EC1310 Economics for Business 2019/20 Solutions
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EC1310
2019/20
Economics for Business
Section A: Answer ALL questions using Yellow Answer Sheet
1. C
2. D
3. B
4. A
5. B
6. C
7. B
8. C
9. D
10. D
11. C
12. A
13. D
14. A
15. A
16. C
17. B
18. A
19. B
20. C
Section B: Answer BOTH questions
Please use a separate booklet
21. Answer three of the following questions. (5 marks each)
(a) Many factors affect agricultural prices, linked to shifting demand and supply curves, e.g. good harvest, drought, number of farmers, world demand for food, costs of production of food, tariffs/subsidies on products etc. For manufactured products, similar things will have an effect, e.g. costs of production, demand for the product, technological development, tastes/preferences, income, taxes, rents etc. With agriculture the weather and natural disasters can have a much bigger impact on supply than for manufactured products. Also with agricultural products (particularly food), demand is fairly inelastic, this means that any change in supply will have a bigger effect on price relative to that in manufacturing. Therefore the price fluctuations in manufactured products are likely to be smaller than those in the agricultural sector.
(b) The case in the quote holds with CRS, as here when inputs are doubled, output will increase in proportion. But if inputs double, output could more than or less than double, i.e. IRS or DRS. Reward explanation for what CRS, IRS and DRS are. Under the next scenario, we have diminishing marginal returns, as doubling labour causes
output to increase but by less. The cost curves will be:
SRATC looks as above. The reason is that when output increases, the fixed cost effect
is pushing down average costs, but the variable cost effect is pushing them up. At lower levels of output the fixed cost effect dominates and at higher levels of output, the variable cost effect dominates. Consider: TC = b + wQ + wQ2
AFC = b/Q; AVC = w + wQ. As Q rises, b/Q falls, but w + wQ rises, so these terms are in conflict as Q rises.
Therefore we have a U-shaped AC curve. MC will be increasing at all levels of output. AFC will be falling at all levels of output. AVC will be rising at all levels of output.
(c) Economic vulnerability looks at the different things that make a firm susceptible to changing economic conditions. Firstly (Type 1) by facing a steep SRATC curve: this means that if Q falls by a small amount (from minimum AC), the increase in SRATC will be much larger. This means that with a steep SRATC curve, the impact on profit margin and thus on profits will be very big. Type 2 vulnerability relates to changes in external or bought in costs. If a firm is highly dependent on inputs that are purchased externally (e.g. oil) then any changes to their prices can have a big effect on the firm’s costs of production and thus on profit margin and profit. With an airline, they are likely to be vulnerable in both ways. Their fixed costs are typically very high and they are very reliant on things like oil.
The way in which economic vulnerability can be reduced will depend on the vulnerabilities identified.
(d) Oligopolies have a few dominant firms, each with a sufficiently large share of the market to influence market price. They are price makers and face downward sloping demand curves. The product can be differentiated or undifferentiated. Firms are interdependent, so when making decisions about price, output etc., each firm must consider the reactions of other competitors. This means that the outcomes in terms of price and output can be very different depending on how firms compete. E.g. do they compete on price or quantity and simultaneously or sequentially. Price could be set equal to MC in equilibrium or firms could make supernormal profits. Compared to a monopolist, this is just one firm, with a unique product. It will produce where MC = MR at profit maximization and so will probably produce a lower output and at a higher price than an oligopolist, but clearly it will depend on how the oligopolist is competing. For example, if oligopolists are colluding, they could be acting as a profit maximizing monopolist.
22. Answer three of the following questions. (5 marks each)
(a) The marginal propensity to withdraw is 0.25, therefore the multiplier is K = 1/mpw = 1/0.25 = 4. Therefore with an injection of £200 million, national income will rise by 4 times that, so the final increase will be £800 million. If there is an increase in injections, the final increase in national income may still be inaccurate, because it may have under or over-estimated the size of the mpc. Also, with the accelerator effect, when national income rises, this may lead to an increase in the rate of change in consumption. This may encourage firms to invest more. Therefore the final increase in national income may be even larger.
(b) Equilibrium unemployment occurs when the demand for labour equals the supply of labour. It is like voluntary unemployment or the natural rate of unemployment. Examples are frictional and structural unemployment. Disequilibrium unemployment occurs when the supply of labour exceeds the demand for labour. Examples are cyclical/demand deficient or real wage unemployment.
Keeping unemployment low is important as a means of minimizing inefficiency. If unemployment is high, it means wasted resources. It also means less money coming in through tax revenue, both in terms of income taxes, but also VAT etc. as spending will be lower. It probably also means higher benefit payments, so there is a negative impact on government finances. There are also broader costs on the individual and their family, through lost income, welfare effects, potentially LT unemployment can be created, because of a loss of skills and this can be expensive for companies to invest in.
(c) Equilibrium is determined by the intersection of the income and expenditure functions at Y1 in the diagram. If there is an increase in government spending, the expenditure function will shift upwards leading to a new higher level of national
income at Y2. The increase in national income will be bigger than the injection, due to the multiplier effect, which is why the horizontal gap between Y1 and Y2 is bigger than the upward shift in the E function.
An excess demand would have a level of national income to the left of the
equilibrium. J > W and E > Y. This means that a firm would see its stocks dwindling and so would need to increase production. They would therefore take on more workers and this would create more jobs and hence income. As national income rises, we move up the Y function and also the E function, as consumers will start spending more money. But also as some of the extra income would be withdrawn, we would also move up the withdrawals function until we reach a new higher level of national income.
(d) Quantitative easing will push up the money supply so it will shift the money supply curve to the right. The increase in the money supply pushes down the rate of interest and thus decreases the cost of borrowing. As this falls, more firms will invest, ceteris paribus and so there will be a movement down along the investment demand schedule and investment will rise. The increase in investment will shift the injections and expenditure function upwards leading to a multiplied rise in national income, unemployment will fall and it is likely that inflation will rise as AD rises. At the same time, the lower rate of interest will push the exchange rate down, which will increase exports and reduce imports, also adding to the upward effect on national income. The theory behind this effect is straightforward, but it’s very difficult to predict the final decrease in national income, following the expansion of the money supply. One reason is because of the difficulties in calculating the size of the multiplier. Another is the shape of the demand for money curve and its stability. When the money supply rises, interest rates will fall, but by how much? This will depend on the shape of the demand for money curve. Furthermore, when the money supply curve rises, we expect interest rates to fall, but if the demand for money curve shifts to the right, equilibrium interest rates will be pushed upwards and if it shifts to the left, they will be pushed further down. A further problem relates to the shape of the investment demand curve. The more elastic it is, the greater the effect of any change in interest rates on the amount that is invested. Also, whether the investment demand curve shifts due to other factors.
2022-05-12