CITY UNIVERSITY LONDON. BSc (Honours) Degree in Actuarial Science BSc (Honours) Degree in Insurance and Investment. Part I Examination

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1 CITY UNIVERSITY No b LONDON BSc (Honours) Degree in Actuarial Science BSc (Honours) Degree in Insurance and Investment Part I Examination Introduction to Economics Monday 3 June pm pm Answer all 26 questions in Section A, all 10 questions in Section B, and ONE question from Section C. The number of marks for each question and section (out of 100) is given in brackets. Use a separate answer book for each Section. For Sections B and C, use a new page to start each question. SECTION A (Answer all question: 39 marks) In each of questions 1 to 26 inclusive, write down the letter corresponding to the item which, in your view, best completes the statement or answers the question. 1. If margarine is an inferior good, a decrease in income will cause: a) a movement up along the demand curve for margarine b) a rightward shift of the demand curve c) a leftward shift of the demand curve d) a movement down along the supply curve e) none of the above (1.5) 2. Which of the following will shift the supply curve of good X to the left? a) an increase in the cost of machinery used to produce X b) a technological improvement in the production of X c) a situation where quantity demanded exceeds quantity supplied d) a decrease in the wages of workers employed to produce X e) all of the above (1.5) Page 1 of 8

2 3. The magnitude of both the elasticity of demand and the elasticity of supply depend on a) the ease of substitution between goods b) the time elapsed since the price change c) the proportion of income spent on the good d) the technological conditions of production e) none of the above (1.5) 4. Susan is maximising her utility with respect to bread and cheese. If the marginal utility of her last pound of cheese is twice the marginal utility of the last loaf of bread purchased, we know with certainty that: a) Susan buys twice as many pounds of cheese as loaves of bread b) Susan buys twice as many loaves of bread as pounds of cheese c) Susan buys more cheese than loaves, but we do not know how many more d) The price of a loaf is twice the price of a pound of cheese e) The price of a pound of cheese is twice the price of a loaf (1.5) 5. Which of the following statements best describes a consumer's budget line? a) the amount of each good a consumer can purchase b) the limits to a consumer's set of affordable consumption choices c) the consumption choices made by a consumer d) the set of all affordable consumption choices e) the desired level of consumption for the consumer (1.5) 6. The present value of a future payment of money will be higher the a) higher the interest rate or the further in the future the payment b) lower the interest or the further in the future the payment c) higher the interest rate or the nearer the date of the future payment d) lower the interest rate or the nearer the date of the future payment e) higher the interest rate and independent of the date of the future payment (1.5) 7. In which of the following situations will a perfectly competitive firm earn economic profits? a) AR > AVC b) MR > AVC c) MR > ATC d) ATC > AR e) AR > ATC (1.5) Page 2 of 8

3 8. If a profit-maximising monopoly is producing at an output at which marginal cost exceeds marginal revenue, it a) should raise price and lower output b) should lower price and raise output c) should lower price and lower output d) is making losses e) is currently maximising profit (1.5) 9. For an employee who can choose hours of work in response to variations in the hourly wage rate, which of the following statements is true? a) If leisure is a normal good, the income effect of a wage increase will lead to more hours of work b) The substitution effect of a wage increase will lead to more hours of work c) An increase in income tax will always reduce the number of hours worked d) The income and substitution effects of the wage increase work in the same direction e) None of the above (1.5) 10. A price ceiling set below the equilibrium price will result in a) an increase in demand b) an increase in supply c) the equilibrium price d) excess supply e) excess demand (1.5) 11. A decrease in the price of X from 6 to 4 causes an increase in the quantity of Y demanded (at the current price for Y ) from 900 to 1,100 units. What is the crosselasticity of demand between X and Y? (Hint: use the average values of price and quantity). a) 0.5 b) -0.5 c) 2 d) -2 e) a) or b), depending on whether X or Y are substitutes or complements. (1.5) 12. A normative statement is a statement regarding a) what is usually the case b) what ought to be c) the assumptions of an economic model d) the predictions of an economic model e) what is (1.5) Page 3 of 8

4 13. Economic rent is the a) price paid for the use of a hectare of land b) price paid for the use of a unit of capital c) income required to induce a given quantity of a factor of production to be supplied d) income received that is above the amount required to induce a given quantity of a factor of production to be supplied e) transfer earnings of a factor of production (1.5) 14. For a firm using the least-cost production technique, the marginal product of capital is 5, the price of a unit of capital is 20, and the price of a unit of labour is 8. What is the marginal product of labour? a) 0.5 b) 2.0 c) 5.0 d) 12.5 e) 32.0 (1.5) 15. If disposable income rises by 200M and consumption rises by 180M, then we can be sure that the a) marginal propensity to save is 0.1 b) marginal propensity to consume is 0.8 c) average propensity to consume is 0.9 d) average propensity to consume is 0.8 e) marginal propensity to consume is greater than one (1.5) 16. A rise in nominal interest rates matched by an equal rise in inflation will a) lower investment b) lower the demand for money c) lower consumer's expenditure d) lower government spending e) all of these (1.5) 17. The open-economy aggregate-expenditure multiplier for fixed prices and interest rates must a) be greater than one b) be between 0 and 1 c) be greater than zero d) be greater than two e) be less then zero (1.5) Page 4 of 8

5 18. 'Crowding out' may be due to a) lower investment b) lower exports c) lower consumers' expenditure d) higher imports e) all of these (1.5) 19. In the long run with flexible prices a one-off rise in the money supply will a) lower real interest rates b) lower nominal interest rates c) lower real and nominal interest rates d) leave interest rates unchanged e) raise real and nominal interest rates (1.5) 20. In the short run a rise in the money supply will raise demand as a) households spend the extra money on consumption b) the rise in interest rates boosts the value of the pound c) the fall in interest rates boosts investment d) higher inflation encourages consumers' expenditure e) government spending will rise (1.5) 21. In the short run with prices and interest rates fixed a rise in government spending financed by an equal rise in taxes will a) leave aggregate demand unchanged b) boost investment c) raise aggregate demand by the amount of the rise in government spending d) raise aggregate demand by more than the amount of the rise in government spending e) lower output (1.5) 22. The long run Phillips curve a) is vertical b) shifts when inflation expectations change c) is negatively sloped d) shifts when inflation changes e) is horizontal (1.5) Page 5 of 8

6 23. A rise in the exchange rate (an appreciation) a) lower exports b) raises exports c) raises exports and imports d) lowers exports and imports e) none of these (1.5) 24. In the long run with flexible prices a one-off rise in the money supply will a) leave the price level unchanged b) raise prices and output c) leave output unchanged d) raise prices and lower interest rates e) raise inflation (1.5) 25. For given output, a one-off rise in prices will a) lower interest rates b) raise interest rates c) lower unemployment d) lower inflation e) raise inflation (1.5) 26. An adverse supply shock will a) lower prices and output b) lower prices and raise output c) raise prices and lower output d) raise prices and output e) leave output unchanged (1.5) SECTION B (Answer all questions: 41 marks) 27. Explain briefly: a) the relationship between accounting and economic profits, and (2) b) their role in firms entry and exit decisions. (2) 28. Would the output of a competitive industry always be greater than the output of the same industry under single-price monopoly? (4) 29. Explain what micro-economists mean by the long run. (2) Why does supply tend to be more elastic in the long run? (3) Page 6 of 8

7 30. Explain what happens to prices and quantities when the government imposes a tax on a specific commodity. (4) 31. What difference, if any, is there between diminishing returns and decreasing returns to scale? (4) 32. Explain how an increase in the money supply affects interest rates and the level of output in a closed economy with fixed prices. (4) 33. The marginal propensity to consume is 0.5; the average and marginal tax rate out of income is 0.2; the average and marginal propensity to import is 0.2. Calculate the expenditure multiplier for (a) a closed economic with no taxes (1) (b) an open economy with taxes (2) 34. Explain the effects of a rise in government spending on output, prices and investment in (a) the very short run (prices fixed) (3) (b) the medium-run (prices can move: SRAS) (3) (c) the long-run (vertical LRAS) (2) 35. What happens to the rate of inflation in the short- and long-run, if the government tries to keep unemployment below the natural rate of unemployment (the NAIRU)? (3) 36. Explain why monetary policy is ineffective under fixed exchange rates with perfect capital mobility. (2) SECTION C (answer one question: 20 marks) 37. Show how the idea of expected utility can be used to explain the purchase of insurance and lottery tickets by the same person. Page 7 of 8

8 38. There are two possible investment opportunities with cash-flow profiles shown below. Cash flows Year Project A Project B As an investment manager, write a report to your managing director (who has no finance background) explaining which project should be undertaken, and why. (Assume that the projects are mutually exclusive and that the cost of borrowing is 12%.) 39. The market economy ensures that resources will tend to gravitate towards uses where they are valued most. Discuss, and illustrate your answer with examples. 40. Discuss the arguments for an against the use of macroeconomic stabilisation policy. 41. Is an increase in the stock of money the basic cause of inflation? 42. How may governments reduce the rate of inflation? Pay particular attention to the notions of credibility and expectations. Page 8 of 8