This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON EC1002 ZB

BSc degrees and Diplomas for Graduates in Economics, Management, Finance

and the Social Sciences, the Diplomas in Economics and Social Sciences

Introduction to Economics

Wednesday, 3 May 2017 : 14:30 to 17:30

This paper consists of THREE sections:

Section A (40 marks): TEN multiple choice questions, each worth FOUR marks. Candidates
must answer all questions. No explanation is needed.

Section B (30 marks): Candidates must answer ONE of TWO questions on microeconomics.
It is essential that candidates explain their answers.

Section C (30 marks): Candidates must answer ONE of TWO questions on macroeconomics.
It is essential that candidates explain their answers.

PLEASE TURN OVER

© University of London 2017

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Please mark the correct answer in the special multiple choice
answer sheet provided using an HB pencil.

Candidates should write their candidate number in the boxes and then mark up their
appropriate letter and numbers in the grid.

The date, candidate first name(s) and surnames should be written in the appropriate
space.

Candidates should use an eraser to remove any unwanted marks as fully as

possible.

If an eraser is unavailable, please put a cross (X) through the incorrect mark.

The sheets should not be folded or creased in any way as this will make them
unreadable.

Candidates should not write anywhere else on the sheet other than to mark their
answers as shown on the sheet; any writing or marks in an inappropriate place could
make the sheet unreadable.

PLEASE TURN OVER

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SECTION A

Answer all questions from this section.

Choose one answer for each question; no explanation is needed.

Note that some questions ask you to choose which statement is correct and others ask
you to choose which statement is not correct.

1 Figures a-d show long run average cost curves (LAC). Which of the figures shows economies
of scale at all levels of output?

figure a figure b

figure c figure d

Question 1

(a) figure a
(b) figure b
(c) figure c
(d) figure d

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 2 The table shows the total revenue of a firm. Find marginal revenue at each level of output.
Which of the following statements is correct?

output revenue
1 7
2 12
3 15
4 16
5 15
6 12

(a) The marginal revenue from increasing output from 3 to 4 units is 3.

(b) Increasing output always increases profits if marginal revenue is positive.
(c) If marginal cost is 1 at all levels of output then the profit maximizing level of output is
4.
(d) If marginal revenue is less than marginal cost then increasing output increases profits.

3 Which of the following statement is correct?

(a) Congested roads carrying a large amount of traffic are public goods.
(b) If a good is public then consumption by one person does not reduce the amount
available for other people.
(c) A public good is a good produced by the government.
(d) A public good is a good that the government pays for.

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 4 You are told that the own price elasticity of demand for a good is -0.5. Which of the
following statements is correct?

(a) If the price increases by $1 then the quantity of the good demanded increases by 0.5.
(b) If the price decreases by $1 then the quantity of the good demanded decreases by
0.5.
(c) If the price increases by 1% then the quantity of the good demanded increases by
0.5%.
(d) If the price increases by 1% then the quantity of the good demanded decreases by
0.5%.

5 The figure shows a supply and demand diagram. Find the equations of the supply and
demand curves. Which of the following statements about the equilibrium price p and
quantity Q is correct?

p
supply
90

demand

0 30 60 Q

Question 5

(a) p = 75, Q = 25
(b) p = 60, Q = 20
(c) p = 45, Q = 15
(d) p = 30, Q = 10

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 6 Which of the following statements is correct?

(a) The labour market is in equilibrium if there is zero voluntary unemployment.

(b) The labour market is in equilibrium if demand for labour at the current wage is equal
to the number of workers willing to accept a job at the current wage.
(c) The labour market is in equilibrium if demand for labour at the current wage is equal
to the size of the labour force.
(d) It is impossible to increase the level of equilibrium unemployment by improving the
match between the skills employers require and the skills workers have.

7 Use the IS-LM diagram to answer this question. Suppose the government cuts taxes but
does not change expenditure or monetary policy. Which of the following statement is
correct?

(a) The IS curve shifts downwards.

(b) The LM curve shifts downwards.
(c) Income increases but the interest rate falls.
(d) Both income and the interest rate increase.

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 8 Consider a closed economy with no government. Use notation
Y income
C consumption
I investment
S saving
Assume that consumption is given by C = A + cY and Y = C + I where A and c are both
positive and c is less than 1. Which of the following statements is correct?

(a) If c = 0.80 then the multiplier is 0.80.

(b) If consumers become more willing to consume so c increases but I and A do not
change then income falls.
(c) Suppose that c = 0.80. Suppose that investment falls by 10 because investors be-
come less optimistic. Then income falls by 40.
(d) If saving and investment are at their planned levels and S = I then the economy is in
equilibrium.

9 Central Banks such as the Federal Reserve in the USA and the Bank of England in the UK
operate monetary policy. Which of the following statements is not correct?

(a) No central banks ever allows other banks to become bankrupt.

(b) Many central banks control the interest rate but not the money supply.
(c) Some central banks buy both government and private sector bonds.
(d) Many central banks aim to control the rate of inflation. Some central banks are con-
cerned about both inflation and the level of unemployment.

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 10 The UK has a floating exchange rate and capital mobility. The exchange rate between the
US dollar and the UK pound changed from $1.48 dollars per pound on June 23rd 2016 to
$1.36 dollars per pound on June 24th 2016 following the vote to leave the European Union.
Which of the following statements is correct?

(a) The UK pound appreciated relative to the US dollar.

(b) The change in the exchange rate makes it less expensive for UK residents to buy
goods manufactured in the US.
(c) The change in the exchange rate makes exporting to the US more attractive for UK
based firms.
(d) The change in the exchange rate is likely to decrease the rate of inflation in the UK.

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 Section B: Microeconomics long questions

Answer one of the two following long questions. It is essential that

you explain your answers.

Question 11: 30 marks

(a) 8 marks The indifference curve diagram has the quantities of two goods x and y on the
axes. Explain the meaning of the assumptions that the consumer prefers more to less and
has a diminishing marginal rate of substitution. Show in a diagram the indifference curves
of a consumer who prefers more to less and has a diminishing marginal rate of substitution.
Indicate which set of points gives higher utility than the points on the indifference curve.

(b) 6 marks What does the budget line represent? If the price of good x is px, the price of
good y is py and income is M what is the equation of the budget line? Show the budget
line in a diagram. Where does the budget line meet the x axis? Where does the budget
line meet the y axis? What is the slope of the budget line? What happens to the budget
line if the price of good x, the price of good y and income M all increase by 203?

(c) 8 marks Show in a diagram the relationship between the indifference curve and the budget
line at the consumer’s chosen bundle. What is the relationship between the marginal rate
of substitution and the prices px and py of goods at the consumer’s chosen bundle? Show
in your diagram what happens to the budget line and the chosen bundle if the price of good
x increases while the price of good y and the consumer’s income do not change.

(d) 8 marks What is a normal good? Assume both goods are normal. Show in a new diagram
the breakdown into income and substitution effects of an increase in the price of good x
with no change in the price of good y and income.

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 Question 12: 30 marks

(a) 6 marks What is the relationship between total cost, marginal cost and average cost? If
the long run total cost for a firm of producing output q is 2q what is the long run marginal
cost function and what is the long run average cost function?

(b) 8 marks What is perfect competition? Suppose an industry is perfectly competitive and all
firms have the same long run cost function. What is the relationship between the industry
price, marginal cost and average cost in the long run? Explain your answer.

(c) 4 marks Assume that an industry is perfectly competitive. For all firms in the industry the
long run cost of producing output q is 2q. The demand curve for the industry is Q = 6 - p
where p is price and Q is industry output. What is the industry price? How much does the
industry sell? What profits does the industry make?

(d) 12 marks What is monopoly? Assume that the industry is a monopoly which produces
output Q at total cost 2Q. As before the demand curve for the industry is Q = 6 - p so
the inverse demand curve is p = 6 - Q. Write down total revenue as a function of Q and
find the profit maximizing output and price. What profits does the industry make? Are the
consumers better or worse off with monopoly than they are with perfect competition?

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 Section C: Macroeconomics long questions

Answer one of the two following long questions. It is essential that

you explain your answers.
Question 13: 30 marks

(a) 8 marks The aggregate demand and aggregate supply diagram has output on the horizon-
tal axis and inflation on the vertical axis. Explain the derivation of the aggregate demand
schedule from the IS schedule and monetary policy. Why is it downward sloping? Explain
your answer mathematically.

(b) 8 marks What causes movements along the aggregate demand schedule? What happens
to the aggregate demand schedule if government expenditure increases and tax revenue
does not change? What happens to the aggregate demand schedule if the target inflation
rate is increased?

(c) 6 marks What is the shape of the aggregate supply curve if prices and wages are com-
pletely flexible. What determines potential output?

(d) 8 marks Suppose that economy starts at a point where aggregate demand and short and
long aggregate supply are all equal. The central bank then tightens monetary policy in
order to reduce the rate of inflation. Use a diagram to discuss what happens to aggregate
demand and supply in the short and long run.

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 Question 14: 30 marks

(a) 6 marks The Phillips curve diagram has unemployment on the horizontal axis and inflation
on the vertical axis. Professor Phillips of the London School of Economics published a
paper in 1958 showing a statistical relationship between annual inflation and employment
with low unemployment when inflation was high and high unemployment when inflation was
low. Why do economists now believe about the shape of the long run the Phillips curve?
Why is the short run Phillips curve downward sloping? Where do the long and short run
Phillips curves intersect?

(b) 8 marks What is the mathematical relationship between inflation Jr, expected inflation Jre,
actual employment U and equilibrium employment U * that describes the short run Phillips
curve? What happens to the long run and short run Phillips curve if expected inflation
increases? Can governments in this model reduce unemployment by increasing inflation
in a predictable way?

(c) 8 marks What are the costs of anticipated and unanticipated inflation?

(d) 8 marks Is deflation (a negative rate of inflation) desirable?

END OF PAPER

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