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Topics In Economic Theory Question Paper

Topics In Economic Theory

Course:Bachelor Of Arts In Economics

Institution: Kenyatta University question papers

Exam Year:2008

KENYATTA UNIVERSITY
UNIVERSITY EXAMINATIONS 2008/2009
FIRST SEMESTER EXAMINATION FOR THE DEGREE OF BACHELOR OF
ARTS
AEC 400: TOPICS IN ECONOMIC THEORY

DATE: FRIDAY, 5TH DECEMBER 2008
TIME: 4.00 P.M. – 6.00 P.M.

INSTRUCTIONS:

1.
This question paper has three sections i.e. A, B and C.
2.
Attempt FOUR QUESTIONS by answering at least ONE QUESTION from each
section, and any other question from any secton.
3.
All questions carry equal marks.
4.
Answers for different sections must be in separate answer books.

SECTION A

1.
Given that a utility maximizing decision maker has the following utility function

U(W) = lnW
(a)
Describe this decision maker’s attitude towards risk.
(b)
Find the coefficient of Absolute Risk Aversion and briefly comment on it.
(c)
How does this decision maker’s extent of risk aversion compare with that of a
second decision maker with a utility function given as
U(W) = W?

2.
Using an appropriate example show that positive skewness in the distribution of wealth
(W) is preferred by all risk averse investors.

2

SECTION B
Question Three
(a)
Differentiate between stable, unstable and metastable equilibrium.
(6 marks)
(b)
The following table gives the market demand schedule and the markets
supply schedule of commodity Y.

Price
5
4
3
2
1
Quantity Demand
5,000
6,000
7,000
8,000
9,000
Quantity Supplied
1,000
4,000
7,000
10,000 13,000

Is the equilibrium for commodity Y stable or unstable? Explain your answer with
illustration.

(4.5 marks)
(c)
Find equilibrium income (Y ) and consumption (C) from the following

and prove the validity of the solution.

(7 marks)
Y ? C ? I ? G
o
o
C ? 25 ? 6 .05
Y

I ? 16
o
G ? 14
o
Question Four
Let the linear demand function of an isolated market model be replaced by a quadratic
demand function: Qd = 4 – P2, while the supply function remains linear: Qs = 4P – 1.
(a)
Form a quadratic equation and find the economically feasible equilibrium price
and quantities.

(7 marks)
(b)
The market equilibrium condition Qd = Qs, is often expressed as an equivalent
alternative form, Qd – Qs = 0, which has the economic interpretation “excess
demand is zero.” Does the quadratic equation in (a) represent the latter version
of the equilibrium condition? Explain your answer.

(2.5 marks)
(c)
Suppose the government levies a tax of KShs 4 per unit output in order to
discourage consumption.
(i)
What will be the equilibrium quantity, the price the consumers will
pay, and the price the firms will receive?

(6 marks)

(ii)
Comment on your answer.

(2 marks)

3

SECTION C

1.
Consider an economy with one consumption good. Labor and money and the
utility function of the consumer whose economic life time is two given by:
? 1
? ? ?
c ? ? ?
c
if
?
1
2 ?
?
? 0?

u(L c c ) ?
:

1 1 2
? ?
?
?ln c ?? ln c if ? ? 0?
?
1
2
?

With ? ? ,
1 ? ? ,
0 0 ? L ? L where L is the total labor available in the economy.

The consumer works in the first period earning a wage rate of w for every unit of labor he
supplies so that his total income is wL . There is full employment of labor in the
economy. Out of his earnings in period one, he saves a portion s which he uses for the
next period’s consumption. He uses all his savings in period two so that he has nothing
left at the end of period two. Assume that the does not work in the second period. Let p1
be the price of the good in period one and pe be the expected price of the good in period
two. Assume also that in period two, he gets no returns on his savings but only what he
saved. The consumer is endowed with initial money balances amounting to M .
i.
Determine the equilibrium consumption demand in period one c1 and savings
rate when ? ? 0 ,

(7 1 marks)
2
ii.
Determine the equilibrium consumption demand in period one c1 and
savings rate when ? ? 0 .

(10 marks)

2.
Consider an economy with a representative consumer consuming a domestically
produced good c1 and an imported good c2. His preferences over c1 and c2 are
represented by the utility function given as:

u?c ,c ? c
? c
1
2 ?
2
1 2
The price of c1 is p and the price of c2 is q. He inherits some wealth amounting
to m which he can use to consume the two goods. In addition, he earns a wage
rate of w per unit of labor (his total wage income is therefore wL). Out of this wage
income, he pays a proportionate tax at the rate of tax and saves another proportion
s of what remains from his consumption.

4

The domestic firms produce only c1 using a strictly increasing and strictly concave
production technology which satisfies the weak Inada conditions given as:
A
f ?L?:?
LB A ? ,
0 0 ? B ? 1
B
The firms pay w as the wage rate for L units of labor used in production. There is full
employment of labor in the economy with L denoting the full employment level of
employment c2 is imported from another country.
i.
Determine the equilibrium demand for labor L

(4 marks)
ii.
What is the equilibrium supply of c1

(3 marks)
iii.
Derive equilibrium real wages ?w p? in terms of L

(4 marks)
iv.
Determine the domestic goods market equilibrium (of c1)
(6 1 marks)
2

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