4QQMN136/146 Introduction to Micro/Macroeconomics

Example exam questions – answer all four questions, which are each worth 25 marks in total

Question 1:

Explain why employers pay a lower efficiency wage when unemployment is high. How would the efficiency wage change in an economy if it became easier to monitor the work that employees did? Other than to incentivise workers to put in effort, can you think of any other reasons why wages might be higher when unemployment is low (i.e. an upward-sloping wage-setting curve)?           [25 marks]

Question 2:

To support the economy against a recession triggered by the Coronavirus, the government is considering increasing public spending. Suppose the government decides to finance the additional spending with new taxes, and to increase taxes   by the same amount as public spending. A critic to the government objects saying  that if public spending and taxes increase by the same amount, no increase in GDP should be expected: what the government gives to the economy is taken back via   taxes.

Use the model of aggregate demand and aggregate supply to study if the proposed economic policy could increase GDP by computing the fiscal multipliers.

a.  Start from the model C + I + G + NX = Y with C the aggregate level of consumption, I the aggregate level of investment, G the level of fiscal spending, NX the net experts and Y the level of GDP. Assume NX = 0 and assume that C = c0 + c1(Y-T), with T the level of taxes. Interpret the economic intuition behind the function for consumption. What is c1? [5 marks]

b.  Derive the equilibrium level of GDP associated with this model. Study by how much Y increases when G increases under the assumption T=G. Does your model predict that Y will be affected by the government intervention?   Why?            [10 marks]

c.  Now assume that NX = X - mY, where X represents total exports and m represents the marginal propensity to import. How does your answer to question b) change? Why?                                    [10 marks]

Question 3:

a.  Suppose you walk into a large supermarket at 2 am with a friend. Your friend says, "I can't believe that these stores stay open all night. Only one out of fifteen checkout lines is open. There can't be more than ten shoppers in this store. It just doesn't make any sense for this store to be open all night." What conditions must be true for it to be to the advantage of the supermarket to stay open all night?                                                [13 marks]

b. Your friend has a large garden and grows fresh fruit and vegetables to be sold at a local "farmer's market." Last year your friend was the only worker in the garden, without any additional workers. However, this year your friend hired a worker and production more than doubled. He comments “Next summer, I think I'll hire another two workers (so total workers including myself would go up from 2 to 4) and my output should again more than double". Is it likely that he could hire more workers and always continue to reap greater than proportional increases in production? Why? [12 marks]

Question 4:

The government decides to place a £25 per unit-subsidy on the sales of books. The initial demand and supply curves for books in this country are respectively:

Qd = 1000 - 2*P and Qs = 3*P + 500 where price in measured in Great British Pounds per book.

a.  What is the pre-subsidy equilibrium price and equilibrium quantity of books?  Illustrate demand and supply curves and the market equilibrium in a diagram indicating the respective intercepts. What are Consumer and Producer Surplus in this market?         [5 marks]