UNIVERSITY OF MAURITIUS

YEARLY EXAMINATIONS

MAY 2011

PROGRAMME BSc (HONS) ECONOMICS AND FINANCE – YEAR 1 & YEAR 2

BSc (HONS) ECONOMICS WITH MANAGEMENT – YEAR 1 & YEAR 2
BSc (HONS) ECONOMICS WITH MANAGEMENT – YEAR 3 & RESIT
BA/BSc (HONS) ECONOMICS AND LAW – YEAR 1 & YEAR 2
BSc (HONS) ECONOMICS WITH INTERNATIONAL RELATIONS –
YEAR 1 & YEAR 2
BSc (HONS) BUSINESS STATISTICS WITH ECONOMICS – YEAR 1

MODULE NAME INTRODUCTION TO ECONOMIC ANALYSIS

DATE SATURDAY MODULE CODE ECON 1005Y(1)

21 MAY 2011

TIME 09.30 – 12.30 HRS DURATION 3 HOURS + 10 MINS

READING TIME

NO. OF QUESTIONS 8 NO. OF 4

SET QUESTIONS TO BE
ATTEMPTED

INSTRUCTIONS TO CANDIDATES

There are 2 Sections in this paper: Section A and Section B.

Section A consists of 4 questions. Answer any 2 questions from Section A.

Section B consists of 4 questions. Question 5 is compulsory. Answer any other

question from Section B.

Use separate answer books for each Section.

 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

SECTION A

Answer any 2 questions from this Section.

Use separate answer books for each Section.

Question 1

(a) Compare the effects of the following policies on consumer welfare:

(i) Lump-sum tax.

(ii) Price-subsidy on food

[10 marks]

(b) Distinguish between Hicks and Slutsky approaches to measurement of income

and substitution effects for a rise in price of an inferior good.
[10 marks]

(c) What are the advantages of the Slutsky approach?

[5 marks]

Question 2

(a) Explain the concepts of price elasticity, income elasticity and cross elasticity of
demand.
[8 marks]

(b) Discuss how knowledge of price elasticity, income elasticity, and cross elasticity
might be of practical use to manager of restaurant.
[11 marks]

Page 2 of 8
 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

(c) Suppose John Corporation is a personal computer retailer. The company hires
an economist to determine the demand for its product and reports the following
equation.

Qa = 100 – 2Pa + Pb + 0.5Y

Where Qa is the demand for the company’s product, Pa is the price charged by
the company, Pb is the price of computers from another company and Y is the
income per capita. Suppose Pa = 10, PB =5, Y = 20.

(i) Find whether demand is elastic or not. [2 marks]

(ii) Find the cross elasticity of demand. Are the products substitutes or
complements? Explain. [2 marks]

(iii) Find the income elasticity of demand. Interpret your result. [2 marks]

Question 3

(i) Suppose the inverse market demand curve for a telecommunications equipment
is P = 50 – Q. Suppose there are two firms with constant marginal cost $20.
Assuming they behave as Cournot duopolists, what will be the price and total
industry output?
[5 marks]

(ii) A firm has a production function Q = 100K0.5L0.5. Cost of Labour, w, and capital,
r, are Rs. 30 and Rs. 40. Determine the amount of labour and capital that the firm
should use in order to produce an output of 722 units. What is the minimum
cost?
[8 marks]

Page 3 of 8
 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

(iii) Two firms, A and B, are operating in the US market industry under duopolistic
condition and choose to either produce at “High” price or a “Low” price. The
pay-offs are the profits. Suppose you are the manager of firm A and you are
required to advise the Board of Directors about the following strategic options:

Firm B
High Price Low Price

Firm High Price (17,17) (5,20)

A
Low Price (20,5) (3,3)

(a) If Firm B chooses High Price, what is Firm A’s best strategy and why?
[2 marks]

(b) What is the Nash equilibrium for both firms? Explain. [4 marks]

(c) Suppose both firms decide to come to an agreement to charge a high price.
What measures could you adopt to convince Firm B that you will abide to the
agreement?
[4 marks]

(d) Suppose that both firms produce at “Low” price and each firm makes a profit
of 3. In that context, can you explain this outcome?
[2 marks]

Question 4

(i) Suppose a discriminating monopolist is selling a product in two separate

markets in which demand functions are:

P1 = 6 – Q1
P2 = 18 – 2Q2
The monopolist’s total cost function is: TC = 5 + 2Q. Suppose you have been employed
as the adviser. You are asked to determine the prices to be charged in the two markets
and amount to be sold in each market so that profits are maximized. You are asked to
calculate the total profits to be made from the strategy of price discrimination. What
advise will you give?
[8 marks]

Page 4 of 8
 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

(a) Explain why the government should make provision of social goods. Describe
these goods.
[7 marks]

(b) In Brazil, plantation companies have been clearing high areas of rain forest for
rubber production and caused large fires, choking people and killing many
endangered species of animals. A state of emergency was declared as air
pollution reached dangerous labels. Discuss how economic analysis could find a
solution to prevent these problems from happening again.
[10 marks]

Page 5 of 8
 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

SECTION B

Answer Question 5 which is compulsory and any other question from this Section.

Question 5 (Compulsory)

Determine whether each of the following statements is TRUE or FALSE, or

UNCERTAIN. Justify your answers FULLY.

(a) Let g1 (>0) and g2 (<0) be the marginal propensity to spend of governments in
economies 1 and 2, respectively. Economy 1 applies a lump-sum tax system
while economy 2 employs a proportional tax system. If the marginal propensity
to consume and to import is identical in both economies, the income multiplier of
economy 1 will be greater than the multiplier of economy 2.

(b) The effect of an increase in government spending in a closed economy will be

greater when it is financed by printing money than when it is financed by
borrowing from the public.

(c) The total value of loans in an economy is $400 billion and the reserve ratio is
20%. An increase of $50 billion in the amount of deposits held at commercial
banks together with an increase in the reserve ratio to 25% will leave the total
amount of loans unchanged.

(d) A current account deficit only means that the country is living beyond its means.
It can in no way be a good thing.

(e) The monetarist belief in a long-run vertical Phillips curve implies that an
increased rate of monetary expansion can reduce unemployment below the
natural rate only because the resulting inflation is unexpected.
[5 x 5 marks = 25 marks]

Page 6 of 8
 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

Question 6

The economy of Congolo is in recession. The government is considering increasing its

own spending and financing it by borrowing from the public. Critics argue that it is
always better to use an expansionary monetary policy rather than an expansionary
fiscal policy regardless of how the latter is financed.

Assume that Congolo maintains a fixed exchange rate regime, and that no restriction is
imposed on capital movements.

(a) Compare and contrast the effects of a fiscal expansion financed by borrowing
from the public with a monetary expansion.
[10 marks]

(b) Explain fully how the effects would be different if Congolo had a freely floating
exchange rate regime.
[10 marks]
(c) In light of the above, explain whether the critics’ view is justified?
[5 marks]

Question 7

In a Keynesian-type closed economy with fixed wages and prices, the poor earn the
fraction  of national income. Their marginal propensity to consume is greater than
that of the rich, but only the rich pay the proportional tax (t). The government, which is
committed to a non-interventionist policy, claims that redistribution occurs naturally
through the sympathy of the rich who donate, annually, the fraction  of their income
to the poor. In addition, the government has a strict balanced budget policy where the
government spending depends on the amount of tax raised.

(a) Assuming that the decision on the amount to donate is made on the basis of
gross income, formulate an equation for the disposable income of the poor and
the rich.
[4 marks]
(b) Hence, show that the aggregate expenditure function (E) can be written as:

 
E  c 0  I (r0 )  c1P    1     c1R 1  t 1      1     t 1    Y
[5 marks]

Page 7 of 8
 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

(c) Solve for the economy’s equilibrium level of income and show that the income
multiplier with and without donations is given by:

1
With donation: k 
 P
1
R
1 
1  c    1     c 1  t 1      1     t 1   

1
Without donation: k 

1  c    c 1  t 1     t 1   
P
1
R
1 
[6 marks]

(d) Hence, compare the value of the multiplier of the economy with and without
donations. Provide an intuitive explanation for your answer.
[4 marks]

(e) Critically analyze the impact of an increase in donations to the poor on this
economy.
[6 marks]

Question 8

“Friedman’s expectations-augmented Phillips curve theory helped reconcile the classical

proposition with respect to the long-run neutrality of money while still allowing money to have
real effects in the short run.”

Discuss the extent to which you agree with the above statement.
[25 marks]

END OF QUESTION PAPER

Page 8 of 8