Subject1072000 2004

Faculty of Actuaries
Institute of Actuaries
EXAMINATIONS
11 April 2000 (am)
Subject 107 Economics
Time allowed: Three hours INSTRUCTIONS TO THE CANDIDATE 1. 2. 3. Write your surname in full, the initials of your other names and your Candidates Number on the front of the answer booklet. Mark allocations are shown in brackets. Attempt all 37 questions; answer the 26 multiple questions continuously and then begin each answer from question 27 on a separate sheet. Graph paper is not required for this paper. AT THE END OF THE EXAMINATION Hand in BOTH your answer booklet and this question paper. In addition to this paper you should have available Actuarial Tables and an electronic calculator.
107A2000
Faculty of Actuaries Institute of Actuaries
For questions 126 indicate in your answer booklet which one of the answers A, B, C or D is correct.
A maximum price is set for Good X at 20 which happens to coincide with the free market price. A decrease in the demand for Good X keeping the maximum price fixed at 20 will lead to: A B C D no change in price and a surplus. a fall in price and a surplus. a fall in price and a shortage. a fall in price and a fall in the number of units sold.
[1]
Which one of the following is NOT a characteristic of a normal good? A B C D It has a positive income elasticity of demand. A price fall will lead to a rise in demand. The substitution and income effects of a price change work in opposite directions. The substitution effect of a price fall has a positive effect on demand. [1]
Under what conditions should a profit maximising firm definitely keep open its production in the short run? A B C D When average fixed cost is above average revenue and average fixed costs are less than average variable costs. When average revenue is above average variable cost. When average revenue is above average fixed costs. When total revenue is above total fixed costs and total fixed costs are less than total variable costs. [1]
If a demand curve is described as having a price elasticity of minus unity throughout itsentire length, this means that the demand curve is: A B C D a straight line and total expenditure is the same at all prices. not a straight line and total expenditure rises as price rises. not a straight line and total expenditure is the same at all prices. a straight line and total expenditure falls as price rises.
[1]
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The price of good X is twice the price of good Y. A consumer spends all his income on the two goods, the consumer is in equilibrium when which one of the following conditions is met? A B C D The marginal utility of Good X is equal to the marginal utility of Good Y. The ratio of the quantity of Good X to the quantity of Good Y is equal to the ratio of the price of good X to the price of good Y. The marginal utility of Good X is twice the marginal utility of Good Y. The total utility of Good X is twice the total utility of Good Y. [1]
Which one of the following is TRUE: A B C D Diseconomies of scale means that the ratio of inputs to outputs rises as output rises. The minimum efficient scale is the point at which long run average costs must begin to fall. In the long run a firm cannot alter its fixed costs of production. Constant returns to scale means that if a firm doubles its inputs then output remains the same. [1]
A managing director of a monopoly firm is given the following data: Marginal revenue = 9 Marginal cost = 10 Average cost = 11 Average revenue = 15 To maximise profits the firm should: A B C D reduce price and increase output. reduce price and reduce output. increase price and increase output. increase price and reduce output.
[1]
A movement along a consumers indifference curve from left to right means that the consumers A B C D marginal utility will rise. total utility will be unchanged. marginal utility will fall. money income is unchanged.
[1]
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Which one of the following conditions indicates that a firm is operating in a monopolistically competitive industry rather than a perfectly competitive industry? A B C D Output of the firm is where marginal revenue equals marginal cost. The cost curves of the firm are U shaped. The marginal revenue of the firm is below its average revenue. The marginal cost curve cuts the average cost curve at its minimum point. [1]
10
Consider the following table: Units of capital 10 10 10 10 10 Units of labour 1 2 3 4 5 Output 100 190 270 340 400
The table illustrates which one of the following: A B C D increasing returns to scale. constant returns to scale. decreasing returns to scale. diminishing marginal productivity.
[1]
11
The principle of diminishing marginal utility of wealth implies that a risk averse individual will be prepared to insure himself against an event: A B C D even though the expected return is negative. only if the expected return is zero. only if the expected return is positive. only if the event has a high probability of occurrence.
[1]
12
A budget line shows an individuals expenditure constraints. If the price of the good measured on the vertical axis goes up by a bigger percentage than the price of the goodmeasured on the horizontal axis then the budget line will: A B C D not change position. be steeper than before. be flatter than before. shift to the right.
[1]
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13
A profit maximising firm has fixed costs of 40 and the marginal costs of production shown in the table below. The firm can sell as much of its output as it wishes at a fixed price of 100 each. How much profit does the firm make? Quantity Produced 1 2 3 4 5 6 A B C D 20 60 80 120 Marginal Cost () 40 60 80 100 120 140
[1]
14
If a country has negative net property income from abroad then: A B C D Gross Domestic Product is greater than Gross National Product. Gross Domestic Product is less than Gross National Product. Gross Domestic Product is the same as Gross National Product. we cannot say whether Gross Domestic Product differs from Gross National Product from this information. [1]
15
Which one of the following statements about real variables in the economy is always TRUE? A B C D Real interest rates are negative if the nominal interest rate exceeds the expected inflation rate. If nominal Gross Domestic Product (GDP) falls by 10 per cent and the GDP deflator falls by 2 per cent then real GDP has risen. If real wages rise then this must mean that the domestic price level has fallen. If the nominal money stock is constant and the general price level falls then the real money stock will have risen. [1]
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16
The monetary base is 300 billion, the publics cash to deposit ratio is 0.35 and the broad money supply is 450 billion. What is the reserve to deposit ratio of the banking system? A B C D 2 0.9 0.55 0.23
[1]
17
Government attempts to increase the narrow money supply through open market operations are likely to cause short term interest rates to: A B C D rise and reduce money demand. rise and raise money demand. fall and reduce money demand. fall and raise money demand.
[1]
18
Unanticipated inflation: A B C D increases the opportunity cost of holding money and redistributes wealth from fixed rate borrowers to lenders. increases the opportunity cost of holding money and redistributes wealth from fixed rate lenders to borrowers. reduces the opportunity cost of holding money and redistributes wealth from fixed rate borrowers to lenders. reduces the opportunity cost of holding money and redistributes wealth from fixed rate lenders to borrowers. [1]
19
Assume that the actual rate of unemployment is below the natural rate of unemployment because the expected rate of inflation is below the actual rate of inflation. If the expected rate of inflation rises to equal the actual rate of inflation then real wages will eventually: A B C D fall and real output rise. fall and real output will fall. rise and real output will rise. rise and real output will fall.
[1]
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20
Which of the following characterises the views of a monetarist? A B C D In the long term unemployment can be reduced by an expansionary fiscal policy. In the long term unemployment can be reduced by an expansionary monetary policy. In the long term unemployment is unaffected by monetary policy. In the long term unemployment can be reduced but only at the cost of a higher rate of inflation. [1]
21
Given the following data for an economy: Consumer expenditure Investment Government expenditure Exports Imports Capital depreciation Net property Income from abroad 70 million 20 million 40 million 10 million 30 million 20 million 10 million
What is the value of its Net National Product? A B C D 90 million 100 million 110 million 120 million
[1]
22
Other things being equal, an increase in the fiscal surplus will lead to a: A B C D rise in long term interest rates. increase in the money supply. a rise in bond prices. none of the above.
[1]
23
Which one of the following will increase the size of the multiplier? A B C D An increase in the marginal propensity to import. An increase in the marginal tax rate. A decrease in the marginal propensity to consume. A decrease in the marginal propensity to save.
[1]
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24
If savings exceed investment by 100 million and government tax revenue exceeds government expenditure on goods and services by 200 million then which of the following applies to net exports? A B C D Net exports are 100 million. Net exports are 100 million. Net exports are 300 million. Net exports are 300 million.
[1]
25
If the current account is in surplus then which of the following applies to the trade account? A B C D It must be in surplus. It must be in deficit. It must be in balance. It is not possible to say which of the above is applicable.
[1]
26
The current dollar ($) per pound () exchange rate is $1.50. The forecast for inflation rates for the year is 6% for the United States and 4% for the United Kingdom. What would be the forecast for the dollar-pound exchange rate one year from now if purchasing power parity applies? A B C D $1.65 $1.53 $1.47 $1.35
[1]
27
Draw a diagram to illustrate each of the following: (i) (ii) (iii) (iv) a demand curve for an inferior but non Giffen good. a demand curve for a Giffen good. a demand curve with minus unity price elasticity. a supply curve with unity price elasticity. [1] [1] [1] [1] [Total 4]
28
Read parts (i) to (iv) before answering. Answer all parts on the same diagram. A consumer has an income of 1000 all of which is spent on a combination of Goods X and Y. Good X costs 25 per unit and Good Y costs 20 per unit. Good X is an inferior good and Good Y is a normal good. (i) Draw the budget line of the consumer, labelling the quantities of Good X and Good Y at the points where the budget line meets the Good X and Good Y axes. Label the budget line as B1. [1]
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(ii)
Draw an indifference curve for Good X and Good Y at a point where the consumer is maximising his satisfaction. Label the indifference curve IC1. Mark the quantities of X and Y consumed as X1 and Y1 respectively. [1] Draw a new budget line to show what would happen to the budget line if the consumers income rose to 2000. Label the budget line as B2. [1] Draw a new indifference curve for Good X and Good Y at a point where the consumer is maximising his satisfaction following the change in income. Label the indifference curve IC2. Mark the quantities of X and Y consumed as X2 and Y2 respectively. [2] [Total 5]
(iii) (iv)
29
Consider the following options A to E. Each option relates to an individual firm operating under a certain market structure. Option A B C D E (i) (ii) (iii) (iv) Marginal cost 20 24 30 18 40 Average cost 20 18 36 28 40 Marginal revenue 20 24 30 28 20 Average revenue 20 24 40 40 40 [1] [1]
Which option indicates a short run equilibrium output for a profit maximising monopolist? Write down ALL the options that indicate that a firm is both profit maximising and making excess profits.
Write down ALL the options that indicate that the firm could reduce its output and increase its profits. [1] Write down ALL the options that would be consistent with a perfectly competitive firm in long run equilibrium. [1] [Total 4]
30
State FOUR factors which will make the demand curve for a good more price elastic, other things being equal. [4]
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31
Read both parts (i) and (ii) before answering. (i) Draw a diagram to show a firm in a perfectly competitive industry making a loss sufficiently small that it pays the firm to continue to operate in the short run. Make sure you use the following labels, AC1 for the average total cost curve, AVC1 for average variable cost curve, MC1 for the marginal cost curve, MR1 for marginal revenue schedule, AR1 for the average revenue schedule, P1 for price and Q1 for quantity. [2] Illustrate on the diagram drawn in part (i), the long run equilibrium price and quantity of the firm assuming all the cost curves remain unchanged. Mark the new revenue curves as MR2 and AR2, and P2 and Q2 for the long run equilibrium price and quantity. [2] [Total 4]
(ii)
32
(i)
Explain the difference between diminishing marginal productivity and diseconomies of scale as they relate to average cost curves. [3] State what is meant by the law of diminishing marginal utility in consumption. [1] [Total 4]
(ii)
33
You are given the following data on an economy: millions Investment expenditure Government expenditure on good and services Exports Notes: (a) (b) All tax revenues are derived from a uniform rate of income tax of 50% of income. Consumption expenditure is given by: C = 0.8 Yd where Yd is disposable national income (i.e. income less taxes) C is consumption expenditure (c) Import expenditure is given by: Z = 0.1 Y where Y is national income Z is import expenditure 20 70 50
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(i) (ii) (iii) (iv)
Calculate the equilibrium value of national income. Calculate the current account balance at the equilibrium value of national income.
[1] [1]
Calculate the fiscal surplus (+) or deficit () at the equilibrium value of national income. [1] Calculate the effect of a rise in government expenditure of 14 million on the current account. [1] [Total 4]
34
Briefly discuss the long run effects of lower (but still positive) domestic inflation on the following variables, while inflation in the rest of the world is zero. (i) (ii) The level of nominal wages in the long term. The exchange rate of the domestic currency. [2] [2] [Total 4]
35
Define the following: (i) (ii) (iii) (iv) the Public Sector Borrowing Requirement. the National Debt. Direct taxes. Progressive taxation. [1] [1] [1] [1] [Total 4]
36
(i)
With the aid of a numerical example, explain briefly the concept of the multiplier. [2] Explain briefly the relationship between the accelerator and the business cycle. [2] [Total 4]
(ii)
37
(i)
Inflation imposes heavy costs upon an economy and can be caused by either cost-push or demand-pull factors. Discuss. [10] Explain the theory behind how monetary policy can be used to control inflation and discuss some of the practical problems associated with using monetary policy to control inflation. [10] [Total 20]
(ii)
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EXAMINATIONS
April 2000 Subject 107 Economics EXAMINERS REPORT
Subject 107 (Economics) April 2000 Examiners Report
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
D C B C C A D B C D A C C A D C D B D C B C D D D B
The multiple choice questions were generally well answered.
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27
(i)
Page 3
Subject 107 (Economics) April 2000 Examiners Report (ii)
Page 4
Subject 107 (Economics) April 2000 Examiners Report (iii)
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Subject 107 (Economics) April 2000 Examiners Report (iv)
Quite a few candidates failed to correctly answer parts (iii) and (iv).
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28
IC2
IC1 B1 X1
B2
It seems that a number of candidates did not read the question correctly and assumed Good X to be a normal good, when the question states that it is an inferior good.
29
(i) (ii) (iii) (iv)
c B, C E A
Generally well answered.
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30
There are numerous factors that may make demand for a product more price elastic these include: (i) (ii) (iii) (iv) a rise in the number of substitute products available. a lengthening of the time horizon. the higher the proportion of income that is spent on the good. the less necessary the good is.
Quite a few candidates could only identify 2 or 3 factors that make demand for a product more price elastic.
31
Part (i) of this question was not well answered, with the correct placing of the AVC1 curve being a problem. Also the gap between the average variable cost curve and average total cost curve was not shown as narrowing as output expands by a significant number of candidates.
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32
(i)
Diminishing marginal productivity is applicable only to the short run when one has one fixed factor of production (usually capital) and one variable factor of production (usually labour). It says that after a certain point as you add more of the variable factor to a given amount of the fixed factor of production then the marginal product and the average product of the variable factor will decline, It leads to U - shaped short run costs curves. By contrast, diseconomies of scale concerns increases in long run average costs. Diseconomies of scale occur when output increases less than proportionately to increases in all inputs. Diseconomies of scale will gives upward sloping long run average cost curves and thus help to explain U shaped long run cost curves. The law of diminishing marginal utility in consumption states that as you increase consumption of a good then marginal utility derived from the good will decline.
(ii)
In part (i) the distinction between the short and the long run needed to be brought out more fully in the answers to this question. Part (ii) was generally well answered.
33
(i)
Y=C+I+G+X-Z Y= 0.8 (Y-0.5Y) + 20 + 70 + 50 - 0. 1Y Y= 0.3 Y + 140 0.7 Y = 140 Y = 200 million
(ii)
Exports = 50m Imports = 0.1(200) = 20m Hence current account is in surplus of 30m Tax revenue = 0. 5 (200) 100 million Government expenditure = 70 million Hence budget is in surplus of 30 million The increase in government expenditure will increase Y to 220m. Exports = 50m Imports = 0.1(220) = 22m. Hence the current account surplus will fall by 2m to 28m.
(iii)
(iv)
The calculations in this question seemed to present a number of candidates with problems particularly in relation to parts (iii) and (iv).
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34
(i)
A lower but still positive rate of inflation will mean a higher level of nominal wages in the long term as workers will require positive rises in wage levels to compensate for inflation. However wages will rise by less than they would have done had the fall in inflation not taken place. The exchange rate of the domestic currency should depreciate as this will help maintain purchasing power parity over the long run and maintain the competitiveness of the currency. However the exchange rate will fall by less than it would have done had the fall in inflation not taken place.
(ii)
Lower but still positive expected rate of inflation while assuming inflation in the rest of the world was zero means that nominal wage rates will grow more slowly than otherwise and the exchange rate depreciate more slowly than otherwise. Too many candidates answered this question as if it was phrased "examine the effects of inflation on wage growth and the exchange rate of the domestic currency" rather than in the spirit of the effects of lower inflation.
35
(i)
The PSBR is the excess of the government expenditure over the income from taxation. The National Debt is a debt of the public sector. The debt may be owed to citizens and organisations within the country or to overseas citizens or organisations. A direct tax is a tax on a payment made to a factor of production, e.g. wages, rent, dividends, interest, profit. A tax is said to be progressive if it takes an increasing proportion of a persons income as income rises.
(ii)
(iii)
(iv)
All four parts were generally well answered.
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36
(i)
An increase in an injection to the national income flow (e.g. an increase in investment spending), causes an increase in the equilibrium level of national income greater than the increase in the injection. The multiplier is the ratio of the increase in equilibrium national income to the original increase in the injection. In the special case where I,G,X and Z are all exogenous and there are no direct taxes the value of the multiplier is
1 1 - MPC
Where: MPC = Marginal Propensity to consume. If MPC = 0.8 then the multiplier = 5. (ii) According to the accelerator principle, investment is determined by the rate of change of national income. The capital stock is the current amount of capital equipment available in the economy. The capital output ratio is the amount of capital needed to produce one unit of output. If national income falls the required capital stock is reduced and investment demand will fall. Similarly a rise in national income will increase the required capital stock causing a rise in investment demand. Therefore, the demand for investment will change when national income changes. The combination of the accelerator principle and the multiplier can explain the business cycle. An increase in investment will cause national income to rise (the multiplier effect) which in turn causes a further increase in investment (the accelerator effect) and an upward trend in the business cycle. A fall in investment will cause national income to fall (the multiplier effect) which in turn causes a further fall in investment (the accelerator effect) and a downward trend in the business cycle. Part (i) was very poorly answered with many students failing to include a simple numerical example as the question asked. Part (ii) few candidates were able to make a good explanation of the relationship between the accelerator and the business cycle.
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(i)
Inflation is the annual percentage rate of change in the price of a weighted bundle of goods and services. There are numerous harmful effects to the economy that are caused by inflation. Inflation can arbitrarily redistribute the national income for example, it hits those on fixed incomes, debtors who borrow at fixed rates of interest gain while lenders who lend at fixed rates lose. Inflation erodes the real value of savings. In addition, inflation hits business planning and investment with businesses finding it harder to forecast costs, revenues, interest rates etc. Inflation will harm a country's international competitiveness especially if the currency is part of a fixed exchange rate regime. Inflation will also have the effect of placing upward pressure on interest rates, and long term bond yields may have a high inflation risk premium if a country has a poor inflation performance, this will undermine long term investment in the economy. Finally, inflation is an average of price rises which means that while some firms with above average price increases will be able to meet higher wage demands other firms that raise their prices by less than the inflation rate will not. These firms may suffer from strikes and industrial disruption as workers seek compensation. Most economists today recognise that there is a need to distinguish between anticipated and unanticipated inflation. To the extent that inflation is anticipated then it will generally speaking be less harmful than when it is unanticipated. Inflation is sometimes blamed on cost push factors, that is higher production costs, which are then passed onto the consumer in the way of higher prices. There are numerous possible causes of these cost push pressures, excessive wage demands (wages rises not justified by productivity increases), rises in commodity and raw material prices, a rise in imported input costs due to a depreciation of the currency and attempts by firms to raise their profit margins. Demand pull pressures are where increases in aggregate demand (consumer expenditure, government expenditure, investment and exports) exceed the output potential of the economy resulting in upward pressure on prices. Excess aggregate demand is especially likely to result in inflationary pressures as the economy approaches full employment. The causes of demand pull pressures are numerous but expansionary monetary and fiscal policies are usually cited. On occasions excessive domestic demand factors are reinforced by a booming world economy.
(ii)
Contractionary monetary policy can prove to be a powerful weapon in controlling inflation. According to the quantity theory of money which assumes a stable money demand function and a fixed level of real domestic output a fall in the rate of growth of the money supply will lead to a similar fall in the rate of inflation. For example a 10% increase in the money supply leads to 10% inflation whereas a 5% increase in the money supply will lead to only 5% inflation. A contractionary fiscal policy helps to reduce inflationary pressures in the economy by reducing aggregate demand in the economy. A contractionary monetary policy operates through government sales of treasury bills and bonds which places downward pressure on bond prices
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Subject 107 (Economics) April 2000 Examiners Report implying higher short term interest rates. A contractionary open market operation means that the public holds more bonds and less money which in turn will reduce the broad money supply measure associated with the money multiplier. A lower level of money will in turn imply a reduced demand for goods and services which will then translate into a lower inflation rate. The higher short term interest rates will discourage consumption and investment thereby reducing aggregate demand in the economy. The quantity theory of money makes it clear that there is a link between the rate of growth of the money supply and the rate of inflation, slower monetary growth will have the effect lowering current and expected inflation rates. A further benefit of contractionary monetary policy is that the exchange rate will tend to appreciate in value (sometimes quite significantly) which will lower the cost of imports. Since most economies are fairly open this can represent a significant contribution to inflation control especially as lower prices for goods will in turn encourage wage moderation. In practice, however, monetary policy is more difficult to implement than the quantity theory of money suggests. Firstly money demand can be unstable especially in the short run so that reductions in the money supply might not have the intended impact if money demand is falling at the same time. Then there is the question of defining the appropriate monetary aggregate to target, should it be a narrow definition of the money supply or a broad monetary aggregate? The financial sector is always innovating and this too complicates the process of controlling the monetary aggregates the monetary authorities might succeed in controlling their intended monetary aggregate but find that other monetary aggregates are not under control. There is also a problem of time lags in the economic system. The precise time it will take for monetary tightening to cool the economy is quite uncertain and there is a danger that a monetary tightening will be enacted at a time when the economy is slowing of its own accord leading to the possibility of a policy induced recession. Finally, policy makers cannot be sure about the degree of monetary tightening that will be required to keep inflation under control, some economists advocate a gradual approach to the tightening of monetary policy so that it gives economic agents time to adjust their wages and price setting, behaviour while other economists advocate a more hawkish approach to the implementation of monetary policy in which a significant monetary tightening is implemented in a short period of time as the best means of controlling inflation. This was by the poorest section of the paper with the quality of handwriting and legibility of some of the answers being below what can reasonably be expected. In part (i) many candidates failed to make a distinction between anticipated and unanticipated inflation with the latter being by far the most harmful aspect of inflation. In part (ii) many candidates failed to make mention of the quantity theory of money. The answers on the difficulty of implementing monetary policy is practice were often quite weak such as the problem of defining the appropriate monetary aggregate, instability in money demand, uncertainty and time lags often not mentioned. Page 13
EXAMINATIONS
12 September 2000 (am)
Time allowed: Three hours INSTRUCTIONS TO THE CANDIDATE 1. Write your surname in full, the initials of your other names and your Candidates Number on the front of the answer booklet. Mark allocations are shown in brackets. Attempt all 37 questions, beginning your answer to each question on a separate sheet.
2. 3. 4.
Graph paper is not required for this paper.
AT THE END OF THE EXAMINATION Hand in BOTH your answer booklet and this question paper. In addition to this paper you should have available Actuarial Tables and an electronic calculator.
107S2000
Scarcity exists if: A B C D prices are too high. economies are not perfectly competitive. human wants cannot be satisfied when price is zero. there are shortages of some goods.
[1]
Diseconomies of scale means: A B C D short run average total cost falls as output rises. long run average total cost falls as output rises. long run average total cost rises as output rises. short run average total cost rises as output rises.
[1]
Which of the following events would shift the demand curve for good X to the left? A B C D An increase in the price of good X. An increase in the price of a substitute good. An increase in the price of a complementary good. An increase in consumer income.
[1]
The demand equation for good X is Qd = 15 0.5P and the supply equation for good X is Qs = 3 + 2P, where P is the price. When the price is 6 there will be: A B C D a surplus of good X and price will rise. a shortage of good X and price will fall. a surplus of good X and price will fall. a shortage of good X and price will rise.
[1]
Individual A can choose between good X and good Y. The price of good X is 2 and the price of good Y is 5. What will be the ratio of the marginal utilty of X over the marginal utility of Y when individual A maximises total utility? A B C D 5/2 7/2 1/1 2/5
[1]
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Which of the following assumptions apply when constructing a budget line? A B C D Consumer preferences exhibit diminishing marginal substitution. The consumers income is fixed. Consumers prefer more of a good to less of it. A consumer can rank any two bundles of goods.
[1]
Which of the following statements regarding the productivity of labour is correct? A Average product is maximised when average product equals marginal product. Average product is maximised when marginal product is maximised. Marginal product increases when average product is above marginal product. Average product increases when marginal product is below average product.
B C
[1]
If the total cost of production is 48 when output is 5 units and rises to 78 when output is 7 units, the marginal cost of production will be: A B C D rising and less than the average total cost of production. falling and less than the average total cost of production. rising and greater than the average total cost of production. falling and greater than the average total cost of production.
[1]
If firms in a perfectly competitive industry are making economic profit the long run effect will be to: A B C D increase the output of the firms and the industry. reduce the output of the firms and the industry. reduce the output of the industry and increase the output of the firms. reduce the output of the firms and increase the output of the industry. [1]
10
In the long run, profit maximising firms operating under conditions of monopolistic competition will produce at a level of output where: A B C D price equals marginal cost. price equals average total cost. price equals average variable cost. price equals average fixed cost.
[1]
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11
If the government places an indirect tax on good X, the price of good X to consumers will not change when: A B C D supply of good X is price elastic. supply of good X is completely price inelastic. demand for good X is price elastic. demand for good X is completely price inelastic.
[1]
12
In a country with a population of 25 million people there are 16 million in the total workforce and 2 million unemployed. What is the rate of unemployment? A B C D 8% 11.1% 12.5% 44%
[1]
13
The need to employ workers with certain skills may decline even if the industry as a whole is not in decline . This form of unemployment is called: A B C D structural. demand-deficient. regional. technological.
[1]
14
Which of the following costs of inflation occurs because of the possibility of unanticipated inflation? A B C D Inflation risk premium. Menu costs. Shoe-leather costs. Institutional sluggishness.
[1]
15
Other things remaining the same, the result of an increased PSBR is: A B C D higher short term interest rates because the LM curve moves to the left. lower short term interest rates because the LM curve moves to the right. higher short term interest rates because the IS curve moves to the right. lower short term interest rates because the IS curve moves to the left. [1]
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16
In the circular flow of income model of an economy with no government or international trade, the flow of money is: A from firms to households in return for goods and services provided. and from households to firms in return for the factor services provided. from households to firms in return for the factor services provided. from firms to households in return for the factor services provided. and from households to firms in return for the goods and services provided. from firms to households in return for goods and services provided. [1]
B C
17
The macroeconomic demand schedule slopes downwards because at higher price levels the real money supply: A B C D increases and national income is lower. increases and national income is higher. decreases and national income is lower. decreases and national income is higher.
[1]
18
The short run aggregate supply schedule tells us that an increase in the average price level will encourage firms to: A B C D increase output and employment. reduce output and employment. increase output and reduce employment. reduce output and increase employment.
[1]
19
If consumption expenditure increases from 18,000 to 19,500 when disposable income increases from 20,000 to 26,000, then: A B C D the marginal propensity to consume is 0.25 and the multiplier is 1.33. the marginal propensity to consume is 0.25 and the multiplier is 4. the marginal propensity to consume is 0.75 and the multiplier is 4. the marginal propensity to consume is 0.75 and the multiplier is 1.33. [1]
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20
A fall in real Gross Domestic Product would result from an increase in all of the following with the exception of: A B C D saving. imports. taxation. government expenditure.
[1]
21
An unexpected increase in the price level which causes a temporary reduction in the real wage rate may: A B C increase the natural rate of unemployment. decrease the natural rate of unemployment. give an actual rate of unemployment which is temporarily greater than the natural rate. give an actual rate of unemployment which is temporarily lower than the natural rate. [1]
22
In Country A government expenditure is 360 billion, tax revenue is 375 billion, aggregate saving is 225 billion and aggregate investment is 205 billion. The net exports of Country A are equal to: A B C D deficit of 35 billion. surplus of 35 billion. deficit of 15 billion. surplus of 15 billion.
[1]
23
Keynesian economists support the argument that: A the aggregate labour market will automatically move towards equilibrium. changes in interest rates have little effect on aggregate investment in the short term. changes in the money supply have a proportionate impact on the rate of inflation. crowding out effects will seriously reduce the impact of increases in government expenditure.
[1]
1076
24
A fall in a countrys terms of trade index means that: A the index of export prices has risen by a smaller percentage than the index of import prices. the index of export prices has risen but the index of import prices has remained the same. the index of export prices remains the same whilst the index of import prices falls. the index of export prices has fallen by a smaller percentage than the index of import prices. [1]
25
In Country A it takes 15 hours to produce a unit of good X and 12 hours to produce a unit of good Y. In Country B it takes 10 hours to produce a unit of good X and 15 hours to produce a unit of good Y. Which of the following statements is correct? A Country B has a comparative advantage in the production of good X and an absolute advantage in the production of good Y. Country B has a comparative advantage in the production of good X and an absolute advantage in the production of good X. Country A has a comparative advantage in the production of good X and an absolute advantage in the production of good Y. Country A has a comparative advantage in the production of good X and an absolute advantage in the production of good X. [1]
26
An appreciation of the domestic currency: A reduces the foreign price of exports and increases the domestic price of imports. reduces the foreign price of exports and reduces the domestic price of imports. increases the foreign price of exports and reduces the domestic price of imports. increases the foreign price of exports and increases the domestic price of imports. [1]
1077
PLEASE TURN OVER
27
Illustrate on four separate supply and demand diagrams the effect on equilibrium price and quantity of good X (which is a normal good) of (i) to (iv) below. Use the labels P1 and P2 for the original and new price and Q1 and Q2 for the original and new quantity respectively. (i) (ii) (iii) (iv) A reduction in the price of a substitute good. The introduction of an indirect tax on good X. An increase in the productivity of labour in producing good X. An increase in consumers incomes.[1] [1] [1] [1] [Total 4]
28
Consumer A demands 450 units of good X per year given that the price of good X is 3.50 per unit, the price of good Y is 4.80 per unit and consumer As income is 35,000 per year. (In each case your answer should be given to two decimal places.) (i) When the price of good X falls to 2.80 per unit, consumer As demand for good X rises to 530 units per year, other things remaining the same. What is consumer As price elasticity of demand for good X? [2] When the price of good Y falls to 4.40 per unit, consumer As demand for good X declines to 380 units per year, other things remaining the same. What is consumer As cross price elasticity of demand for good X? [2] When consumer As income increases to 38,000 per year his demand for good X increases to 480 units per year, other things remaining the same. What is consumer As income elasticity of demand for good X? [2] [Total 6]
(ii)
(iii)
29
Define the following: (i) (ii) (iii) an inferior good. a Giffen good. a normal good. [1] [1] [1] [Total 3]
30
Read all parts of the question before answering. (i) Draw a diagram to show a monopoly firm making a profit. Label your diagram as follows: AR for average revenue, MR for marginal revenue, AC for average total cost and MC for marginal cost. Indicate on your diagram the profit maximising price P1 and output Q1. [2] Indicate on the diagram drawn in part (i) the socially optimal output level Q2. [1] Indicate and label on the diagram drawn in part (i) the social cost of monopoly. [1] [Total 4]
(ii)
(iii)
1078
31
Define the following: (i) (ii) adverse selection. moral hazard. [2] [2] [Total 4]
32
Discuss briefly FOUR factors that would explain why economies of scale might occur in large firms. [4]
33
A perfectly competitive firm manufactures good X which sells at 9.50 per unit. The total output per week at each level of employment is given below. Number of employees per week 1 2 3 4 5 6 (i) Total output per week (units) 6 13 22 32 39 44
Construct a table to provide the following information per week at each level of employment; (a) (b) (c) marginal product of labour. marginal revenue product of labour. total revenue.
[3]
(ii)
Determine the level of employment after which the firm begins to experience diminishing marginal returns.
[1] [Total 4]
1079
PLEASE TURN OVER
34
Use the following annual data for Country A to answer the questions below. Consumer expenditure Government expenditure Investment expenditure Direct tax revenue Transfer payments Export expenditure Import expenditure (i) (ii) = 203 million plus 75% of disposable national income. = 120 million. = 90 million. = 100 million. = 64 million = 85 million = 68 million [1]
What is the equilibrium value of national income? If government expenditure increased by 15 million: (a) (b) (c) by how much would national income increase? by how much would consumer expenditure increase? by how much would saving increase?
[1] [1] [1] [Total 4]
35 36 37
Explain four economic benefits of international trade.
[4]
Briefly discuss four factors which explain economic growth.
[4]
(i)
Explain what IS and LM curves show. Use an IS-LM graph to explain how the equilibrium national income and the equilibrium level of interest rates is determined. [5] Discuss, with the aid of IS-LM graphs, the impact on interest rates and national income of: (a) (b) (c) an increase in injections. an increase in the money supply. an increase in the average price level.
(ii)
[15] [Total 20]
10710
EXAMINATIONS
September 2000 Subject 107 Economics
EXAMINERS REPORT
Subject 107 (Economics) September 2000 Examiners Report
Overall comments One comment for the next set of exams is that it is a waste of time and paper to have the multiple choice questions answered on separate pages. The instructions for the next exams will clearly state that for multiple choice, a new page should not be used for each question.
There was considerable evidence of poor exam technique, for example:

appearing to fail to consider all the options in multiple choice questions not giving sufficient weight to high mark questions disregarding the wording of questions eg 2 decimal places, discuss.
Handwriting ranged from the clear to the terrible. Diagrams, in particular, were very poor in many cases. Many diagrams were drawn freehand (without a ruler) and therefore lacked clarity. Many diagrams were also too small for the answers to be clear. Candidates should use rulers, and diagrams should be of a sufficient size to show movements clearly.
Comments on individual questions appear in italics at the end of each corresponding solution.
Page 2
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
C C C C D B A C D B B C D A C C C A A D D B B A B C
Q1-Q26 Generally, the multiple choice questions were well answered. The questions which caused the main problems were numbers 7, 9, 11, 12 and 21. Of these, 11 was answered incorrectly most often.
Page 3
27
(i)
Price S P1
P2
D2 0 (ii) Price S2 S1 P2 P1 Q2 Q1 Quantity
D1
D 0 (iii) Price S1 S2 P1 P2 Q2 Q1 Quantity
D 0 (iv) Price S P2 Q1 Q2 Quantity
P1
D1 0 Well answered by most. Q1 Q2
D2
Quantity
Q27
Page 4

% change in Qd(X) = 0.89 % change in P(X) % change in Qd(X) = 1.87 % change in P(Y)
28
(i)
Price Elasticity of Demand =
(ii)
Cross Price Elasticity of Demand =
(iii)
Income Elasticity of Demand =
% change in Qd(X) = 0.78 % change in income
Alternative answers using arc elasticity measurement: (i) (ii) (iii) Q28 0.73 1.94 0.78
Well answered by most. Marks were given for part (i) where the minus sign was missed out, as it explicitly states in the core reading that some economists do miss out the minus sign. The most common error was to base the answer on the change in the quantity or price rather than the percentage change.
29
(i)
An inferior good is a good for which the income elasticity of demand is negative. So the quantity demanded fall as income increases. A Giffen good is a good for which the price elasticity of demand is positive. So, as its price rises the quantity demanded increases. A normal good is a good for which the income elasticity of demand is positive. So the quantity demanded increases as income increases.
(ii)
(iii)
Q29
Very well answered.
Page 5
30
Q30
Reasonably well answered by most. The most common error was not knowing the area representing the social cost of monopoly.
31
(i)
Adverse selection describes the fact that people who know that they are particularly bad risks are more inclined to take out insurance than those who know that they are good risks. Moral hazard describes the fact that a policyholder may, because they have insurance, act in a way which makes the insured event more likely.
(ii)
Q31
Well answered by most, although some candidates lost marks by simply giving an example for each rather than defining, as the question required.
Page 6
32
Any four of the following factors might be discussed to explain economies of scale: Spreading of fixed costs, e.g. administration, marketing, research and development. Specialisation; division of labour allows employees to specialise thus increasing productivity. Similarly more specialist equipment is employed as output rises Physical economies; increasing the volume of a physical object requires a less than proportionate increase in surface area. Finance; large firms may be seen as more credit worthy and consequently should obtain finance more cheaply. Bulk purchase; a larger firm is able to exert more pressure on suppliers to set lower prices. By-products; some production processes produce small amounts of potentially useful by-products. It may not be worthwhile selling this unless the scale of production (and hence the output of the by-product) is sufficiently large. The principle of multiples; different machines needed in the production process may have different capacities. In this case use of all machines capacities may only be possible at high output levels.
Q32
Very well answered. No marks were given where candidates simply stated factors without discussing them.
33
(i)
Number of employees per week 1 2 3 4 5 6
Marginal product of Labour
Marginal Revenue Product of Labour () 57 66.5 85.5 95 66.5 47.5
Total Revenue () 57 123.5 209 304 370.5 418
6 7 9 10 7 5
(ii)
Diminishing Marginal Returns are experienced when the number of employees per week exceeds 4.
Q33
Well answered by most. In part (i) full marks were given where candidates either marked the MPL between rows recording the number of employees per week, or in the same rows. In part (ii) full marks were given for 4 or for if a 5th person is added, but no mark for 5 by itself.
Page 7
34
(i)
Y=C+G+I+X-Z C = 203 + 0.75( Y + 64 - 100 ) Y = 203 + 0.75( Y +64 - 100 ) + 120 + 90 + 85 - 68 Y = 403 + 0.75( Y ) Y = 1612 million.
(ii)
(a)
When G = 120 million, Y = 1612 million. When G = 135 million, Y = 1672 million The increase in Y = 60 million.
(b)
When G = 120 million, C = 1385 million. When G = 135 million , C = 1430 million. The increase in C = 45 million.
(c)
When G = 120 million, S = 191 million. When G = 135 million, S = 206 million. The increase in S = 15 million.
Q34
Poorly answered. Many candidates calculated (i) incorrectly but went on to correctly derive the increases in (ii). Conversely some candidates who calculated the first part correctly, complicated part (ii). Many candidates neglected to take taxation into account in part (i).
35
The existence of international trade: (a) allows countries to specialise in the production of the goods which they can produce relatively more efficiently than other countries. increases the scope for benefits from economies of scale by increasing the size of the available markets. increases the range of goods and services which consumers can buy. leads to lower prices through increased competition.
(b)
(c) (d) Q35
Not very well answered. No marks were given where candidates simply stated factors without explaining them.
Page 8
36
Economists explain economic growth in terms of increases in: (a) capital; an increase in the stock of capital occurs when new investment exceeds depreciation of the existing stock of capital. labour; an increase in the labour force occurs as a result of population growth or an increase in the proportion of the population employed - that is the participation rate or an increase in working hours. Furthermore, the productivity of labour can be increased through education and training and health improvements. land; increases in the availability of land and natural resources may arise from more efficient land use and the discovery of new resources. technical knowledge; the rate of technical advance will depend on the amount of research and development taking place giving rise to new inventions and innovation. economic efficiency; improved utilisation of the available capital, labour, land, and technical knowledge can lead to increased growth.
(b)
(c)
(d)
(e)
Q36
Poorly answered. Again, no marks were given where candidates simply stated factors without discussing them.
37
(i)
Points on the IS curve show combinations of interest rates and national income at which injections equal withdrawals and consequently the total output (national income) equals total expenditure, giving equilibrium in the markets for goods and services. Points on the LM curve show combinations of interest rates and national income at which the demand for money (liquidity) equals the supply of money, giving equilibrium in the money markets. Interest Rate (i) IS LM
i1
Y1
National Income (Y)
The IS-LM curves are drawn on a graph with interest rates on the vertical axis and national income on the horizontal axis. The IS curve slopes downward from left to right showing that lower rates of interest lead to Page 9
Subject 107 (Economics) September 2000 Examiners Report higher levels of national income. The LM curve slopes upward from left to right showing that in order to obtain equilibrium in the money market, given the supply of money, higher levels of national income are associated with higher rates of interest. At the rate of interest and level of national income where the IS-LM curves intersect in the graph both the money market and the market for goods and services are in equilibrium. (ii) (a) An increase in injections will shift the IS curve to the right giving an increase in the equilibrium rate of interest and national income. The rate of interest rises because the increase in national income, brought about by the increase in injections times the multiplier, increases the demand for money. Given a fixed money supply interest rates must rise to choke off the excess demand for money. The increase in interest rate will reduce investment and consumer expenditure so that national income does not rise by the full multiplier effect. The fall in investment and consumer expenditure is called crowding out.
Interest Rate (i) IS1 IS2 LM
i2 i1
0 (b)
Y1
Y2
National Income (Y)
An increase in the money supply will shift the LM curve to the right giving a reduction in the equilibrium rate of interest and an increase in the equilibriumnational income. The increase in the money supply gives an excess supply of money causing rates of interest to fall. The fall in the rate of interest encourages higher levels of investment and consumer expenditure, increasing injections causing the equilibrium level of national income to rise.
Page 10
Interest Rate (i) IS LM1
i1
LM2
i2
0 (c)
Y1
Y2
National Income (Y)
An increase in the average price level will result in a reduction in the real value of the money supply. A reduction in the money supply will shift the LM curve to the left giving an increase in the equilibrium rate of interest and a fall in the equilibrium level of national income. The reduction in the money supply gives an excess demand for money causing rates of interest to rise. The rise in interest rates discourages investment and consumer expenditure, reducing injections and causing the equilibrium level of national income to fall.
Interest Rate (i) IS i2
LM2 LM1
i1
0 Q37
Y2
Y1
National Income (Y)
This question was particularly poorly answered. Many candidates spent too much time on part (i) rather than part (ii), despite the clear allocation of marks between the two parts. The standard of diagrams overall was very poor in this question. A surprisingly high number of candidates confused the slope of the IS and LM curves. Candidates who did well tended to have simple, accurate diagrams and short, clear supporting text.
Page 11
EXAMINATIONS
3 April 2001 (am) Subject 107 Economics
Time allowed: Three hours INSTRUCTIONS TO THE CANDIDATE 1. Write your surname in full, the initials of your other names and your Candidates Number on the front of the answer booklet. Mark allocations are shown in brackets. Attempt all 37 questions. From question 27 onwards begin each answer on a separate sheet.
2. 3.
107A2001
Good X has a cross price elasticity of demand with respect to Good Y that is negative and Good Z has a cross price elasticity of demand with respect to Good Y that is positive. Which of the following is correct? A B C D Goods X and Y are substitutes. Goods Y and Z are complements. Goods X and Z are substitutes. Goods X and Y are complements.
[1]
Which of the following will result from the imposition of a 10 per cent tax on Good X, the demand for which has a price elasticity of demand equal to 1.5? A B C D A rise in the price of Good X by 15 per cent. A rise in the price of Good X by 11.5 per cent. A rise in the price of Good X by 10 per cent. A rise in the price of Good X by less than 10 per cent.
[1]
A monopoly firm is able to sell 46 units of output per day when the price is 17.50 per unit and 47 units when the price is 17.25. The marginal revenue from the 47th unit sold is: A B C D 17.50 17.25 5.75 25 pence
[1]
Which one of the following will shift the supply curve for Good X to the right? A B C D A government subsidy on the production of Good X. A decrease in labour productivity in industry X. A rise in price of raw materials used to produce Good X. An increase in real wages in industry X.
[1]
A minimum price is set for Good X at 10 which happens to be below the free market price. A decrease in the supply of Good X keeping the minimum price fixed at 10 will result in: A B C D a rise in price and a surplus of Good X a rise in price and a shortage of Good X a rise in price and a balance between supply and demand for Good X no change in price and a shortage of Good X [1]
107 A20012
Revenues from the sale of a good will decrease if: A B C D income increases and the good is normal its price rises and demand is price elastic its price rises and demand is price inelastic income falls and the good is inferior
[1]
Consider the budget line of a consumer that consumes only two Goods X and Y, with the quantity of Good X represented on the horizontal axis and quantity of Good Y represented on the vertical axis. If money income is held constant, a fall in the price of Good X and a rise in the price of Good Y will: A B C D shift the entire budget line to the left shift the entire budget line to the right make the budget line steeper make the budget line less steep
[1]
Which one of the following statements reflects decreasing returns to scale? A B C D If more labour is added to a given amount of capital, the marginal and average product of labour falls. If the ratio of labour to capital doubles, the output of the firm less than doubles. If the input of capital and labour doubles, the output of the firm less than doubles. If the input of capital and labour doubles, the ratio of inputs to output falls. [1]
Points on the LM curve show combinations of real Gross Domestic Product (GDP) and the interest rate where: A B C D the product market is in equilibrium the money market is in equilibrium aggregate demand equals aggregate supply both the product and money markets are in equilibrium
[1]
107 A20013
PLEASE TURN OVER
10
A firm with fixed costs of 400 per week and constant average variable costs of 8 per unit of output, has the following information about its weekly sales: Sales 10 20 30 40 50 60 Total Revenue (s) 400 720 960 1,120 1,250 1,280
Which of the following levels of output yields the highest profit? A B C D 50 40 30 20
[1]
11
Which one of the following statements correctly distinguishes monopolistic competition from perfect competition? A B C Under monopolistic competition firms can make short run supernormal profits but this is not possible under perfect competition. Under monopolistic competition firms can make long run supernormal profits but this is not possible under perfect competition. Under monopolistic competition a firm can unilaterally raise its price without losing all its customers but this is not possible under perfect competition. Under monopolistic competition the firm does not set its price at the point where marginal cost equals marginal revenue but a perfectly competitive firm does. [1]
12
Which one of the following statements about market structure is FALSE? A B C D Under perfect competition, in the long run all firms make only normal profits. Under oligopoly firms make decisions taking into account the possible reactions of their competitors. For a monopolist facing a linear demand curve, average revenue is always greater than marginal revenue. Firms under monopolistic competition have marginal revenue equal to their average revenue. [1]
107 A20014
13
Which one of the following economic statements correctly defines moral hazard in relation to insurance? A B C D Moral hazard describes the fact that people who know that they are a particularly bad risk are more inclined to take out insurance. Moral hazard describes the fact that a policyholder may act in a way which makes the insured event more likely. Moral hazard describes the fact that people who know that they are a particularly bad risk are less inclined to take out insurance. Moral hazard describes the fact that a policyholder may act in a way which makes the insured event less likely. [1]
14
The three injections into the circular flow of income are: A B C D investment, consumer expenditure and exports investment, consumer expenditure and government expenditure investment, government expenditure and exports investment, consumer expenditure and imports
[1]
15
If the level of real Gross Domestic Product (GDP) in an economy is greater than the level of its planned aggregate expenditure then real GDP: A B C D and planned aggregate expenditure will both rise and planned aggregate expenditure will both fall will rise and planned aggregate expenditure will fall will fall and planned aggregate expenditure will rise
[1]
16
You are given the following data on the relationship between national income (Y) and consumer expenditure (C) in a simple closed economy with no government sector: Y 100 120 140 C 80 95 110
What is the value of the simple Keynesian multiplier? A B C D 1.25 1.33 4 5
[1]
107 A20015
PLEASE TURN OVER
17
If a country has a positive balance of net property income from abroad then: A B C D Gross Domestic Product is greater than Gross National Product. Gross Domestic Product is less than Gross National Product. Gross Domestic Product is the same as Gross National Product. We cannot say whether Gross Domestic Product differs from Gross National Product from this information. [1]
18
Which of the following will decrease the value of the multiplier? A B C D An increase in the marginal propensity to import. A decrease in the marginal propensity to consume. A decrease in the marginal tax rate. A decrease in government expenditure.
[1]
19
If the level of real output is assumed to be fixed, the quantity theory of money in its simplest form assumes that the: A B C D ratio of the velocity of circulation to the price level rises when the money supply increases ratio of the velocity of circulation to the price level is fixed ratio of the money supply to the velocity of circulation is fixed ratio of the money supply to the price level is fixed [1]
20
Which one of the following statements about real variables in the economy is TRUE? A B C D Real interest rates are positive if the expected rate of inflation is less than the nominal rate of interest. Real wages must rise if inflation is positive. An increase in real income will lead to a reduced demand for real money balances. If nominal Gross Domestic Product (GDP) rises by 10 per cent, the GDP deflator rises by 15 per cent and the population rises by 10%, then real GDP per capita has fallen. [1]
107 A20016
21
Which one of the following is the most accurate description of the National Debt ? A B C D The annual gap between total government tax receipts and total government expenditure. The total amount owed by a country to the rest of the world. The net accumulation of a countrys budget deficits. The net accumulation of a countrys current account deficits. [1]
22
The money multiplier will be higher the: A B C D lower the ratio of cash held by the public to their bank deposits higher the banks reserve ratio (cash to deposits) higher the banks reserve ratio (cash to deposits) and the lower the ratio of cash held by the public to their bank deposits lower the banks reserve ratio (cash to deposits) and the lower the ratio of cash held by the public to their bank deposits [1]
23
The introduction of an expansionary monetary policy in an open economy operating with a flexible exchange rate would most likely lead in the short run to: A B C D higher domestic interest rates and an exchange rate appreciation of the domestic currency higher domestic interest rates and an exchange rate depreciation of the domestic currency lower domestic interest rates and an exchange rate appreciation of the domestic currency lower domestic interest rates and an exchange rate depreciation of the domestic currency [1]
24
A government policy that will decrease the number of voluntary unemployed in an economy is: A B C D an increase in unemployment benefit an increase in income taxes a decrease in the minimum wage none of the above
[1]
107 A20017
PLEASE TURN OVER
25
According to purchasing power parity theory, if the British inflation rate is 4 per cent and the European inflation rate is negative at 1 per cent then the pound should: A B C D depreciate against the euro by 5 per cent depreciate against the euro by 3 per cent appreciate against the euro by 5 per cent appreciate against the euro by 3 per cent
[1]
26
You are given the following data on a countrys balance of payments: millions Exports of goods and services Imports of goods and services Interest Profit and Dividend Received from ROW Interest Profit and Dividend Paid to ROW Transfer payments from ROW Transfer payments to ROW Borrowing from ROW Lending to ROW Note ROW stands for rest of the world. What are the values of the current account balance and capital account balance respectively? A B C D 300 million, 200 million 300 million, 200 million 200 million, 300 million 200 million, 300 million 900 600 100 200 150 50 500 300
[1]
27 28
Explain briefly the accelerator principle.
[4]
Draw a separate diagram in each case to illustrate the following: (i) (ii) (iii) (iv) a demand curve with zero price elasticity throughout its entire length [1] a demand curve that would yield the same total revenue at each price level [1] a supply curve with infinite price elasticity throughout its entire length [1]
a supply curve with a price elasticity of 1 throughout its entire length [1] [Total 4]
107 A20018
29
You are given the following data concerning the total utility from consumption of two Goods X and Y for a consumer. Good X costs 1 and Good Y costs 2. The consumer has 10 of income which is spent on consumption of the two goods. Consumption of Good X 0 1 2 3 4 5 6 7 8 9 10 (i) (ii) Total Utility from Good X 0 100 190 270 340 400 450 490 520 540 550 Consumption of Good Y 0 1 2 3 4 5 6 7 8 9 10 Total Utility from Good Y 0 520 900 1,040 1,160 1,200 1,220 1,230 1,235 1,238 1,240
Calculate the utility maximising combination of Good X and Good Y of the consumer. [1] Calculate the consumption quantities of Good X and Good Y that would give the lowest total utility. Assume the consumer has to spend all his income. [1] Assume that the consumer is currently consuming 5 units of Good Y and 0 units of Good X. Calculate the increase in the consumers total utility from switching to the utility maximising combination of Good X and Good Y. [1] Calculate the utility maximising consumption of Good X and Good Y, if the price of Good Y was to halve to 1 and the consumers income was to rise by 2 to 12. [2] [Total 5]
(iii)
(iv)
30
Draw a diagram showing a monopolist making a loss in the short run that is not sufficient to make it close down. Include the following curves; marginal revenue (MR), average revenue (AR), average total cost (AC) and average variable cost (AVC). Indicate the loss minimising price (P1), output (Q1), average variable cost (AVC1) and average total cost (C1). [4]
107 A20019
PLEASE TURN OVER
31
You are given the following data concerning the production costs and the average revenue of a profit maximising firm that produces Good X. The fixed costs of production are initially 200. Output Of Good X 1 2 3 4 5 6 7 8 9 10 (i) (ii) (iii) Short Run Average Variable Cost Of X 220 190 160 150 162 170 180 200 220 240 Average Revenue 600 500 420 360 300 240 200 180 160 140 [1]
Calculate the profit maximising output of the firm.
Calculate the smallest rise in total variable costs that would force the firm to cease production in the short run. [2] State what will happen to production in the short run if the fixed costs of production rise from 200 to 500. [1] [Total 4]
32
The consumption function for a closed economy with no government sector is given by the equation: C = 100 million + 0.7Y Where: C is aggregate consumption Y is national income (i) (ii) (iii) Calculate the value of aggregate savings if the level of national income is 1000 million. [1] Calculate the change in national income if planned investment rose by 100 million. [1] Calculate the value of aggregate consumption at the equilibrium level of national income, if the level of planned investment is 500 million. [2] [Total 4]
33
Explain the term crowding out, giving TWO examples of crowding out effects. [4]
107 A200110
34
(i) (ii)
State what happens to the price of treasury bills and the money supply if the authorities conduct a contractionary open market operation. [1] Explain what is likely to happen to the long-term rate of interest and the price of government bonds, if the conduct of monetary policy is such that it raises the expected rate of inflation and creates additional uncertainty concerning the conduct of monetary policy. [3] [Total 4]
35
Define each of the following: (i) (ii) (iii) (iv) a direct tax an indirect tax a progressive tax a regressive tax [1] [1] [1] [1] [Total 4]
36
The world consists of two countries A and B and the only factor of production is labour. In country A it takes 50 hours to produce one unit of Good X and 25 hours to produce one unit of Good Y. In country B it takes 40 hours to produce one unit of Good X and 10 hours to produce one unit of Good Y. State whether each of the following statement is true or false. (i) (ii) (iii) (iv) Country B has an absolute advantage in the production of Good X. Country B has a comparative advantage in the production of Good X. [1] [1]
Exchanging 3 units of Good Y for 1 unit of Good X represents terms of trade which are mutually beneficial. [1] Before trade is opened up Country A must have a lower level of total production of both goods than Country B. [1] [Total 4]
37
(i)
Outline the characteristics of an oligopolistic market structure and explain how they differ from the characteristics of a monopoly market structure. [10] Discuss, with the aid of a diagram, the reasons why firms in an oligopolistic market are sometimes reluctant to raise or lower their prices. [10] [Total 20]
(ii)
107 A200111
EXAMINATIONS
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27
D D C A C B D C B A C D B C B C B A or B D A or D C D D D A A
According to the acceleration principle investment is determined by changes in national income and small changes in national income can lead to large fluctuations in investment demand. Consequently investment is a very unstable component of aggregate demand and a major factor contributing to trade cycle fluctuations. When national income is stable investment is only needed to replace machinery and equipment that has worn-out or become obsolete. When national income is rising firms will wish to expand their production capacity and will demand new investment to increase their stock of capital. When national income is falling firms will require less production capacity and investment will fall. The relationship between investment demand and the change in national income is determined by the desired capital-output ratio, this is the amount of capital needed to produce 1 unit of output.
Page 2
28
(i) Price Demand
Quantity (ii) Price
Demand Quantity
Page 3
(iii) Price
Supply
Quantity (iv) Price
Supply
Quantity
Page 4
29
(i) (ii) (iii) (iv)
4 units of X and 3 units of Y 10 units of X 180 units of utility 7 units of X and 5 units of Y
30
Price
MC C1 P1
AC AVC
AVC1
MR Q1
AR Quantity
31
(i) (ii) (iii)
4 units 840 or 841 Nothing there is no change in output
Page 5
32
(i)
S = 100m + 0.3Y = 200 million
(ii)
dY =
1 100 million 1 MPC
where MPC is the marginal propensity to consumer dY =

1 100 million 1 0.7
Therefore, national income would rise by 333 million (iii) Y = 100 + 0.7 Y + 500 Y = 2000 million Therefore, C = 100 + 0.7(2,000) C = 1,500 million
33
Crowding out is the short run consequence of expansionary fiscal policy. An increase in government expenditure or lower taxation will increase national income via the multiplier. The higher level of national income will increase the precautionary and transactions demand for money. Assuming that money supply is unchanged the higher demand for money will force up interest rates. The PSBR will also increase. The fact that expansionary fiscal policy leads to higher interest rates will adversely affect (crowd out) private consumption and investment. Increased public borrowing and higher interest rates might lead to large capital inflows and exchange rate appreciation which will adversely affect (crowd out) net exports.
34
(i)
If the authorities conduct a contractionary open market operation, they will sell Treasury bills. The price of treasury bills will fall and the money supply will fall. If monetary policy is sufficiently expansionary as to raise the expected rate of inflation and increase risk, then this will lead market participants to seek a higher longer-term rate of interest to compensate them for the increased inflation and risk. The result is that the long term rate of interest will rise and the price of government bonds will fall.
(ii)
Page 6
35
(i) (ii)
A direct tax is a tax on a payment made to a factor of production, e.g. wages, rent and interest. An indirect tax is a tax on expenditure. An indirect tax is a tax paid when a good is sold or a service provided, e.g. VAT, excise duty and customs duty. A tax is said to be progressive if it takes an increasing proportion of a persons income as income rises. A tax is said to be regressive if it takes a decreasing proportion of a persons income as income rises.
(iii) (iv)
36
(i) (ii) (iii) (iv)
True False True False
37
(i)
In an oligopolistic market: There are only a small number of firms whereas in a monopoly there is just one firm. There is a high degree of interdependence between firms. This means that firms have to take into account decisions made by other firms when making their price and output decisions. This is a problem that a monopolist does not have to worry about although there might be concerns about potential competition if price is set too high. Each firm has only a share of the market demand curve whereas for a monopoly the market demand curve is the firms demand curve. Each firm may be selling either identical or differentiated products and they tend to compete with each other on both price and quality. A monopolist may also produce just one good or a variety of goods. There are barriers to entry in both market structures although they tend to be stronger in the case of a monopoly. The existence of barriers to entry means that there is the potential to make abnormal profits in the long run in both market structures but clearly a monopolist would have the potential to yield superior abnormal profits compared to firms operating in an oligopolistic market structure. [10]
Page 7
(ii)
It is sometimes observed that prices in an oligopolistic market structure tend be sticky. This can be explained with reference to the kinked demand theory. According to this theory an oligopolistic firm may be reluctant to raise prices from their current level because it believes that the other firms will not raise theirs. Hence the demand curve facing the firm is perceived to be highly elastic above the current price. Conversely, if the firm cuts its price it believes that the other firms will retaliate and cut theirs and so it will not gain that many extra customers. Hence the demand curve facing the firm is perceived to be inelastic below the current price. This is depicted in the diagram below. Price
P1
MC
b Demand (AR) MR Q1 Quantity
The perceived demand curve is elastic above the current price P1 and is perceived to be inelastic below that price. The kink in the demand curve means that so long as the marginal cost (MC) fluctuates between the region ab where there is a discontinuity in the marginal revenue curve, then there is no reason for the firm to change its price. This combined with the fear of losing too many customers when raising prices and losing revenue when cutting prices may help explain the sticky prices that are sometimes observed under oligopoly.
Page 8
EXAMINATIONS
6 September 2001 (am) Subject 107 Economics
Time allowed: Three hours INSTRUCTIONS TO THE CANDIDATE 1. Write your surname in full, the initials of your other names and your Candidates Number on the front of the answer booklet. Mark allocations are shown in brackets. Attempt all 36 questions. From question 27 onwards begin each answer on a separate sheet.
2. 3.
107S2001
In a particular economy the value added by all firms is the same in 2001 as in 2000. However, consumption is 100m lower. Compared with 2000: A B C D GDP will be 100m lower in 2001 expenditure on final goods and services will be lower in 2001 incomes will be lower in 2001 investment in inventories will be higher in 2001
[1]
Assume that the actual rate of unemployment is above the natural rate of unemployment because the expected rate of inflation is above the actual rate of inflation. If the expected rate of inflation falls to equal the actual rate of inflation then real wages will: A B C D fall and real output will rise fall and real output will fall rise and real output will rise rise and real output will fall
[1]
The top rate of income tax is cut from 50% to 45%. Other things remaining the same, the effect on the multiplier will be: A B C D a rise a fall no change uncertain
[1]
The government is planning an increase of 100m in public spending on goods and services. By choosing to finance the increase with extra taxation rather than public borrowing, the resulting equilibrium level of national income would be: A B C D higher lower the same uncertain
[1]
Which of the following is not part of the measure of money supply known as sterling M3? A B C D 1 held as a coin by an individual. 1 held in a private sector building society account. 1 held in a private sector sterling time deposit. 1 held in a private sector cheque account.
[1]
107 S20012
An increase in the money supply will have a bigger impact on real output the more: A B C D interest elastic is the demand for money and the more interest elastic is the level of investment interest inelastic is the demand for money and the less interest elastic is the level of investment interest elastic is the demand for money and the less interest elastic is the level of investment interest inelastic is the demand for money and the more interest elastic is the level of investment [1]
The relationship between planned investment and the rate of interest is: A B C D positive because at higher interest rates the returns to investment are higher negative because at higher interest rates the returns to investment are higher negative because the interest rate is the opportunity cost of capital positive because the interest rate is the opportunity cost of capital [1]
If both government spending and the money supply are increased: A B C D national income and interest rates will both rise national income and interest rates will both fall the effect on both national income and interest rates is uncertain national income will rise but the effect on interest rates is uncertain [1]
Which of the following does not cause a shift in the demand curve for Good X? A B C D A change in the price of Good X. A change in the price of a substitute Good Y. A change in consumer incomes. A change in consumer tastes.
[1]
107 S20013
PLEASE TURN OVER
10
Which of the following is not correct? A B C D A Giffen good is a good for which the income elasticity of demand is positive. An inferior good is a good for which the income elasticity of demand is negative. A normal good is a good for which the income elasticity of demand is positive. A luxury good is a good for which the income elasticity of demand is greater than 1. [1]
11
A consumer can spend his or her entire income by buying either 28 units of Good X or 35 units of Good Y. If the quantity of Good X is represented on the vertical axis, and the quantity of Good Y is represented on the horizontal axis, the slope of his or her indifference curve at maximum utility is: A B C D 1.25 0.80 1.25 0.80
[1]
12
A consumers demand curve for Good X is represented by the equation Qx = 50 0.2Px where Qx is the quantity of Good X demanded and Px is the price of Good X. A producers supply curve for Good X is represented by the equation Qx = 10 + 0.6Px where Qx is the quantity of Good X supplied and Px is the price of Good X. Demand and supply are in equilibrium when: A B C D Qx is 20 and Px is 150 Qx is 30 and Px is 100 Qx is 35 and Px is 75 Qx is 40 and Px is 50
[1]
107 S20014
13
For a profit maximising firm fixed costs are 20 and the owners opportunity cost is 10. The marginal costs of production are shown in the table below. The firm faces a horizontal demand curve where price is 50. How much supernormal profit does the firm make? Quantity Produced 1 2 3 4 5 6 A B C D 30 40 50 60 Marginal cost () 20 30 40 50 60 70
[1]
14
Which of the following views will be held by a typical Keynesian? A B C D Markets work efficiently. Most individuals suffer from money illusion. Increased government spending will do little to influence the level of economic growth. Supply side policies should be used to improve the efficiency of markets. [1]
15
Other things being equal, in the long run higher government expenditure: A B C D will reduce demand for money will increase net exports will reduce interest rates will increase the rate of inflation
[1]
16
The socially optimal output for a monopoly is at the point where: A B C D the marginal cost curve cuts the marginal revenue curve the marginal cost curve cuts the demand curve the average cost curve cuts the marginal revenue curve the average cost curve cuts the demand curve
[1]
107 S20015
PLEASE TURN OVER
17
Which of the following features is not a typical characteristic of oligopoly? A B C D A kinked demand curve. Supernormal profits. A belief that one firms actions have little influence on the actions of other firms. Advertising. [1]
18
Other things remaining the same, the effect of an increase in the Public Sector Debt Repayment is: A B C D lower short term interest rates because the IS curve shifts to the left higher short term interest rates because the IS curve shifts to the right lower short term interest rates because the LM curve shifts to the right higher short term interest rates because the LM curve shifts to the left [1]
19
All other things being equal, which of the following will not increase the Public Sector Borrowing Requirement: A B C D an increase in local government expenditure an increase in grants from central government to nationalised industries an increase in transfer payments an increase in the interest rate paid on the national debt [1]
20
A consumer spends all her income on Good X and Good Y in such a combination that the marginal utility of Good X is one third of the marginal utility of Good Y. If the price of Good X is 30 and the price of Good Y is 10 then: A B the consumer cannot increase her total utility to maximise total utility the consumer needs to increase the consumption of Good X so that the marginal utility from Good X is equal to the marginal utility from Good Y to maximise total utility the consumer needs to decrease the consumption of Good X so that the marginal utility from Good X is equal to the marginal utility from Good Y to maximise total utility the consumer needs to rearrange consumption so that the marginal utility from consuming Good X is three times the marginal utility from consuming Good Y [1]
107 S20016
21
When taxes on all income are regressive: A B C D the marginal tax rate will initially be less than but eventually be greater than the average tax rate the marginal tax rate will initially be greater than but eventually be less than the average tax rate the marginal tax rate will always be greater than the average tax rate the marginal tax rate will always be less than the average tax rate [1]
22
Which of the following cases is true? A B C D Where demand is price elastic, the effect of a price change on the quantity demanded will tend to be small. If demand is price inelastic, a cut in price will increase revenue. Demand is said to have unit elasticity when the own price elasticity of demand is 1. Where demand is elastic, the own price elasticity of demand is more negative than 1. [1]
23
Which of the following assumptions is usually made when drawing indifference curves? A B C D It is difficult for consumers to choose between two different bundles of goods. Indifference curves nearer to the origin yield higher utility. The prices of goods are fixed. Consumer preferences exhibit diminishing marginal substitution. [1]
24
Which of the following is not a direct tax? A B C D A tax on interest. A tax on professional fees. A tax on rent. A tax on company profits.
[1]
107 S20017
PLEASE TURN OVER
25
The following table gives a breakdown of a firms average cost and average revenue at various levels of output. Output 1 2 3 4 5 6 Which of the following is true? A B C D The marginal cost of producing the fourth item is greater than that of producing the first item. The marginal cost of producing the fourth item is less than the marginal revenue from selling the fourth item. The marginal revenue from selling the sixth item is negative. The marginal revenue from selling the fifth item is the same as that from selling the fourth item. [1] Average cost 15 13 12 12 14 16 Average revenue 20 19 18 15 12 9
26
In perfect competition: A B C D the price charged to customers is equal to marginal cost the demand curve faced by each firm is inelastic there may be difficulty for some firms in exiting the industry there are no supernormal profits in the short run
[1]
27
Explain, with the use of demand and supply curves, how a per unit subsidy on a good will affect the price paid by consumers (the net price), the price received by producers (the gross price) and the equilibrium quantity traded when the subsidy is given to: (i) (ii) consumers producers [3] [3] [Total 6]
28
(i) (ii) (iii)
Define the marginal product of labour.
[1]
State the relationship between the marginal productivity of labour and short run marginal costs. [1] Define the marginal revenue product of labour and explain its relationship with the marginal productivity of labour. [2] [Total 4]
107 S20018
29
Discuss, with the aid of diagrams, why monopolists may engage in price discrimination.
[6]
30
Define the following types of unemployment: (i) (ii) (iii) (iv) structural unemployment demand-deficient unemployment technological unemployment frictional unemployment [1] [1] [1] [1] [Total 4]
31
Describe briefly five different reasons why long run average costs might fall as output is increased. [5]
32
Explain the differences between a centrally controlled economy and a free market economy. [4]
33
Discuss briefly, with examples, four factors which influence price elasticity of demand. [4]
34
(i) (ii)
Explain briefly, with the use of a diagram, the circular flow of income in an open economy with a government. [4] State three equivalent ways of defining Gross Domestic Product. [1] [Total 5]
35
You are given the following information on an economy. National income at factor cost Consumption Transfer benefits Direct taxes Indirect taxes Government spending Investment Exports (i) (ii) (iii) 300bn 200bn 10bn 50bn 30bn 40bn 30bn 80bn [1] [1] [1] [Total 3]
Calculate the surplus or deficit in the private sector. Calculate the surplus or deficit in the government sector. Calculate the surplus or deficit in the foreign sector.
107 S20019
PLEASE TURN OVER
36
(i) (ii)
Discuss the effectiveness of monetary and fiscal policy with fixed and floating exchange rates. [10] Discuss the advantages and disadvantages of fixed and floating exchange rates which a government would take into consideration when deciding which system to operate. [10] [Total 20]
107 S200110
EXAMINATIONS
September 2001 Subject 107 Economics EXAMINERS REPORT
Overall comments Many candidates wasted time by writing answers which were too long and which lacked focus. Candidates who did well tended to have short, clear text supported by simple and accurate diagrams. Once again the general standard of diagrams was poor. Many diagrams were drawn freehand (without a ruler). Sloppy work can lead to deduction of marks for lack of clarity. Many diagrams were also too small for the answers to be clear. Candidates should use rulers, and diagrams should be of a sufficient size to show movements clearly. Individual comments Q1-Q26 The multiple choice questions were generally well answered. The questions which caused the main problems were numbers 4, 6, 18, 19 and 21. Of these, 4 was answered incorrectly most often. Q27 Reasonably answered. Many candidates failed to give a clearly reasoned response. Many did not distinguish between net and gross price, often only discussing price. Reasonably answered. Most candidates defined the terms correctly (although most students missed the assumption of all other factors remaining constant) but few were able to answer part (iii). Some students were unable to distinguish between marginal product and marginal revenue product. Badly answered. The most common mistake was for candidates to waste time talking in general about monopolies, spending too little time talking about the question on price discrimination. While most candidates were able to describe price discrimination, few gave a comprehensive explanation of its effects on a monopolists revenue and profits. Well answered by most. Some students just gave examples of the different types of unemployment rather than defining. Very well answered. Reasonably answered. Many candidates failed to describe the free market situation fully. Well answered by most, though some candidates described a shift, rather than a movement, in demand. Some candidates gave either a description of the factor, or an example, rather than both.
Q28
Q29
Q30 Q31 Q32 Q33
Page 2
Q34
Reasonably answered. In part (i), most candidates produced a good diagram though many failed to explain fully their abbreviations. The most common errors were mixing up direct and indirect taxes, and the flow directions of exports and imports. In part (ii), there were many cryptic answers and few got the correct definitions. Reference to the domestic economy was usually missed. While part (ii) was reasonably answered, part (i) and particularly part (iii) were badly answered. Poorly answered. Candidates getting high marks divided the question and gave well thought out, structured answers. Candidates getting lower marks tended to use more of a scattergun approach. In part (i), many candidates wasted time describing the terms used rather than discussing the effects. Part (ii) was usually answered slightly better.
Q35 Q36
Page 3
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
D A A B B D C D A A B D A B D B C C B D D D D B C A
Page 4
27
(i)
A subsidy given to consumers per unit of the good purchased will encourage consumers to increase demand. This is shown by an upward shift in the demand curve (D1 to D2). The price paid by consumers (the net price) will decrease (P1 to P2), the price received by producers (the gross price) will increase (P1 to P3). The equilibrium quantity traded will increase (Q1 to Q2).
Price D2 D1 P3 P1 P2 S
Q1 Q2 (ii)
Quantity
A subsidy given to producers per unit of the good supplied will encourage producers to increase supply. This is shown by a downward shift in the supply curve (S1 to S2). The price paid by the consumer (net price) will decrease (P1 to P2), the price received by the producers (gross price) will increase (P1 to P3). The equilibrium quantity traded will increase (Q1 to Q2). Price S1 D P3 P1 P2 S2
Q1 Q2
Quantity
Page 5
28
(i)
The marginal product of labour is the increase in total output obtained by employing one extra worker, holding the amount of other factor inputs constant. Assuming that labour is the only variable input, there is a direct inverse relationship between the marginal productivity of labour and short run marginal costs. The marginal revenue product of labour is the change in the firms total revenue when it sells the output of each extra worker. Diminishing marginal productivity means that marginal productivity falls. Additionally, as output rises, the price has to fall so marginal revenue may be quite low. Therefore marginal revenue product of labour can fall quite steeply.
(ii)
(iii)
29
Price
P*
MC AC
MR1 Q1
DD Quantity
A monopolist who cannot price discriminate will maximise profits by equating marginal cost with marginal revenue and producing this output. However, because monopolies face no competition, they may be able to charge different prices to different consumers or groups of consumers. This is known as price discrimination. If it is possible for a firm to use price discrimination, it will be profitable for the firm to do so. The monopoly will be able to expand its output and increase its profits.
Page 6
Perfect price discrimination would allow a monopolist to operate at the socially optimal point increasing output to Q2 in the diagram below. The old demand curve now becomes the new marginal revenue curve (MR2). The perfectly price discriminating monopolist makes additional profit on the quantity of goods he used to sell, consisting of the triangle bounded by the area between MR1, MR2 and the vertical line going through Q1. He also makes profit from the extra quantity now produced, from the triangle bounded by MR2, MC and the vertical line going through Q1.
Price
MC AC
DD=MR2 Q1 Q2 MR1 Quantity
30
(i)
Structural unemployment arises because of a mismatch between the skills that employers require, and the skills that the unemployed possess. This can be caused by the fact that at any time, some industries are in decline, while others are growing. Demand-deficient unemployment arises due to fluctuations in national output that occur due to the business cycle giving temporary periods of deficient demand. Technological unemployment arises when the need to employ workers with certain skills declines even if the industry as a whole is not in decline. Frictional unemployment refers to the level of unemployment that would still exist in a well functioning economy in the absence of any other problems. It will include, for example, people who have left one job to look for another one.
(ii)
(iii)
(iv)
Page 7
31
Any five of the following. Spreading of fixed costs: for example doubling output is unlikely to require double the number of administrative staff; marketing and R&D costs are often independent of output levels. Specialisation: division of labour allows people to become experts at small parts of the production process, increasing output per person. Similarly with machines. Physical economies: these can arise because an increase in the volume of a physical object, e.g. a storage tank, requires a less than proportionate increase in surface area. Finance: larger firms may be seen as being more credit worthy, and should face lower interest costs. Bulk purchases: a larger firm is able to exert more pressure on suppliers to set low prices. By-products: some production processes produce small amounts of potentially useful by-products. It may not be worthwhile selling this unless the scale of production is sufficiently large. The principle of multiples: different machines needed in the production process may have different capacities. In this case full use of all machines capacities may only be possible at high output levels.
32
In a centrally controlled economy, a central agency decides what is to be produced, how it is to be produced, and for whom it is to be produced. In this context a central agency is a government department, staffed by economists and administrators, who will try to make sure that the decisions they make produce a consistent plan. In practice, some local control may exist over the method of production and consumers retain some choice as to which goods they consume. In a free market economy there is no government intervention. The interaction of supply and demand, driven by individuals acting in their own self interest, solves all the allocation questions. The goods produced are those for which the amount that consumers are willing to pay exceeds the cost of production. The methods of production are the ones that minimise the costs of production. Consumption patterns are determined by which goods and services consumers are willing and able to pay for.
Page 8
33
Broadness of product definition: it is easier to find a substitute for a product which is narrowly defined, for example the elasticity of demand will be greater for one particular chocolate bar than it will be for chocolate as a whole. The length of time considered: it is easier to find and make use of a substitute in the long run than in the short run. For example, in the short run the elasticity of demand for petrol will be less than it will be in the long run, as people can switch to vehicles that use different fuels. The degree of brand loyalty or addiction: if people are very loyal to a particular brand, or are addicted to a particular product, the elasticity of demand will be less. For example, if people are loyal to a particular type of jeans, there will be a lower elasticity of demand. The proportion of consumers incomes spent on the good: if people spend a large proportion of their income on a good the elasticity of demand will be lower than if they spend a small proportion. For example, if somebody spends a large proportion of their income on food the elasticity of demand will be lower than somebody who spends a small proportion.
34
(i)
The circular flow is the flow of money from firms to households (in return for the factor services provided) and from households to firms (in return for goods and services provided).
Td Y B Government I Firms G Te Households S
X-Z C
Firms pay income (Y) to households. Direct taxes (Td) are paid out of this income to the government, but transfer benefits (B) are also paid from the government to supplement households incomes. Households spend all their income on either consumption (C) or savings (S). Indirect taxes (Te) are paid to the government on what they consume.
Page 9
Firms receive government expenditure (G) and also investment expenditure (I) and payment for exports (X), but pay out for imports (Z). (ii) Expenditure in the domestic economy. The value added by all firms located in the domestic economy. The factor incomes of all factors of production located in the domestic economy.
35
(i)
S S
= Y - Td + B - C = 300b - 50b + 10b - 200b = 60b
= 30b
S - I = 30b Private sector surplus = 30b (ii) Tax revenues = Td + Te = 50b + 30b = 80b Government expenditure = G + B = 40b + 10b = 50b Government sector surplus = 30b (iii) Y = C + I + G + X - Z - Te 300b = 200b + 30b + 40b + 80b - Z - 30b Z = 20b
Z X = 20b - 80b = -60b Foreign sector deficit of 60b
Page 10
36
(i)
Monetary policy with floating exchange rates A reduction in the money supply increases interest rates (by shifting the LM curve to the left) and reduces price inflation (as explained by the quantity theory of money). Under floating exchange rates, higher interest rates will increase the value of the currency. A higher exchange rate will reduce both cost push inflation and demand pull inflation (by reducing net exports). Thus, floating exchange rates make monetary policy more effective at controlling price rises. Monetary policy with fixed exchange rates If interest rates are higher in country A than in country B, with a fixed exchange rate money from abroad will flood in from country B to country A, as there is no possibility of exchange rate depreciation. To maintain the fixed exchange rate the government will have to sell the domestic currency to meet the demand for money. Selling the domestic currency increases the money supply and pushes interest rates down, towards the level in country B. Thus, an independent monetary policy is not possible under fixed exchange rates. Fiscal policy with floating exchange rates An increase in government expenditure tends to increase interest rates (as the IS curve shifts to the right). Under a floating exchange rate the rise in interest rates will lead to an increase in the value of the currency. The increase in the value of the domestic currency will reduce net exports, worsening the effects of crowding out. Thus fiscal policy is less effective with floating exchange rates. Fiscal policy with fixed exchange rates With fixed exchange rates, interest rates must be maintained at the world level.
Page 11
Normally, when an expansionary fiscal policy is introduced, private sector consumption and investment is crowded out by higher interest rates and higher prices. Under fixed exchange rates interest rates cannot be allowed to rise, which limits the amount of crowding out that can occur. Hence fiscal policy is more effective with fixed exchange rates. (iii) Advantages of fixed exchange rates Fixed exchange rates give greater certainty, and hence encourage foreign trade, allowing the potential gains from trade to be realised. Fixed exchange rates can lead to lower inflation when the domestic currency is fixed relative to a low inflation currency. Under fixed exchange rates, interest rates must stay at the world level, so Keynesian crowding out is less likely to occur. (Although the government could just increase money supply which would have the same effect.) Fixed exchange rates may in some circumstances add to political, social and economic harmonisation. Disadvantages of fixed exchange rates If there is a balance of payments deficit, the level of domestic aggregate demand must be reduced, which can have serious effects in terms of higher unemployment and lost output. Usually a balance of payments deficit can be corrected by reducing the value of the domestic currency, which is not an option with fixed exchange rates. The government may find it difficult in practice to maintain a fixed exchange rate, as there may be a lot of money speculating in case of a devaluation. Fixed exchange rates can be maintained by imposing controls on capital flows, together with quotas and tariffs. This is economically inefficient as it prevents a globally pareto optimal allocation of resources. Advantages of floating exchange rates Monetary policy can be conducted independently of other countries without the need for controls on the movement of capital. A floating exchange rate will tend to move to automatically offset a balance of payments deficit or surplus.
Page 12
There is no need for the central bank to hold large amounts of gold and foreign currencies, as the government need not intervene in foreign exchange markets. Disadvantages of floating exchange rates The major disadvantage of floating exchange rates is that they introduce uncertainty into foreign trade transactions. However, traders can alternatively use financial markets to carry out forward exchange deals to protect themselves against unexpected movements.
Page 13
EXAMINATIONS
Time allowed: Three hours INSTRUCTIONS TO THE CANDIDATE 1. Enter all the candidate and examination details as requested on the front of your answer booklet. You must not start writing your answers in the booklet until instructed to do so by the supervisor. Mark allocations are shown in brackets. Attempt all 37 questions. From question 27 onwards begin each answer on a separate sheet.
2.
3. 4.
AT THE END OF THE EXAMINATION Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this question paper. In addition to this paper you should have available Actuarial Tables and your own electronic calculator.
107A2002
Good X has a cross elasticity of demand with respect to Good Y which is equal to minus unity (-1). Good X is which of the following with respect to Good Y? A B C D A perfect substitute. An imperfect substitute. A perfect complement. An imperfect complement.
[1]
Which of the following will result from the imposition of a 10 per cent sales tax on Good X, the demand for which has an own price elasticity of demand equal to 1? A B C D A rise in the price of Good X by 10 per cent. A rise in the price of Good X by less than 10 per cent. A rise in the price of Good X by 20 per cent. No change in the price of Good X. [1]
Consider the budget line of a consumer that consumes only two Goods X and Y, with the quantity of Good X represented on the horizontal axis and the quantity of Good Y represented on the vertical axis. If money income is unchanged, the price of Good X falls by 50% and the price of Good Y rises by 50% the net result will be to: A B C D shift the entire budget line to the left shift the entire budget line to the right make the budget line steeper make the budget line less steep
[1]
A movement along a consumers indifference curve from left to right means that the consumers: A B C D utility will rise utility will fall utility will be unchanged money income is unchanged
[1]
If the income elasticity of demand for Good X is 2, a rise in all consumers disposable incomes from 50 million to 52 million will increase the quantity demanded of Good X by: A B C D 2% 4% 6% 8%
[1]
107 A20022
Which one of the following statements about short run costs is FALSE? A B C D Marginal cost is equal to average variable cost when average variable cost is at a minimum. Average fixed costs always fall as output rises. Average total costs exceed average variable costs by an amount that increases with increasing output. Marginal costs of production can be above or below average total costs. [1]
Diseconomies of scale means: A B C D short run average total cost increases as output rises long run average total cost increases as output rises the price of a product increases as output rises the total cost of a product increases as output rises
[1]
A perfectly competitive firm is producing at a level of output where short run marginal cost exceeds marginal revenue. What should the firm do to maximise its short run profits? A B C D Reduce its output. Raise its output. Raise its price. Reduce its price.
[1]
A monopoly firm facing a linear demand schedule and having positive but constant marginal costs is currently producing where its marginal cost is below its marginal revenue. If the firm wishes to maximise profits then it should: A B C D lower its price and increase output raise its price and increase output lower its price and decrease output raise its price and decrease output
[1]
107 A20023
PLEASE TURN OVER
10
Which one of the following statements about market structure is TRUE? A B C D Perfect competition is distinguished from all other market structures because of the assumption of no barriers to entry/exit from the industry. Firms under monopolistic competition face horizontal demand curves for their products. A monopoly will find that its average revenue is always greater than its average costs. Under perfect competition, in the long run, each firm will find that its marginal cost is equal to its average cost of production. [1]
11
Total Revenue from the sale of a good will decrease if: A B C D income increases and the good is normal income falls and the good is inferior its price rises and demand is price inelastic its price rises and demand is price elastic
[1]
12
Which one of the following does NOT follow from the kinked demand curve theory of oligopoly? A B C D The oligopolist will seek to maximise profits. There is a discontinuity in the marginal revenue curve of the oligopolist. There is a discontinuity in the average revenue curve of the oligopolist. There is a kink in the average revenue curve of the oligopolist. [1]
13
If the government imposes a price ceiling on Good X which exceeds the equilibrium price then for Good X: A B C D the price will rise above the equilibrium price the market price will prevail a shortage will arise a surplus will arise
[1]
107 A20024
14
You are given the following data on the relationship between national income (Y) and consumer expenditure (C) in a closed economy with no taxes: Y C 100 80 120 96 140 112
What is the value of the simple Keynesian multiplier? A B C D 0.8 1.25 4 none of the above
[1]
15
The accelerator principle states that: A B C D investment is increased when interest rates fall an increase in national income can lead to a more than proportionate increase in the level of investment an increase in investment can lead to a more than proportionate increase in national income the rate of change of investment affects the rate of change of output [1]
16
The following table contains output and expenditure data for an economy: billions Consumption (at market prices) Investment (at market prices) Government spending (at market prices) Net Exports (at market prices) Net Property income from abroad Indirect taxes 300 90 100 -10 15 60
Gross Domestic Product at FACTOR COST and Gross National Product at MARKET PRICES are respectively: A B C D 420, 495 480, 435 420, 435 480, 495
[1]
107 A20025
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17
Which of the following will decrease the size of the multiplier? A B C D A decrease in the marginal propensity to save. An increase in the marginal propensity to consume. An increase in the marginal rate of taxation. A decrease in government expenditure.
[1]
18
In an open economy with a government sector, which one of the following conditions will ensure that national income and expenditure are equal? Given: S = Savings , I = Investment, T = Taxation, G = Government expenditure B = Transfer Payments, Z = Import expenditure, X = Export receipts, C = Consumer expenditure A B C D S+T+Z=I+G+C+X S+T+Z=I+G+B+X S+T+C=I+G+B+X None of the above.
[1]
19
The quantity theory of money in its simplest form assumes that the: A B C D velocity of circulation and nominal output are reasonably stable ratio of the velocity of circulation to the price level is reasonably stable ratio of the money supply to the velocity of circulation is reasonably stable velocity of circulation and real output are both reasonably stable [1]
20
Which one of the following is the most accurate description of the National Debt? A B C D The annual gap between total government tax receipts and total government expenditure. The total amount owed by a country to the rest of the world. The net accumulation of a countrys budget deficits. The net accumulation of a countrys balance of payments deficits. [1]
21
A contractionary open market operation by the central bank will result in a fall in the money supply and: A B C D a fall in the short term rate of interest and a fall in the price of treasury bills a fall in the short term rate of interest and a rise in the price of treasury bills a rise in the short term rate of interest and a fall in the price of treasury bills a rise in the short term rate of interest and a rise in the price of treasury bills [1]
107 A20026
22
In the event of a recession in the economy, automatic stabilisers would be expected to: A B C D raise government expenditure and reduce tax revenue raise government expenditure and raise tax revenue reduce government expenditure and raise tax revenue reduce government expenditure and reduce tax revenue
[1]
23
Which one of the following will lead to the most crowding out after an increase of government expenditure? A B C D The demand for money is interest elastic and private investment is interest inelastic. The demand for money is interest inelastic and private investment is interest elastic. The demand for money and private investment are both interest inelastic. The demand for money and private investment are both interest elastic. [1]
24
The nominal rate of interest is 2% and the rate of inflation is negative at -3%. Which one of the following is TRUE? A B C D The real rate of interest is negative. The rate of inflation is greater than the real rate of interest. The real rate of interest is greater than the nominal rate of interest. The real rate of interest is -1%.
[1]
25
The current equilibrium dollar ($) per pound () exchange rate is $1.50/1. The forecast for inflation rates for the next year are 8% for the United Kingdom and 3% for the United States. What would be the forecast for the equilibrium dollar-pound exchange rate one year from now if purchasing power parity is used? A B C D $1.67/1 $1.58/1 $1.43/1 $1.34/1
[1]
107 A20027
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26
Other things being equal, which one of the following statements is always TRUE? A B C D An appreciation of a countrys exchange rate will increase its import volumes and decrease its export volumes. An appreciation of a countrys exchange rate will increase its import expenditure and decrease its export revenues. A depreciation of countrys exchange rate will decrease its import volumes and decrease its export volumes. A depreciation of a countrys exchange rate will decrease its import expenditure and decrease its export revenues. [1]
27
A consumer has 2.00 of income which is entirely spent on Good X and Good Y. Good X costs 20 pence, Good Y costs 40 pence. The relevant marginal utilities for the consumer are: Quantity of Good X 1 2 3 4 5 6 (i) (ii) (iii) Marginal Utility of Good X 100 80 60 40 20 10 Quantity of Good Y 1 2 3 4 5 6 Marginal Utility of Good Y 170 120 80 60 50 40 [2]
Calculate the quantity of Good X and quantity of Good Y the utility maximising consumer will buy.
State the total utility of the consumer when he is maximising his satisfaction. [1] If the consumers income is doubled to 4 and the price of Good X is doubled to 40 pence, what will be the new utility maximising quantities of Goods X and Y purchased? [1] [Total 4]
107 A20028
28
A producer has constant average total costs of production of 1 per unit of output produced. The producer knows the following data on the weekly sales for Good X at different price levels: Price (s) 3 4 5 6 (i) Quantity sold 300 250 200 150
Draw a diagram to show the relationship between price (horizontal axis) and total profit (vertical axis) from the above data. Indicate clearly the level of profits at each price. [2] Calculate the price elasticity of demand for a rise in price from 4.00 to 5.00. [1] Calculate the approximate marginal revenue associated with changing prices from 5 to 6. [1] [Total 4]
(ii) (iii)
29
Draw a diagram for a profit maximising monopoly firm with constant marginal costs at all levels of output making losses in the short run and yet finding it viable to continue production. Use the following labels: AR MR MC AC AVC Average Revenue Curve Marginal Revenue Curve Marginal Cost Curve Average Total Cost Curve Average Variable Cost Curve
Indicate the price (P1), quantity (Q1), average total cost (C1) and average variable cost (AVC1) at the loss minimising level of output. [5]
30
(i) (ii)
Describe the substitution effect of a price change. Describe the income effect of a price change.
[2] [2] [Total 4]
31
(i) (ii)
Explain briefly the problem of adverse selection and how it might be dealt with by insurance companies. [2] Explain briefly the problem of moral hazard and how it affects the price of insurance. [2] [Total 4]
107 A20029
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32
Describe how the following might be taken account of in measures of national income. (i) (ii) a reduction in the value of assets due to wear and tear inflation [2] [2] [Total 4]
33
(i) (ii)
Explain what the IS curve for a closed economy depicts. Explain two factors that may shift the IS curve to the right in a closed economy.
[2] [2] [Total 4]
34
State for each of the following whether the proposition is more likely to be Keynesian or Monetarist. (i) (ii) Both the short run and long run Phillips curves are vertical. [1]
Money and other financial assets are relatively close substitutes for one another. This means that money demand is relatively elastic with respect to changes in interest rates. [1] Money demand can be highly unstable in both the short run and long run. [1] The IS curve is likely to be steep and the LM curve likely to be relatively flat. [1] [Total 4]
(iii) (iv)
35
(i) (ii)
Describe the differences between direct and indirect taxes and provide examples of both.
[2]
Describe the differences between progressive and regressive systems of taxation and provide examples of both. [2] [Total 4]
107 A200210
36
A perfectly competitive firm can sell its output of Good X for 20 per unit. Labour is the only variable input and the daily wage rate is 100. You are given the following information: Quantity of Labour Input (per day) 1 2 3 4 5 (i) Output of Good X (per day) 5 14 30 38 42
Construct a table to show at each quantity of labour employed per day: (a) (b) the marginal product of labour the marginal revenue product of labour [2] [2] [Total 4]
(ii)
Determine the profit maximising quantity of labour input.
37
(i) (ii)
Describe and discuss the various categories of unemployment that can exist in an economy. [10] Explain what is meant by the term economic growth and discuss the various factors that can raise the economic growth rate. [10] [Total 20]
107 A200211
REPORT OF THE BOARD OF EXAMINERS ON THE EXAMINATIONS HELD IN

April 2002
Introduction The attached subject report has been written by the Principal Examiner with the aim of helping candidates. The questions and comments are based around Core Reading as the interpretation of the syllabus to which the examiners are working. They have however given credit for any alternative approach or interpretation which they consider to be reasonable.
K Forman Chairman of the Board of Examiners 11 June 2002 Faculty of Actuaries Institute of Actuaries
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
D B D C D C B A A D D C B D B A C B D C C A B C C A
Comment The multiple-choice section was well answered by most candidates. However, a large number of candidates answered question 1 incorrectly. Other questions that had a less than satisfactory proportion of correct responses were questions 2, 9, 14, 18, 19 and 23.
Page 2
27
(i) (ii) (iii)
4X 3Y 650 4X 6Y
Comment Generally well answered, though many candidates made numerical slips.
28
(i)
Profit Profit 800 750 600
Price
(ii)
The price elasticity of demand is given by: % change in quantity demanded % change in price = -0.2/0.25 = -0.8
Answers of 1 (and 1) also allowed as no change in total revenue (iii) Marginal revenue from 5 to 6 = --100/-50 = 2
Comment Many diagrams were poorly drawn for part (i). Part (ii) was well answered, correct responses of 0.8 or 1 (and 0.8 and 1) were allowed. Few determined the answer to part (iii) correctly; most failed to divide the (negative) change in total revenue by the (negative) change in the number of items sold. Answers of -2 were also allowed in part (iii).
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29
Price
C1 P1
AVC1
AC MC/AVC
Q1
Comment
MR
AR
Output/Quantity
This question was very poorly answered with few candidates correctly deducing the shape of the AC and AVC curves from the constant MC criteria. This was despite the fact that the word constant was written in italics on the exam paper. Most drew U shaped AC and AVC curves, and many MC lines were increasing.
30
(i)
The substitution effect of a price change is the change in demand for a good caused by the change in relative prices, holding the consumers level of utility (or real income) constant. The income effect of a price change is the change in demand caused by a change in the real income of a consumer when a price changes.
(ii)
Comment Quite well answered, though some candidates described a graphical representation, often in complex detail, without a clear explanation of the terms requested. Maximum marks were obtainable without the use of diagrams.
Page 4
31
(i)
Adverse selection refers to the fact that people who know that they are particularly bad risks are more inclined to take out insurance than those who know that they are good risks. To try to reduce the problems of adverse selection insurance companies try and find out information about potential policyholders. Policyholders can then be put in small, reasonably homogeneous pools and charged appropriate premiums. Moral hazard describes the fact that a policyholder may, because they have insurance, act in a way which makes the insured against event more likely to occur. Moral hazard makes insurance more expensive. It may even push the price of insurance above the maximum premium that a person is prepared to pay.
(ii)
Comment Very well answered
32
(i)
The true reduction in the value of assets due to wear and tear is depreciation. Depreciation must be deducted from GNP at factor cost in order to obtain the measure of economic activity known as national income (net national product at factor cost). In order to take account of inflation it is necessary to convert nominal or money values of national income, calculated using current prices, into real values, calculated using constant prices, (prices which prevailed in some base year). This is achieved by using the GNP deflator The GNP deflator takes account of price changes in C, I, G, X and Z.
(ii)
Comment Well answered, though some candidates explained the microeconomic issues or the effects on the economy.
33
(i)
The IS curve for a closed economy shows different combinations of the rate of interest and the level of national income for which the goods market is in equilibrium, that is injections (investment plus government expenditure) equal leakages (savings plus taxes). The IS curve for a closed economy could shift to the right for a number of reasons. (a) (b) a rise in investment caused by a rise in business confidence a fall in savings/rise in consumption caused by an increase in consumer confidence
(ii)
Page 5
(c) (d)
Comment
an increase in government expenditure a decrease in taxes
Part (ii) was poorly answered with many candidates describing reasons for a movement along the IS curve, rather than a shift. Also the question specified a closed economy and so open economy effects on the IS curve were not valid answers.
34
(i) (ii) (iii) (iv)
Monetarist Keynesian Keynesian Keynesian
Comment Most candidates answered (i) correctly but parts (ii)-(iv) were less well done.
35
(i)
A direct tax is a tax on a payment made to a factor of production e.g. wages, rent dividend/interest/company profits. Examples are: income tax, national insurance payments, capital gains tax and corporation tax. An indirect tax is a tax on expenditure. In other words, an indirect tax is a tax paid whenever a good is sold, or a service provided. Examples are: value added tax, excise duties on tobacco petrol and alcohol, licence fees for motor cars and television, customs duties on imports.
(ii)
A tax is said to be progressive if it takes an increasing proportion of a persons income as income rises. Examples include income tax where the rate of tax increases with higher incomes and indirect taxes on goods and services on which the rich spend a much higher proportion of income than do the poor. A tax is said to be regressive if it takes a decreasing proportion of a persons income as income rises. Examples include indirect taxes on goods and services on which the poor spend a much higher proportion of income than do the rich.
Comment Very well answered, with clear definitions given. The examples were not always complete.
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36
(i)
Quantity of Labour Input (per day) 1 2 3 4 5
Marginal Product of Labour 5 9 16 8 4
Marginal Revenue Product of Labour 100 180 320 160 80
(ii)
Comment
Very well answered.
37
(i)
There are a number of categories of unemployment including: Frictional is the irreducible minimum amount of unemployment caused by labour market turnover when new people enter the labour force and look for jobs and existing workers change jobs. Frictional unemployment is most easily identifiable when unemployment is low and the majority of the workforce has been unemployed only for a short time. Structural occurs because changes in the regional, occupational and industrial structure of the demands for labour do not match changes in the structure of the supply of labour. Changes in demand may be due to international competition, e.g. shipping decline in UK, or new technology, e.g. motor car industry. Many of the unemployed are from particular declining sectors of an economy. Structural unemployment is often associated with the decline of particular sector due to technological change. Such unemployment is referred to as technological unemployment. Regional occurs when a whole region is in decline due to closure of one or more industries within the region. Regional unemployment is identifiable if the unemployment in a particular region is substantially higher than other regions of a country. Demand Deficient/Keynesian is due to a lack of aggregate demand in the economy as a whole. Affects all regions but some hit more than others. A sign of Demand Deficient Unemployment is that the unemployment rate is quite high across the whole country. Real Wage Unemployment/Classical Unemployment occurs because real wages are too high in relation to labour productivity. At the going real wage it does not pay firms to employ all the labour force that is willing to work at the real wage. A sign of real wage unemployment can be that real wages have risen by more than can be justified by productivity increases.
Page 7
Seasonal Unemployment refers to unemployment caused by seasonal fluctuations in the demand for labour. For example there is normally increased unemployment in the construction industry in winter. Modern analysis also makes a distinction between voluntary and involuntary unemployment. Voluntarily unemployed are not willing to work at the going real wages while the involuntary would work at the going real wage but cannot find work. One key factor that may raise the amount of voluntary unemployment is a rise in the net income with no work to net income when working ratio. (ii) The term economic growth refers to increases in the real Gross Domestic Product or real Gross National Product. The economic growth rate measure the percentage increase in the real Gross Domestic Product from one year to the next. Sometimes the term economic growth refers to the increase in the trend rate of real Gross Domestic Product rather than the actual increase in output. The economic growth rate can be raised by increases in the various inputs to the production process (capital, labour and raw materials/land) and also by the way that these inputs are utilised as measured by the state of technical knowledge and economic efficiency. Capital is a vital part of the production process and if the country increases its capital stock through net new investment then this will tend to boost economic growth. The capital stock will increase if the annual investment in new capital is greater than the depreciation of the existing capital stock. Any net increase in investment aids economic growth in two ways (i) by expanding the productive base of the economy and (ii) the new capital is typically more productive than the old capital which it replaces. Labour is a vital part of the production process and increases in the quantity of labour and improvements in its quality will tend to raise the economic growth rate. The quantity of the labour force is determined by the size of the population, the proportion of the population employed and working hours. In addition improved education, training and health care improve the quality and productivity of the labour force and so raise the economic growth rate. The stock of human capital will rise with better education and training and so improve the economic growth rate. Land and raw materials are also important inputs into the production process. Increases of the input of land come about mainly through the better use of land principally as a result of investment. Increased input of raw materials can improve a countrys economic growth rate. To the extent that the price of imported commodity inputs falls then this boosts the economic growth rate of the importing country. The state of technical knowledge is a vital determinant of economic growth. As the state of technical knowledge increases production will increase giving a higher rate of economic growth.
Page 8
Another determinant of the economic growth rate is the degree of economic efficiency. An improvement in economic efficiency raises the output per unit of input and in so doing will inevitably raise the economic growth rate. Economic efficiency can be promoted by governments taking steps to: reduce bureaucracy; privatise state-owned monopolies; promote competition; invest in education and training; liberalise financial and labour markets; and generally allow a greater role for market forces.
Comment Most candidates made a fair attempt at this question, though not many gave a very good answer to both parts. Too many candidates simply described the various factors in both parts but they were also expected to incorporate some discussion as requested in the question. The term economic growth refers to increases in real GDP and quite a lot of candidates did not make this clear in that they failed to distinguish between real and nominal GDP. Part (i) was generally better answered than part (ii).
Page 9
EXAMINATIONS
2.
3. 4.
107S2002
For questions 1-26 indicate in your answer booklet which one of the answers A, B, C or D is correct.
If the own price elasticity of demand for Good X is 0.8 and the income elasticity of Good X is 0.3, which of the following is correct? A B C D Demand for Good X is elastic. A cut in the price of Good X will increase revenue for a firm producing Good X. Good X is a Giffen good. Good X is an inferior good. [1]
Which of the following will NOT cause a shift in the demand curve for Good X? A B C D A change in the price of Good X. A change in the price of other goods. A change in consumer incomes. A change in consumer tastes.
[1]
Which of the following is TRUE? A B C D By making the supply of a good illegal, the supply curve for that good will move downward to the right. A price ceiling set below the free market price produces excess demand. A binding quota will decrease prices. A subsidy given to consumers can be shown as a downward shift to the left of the demand curve using the net price on the price axis. [1]
If the price of Good X falls and there is a fall in the consumption of Good X then the income effect of the price change is: A B C D positive and exceeds the substitution effect positive and reinforces the substitution effect negative and reinforces the substitution effect negative and exceeds the substitution effect
[1]
107 S20022
The budget line for a particular consumer is given as 3Qx + 2Qy = 30 where Qx is the quantity of Good X and Qy is the quantity of Good Y. Note that Goods X and Y can only be consumed in whole units. Which of the following is TRUE? A B C D The price of Good X is 2. The consumption bundle consisting of 3 units of Good X and 10 units of Good Y is on the consumers budget line. If the consumer decides to buy as many units as possible of Good X, he will still have enough income left over to buy one unit of Good Y. A rational consumer will choose a consumption bundle such that his marginal rate of substitution of Good X for Good Y is equal to 1.5. [1]
A consumer spends all her income on Good X and Good Y in such a combination that the marginal utility of Good X is one third that of Good Y. If the price of Good X is 10 and the price of Good Y is 30 then: A B C to maximise total utility the consumer must increase her consumption of Good X and decrease her consumption of Good Y to maximise total utility the consumer needs to increase her consumption of Good Y and decrease her consumption of Good X to maximise total utility the consumer needs to rearrange consumption so that the marginal utility from consuming Good X is three times the marginal utility from consuming Good Y the consumer cannot increase her total utility [1]
The principle of diminishing marginal utility of wealth makes: A B C D more people risk averse fewer people risk averse more people risk loving more people risk neutral
[1]
107 S20023
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A lawyer operates with just one assistant. Assume that: - she has 100,000 of her own capital tied up in her business - the best rate of return she could get elsewhere on this capital is 6% a year - her assistant is paid 15,000 each year - she earns 300,000 in revenue each year - she pays 50,000 in rent each year - expenses of business and depreciation total 75,000 each year - there are no taxes
If she was employed in a bigger practice, the lawyer calculates that she would earn 100,000 a year. Calculate her annual economic profit. A B C D 0 54,000 100,000 154,000
[1]
Which of the following statements is relevant to the distinction between the short run and the long run in the production process? A B C D Labour input is fixed in the short run but variable in the long run. Labour input is variable in the short run but fixed in the long run. Capital input is fixed in the short run but variable in the long run. Capital input is variable in the short run but fixed in the long run.
[1]
10
Which of the following does not contribute to economies of scale? A B C D Spreading of indivisibilities. The principle of multiples. Dilution of ownership. Specialisation.
[1]
11
Constant returns to scale means that as a firms scale of production is increased: A B C D long run total costs remain constant total output remains unchanged long run average costs and long run marginal costs are equal fixed costs remain constant
[1]
107 S20024
12
Which of the following statements is FALSE? A B C D In monopolistic competition, supernormal profits cannot be made in the long run. Perfect price discrimination would allow the monopolist to produce the socially efficient level of output. Collusion may occur between firms in oligopolistic competition. A firm in perfect competition faces a perfectly inelastic demand curve. [1]
13
For a monopoly, price exceeds marginal revenue because: A B C D the firm has to charge a price higher than the marginal cost of producing the last unit any decision by the monopolist to sell an additional unit of output does not affect product price the firm has to reduce price on all units sold in order to sell an additional unit of the law of diminishing returns [1]
14
A monopoly firm is able to sell 13 units of Good X per day when the price of Good X is 4.50 per unit and 14 units of Good X per day when the price is 4.25 per unit. The marginal revenue for the 14th unit of Good X sold is: A B C D -0.25 1.00 4.25 4.50
[1]
15
When taxes on all income are progressive then as income increases: A B C D the marginal tax rate will be less than the average tax rate. the marginal tax rate will be greater than the average tax rate. the marginal tax rate will be equal to the average tax rate. the marginal tax rate will initially be less than but eventually greater than the average tax rate. [1]
107 S20025
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16
The three leakages from the circular flow of income are: A B C D investment, government expenditure and exports savings, government expenditure and imports savings, taxes and imports savings, taxes and exports
[1]
17
Calculate the amount of investment in the following three sector economy: Savings Total taxes less transfer payments Net exports Government expenditure A B C D -50 150 300 400 = 100 = 250 = 75 = 125
[1]
18
If national income is 100 billion and the total level of planned expenditure is 80 billion then there will be an: A B C D accumulation of stock and output will rise accumulation of stock and output will fall unplanned reduction in stock and output will fall unplanned reduction in stock and output will rise
[1]
19
Assume that the total output of goods and services is held constant and the price level increases. Which of the following observations concerning Gross Domestic Product (GDP) is TRUE? A B C D Nominal GDP rises, real GDP falls. Nominal GDP falls, real GDP rises. Nominal GDP rises, real GDP stays the same. Nominal GDP stays the same, real GDP rises.
[1]
107 S20026
20
Which one of the following is not a crowding out effect resulting from a fiscal expansion? A B C D A fall in investment due to the associated rise in the interest rate. A fall in consumer demand due to fear of higher future taxes. Reduced import expenditure due to increased government demand for domestically produced goods. A fall in demand for exports due to an exchange rate appreciation caused by the associated rise in the interest rate. [1]
21
If the ratio of cash held by the public to deposits is 0.1, and the banks reserve ratio is 0.07, the value of the money multiplier (to two decimal places) is: A B C D 5.88 6.17 6.29 6.47
[1]
22
When it is said that country A has a comparative advantage in the production of a good, this means that: A B C D Country A must give up less of other goods than other countries to produce 1 more unit of that good. The cost of raw materials to produce the good is less in country A than in other countries. Country A produces the good at a lower total cost than other countries. Wages paid are lower in country A than in other countries. [1]
23
Devaluation of a countrys currency will lead to the greatest improvement in the current account of a country's balance of payments when: A B C D the demand for imports is price elastic and the demand for exports is price inelastic the demand for imports is price inelastic and the demand for exports is price elastic the demand for both imports and exports is price inelastic the demand for both imports and exports is price elastic [1]
107 S20027
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24
Which of the following statements on economic activity data is FALSE? A B C D The Financial Times publishes daily indications of gilts prices and yields. The Retail Prices Index uses prices obtained over a few days during the middle of each month. Official reserve figures are published monthly by the manufacturing industry. The National Average Earnings Index is constructed using a monthly sample of representative firms. [1]
25
A country has a total population of 15 million, 12 million of whom are in employment and 1 million of whom are registered unemployed. What is the countrys unemployment rate? A B C D 3.7% 6.7% 7.7% 8.3%
[1]
26
According to Keynesian analysis, the adoption of a policy to reduce the governments budget deficit will involve: A B C D an increase in aggregate demand and a reduction in real output an increase in aggregate demand and an increase in real output a reduction in aggregate demand and a reduction in real output a reduction in aggregate demand and an increase in real output
[1]
27
Describe and discuss the scope of economics in terms of the problems of the allocation of scarce resources.
[4]
28
Define each of the following: (i) (ii) (iii) (iv) price elasticity of demand of Good X price elasticity of supply of Good X cross price elasticity of demand of Good X with respect to the price of Good Y income elasticity of demand of Good X [4]
107 S20028
29
(i)
The utility of any level of wealth for a particular individual is given by the function: U = 100 + w +
600 w
where U = utility and w = wealth This individual can insure against a particular event, which has a probability of occurrence of 0.1. The individuals initial level of wealth is 100. The loss to the individual if the event did occur would be 150. Calculate, to the nearest penny, the maximum premium the individual is prepared to pay. (ii) The utility of any level of capital for a particular insurer is given by the function: U = 5,000 + 0.5 c where U = utility and c = capital The insurers initial level of capital is 1,000. Calculate the minimum premium the insurer is prepared to charge if, in the likelihood of the event occurring, they will be wholly liable for the loss. [2] (iii) State whether, given the answers to (i) and (ii) above, the insurance transaction is feasible. [1] [Total 6] [5] [3]
30 31
Describe the conditions needed for perfect competition.
Explain the economic argument which says that under monopoly output is too low to maximise social welfare. [6]
107 S20029
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32
A perfectly competitive firm manufactures Good X which sells at 16 a unit. The total costs of production for different levels of output per day are given below. Output 0 1 2 3 4 5 (i) Total Cost () 10 18 30 47 67 92
Construct a table to provide the following information at each level of output: (a) (b) (c) Total Fixed Cost Marginal Cost Average Total Cost
[3] [1] [Total 4]
(ii)
Determine the level of output at which profit will be maximised.
33
List the ways by which the government can pay for its expenditure. Separately, list the ways by which the government can finance the Public Sector Borrowing Requirement. Explain why the two lists are not the same. [4] Discuss, with the aid of a diagram, what will happen to inflation and unemployment, in the short run and the long run, following an increase in the growth rate of the money supply. [6]
34
35
Define the following types of unemployment: (i) (ii) structural unemployment technological unemployment [1] [1] [Total 2]
36
(i)
(a) (b)
Explain, with the use of a worked example, how the multiplier principle operates. Discuss how injections and leakages will affect the level of economic activity. [10]
(ii)
Discuss the accelerator principle and the claim that the accelerator-multiplier theory can be used to explain why economies move in cycles. [10] [Total 20]
107 S200210
EXAMINATIONS
Introduction The attached subject report has been written by the Principal Examiner with the aim of helping candidates. The questions and comments are based around Core Reading as the interpretation of the syllabus to which the examiners are working. They have however given credit for any alternative approach or interpretation which they consider to be reasonable. K G Forman Chairman of the Board of Examiners
12 November 2002
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
D A B D D D A B C C C D C B B C B B C C D A D C C C
In general the multiple choice questions were well answered by most candidates. Some questions were answered incorrectly more frequently than others. These included questions 18, 20 and 26.
Page 2
27
Economics is the study of the allocation of scarce resources. A resource is scarce if there would not be enough of it to satisfy all the people who would want to make use of it if it had a zero price. Economists usually categorise resources into three broad types: Land all natural resources Labour all human effort Capital all man-made resources used in production.
There are three main allocation problems which have to be solved by any economic system Which goods and services should be produced (and in what quantities)? How should these goods and services be produced? Who should consume the goods and services that have been produced?
Most candidates made a fair attempt at the question. Some were tempted merely to list or describe types of resources and the main allocation questions without discussing these in any detail. % change in quantity demanded of Good X % change in price of Good X % change in quantity supplied of Good X % change in price of Good X % change in quantity demanded of Good X % change in price of Good Y % change in quantity demanded of Good X % change in income
28
(i)
(ii)
(iii)
(iv)
Very well answered by candidates. Full marks were given for an accurate verbal or algebraic description. Marks were often lost where candidates failed to identify the importance of the percentage change in prices, quantities and income.
29
(i)
For maximum premium P, solve so that the utility from insuring equals the expected utility from not insuring. 100 + 100 P + 600 / (100 - P) = 0.1 * (100 50 - 12) + 0.9 * (100 + 100 + 6) 200 P + 600 / (100 - P) = 189.2 10.8 + 600 / (100 - P) = P P2 110.8P + 1680 = 0
Page 3
P = (110.8 +/- root (110.82 4 * 1680)) / 2 P = 92.67 or 18.13 The maximum premium is therefore 18.13. (ii) For minimum premium Q, solve so that the expected utility from taking on the insurance equals the utility from not taking it on. 0.1 * (5000 + 0.5 * (1000 150 + Q)) + 0.9 * (5000 + 0.5 * (1000 + Q)) = 5000 + 0.5 * 1000 542.5 + 0.05 Q + 4950 + 0.45 Q = 5500 5492.50 + 0.5 Q = 5500 P = 15 The minimum premium is therefore 15.00. (iii) As the minimum premium the insurer is prepared to accept is less than the maximum premium the individual is prepared to pay, the transaction is feasible.
This question caused many of the candidates a good deal of trouble. Simple arithmetic and algebraic errors were common. Of those able to solve the quadratic equation a surprising number chose the higher of the two roots. Where formulae were known parts (ii) and (iii) were well answered.
30
A very large number of firms is needed. If each firm has an infinitesimally small share of the market, an x% change in output by one firm will have (virtually) no effect on the overall level of industry output. Each firm must produce exactly the same product. A price raising firm could lose all its sales. Similarly, if it dropped its price fractionally large numbers of customers might want to buy the output from that firm. Customers must have perfect information. If we assume that customers have perfect information concerning the price charged by different firms, and know that all firms are producing exactly the same product, then a price raising firm may well lose all its sales. Customers must act rationally. This means that, using their perfect information, customers will choose to purchase from the cheapest suppliers. There is free entry and exit of firms, so that collusion between firms can be ruled out.
Many candidates merely listed the conditions for perfect competition and so did not obtain full marks. The question asked for descriptions - some of which were brief but adequate. Credit was not given to candidates who moved away from the question to discuss imperfect markets.
Page 4
31
The way to explain that output under monopoly is too low to maximise social welfare is to consider the monopolys chosen (profit maximising) output level (q*) and weigh up the costs and benefits to society of increasing output by one unit.
social cost
MC
MR q* q**
DD Q
The main cost to society will be whatever it costs the monopolist to produce the one extra unit. If there are no other costs imposed on society then the monopolists marginal cost is the marginal cost to society. The demand curve can be assumed to show the marginal benefit to society of each extra unit produced. So long as the demand curve exceeds the monopolists marginal cost curve, social welfare can be increased by setting output at a higher level. The socially optimal output level (q**) is thus where the marginal cost curve cuts the demand curve. Most candidates correctly identified the relevant diagram, but in many cases the quality of the sketch was poor. The written explanation accompanying the diagram differentiated between candidates. A discussion of price discrimination was not required.
32
(i) Output 0 1 2 3 4 5 Total Cost 10 18 30 47 67 92 Total Fixed Cost 10 10 10 10 10 10 Marginal Cost 8 12 17 20 25 Average Total Cost 18 15 15.67 16.75 18.4
Page 5
(ii)
2 units of output
A straightforward question that was generally very well answered. Some candidates failed to identify correctly the profit maximising level of output, and some gave confusing figures for Marginal Cost and Average Total Cost at zero output.
33
The government can pay for its expenditure in one of five ways: taxation profits from publicly owned companies and other income sales of public assets borrowing printing money
The government can finance the PSBR by: borrowing printing money
The two lists are not the same because the proceeds from the sale of nationalised industries and also their profits are treated as negative expenditure, therefore increased proceeds from nationalised industries will reduce the PSBR, rather than being a way of funding it. Taxation also reduces the PSBR, by definition, and, therefore, does not fund it. The quality of answers varied widely with some candidates having difficulty distinguishing between the contents of the two lists.
34
Inflation LRPC C 10% 5% B
D A
SRPC2 SRPC1
U1
Unemployment
The long run Phillips curve (LRPC) and the short run Phillips curve (SRPC) show the relationship between inflation and unemployment in the long run and short run respectively.
Page 6
Starting at point A with LRPC and SRPC1, the natural level of unemployment is U1 and the rate of money supply growth is 5% per year. Thus, actual and expected price and wage inflation are all 5% per year as well. If the government increases the rate of growth of the nominal money supply to, say, 10% but inflation remains at a lower level the real money supply will expand. This causes interest rates to fall. Private sector investment and consumption will rise leading to lower unemployment. So long as workers expect the money supply to expand at 5% per year in the long run, the economy stays on SRPC1. Wage claims and inflation are increased only a little above 5% by the fall in unemployment and rise in aggregate demand. With inflation lower than monetary growth the real money supply continues to expand. Consequently interest rates and unemployment continue to fall. The economy moves to the left up SRPC1, for example to point B on the diagram. In the long run, the economy will return to LRPC either at point A or D. What happens depends upon the governments and workers reactions. If the government decides to accommodate wage rises by less than 10% by once again expanding the money supply at 5%, the economy will move back to point A. This happens because, while it persists, falling unemployment will keep wage rises and thus price inflation above 5%. This means that the real money supply will be contracting with interest rates and thus unemployment rising as a result. If the government continues to expand the money supply at 10%, workers will eventually come to expect 10% inflation in the long run and the economy will move on to SRPC2 at point C. Wage inflation will be a little higher than 10% and so the real money supply is contracting, eventually taking the economy back to LRPC at point D as interest rates and thus unemployment rise. Again diagrams varied in quality. Most correctly used the Phillips curve apparatus, but some focussed instead on aggregate supply diagrams failing to cover the effects on unemployment. A few discussed the effects of a decrease rather than an increase in the growth rate of the money supply.
35
(i)
At any point in time, the demand for the products of some industries is in long term decline. The result is structural unemployment: a mismatch between the skills employers require, and the skills of the unemployed. Technological unemployment arises because the need to employ workers with certain skills may decline even if the industry as a whole is not in decline.
(ii)
Although consisting of straightforward definitions there was considerable variation in the quality of answers.
Page 7
36
(i)
(a)
The multiplier principle An increase in an injection to the national income flow (e.g. an increase in investment expenditures) causes an increase in the equilibrium level of national income greater than the increase in the injection. Explanation: The multiplier is the ratio of the increase in equilibrium national income to the original increase in the injection. The multiplier can be explained as follows. Assume investment increases by 60 and the marginal propensity to consume is 0.8. In the first time period following the extra 60 investment expenditure, national income will be higher by 60. But this is not an equilibrium position. In the next time period, the factors of production who received the extra 60 will be able to spend more. Given that the marginal propensity to consume is 0.8, we know that another 48 will be added to national income. This will, in turn, give rise to extra factor incomes of 48, and therefore subsequent expenditure of 38.4. This 38.4 will also give rise to further incomes and expenditure, and so on. The total increase in national income is found by summing the increase in each successive round of the multiplier: 60 + 0.8 * 60 + 0.82 * 60 + This is a geometric progression. Its sum is:
a 1- r
where a = 60 and r = 0.8 Its value is 60 / 0.2 This is the same as 60 / MPS, or 60 / (1 MPC) Where MPS is the marginal propensity to save and MPC is the marginal propensity to consume. In the special case where I, G, X, and Z are all exogenous and where there are no direct taxes, the value of the multiplier is 1 / MPS or 1 / (1 MPC)
Page 8
(b)
An increase in an injection into the circular flow of income will increase the equilibrium level of national income. In each case, if it is an autonomous part of the injection / leakage that changes, the resulting change in equilibrium national income will be: Change in injection/leakage x multiplier In equilibrium planned injections must equal planned leakages. An increase in planned injections into the circular flow of income will tend to raise the equilibrium level of national income. The equilibrium is changed because planned withdrawals must also change (and by the same amount) in order to maintain the equilibrium condition that planned withdrawals equal planned injections. Planned withdrawals are an increasing function of national income. Thus an increase in injections / withdrawals means that equilibrium national income is higher. Equivalently, the effect of an increase in planned injections can be seen by considering the multiplier. An increase in injections is an increase in one of the components of aggregate demand. This increase in aggregate demand will increase factor incomes. This leads to a further increase in aggregate demand etc.
(ii)
According to the accelerator principle, investment expenditure is determined by the rate of change of national income. Small fluctuations in national income can lead to large fluctuations in investment demand. The capital stock is the current amount of capital equipment available in the economy. It consists of machines, factories, offices, commercial vehicles etc. which are all used to allow production of other goods. The capital stock is long lasting. Unlike raw materials it is not used up in production. The capital output ratio is the amount of capital needed to produce 1 unit of output. If national income falls slightly, the required capital stock is reduced slightly. However, the negative investment needed to meet the reduction in the required capital stock may swamp the small annual replacement demand. Similarly, a small rise in national income can lead to a very large rise in investment demand. Therefore the demand for investment can fluctuate greatly. The accelerator-multiplier theory can be used to explain why economies move in cycles. A one-off shock within a very simple model leads to a complex cycle of economic activity. Because investment depends on the rate of change of national income, which can change much more rapidly than its absolute level, investment demand is particularly volatile.
Page 9
Part (i)(a) of the question was quite well answered, although some candidates were sidetracked into a discussion of the money multiplier. For the worked example many simply reproduced a page or more of algebra without giving a full explanation to interpret the various mathematical expressions. Part (i)(b) was less well handled. Very few gave a good explanation of the link between injections and leakages and the point at which these came into equilibrium. Again others were sidetracked by irrelevant discussions of crowding out. Answers to Part (ii) were surprisingly brief and superficial given that half of the allocated marks for the question were available. Turning points in the economic cycle were a source of confusion in the accelerator-multiplier discussion. In several instances handwriting was virtually illegible.
Page 10
EXAMINATIONS
2.
3. 4.
107A2003
Which one of the following is true of a negatively sloped linear demand curve? A B C D It becomes more elastic as price rises. It become more inelastic as price rises. It has a constant elasticity throughout its entire length. It switches from positive to negative elasticity as price rises.
[1]
If Good X is a Giffen good then an increase in income will cause a: A B C D rightward shift of the demand curve for Good X. leftward shift of the demand curve for Good X. movement along the demand curve for Good X from left to right. movement along the demand curve for Good X from right to left.
[1]
Consider the budget line of a consumer that consumes only two Goods X and Y, with the quantity of Good X represented on the horizontal axis and quantity of Good Y represented on the vertical axis. If money income is increased and there is a fall in the price of Good X while the price of Good Y remains the same then the budget line will shift to the: A B C D left and become steeper left and become less steep right and become steeper right and become less steep
[1]
A monopolist increases his sales from 7 units to 8 units by reducing the price of his product from 20 to 18. The marginal revenue from the 8th unit sold is: A B C D 18 4 -2 -4
[1]
Which one of the following conditions indicates that a firm is operating in a perfectly competitive industry rather than a monopolistic industry? A B C D Output of the firm is where marginal revenue equals marginal cost. The cost curves of the firm are U-shaped. Marginal revenue equals average revenue. The marginal cost curve cuts the average cost curve at its minimum point. [1]
107 A20032
What will be the consequence of an increase in a firms fixed costs of production on the firms marginal costs? A B C D Marginal cost will increase by more than fixed cost. Marginal cost will increase by the same amount as fixed cost. Marginal cost will increase but by less than fixed cost. Marginal cost will remain unchanged.
[1]
Which one of the following relationships between marginal product and average product is always TRUE? A B C D If marginal product is greater than average product then average product must fall. If marginal product is greater than average product then average product must rise. If marginal product is positive then average product must rise. If marginal product is falling then average product must be falling. [1]
If a minimum guaranteed price is set for Good X above the equilibrium price for Good X this will result in: A B C D an increase in demand for Good X a decrease in supply of Good X excess supply of Good X excess demand for Good X
[1]
The price of Good X is half the price of Good Y. A consumer spends all his income on the two goods. Which one of the following conditions is met when the consumer maximises utility? A B C D The marginal utility of Good X is double the marginal utility of Good Y. The ratio of the quantity of Good X to the quantity of Good Y is double the ratio of the price of Good X to the price of Good Y. The marginal utility of Good X is half the marginal utility of Good Y. The total utility of Good X is twice the total utility of Good Y. [1]
107 A20033
PLEASE TURN OVER
10
Which one of the following is TRUE: A B C D Diseconomies of scale means that the ratio of inputs to outputs rises as output rises. Economies of scale means that the ratio of inputs to outputs rises as output rises. In the long run a firm cannot alter its fixed costs of production. Constant returns to scale means that if a firm doubles its inputs then output remains constant. [1]
11
Which one of the following statements about market structure is FALSE? A B C D Under perfect competition, in the long run all firms make only normal profits. Firms under monopolistic competition produce homogeneous products. Under oligopoly, firms make decisions taking into account the possible reactions of their competitors. Under monopoly, a profit maximising firm with positive marginal costs always produces in the region of price elastic demand. [1]
12
Which one of the following is an example of moral hazard? A B C D A person will not take out an insurance policy because they object to the investment policy of the insurance company. A person takes out an insurance policy but lies on the insurance policy form. A person who is insured against theft makes a false claim. A person who takes out a insurance policy is more careless with the insured goods than if they had not taken out an insurance policy. [1]
107 A20034
13
Adverse selection describes the fact that people who know that they are particularly: A B bad risks are more inclined to take out insurance than those who know that they are good risks. High premiums should be charged to all policyholders. good risks are more inclined to take out insurance than those who know that they are bad risks. Appropriate premiums should be charged to all policyholders. bad risks are more inclined to take out insurance than those who know that they are good risks. Appropriate premiums should be charged to all policyholders. good risks are more inclined to take out insurance than those who know that they are bad risks. Low premiums should be charged to all policyholders. [1]
14
Assume that the total output of goods and services is held constant and the general price level increases. Which one of following observations concerning Gross Domestic Product (GDP) is FALSE? A B C D Nominal GDP increases. Real GDP remains constant. Nominal GDP changes by more than real GDP. Nominal GDP changes by less than real GDP.
[1]
15
If an economy experiences an unplanned increase in its inventories (stocks of goods) then: A B C D Gross Domestic Product will have increased. Recorded investment will have increased. Producers desired level of inventories is more than the actual level. Total expenditure in the economy is greater than the value of total output produced. [1]
107 A20035
PLEASE TURN OVER
16
According to Keynesian analysis, once a closed economy is in macroeconomic equilibrium such that planned savings equals planned investment then: A B C D there will be no unemployment in the economy the marginal propensity to consume must be greater than the marginal propensity to save consumption will be equal to or greater than income there may or may not be unemployment [1]
17
You are given the following data for an economy: Consumer Expenditure Investment Government Expenditure Exports Imports Net Property Income from abroad 80 million 20 million 40 million 20 million 30 million 10 million
What is the value of its Gross Domestic Product? A B C D 130 million 140 million 150 million 160 million
[1]
18
The monetary base is 200 billion, the publics cash to deposit ratio is 0.5 and the broad money supply is 400 billion. This means that the reserve ratio of the banking system (cash to deposits) is: A B C D 2 0.25 0.5 1
[1]
19
Which one of the following statements about the demand for money is FALSE? A B C D The demand for money is negatively related to the interest rate. The demand for money is positively related to nominal income. The demand for money is negatively related to the general price level. The demand to hold money is positively related to real income.
[1]
107 A20036
20
An increase in the general price level with no change in the money supply will: A B C D Raise aggregate demand and increase real money balances. Raise aggregate demand and decrease real money balances. Lower aggregate demand and increase real money balances. Lower aggregate demand and decrease real money balances.
[1]
21
Which one of the following statements is NOT associated with the monetarist argument concerning the so called vertical long run Phillips curve? A B C D At a given rate of unemployment there will be a unique rate of inflation. If the actual rate of unemployment is above the natural rate, then we would expect to observe a decrease in the rate of wage and price inflation. If the actual rate of unemployment is below the natural rate of unemployment, then we would expect to observe an increase in wage and price inflation. In the long run, the government can influence the rate of inflation. [1]
22
The level of consumption in a closed economy with no government sector is 80% of national income and planned investment is 50 billion. The equilibrium level of national income is: A B C D 400 billion 250 billion 40 billion indeterminate from the information given
[1]
23
The IS curve for a closed economy shows different combinations of the rate of interest and level of national income for which the sum of: A B C D savings and taxation equals the sum of investment plus government expenditure savings and taxation equals the sum of consumption plus government expenditure savings and taxation equals the sum of consumption plus investment expenditure savings and investment equals the sum of consumption plus government expenditure [1]
107 A20037
PLEASE TURN OVER
24
A country has a government budget deficit of 200 million, private sector investment of 100 million and private sector savings of 150 million. The current account position of the country is: A B C D 250 million in deficit 150 million in deficit 50 million in surplus 150 million in surplus
[1]
25
Which one of the following would constitute a supply side economic policy for reducing unemployment? A B C D Increasing social security benefits. Increasing the money supply. Reducing corporate and personal taxation. Increasing fiscal expenditure aimed at exploiting the fiscal multiplier effect. [1]
26
Which one of the following statements about real variables in the economy is FALSE? A B C D If all else is constant, a rise in money wages is also a rise in real wages. Real interest rates are negative if the rate of inflation exceeds the nominal rate of interest. Real interest rates are negative if the rate of inflation is negative. If nominal Gross Domestic Product (GDP) rises by 10 per cent and the GDP deflator rises by 5 per cent then real GDP has risen. [1]
27
Read all parts of the question before answering. A consumer has an income of 200 which can be spent either on Good X or on Good Y. Good X costs 20 per unit and Good Y costs 10 per unit. Good X is a Giffen good and Good Y is a normal good. Draw a single diagram to show: (i) The budget line for the consumer. Label the quantities of Good X and Good Y at the points where the budget line meets the Good X (horizontal) and Good Y (vertical) axes. [1] An indifference curve for Good X and Good Y at a point where the consumer is maximising satisfaction. Label the curve A, the quantity of X consumed as X1 and quantity of Y consumed as Y1. [1]
(ii)
107 A20038
(iii)
The effect on the budget line of a fall in the price of Good X to 10 per unit. Label the quantities of Good X and Good Y at the points where the budget line meets the Good X and Good Y axes. [1] A new indifference curve for Good X and Good Y on the new budget line drawn in part (iii) at a point where the consumer is maximising his satisfaction. Label this new curve B, the quantity of X consumed as X2 and quantity of Y consumed as Y2. [1] [Total 4]
(iv)
28
Consider the following options A to E. Each option relates to an individual firm operating under a certain market structure in the short run. OPTION A B C D E (i) (ii) (iii) (iv) Marginal cost 25 20 24 15 9 Average cost 20 20 18 18 14 Average revenue 20 20 24 20 20 Marginal revenue 10 20 24 15 14
State ALL the options that indicate the firm is not seeking to maximise its profits nor minimise its losses. [1] State ALL the options that indicate that the firm is making excess profits. [1] State ALL the options that indicate that the firm could increase its output and increase its profits. [1] State ALL the options which could correspond to the firm operating in a long run perfectly competitive environment. [1] [Total 4]
29
Draw a diagram to illustrate the short run profit maximising price and output for a monopolistic competitor firm making losses but with sufficient revenue to continue production in the short run. Label the diagram as follows: AC1 average cost curve MC1 marginal cost curve AVC1 average variable cost curve MR1 marginal revenue curve AR1 average revenue curve P1 price Q1 quantity CI average cost C2 average variable cost [4]
107 A20039
PLEASE TURN OVER
30
The world consists of two countries A and B and the only factor of production is labour. In Country A it takes 40 hours to produce one unit of Good X and 10 hours to produce one unit of Good Y. In Country B it takes 50 hours to produce one unit of Good X and 25 hours to produce one unit of Good Y. (i) (ii) (iii) State which country has a comparative advantage in producing Good X. Calculate the opportunity cost of producing Good X in country A. [1] [1]
Explain whether mutually advantageous international trade would be possible between the two countries if the terms of trade were 3 units of Good Y for 1 unit of Good X. [2] [Total 4]
31
(i)
Draw a diagram showing a real money supply curve (labelled MS1), a real money demand curve (labelled MD1) and the interest rate (labelled r1) that clears the money market. Show how an increase in the real money supply to MS2 would affect the market rate of interest in the short run. [3] State how an increase in the real money supply through open market operations will affect the price of Treasury bills. [1] [Total 4]
(ii)
32
The government in a closed economy undertakes expenditure on goods and services of 60 billion, investment expenditure is 20 billion. The rate of direct taxation is 20 percent of all income. The consumption function is given by the equation: C = 0.75 Yd Where Yd is disposable income (national income less taxes) (i) (ii) (iii) Calculate the equilibrium level of national income. [1]
Calculate the level of national income where the government has a balanced budget. [1] Calculate the required budget deficit to achieve the full employment level of national income of 350 billion. [2] [Total 4]
107 A200310
33
(i)
Using an IS/LM diagram briefly explain the likely effects of a fiscal contraction on both the domestic interest rate and the level of economic activity.
[2]
(ii)
Using a second IS/LM diagram briefly explain the likely effects of a monetary contraction on both the domestic interest rate and the level of economic activity. [2] [Total 4]
34
(i) (ii)
Explain briefly the concepts of voluntary and involuntary unemployment. [2] Outline two reasons which might explain why some people choose to be voluntarily unemployed on a long term basis. [2] [Total 4]
35
(i) (ii)
Outline how the national debt may be linked to this years fiscal deficit and how a rising national debt can impact on next years fiscal deficit. [2] Outline why it is that countries with a high national debt tend to have to pay a higher rate of interest, other things being equal, than countries with a low national debt. [3] [Total 5]
36
State the effects of an appreciation of the exchange rate of a country on its: (i) (ii) (iii) (iv) import volumes [1]
inflation rate as measured by a consumer price index made up of domestic produced and imported goods [1] export volumes export earnings measured in the domestic currency. [1] [1] [Total 4]
107 A200311
PLEASE TURN OVER
37
(i)
Discuss the differences between a market structure characterised by monopolistic competition and one characterised by monopoly. In your answer refer to both the short and the long run. (No diagrams are required in your answer.) [10]
(ii)
Explain the effects of a per unit sales tax on Good X on the producers of Good X, the consumers of Good X and the government tax revenues. Discuss any net welfare effects for society as a whole. Illustrate your answer using a diagram and discuss the welfare implications using the concepts of consumer and producer surplus. [10] [Total 20]
107 A200312
REPORT OF THE BOARD OF EXAMINERS

J Curtis Chairman of the Board of Examiners 3 June 2003
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
A B D B C D B C C A B D C D B D A B C D A B A B C C
The multiple choice part was in general well answered and many students secured high marks. The questions which contained most incorrect responses were 7, 11, 13, 15, 16, 21, and 24.
Page 2
27
Quantity Of Good Y
20
Y2
Y1
A X2 X1 10 20 Quantity Of Good X
Some candidates put x2 to the right of x1, and failed to show the impact of a Giffen good.
28
(i) (ii) (iii) (iv)
A, E C, D, E E B
Page 3
29
Price/Cost
MC1 AC1 C1 P1 C2 AVC1
AR1 MR1 Q1 Quantity
Many candidates failed to place the price P1 below the average cost curve but above the average variable cost curve. Some candidates drew the average cost curves poorly not showing the correct relationship with the marginal cost curve.
30
(i) (ii) (iii)
Country B 4 units of Good Y Yes, country A will be better off if less than 4Y is traded for 1X and country B will be better off if more than 2Y is traded for 1X.
Page 4
31
(i)
interest rate
MS1
MS2
r1
r2
MD1
real money supply
(ii)
An increase in the real money supply resulting from open market operations will raise the price of treasury bills.
The diagrams was generally well drawn but in part (ii) many candidates failed to indicate that a rise in the money supply will raise the price of Treasury bills.
32
(i)
Y = 0.75(1 - 0.2)Y + 20 + 60 Y = 200 billion
(ii)
Since G = 60 billion with 20% tax rate we require national income to be 60 billion = 0.2 Y so that Y = 60 billion/0.2 = 300 billion
(iii)
The fiscal multiplier is
1 1 = = 2.5 1 - c(1 - t ) 1 - 0.75(1 - 0.2)
Hence to increase income from 200 billion to 350 billion requires an increase in government expenditure of 150 billion/2.5 = 60 billion. Hence government expenditure needs to be 120 billion while tax revenue at 350 billion is 70 billion implying a budget deficit of 50 billion.
Page 5
33
(i)
interest rate LM
r1 r2
IS1 IS2 Y2 Y1 Output/income
A fiscal contraction via either a cutback in government expenditure or a rise in taxes will result in a shift to the left of the IS curve from IS1 to IS2. The result will be a fall in the rate of interest from r1 to r2 and a fall in the level of national income/output in the economy from Y1 to Y2. (ii) interest rate LM2 LM1
r2 r1
IS1 Y2
Page 6
Y1
Output/income
The fall in the money supply will result in a shift to the left of the LM curve from LM1 to LM2. The result will be a rise in the rate of interest from r1 to r2 and a fall in the level of national income/output in the economy from Y1 to Y2. Diagrams were usually correct but many candidates failed to give good explanations of the reasons for fiscal and monetary contractions causing interest rate and output changes.
34
(i)
Voluntary unemployment. A worker who is registered as part of the labour force but is not prepared to immediately accept a job at the going wage rate for his skills is voluntarily unemployed. Involuntary unemployment. A worker who is registered as unemployed and is prepared to accept a job immediately at the going wage rate for their skills is involuntarily unemployed.
(ii)
People are more likely to choose to be voluntarily unemployed on a long term basis if: - high state benefits for being unemployed reduce the opportunity cost of being unemployed - high rates of tax on earned income reduce the incentive to work - finding out about jobs and travelling to interviews is expensive (i.e. high search costs) - retraining is difficult to obtain and / or expensive.
Many incorrectly defined voluntary and involuntary unemployment.
35
(i)
This years fiscal deficit may be financed by bond sales which will increase the size of the national debt. A higher national debt will then impact upon next years fiscal deficit because interest on the national debt is part of the government expenditure used to calculate the fiscal deficit. The national debt of a country is the outstanding stock of government bonds in the market. The higher a countrys national debt the higher the stock of bonds available on the market and, other things being equal, the higher the interest rate. Apart from this, governments with a high national debt tend to be distrusted by the financial markets. The markets may attach a higher risk to countries with high national debts for fear that the government may ultimately redeem the debt by printing money which could lead to inflation. This extra inflation risk will tend to be priced into the rate at which the government can borrow.
(ii)
Many of the responses were weak and the majority of candidates did not demonstrate an understanding of the link between fiscal deficits and the national debt.
Page 7
36
(i) (ii) (iii) (iv)
An appreciation of the exchange rate will make imports cheaper and therefore result in a rise in import volumes. An appreciation of the exchange rate will make imports cheaper and therefore help to lower the inflation rate. An appreciation of the exchange rate will make exports more expensive in foreign currencies and therefore result in a fall in export volumes An appreciation of the exchange rate will make exports more expensive in foreign currencies and therefore result in a fall in export volumes and, therefore, lower export earnings measured in the domestic currency.
Generally well answered, but many candidates failed to give a correct response to part (ii), an appreciation of the domestic currency by lowering the price of imports will lower the inflation rate.
37
(i)
There are significant differences between the market structures of monopolistic competition and monopoly. With monopolistic competition there are many competing firms whereas with monopoly there is only one firm. Under monopolistic competition each firm sells a differentiated product whereas a monopoly may sell either a single product or a range of differentiated but similar products. A crucial difference between the two structures is that with monopolistic competition there are no barriers to entry whereas with monopoly there are barriers to entry. The absence of barriers to entry mean that firms in a monopolistic competition industry will only make normal profits in the long run although super normal profits can be made in the short run. With monopoly, the existence of barriers to entry means that in both the short and the long run excess profits can be made. Although both monopolistic and monopoly firms face downward sloping demand curves, the market demand curve is the demand curve for a monopolist whereas a monopolistic competitor firm only has a share of the market. The presence of competition will also tend to make the demand curve facing a monopolistic firm more price elastic than for a monopoly firm. While both types of firm can be profit maximisers, competition means that a monopolistic competitor firm will have to seek to minimise costs whereas a monopoly firm can afford to some extent to be inefficient. Monopoly firms will be better able to exploit economies of scale as their production runs will be bigger than monopolistic competitor firms.
Page 8
(ii)
The effect of a per unit sales tax is illustrated in the diagram below. Price S2
P2 Tax P1 P3
A D B
S1
D1 Q2 Q1 Quantity
Before the introduction of the tax the supply and demand curves S1 and D1 intersect to give the equilibrium price and quantity of P1 and Q1 respectively. If a per unit sales tax is introduced this will have the effect of shifting the supply curve to the left by the full amount of the tax per unit from S1 to S2. The result is a new equilibrium price and quantity given by the intersection of the new supply curve S2 and the original demand curve D1 giving a new equilibrium price and Quantity of P2 and Q2 respectively. It should be noted that the rise in the price of the good is less than the amount of the tax. The effect of the tax is to create a wedge between the price paid by the consumer P2 and the price received by the producer P3. There is a reduction in consumer surplus equal to area P2ABP1. There is also a reduction in producer surplus equal to area P1BCP3 as they suffer both a lower price received from P1 to P3 and produce a lower quantity of units Q2 than before the imposition of the tax. There is one party that gains from the tax and that is the government which receives a tax of P2 - P3 per unit sold, hence the government receives tax revenue equal to area P2ACP3. The gain to the government is less than the combined losses of consumers and producers, so that there is a net loss from the tax given by the area ABC. The net loss is relatively easy to explain, the area ABD is the consumer surplus loss suffered by consumers who are willing to pay between price P1 and P2 but unable to do so at the price P2, while the area BCD is the producer surplus loss suffered by domestic producers who are willing to produce the good between the price P3 and P1 but who no longer do so as a result of the tax. This section was the poorest part of the examination.
Page 9
In part (i) many defined some of the characteristics/ differences but overall there were relatively few good explanations and too few candidates made direct comparisons of monopoly and monopolistic competition as required by the question. Part (ii) was not well answered, diagrams were poor and many moved the demand curve instead of the supply curve. The analyses were generally weak with poor explanations of producer and consumer surplus effects and many candidates were not able to explain the welfare implications.
Page 10
EXAMINATIONS
2.
3. 4.
107S2003
A minimum price is set for Good X at 12 which happens to coincide with the free market price. Keeping the minimum price fixed at 12, an increase in the demand for good X will lead to: A B C D no change in price and a shortage a rise in price and a shortage a rise in price and a surplus a rise in price and quantity sold
[1]
Good Y has a cross elasticity of demand with respect to Good X of 0.5 and 100 units of Good Y are demanded when Good X costs 60 pence. A rise in the price of Good X to 90 pence will lead to a change in the demand for Good Y to: A B C D 150 units 125 units 75 units 50 units
[1]
Consider the budget line of a consumer that consumes only two goods X and Y, with the quantity of Good X represented on the horizontal axis and the quantity of Good Y represented on the vertical axis. If real income and the price of Good Y are held constant, a rise in the price of Good X will: A B C D shift the entire budget line to the left shift the entire budget line to the right make the budget line steeper make the budget line less steep
[1]
Which of the following is true for total utility and marginal utility as consumption of a good increases? A B C D Total utility is increasing and marginal utility is increasing. Total utility is increasing and marginal utility is decreasing. Total utility is decreasing and marginal utility is increasing. Total utility is decreasing and marginal utility is decreasing.
[1]
107 S20032
Which of the following is NOT TRUE of a risk averse person? A B C D A risk averse person chooses a course of action designed to maximise expected utility. A risk averse person will tend to reject a fair gamble. A risk averse person will be unwilling to pay more for insurance than the long run average value of claims which will be made. A risk averse person will be willing to pay more for insurance than the long run average value of claims which will be made. [1]
Which one of the following statements about short run costs of production is FALSE? A B C D Marginal cost cannot exceed average total cost. Marginal cost is equal to average variable costs when average variable cost is at a minimum. Average fixed cost always falls as output rises. Average total cost exceeds average variable cost by an amount that declines with increasing output. [1]
Consider the following table: Units of Labour 1 2 3 4 5 The table illustrates which of the following? A B C D The law of diminishing marginal returns. Increasing returns to scale. Constant returns to scale. Decreasing returns to scale. Units of Capital 1 2 3 4 5 Output 100 190 270 340 400
[1]
107 S20033
PLEASE TURN OVER
Each of the following is a characteristic of monopolistic competition. Which one is NOT a characteristic of oligopoly? A B C D Each firm faces a downward-sloping demand curve. Firms are profit-maximisers. The sales of one firm will not have a significant effect on other firms. There is more than one firm in the industry.
[1]
All the following, except one, describe both monopoly and perfect competition. Which does not? A B C D Both may make supernormal profits in the short run. Both determine output by equating marginal cost and marginal revenue. Both reduce output if marginal cost exceeds marginal revenue. Both face a perfectly elastic demand curve. [1]
10
A movement along a consumers indifference curve from right to left implies that: A B C D a consumers utility will be unchanged a consumers money income will be unchanged a consumers utility will rise a consumers utility will fall
[1]
11
When personal income taxes are progressive then, for an individual, as income increases: A B C D the marginal tax rate will be less than the average tax rate the marginal tax rate will be greater than the average tax rate the marginal tax rate will be equal to the average tax rate the marginal tax rate will initially be less than, but eventually greater than, the average tax rate [1]
12
Which of the following types of unemployment would exist even in a well functioning economy: A B C D classical unemployment frictional unemployment technological unemployment structural unemployment
[1]
107 S20034
13
In the circular flow of income model: A B C D savings, taxes and investment are leakages exports, imports and government expenditure are leakages investment, government expenditure and exports are injections investment, exports and consumption are injections
[1]
14
Assume that the total output of goods and services is held constant and the price level increases. Which one of the following observations concerning Gross Domestic Product (GDP) is FALSE? A B C D Nominal GDP rises. Real GDP remains constant. Nominal GDP rises while real GDP falls. Nominal GDP changes by more than real GDP.
[1]
15
The accelerator principle implies that: A B C D investment is determined by the rate of change of national income national income is determined by the rate of change of investment investment is increased when interest rates fall national income is increased when interest rates fall
[1]
16
Which one of the following situations will lead to the most crowding out following an increase in government expenditure? A B C D The demand for money is interest elastic and private investment is interest inelastic. The demand for money is interest inelastic and private investment is interest elastic. The demand for money and private investment are both interest inelastic. The demand for money and private investment are both interest elastic. [1]
107 S20035
PLEASE TURN OVER
17
The direct impact of open market operations, where the central bank purchases government securities is to: A B C D increase the cash reserves of commercial banks and increase the monetary base increase the cash reserves of commercial banks and reduce the monetary base reduce the cash reserves of commercial banks and increase the monetary base reduce the cash reserves of commercial banks and reduce the monetary base [1]
18
Which of the following is NOT a cost of inflation? A B C D menu costs shoe-leather costs arbitrary redistribution of wealth from lenders to borrowers arbitrary redistribution of wealth from borrowers to lenders
[1]
19
Which of the following statements best characterises the views of a monetarist? A B C D In the long term unemployment can be reduced by an expansionary fiscal policy. In the long term unemployment can be reduced by an expansionary monetary policy. In the long term unemployment can be reduced by increasing efficiency and productivity. In the long term unemployment can be reduced but only at the cost of a higher rate of inflation. [1]
20
The law of comparative advantage states that countries should specialise in producing and exporting the goods that they produce at a lower: A B C D marginal cost than other countries absolute cost than other countries total cost than other countries opportunity cost than other countries
[1]
107 S20036
21
The terms of trade index may be defined as: A B C D the ratio of the index of import prices to the index of export prices the ratio of the index of export prices to the index of import prices the ratio of the quantity of imports to the quantity of exports the ratio of the quantity of exports to the quantity of imports
[1]
22
Which of the following would NOT be included in the current account of the United Kingdoms balance of payments? A B C D Property income from abroad. The purchase of shares in a UK company by foreign investors. Interest and dividends paid to the rest of the world. Exports of services.
[1]
23
Other things being equal, which one of the following statements is always TRUE? A B C D An appreciation of a countrys exchange rate will increase its import volumes and decrease its export volumes. An appreciation of a countrys exchange rate will increase its import expenditure and decrease its export revenues. A depreciation of a countrys exchange rate will decrease its import volumes and decrease its export volumes. A depreciation of a countrys exchange rate will decrease its import expenditure and increase its export revenues. [1]
24
The marginal propensity to consume in an open economy with no government sector is 0.9. Planned investment is 100 billion and exports are 15 billion. The equilibrium level of national income is: A B C D 103.5 billion 115 billion 1150 billion indeterminable from the information given
[1]
107 S20037
PLEASE TURN OVER
25
Assume that the United Kingdom interest rate is 10% per annum and the United States interest rate is 5% per annum. What is the expected annual movement in the dollar-pound exchange rate? A B C D The dollar is expected to depreciate by 2%. The dollar is expected to appreciate by 2%. The dollar is expected to appreciate by 5%. The dollar is expected to depreciate by 5%.
[1]
26
Which of the following is least likely to lead to an increase in long run economic growth? A B C D An increase in the money supply. An increase in capital investment expenditure. An increase in education expenditure. An increase in research and development expenditure.
[1]
27
A small manufacturing company sells cameras. At present total costs of production vary with output as follows: Output 0 10 20 30 40 50 60 Total Cost () 200 650 1000 1300 1600 2000 2500
The relationship between quantity demanded and price is given by the equation: Q = 150 - 2P Where: Q = quantity demanded P = price (i) For each level of output in the table, calculate the following (round all figures to the nearest pound ()): (a) (b) (c) (d) (ii) Average Total Cost Average Revenue Marginal Cost Marginal Revenue
[4] [1] [Total 5]
From the table select the profit-maximising level of output.
107 S20038
28
Read both parts (i) and (ii) of the question before answering. (i) Draw a diagram to show a firm in a monopolistically competitive industry making normal profits. Label the diagram as follows: AC average cost curve, MC marginal cost curve, MR marginal revenue curve, AR average revenue curve, P price and Q quantity. [2] State, but do not show on the diagram, the short and long run effects of a fall in the fixed costs of production facing all firms in the industry. [2] [Total 4]
(ii)
29
Workers in two countries A and B can produce shoes and computers. The annual productivity of a worker in each country is given in the table below. Country A B (i) (ii) (iii) Computers 5,000 200 Shoes 10,000 5,000 [1]
State which country has a comparative advantage in the production of computers.
State which country has a comparative advantage in the production of shoes. [1] Explain whether international trade would take place between the two countries if the terms of trade were 10 shoes per computer. [2] [Total 4]
30
(i)
Define the following: (a) (b) (c) (d) own price elasticity of demand cross price elasticity of demand income elasticity of demand own price elasticity of supply
[2] [2] [Total 4]
(ii)
State two factors which affect income elasticity of demand.
31
Outline two difficulties encountered in placing a value on measures of national income.
[4]
32
Outline four actions a government could take to reduce an adverse trade balance. [4]
107 S20039
PLEASE TURN OVER
33
You are given the following data on an economy: Consumption expenditure Taxation Investment Government Expenditure Exports Imports = 50 million + 0.8 Yd = 0.25Y = 120 million = 280 million = 150 million = 0.2Y
where Y = national income, and Yd = disposable national income. (i) (ii) (iii) Calculate the equilibrium level of national income. [2]
Calculate the current account deficit as a percentage of the national income at the equilibrium level of national income. [1] Calculate the budget deficit as a percentage of the national income at the equilibrium level of national income. [1] [Total 4]
34
You are given the following information: c = the ratio of cash held by the public to their deposits r = the banks reserve ratio (cash to deposits) where: c = 0.6 r = 0.2 (i) (ii) (iii) (iv) Calculate the value of the monetary base when the broad money supply is 600 million. [1] Calculate the value of the broad money supply when the monetary base is 200 million. [1] What would be the percentage effect on the broad money supply of an increase in the monetary base of 10%? [1]
Calculate the value of the broad money supply if the monetary base were 200 million and the banks were to reduce their reserve ratio from 0.2 to 0.1 while the proportion of deposits held by the public as cash fell to 0.5. [1] [Total 4]
107 S200310
35
(i) (ii)
Explain the difference between a fixed and a floating exchange rate regime. [2] List two advantages of fixed exchange rates and two advantages of floating exchange rates. [2] [Total 4]
36
Explain briefly: (i) (ii) the law of diminishing marginal returns diseconomies of scale [2] [2] [Total 4]
37
(i) (ii)
Discuss the conditions needed for a perfectly competitive market to exist. [10] Assess the welfare advantages of perfect competition compared with monopoly and use this to comment on the assertion that monopolies are bad for society. [10] [Total 20]
107 S200311
REPORT OF THE BOARD OF EXAMINERS

J Curtis Chairman of the Board of Examiners 11 November 2003
EXAMINATIONS
General Comments In several instances handwriting was virtually illegible. Diagrams were often drawn freehand. Clarity would have been enhanced through the simple use of a ruler. Specific comments on individual questions appear after each solution listed below.
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
D B C B C A D C D A B B C C A B A D C D B B A D C A
The overall performance of candidates for multiple choice questions was good. Some questions were answered incorrectly more frequently than others. These included questions 7, 21 and 25.
Page 3
27
(i) Output Total Cost () Ave Total Cost () 65 50 43 40 40 42 Ave Rev () 70 65 60 55 50 45 Marg Cost () 45 35 30 30 40 50 Marg Rev () 70 60 50 40 30 20
0 10 20 30 40 50 60
200 650 1000 1300 1600 2000 2500
(ii)
Profit-maximising output level = 40 units
Generally well answered. Most candidates proved able to compute the figures accurately with only minor slips. For example the fact that output steps were expressed in units of 10 caused confusion in some cases.
28
(i)
Price
MC AC P
MR
0 Q
AR
Quantity
(ii)
In the short run the firms in the industry will make a supernormal profit. In the long run the entry of competitors will result in a return to normal profits.
Part (i) was well answered. In Part (ii) some were unsure of the distinction between the short and long run.
Page 4
29
(i) (ii) (iii)
Country A Country B Yes. B will trade shoes for As computers. Explain in terms of opportunity cost and potential for mutually beneficial trade. The relative price must lie between 2 shoes per computer (the A opportunity cost) and 25 shoes per computer (the B opportunity cost).
A straightforward question. Part (iii) proved problematic for some with a limited understanding of opportunity cost.
30
(i)
(a)
% change in quantity demanded of Good X / % change in the price of Good X % change in quantity demanded of Good X / % change in the price of Good Y % change in quantity demanded of Good X / % change in income % change in quantity supplied of Good X / % change in the price of Good X
(b)
(c) (d)
(ii)
Explanations may include: the extent to which the good is preferred to possible alternatives how vital the good is to life support the proportion of consumers income spent on the good
Extremely well answered. Candidates recognised that the question drew on standard material in the Core Reading.
31
The four main difficulties alluded to in the Core Reading are: (i) Depreciation, i.e. capital consumption. This is the true reduction in the value of assets due to wear and tear. In practice estimates are difficult to make and are likely to be inaccurate. Inflation. Use of the GNP deflator to convert nominal economic activity to real economic activity. (iii) Exchange rates. It is not clear which exchange rate should be used, e.g. an average exchange rate over the year or the end year exchange rate? Net Economic Welfare.
(ii)
(iv)
Page 5
We should allow for other factors which affect economic welfare, e.g. unreported market transactions, non-marketed goods and services, externalities, leisure time. This question proved challenging. Many candidates did not get beyond a discussion of nonreported economic activities, i.e. non-traded / non-market goods etc. Some discussed measurement of national income in detail (alternative approaches) risking irrelevance.
32
(i)
Reduce the value of the currency, i.e. a devaluation. Reduces demand for imported goods and raises demand for exports. Reduce aggregate demand. Again this will lower imports and increase exports. A fairly drastic way of eliminating a balance of payments deficit. The result of lower aggregate demand may be a prolonged period of mass unemployment. Help exporters, e.g. export credit insurance, subsidies to exporters, help with marketing, improving infrastructure, encouragement (awards to exporters). Discourage imports, e.g. tariffs, quotas and persuasion.
(ii)
(iii)
(iv)
Very well answered. Again Core Reading material gave a good guide to what was required. Y = 50 + 0.8(1 0.25)Y + 120 + 280 + 150 0.2Y = 1000 million (ii) (iii) 50m/1000m * 100 = 5% 30m/1000m * 100 = 3%
33
(i)
Well answered. Calculations were straightforward and many candidates showed their workings clearly. Some marks were lost due to careless work.
34
N.B
Broad money = money multiplier x monetary base Money multiplier = (1 + c)/(r + c) 300 million 400 million a rise of 10% 500 million
(i) (ii) (iii) (iv)
Well answered. Calculations were straightforward. Some marks were lost due to careless work.
Page 6
35
(i)
A fixed exchange rate means that the government stands ready to intervene directly in the foreign exchange markets in order to maintain a fixed level of the domestic currency against a foreign currency or against an external standard of value. A floating exchange rate means that the government does not intervene directly in the foreign exchange markets. Under a floating exchange rate the foreign exchange value of the domestic currency is determined solely by supply and demand from current and capital account transactions. Advantages of fixed exchange rates: interest rates must stay at the world level and hence Keynesian Crowding Out cannot occur greater certainty, hence encourage foreign trade, allowing potential gains from trade to be realised can lead to lower inflation as a step towards a single currency may (or may not!) promote economic, political and social harmonisation
(ii)
Advantages of floating exchange rates: monetary policy can be conducted independently of other countries without the need for controls on the movement of capital a floating exchange rate will tend to move to automatically offset a balance of payments deficit or surplus (assuming that import and export demands are sufficiently elastic) there is no need for the central bank to hold large amounts of gold and foreign currencies monetary policy is more effective for controlling price rises
Well answered. Core Reading material was closely followed.
36
(i)
Law of diminishing marginal returns. A short run concept. One factor of production (often capital) is assumed fixed and another factor (often labour) is varied. Diminishing returns at the margin eventually occur as the input of the variable factor is increased. This implies that short run average and marginal cost curves will eventually slope upwards.
(ii)
Diseconomies of scale. A long run concept. All factors of production are assumed to be variable in the long run and in the presence of diseconomies of scale long run average costs rise. Even if both factors of production are increased in equal proportion output rises less than proportionately. Reasons offered for this phenomenon include, managerial diseconomies, dilution of ownership, quality of resources, and physical diseconomies of scale.
Page 7
One of the most poorly answered questions on the paper. Once again it was clear that the difference between the short run and the long run was not understood by many candidates. A large number were unable to distinguish diminishing marginal returns from diminishing marginal utility and diseconomies of scale.
37
(i)
The following five conditions are needed to ensure that each firm faces a horizontal demand curve: (a) A very large number of firms. If each firm has an infinitesimally small share of the market, an x% change in output by one firm will have (virtually) no effect on the overall level of industry output. Each firm produces exactly the same product. A price raising firm could lose all its sales. Similarly, if it dropped its price fractionally large numbers of customers might want to buy the output from that firm. Customers have perfect information. If we assume that customers have perfect information concerning the price charged by different firms, and know that all firms are producing exactly the same product, then a price raising firm may well lose all its sales. Customers act rationally. This means that, using their perfect information, customers will choose to purchase from the cheapest suppliers. Free entry and exit and firms. By assuming that there is free entry and exit of firms, collusion between firms can be ruled out.
(b)
(c)
(d)
(e)
(ii)
Under monopoly the output level is too low to maximise social welfare. So long as the demand curve (i.e. consumers valuation of each extra unit of output) exceeds the monopolists marginal cost curve (i.e. the marginal cost to society), social welfare can be increased by setting output at a higher level. Diagram: Social Cost of Monopoly
Price Social Cost MC MR DD q* q** Quantity
Page 8
There may be an additional loss if we are prepared to make value judgements about the effect of a monopolys pricing policy on social welfare. Because monopolies do not face any competition (actual or potential) they may be able to charge different prices to different groups of customers i.e. price discriminate. If it is possible for a firm to employ price discrimination it will be profitable to do so as the monopoly will be able to expand its output and increase its profits. Counterintuitively price discrimination allows the monopoly to produce the socially efficient level of output. However in the case where monopolies provide an essential service (e.g. gas, electricity, water) governments may establish regulatory agencies or fix rules to ensure that all sections of society have access to these goods or services at affordable prices. They thereby restrict the ability of monopolists to price discriminate on their own terms.
This was a straightforward question. (i) Most candidates managed simply to state the conditions needed for a perfectly competitive market to exist, but fewer demonstrated a clear understanding of each. Explanations varied quite widely in length and quality. Most candidates offered an adequate explanation of the social cost of monopoly compared to perfect competition but few developed a well structured and reasoned argument as to whether or not monopolies are bad for society.
(ii)
Page 9
EXAMINATIONS
2.
3. 4.
107
A2004
For questions 1 26 indicate in your answer booklet which one of the answers A, B, C or D is correct.
The economic problem of HOW a good shall be produced (the capital-labour mix) is solved in capitalist societies: A through the purchasing decisions made by consumers in the market place for the final good produced by means of the profit motive which prompts producers to keep their production costs to a minimum purely by comparing the cost of capital relative to the cost of labour. by the use of relatively capital intensive methods of production [1]
C D
Which one of the following will shift the supply curve for good X to the right? A B C D A decrease in labour productivity in industry X. A fall in the price of raw materials used to produce good X. An increase in real wages in industry X. A government sales tax on the production of good X. [1]
A maximum price is set for good X at 30 which happens to coincide with the free market price. An increase in the supply of good X keeping the maximum price fixed at 30 will lead to: A B C D no change in price and a surplus no change in price and a shortage a fall in price and a fall in the quantity sold a fall in price and a rise in quantity sold [1]
Good Y has a positive cross price elasticity of demand with respect to good X of 0.5 and 100 units of good Y are demanded when good X costs 20 pence. A rise in the price of good X to 30 pence will lead to a change in the demand for good Y to: A B C D 150 units 125 units 75 units 50 units [1]
107 A2004
If public transport is an inferior good, which of the following will cause its demand curve to shift to the left? A B C D A rise in the price of cars. An increase in consumers incomes. An increase in the price of petrol. An increase in the price charged to use public transport. [1]
You have the following data on the price of good X and the quantity sold of good X. If the market price is set at 12 what is the total value of consumer surplus? Price of good X 15 14 13 12 11 A B C D 48 4 5 6 Quantity of good X sold 1 2 3 4 5
[1]
Which one of the following is NOT a characteristic of a normal good? A B C It has a positive income elasticity of demand. A price fall will lead to an increase in demand. The substitution and income effects of a price change work in opposite directions. The substitution effect of a price rise works to reduce demand for the good. [1]
Which one of the following characteristics applies to an oligopolistic market structure? A B C D There is a large number of firms. The absence of barriers to entry into the market. Demand is infinitely price elastic. The output decisions of one firm may exert a significant influence on other firms in the industry. [1]
107 A2004
PLEASE TURN OVER
The kinked demand curve model of oligopoly is based upon the assumption that: A B C D a firm s competitors match both its price increases and price reductions one firm in the industry sets the price for all other firms a firm s competitors match its price reductions but not its price increases the price charged by the firm can either rise or fall depending on what happens to its competitors prices [1]
10
Which one of the following is NOT a feature of perfect competition? A B C D In the long run firms make only normal profits. Price is equal to marginal cost. Price is equal to average revenue. Firms can unilaterally raise their price without losing all their customers. [1]
11
A profit maximising monopoly facing a linear demand schedule and with zero marginal costs will set his price in the region of the demand curve where the absolute price elasticity of demand is: A B C D greater than unity but finite equal to zero between zero and unity unity [1]
12
A managing director of a monopoly firm with constant marginal costs has the following data: Average revenue Marginal revenue Marginal cost Average variable cost Average total cost = 14 = 10 = 8 = 8 = 12
To maximise profits/minimise losses in the short run the firm should: A B C D reduce price and increase output reduce price and reduce output increase price and increase output close down [1]
107 A2004
13
Which one of the following is TRUE? A The long run average total cost curve passes through the minimum point of all the short run average total cost curves. The minimum efficient scale is the point at which long run average costs must begin to fall. In the long run a firm cannot alter its fixed costs of production. If a firm trebles all its inputs and its output doubles then this is indicative of diseconomies of scale. [1]
C D
14
The following transactions take place in a simple closed economy. A company producing good X sells its output for 1 million. In producing good X the company buys raw materials for 400,000, uses 100,000 worth of electricity and depreciates capital equipment to the value of 200,000. What is the contribution of the company to the country's Gross Domestic Product? A B C D 600,000 500,000 400,000 300,000
[1]
15
In an open economy with a government sector, which one of the following conditions will ensure an equilibrium level of output in the Keynesian model? Where: C = planned consumption, S = planned savings, I = planned investment, T = taxation, G = government expenditure, B = transfer payments, M = import expenditure, X = export receipts. A B C D S+T+M=I+G+B+X S+T+M =I+C+B+X S=I none of the above
[1]
107 A2004
PLEASE TURN OVER
16
In a simple closed economy with no government sector the consumption function relating consumption (C) to national income (Y) is given by the expression: C = 20 million + 0.8Y Planned investment is constant at 50 million. Which one of the following is TRUE? A B The multiplier has a value of 4. An increase in the level of national income will raise the average propensity to consume. The economy is in equilibrium when national income is 300 million. None of the above. [1]
C D
17
In a simple closed economy with no government sector which one of the following statements about the consumption function is TRUE? A The consumption function describes the relationship between aggregate consumption and the price level. The consumption function describes all equilibrium levels of income where planned savings and planned investment are equal. The consumption function has a slope equal to the average propensity to consume. The consumption function has a slope equal to the marginal propensity to consume. [1]
18
One way of reducing the natural level of unemployment would be to increase: A B C D unemployment benefit government consumption expenditure information on job availability the money supply [1]
107 A2004
19
If an increase in the level of the money supply results in no change in either the nominal or real value of national income, then which of the following is TRUE? A B C Interest rates must have risen. The velocity of circulation must have fallen. The price level must have risen by the same proportion as the increase in the money supply. Taxes must have risen. [1]
20
Assuming all other variables remain constant, a decrease in the average price level will result in a: A B C D fall in the real interest rate fall in the nominal wage rate rise in the real wage rate rise in the nominal interest rate [1]
21
The following table contains output and expenditure data for an economy. billions Consumption (at market prices) Investment (at market prices) Government spending (at market prices) Net Exports (at market prices) Net Property income from abroad Taxes on production 260 70 85 5 5 60
Gross Domestic Product at market prices and Gross National Product at factor cost are respectively: A B C D 415, 420 410, 355 415, 355 410, 415
[1]
22
If nominal Gross National Product (GNP) per capita is 10,000 and the GNP deflator (base year 100) is 250 then real GNP per capita is: A B C D 7,500 2,500 4,000 12,500 [1]
107 A2004
PLEASE TURN OVER
23
Which one of the following statements about real variables in the economy is FALSE? A Real interest rates are negative if the anticipated rate of inflation exceeds the nominal rate of interest. If all else is constant, a rise in money wages is also a rise in real wages. An increase in real income will lead to a reduced demand for real money balances. None of the above. [1]
B C
24
Which of the following is a possible explanation for an increase in the average price level and a decrease in real national income? A B C D An increase in short run aggregate supply. A decrease in short run aggregate supply. An increase in aggregate demand. A decrease in aggregate demand. [1]
25
Which one of the following is most likely to be the best method of reducing long term structural unemployment? A B C D Expansionary fiscal policy. Expansionary monetary policy. A reduction in trade union powers. Better education and training.
[1]
26
Which one of the following is NOT likely to lead to cost push inflation? A B C D An increase in trade union powers. An appreciation of the domestic currency s exchange rate. An increased budget deficit which causes interest rates to rise. An increase in the profit margins applied by firms. [1]
107 A2004
27 28
List FOUR factors that increase the price elasticity of demand for a product.
[4]
Consider the following data for a perfectly competitive firm, where the market price for the commodity is 30: Output per week 0 1 2 3 4 5 6 7 (i) Total Cost ( s) 5 45 78 99 114 132 162 210
Construct a table showing the marginal cost and average variable cost at each level of output. [2] State the profit maximising level of output of the firm. Calculate the profit at the profit maximising level of output. [1] [1] [Total 4]
(ii) (iii)
29
(i)
Explain the difference between the law of diminishing returns and the law of diminishing marginal utility. [2] Draw a marginal product curve for good X that you would expect from the laws of increasing and diminishing returns. Clearly indicate on the curve a region of negative marginal product. [1] Draw a marginal utility curve for good X that you would expect from the law of diminishing marginal utility. Indicate on the curve a region of negative marginal utility. [1] [Total 4]
(ii)
(iii)
30
Draw a diagram showing a profit maximising monopolist making supernormal profit at its profit maximising output. Ensure that the firm has constant average costs at all levels of output. Make sure that you include the following curves with the labels as in the parentheses: marginal revenue (MR), average revenue (AR), marginal cost (MC) and average cost (AC). Mark the price P1, quantity Q1 and average cost C1. [4]
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31
Discuss the key factor that distinguishes monopolistic competition from perfect competition and the implications for the demand curve facing the individual firm in each market structure. [4]
32
Explain the meaning of the following words when used in economics. (i) (ii) (iii) resources scarce allocation [2] [1] [2] [Total 5]
33
Explain how the introduction of the following controls will affect prices, quantity supplied and quantity demanded, and whether the outcome will be a surplus or a shortage of goods supplied. (i) (ii) A price ceiling set below the free market price. A price floor set above the free market price. [2] [2] [Total 4]
34
(i) (ii)
Define economies of scale and diseconomies of scale . List FOUR reasons for economies of scale.
[2] [2] [Total 4]
35
(i)
Using the IS-LM diagram explain the effects of a contractionary open market operation on the money supply, the short term rate of interest and the level of national income. [2] Using the IS-LM diagram explain the effects of an expansionary fiscal policy financed by bond sales on the money supply, the long term rate of interest and the level of national income. [2] [Total 4]
(ii)
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36
You are given the following data on Country A s international transactions for the year 2003 with the rest of the world (ROW): millions Exports of goods and services Imports of goods and services Interest, Profits, Dividends received from ROW Interest, Profits and Dividends paid to ROW Unilateral receipts from ROW Unilateral payments to ROW Capital inflows from ROW Capital outflows to ROW Statistical error Increase in official reserves (i) 180 150 30 50 20 40 80 40 ? 25
Calculate the current account balance indicating whether it is in surplus(+) or deficit( ). [1] Calculate the statistical error indicating whether it is positive(+) or negative( ).
(ii)
[1]
(iii)
State whether the increase in official reserves indicates that the Central Bank has been buying or selling (a) foreign currency (b) sterling, in the foreign exchange market. [1] State with reasons whether or not it is possible to calculate the trade balance amounts from the above set of figures. [1] [Total 4]
(iv)
37
(i)
Discuss the view that the best way for a country to tackle a current account deficit is to devalue its currency. In your answer, discuss what other macroeconomic policy measures may be used to reduce a current account deficit. [10] Discuss the possible advantages that adherence to a fixed exchange rate regime may have over a floating exchange rate regime. [10] [Total 20]
(ii)
END OF PAPER
107 A2004
11
EXAMINATIONS
April 2004 Subject 107 Economics
EXAMINERS REPORT
Subject 107 (Economics)
April 2004
Examiners Report
General comment There were a few instances where the candidates answers to some questions were totally illegible - accordingly it was impossible to award any marks in these instances. The overall standard was generally good with many candidates exhibiting high marks.
Multiple choice Section Generally well answered although questions 3,6,11,13,19,23 and 24 caused most problems for candidates.
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
B B D B B D C D C D D A D B A D D C B C B C C B D B
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27
(1) (2) (3) (4) (5) (6) (7)
An increase in the number of close substitutes. An increase in the proportion of the consumer s income spent on the good. A reduction in the degree of necessity of the good. An increase in the time period under consideration. A reduction in the volatility of the price of the product. A reduction in the brand loyalty for the product. Other relevant factors correctly described.
References to broadness of product description tended to be confused. Many people stated the general factors, but not which way in it should move to increase elasticity.
28
(i) Output per week 0 1 2 3 4 5 6 7 (ii) (iii) 5 or 6 units 18 Total Cost ( s) 5 45 78 99 114 132 162 210 Marginal Cost ( s) Average Variable Cost ( s)
40 33 21 15 18 30 48
40 36.5 31.33 27.25 25.4 26.16 29.28
Entries for marginal cost were frequently wrong.
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29
(i)
The law of diminishing returns applies to the short run production process. It states that as you add increasing amounts of a variable factor of production to a given amount of a fixed factor of production then after a certain point the marginal product of the variable factors will decline. By contrast the law of diminishing marginal utility applies to consumption. It states that as a consumer consumes increasing amounts of a given product then the marginal utility derived from the product will decline.
(ii) Marginal product of Good X
Negative marginal product
Quantity of variable factor e.g. labour
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(iii) Marginal utility of Good X
Negative marginal utility
Quantity of Good X consumed
In part (i) the short run (or capital factors fixed) was rarely mentioned; relatively few candidates correctly charted the marginal amounts. Some candidates confused marginal product and total product. Parts (ii) and (iii) were poorly answered with a significant number of candidates labelling the axes incorrectly.
30
Price/cost
P1
C1
MC=AC
MR Q1
AR output
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Despite using a constant Average Cost line, many candidates incorporated an increasing Marginal Cost curve. Some candidates did not label axes and curves as requested in the question.
31
The key factor that distinguishes monopolistic competition from perfect competition is that under monopolistic competition the firms sell similar but differentiated products whereas under perfect competition all the firms sell identical products. This means that firms under monopolistic competition have some pricing power (e.g. brand loyalty) and can raise their price without losing all their customers. The firm faces a downward sloping demand curve for its product. Under perfect competition since firms are selling identical products they have no pricing power and are price takers . Each firm therefore faces a horizontal demand curve for its product.
Generally well answered - some candidates failed to bring out product differentiation.
32
(i)
In economics resources are divided into three broad types. Land: All natural resources Labour: All human effort Capital: All man-made resources used in production. Sometimes entrepreneurs (i.e. people who own business) is added to this list.
(ii)
A resource is scarce if there would not be enough of it to satisfy all the people who would want to make use of it if it had a zero price. Allocation refers to how resources are used. There are three main allocation questions: Which goods and services should be produced? How should the goods and services be produced? Who should consume the goods and services which have been produced?
(iii)
Generally well answered - many simply stated the elements in (i) and few candidates mentioned entrepreneurial resource. Part (ii) was very well answered and part (iii) was also generally well answered.
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33
(i)
Price will be reduced, quantity supplied will fall, quantity demanded will rise. There will be a shortage.
(ii)
Price will be increased, quantity supplied will rise, quantity demanded will fall. There will be a surplus.
Many used diagrams but failed to state the effects on all the factors specified in the question. Some candidates failed to answer the question by explaining explicitly what would happen to prices, quantity demanded and supplied.
34
(i)
Economies of scale refer to the situation where long run average costs fall as output is increased. Diseconomies of scale refer to the situation where long run average costs rise as output is increased. The four reasons might include: Indivisibilities Specialisation Physical economies Finance Bulk purchases By-products The principle of multiples
(ii)
Generally well answered. However many candidates did not the mention long run. There was some confusion between average costs and total costs, and also confusion between diseconomies of scale and diminishing marginal returns. Part (ii) was very well answered.
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35
(i)
With a contractionary open market operation the Central Bank will sell Treasury bills in exchange for money. The result is that the price of treasury bills falls, the short term rate of interest rises and the rise in interest rates will reduce investment and consumption so lowering the level of national income. This is depicted in the diagram below with the reduction in the money supply shifting the LM curve to the left from LM1 to LM2, the interest rate rising from r1 to r2 and the level of national income falling from Y1 to Y2. LM2 LM1 r2 r1
rate of interest
IS1 Y2 Y1 national income
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(ii)
With an expansionary fiscal policy financed by the sale of bonds, the government sells bonds and uses the proceeds raised to finance increased government expenditure. The effect on the money supply should be zero as the money raised from the bond sales is spent by the government, however, the increase in the supply of bonds for sale pushes down bond prices and raises the interest rate. There is a multiplier effect associated with the increase in government expenditure which is only partially offset by the effect of rising interest rates on consumption and investment so there is a net increase in the level of national income. This is depicted in the diagram below with the increase in government expenditure shifting the IS curve to the right from IS1 to IS2 and the interest rate rising from r1 to r2 and the level of national income rising from Y1 to Y2.
rate of interest r2 r1
LM1
IS2 IS1 Y1 Y2 national income
Part (i) was better answered than part (ii). Few mentioned the money supply in part (ii) despite question specifically for this.
36
(i) (ii) (iii)
Deficit 10 million minus 5 million The increase in official reserves indicates that the Central Bank has been buying foreign currency and selling sterling in the foreign exchange market. It is not possible to calculate the trade balance as this is the balance of exports in goods minus imports of goods only. The above figures are for both goods and services and we need to know the value of the services component before we can calculate the trade balance.
(iv)
Generally well answered. Although part (iv) was not particularly well answered.
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37
(i)
There is no easy way to tackle a current account deficit. A current account deficit means that a country s expenditure on goods/services from the rest of the world is greater than its revenues received from exports of goods/services from the rest of the world. Devaluation is certainly a useful tool in the medium to long term in helping to correct a current account deficit. This is because a devaluation makes exports more competitive as measured in the foreign currency and imports more expensive as measured in the domestic currency. According to the Marshall Lerner condition provided the sum of the elasticity of demand for exports and imports is greater than unity then a devaluation will improve the current account. In the short run, devaluation is less likely to be effective in correcting a current account deficit since elasticities of demand for imports and exports are lower in the short run. Imports cost more in the domestic currency while import volumes do not decline sufficiently and exports earn less with exports not increasing sufficiently. Indeed, empirical evidence tends to suggest that the elasticities of demand for imports and exports in the short run are so low that the current account initially deteriorates. The idea of an initial deterioration in the current account followed by a subsequent improvement is known as the Jcurve effect depicted in the figure below: The J-curve
current account surplus
0 Time
current account deficit One major problem with devaluation is that by making imports more expensive it could spark off wage and price pressures which to some extent will undermine the increased competitiveness one might otherwise have expected. In addition, the effectiveness of devaluation will be undermined if other trading competitors devalue their currencies so as maintain their international competitiveness.
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There are other means that a government can use than devaluation to correct a current account deficit. These include tighter fiscal and monetary policies. The current account which ignoring transfers is given by exports minus imports (X M) has its counterpart in either domestic investment (I) being greater than domestic savings (S) and/or government expenditure on goods and services (G) exceeding tax revenue (T) as given by the equation below: (X M ) = (S I ) + (T G)
Introducing a tighter monetary policy by raising the domestic interest rate will discourage consumption (encourage savings) and reduce investment so helping to improve the first bracketed expression on the right hand side. Tighter fiscal policy in the form of a rise in taxes or cut in government expenditure will reduce national income and with it expenditure on imports also helping to improve the current account. Devaluation is by no means the only mechanism for improving the current account and its relative effectiveness as compared to fiscal and monetary policies will depend upon the structural parameters of the particular economy under consideration. However, there can be little doubt that a combination of devaluation supported by tighter fiscal and monetary policies will be the most effective means of tackling a current account deficit although this may have adverse consequences for employment and output.
(ii)
There are numerous potential advantages that fixed exchange rates may have over floating exchange rates. (a) Reduction in exchange rate uncertainty fixed exchange rates provide a degree of stability that may not be present under floating exchange rates. As such they help to promote trade and investment. Discipline for economic policy provided the currency is pegged to a low inflation currency then it will provide a degree of discipline for economic policy that may not be present if the country has a floating exchange rate. The need to keep its inflation rate in line with a low inflation currency will mean the authorities will have to conduct prudent fiscal and monetary policies. Fixed exchange rates promote international policy cooperation the need to maintain fixed exchange rates means that the countries involved in the arrangement need to coordinate their macroeconomic policies and this may lead to better economic policies than under floating exchange rates where the need to coordinate is less. Fixed exchange rates reduce the dangers of destabilising exchange rate speculation, which can lead to misaligned exchange rates under floating. It is sometimes claimed that floating exchange rates can be characterized by bouts of destabilizing speculation which moves exchange rates out of line with economic fundamentals which then
(b)
(c)
(d)
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causes harm to the real economy and such misalignments can be reduced by fixed exchange rates. (e) Fixed exchange rates reduce the need to engage in hedging activity. Under fixed exchange rates the greater certainty about the future spot exchange rate means that there is less need for businesses to engage in costly hedging of foreign exchange risk. By contrast, the greater uncertainty that exists under floating exchange rates requires businesses to engage in greater hedging activity.
The Essay questions were the least well answered part of the examination with many candidates writing insufficient quantity and quality. Part (i) few mentioned the 'J' curve effect and distinguished between short and long run effects of a devaluation. Reducing aggregate demand was not given sufficient emphasis by a significant minority of candidates. In part (ii) many candidates found it difficult to stick to the advantages as the question asked. Candidates need to stick to the question asked and not just talk about fixed and floating exchange rate regimes in a general way.
END OF REPORT
Page 12
EXAMINATIONS
2.
3. 4.
107
S2004
For questions 1 26 indicate in your answer booklet which one of the answers A, B, C or D is correct.
The problem of scarcity in economics: A B C D exists only in economies which rely on the market mechanism could be eliminated if we force prices to fall means that there are shortages of some goods exists because there are insufficient resources to satisfy human wants [1]
Which of the following would NOT cause an increase in demand for a normal good? A B C D An increase in income. An increase in the price of a substitute. A decrease in the price of a substitute. A decrease in the price of a complement. [1]
Revenues from the sale of a good will decrease if: A B C D income increases and the good is normal its price rises and demand is elastic its price rises and demand is inelastic income falls and the good is inferior [1]
The price elasticity of demand for a product is 3. A reduction in price from 30 pence to 29 pence will result in an increase in demand of: A B C D 3.0% 3.3% 6.0% 10.0% [1]
If the cross elasticity of demand between goods X and Y is positive then: A B C D X and Y are complements X and Y are substitutes the demand for X and Y are both price elastic the demand for X and Y are both price inelastic [1]
107 S2004
The problem of moral hazard: A describes the situation in which those who know they are particularly bad risks are more inclined to take out insurance than those who know they are good risks reduces the cost of insurance for low risk people describes the situation in which those with insurance act in a way which makes the insured event more likely reduces the cost of insurance for high risk people [1]
B C
A firm s marginal product of labour is positive but diminishing. In the short run, the employment of additional units of labour will cause: A B C D total product to fall at an increasing rate total product to fall at a decreasing rate total product to rise at an increasing rate total product to rise at a decreasing rate [1]
If the price of a fixed factor of production increases by 50%, what effect would this have on the marginal costs facing a firm? A B C D Marginal costs would increase by 50%. Marginal costs would increase by less than 50%. Marginal costs would increase by more than 50%. No effect. [1]
Which of the following DOES NOT describe both perfect competition and monopolistic competition? A B C D Each firm produces an identical product. Normal profits are made in the long run. The demand curve for the industry as a whole slopes down. Free entry and exit of firms. [1]
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10
Which of the following is NOT a barrier to entry in oligopoly? A B C D Product proliferation. Investment in spare capacity. Constant returns to scale. High advertising expenditure. [1]
11
Which of the following taxes is indirect? A B C D A tax on expenditure. A tax on earned income. A tax on investment income. A tax on rent received. [1]
12
If a profit maximising firm s marginal revenue is less than its marginal cost, the firm: A B C D must be experiencing economic losses must be making supernormal profits should decrease its output should increase its output [1]
13
A firm with fixed costs of 100 per week and a constant average variable cost of 3 per unit of output, has the following information about its weekly sales. Quantity 30 40 50 60 Total Revenue 240 280 300 310
Which of the following quantities of sales per week produces the highest level of profits? A B C D 30 units. 40 units. 50 units. 60 units. [1]
107 S2004
14
Net National Product is defined as Gross National Product minus: A B C D taxes transfer payments depreciation retained corporate earnings [1]
15
Which of the following is an example of an injection into the circular flow of income? A B C D Investment Saving Taxation Imports [1]
16
Which of the following factors helps explain why the aggregate demand curve has a negative slope? As the price level falls: A domestic consumers have an incentive to purchase more of the cheaper goods and services the central bank will have to increase the supply of money which will lead to an increase in the amount purchased the government will have to reduce taxes which will lead to an increase in the amount purchased the real balances of people holding a fixed quantity of money increases causing them to expand their purchases [1]
17
If a household s disposable income increases from 15,000 to 20,000 and as a result its consumption increases from 12,000 to 15,000, what is the household s marginal propensity to consume? A B C D 0.8 0.75 0.7 0.6 [1]
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18
The economy cannot stay at a level of real national income above long-run aggregate supply because wages will: A B C D fall, thus shifting the long-run aggregate supply curve rightward fall, thus shifting the short-run aggregate supply curve rightward rise, thus shifting the long-run aggregate supply curve leftward rise, thus shifting the short-run aggregate supply curve leftward [1]
19
Crowding out describes the: A extent to which government expansionary policy is counteracted by lower private spending resulting from higher interest rates extent to which government contractionary policy is counteracted by lower private spending resulting from higher interest rates increase in interest rates caused by contractionary monetary policy increase in consumption expenditure caused by lower taxes [1]
C D
20
The higher the reserve requirements for commercial banks: A B C D the higher the money multiplier the lower the money multiplier the larger the amount of total deposits that can be created from a new deposit the larger the amount of total money that can be created from a withdrawal [1]
21
Money that is held because of possible unforeseen events is held because of the: A B C D speculative motive for holding money transactions motive for holding money precautionary motive for holding money asset motive for holding money [1]
107 S2004
22
Purchasing Power Parity is the principle that: A the exchange rate adjusts to equate the standard of living in the trading countries the exchange rate adjusts to offset differences in inflation rates between countries the exchange rate adjusts to equate currency values relative to gold the exchange rates between currencies are fixed [1]
C D
23
If the hourly production of good X and good Y by individuals A and B is as follows: Good X Individual A Individual B A B C D 10 40 Good Y 50 800
B has a comparative advantage in producing X and Y B has a comparative advantage in producing X A has a comparative advantage in producing X A has a comparative advantage in producing X and Y [1]
24
Under a fixed exchange rate system the following approaches might be considered by governments to correct a balance of payments deficit. I II III Discouragement of imports. Support for exporters. Increase the level of aggregate demand.
Which of the following is most likely to achieve this objective? A B C D I only. II only. I and II only. I, II and III. [1]
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25
If unemployment is above the natural level, the long run Phillips curve would suggest that, other things remaining the same, real wages would: A B C D fall and unemployment would rise fall and unemployment would fall rise and unemployment would fall rise and unemployment would rise [1]
26
Which of the following is best suited to reducing the level of structural unemployment? A B Provision of government funds for retraining the unemployed. Providing higher voluntary redundancy payments for those in declining industries. Increasing general government fiscal expenditure. Raising unemployment benefit. [1]
C D
27
(i)
A firm, operating in a perfectly competitive market, sells goods for 10 per unit (the market price). The wage rate for workers is 70 each per day. As more workers are employed, the output of the firm increases as shown in the table below: Number of Workers 0 1 2 3 4 5 6 Output per Day 0 24 44 59 67 73 77
Construct a table to show at each level of employment (i.e. for each number of workers) the firm s (a) (b) (c) average product of labour per day marginal product of labour per day marginal revenue product of labour per day [3] (ii) State the profit maximising level of employment. [1] [Total 4]
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28
(i)
Draw a diagram to show the profit maximising price and output of a firm with a kinked demand curve in an oligopoly market. The curves in the diagram should be labelled: MR for marginal revenue, AR for average revenue, MC for marginal cost. Price and quantity should be labelled P1 and Q1 respectively. [3] Explain why the demand curve is kinked. [2] [Total 5]
(ii)
29
(i)
Define the following: (a) (b) the IS curve the LM curve [2]
(ii)
Using an IS/LM diagram, describe the effect of an increase in government expenditure (fiscal expansion) on the equilibrium values of the rate of interest and national income. [2] [Total 4]
30
(i) (ii)
Explain two potential problems caused by unanticipated inflation. Explain four potential problems caused by anticipated inflation.
[2] [2] [Total 4]
31
(i)
In each of the following cases calculate the value of the multiplier assuming that the components of aggregate demand are exogenous and that there are no direct taxes. (a) (b) The marginal propensity to save is 0.4. The marginal propensity to consume is 0.75. [2]
(ii)
Explain how direct taxes which are proportional to income will affect the value of the multiplier. [2] [Total 4]
32
(i) (ii)
Explain the meaning of the term economic growth . Outline the factors which may lead to economic growth.
[1] [3] [Total 4]
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33
Using a Phillips curve diagram, illustrate how a reduction in the rate of growth of money supply may lead to a reduction in the rate of inflation. Use the labels LRPC and SRPC for long run and short run Phillips curves respectively. [4]
34
Use the following data for a hypothetical Keynesian economy to answer the questions below. Consumption expenditure is 425 million plus 80% of disposable national income. The tax rate is 15% of national income. Investment expenditure is 265 million. Government expenditure is 210 million. Export expenditure is 230 million. Imports are 10% of national income. (i) Calculate the level of consumption expenditure when GDP is 2400 million. [1] Calculate the surplus or deficit on the balance of trade when GDP is 2400 million. [1] Calculate the equilibrium level of GDP. [2] [Total 4]
(ii)
(iii)
35
(i) (ii)
Outline the economic benefits which arise from international trade. Explain the expression the terms of trade .
[2] [2] [Total 4]
36
(i)
Describe the relationship between the marginal productivity of labour and short run marginal costs. [2] Describe the relationship between average long run costs of production and (a) (b) economies of scale diseconomies of scale [2] [Total 4]
(ii)
37
(i)
Describe an indifference curve and discuss briefly the assumptions which underpin indifference curve analysis. [5] Use indifference curve analysis to explain the effect of a price change on the demand for a normal good and a Giffen good. [15] [Total 20]
(ii)
END OF PAPER
107 S2004
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September 2004
Examiners Report
EXAMINATIONS
September 2004 Subject 107 Economics
EXAMINERS REPORT
September 2004
Examiners Report
Q1-26 Multiple Choice The overall performance of candidates for multiple choice questions was good. Some questions were answered incorrectly more frequently than others. These included questions 16, 18 and 23 (where answer b was the most frequent error). Q27 Generally well answered. There were minor slips in the construction of the table and some confusion between revenue and profit when calculating the marginal revenue product of labour. Q28 In some cases the diagram was poorly drawn and therefore unclear. In part (ii) many candidates failed to mention elasticity in their answer. Q29 Although straightforward, Part (i) was rather poorly answered. In Part (ii) many candidates wrote essay length answers (generally of a high standard) to a part of the question worth only 2 marks. Q30 In some cases there was basic confusion between anticipated and unanticipated inflation. Some candidates listed rather than explained . The length of the answers varied considerably and it should be noted that only 2 marks were allocated to each part. Q31 Generally well answered. In part (ii) some candidates only gave a formula for the multiplier without a full answer to the question. Q32 Most candidates organised their answer around a discussion of GDP or GNP, however some failed to distinguish between nominal and real measures. Q33 Although diagrams showing the adjustment loop were reproduced accurately in many cases, candidates were less able to explain the mechanism by which a reduction in the rate of growth of money supply may lead to a reduction in the rate of inflation. Q34 Well answered. Calculations were straightforward. Some marks were lost due to careless work.
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Q35 Part (i) was generally well answered. In part (ii) some candidates incorrectly identified the terms of trade with the trade balance. Others argued that it was a contract drawn up by two countries listing the terms under which they would trade. Q36 One of the more poorly answered questions on the paper. It was clear that the difference between the short run and the long run was not understood by many candidates. There was little understanding of how marginal product would go down and marginal cost up. Q37 The essay question was straightforward. (i) Surprisingly the quality of answers in this part of the question varied greatly in terms of the definitions and number of assumptions discussed. In particular diminishing marginal rate of substitution was not well handled. The most common pitfalls included, trying to explain both cases using one diagram (which was unclear and confusing) and the omission of a discussion of income and substitution effects. The most ambitious sought to analyse the effect of a price change considering both a price increase and a price decrease. This was unnecessary.
(ii)
General Comments This was a straightforward paper. In several instances handwriting was virtually illegible. Diagrams were often drawn freehand. Clarity would have been enhanced through the simple use of a ruler.
September 2004
Examiners Report
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
D C B D B C D D A C A C B C A D D D A B C B C C B A
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27
(i) No. of Workers 0 1 2 3 4 5 6 APL MPL MRP 0 240 200 150 80 60 40
24 22 19.7 16.8 14.6 12.8
24 20 15 8 6 4
(ii)
4 workers
28
(i)
Kinked demand curve model of Oligopoly MC
Price
P1
MR 0 Q1
AR Quantity
September 2004
Examiners Report
(ii)
The demand curve is kinked at the current price because the demand curve is more elastic above the current price and more inelastic below. If an oligopolist cuts its price, rivals will follow suit. If an oligopolist raises its price rivals will not follow.
29
(i)
(a)
The IS curve shows combinations of interest rates and national income at which investment demand will equal savings. The LM curve shows combinations of interest rates and national income for which the demand for liquidity equals the supply of money.
(b)
(ii)
R R2 R1
LM
IS2 IS1 0 Y1 Y2 Y
The increase in government expenditure will move the IS curve to the right (IS1 to IS2) and result in an increase in national income (Y1 to Y2) and the rate of interest (R1 to R2).
30
(i)
The potential problems caused by unanticipated inflation are: Unintended and arbitrary redistribution of wealth from lenders (typically the elderly) to borrowers (typically the young) when inflation is unexpectedly high. Lenders may require a higher real rate of interest to compensate them for the risk of unexpected inflation. This is sometimes called inflation risk premium .
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People who are due to receive money under any type of fixed price contract or pension arrangement will lose out if inflation is unexpectedly high.
(ii)
The potential problems caused by anticipated inflation are: Money illusion mistake a difference in prices caused by inflation for a real difference in price. Menu costs prices. scarce resources are wasted purely to cope with changes in
Shoe-leather costs more frequent financial transactions so that more resources are required in the financial services industry; less cash is held which may result in missed opportunities. High inflation would be a problem if there was a desire to maintain the value of the currency. The possibility of leading to a situation of hyper-inflation.
31
(i)
(a) (b)
2.5 4
(ii)
The introduction of a proportional tax on income will give a further leakage from consumer expenditure as national income rises. This will reduce the marginal propensity to consume out of national income and the value of the multiplier will fall.
September 2004
Examiners Report
32
(i)
The term economic growth is used to refer to increases in real GNP or GDP. Sometimes, economists will consider GNP (or GDP) per capita, so that economic growth can be used to refer to real growth in GNP per person. Economists explain economic growth in terms of increases in the quantity and productivity of the following factors used in production: Capital man-made resources. Labour all human effort. Land all natural resources Technical knowledge invention and innovation
(ii)
33
Inflation Rate
LRPC
10% 5%
A D B
SRPC2
C 0
SRPC1
U1 Unemployment Rate
Starting at point A with LRPC and SRPC2 the natural level of unemployment is U1 and the rate of money supply growth is 10%pa. Thus actual and expected price and wage inflation are all 10% pa as well. If the government cuts the rate of growth of the nominal money supply to say 5% but inflation remains at a higher level the real money supply will contract. This causes interest rates to rise. Private sector investment and consumption will fall leading to higher unemployment. The economy will move right from A to B down the SRPC2 curve and unemployment will rise. If the government continues to expand money supply at only 5% workers will eventually come to expect 5% inflation in the long run and the economy will move onto SRPC1 at point C. Wage inflation will be a little lower than 5% and so the real money supply is expanding, eventually taking the economy back to LRPC at point D as interest rates and thus unemployment fall.
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34
(i)
C = 425 + 0.8(2400 C = 2057
0.15(2400))
(ii)
Exports = 230 million Imports = 0.1(2400) = 240 million Balance = 10 million (deficit)
(iii)
Y = 425 + 0.8 (Y 0.15(Y)) + 265 + 210 + 230 Y = 1130 + 0.58 (Y) Y = 2690 million
0.1(Y)
35
(i)
International trade allows the world's resources to be used in a more economically efficient way. In particular, the existence of world trade: Allows countries to specialise in the production of the goods which they can produce relatively more efficiently than other countries. Increases the scope for benefits from economies of scale by increasing the size of the available markets. Increases the range of goods and services which consumers can buy. Leads to lower prices through increased competition which benefits consumers rather than producers.
(ii)
The terms of trade for a country is the quantity of domestically produced goods that have to be sacrificed in order to obtain a unit of imported goods. In other words, the terms of trade is the opportunity cost of imported goods in terms of the goods that have to be exported to pay for imports.
September 2004
Examiners Report
36
(i)
Since capital is fixed in the short run, the amount of capital available to each worker declines as more workers are employed. Consequently diminishing marginal productivity will eventually arise. If we assume that labour is the only variable input, there is a direct inverse relationship between the marginal productivity of labour and short run marginal costs. As more labour is employed to increase output, marginal productivity of labour will eventually fall and short run marginal costs will rise. (a) Economies of scale refer to the situation where long run average costs fall as output is increased. This will be the case when an increase in all inputs gives a greater than proportional increase in outputs. This can only happen in the long run when all factor inputs are variable. Diseconomies of scale refer to the situation when long run average costs rise as output is increased. This is often explained by the problem of efficiently managing large companies.
(ii)
(b)
37
(i)
An indifference curve joins all the two good consumption bundles of equal utility. The slope of an indifference curve will depend on the consumer s preferences and is equal to the marginal rate of substitution, (the amount of one good that the consumer is prepared to swop for one extra unit of another good). The key assumptions are: A consumer can rank any two bundles and can therefore pick a set of consumption bundles that give the same utility. Consumers prefer more of a good to less of it therefore indifference curves slope downwards from left to right and indifference curves further from the origin give higher utility. Consumer preferences exhibit diminishing marginal rates of substitution and are convex to the origin.
(ii)
In answering the question an understanding of the substitution and income effects of a price change is necessary. The substitution effect of the price change is the change in demand for the good caused by the change in relative prices, holding the level of utility (or real income) of consumers constant. The substitution effect of a price change is always negative, it is the opposite direction to the change in price. The income effect of the price change is the change in demand for the good caused by the change in the real income of consumers. It can either be negative (when it is in the opposite direction from the change in price and the good is a normal good), or positive (when it is in the same direction as the change in price and the good is an inferior good or Giffen good).
Page 11
September 2004
Examiners Report
The examples below relate to example where a consumer has a choice between bundles of good X and Y. Normal Good: Consider the case where good Y is a normal good. If the price of good Y falls and the price of good X remains the same the budget line will pivot out from ab1 to ab2. The consumption point changes from A1B1 to A2B2. For a normal good the income and substitution effects will both be negative, (demand will change in the opposite direction to the price change), and reinforce each other. They both involve an increase in the quantity demanded as price falls.
Good X a
A2 A1 I2 I1
B1
B2
b1
b2 Good Y
September 2004
Examiners Report
Giffen Good: Consider the case where good Y is a Giffen good and the price of good Y falls. In terms of the indifference curve diagram the budget line pivots from ab1 to ab2. In the case of a Giffen Good the positive income effect, which reduces demand as price falls, is strong enough to exceed the negative substitution effect, which increases demand as price falls. The overall effect of the fall in the price of good Y is to decrease the quantity of good Y demanded. Before the price fall consumption of good X was A1 and good Y was B1. After the price falls consumption is A2 and B2 for goods X and Y respectively.
Good X a
A2 A1
I2
I1
B2
B1
b1
b2 Good Y
In both cases the diagrams can be used to separate out the income and substitution effects of the price fall. This is achieved by drawing a hypothetical budget line, which has the slope of the new budget line and is tangential to the old indifference curve. The movement along the old indifference curve from the old consumption bundle to the intermediate bundle with the same utility is the substitution effect. The income effect is the change from the intermediate bundle on the old indifference curve to the point where the new budget line is tangential to the new indifference curve.
END OF EXAMINERS REPORT
Page 13

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(i) (ii) (iii) (iv)

Faculty of Actuaries Institute of Actuaries

Subject 107 (Economics) April 2000 Examiners Report

The multiple choice questions were generally well answered.

Subject 107 (Economics) April 2000 Examiners Report

Subject 107 (Economics) April 2000 Examiners Report (ii)

Subject 107 (Economics) April 2000 Examiners Report (iii)

Subject 107 (Economics) April 2000 Examiners Report (iv)

Subject 107 (Economics) April 2000 Examiners Report

(i) (ii) (iii) (iv)

Generally well answered.

Subject 107 (Economics) April 2000 Examiners Report

Subject 107 (Economics) April 2000 Examiners Report

Y=C+I+G+X-Z Y= 0.8 (Y-0.5Y) + 20 + 70 + 50 - 0. 1Y Y= 0.3 Y + 140 0.7 Y = 140 Y = 200 million

Subject 107 (Economics) April 2000 Examiners Report

All four parts were generally well answered.

Subject 107 (Economics) April 2000 Examiners Report

Subject 107 (Economics) April 2000 Examiners Report

Subject 107 Economics

Graph paper is not required for this paper.

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[1] [1] [1] [Total 4]

Explain four economic benefits of international trade.

Briefly discuss four factors which explain economic growth.

[15] [Total 20]

Faculty of Actuaries Institute of Actuaries

Subject 107 (Economics) September 2000 Examiners Report

Subject 107 (Economics) September 2000 Examiners Report

Subject 107 (Economics) September 2000 Examiners Report

D2 0 (ii) Price S2 S1 P2 P1 Q2 Q1 Quantity

D 0 (iii) Price S1 S2 P1 P2 Q2 Q1 Quantity

D 0 (iv) Price S P2 Q1 Q2 Quantity

D1 0 Well answered by most. Q1 Q2

Subject 107 (Economics) September 2000 Examiners Report

Price Elasticity of Demand =

Cross Price Elasticity of Demand =

Income Elasticity of Demand =

% change in Qd(X) = 0.78 % change in income

Very well answered.

Subject 107 (Economics) September 2000 Examiners Report

Subject 107 (Economics) September 2000 Examiners Report

Number of employees per week 1 2 3 4 5 6

Marginal product of Labour

Marginal Revenue Product of Labour () 57 66.5 85.5 95 66.5 47.5

Total Revenue () 57 123.5 209 304 370.5 418

Subject 107 (Economics) September 2000 Examiners Report

(c) (d) Q35

Subject 107 (Economics) September 2000 Examiners Report

National Income (Y)

Interest Rate (i) IS1 IS2 LM

National Income (Y)

Subject 107 (Economics) September 2000 Examiners Report

Interest Rate (i) IS LM1