University of London 2013

UL13/0027 Page 1 of 5
D1

~~EC1002 ZA d0

This paper is not to be removed from the Examination Halls



UNIVERSITY OF LONDON EC1002 ZA


BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the
Social Sciences, the Diplomas in Economics and Social Sciences and Access Route


Introduction to Economics


Thursday, 02 May 2013 : 10.00am to 1.00pm


Candidates should answer FOUR of the following EIGHT questions: QUESTION 1 and ONE
further question from Section A, and QUESTION 5 and ONE further question from Section B.
All questions carry equal marks.

If more questions are answered than requested, only the first answers attempted will be counted.




PLEASE TURN OVER
University of London 2013
UL13/0027 Page 2 of 5
D1



SECTION A

Answer question 1 and one further question from this section.


1. Answer three of the following questions:

(a) An economy cannot be efficient if capital is not fully utilised. True or false? Explain.

(b) When income and substitution effects work in opposite directions, the good must be an inferior
good. True or false? Explain.

(c) The minimum average cost is the only point where firms choices of inputs are consistent with
productive efficiency. True or false? Explain.

(d) An increase in the cost of travel to work (which is not covered by the employer) would only
cause a reduction in the labour supply at the level of wages where the supply of labour is
backward bending. True or false? Explain.

(e) Monopolistic competition produces a long run equilibrium which is both productively and
allocatively efficient as firms, as in the long run equilibrium of perfect competition, make no
profits above the normal. True or false? Explain.

(f) In the presence of missing markets, competitive equilibria are no longer efficient even though
market prices do reflect social costs. True or false? Explain.



2. Mr and Mrs Iowa own a large farm near Lake Yevtushenko where they produce wheat (w). Their annual
yield in normal years is (w).The price of wheat is given at w p
0
. The price of bread (x) is always a
mark up on the price of wheat: ) 1 (
0 0
z p p w x + = . There are two types of consumption goods: bread (x)
and all other goods (y).

(a) Describe, using diagrams, the initial choice of x and y which Mr and Mrs Iowa will make.
-.(Hint: begin by writing the equation representing their income which comes only from the
production of w.)

(b) In one bad year, they only managed to grow a fraction () of their regular yield. This, in turn, led to
an increase in the price of wheat
w
p which, subsequently, led to an increase in the mark up on
bread. Is it possible that Mr and Mrs Iowa will be unaffected by the change? If so, under what
conditions would this happen?

(c) Back in a normal year, a local bread company, Chlieb, approaches the Iowas and proposes to buy a
fraction () of their wheat at a higher than market price which would then allow them to sell bread
locally at a lower mark-up. Would the Iowas take up the offer? Would they become better off?
University of London 2013
UL13/0027 Page 3 of 5
D1



3. The demand for agricultural products comprises local consumers who need fresh food (x) for their healthy
daily diet and companies which buy the food to be frozen and used for the production of pre-prepared
frozen meals (y).

(a) Show the initial equilibrium in the market for x.

(b) Some foreign companies have now begun to sell pre-prepared frozen meals (y) (consider the effect
that this would have on the price of y). Analyse the effect of this change on the equilibrium price
and quantity of x, spending by local consumers and frozen food companies, and on local producers
of x.

(c) To avoid the effects in (b) the government proposes to provide a subsidy for local consumers that
would offset the initial change. Analyse the outcome of this action.

(d) Others argued that it is better to tax the frozen-meal companies. Analyse the effect of such a policy
and compare the consequences.

(e) How would your answer to (b) change if the frozen-meal companies suffered from worsening
labour relations?



4. The demand for Cruise-With-Clues(x), a journey of learning and discovery through fun and games, is
given by the following inverse demand function: p(x)=10000-2x. The marginal cost of a passengers
journey per cruise is constant (at 1000). The industry also faces fixed cost (F) one needs to maintain a
ship or two which we will leave unspecified.

(a) What would be the market equilibrium if there was perfect competition in the market?

(b) Is there a level of fixed cost at which such equilibrium would exist?

(c) Suppose now that x is provided by one company alone. What would be the equilibrium price and
quantity in such a market? Would it be efficient? If not, could we measure this inefficiency?

(d) Suppose now that another company decides to enter the market for Cruise-with-Clues. What would
now be the equilibrium price and quantity? Show that your conclusion is indeed a Nash
Equilibrium. Would this be a Prisoners Dilemma?

(e) At what levels of fixed cost would the second firm not enter the market?

University of London 2013
UL13/0027 Page 4 of 5
D1


SECTION B

Answer question 5 and one further question from this section


5. Answer three of the following questions.

(a) An increase in demand for liquid assets will have no effect on an economy if it is accompanied by
an increase in the supply of money and prices are fixed. True or false? Explain.

(b) When the marginal propensity to consume increases with income, a transfer of income from the rich
to the poor will have a contractionary effect on the economy. True or false? Explain.

(c) There is no paradox of thrift in a closed economy with flexible prices and wages. True or false?
Explain.

(d) An increase of 10% in the required reserve ratio would lead to an increase of 5% in wealth
assuming that there are no other assets in the economy. True or false? Explain.

(e) An increase in the purchases of foreign assets would necessarily cause a recession in the home
economy. True or false? Explain.

(f) Fiscal expansion will lead to a fall in domestic investment in an open economy without capital
mobility and a fixed exchange rate policy. True or false? Explain.



6. The government of Prudonia announces that from now on, government spending will be divided between
those things which are essential and, therefore, independent of the level of national income and those
which are dependent on the level of national income. The latter, they say, will from now on be decreasing.
Namely, as the economy becomes more prosperous, the overall level of government spending will fall by
the governments marginal rate of spending announced to be
1
g . This is a closed economy with a
proportional tax system.

(a) What would be the multiplier of the economy?

(b) Describe the initial equilibrium assuming prices and wages are flexible.

(c) What would be the multiplier if the government insists on a balanced budget where the tax rate is
adjusted to the required level of spending? Could the balanced budget multiplier, in this case, be
greater than the multiplier without a commitment to a balanced budget?

(d) If initially overall government spending before and after the announcement was the same (i.e.
0 1 0 0
y g g G = ) how would the declared change in government policy affect the economy?

(e) What would be the effect of introducing the balanced budget constraint (assume flexible prices and
wages)?
University of London 2013
UL13/0027 Page 5 of 5
D1



7. A discovery of a rare mineral which has the potential of prolonging lives was made in the main trading
partner of an economy.

(a) What would be the immediate effect that this would have on the economy? Would the immediate
effect have been different had there been perfect capital mobility?

(b) Analyse the short run and long run effect that this would have on an open economy without capital
mobility and a fixed exchange rate regime. What would happen to the long run level of domestic
investment?

(c) How would your answer change had there been perfect capital mobility and a flexible exchange rate
regime?

(d) Would your answer to (c) be different had there been a fixed exchange rate regime?



8. A desert rich economy, Eluria, is exporting refined sand which, it is said, has special healing effects. It is,
of course, an open economy. Assume first that there is no capital mobility but that the exchange rate is
flexible. However, this creates a short fall in domestic investment which leads to a decline in the
economys stock of capital.

(a) How could the richness in sand lead to a decline in the stock of capital of Eluria?

(b) Analyse the effect that this would have on the economy in the short and in the long run (assume that
prices and wages are flexible as well).

(c) Would you advise the government to pursue fiscal or monetary policy to rectify the situation?





END OF PAPER