INTRODUCTORY ECONOMICS

Transcription

1 4265 FIRST PUBLIC EXAMINATION Preliminary Examination for Philosophy, Politics and Economics Preliminary Examination for Economics and Management Preliminary Examination for History and Economics INTRODUCTORY ECONOMICS LONG VACATION 2014 Monday 8th September 2014, 09:30-12:30 Please start the answer to each question on a separate page. There are 10 questions in this paper. Answer four questions: three from Part A and one from Part B. All questions attract the same number of total marks. For multipart questions, the weight assigned to each part is indicated in square brackets. Candidates should show knowledge of both Microeconomics and Macroeconomics by answering at least one question on Microeconomics and at least one on Macroeconomics. Candidates may use a calculator as specified by the Department of Economics. Do not turn over until told that you may do so. 1

2 1. Microeconomics Part A Answer three of the 6 questions in this section. (i) What properties do well-behaved indifference curves have? [5%] (ii) Assume a consumer has a given income, m, and is interested in consuming only two goods. Denote the prices of the two goods by p 1 and p 2 and the quantities consumed by x 1 and x 2. Write down an equation for the budget constraint and show the budget set in a diagram. Show how the slope of the budget constraint relates to the ratio of the prices of the two goods. [5%] (iii) Describe how the consumer chooses the optimal quantities of the two goods. Must the marginal rate of substitution always equal the ratio of the prices of the two goods if the choice is optimal? Illustrate your analysis with diagrams. [30%] (iv) Assume the price of good 1 decreases. Explain and illustrate the income and substitution effects. [30%] (v) Assume that the preferences of the consumer can be represented by the utility function U(x 1, x 2 ) = x 2/3 1 x 1/3 2. (a) Find the marginal rate of substitution. (b) Derive the demand functions for good 1 and good 2. [30%]

3 2. Microeconomics Suppose a homogeneous product has a demand curve given by Q = 100 P, where Q is quantity and P is price, and that the marginal cost for all firms is initially 20. (i) What is the price under (a) monopoly, (b) quantity-setting duopoly (i.e. Cournot duopoly), and (c) price-setting duopoly (i.e. Bertrand duopoly)? Explain why prices are different for the two types of duopoly. [30%] (ii) Suppose now a new technology is available that reduces the marginal cost to zero and that, when there is a duopoly, a firm can immediately copy a new technology after it is introduced by a competitor. How much does a firm benefit from introducing the new technology under monopoly and price-setting duopoly? Explain your answer. [25%] (iii) Now suppose that if one firm obtains the new technology, the other firm in a duopoly is not able to copy it. How much does a firm benefit from introducing the new technology under price-setting duopoly? Compare your answers with those to part (ii). [20%] (iv) Now suppose that it is possible to advertise the product, and that this shifts the demand curve from Q = 100 P to Q = 120 P. How much does a firm benefit from the advertising campaign under (a) monopoly, (b) quantity-setting duopoly, and (c) price-setting duopoly? Discuss your answer. [25%] turn over

4 3. Microeconomics Consider a perfectly competitive industry with a large number of identical firms producing a homogeneous good. In the short run the number of firms is fixed but in the long run there is free entry and exit. (i) Explain carefully what determines the short and long-run supply curves of the industry. [15%] (ii) Explain what is mean by consumer and producer surplus. Why are they used as measures of welfare and what are their limitations? [15%] (iii) Discuss, using diagrams, the effect on the equilibrium price, quantity, consumer surplus and profits in the short and long run of (a) a tax on purchases of the good, (b) a fixed levy on each firm operating in the industry. [35%] (iv) Consider now a competitive industry where the inverse demand curve is p = 15 q, where p denotes price and q quantity and the short-run inverse supply curve is p = q/2. (a) Find the short-run equilibrium price and quantity produced, together with the consumer and producer surplus. (b) Suppose the government imposes a tax of 3 per unit on purchases of the good. Find the new short-run equilibrium price and quantity. Find also the change in consumer and producer surplus and the tax revenue raised. (c) Comment briefly on your answers. [35%]

5 4. Macroeconomics (i) Use the IS-LM model to explain carefully why the aggregate demand (AD) curve slopes downwards. [15%] (ii) How does the sensitivity of investment to the interest rate affect the slope of the AD curve? [15%] (iii) Explain what is meant by the natural level of output. Explain why the aggregate supply (AS) curve may slope upwards in the short run but is assumed to be vertical in the long run. [15%] (iv) How is the Phillips curve related to the AS curve? [15%] (v) Discuss, using relevant diagrams and/or equations, how a house price bubble may affect aggregate consumption, output and the general price index. [20%] (vi) Starting from a position of long run equilibrium, suppose there is a sudden and permanent decline in productivity. Discuss, using relevant diagrams or equations, the effects in the long and short run on output, prices, consumption and unemployment. [20%] turn over

6 5. Macroeconomics Consider a small open economy with perfect capital mobility. Assume that prices are fixed. The exchange rate, e, is defined as the amount of foreign currency per unit of domestic currency, such that a rise in e represents an appreciation/revaluation of the currency. (i) Initially this economy has adopted a fixed exchange rate regime, with e fixed at e. Explain how the Central Bank keeps the exchange rate at that level by illustrating in a diagram what happens whenever the market exchange rate is above e. [20%] (ii) Using the Mundell-Fleming model, and assuming a fixed exchange rate regime, explain using diagrams, the impact of each of the following changes in this economy: (a) a decrease in Government spending (b) a decrease in Money Supply (c) an increase in firms pessimism about future profits (d) the imposition of a tariff on imported goods. [40%] (iii) How different would your answer to part (ii) had been if this economy were under a floating exhange rate regime? Explain carefully and illustrate your answers to each part in (ii) using diagrams. [40%]

7 6. Macroeconomics (i) Explain the difference between portolio and transaction theories of money demand. [20%] (ii) Consider the Baumol-Tobin model of the transactions demand for money. (a) Show that the total cost of holding money in the course of a year is given by T C = i Y 2N + F N where i is the interest rate, Y is total spending, N is the number of trips to the bank and F is the cost of each trip. [10%] (b) What is the optimal number of trips to the bank? How much should an individual withdraw each time? [10%] (c) Show that the optimal average money holding is given by M = Y F 2i (d) Define and calculate the elasticity of money demand with respect to (A) income and (B) the interest rate. [25%] (e) According to the model, what happens to money demand if A. the interest rate goes up; B. income goes up; C. there is an increase in the number of cash point machines Provide intuitive explanations for each part. [15%] (f) Evaluate the model s assumptions and its predictions. [15%] [5%] turn over

8 Part B Answer one of the 4 questions in this section. 7. Microeconomics The absence of perfect competition is the only valid reason for government intervention in a market. Discuss. 8. Microeconomics Using indifference curve analysis explain carefully why a worker s labour supply curve could bend backwards. How does a lump sum tax affect the number of hours the individual decides to work? Explain carefully the substitution and income effects. 9. Macroeconomics Is it possible to reduce inflation without increasing unemployment? Explain. 10. Macroeconomics Explain why the real wage may remain above the level that equilibrates labour supply and labour demand. What does this imply in terms of policy towards Unemployment? last page