Assume that WA Drilling is the only firm in Western Australia capable of drilling tunnels through hard rock.



Question 1a (Topic: Market Structures under Price Discrimination)

Assume that WA Drilling is the only firm in Western Australia capable of drilling tunnels through hard rock. In addition, 20 local firms are interested in potentially buying this service this year. As an economist, you are asked to address these questions for this market in detail using microeconomic theory (use diagrams where appropriate):

(a) Would it be a good idea for WA Drilling to advertise a fixed price on their website? If not, what would be the optimal pricing strategy for WA Drilling? (6 Marks)
(b) Some of the 20 firms contact the local consumer protection authority claiming that the decision of WA Drilling to not advertise the price of its services on their website is an “unfair practice”. Is this statement justifiable? What can you say about economic efficiency and consumers’ surplus? (6 Marks)
(c) Following up on the claim presented in (b), now the local economic regulation authority wishes to implement a policy that will help improve the level of wellbeing of the clients of WA Drilling. What policy do you think would be best to achieve this outcome without deteriorating economic efficiency? (6 Marks)
(d) How would a policy establishing a price cap on WA Drilling’s service affect the economic efficiency of the market? (6 Marks)
(e) Suppose that now the local regulation authority is considering that WA Drilling be forced to publish a fixed list of prices (menu options depending on the size of the job) on their website. How would the market outcome for this arrangement compare to the policy alternatives analysed earlier? What would be your final policy recommendation? (6 Marks)


Question 2a (Topic: Uncertainty and Asymmetric Information)

Using appropriate models, analyse market outcomes for comprehensive car insurance in the following way:

(a) Analyse how a risk-averse individual makes decisions facing uncertainty. (10 Marks)
(b) Analyse the best pricing strategies for insurance firms, assuming that there are individuals with different levels of risk aversion and that the firms in this market collude in their pricing strategies. (5 Marks)
(c) Discuss how the outcomes in (b) would differ if you assumed perfect competition. (5 Marks)
(d) Discuss the outcomes when the suppliers lack information about the level of risk facing each potential insuree. Carefully explain why some potentially beneficial economic transactions can “go missing” in the presence of this information asymmetry. (10 Marks)


Question 3a (Topic: Coordination Games and Public Goods)

Members of a local council are discussing building a new local library. You are asked to analyse two aspects of this problem:

(a) Council members worry that the received private voluntary donations towards the library, totalling $4 million, may not provide the level of satisfaction that the community wants. A survey revealed that the community would be happy to pay a new local tax to raise the library’s budget to $20 million. Provide an economic justification for this tax policy using an n=500 community member public good model. Explain carefully your assumptions, diagrams, and private and policy-intervention outcomes. (20 Marks)

(b) The $20 million have now been raised. However, in a new meeting the Council members start discussing alternative uses of these funds. The debate is whether the $20 million should be used for: (a) Building the local library, (b) Building a communal tennis court and (c) Building a community hall. The discussion is disorganised and it has been proposed breaking the agenda to comparing and discussing two projects at a time. Based on the Condorcet’s Paradox, explain how agenda manipulation could affect the final voting outcomes of these discussions, why some Council members might want to vote “strategically” as opposed to “sincerely”, and what would be the best way of approaching this discussion. Explain carefully your assumptions, diagrams and outcomes. (20 Marks)


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