INTRODUCTORY ECONOMICS

Transcription

1 FIRST PUBLIC EXAMINATION Preliminary Examination for Philosophy, Politics and Economics Preliminary Examination for Economics and Management INTRODUCTORY ECONOMICS LONG VACATION 2013 Monday 9th September 2013, 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. Consider a perfectly competitive firm which produces a single output. (i) Explain the relationship between its long run average and marginal cost curves and draw a diagram to illustrate this. (ii) Explain also and draw diagrams to illustrate: (a) the relationship between its short and long run average cost curves; (b) the relationship between its short and long run marginal cost curves. [30%] (iii) Suppose now that the firm has total cost C = q 2 /6 of producing q units of output, and faces a competitive price p = 4. (a) Draw the firm s supply curve, and find its output. (b) Explain what is meant by producer surplus, and calculate it for this firm. [25%] (iv) Suppose now that for the firm in the previous part, each unit of output inflicts 1 of social damage on the environment. (a) Find the socially efficient level of output, and explain intuitively why the firm produces too much. (b) Discuss what policies the government might use to ensure that an efficient level of output is produced. 2

3 2. Microeconomics Abigail has income, m, to spend on the two things that give her pleasure in life, books and films, which have prices p x and p y respectively. (i) Assuming she has well-behaved preferences, explain carefully, using diagrams: how her optimal consumption bundle is determined; what happens to her consumption if income rises, assuming both goods are normal; what happens if her income falls, and books are an inferior good. [35%] (ii) Bert s income fluctuates from month to month. In August, when p x = 2 and p y = 1, he buys 5 books and 4 films. In September, when p x = p y = 1, he buys 3 books and 7 films. Draw a diagram to illustrate these choices. What conclusions can we draw about his preferences? [20%] (iii) Suppose that Abigail s utility function is u = x 2 y 3, where x and y are the quantities of books and films respectively. (a) Show that her demand function for books is x = 2m and find her demand 5p x function for films. [20%] (b) Find the income elasticity of her demand for books. good? Are books a normal [10%] (c) If her income is 25, and the prices of both goods are 1, what is her consumption bundle? Now suppose that the price of books doubles, but she is given enough additional income so that she can afford her original bundle. How much extra income does she need? Find her new consumption bundle, and draw a diagram to illustrate this situation. Is she better or worse off than before? 3 turn over

4 3. Microeconomics Assume there are only two firms supplying a given market. (i) Describe in detail how the equilibrium is determined in a Cournot simultaneous quantity-setting model. [40%] (ii) How would the firms reaction functions change if the marginal cost of one firm increased? [10%] (iii) With the help of a diagram, discuss how you would expect the quantity and the profit of one of the firms to change if the marginal cost of the other firm increased. [10%] Assume the inverse demand curve for this market is P = 35 2(q 1 + q 2 ), where P is the price, and q 1 and q 2 are the quantities produced by firms 1 and 2. The two firms have no fixed costs, and the same constant marginal cost, 5. (iv) Assuming that firm 1 expects firm 2 to produce a given quantity q 2, write down an expression for firm 1 s revenue and marginal revenue. [10%] (v) Calculate the equilibrium price and quantities in this Cournot model. What profits do firms make? [30%] 4. Macroeconomics A small oil-importing economy has a short-run aggregate supply (AS) function of the form y t = y + α(p t P e t ) where y t is the level output in period t, Pt e the expected price level for period t and P t is the actual price level. y > 0 and α > 0 are constants. (i) Explain why aggregate supply is usually assumed to have this form. [25%] (ii) Using the ISLM model, explain how to derive the AD curve. [25%] (iii) Analyse the short and long-run effects on output, unemployment, the price level and interest rates of (a) an aggregate demand shock, (b) a permanent increase in oil prices. [30%] (iv) Discuss what government policy might be appropriate in the two cases in part (iii). [20%] 4

5 5. Macroeconomics (i) What is the IS curve, and what does it represent? Suppose the components of demand are described by the equations below. C = Y D C is consumption and Y D disposable income I = r I is investment and r is the real interest rate T = 0.1Y where T is tax revenues and Y is national income T r = Y T r are transfers from government to households G = 200 G are government purchases Show that disposable income is Y D = 0.8Y + 200, and find the equation for the IS curve, explaining your derivation. [20%] (ii) Suppose that money demand and supply are given by: M D = 0.4Y 10r M S = 850 Find the equation for the LM curve, and explain what it represents. [10%] (iii) Solve for the equilibrium values of the real interest rate and national income, and illustrate your solution in an ISLM diagram. Show that the government budget surplus is 50. [20%] (iv) Suppose that investors lose confidence in the future profitability of possible investment projects, so that the investment equation becomes: I = r What happens to national income and to the interest rate? Explain and illustrate your answer with a diagram. [20%] (v) What happens to the government s budget surplus when investment falls in part (iv)? Explain the reasons for the change you find. (vi) In public debate one often hears that austerity may be self-defeating. Is that true in this model? What would happen to the budget surplus if government purchases were cut? 5 turn over

6 6. Macroeconomics (i) Draw a diagram to illustrate the Keynesian consumption function, in which consumption C is related to income Y by: C = C + cy where C and c are constant parameters If income increases by Y, what happens to consumption? What happens to saving? How does the average propensity to consume vary with income? (ii) Consider the intertemporal choice model in which households with current income Y 1 and future income Y 2 have well-behaved preferences over current and future consumption, C 1 and C 2. (a) Explain intuitively why, if they can borrow and save at the market interest rate r, consumption satisfies: C 1 + C r = Y 1 + Y r (b) Explain using indifference curves what happens to current consumption and saving if: - current income increases by Y - income in both periods increases by Y. [25%] (c) Draw a diagram to illustrate the situation of a household that is creditconstrained. Will it respond differently to an increase in current income? (iii) Discuss whether the predictions of the models in parts (i) and (ii) are consistent with empirical evidence on the relationship between consumption and income in the short-run and the long-run. (iv) Explain and critically assess the argument that a tax cut will have no effect on aggregate consumption. 6

7 Part B Answer one of the 4 questions in this section. 7. Microeconomics The message from microeconomic theory is clear: governments should never interfere with market prices. Discuss. 8. Microeconomics Why does a monopolist restrict output below the efficient level? Why do competitive firms not do so? 9. Macroeconomics Is there a trade-off between unemployment and inflation? What are the implications for macroeconomic policy? 10. Macroeconomics Should exchange rates be floating or fixed? 7 last page