KENYATTA UNIVERSITY

UNIVERSITY EXAMINATIONS 2009/2010

INSTITUTIONAL BASED PROGRAMME
EXAMINATION FOR THE DEGREE OF MASTER OF ECONOMICS
EET 502 : MICRO ECONOMIC THEORY 2

=================================================================
DATE: FRIDAY 30TH APRIL 2010 TIME: 9.00 A.M. – 12.00 NOON

INSTRUCTIONS
Answer ALL four Questions.

1. a) There are two firms in an oligopoly each with constant marginal costs given
as MC = c and producing identical products. The industry output is given as:
Q = Q1 +Q2 where Q1 and Q2 are the outputs of firm 1 and firm 2 respectively.
The price in the industry is a function of the total industry output and is given
as: P = a-bQ, where a and b are constants. Determine the supply functions of
firm 1 and 2 given that firm 1 is a quantity leader. (14 marks)

b) Explain the equilibrium condition in an oligopoly industry with two firms

with simultaneous price setting. (5 marks)

2. a) In certain estate, there are five households, each with different preferences and
valuations on street lights that is to be installed. The street light will cost
Kshs. 24,000 to install. They have to agree whether to install the lights or not.
If it is installed all of them will contribute equal amounts. Households 1 is
willing to pay 3,200, household 2 Kshs. 3,600, household 3 Kshs. 4,200,

Page 1 of 2
 household 4 Kshs. 12,000 and household five kshs. 16,000. Clearly show
the pivotal agents in this case and how much each should pay as a Clarke tax.

b) Discuss the major characteristics of public goods and suggest why they are
best provided by the government. (7 marks)

3. a) The demand functions of good 1 for 2 agents A and B are given as QA1
( P1 , P2 ) and QB1(P1 , P2) respectively while the demand functions for good 2
are given as QA2 (P1 , P2) and QB2 (P1 , P2 )respectively. The endowment of
good 1 and 2 for agent A are given as WA1 and WA2 and for agent B are given
as WB1 and WB2.

i) Use an edgeworth box to represent the information given. (Hint:

Ensure you note any assumptions you make on the relationship
between the endowments of resources and the total demand for each
agent). (6 marks)
ii) Proof that Walras’ law holds in this case. (8 marks)

b) Using the second theorem of welfare economics, discuss the condition

necessary for a pareto efficient allocation to also be a market equilibrium.
(5 marks)

4. Moral hazard and adverse selection are sources of market failures in economy.
a) Show how each of them contributes to inefficiencies in the economy using
relevant examples. (10 marks)
b) Briefly discuss how the inefficiencies in (a) can be resolved using examples.
(7 marks)

Page 2 of 2