Answer ALL questions from Section A and ONE question from Section B. Section A weighs 60% of the total mark and Section B 40% of the total mark.

Transcription

1 UNIVERSITY OF EAST ANGLIA School of Economics Main Series PGT Examination ECONOMIC CONCEPTS ECO-7011A Time allowed: 2 hours Answer ALL questions from Section A and ONE question from Section B. Section A weighs 60% of the total mark and Section B 40% of the total mark. Notes are not permitted in this examination. Do not turn over until you are told to do so by the Invigilator. ECO-7011A Module Contact: Dr Jibonayan Raychaudhuri, ECO Copyright of the University of East Anglia Version 1

2 Page 2 SECTION A (Answer ALL questions in this section). Question 1 [30 marks] Consider a model of a closed economy given by: Goods market CC = (YY TT) II = rr where Y is national income, C is consumption, I is investment, and r is the real rate of interest. Government expenditure (GG ) and taxes (TT ) are exogenous and both initially equal to 100. The goods market is in equilibrium when YY = CC + II + GG Money market (MM/PP) SS = 500 (MM/PP) DD = YY 100rr where (MM/PP) SS is the real money supply and (MM/PP) DD is real money demand. The money market is in equilibrium when (MM/PP) SS = (MM/PP) DD (a) What are the equations of the IS and LM curves? [6 marks] (b) What are the equilibrium levels of national income and interest rate? Provide a diagram to illustrate the IS curve, LM curve and the equilibrium. [6 marks] (c) Suppose GG decreases to 50. What are the new equilibrium levels of national income and the interest rate? Draw a graph and explain verbally what is happening in the model. [8 marks] (d) Suppose that GG remains at 50 and that the central bank wants to increase the money supply (MM/PP) SS to bring national income back to the level found in part (b). What level of (MM/PP) SS is required? What are the new equilibrium levels of national income and the interest rate? Draw a graph and explain verbally what is happening in the model. [10 marks] ECO-7011A Version 1

3 Page 3 Question 2 [20 marks] Consider a monopoly with marginal cost MC=6. The inverse demand function is P = 10 2Q where P denotes price and Q denotes quantity. Derive the following (remember to define clearly all variables that you use and show each step of your work): a) The marginal revenue (MR) function for this monopolist. [10marks] b) Compute the profit maximizing output and price of this monopolist. [10marks] Question 3 [10 marks] Define any two of the following: a) Producer Surplus b) Marginal Cost c) Marginal Revenue d) Deadweight Loss of a monopoly SECTION B (Answer ONE question in this section) Question 4 [40 marks] a) Define price elasticity of demand? [5 marks] b) If the number of substitutes of a product increases what happens to the price elasticity of demand for the product? [5 marks] c) What is total revenue? [5 marks] d) What happens to total revenue in the case of a price rise when the price elasticity of demand is (i) elastic, (ii) inelastic and (iii) unit elastic? [10 marks] e) Define cross price elasticity of demand? [5 marks] f) What is the sign of the cross price elasticity if two goods are (i) substitutes (ii) complements? Explain your answers in detail. [10 marks] TURN OVER ECO-7011A Version 1

4 Page 4 Question 5 [40 Marks] James gets utility from consuming only two goods, burger (B) and fries (F). His utility function is given by: UU = BB 0.5 FF 0.5 Where B is the amount of burgers and F the servings of fries. James has an income of 20 and the prices of burgers and fries are 5 and 2 respectively. Answer the following questions: a) Find the marginal utility of a burger? [5 marks] b) Find the marginal utility of an order of fries? [5 marks] c) Find the utility maximizing quantities of burgers and fries? You must clearly state the mathematical rule that you use to derive the consumption bundle and show all the steps in your work. [20 marks] d) Give an economic explanation of the mathematical rule in part(c) above that James uses to choose his consumption bundle. [10 marks] Question 6 [40 Marks] Use the AD-AS model to analyse the short and long-run implications of an unexpected fiscal expansion. You should assume that prices are sticky in the short run. Question 7 [40 marks] Describe the Solow growth model. Your discussion should make clear how the addition of population growth and technological progress to the basic model helps to better capture observed patterns in economic growth. END OF PAPER ECO-7011A Version 1

5 Examination Feedback Module: ECO-7011A, Economic Concepts, Structure of the exam: Answer ALL questions from Section A and ONE question from Section B. Section A weighs 60% of the total mark and Section B 40% of the total mark. Marks distribution: General Feedback: Examination performance was broadly satisfactory. Some general points for observation. Students on the exam did not always provide answers with necessary depth and/or detail. There were some very good, comprehensive answers which were free of the aforementioned deficiencies and were consequently rewarded with high points. Thus, this year's answers were broadly competent, leading to solid overall performance, but many answers lacked the polish and demonstration of clarity of understanding an exemplary answer provides. Feedback by question SECTION A Question 1 This is a simple numerical problem. A brief solution is given below (a) Appropriate substitution into the goods market equilibrium gives, This simplifies to give, Y = (Y 100) r Y = r (IS curve) Appropriate substitution into the money market equilibrium gives, This simplifies to give, 500 = Y 100r Y = r (LM curve) (b) Setting the IS and LM curves equal to one another we get

6 r = r 200r = 1200 r = 6% Substituting for r into either IS or LM equations gives, Y = 1100 Figure 1 shows the IS and LM curves plotted in [Y,r] space. Figure 1 (c) Decreasing government spending affects only the IS curve (note that G does not appear in the LM curve equation). Substituting into the goods market equilibrium gives, This simplifies to give, Y = (Y 100) r + 50 Y = r (IS2 curve)

7 Figure 2 As shown in Figure 2 this is a parallel shift of the IS curve to the left. It is immediately clear that the new equilibrium will have lower Y and lower r. Setting this new IS curve equal to the original LM curve gives, r = r 200r = 1000 r = 5% Substituting for r into either IS or LM equations gives, Y = 1000 Figure 2 shows the IS and LM curves plotted in [Y,r] space. A The decrease in G shifts the IS curve leftwards. If interest rates remained unchanged at 6%, the economy would move to point A. At A however, the economy would be off the LM curve and the money market is in disequilibrium the interest rate is too high for the level of money demand (which is lower due to lower planned expenditure). As income decreases, money demand decreases, and in the money market people buy bonds. This pushes up bond prices, pushing down interest rates. Some of the potential decrease in output due to the decrease in G is offset, via higher investment, caused by the lower

8 interest rate associated with decreased money demand. (d) We need to find the money supply that brings national income back to 1100 (found in part(b)), but on the IS curve associated with G = 50 (from part (c)). The IS curve from part (c) is Y = r (IS2 curve) It is easily seen that for Y = 1100 we need r = 4% So, we need to find the money market equilibrium when Y = 1100 and r = 4% (M/P) S = Y 100r = (1100) (100 4) = 700 The central bank needs to set (M/P) S = 700, and the new LM curve becomes, Y = r (LM2 curve) As shown in Figure 3 this is a parallel shift of the LM curve to the right. The new (final) equilibrium moves Y back to its initial level 1100, but now with r = 4%. Figure 3

9 The increase in (M/P) S shifts the LM curve rightwards. As the interest rate falls this stimulates investment and national income rises until the new equilibrium of IS and LM is once again reached. The initial fall in national income, due to the cut in government spending, is completely offset via higher investment, due to the looser monetary policy (increased money supply; lower interest rate). Question 2 This is a simple numerical problem. A brief solution is given below a) From P = 10-2Q, we have TR = PQ = 10 Q 2Q 2 Differentiating TR we get MR = 10-4Q b) We use MR = MC => 10 4Q = 6 => Qm = 1 and Pm= 10 2Qm = 8 Question 3 These are standard definitions. Examples and diagrams will help in explaining the concepts better. Too many details are not necessary. SECTION B Question 4 These are standard definitions. Examples and diagrams will help in explaining the concepts better. Too many details are not necessary. Question 5 This is similar to a problem done in seminar. You will have to give more details that what is mentioned here. I have worked out the details below. (a) U/ B = 0.5B 0.5 F 0.5 (b) U/ F = 0.5B 0.5 F 0.5 (c) U B U F = P B P F 0.5B 0.5 F B 0.5 F 0.5 = 5 2 Solving we get: F = 2.5B Using the budget constraint Y = P F F + P B B or 20 = 2F + 5B We have 20 = 10B or B = 2 AND F = 5 (d) Here you have to state the marginal principle of optimization : equal values across goods. Question 6 See lecture notes. Question 7 See lecture notes.