University of Hertfordshire Business School

Dept of Accounting Finance and Economics

4BUS1037 - Economics For Business

Semester A 2016-17

Tutorial 1- Week starting 3rd October

Answer all questions (refer to your Essentials of Economics textbook)

True or False
1. The opportunity cost is the benefit forgone from the next best True/False
alternative.

2. The economic examination of inflation would be a microeconomic topic. True/False

3. The economic examination of a firm, or industry would be a microeconomic True/False

topic.

4. The law of demand states that as the price of a product falls, the True/False
willingness to demand increases.
5. A rise in income will lead to a rise in demand for a product. True/False
6. Mortgages and homes are complements. True/False

7. For an inferior good, as income rises quantity demanded falls. True/False

8. Razor and blades are substitutes. True/False

Question 1
Give four reasons as to why a demand curve may shift to its right.

i) ………increase in price of substitute……. ii) trends/ growth in population

iii) increase in income & expectaitons iv) Decrease in a complement good

1
Question 2
The following expression shows the demand equation for a product: D = 480 – 6p where p is
price in £.

a. Create a demand schedule in the table below and show total revenue (TR):

Price 0 10 20 30 40 50 60 70 80
Quantity
TR

b. Plot the demand curve from your schedule on the graph below:

2
0
Quantity
c. The company has an advertising campaign that significantly promotes the brand of its
product. This changes the demand equation to:

D = 500 – 3p where p is the price in £

Calculate the new demand schedule and plot as D2 against the original demand curve.

Price 0 10 20 30 40 50 60 70 80 90 100

Quantit
y

d. Look at your graph and explain the effect of the advertising campaign.
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………

Question 3

a) List four activities that you would like to do tonight

i) ……………………………..…. ii) …………………..………………..

3
iii) ………………………………………. Iv) ………………………………………

b) Which activity do you think you will do and what is the opportunity cost, to you, of choosing
this activity?

i) ……………………………..……………………………………………………………
…………………………………………………………………………………………..
…………………………………………………………………………………………..
ii) ……………………………..……………………………………………………………
…………………………………………………………………………………………..
…………………………………………………………………………………………..

4
Tutorial 2- Week starting 10th October
Demand and Supply equilibrium

1. The following passage refers to the operation of a free-market economy. Delete the words (in
italics) which are incorrect.

In a totally free-market economy, the quantities of each type of good that are bought and
sold, and the amounts of factors of production (labour, land and capital) that are used, are
determined by the decisions of individual households and firms through the interaction of
demand and supply.

In goods markets, households are suppliers / demanders and firms are suppliers /
demanders. In labour markets, households are suppliers / demanders and firms are
suppliers / demanders.

Demand and supply are brought into balance by the effects of changes in price. If supply
exceeds demand in any market (a surplus), the price will rise / fall / stay the same. This
will lead to a rise in the quantity both demanded and supplied / a fall in the quantity
both demanded and supplied / a rise in the quantity demanded but a fall in the quantity
supplied / a rise in the quantity supplied but a fall in the quantity demanded. If,
however, demand exceeds supply in any market (a shortage), the price will fall / rise /
stay the same. This will lead to a fall / rise in the quantity demanded and a fall / rise in
the quantity supplied. In either case, the adjustment of price will ensure that demand and
supply are brought into equilibrium, with any shortage or surplus being eliminated.

2. How will the following changes affect the market price of wheat flour (assuming that the
market is initially in equilibrium)? In each case, sketch what happens to the demand and/or
supply curves and, as result, what happens to the equilibrium price.

(a) People consume more bread. (b) The discovery of a new cheaper way
of milling flour.

5
 (c) The prices of other grains rise. (d) Rice and potatoes fall in price.

3. The diagram below shows the demand for and supply of petrol. The market is initially in
equilibrium at point x.

There is then a shift in the demand and/or supply curves, with a resulting change in
equilibrium price and quantity.

To which equilibrium point (a, b, c, d, e, f, g or h) will the market move from point x after
each of the following changes?

S2
S0
S1
a
h b
Price

g x c

f d

D1

D0
D2

Quantity

6
 The market for petrol
(a) A rise in the cost of refining petrol...........................................................................................

(b) A fall in bus and train fares.......................................................................................................

(c) A fall in the price of crude oil and an increase in the price of cars............................................

(d) A rise in tax on petrol and a reduction in tax on cars................................................................

4. The demand and supply schedules for wheat in a free market are as follows:

Price per tonne (£) 120 160 200 240 280 320 360 400
Tonnes demanded per week 725 700 675 650 600 550 500 425
Tonnes supplied per week 225 300 400 500 600 750 1000 1300

(a) Draw the demand and supply curves on the following diagram:
400

360

320
Price (£ per tonne)

280

240

200

160

120
0 200 400 600 800 1000 1200 1400 1600

Quantity (tonnes per w eek)

(a) ..................................................................................................What is the equilibrium price?

(b) ...........Suppose the government fixes a maximum price of £200 per tonne. What will be the
effect?
................................................................................................................................................

(c) Suppose that supply now increases by 150 tonnes at all prices. Enter the new figures.
Price per tonne (£) 120 160 200 240 280 320 360 400
Tonnes demanded per week 725 700 675 650 600 550 500 425
(old) Tonnes supplied per week 225 300 400 500 600 750 1000 1300
(new) Tonnes supplied per week

7
 (d) How much will price change from the original equilibrium (assuming that the
government no longer fixes a maximum price)? How much more will be sold?

Change in price .......................................................................................................................

Change in quantity...................................................................................................................

CASE STUDY- Read the following extracts and answer the questions below

BBC News online 5/08/2016

“People spend more than a third of their disposable income on rent across large
parts of England, a BBC investigation has found.

Analysis shows the average rent of a one-bedroom property in almost half of all
districts, boroughs and cities would cost more than 30% of the median take-
home salary for the area.

The problem is most acute in London and the South East. The government said it
was committed to building more affordable homes.

BBC England's data unit analysed the average rents for different types of
property in each local authority area and the median weekly wage for those
areas, using figures published by the Office for National Statistics.

According to Shelter and the Joseph Rowntree Foundation, spending more than a
third of your disposable income on rent or a mortgage means you may not be
able to afford other basic needs.

Based on average rents and median weekly wages, our investigation found:

 Renting a studio flat exceeds 30% of take-home pay in every London

borough except Bexley. The cost of a studio exceeds £1,000 a month in
Camden, Hackney, Islington, Kensington and Chelsea, Southwark, Tower
Hamlets and Westminster

 Renting a room in a house or flat would swallow up more than 30% of

the average disposable income in 15 of London's 32 boroughs

 It is impossible to rent a one, two or three bed property within the

recommended limits across the whole of the capital. In 24 London
boroughs and the City of London, a one-bedroom property would
consume more than half your disposable income

 The average cost of renting a room in a flat or a house in London is

£607 a month, compared to £424 across the South East

8
Average wages vs average rent

Experts say housing should cost no more than 30% of take home pay

30% of average monthly take home wage in England : £550

 £694-Average rent for one-bed flat

 £867 Average rent for three-bed home

 £760 Average rent for two-bed home

 £641 Average rent for a studio flat

 £382 Average rent for house share

Source: Office for National Statistics

1. Using demand and supply diagrams, illustrate the situation in the rental
market in the capital.

2. Illustrate what would happen if more housing was built.

9
Tutorial 3: Week starting 17th October
Elasticity

1. (a) The price elasticity of demand measures the responsiveness of the quantity demanded /
price to a change in the quantity demanded / the quantity supplied / price.
[Delete wrong words.]

(b) Give the formula for price elasticity of demand.

.................................................................................................................................................

2. In each of the following pairs, tick which of the two items is likely to have the more elastic
demand. Give reasons for your answer.

(a) Petrol (all brands) Esso petrol

.................................................................................................................................................

.................................................................................................................................................

(a) Holidays abroad Bread

.................................................................................................................................................

.................................................................................................................................................

(a) Salt Clothing

.................................................................................................................................................

3. The formula for price elasticity of demand is as follows:

Proportionate (or percentage) change in quantity demanded

Proportionate (or percentage) change in price

This can be summarised as:

Qd / mid Qd  P / mid P

The following table shows the quantity of a product demanded at two different prices:

P Qd
16 25
14 35
10
 (a) Calculate the proportionate change in quantity demanded when price falls from £16 to
£14.
(Use the first part of the formula, i.e. Qd / mid Qd , to do your calculation.)

.................................................................................................................................................

.................................................................................................................................................

(b) Calculate the proportionate change in price when price falls from £16 to £14.
(Use the second part of the formula, i.e. P / mid P, to do your calculation.)

.................................................................................................................................................

.................................................................................................................................................

(c) What is the price elasticity of demand between £16 and £14?

.................................................................................................................................................

.................................................................................................................................................

4. Fill in the rest of the following table:

(For the final column use the formula: Qd / mid Qd  P / mid P)

Quantity Price Total Elastic or

Price elasticity
demanded (£) consumer inelastic
of demand
(000s) expenditure demand

7 13 ………..
………. ……….
9 11 ………..
………. ……….
11 9 ………..
………. ……….
13 7 ………..

5. (a) What is the formula for income elasticity of demand?

.................................................................................................................................................

(b) Which of the following would you expect to have a demand which is elastic with respect
to income? (There are more than one.)

(i) Flour....................................................................................................Yes / No / Possibly

(ii) Ready-prepared meals for the microwave ...........................................Yes / No / Possibly

11
 (iii) Champagne..........................................................................................Yes / No / Possibly
(iv) Socks ..................................................................................................Yes / No / Possibly

(v) Designer jeans.....................................................................................Yes / No / Possibly

(vi) Electricity............................................................................................Yes / No / Possibly

(vii) Bus journeys........................................................................................Yes / No / Possibly

(viii) Insurance Yes / No / Possibly

Case Study

You are from a firm of consultants called to advise the Airline, Flyalot, on its pricing strategy.
You use the concept(s) of elasticity in your analysis.

Your airline Flyalot has daily flight from Stanton to Paris. The plane has a capacity of 100, but at
the present fare of £70 only 50 seats on average are sold per flight. Some market research
indicates that on average 20 out of the 50 passengers are business travellers, while the remaining
30 travellers are tourists.

A. You know from sales data that, over a given period of time, a 10 per cent average
increase in income brings about a 20 per cent increase in demand. What is the income
elasticity of demand?

…………………………………………………………………………………………………..

B. Give the formula for cross elasticity of demand.

………………………………………………………………………………………………

You calculate that when your competitors Whizzjet put their prices down by 10 per cent, you
experience a 5 per cent fall in demand in the same period. What is the cross elasticity of
demand? Interpret your answer.

……………………………………………………………………………………………………

Revenue, Elasticity and Prices

C. What is the current revenue of the airline on this route?

……………………………………………………………………………………………..

12
You are asked to investigate a strategy of lowering the price of the tourist class from £70 to £56
which results in an increase in demand from 30 to 50. What is the price elasticity of demand?
What impact will this strategy have on revenue from the tourist class?

Illustrate this proposed change with a diagram.

………………………………………………………………………………………………

………………………………………………………………………………………………

13
Tutorial 4: Week starting 24th October
Cost of production

Section A
1. All of the following would be short run decisions faced by the firm except: 
A. Should the labour input work overtime if output sales increase.
B. If sales increase, should a new plant be constructed.
C. If sales fall, should the plant be shut down.
D. Should labour be laid­off if the demand for the firm's output declines.

2. A firm's total cost curve shows 
A. the only levels of output that the firm may produce.
B. the minimum cost of producing each level of output.
C. that as output increases, the total cost of production rises.
D. that as output increases, the cost of producing each level of output remains constant.
E. none of the above.

 3. A firm's marginal cost of production is 
A. its total cost of production divided by total output.
B. the change in average cost of production divided by the level of output.
C. the change in total cost incurred as a result of producing one more unit of output.
D. the cost incurred by the firm even if no output is produced.

 4. If a firm incurs a total cost of £874 when it produces 10 units of output and a total cost of 
£950 when it produces 11 units of output, the marginal cost is 
A. 1824
B. 950
C. 54
D. 76
E. cannot be determined from the information given.

5. The law of diminishing returns 
A. shows that output can always be expanded by adding more of the variable input.
B. states that after a point, each additional unit of a variable input produces less than the previous
unit.
C. is the same as total costs
D. A and C above.

6. The following is a list of various types of economies of scale:

14
 (i) The firm can benefit from the specialisation and division of labour.
(ii) It can obtain inputs at a lower price.
(iii) The firm may be able to obtain finance at lower cost.
(iv) It becomes economical to sell by-products.
(v) Production can take place in integrated plants.
(vi) Risks can be spread with a larger number of products or plants.

Match each of the following examples for a particular firm to one of these types of economy of
scale.

(a) It can more easily make a public issue of shares.

(b) It can diversify into other markets.
(c) Workers spend less time having to train for a wide variety of different tasks,
and less time moving from task to task.
(d) It negotiates bulk discount with a supplier of raw materials.
(e) A clothing manufacturer does a deal to supply a soft toy manufacturer with
offcuts for stuffing toys.
(f) Conveyor belts transfer the product through several stages of the manufacturing
process

7. Complete the following table which gives the costs for Firm A.

Output Total cost £ Marginal cost £ Average costs

0 0

1 30

2 54

3 74

4 91

5 107

6 126

7 149

8 176

9 207

10 243

15
 I) Is firm A operating in the short-run or the long-run? Explain.

8. The figure below shows the total cost and revenue curves for a firm on the same diagram.

60 TC

50
Costs and Revenues(£).

40
TR

30

20

10

0
0 10 20 30 40 50 60 70 80 90

Quantity

(a) At what output is the firm’s profit maximised?..................................................................................

(b) How much profit is made at this output?...........................................................................................

(c) How much is total fixed cost?............................................................................................................

16
Tutorial 5: Week starting 31st October
Market structures

1. It is usual to divide markets into four categories. In ascending order of competitiveness

these are (fill in the missing three):
1. monopoly.
2. ..........................................................................................................................................
3. ..........................................................................................................................................
4. ..........................................................................................................................................

2. To which of the above four categories do the following apply to the member firms? (There
can be more than one market category in each case.)
(a) Firms face a downward sloping demand curve. ....................................................................
(b) New firms can freely enter the industry. .................................................................................
(c) Firms produce a homogeneous product. ................................................................................
(d) Firms are price takers. ............................................................................................................
(e) Firms are concerned with their rival’s actions and reactions...................................................
(f) There is perfect knowledge on the part of consumers of price and product quality.
..........................................................................................................................................

3. In which of the four categories would you place each of the following? (It is possible in
some cases that part of the industry could be in one category and part in another: if so name
both.)

(a) A village post office.................................................................................................................

(b) Restaurants in large town ........................................................................................................
(c) UK high street banks................................................................................................................
(d) UK energy companies..............................................................................................................
(e) Producers of barley .................................................................................................................
(f) Water supply ...........................................................................................................................
(g) Local buses .............................................................................................................................
(h) The market for foreign currency .............................................................................................

4. Even if a firm is currently a monopoly, it may be forced to behave as if it were in a

competitive market if there is potential competition: i.e. if the market is contestable.

(a) The threat of this competition will be greater the higher / the lower [delete as
applicable] the entry costs to the industry and
17
 (b) the higher / the lower [delete as applicable] the exit costs from the industry

5. A perfectly contestable market is defined as one where...................................................................

..........................................................................................................................................................

..........................................................................................................................................................

6. What would a monopolistically competitive industry have in common with a perfectly

competitive industry?
(a) There are no barriers to the entry of new firms into the market. Yes/No
(b) Firms in the industry produce differentiated products. .................................................Yes/No
(c) The industry is characterised by a mass of sellers, each with a small market share.......Yes/No
(d) A downward sloping demand curve means the firm has some control over the product's
price..............................................................................................................................Yes/No
(e) In the long run only normal profits will be earned.........................................................Yes/No
(f) Advertising plays a key role in bringing the product to the attention of the consumer.
Yes/No

7. Which of the following are characteristics of oligopoly?

(a) There are just a few firms that dominate the industry. ..................................................Yes/No
(b) There are few if any barriers to the entry of new firms into the industry. .....................Yes/No
(c) The firms face downward sloping demand curves. ......................................................Yes/No
(d) There is little point in advertising because there are so few firms. ...............................Yes/No
(e) Oligopolists tend to take into account the actions and reactions of other firms. ...........Yes/No

8. Assume that there are six firms in a country's carpet manufacturing industry and that they
collude to restrict output, thereby maintaining a high price. Under which of the following
circumstances is collusion likely to break down?
(a) The government imposes higher duties on imported carpets.........................................Yes/No
(b) Several new chains of discount carpet retailers enter the market...................................Yes/No
(c) One of the firms develops a new cost saving technique of producing carpets...............Yes/No
(d) Three of the smaller manufacturers merge....................................................................Yes/No
(e) One of the firms becomes dominant in the industry.......................................................Yes/No
(f) The demand for carpets falls.........................................................................................Yes/No
(g) Legislation is passed preventing the exchange of information by producers on
costs, sales and product development............................................................................Yes/No

9. Read the case study and discuss the questions at the end

18
Case study 1

Extract from BBC News online, 22/10/2015

“The UK's competition watchdog says bank customers can save £70 a year by
switching their current account provider.

Those who go into an overdraft on a regular basis could save as much as £260 a
year by switching accounts. There are 68 million active personal current
accounts in the UK, but only 3% of customers switched last year. So, what does
the Competition and Markets Authority (CMA) suggest to get those customers
moving and, perhaps more importantly, what proposals does it rule out?

Customers need to choose a new bank and account. If the bank or building
society is part of the current account switch guarantee (and most of them are)
you choose a date for the switch to start. The new bank will switch over the
customer's balance and all direct debits and standing orders. The process should
be complete within seven working days and, for the next 36 months, any
payments made accidentally to the old account will be redirected automatically.

The retail banking industry is no stranger to competition reviews, such as:

 In 2002 there was a Competition Commission inquiry into the supply of

banking services to small businesses by clearing banks

 In 2008 the Office of Fair Trading investigated the provision of personal

current accounts

 In 2011 the Independent Commission on Banking also made

recommendations aimed at promoting financial stability and
competition.

All of them, in one way or another, have called for an encouragement for
customers to switch.

Questions to discuss:

A. How would you describe the market structure of for high street banks operating in the
UK?

B. Discuss the possible barriers to entry in this industry and the type of profits that can be
earned.

19
Tutorial 6: Week starting 7th November
Discussion of Test paper

Week starting 14th November: Reading week

Please read Chapter Chapter 8-Sections 8.1-8.3, Chapter 9 Sections 9.1-9.3, Chapter 11
Section 11.3 in Sloman [E-book]

Week starting 21st November 2016

Tutorial 7: GDP and Unemployment

1.  The simple circular flow model shows that:  
A.  firms hire the factors from households and produce the output consumed by households. 
B.  households provide the factors to firms and buy the output produced by firms. 
C.  the source of household income is the producing sector. 
D.  the source of firms' revenue is households. 
E.  All the above. 

 2.  A primary difference between microeconomics and macroeconomics is that:  
A.  macroeconomics studies the operation and performance of the economy as a whole. 
B.  microeconomics studies the aggregate level of income and employment. 
C.  in formulating and implementing government policy, microeconomics shows the effects of 
policy variables on the entire economy. 
D.  macroeconomics studies the operation and performance of individual economic units. 
 

3.  An economy's real GDP measures the:  
A.  market value of all goods and services produced during a particular time period. 
B.  value of all goods and services produced during a particular time period when prices are held 
constant. 
C.  value of all investment goods and services produced during a particular time period when 
prices are held constant. 
D.  market value of all investment goods and services produced during a particular time period. 

 4.  Unemployment, inflation and economic growth are all issues of:  
A.  macroeconomics. 
B.  microeconomics. 
C.  econometrics. 
D.  ecology. 
 

20
5.  The purchase of new capital goods by firms is called:  
A.  investment. 
B.  consumption. 
C.  depreciation 
D.  planting. 

6. Position each of the following eight terms in the UK’s circular flow of income diagram below:
Consumption (of domestically produced goods and services); Net saving; Net taxation;
Government expenditure; Factor payments (national income); Expenditure on imports;
Investment; Expenditure on exports.
Economists use specific letters to label each of these terms. The letters used are:
S, G, X, M, I, Cd, T, Y
Attach the correct letter to each of the terms you have written on the diagram.

7. Which of the following are changes in injections into, and which are changes in withdrawals
from the UK’s circular flow of income? In each case, identify whether the change is an increase
or a decrease. In each case, assume that this is the only change. (Delete wrong words.)
(a) A council funds the building of new libraries. .....................................Withdrawal/Injection
Increase/Decrease
(b) Fewer tourists visit the UK...................................Withdrawal/Injection Increase/Decrease
(c) Firms, anticipating a rise in consumer demand, borrow ..........more money in order to build
up their stocks. .....................................................Withdrawal/Injection Increase/Decrease
(d) People invest more money in banks and
building societies. Withdrawal/Injection Increase/Decrease

8. a) Explain what is meant by the term ‘the business cycle’?

………………………………………………………………………………………………
……………………………………………………………………………………………..
21
………………………………………………………………………………………………
………………………………………………………………………………………………
…………………………………………………………………………………………….
………………………………………………………………………………………………

b) An economy moves from recession into a boom; what happens within firms and what
happens within households?
………………………………………………………………………………………………
……………………………………………………………………………………………..
………………………………………………………………………………………………
………………………………………………………………………………………………
…………………………………………………………………………………………….
………………………………………………………………………………………………

9. UK GDP in 2010 was £1458452m. Consumption expenditure of households, C, was

£937906m, Government expenditure, G was £338067m, exports of goods and services, X, was
£436796m, imports of goods and services, M, was £476480m. The statistical discrepancy was -
£2415m.

What was gross capital formation, I?

10. Explain the four different categories of unemployment: Frictional, Structural, Cyclical
(demand-deficient) and Seasonal and choose a category for the following examples:

i) Unemployment of unskilled workers from Frictional / structural / demand-

declining industries deficient / seasonal

ii) Unemployment which results from the closure of Frictional / structural / demand-
ski resorts during summer time deficient / seasonal

iii) Unemployment stemming from a decline of Frictional / structural / demand-

world GDP deficient / seasonal

22
23
Tutorial 8: Week starting 28th October
Inflation

1. The following table shows the consumer prices index (CPI) for the UK, where 2005 = 100.0.
Calculate the rate of inflation for the eight years 1998–2001 and 2007–10. The formula is:
Inflation = ((Pt  Pt1) / Pt1)  100
where t is the year in question and t1 is the previous year. Give your answer to one
decimal place. (The figures for 1997 and 2006 are given.)

Year 1997 1998 1999 2000 2001 2006 2007 2008 2009 2010

Price index (P) 89.7 91.1 92.3 93.1 94.2 102.3 104.7 108.5 110.8 114.5

Rate of
1.8 2.3
inflation

2. Will the following lead to cost-push or demand-pull inflation, or both?

(a) The Bank of England cuts interest rates and the economy booms.
Cost-push / Demand-pull / Both

(b) As a result of falling unemployment, trade unions become more militant and demand
higher wages.
Cost-push / Demand-pull / Both

(c) The government raises the rate of VAT. Cost-push / Demand-pull / Both

(d) The government cuts income tax rates and raises government expenditure at a time of
near full employment.
Cost-push / Demand-pull / Both

(e) Increasing industrial concentration leads to more oligopolistic collusion to raise prices.

Cost-push / Demand-pull / Both

3. Why is a high rate of inflation undesirable?

24
Read the article and answer the questions.

Zimbabwe

A worthless currency
Jul 17th 2008 | JOHANNESBURG
From The Economist print edition

The local dollar is fast shrivelling away

EPA

The tragi-comedy continues

Get article background

WITH prices doubling every few days, Zimbabweans now spend huge amounts of time and
energy preventing their meagre cash resources from completely evaporating. Trying to catch up
with galloping hyperinflation, now officially running at 2.2m per cent a year and at least four
times faster in reality, the central bank has been printing ever bigger denominations. But it is
outrun by galloping prices: at last count, the most valuable banknote available was for 50 billion
Zimbabwean dollars, now worth barely 70 American cents on the black market, and the stock of
Zimbabwean dollars is dwindling. Local cash could become scarcer still, now that the German
company that was providing Zimbabwe with paper to print its banknotes has cancelled its
contract; the Zimbabwean monetary authorities are likely to turn to a less specialised supplier.
Meanwhile, people do not even bother to pick up notes of hundreds of thousands on the
pavements of Harare, the capital. At independence in 1980, the Zimbabwe dollar was more
valuable than the American greenback.

It may seem odd that the local currency is still used at all. From Z$25 billion to the American
dollar at the beginning of this month, the cash exchange rate had jumped threefold within a
fortnight. In restaurants or shops, prices are still quoted in local currency but revised several
25
times a day. Salaries are paid in Zimbabwean dollars, still the only legal tender. A minibus driver
taking commuters into Harare every day still charges his clients in Zimbabwe dollars—but at a
higher price on the evening trip home—and changes his local notes into hard currency three
times a day. The local money is losing its relevance.

Zimbabweans spend their local dollars as fast as possible or change them into hard currency on
the black market. A parallel system is thriving in back offices and parking lots. Ronald was a
civil servant but became a money dealer about a year ago to feed his family. He now makes
about $100 a month, whereas his former colleagues earn the equivalent of less than $2 a month,
enough to buy two loaves of bread. On a recent trip, this correspondent changed money from a
central-bank employee running an illegal foreign-exchange business in his own office.

With a strict daily limit (currently less than $1.40) on bank withdrawals, people shun banks as
much as possible and are returning to a cash economy. Petrol and rents are now charged mainly
in American dollars or South African rand, but since some landlords have been taken to court,
rents are increasingly often paid for in groceries. People buying overpriced cooking oil or sugar
on the black market, since those items have long vanished from shops due to official price
controls, are charged more if they pay in local dollars. Petrol coupons have become a virtual
currency.

John Robertson, a local economist, reckons that the informal economy has probably become
larger than the formal one. Though estimates are fuzzy, he believes that money sent by
Zimbabweans abroad to friends and relatives at home, which used barely to register on
Zimbabwe’s foreign-exchange radar screen, now accounts for probably a third or so of the
country’s foreign-exchange inflows.

Turning to foreign exchange or barter is what you would expect in countries that have had
inflation of more than a few hundred per cent a year. At the height of its inflation crisis, shops in
Argentina were no longer able to price their goods. In some cases, Peruvians started using
lavatory paper, then in short supply, as currency. But Zimbabwe holds the dubious distinction of
being the only country in the world today that is suffering from hyperinflation: that is, prices are
increasing by more than 50% a month. It has not yet reached Hungary’s level after the second
world war, when inflation peaked at 42 quadrillion per cent a month. But it could yet get there.

In May, the central bank decided to let the exchange rate, until then fixed at a grossly overvalued
rate of Z$30,000 to the American greenback, float on the interbank market. For a short while, the
rate settled at a level close to the black market’s. But very few ordinary people can obtain foreign
exchange from banks; most still use the black market to get rid of their Zimbabwean dollars. So
the legal and parallel rates have again grown apart. People sending money or groceries to
relatives in Zimbabwe still use informal channels.

Hyperinflation can usually be tamed within a few months, provided authorities stop spending
money they do not have and no longer turn to printing presses to cover for it. But the damage
lingers for years. Argentines held about 60% of their bank deposits in foreign exchange three
years after the high inflation of the late 1980s was over, compared with less than 10% before the
crisis. In Peru and Bolivia, over 80% of bank deposits were held in hard currency three years
after the countries’ inflation crises.

Reform will eventually come and prices will stabilise in Zimbabwe, especially if President
Robert Mugabe is replaced; but the local dollar will never be the same. Some people have
suggested that a reformed Zimbabwe should become part of the rand zone, but so far neither the
South Africans nor Zimbabwe’s battered opposition have sounded keen on the idea.
26
Source: The Economist (2008)
Read the above article and answer the following questions:

1) What happened to the Zimbabwean currency in 2008?

2) What problems did the population face because of hyperinflation?

Now read the article in FT on the current situation in Zimbabwe:

http://www.ft.com/cms/s/0/9eb1c2d8-c341-11e5-b3b1-7b2481276e45.html#axzz4KtMC4Men

27
Tutorial 9: Week starting 5th December
Fiscal Policy

1. All of the following would be included in a list of the government's automatic stabilisers 
except 
A. unemployment compensation.
B. education opportunity grants for low income households.
C. personal income taxes.
D. taxes on business income.

 2. When government spending increases and taxes do not, 
A. output falls because of aggregate demand increases.
B. output rises because total spending has increased.
C. output remains the same.
D. aggregate income falls because government borrows from the public.
 

3. To the economist, the term fiscal policy refers to 
A. the use of the spending and taxing powers of government to affect aggregate demand and 
output. 
B. the inequality of private saving and investment in the short run.
C. the role of the private sector in determining the size of gross national product.
D. the attempt by government to finance all of its public spending with tax revenues.
E. none of the above.

 4. During an economic boom or slump, business and households are likely to behave in a way 
that 
A. reduces the prevailing economic problem.
B. lengthens slumps but shortens booms 
C. shortens slumps but lengthens booms.
D. intensifies the prevailing economic problem..
 

28
5. The progressive income tax and unemployment compensation are examples of 
A. full­employment budgeting.
B. monetary policy.
C. automatic stabilisers.
D. a balanced budget multiplier.

 6. Expansionary fiscal policy 
A. decreases aggregate demand.
B. occurs when the government cuts taxes and/or increases spending.
C. occurs when the government increases taxes and cuts spending.
D. occurs when the government cuts taxes by less than it cuts spending.
 

7. The structural budget shows what the budget would be if ______ is at ________. 
A. actual spending; planned spending
B. output; potential output
C. actual tax revenue; forecast tax revenue
D. forecast consumers' expenditure; actual consumers' expenditure

 8. Other things remaining equal, the budget deficit will ____ in a recession and _________ in a 
boom. 
A. decline; grow
B. grow; decline
C. grow; grow
D. decline; decline
 

9. Explain the two macroeconomic effects from the change in government expenditure:
a) The multiplier effect

b) The crowding-out effect

29
10. Since automatic stabilisers reduce the multiplier they do more harm than good. Comment on
this statement.

 Read the following extracts before answering question 11.

Lessons on fiscal policy since the recession by Laura D’andrea Tyson, NY Times 2013 

“In late 2008, the United States economy was caught in the midst of what proved to be its
longest and deepest recession since the end of World War II. Frightened by steep and self-
reinforcing declines in output and employment, both the Federal Reserve and the federal
government responded quickly and boldly. The Federal Reserve dropped the federal funds rate to
near zero, where it remains today, and began its controversial “quantitative easing” purchases of
long-term government securities to contain long-term interest rates. ……

Fueled by the 2009 federal stimulus package, discretionary fiscal policy was also expansionary
in 2009-10, adding to growth during the first year of the recovery at roughly the same pace that
fiscal policy had achieved during previous recoveries. Before the Great Recession, there was a
near consensus among economists that monetary policy by itself could stabilize aggregate
demand and keep the economy on its potential growth path. Under normal economic conditions,
countercyclical fiscal policy was thought to be unnecessary. It was also thought to be both ill
timed, because of lags in Congressional decision-making, and wasteful, because choices among
fiscal measures were driven by politics and rent-seeking rather than cost-benefit considerations.

Most economists also believed that changes in discretionary fiscal policy would have small
effects on aggregate demand and output — that the multipliers for such changes were small —
and this belief was supported by empirical research based on “normal economic conditions.”

But the conditions confronting fiscal policy in late 2008 were anything but normal. Output,
employment and stock values were falling at a faster pace than before the Great Depression, and
short-term interest rates had fallen to their zero lower bound. At least in the short term,
conventional monetary policy alone could not stabilize the economy, so over dire warnings from
some macroeconomists, in early 2009 Congress answered President Obama’s request for a large
temporary stimulus package to end in 2011, by which time it was hoped or expected that a strong
recovery would be under way.

Subsequent empirical analysis indicates that the stimulus worked. New research confirms that
the multipliers for fiscal policy are significantly larger during downturns when there is
considerable excess capacity and when interest rates are at or near their lower bound. They are
30
also larger when private actors are credit-constrained, so their spending depends more on current
income than on future expected income. These were the conditions in 2010-11. Even using a
range of lower multiplier estimates consistent with more normal conditions, the Congressional
Budget Office found that the effects of the stimulus on output and employment were in the
predicted range.

There was a strong case for additional fiscal stimulus in 2011, and that is what President Obama
proposed. But this time Congress rebuffed most of his recommendations, and since then fiscal
policy has shifted to even more contraction in the form of strict caps on discretionary federal
spending, increases in taxes and the sequester. According to the International Monetary Fund,
fiscal policy will reduce gross domestic product in the United States by 1.8 percent this year.

Since 2011, proponents of fiscal austerity have repeatedly raised concerns that the large increases
in the government deficit caused by both the recession itself and discretionary fiscal stimulus
would lead to a spike in long-term interest rates. Bill Gross, the bond-market savant and
influential chief executive of Pimco, warned that a spike would occur by the late summer of
2011. The downgrading of United States government debt in August 2011 after the
Congressional showdown over the debt limit amplified these concerns.

But long-term interest rates did not spike; instead, they fell to historic lows in 2012 and are
currently less than 2 percent, despite further increases in government debt. The experience of the
last four years demonstrates that there is no simple predictable relationship between the
government deficit and long-term interest rates. The relationship depends on economic
conditions. Under current conditions, as long as the recovery remains weak, with considerable
slack between actual and potential output, subdued inflationary expectations and highly
accommodative monetary policy, long-term interest rates are likely to remain low.”

IMF Finance and development, ‘Stimulus worked’, December 2010

“The fiscal (that is, taxing and spending) efforts to end the recession and jump-start the recovery
were built around a series of stimulus measures. Income tax rebate checks were mailed to
households in early 2008; the American Recovery and Reinvestment Act (ARRA) was passed in
early 2009; and several smaller stimulus measures became law in late 2009 and early 2010—
such as the Cash-for-Clunkers tax incentive for auto purchases, the extension and expansion of
the housing tax credit through mid-2010, the passage of a new jobs tax credit through year-end
2010, and several extensions of emergency unemployment insurance benefits. In all, close to $1
trillion, roughly 7 percent of GDP, will be spent on fiscal stimulus. We do not believe it was a
coincidence that the turnaround from recession to recovery occurred in mid-2009, just as ARRA
was providing its maximum impact.”

31
11. Well known limits to fiscal policy indicate that there is no use for this policy tool. Would you
agree? 

32
Tutorial 10: Week starting 12th December
Monetary Policy

1. Monetary policy is one of the two main macroeconomic tools governments use to control the 
aggregate economy, the other being: 
A. fiscal policy.
B. foreign policy.
C. trade policy.
D. immigration policy.

 2. Which of the following is not directly affected by monetary policy? 
A. The money supply
B. The banking system
C. The availability of credit
D. The budget deficit
 

3. In the short run if the Bank of England (BOE) undertakes expansionary monetary policy, the 
effect will be to shift the: 
A. AD curve out to the right.
B. AD curve in to the left.
C. SAS curve up.
D. SAS curve down.

 4. Monetary policy directly affects: 
A. social spending.
B. tax rates.
C. the availability of credit.
D. the antitrust laws.
 

5. Central banks are responsible for: 
A. both monetary policy and fiscal policy.
B. monetary policy but not fiscal policy.
C. fiscal policy but not monetary policy.
D. neither monetary policy nor fiscal policy.

 6. The reserve requirement is the: 
A. maximum ratio of reserves to deposits that a bank can have.
B. minimum ratio of reserves to deposits that a bank can have.
C. maximum level of reserves a bank can have.
D. minimum level of reserves a bank can have.

33
 

7. If the money multiplier is 2.5, the reserve requirement is: 
A. 0.3.
B. 0.4.
C. 0.5.
D. 0.6.

 8. One of the reasons that expansionary monetary policy has not been as effective as expected in
recent years is that: 
A. the central bank’s base rate was high.
B. banks were holding significant excess reserves.
C. Governments continued to run deficits.
D. potential output was rising quickly.
 

9. To increase the nation's money supply, the BOE can: 
A. increase the required reserve ratio.
B. decrease the base rate.
C. increase the base rate.
D. sell bonds.

 10. Open market operations are related to: 
A. actions taken by the BOE to close or merge weakened banks.
B. changes in the reserve requirement.
C. changes in the bank rate.
D. the BOE's buying and selling of government securities.
 

11. Which of the following BOE’s actions increases the money supply? 
A. Decreasing the amount of loans made to commercial banks
B. Buying government securities in the open market
C. Selling government securities in the open market
D. Increasing reserve requirements

 12. Any item can function as a medium of exchange: 
A. as long as it is backed up by some precious metal.
B. as long as the item is easily available.
C. as long as the item is generally accepted in the trade for most goods and services and for 
repayment of debt.
D. but only if the item has been issued by the BOE for use as a medium of exchange.
E. but only if the Treasury Department has designated that item as a medium of exchange.
 

34
13. People who expect a very high inflation rate may: 
A. increase their demand for real money balances in order to be able to purchase the higher­
priced goods later.
B. decrease the speed with which they spend their money, thereby decreasing velocity.
C. shift their money from time deposits to demand deposits.
D. prefer to hold goods instead of money.
E. None of the answers given here are correct.

14. The liquidity of an asset is determined by: 
A. the BOE.
B. the cost of keeping it in a safe place.
C. its potential value to the buyer.
D. the cost, convenience and speed with which it can be converted into money.
E. how frequently it turns over in trade during the year.

 15. An asset (other than money) is considered to be more liquid if: 
A. it has a longer maturity.
B. it is issued by a major company rather than the government.
C. it earns a high rate of interest or dividend.
D. it has more than one use.
E. it can be quickly and cheaply transferred into money.
 

16. A disadvantage of holding money rather than bonds is that: 
A. money loses its value as the interest rate goes up.
B. people who hold only bonds can diversify their portfolios more easily than people who hold 
money and bonds.
C. bonds generally have a higher yield than money.
D. bonds never lose purchasing power.
E. bonds are backed up by the government.

 17. The demand for money is driven by: 
A. a transactions motive.
B. a precautionary motive.
C. a speculative motive.
D. All three answers given here are correct.

35
18. Suppose that the Bank of England wants to lower general interest rates. An appropriate 
policy for the Bank of England would be to 
A. raise the interest rate on certain government bonds.
B. reduce the discount rate.
C. reduce the level of excess reserves that banks hold.
D. increase the required reserve ratio.
 

19. The most frequently employed instrument of monetary policy is 
A. the discount rate.
B. reserve requirement.
C. open market operations.
D. moral suasion.

20. If the supply of money balances curve is vertical, then the stock of money 
A. increases as the level of national income increases.
B. decreases as the rate of interest increases.
C. increases as the rate of interest increases.
D. decreases as the rate of interest decreases.
E. does not respond to changes in the interest rate.

21. If the Bank of England wanted to discourage investment spending and reduce aggregate 
demand, it could 
A. reduce the required reserve ratio.
B. sell securities on the open market.
C. lower the discount rate.
D. buy securities on the open market.

22. Discuss some of the limits to monetary policy. 

 
 

36
23. The central bank sets interest rates, but how do interest rates affect the real economy? 

37