwise M BA = 0
For person B, qB = 200 p P = 200 q = M BB (q) where q < 200,
otherwise M BB = 0
As they both consume the same units, summing these individual marginal
benefits of each unit yields the social marginal benefit of each unit. But
this is difficult, as we need to be careful to sum only over the range where
the marginal benefits are positive.

54

 After the 100th unit, the marginal benefit is positive for B only. Thus, if
Bs value of these units exceeds its cost, we can ignore A.
After 100 units B still gets a marginal benefit 200 100 = 100,
exceeding the MC of 50. Thus, we can ignore As preferences in
computing the optimum here.
Setting M BB (q) = 200 q = mc = 50 will yields the optimum here,
of q = 150.
Interpretation: The optimal units for B alone is 150. As A doesnt
value any units above 50, the fact that A gains from the first 50 units
provided is irrelevant.
Ans to 16.7.b
This question is difficult; the key issue is that each persons optimal choice
depends on the other persons choice! Ultimately, this solution is too involved
for our current purposes. Here are some simple points for your intuition:
We might consider the above demand curves as each persons demand if
the other purchased nothing. We can extend this to consider each persons
best response function: how much mosquito control they would pay for
as a function of what the other would do. We might imagine that for any
outcome, players will be best-responding.
If A purchased no units, B would choose to consume where her M B(Q) =
M C, i.e., qB = 150 units.
If A purchased some amount of units (below 50), B would top these up to
the point where, for the total units provided, M BB (Q) = M BB (qA +qB ) =
M C. This implies M BB (qA +qB ) = 200qA qB = 50. Thus qA +qB = 150
at Bs optimal choice
In this case, even though it is a public good, voluntary provision will
be optimal. (For other examples cases this will not occur)
Ans to 16.7.c
This optimal provision (150), would cost 150 50 = 7500. If we split it according
to the benefits each get, we need to add up not the marginal but the total
benefits each get the area under the demand curve (consumer surplus) from
this amount. I wont bother with the calculation here.

16.8 parts a and b (Cover in tutorial only if time permits,

it is pretty simple)
Suppose there are three people in society who vote on whether the government
should undertake specific projects. Let the net benefits of a particular project
55

be $150, $140, and $50 for persons A, B, and C, respectively.

a. If the project costs $300 and these costs are to be shared equally, would a
majority vote to undertake the project? What would be the net benefits
to each person under such a scheme? Would total net benefits be positive?
Ans to 16.8.a
Total Net Benefits less costs = $340 >$300.
Under equal sharing ($100 each) A and B would vote for the project, C
against it.
Net benefits for person A = 50, for person B = 40, and for person C
= 50.
Ans to 16.8b.
Now net benefits fall short of costs ($340<$375) but A and B would still
vote for the project.
Implication: the democratic process, public choice may lead to
overprovision (or underprovision) of certain goods

16.9 parts a-c (cover in tutorial)

The town of Pleasantville is thinking of building a swimming pool. Building and
operating the pool will cost the town $5,000 per day. There are three groups of
potential pool users in Pleasantville:
1. 1,000 families who are each willing to pay $3 per day for the pool
2. 1,000 families who are each willing to pay $2 per day for the pool, and
3. 1,000 families who are each willing to pay $1 per day for the pool.
Suppose also that the intended pool is large enough so that whatever number of
families come on any day will not affect what people are willing to pay for the
pool. (I.e., no congestion)
Ans to 16.9a
Which property of public goods does this pool have? Which does it
not have?
This pool is excludable (unlike a pure public good). It is nonrival because there
is a zero marginal cost for one more user. (This is thus a club good).
56

Ans to 16.9b
Would building the pool be an efficient use of resources?
Families as a whole are willing to pay $6,000 per day for the pool (3
1000 + 2 1000 + 1 1000).
The pool which would cost only $5,000 per day.
Thus building the pool would improve the allocation of resources
(relative to no pool).
Ans to 16.9c
Consider four possible prices for family admission to the pool: (1)
$3, (2) $2, (3) $1, and (4) $0. Which of these prices would result in
covering the cost of the pool? Which of the prices would achieve an
efficient allocation of resources?
None of these prices would cover the $5000 cost of the pool.
At $3, only the highest-valuing (1000) families would come, yielding
$3000 in revenue
At $2, the highest-valuing families would come, as well as the second
group, yielding 2000 entrants and $4000 in revenue
at $1, all 3000 families would come, yielding $3000 revenue
(Note that here, if the managers knew who had what value, pricediscrimination might raise enough revenue)
Any price that deterred someone with a positive value from using the
pool would be inefficient; this is a key reason why a nonrival good cannot
typically be provided efficiently in the free market.
A price of either $1 or $0 would be efficientas all the families who valued
it would enterbut would require the pool to operate at a loss.
Implication: This is an argument for government provision (have
the government pay for the pool through taxation, i.e., enforced
payment, make it available to all. A similar argument could be made
for subsidizing the railway networks.

57

Ans to 17.2

58

Ans to 17.3 (Cover parts a and b in tutorial, part c if time permits)a

Refer back to Chapter 5, in particular to the Prisoners Dilemma in

Figure 5.1. Imagine that these payoffs are monetary payoffs. Suppose
that players only care about monetary payoffs, with $1= 1 util. Find
the pure-strategy Nash equilibria.
Both play Rat.
b. Suppose that players have a preference for fairness. Each player
loses 1 util for each dollar difference (in absolute value) between
their payoffs. Show how the Prisoners Dilemma payoffs would
change by writing down a new normal form. Find the purestrategy Nash equilibria.
(Note the text uses a particular version of the Prisoners Dillemma payoffs; figure
5.1 differs by textbook edition)
Payoffs unchanged where monetary payoffs are equal for A and B (where
both take same action; both Rat or both Silent)
59

 Where one Rats and the other is Silent, monetary payoffs are 0 and 3,
leading to a 3 point difference in monetary payoffs
This implies each lose 3 utils from this difference, leading to net
payoffs: 3 3 = 0 for the one who Rats and 0 3 = 3 for the one
who stays silent

Now there are two equilibria: both play Rat and both play Silent.

60

Ans to 17.5, parts a-b (Cover in tutorial if time permits)

a. Refer to the Ultimatum Game in Figure 17.7. Recall that the

payoffs are monetary payoffs. Suppose that players only care
about monetary payoffs, with $1=1 util. Find the subgame
perfect equilibrium
Ans: Player 1 makes a low offer; player 2 accepts either offer. (Use backwards
induction)
b. Suppose that players are imperfectly altruistic. They receive 1
util for each dollar they earn but 1/2 for each dollar the other
player earns. Write down the extensive form reflecting the new
payoffs. Find the subgameperfect equilibrium.

61

 For this transformation, for these new payoffs, the SPNE is the same.
However, for other transformations, the SPNE could change (recall
the fairness preferences example)

Ans to 17.7 (Cover quickly in tutorial)

Will and Becky are two college students who are planning on Sunday
how much they will study on Monday for a test on Tuesday. Will
weighs future utility the same as current utility. Becky is more
impulsive. She puts weight 1 on current period utility but only
weight w on utility earned in future periods where 0 < w < 1. Let s
be the cost in terms of utility on Monday from studying. Let b be
the benefit in terms of utility on Tuesday from studying and thus
performing well on the test.
a. Under what condition on s and b would Will plan to study for
the test? What condition is required for him to carry through
on his plan?
Will will plan to study (i.e., would commit on Sunday to study on Monday)
if sum of payoffs from studying exceeds sum from not studying. I.e., if
b > s. Future utility is not discounted.
Will will carry through plan on Monday if b > s (same condition).

62

b. Under what conditions on s and b would Becky plan to study

for the test? What condition is required for her to carry through
on her plan?
Becky will plan to study (i.e., would commit on Sunday to study on
Monday) if sum of payoffs, as assessed on Sunday, from studying exceeds
sum from not studying. Weights utility in future periods at w.
Thus on Sunday, in committing for Monday, she would consider
whether wb > ws, i.e., whether b > s (same as Will.)
On Monday Becky considers the cost of studying as a present cost, thus
it is not weighted downwards. Thus she will carry through on her plan to
study if wb > s.
Implication: Where b > s but wb s Becky would commit on Sunday
to a plan for Monday that she would not want to carry through with
on Monday.

63