~~EC2020 ZA d0

This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON EC1002 Part II 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

Wednesday, 6 May 2015 : 16:00 to 17:30

This is Part II (Sections B and C) of the examination.

Candidates should answer TWO of the following SIX questions: ONE question from
Section B and ONE from Section C.

Part II is worth 50 marks and each of the questions in Sections B and C is worth 25
marks.

PLEASE TURN OVER

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SECTION B

Answer ONE question from this section.

1. A referendum in Love-Thy-Neighbour forces the government of the country to use its tax
revenues to provide every citizen regardless of whether he or she is working with a basic
income (B). This is calculated on the basis of the market value of an essential bundle made
up of units of x and units of y (which are the only two goods in the economy).

(a) Describe the choice that will now be made by an individual who does not work and
therefore, has no other source of income.

(b) Describe how the introduction of the programme will affect the choices and well-being
of those individuals who normally work (and so earn a regular income).

(c) To help fund the scheme, the government levies a tax on commodity x (the less
essential of the two goods). How will the tax affect the choices and well-being of
individuals who rely entirely on their basic income (B)? Analyse the income and
substitution effects for an individual who at first chose to consume the essential bundle.
Will one of the goods necessarily be inferior?

(d) How will the introduction of the tax affect those who work as well as receive their basic
income? Will they be able to continue consuming the same bundle as before? Will their
well-being change? If so, how?

(e) If the purpose of the policy is to introduce greater equity, will it work?

2. The production of Organic Fig-based wine (called Fine) attracts two types of buyers:
environmentally conscious individuals with low price elasticity and carefree individuals (with high
price elasticity). The market is competitive and the government wishes to enlarge the circle of
people who buy organic-based products. To do so, the government proposes to offer a lump-
sum subsidy to the producers.

(a) Draw the initial equilibrium in the market.

(b) Analyse the effects of the lump-sum subsidy on price, output, the distribution of
consumption between the two groups and spending by each group;

(c) Critics of the government have argued against this proposal and suggested considering a
subsidy targeted at the carefree population. Analyse the effects of each of these
proposals;

(d) Assess the implications of the two policies for the welfare of the two groups of consumers.

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3. Consider a monopolist who faces a linear demand. The price elasticity of demand at the
profit maximising quantity is given as -2. The marginal cost is constant at 20, the average
cost at that point is 30 and the profits are 1,000.

(a) What will be the equilibrium price?

(b) What will be the equilibrium quantity?

(c) What will be the deadweight loss created by the monopolist?

(d) If there were two firms in the market, what would be their respective reaction functions?
Would a Nash equilibrium be viable?

SECTION C

Answer ONE question from this section.

4. A vicious civil war in a neighbouring country created an unprecedented influx of refugees into a
country. To deal with the refugees who arrived penniless, the government has had to increase
its transfer payments. Suppose that the country in question is a closed economy (though with
open borders).

(a) Describe the initial equilibrium in the economy before the influx of refugees.

(b) How will the influx of refugees affect the economy in the short run? What will happen to
output, prices, wages and domestic investment?

(c) What will happen to all these variables in the long run? What will be the distributional
consequences if only a few people in the economy have access to income from capital?

(d) How will your answer to (b) and (c) change if the refugees brought skills with them?

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5. A new government came to power in a country with corrupt institutions which stifled
investment. Using sweeping powers, the government managed to cleanse the country from
corruption and in so doing removed a considerable number of bureaucratic obstacles to
investment.

(a) Analyse the effect of this change on a closed economy with flexible prices and wages;

(b) Analyse the effect of this change on an open economy without capital mobility but with
a fixed exchange rate policy;

(c) Analyse the effects of this change on an open economy with perfect capital mobility and
a flexible exchange rate policy;

(d) Would your answer to (c) be different if the exchange rate had been fixed?

6. The aggregate demand for imported goods has a price elasticity which is less than unity.
Analyse the effects of an increase in international prices on:

(a) An open economy without capital mobility and a fixed exchange rate.

(b) An open economy with capital mobility and a flexible exchange rate.

(c) An open economy with capital mobility and a fixed exchange rate.

(d) How would your answers to (a)-(c) change if the price elasticity of demand for imported
goods had been greater than unity?

END OF PAPER

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