FACULTY OF BUSINESS AND ECONOMICS SCHOOL OF ECONOMICS EC102: MICROECONOMICS I FINAL EXAMINATION SEMESTER 1, 2009

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1 The University of the South Pacific Serving the Cook Islands, Fiji, Kiribati, Marshall Islands, Nauru, Niue, Samoa, Solomon Islands, Tokelau, Tonga, Tuvalu, and Vanuatu. FACULTY OF BUSINESS AND ECONOMICS SCHOOL OF ECONOMICS EC102: MICROECONOMICS I FINAL EXAMINATION SEMESTER 1, 2009 Time Allowed 3 hours plus 10 minutes reading INSTRUCTIONS: 100 marks (60% of final grade) 1. This exam has three sections: a. Section A: 10 marks b. Section B: 75 marks c. Section C: 15 marks 2. Answer all questions from sections A and B. 3. Answer ONE question in Section C. 4. Begin answering each question on a fresh page.

2 Section A: Multiple Choice Questions. Write the letter corresponding to your answer, for each question, in the ANSWER BOOKLET. Answer all questions in this section. Mark value: Which of the following statements is not a positive statement? a. Federal tax collections should not be greater than 25% of GDP. b. On average, university graduates enjoy 25% more pay than equivalently aged non-graduates. c. Unemployment benefits are higher today than they have ever been. d. Women are not as well paid as men. 2. Which of the following statements is not a valid reason for studying economics? a. The operation of the economy impacts upon each person and it is in our interest to be better informed about it. b. Economics teaches us practical skills that will help us profit consistently from investments in the stock market. c. Economics teaches us how to avoid some pitfalls to straight thinking about public policy issues. d. Economics teaches us the techniques for analyzing the complex economic relationships we encounter daily. 3. Productive efficiency is said to occur when a. resources are allocated to the production of the goods and services most wanted by the society. b. resources are allocated to the production of goods and services that are least costly to produce. c. society chooses the least costly production techniques for producing the goods and services it wants. d. society produces goods and services with the last waste of its labour resources. 2

3 Answer questions 4 & 5 on the basis of the production possibilities data given in the following table: Type of good A B C D E F G Consumer goods Capital goods For the economy depicted in the table, combination A suggests that resources are a. fully employed. b. less than fully employed because no capital goods are being produced. c. fully employed but being used inefficiently because no capital goods are being produced. d. less than fully employed because the economy could potentially produce 30 units of capital goods as in combination G. 5. The production possibilities curve for the economy depicted in the table exhibits opportunity costs that are a. increasing because a rise in capital goods production always implies the same sacrifice in terms of the production of consumer goods. b. increasing because a rise in consumer goods production always implies the same sacrifice in terms of the production of capital goods. c. decreasing because a rise in capital goods production always implies a falling sacrifice in terms of the production of consumer goods. d. increasing because a rise in consumer goods production implies an increasing sacrifice in terms of capital goods production. 6. If buyers believe that the price of car radiator coolant will rise soon, due to an increase in the price of ethylene glycol, which is used to make coolant, the most likely immediate result will be a. a decrease (shift to the left) in the demand for coolant, due to a change in taste. b. a decrease (shift to the left) in the demand for coolant, due to a shift to substitutes. 3

4 c. an increase in the quantity demanded due to a change in supply. d. an increase (shift to the right) in the demand for coolant, due to a change in expectations. 7. If a new technological breakthrough in genetic engineering makes it possible to grow twice as much wheat per hectare as has been possible in the past, the most likely result will be a. a decrease (shift to the left) in the supply of wheat, due to the increased costs associated with the new technology. b. an increase (shift to the right) in the supply of wheat, due to the reduced cost of production. c. an increase in the demand for wheat, due to the greatly reduced price. d. an increase in quantity supplied, due to the increased willingness to sell wheat. 8. Which of the following could cause an increase in consumer demand for product X? a. an increase in consumer income if product X is a normal good. b. a fall in the prices of goods that are close substitutes for X.. c. a decrease in the price that consumers expect to pay for X in the future. d. a decrease in the supply of X. 9. Which of the following statements is not correct? a. In a competitive equilibrium, marginal social benefit equals marginal social cost and resource allocation is efficient. b. Marginal benefit determines demand, and a demand curve is the marginal benefit curve. c. Price and quantity regulations, taxes and subsidies, externalities, public goods and common resources, monopoly, and high transactions costs help to restore efficiency in the market but lead to deadweight loss. d. Market supply curve is the horizontal sum of the individual supply curves. 4

5 10. The fundamental symmetry principle a. translates into equality of opportunity in economic life. b. Is the requirement that people in similar situations be treated similarly. c. Is the moral principle that indicates that you should behave towards other people in the way you expect them to behave towards you. d. Fulfills all the descriptions in parts (a) to (c) above. Section B: Calculations, Graphical analysis and Short Answers. Answer all questions in this section. Mark value: 75 Question 11 a) When the price of tomato ketchup rises by 15%, the demand for hot dogs falls by 1%. i) Calculate the cross-price elasticity of demand. State the formula and show all working. (4 marks) ii) Are the goods complements or substitutes? Explain. (1 mark) b) Explain why the demand for petrol is inelastic, but the demand for a brand of petrol such as Shell petrol, is relatively elastic? (2 marks) c) Comment on the elasticity along a linear demand curve and sketch a diagram to illustrate your point. (3 marks) Question 12 a) Use relevant diagrams to show and explain the incidence of a tax when: i) demand is perfectly elastic ii) supply is perfectly inelastic (5 marks) 5

6 b) The table below gives the demand for and supply of teenage labour. Quantity demanded (hours per week) Wage rate (dollars per hour) Quantity supplied (hours per week) i) Plot the above information on a graph. (2 marks) ii) What is the quantity of unemployment (if any)? (1 mark) iii) iv) If a minimum wage of $7 an hour is set for teenagers, how many hours do they work? Explain and indicate on your diagram. (1 mark) If a minimum wage is set at $9 an hour for teenagers, what are the quantities of employment and unemployment? Explain and indicate on your diagram. (1 mark) Question 13 Suppose the production of shoes is characterized by the production function Q = LK, where Q represents the number of pairs of shoes produced. Suppose that the price of labor is $10 per unit and the price of capital is $1 per unit. Find the cost-minimizing combination of labor and capital for a manufacturer that wants to produce 121,000 pairs of shoes. Show all working. (6 marks) Question 14 a) Profits are profits. They are what is left over once all costs are taken off. Discuss this statement fully, first from the perspective of an accountant and then from that of an economist. (4 marks) b) Explain why the average variable cost curve and the average total cost curve are both U-shaped. (3 marks) 6

7 c) In the short-run, the shape of the average and marginal cost curves is inextricably linked to the shape of the average and marginal product curves. Do you agree? Justify your answer. (3 marks) Question 15 Discuss the characteristic features of a public good. Why will resources tend to be under allocated to the provision of public goods in market system? How can efficient allocation of resources for public goods be achieved? (5 marks) Question 16 Explain how the marginal revenue product of labour is derived. Why does the marginal revenue product of labour decline faster as output increases, when labour is employed in an imperfectly competitive industry than when it is employed in a perfectly competitive industry? (5 marks) Question 17 Using an appropriate diagram, explain why a monopolistically competitive firm is not as efficient as a competitive firm even though they both earn normal profits in the long-run. (7 marks) Question 18 Explain how the regulation of a natural monopoly influences prices, outputs, producer surplus, and consumer surplus. Use relevant diagrams to support your answer. (7 marks) Question 19 List and critically evaluate any two methods that may be used to achieve the efficient use of a common resource. (7 marks) Question 20 Study the pay-off matrix given on the following page, and answer the questions that follow: 7

8 Firm A s strategies Maintain Raise price price Firm B s strategies Raise price Maintain price $4.5m $4.5m $10m $1.5m $1.5m $10m $7m $7m a) Explain the general character of the data given in the pay-off matrix. You should compare each component of the whole table to an element of a game, using the game theory approach to the study of oligopoly behaviour. (6 marks) b) Use the matrix to explain the concept of mutual interdependence. (2 marks) Section C: Essay: Your essay must be of approximately 300 words. Answer ONE question from this section. Mark value: List and discuss any three market structures that you have studied in EC102. Your discussion should include a comparison of the short-run and long-run equilibrium situations amongst the market structures. Justify your views with logical reasoning and support them with fully labeled appropriate graphs. 22. The existence of externalities and the failing of the market to adequately deal with them have serious implications for the achievement of true allocative efficiency within the economy. Critically analyze the above statement. Your discussion should include proper definitions and types of externalities in an economy, and the different methods that can be used to tackle the problems of the externality issue. Justify your views with logical reasoning and support them with fully labeled appropriate graphs. 23. Describe the major sources of economic inequality, and discuss how inequality may be measured. Use appropriate diagrams to fully illustrate these two points. List and critically discuss the measures that may be taken by the Government to redistribute income in an economy. END OF PAPER 8

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