EC102_Exam_2009

Page 1 of 25LSE 2009/Ec102

Ec102 Economics B: Summer 2009 ExaminationSuitable for candidates taking 2007/8 and 2008/9 syllabus only

Instructions to candidates:

• Time allowed: 3 hours.

• Write all of your answers on these sheets, in the spaces provided. For multiple choice questions, enter your answer in the blank. For short answer questions, write your answer in the box provided. Material written outside of these blanks and boxes will not be considered part of your answer. Scratch space is provided for the harder questions, but, in general, correct answers can be found with clear thinking and minimal computation.

• The exam has 3 sections: A: Easy multiple choice (24 questions); B: Harder multiple choice (12 questions); C: Short answer (10 questions).

• Answer all of the questions in all of the sections.

• Calculators are not allowed in this examination.

Enter your candidate number here: ___________________

Section A: Easy multiple choice (24 questions, each worth 1 point). Choose the one alternative that best completes the statement or answers the question. Write the letter of this alternative in the blank space at the top of the question.

Page of 25LSE 2009/Ec102 2

Question A1: __________The price of peanut butter rises due to a poor peanut

harvest; peanut butter and jam are complements. What happens to the equilibrium quantity and price of jam?

a) Equilibrium price falls, equilibrium quantity increases.

b) Equilibrium price rises, equilibrium quantity falls.

c) Equilibrium price falls, equilibrium quantity falls.

d) Equilibrium price rises, equilibrium quantity rises.

Question A2: __________What assumptions about preferences were used in our

lecture (and textbook) to prove that indifference curves cannot cross?

a) transitivity.

b) completeness.

c) nonsatiation (more is better).

d) a and c.

e) b and c.

f) a, b and c.

Question A3: __________Geometrically, the average product

a) is the slope of the line joining the origin to the specified point on the total product curve.

b) at any point is the slope of the total product curve at that point.

c) is that point at which the total product curve begins to exhibit diminishing returns.

d) falls at low levels of input use (due to Smithianspecialization) and rises at high levels of input use (due to Malthusian diminishing returns).

e) a and d are both true.

Question A4: __________If the consumer, at her current consumption bundle, on her

budget constraint, is willing to give up 3 units of food (vertical axis) in exchange for 1 unit of shelter (horizontal axis) and food is priced at 10 and shelter at 20, then the consumer is:

a) purchasing too much food and too little shelter for utility maximization.

b) purchasing too much shelter and too little food for utility maximization.

c) purchasing just the right amount of each good for utility maximization.

d) not enough information is given to be able to determine which of a, b, or c above is true.



Question A5: __________If the demand for real money balances is kY, where k is a

constant, then velocity is:a) k.

b) 1/k.

c) kP.

d) P/k.

Question A6: __________If 2 Swiss francs trade for £1, the UK price level equals £1

per good and the Swiss price level equals 2 francs per good, then the real exchange rate is _____ Swiss goods per UK good (fill in the blank):

a) 0.5

b) 1

c) 2

d) 4

Question A7: __________If policymakers are free to analyze events as they occur

and choose whatever policy seems appropriate at the time, then this is:

a) policy by rule.

b) policy by discretion.

c) monetary policy.

d) fiscal policy.

Question A8: __________A rise in government purchases by the rest of the world will

result in the following changes in a small open economy.

a) I ↑, X-M ↓

b) I ↓ , X-M ↑

c) I ↑, X-M ↑

d) I ↓ , X-M ↓



Question A9: __________The demand curve facing a perfectly competitive firm is

a) infinitely elastic.

b) perfectly inelastic.

c) downward sloping.

d) none of the above.

Question A10: __________Let short run total cost be given by TC(Q) = 10 + Q.

Marginal cost equals:a) 10.

b) 1.

c) 11.

d) it cannot be determined with the information provided.

Question A11: __________For production functions with decreasing returns to scale, a

proportional increase in outputa) requires a less than proportional increase in all

inputs.

b) requires a more than proportional growth in all inputs.

c) requires a proportional growth in all inputs.

d) will produce a less than proportional increase in total inputs.

Question A12: __________If the price consumption curve of good X, which is on the

horizontal axis, slopes downward, we can be sure that as the price of good X falls:

a) consumers spend less money on X even though they buy more of it.

b) consumers spend the same proportion of their budget on X, even though they buy more of it.

c) consumers spend more money on X.

d) None of the above is necessarily true, because the information provided does not allow us to determine what happens to the amount spent on X as the price of X falls.



Question A13: __________The ex post real interest rate will be greater than the ex

ante real interest rate when:

a) actual inflation is greater than expected inflation.

b) actual inflation is less than expected inflation.

c) the nominal interest rate is positive.

d) the ex ante real interest rate is positive.

Question A14: __________Two economies are identical except that the level of capital

per worker is higher in Highland than in Lowland. The production functions in both economies exhibit diminishing returns to capital. An extra unit of capital per worker increases output per worker:

a) by the same amount in Highland and Lowland.

b) in Highland, but not in Lowland.

c) by more in Highland.

d) by more in Lowland.

Question A15: __________If the fraction of employed workers who lose their jobs each

month (the rate of job separation) is 0.01 and the fraction of the unemployed who find a job each month is 0.09 (the rate of job findings), then the natural rate of unemployment is:

a) 1 percent (.01).

b) 9 percent (.09).

c) 10 percent (.10).

d) about 11 percent (actually, 1/9).

Question A16: __________When an aggregate demand curve is drawn with real GDP

(Y) along the horizontal axis and the price level (P) along the vertical axis, if the money supply is decreased, then the aggregate demand curve will:

a) shift to the right.b) shift to the left.c) not shift at all, this is a movement down the

aggregate demand curve.d) not shift at all, this is a movement up the aggregate

demand curve.e) not shift at all, this will shift the aggregate supply

curve.



Figure A1: The Situation Facing a Monopolist

Price

1

23

4ATC

MC

MR D

0 A B C Quantity

Question A17: __________In Figure A1, the profit maximizing output level is:

a) A.

b) B.

c) C.

d) None of the above.

Question A18: __________In Figure A1, assuming the short run factor input

combination is not optimal in the long run, the firm should:

a) operate in the short run, but shut down in the long run.

b) operate in both the short and long run.

c) operate in the long run, but shut down in the short run.

d) shut down in both the short run and long run.

e) operate in the short run, but there is not enough information available to determine what it should do in the long run.

Question A19: __________In a short run competitive equilibrium, with labour as the

only variable input, if the increase in output due to an additional unit of labour is greater than the average output per unit of labour

a) marginal cost is greater than average variable cost.

b) marginal cost is less than average variable cost.

c) marginal cost is equal to average variable cost.

d) there is no way to infer the relative magnitudes of marginal and variable cost without some information on the unit cost of labour (i.e. the wage).



Question A20: __________An example of a real variable is:

a) the wage in £ someone earns.

b) the quantity of goods produced.

c) the nominal interest rate.

d) the price level.

Question A21: __________

GNP = £2000, C = £1700, G = £50, X-M=£50, and NFI (net factor income) is > 0. Investment (I) is:

a) £200.

b) < £200.

c) > £200.

d) With the information given, none of the above can be stated with any certainty.

Question A22: __________

Suppose the initial exchange rate is $4/£ and the initial UK and US price levels are both 100. After 10 years, the US price level has risen to 300 and the UK price level has risen to 200. What new nominal exchange rate would be consistent with purchasing power parity theory:

a) $2/£

b) $4/£

c) $6/£

d) $8/£

e) None of the above.

Question A23: __________In a steady-state economy with a saving rate s, population

growth n, and labour-augmenting technological progress g (i.e. the growth rate of the “effectiveness” of each unit of labour), the formula for the steady-state ratio of capital per effective worker (k*), in terms of output per effective worker (f(k*)), is (denoting the depreciation rate by δ):

a) sf(k*)/(n+δ+g).

b) f(k*)/[s(n+δ+g)].

c) [s-f(k*)]/(n+δ+g).

d) nf(k*)/(s+n+g).

e) None of the above.



8

5

£20

4

9

£12

Box A1: Take the following information as true.

7653Supplied

67810Demanded

£18£16£14£10

The quantity of toasters supplied and demanded at different prices is given below. The supply curve is always upward sloping; the demand curve is always downward sloping.

Question A24: __________

Refer to Box A1. The market for toasters will clear at a price:

a) Between £10 & £12.

b) Between £12 and £14.

c) Between £14 and £16.

d) Between £16 and £18.

e) Between £18 and £20.

Section B: Harder multiple choice (12 questions, each worth 3 points). Choose the one alternative that best completes the statement or answers the question. Write the letter of this alternative in the blank space at the top of the question.

LSE 2009/Ec102 Page 9 of 25

Two players, Jack and Jill, are put in separate rooms. Then each is told the rules of the game. Each is to pick one of six letters; A, B, C, D, E, or F. If the two happen to choose the same letter, both get prizes as follows:

A negative prize means a player has to pay; a positive prize means he/she receives a payment. If the two players choose different letters, each gets 0. The schedule of payoffs is revealed to both players and both are told that they both know the whole schedule.

Box B1: Take the following information as true.

-1-23456Jill’s prize

5465-2-3Jack’s prize

FEDCBALetter

Question B1: __________

Refer to Box B1, Jack’s dominant strategy is to pick:a) Ab) Bc) Cd) De) Ef) Fg) Jack does not have a dominant strategy.

Question B2: __________

Refer to Box B1, Jill’s dominant strategy is to pick:a) Ab) Bc) Cd) De) Ef) Fg) Jill does not have a dominant strategy.

Scratch


LSE 2009/Ec102 Page 10 of 25

It is well known that I consume only two products: HaagenDazs Ice Cream (IC) and McVitie’s Digestive Biscuits (DB). I am living in Chicago and LSE invites me to move to London. The price of IC in London is double that in Chicago, but the price of DB is one-half that in Chicago. LSE knows that, in Chicago, I spend ½ of my income on IC and ½ on DB, and it knows that I only consume these two products. Otherwise, LSE knows nothing about my preferences.

Given the information it has, LSE wants to make me the smallest salary offer that will guarantee that, no matter what my actual preferences, I am not made worse off by moving to London (i.e. I am at least as happy as I was living in Chicago).

Box B2: Take the following information as true. Question B3: __________Refer to Box B2. Think about whether, given the limited

information LSE has, LSE should calculate a Laspeyres or a Paasche price index to provide the minimum “no worse off” salary offer. Once you have determined which price index LSE should use, think about the formula for the index and how it relates to the limited information in the box. Finally, conclude that LSE decides to offer me a salary equal to the following multiple of my Chicago salary:

a) .5b) .75c) 1d) 1.25e) 1.5f) 2g) None of the above, i.e. LSE cannot figure out what the

minimum “no worse off” salary multiple is.

Scratch Scratch


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Question B4: __________Refer to Box B2. At an LSE cocktail party, I inadvertently

reveal that, to me, IC and DB are perfect complements. LSE now realizes that it needs to offer me the following multiple of my Chicago salary to leave me no worse off:



Question B5: __________Refer to Box B2. At an LSE cocktail party, I inadvertently

reveal that I consider IC and DB to be perfect substitutes. LSE now realizes that it needs to offer me the following multiple of my Chicago salary to leave me no worse off:



Scratch Scratch


LSE 2009/Ec102 Page 12 of 25

Question B6: __________Money demand is given by M/P = kY – hi, where k and h

are positive constants. Given this, in the AS-AD model with sticky prices discussed in lecture, the AD curve will become steeper (i.e. more negatively sloped) as:

a) k increases and h decreases.b) k increases and h increases.c) k decreases and h decreases.d) k decreases and h increases.e) k increases (h’s value does not influence the slope)f) k decreases (h’s value does not influence the slope).g) h increases (k’s value does not influence the slope).h) h decreases (k’s value does not influence the slope).

Question B7: __________In the AS-AD model with sticky prices, if the fraction of

firms with flexible prices (i.e. which adjust their prices within a time period) is zero, then the short run AS curve:

a) is horizontal.b) is vertical.c) has a slope which depends upon the money demand

function.d) has a slope which depends upon the investment

demand function.e) has a positive slope of 1.f) None of the above is true.

Scratch Scratch


LSE 2009/Ec102 Page 13 of 25

The Earthly Bliss dating service charges £100 per date that it arranges. All of their dates will accept an offer of marriage. In your estimation, the quality of the potential spouses offeredby the dating service can be measured by an index that runs from 0 to 100. The potential spouses are uniformly distributed over this range. You value a spouse at £50 per index point. For example, you a value a potential spouse with a quality index of 25 at £50*25 = £1250

Box B3: Take the following information as true. Question B8: __________

Refer to Box B3. You have a match of quality M (between 0 and 100) in hand. Not counting Earthly Bliss’s fee (i.e. ignoring the £100 fee), what is the expected gain from an additional date randomly drawn from the Earthly Bliss pool?

a) [(100+M)/2]*[(100-M)*50/2]

b) [(100+M)/2]*[(100-M)/2]

c) [(100+M)/100]*[(100-M)*50/2]

d) [(100-M)/2]*(100-M)

e) [(100-M)/2]*[(100-M)*50]

f) [(100-M)/100]*[(100-M)*50/2]

g) None of the above.

Question B9: __________Refer to Box B3. If your dates are drawn at random from

the Earthly Bliss pool, at what value of the index would you stop searching (i.e. if you get a draw with an index greater than or equal to this value, you propose marriage and stop searching).

a) 90b) 80c) 70d) 60e) 50f) 40g) 30h) None of the above.

Scratch


LSE 2009/Ec102 Page 14 of 25

There are three industrial firms in the economy. Their initial pollution levels and individual costs of reducing pollution by one unit are given in the accompanying table. Assume that the cost of pollution reduction for each firm is constant, i.e. the unit cost as given, all the way down to zero pollution. For each firm, neither negative pollution nor pollution greater than the initial level is possible.

There are two possible policies: (a) Mandated levels, where each firm is told to reduce its pollution to a level x (i.e. produce no more than x pollution). Each firm must do so. (b) Tradeablepermits, where each firm is given x licenses to pollute, with one license needed for each unit of pollution produced. In this case, firms may trade (buy and sell) the allowances and produce a pollution level equal to the allowances they own aftertrading is completed.

Box B4: Take the following information as true.

Scratch columns

Box B4: Continued

£1050 unitsC

£2570 unitsB

£2080 unitsA

Cost of reducing pollution by one unit

Initial pollution level

Firm

Question B10: __________Refer to Box B4. With tradeable permits of 30 units per

firm (90 in total), the equilibrium levels of pollution produced, after trading is completed, will be:

a) A = 50, B = 0, C = 40b) A = 50, B = 40, C = 20.c) A = 30, B = 30, C = 30.d) A = 40, B = 50, C = 0.e) A = 20, B = 70, C = 50.f) A = 50, B = 70, C = 50.g) None of the above.

Question B11: __________Refer to Box B4. Compare two policies: (a) Mandated levels

of 30 units per firm (90 in total); (b) Tradeable permits of 30 units per firm (90 in total). Relative to mandated levels, tradeable permits lead to the same amount of pollution reduction at a social cost savings of:

a) 50b) 350c) 500d) -50 (i.e. tradeable permits lead to greater costs)e) -350 (i.e. tradeable permits lead to greater costs)f) -500 (i.e. tradeable permits lead to greater costs)g) None of the above.


LSE 2009/Ec102 Page 15 of 25

Question B12: __________Refer to Box B4. Compare two policies: (a) Mandated levels

of 0 units per firm (0 in total); (b) Tradeable permits of 0 units per firm (0 in total). Relative to mandated levels, tradeable permits lead to the same amount of pollution reduction at a social cost savings of:

a) 1650b) 1700c) 2150d) 2200e) -1650 (i.e. tradeable permits lead to greater costs)f) -1700 (i.e. tradeable permits lead to greater costs)g) -2150 (i.e. tradeable permits lead to greater costs)h) -2200 (i.e. tradeable permits lead to greater costs)i) None of the above.

Scratch

Section C: Short answer (10 questions, each worth 4 points). Write your answer to each question in the question box. You do not necessarily have to fill the entire box.

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C1. Manchester United and Wrexham are two football teams. Each has its own stadium. Say that Manchester United is more famous than Wrexham, i.e. at any price more people will want to see Manchester United play in the MU stadium than is the case for Wrexham in the W stadium (assume, unrealistically, that they always play at home, by themselves – i.e. ignore any issues concerning the opposing team). Manchester United will always fill its stadium at a higher price than Wrexham will. Knowing nothing more than the information given above, is the last statement true or false? Explain.


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C2. Sir Stelios Haji-Ioannou, founder of Easy Jet, credits his success to his understanding of economics. Noting that the marginal cost of filling an additional seat on a flight with some remaining empty seats is zero, he lowered his prices until his planes ran at 85% capacity. Assuming that Easy Jet did not have the possibility of buying smaller planes or changing the number of available planes, why didn’t Sir Stelios lower prices until his jets ran at closer to 100% capacity?


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C3. In the 19th century French railway companies deliberately provided two types of carriages: (1) an expensive carriage with a roof; (2) an inexpensive carriage without a roof. Assuming that the cost of providing a roof was zero, and that having a roof on the carriage made the trip more pleasant for all potential passengers, explain why this was a sensible managerial decision. Although not essential, it may help you to know that in the 19th century poor Frenchmen worked outdoors, while the rich stayed inside, so that, in sunny France, poor people tended to have darker skin.


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C4. Hypothecation is the promise to use tax revenue to achieve benefits for the group who bear the tax. For example, health benefits might be provided to smokers or additional transportation infrastructure to areas that pay a great deal of gasoline tax. In the extreme, if benefits are given to individuals in an amount exactly equal to the tax they paid, this policy allows one to achieve a socially optimal resolution of negative externalities, “internalizing the externality” without the deadweight losses of taxes. Is the last sentence true or false? Explain.


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C5. Taxes always distort, producing socially inefficient allocations and production levels. True or false? Explain.


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C6. The world is filled with two types of individuals: (1) Scrooges (S), who own all the capital, supply no labour, and save and invest all of their income; (2) Cratchits (C), who supply all the labour, and consume all of their income. On a cold winter night, the Ss are haunted by ghosts, and from then on give a fraction of their income to the Cs. The Ss continue to save all of their remaining income, the Cs continue to consume all of what they earn and receive. Is this good for all current and future Cs?


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C7. As a consequence of the current credit crisis, the services and advice of Britain’s financiers become less appealing to firms and individuals in other countries. Ignoring any other consequences of the credit crisis, and assuming that all prices and wages in the UK are flexible, explain what happens to the real exchange rate and Britain’s trade balance.


LSE 2009/Ec102 Page 23 of 25

C8. In the AS-AD short run sticky price model, why, precisely, does a rise in consumer savings (i.e. a reduction in consumer expenditure) lead GDP to fall below full employment output? What I want to understand here is why the classical analysis of a savings change does not go through in this framework. You should assume that the money supply, government expenditure and inflation expectations are constant.


LSE 2009/Ec102 Page 24 of 25

C9. In the AS-AD short run sticky price model, assume that all fluctuations in AD come from fluctuations in investment demand (i.e. investor confidence and expectations of the future). There are no changes in inflation expectations, government expenditure or consumer demand. Under these circumstances, the government can stabilize GDP by targeting the interest rate, i.e. expanding and contracting the money supply to maintain a constant nominal interest rate. Is the last sentence true or false? Explain.


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C10. To achieve a sustained (i.e. long run) inflation rate of zero percent per annum, the money supply has to stop growing (i.e. also grow zero percent per annum). True or false? Explain.

EC102_Exam_2009

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