Name ________________________
Final Exam
Economics 503
Fundamentals of Economic Analysis
October 28, 2006
2:30-5:30PM
Write all of your answers on this white exam paper. Do not hand in the blue books.
Multiple Choice (2 points each)
1.
The demand and supply for a product both increase (i.e. both curves shift out).
Which of the following statements is true:
a. the equilibrium price of the product must increase; the equilibrium
quantity of the product must increase.
b. the equilibrium price of the product may or may not increase; the
equilibrium quantity of the product must increase.
c. the equilibrium price of the product must increase; the equilibrium
quantity of the product may or may not increase.
d. the equilibrium price of the product may or may not increase; the
equilibrium quantity of the product may or may not increase.
________B_________
Firms produce more and consumers want to buy more, so output will increase.
But if supply shifts a little and demand shifts a lot, prices will rise. But if supply
shifts a lot and demand shifts a little, prices will fall.
2.
A country’s long-term development strategy focuses on accumulating more
capital equipment without increasing the efficiency of production technology or the
education level of workers. We would expect to see:
a. Increasing returns to capital; Increasing ICOR levels
b. Decreasing returns to capital; Increasing ICOR levels
c. Increasing returns to capital; Decreasing ICOR levels
d. Decreasing returns to capital; Decreasing ICOR levels
________B_________
When technology and human capital are fixed, capital accumulation will have
diminishing returns. More investment will be needed to achieve any increase
in output.
3.
China’s GDP per capita is $2000 while in Japan it is $32,000. China’s GDP per
capita is growing at a rate of 7% per year, while in Japan it is growing at 1% per year. If
this continues indefinitely, China will have caught up within
a. 10 years
b. 20 years
c. 40 years
d. 70 years
_______D__________
China’s GDP doubles every 10 years. After 10 years, it is 4000. After 20, 8000.
After 30, 16000. After 40, 32000. But over those 40 years, Japan will have also
grown.
4.
A firm is termed a natural monopoly when its:
a. average variable costs are initially falling.
b. average fixed costs continue to decline at outputs beyond those sustainable in
the market.
c. average total costs of production continue to decline at outputs beyond those
sustainable in the market.
d. Marginal revenue is less than price.
_________C________
When a single firm can reduce its costs by increasing production until it satisfies total
market demand, it will be most efficient for a single firm.
5.
A monopoly faces a ________________; a perfectly competitive firm faces a
_________________.
a. perfectly elastic demand curve for which marginal revenue is less than
price; perfectly elastic demand curve for which marginal revenue equals
price.
b. Perfectly elastic demand curve for which marginal revenue equals price;
downward sloping demand curve for which marginal revenue is less than
price.
c. Downward sloping demand curve for which marginal revenue is less than
price; perfectly elastic demand curve for which marginal revenue is less
than price.
d. Downward-sloping demand curve for which marginal revenue equals
price; perfectly elastic demand curve for which marginal revenue is less
than price.
e. Downward-sloping demand curve for which marginal revenue is less than
price; perfectly elastic demand curve for which marginal revenue equals
price.
_________E________
When monopolists expand production, they must cut prices, so marginal revenue is
below price; the competitors of the competitive firm make perfect substitutes so they
face a flat price or a perfectly elastic demand curve.
6.
Marginal revenue is
a. the revenue that a firm receives from selling its output
b. the excess of revenue over cost.
c. The extra revenue that firm receives from selling an additional unit.
d. The excess of revenue over fixed costs.
__________C_______
Marginal revenue is the change in revenue per change in output.
The following figure shows a competitive firm’s marginal revenue, marginal cost, and
average cost curves. If the firm were producing Q3, in the short run it should:
P
MC
ATC
Price
Q
Q1
e.
f.
g.
h.
i.
Q2
Q3
Q4
reduce output to Q1 to maximize profit.
reduce output to Q2 to maximize profit
increase output to Q4 to maximize profit
expand output beyond Q4 to maximize profit
continue to produce Q3, which is profit maximizing output
_______E__________
Firms increase their profits by producing more as long as price as greater than
marginal cost. So they should push production up to Q3 and no farther.
7.
Which of the following transactions would be included as part of the expenditure
method of calculating GDP in Japan.
a.
b.
c.
d.
e.
a German expatriate sells a used Toyota to his neighbor in Tokyo
a Japanese fisherman sells fresh fish to a sushi shop in Kyoto
a Japanese miller sells flour to a bakery in Los Angeles
a German expatriate buys shares in Toyota Motor Co.
none of the transactions would be counted.
__________C_______
Exports are part of GDP even if they are intermediate goods
8.
The breakeven point is defined as occurring at a price level equal to the point
where price is equal to
a. the level where the marginal cost curve crosses the average variable cost
curve
b. the highest level of average fixed costs.
c. the lowest level of average total cost
d. all of the above.
__________C_______
The firm will produce at a quantity where price is equal to marginal cost. When price drops to the
minimum of the average total cost curve, it will also be at the minimum of the ATC. When price is
equal to that level, the revenues will exactly equal cost and profits will be zero.
9.
Discretionary counter-cyclical fiscal and monetary policy will both take some
time to affect the economy. We can say that:
a. with fiscal policy the lag occurs before policy is formulated; with
monetary policy the lag occurs after the policy is formulated.
b. with fiscal policy the lag occurs after policy is formulated; with monetary
policy the lag occurs after the policy is formulated.
c. with fiscal policy the lag occurs before policy is formulated; with
monetary policy the lag occurs before the policy is formulated.
d. with fiscal policy the lag occurs after policy is formulated; with monetary
policy the lag occurs before the policy is formulated.
__________A_______
Fiscal policy requires a consensus which takes time. Monetary policy is easily adjusted, but it will
only works when firms adjust investment.
Calculation
1. (5 points) As an experiment, McDonalds raises the price of two of its sandwiches.
The following chart shows the sales per restaurant per week. Calculate the
elasticity of demand for each sandwich using the midpoint method. Will a raise in
the price of either or both sandwiches lead to an increase in revenue? If so,
which?
Before
After
P
Q
P
Q
Big Mac
$12
1200
$15
800
Filet o’ Fish
$20
500
$24
450
Calculate the elasticity of demand for these two sandwiches
Calculate the marginal cost of producing each sandwich is HK$10. What is the
profit maximizing price for each sandwich?
Q2  Q1
.The elasticity of demand is
Q2  Q1
2
P2  P1
. In the case of the Filet of Fish,, the
P2  P1
2
price elasticity of demand is inelastic,so raising the price will increase revenues.
Before
Big Mac
Fish
$12
$20
After
1200
500
% Change in
Demand
Price
Quantity Elasticity
$15
$24
800 0.222222
-0.4
-1.8
450 0.181818 -0.10526 -0.57895
2. (5 points) The GDP deflator index is 116 in 2001. Assuming year 2000 was the
base year, what was the average inflation rate over the period 2000-2001?
Assuming constant velocity and a money growth rate of 15%, what was the
growth rate of real GDP?
The base year deflator was 100, so the growth rate of prices was 16%,
P2001  P2000 116  100

 .16 . We can say that
P2000
100
M t V  Pt  Yt  gtM  gtP  gtY  .15  .16  gtY
 gtY  .01
if money growth was 15%
(7 points) The marginal propensity to consume is .8 and the tax rate is 25% so that
disposable income is .75*Y. Assume that the marginal propensity to import is zero.
a. Calculate the expenditure multiplier. How much would expenditure increase, if
government spending increases by 100?
1
1
1

  2.5
1  mpc  (1  taxrate) 1  .75  (.8) .4
Expenditure increases by 250
b. Assume that output increases to match the increase in the expenditure. Calculate
the increase in tax collection that occurs as a result of the increase in spending.
What is the total impact on the budget deficit that occurs if government spending
increases by 100?
Output increases by 250 and income increases by 250. Taxes increase by 25% of 250
equals 62.5, so the budget deficit increases by 100-62.5 =37.5.
3. (3 points) From the following table, what is the money multiplier (i.e. the ratio of
the M1 money supply to the monetary base) in this economy?
Cash
Reserves
Deposits
100
20
600
Money multiplier = (Cash+Deposits)/(Cash+Reserves) = 700/120 = 5.8333
(5 points) The following table shows a cost schedule and a revenue schedule for a
monopolist which can increases production in batches of 200. Find the profit
maximizing level of output. Calculate the average total cost, the average fixed cost
and the average variable cost at that level of production.
Quantity
0
200
400
600
800
1000
1200
1400
1600
1800
Revenue
0
18000
32000
42000
48000
50000
48000
42000
32000
18000
Total Cost
20000
25000
30000
35000
40000
45000
50000
55000
60000
65000
Marginal cost is always 25. Profit maximization is obtained at Q = 800. Average total
costs are 50. Average fixed costs are 25. Average variable costs are 25.
4. (5 points) The velocity rate is constant over time at V = .5. The growth rate of real
GDP is 5% per year and the growth rate of the money supply is 7% per year.
Calculate the level of the real inflation tax when Real GDP is HK$1 trillion
dollars.
Inflation Tax   t 
M t  V  Pt  Yt 
Mt
Pt
M t Yt
  2Yt when GDP is $1 trillion, the inflation tax is 40
Pt V
 t  gtM  gtY  .07  .05  .02
 Inflation Tax  .04  Yt
billion.
Short Answer
1. (5 points) Assume that the newspaper market in Hong Kong is characterized by
monopolistic competition. The marginal cost of producing South China Morning
Post and Ming Pao are approximately equal. SCMP sells at a price of HK$8 per
copy while Ming Pao sells at a price of $6 per copy. In the long run, would we
expect that SCMP was earning higher profits or lower profits than Ming Pao?
Explain why or why not?
Each of these newspapers are being produced in markets with differentiated goods
and free entry. If SCMP were indeed earning higher profits, new English language
newspapers would enter the market pushing down the demand for SCMP until the
price was equal to average cost. This must mean that the average cost of producing
the SCMP is greater than the average cost of producing Ming Pao. This could be
because the fixed costs are spread over many customers.
2. (5 points) Consider two industries: gravel and gourmet restaurants. The first
produces an undifferentiated product while there are a large number of potential
types of cuisine, each with its own particular qualities. There are not large barriers
to entry into either industry. Explain in which industry firms will be operating at a
scale closest to an efficient level. Why?
The gravel industry is likely to be perfectly competitive. Firms will be operating at a
scale where price equals marginal cost. In the long run, firms will change scale until
the average cost equals price. Marginal cost equals the average cost where average
cost is at a minimum. Firms operate at a scale that minimizes average cost at any
level of demand. The gourmet industry is monopolistically competitive. Firms will
charge a price higher than average cost. In the long run, firms will enter or exit until
price equals average cost. But marginal cost will be below price which is below
average cost. When marginal cost is below average cost, average cost has not
reached its minimum. Firms will produce at a scale below the scale the minimizes
average cost.
3. (2 points) Yao Ming, makes $10 million per year playing center for the Houston
Rockets of the National Basketball Association, discovers that he could spend a
year operating a lemonade stand in his hometown. He can sell 100 glasses of
lemonade at $10 per glass and buy lemon, sugar, water, and paper cups for $1.
Calculate Yao’s accounting profit. What is his economic profit?
Yao Ming makes accounting profits equal to $900. But the opportunity cost of his
time is more than $10 million because the opportunity cost of his time is his NBA
salary. His economic profits are $900 - $10million.
4. (3 points) List the 3 roles of money
iii.
i.
Unit of Account
ii.
Medium of Exchange
Store of Value
(6 points) Americans feel very optimistic and their high animal spirits increase demand
in that country. The US Federal reserve follows a policy of counter-cyclical monetary
policy.
a. Would the central bank in the USA respond with an open market purchase or an
open market sale of government bonds?
To raise interest rates, the Fed must shrink money supply. They would need an open
market sale.
b. Compare the effects of these events on the sales of two firms in Hong Kong. Firm
A is a real estate developer which builds residential housing. Firm B is a company
that makes watches for sale at the best department stores across the world. Which
type of firm is likely to experience the strongest increase in demand as a result of
the two events in the US? Explain the difference in 5 sentences or less.
The open market sale and the high animal spirits push up interest rates in the USA. This
raises interest rates in HK. The high interest rates will have negative impact on
borrowing for housing, but is also likely to have negative effects on consumer durable
purchases. However, the HK Watch company should also receive some additional
demand from the USA export market
Graphing Questions (5 points each)
1. The following table shows information on the Long run average total cost curve
and the demand curve. Plot the following data on a graph. Show the areas of
economies and diseconomies of scale and constant returns to scale. What is the
minimum efficient scale??
Quantity
LR ATC
1
33
2
27
3
25
4
25
5
30
6
38
7
50
Price
Quantity
Demanded
50
1
43
2
36
3
29
4
22
5
15
6
8
7
Scale
Economies
LR
ATC
Scale
Diseconomies
Constant
Returns to
Scles
Q
3
4
2. Some economists argue that the savings behavior is not very responsive to the
interest rate. Other economists argue that savings is strongly affected by the
interest rate. Use the loanable funds framework for a large or closed economy.
Compare the effect of expansionary fiscal policy on the interest rate and
investment in A) an economy in which the supply of loanable funds was inelastic
with respect to the interest rate; with the effect in B) an economy in which the
supply of loanable funds is very elastic. Draw a graph of each theory to show
under which theory there is a bigger impact on investment and under which
theory there is a bigger impact on the interest rate.
r
S
rUS$
2
r
US$
1
S
I
Loanable Funds
Expansionary fiscal policy, a cut in taxes or an increase in spending, leads to an
increase in the budget deficit. There is a drop in domestic saving. An inward shift in
the savings curve leads to excess demand for loanable funds. Market forces push up
the real interest rate, leading to a contraction in investment and an increase in
savings. When saving is inelastic, savings increases by little and the interest rate must
rise sharply so that investment declines by almost the entire size of the increase in the
deficit. When the savings is very interest elastic, a small rise in the interest rate would
attract a lot of extra savings and the interest rate would not rise sharply nor would
investment decline as much.
r
rUS$
2
r
S
US$
1
S
I
Loanable Funds
Use the AS-AD model to describe what happens to output and the price level in the
short-run and the long-run in Hong Kong when US interest rates rise. Show alternate
paths for the economy when 1) the HK government engages in counter-cyclical fiscal
policy; 2) the government does not engage in counter-cyclical policy.
1)
P
YP
SRAS
1
3
2
AD
AD''
AD'
Y
P
YP
SRAS
1
2
3
AD
AD'
Y
2)
Diamonds are discovered in Australia. Foreigners want to buy these diamonds and
need Australian dollars to do so. Draw two graphs of the Forex market: 1)
Demonstrate the effect on the Australian dollar exchange rate if Australian monetary
policy remains unchanged; 2) Demonstrate the effect on the market if the Reserve
Bank of Australia conducts monetary policy to keep the exchange rate from
changing.
YP
S
Supply
Supply′
1
S*
S**
2
Demand
YP
S
Q
Supply
Supply′
1
3
S*
S**
Demand′′
2
Supply′′
Demand
Q
Foreigners need Aussie dollars to buy Aussie diamonds. They will supply more
US dollars to the Oz Forex market, pushing down the price of US dollars in that
market. If the Reserve Bank of Australia cuts the interest rate, then Australians
will switch to US$ increasing demand for US$ and US investors will keep their
funds at home reducing the supply of US dollars in OZ Forex market.
Draw that Curve [3 points each]
1. The graph below shows the cost schedule of a monopolistically competitive firm.
Draw a demand curve which would make this graph describe the long-run
equilibrium of a firm in a monopolistically competitive market. Label the level of
output, Q*, and the level of prices, P*.
P
MC
ATC
Q
2. The graph below shows potential output, the aggregate demand curve and the
short run aggregate supply curve of the economy. Draw the position of the SRAS
in the long-run in the absence of countercyclical policy.
P
YP
AD
Q
3. Draw a money demand curve representing the situation in Japan in 2005.
i
Money
Supply
Money