THIS PAPER IS NOT TO BE REMOVED FROM THE EXAMINATION HALL

EC1002 ZA

BSc DEGREES AND GRADUATE DIPLOMAS IN ECONOMICS, MANAGEMENT,

FINANCE AND THE SOCIAL SCIENCES, THE DIPLOMA IN ECONOMICS AND
SOCIAL SCIENCES AND THE CERTIFICATE IN HIGHER EDUCATION IN SOCIAL
SCIENCES EXAMINATION

Introduction to Economics

Thursday 2 May 2019: 14:30 – 17:30

Time allowed: 3 hours

DO NOT TURN OVER UNTIL TOLD TO BEGIN

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.

Graph paper is provided at the end of this question paper. If used, it must be detached
and fastened securely inside the answer book.

© University of London 2019

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SECTION A: Multiple Choice Questions

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.

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Candidates should 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 other
questions ask you to choose which statement IS NOT correct.

5
1. Consider a market where the demand is given by 𝑄 𝐷 = 120 − 3 𝑃 and supply is
1
given by 𝑄 𝑆 = 3 𝑃. What are the consumer and producer surplus?

a) Consumer surplus is 120 and producer surplus is 600.

b) Consumer surplus is 600 and producer surplus is 1200.
c) Consumer surplus is 240 and producer surplus is 300.
d) Consumer surplus is 1200 and producer surplus is 240.

2. Assume that movie tickets and popcorn are complements. Which of the following
statements IS correct?

a) If the price of movie tickets goes down the quantity of popcorn demanded will
decrease.
b) If the price of movie tickets goes down the quantity of popcorn demanded will
not change.
c) If the price of movie tickets goes up the quantity of popcorn demanded will
decrease.
d) If the price of movie tickets goes up the quantity of popcorn demanded will not
change.

3. Which of the following statements IS NOT correct?

a) A tax does not always lead to the inefficient output.

b) Monopolies do not always create a deadweight loss.
c) If two firms compete in prices (Bertrand competition) they will set a higher
price than if they compete in quantities (Cournot competition).
d) A monopolist chooses the price based on the elasticity of demand with
respect to price (PED).

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4. A farm is located next to a steel mill. The cows are free to go into the field but are
hurt by the pollution created by the steel mill, which creates a negative
externality. The profit function for the farmer is 𝜋 𝐹 = 4𝐶 − 𝐶 2 − 2𝑆 where C is the
number of cows the farmer has and S is the amount of mills the steel mill has.
The profit function for the steel mill is 𝜋 𝑆 = 6𝑆 − 𝑆 2 . The two firms merge to
internalise the externality. What are the outputs they end up producing as one
merged firm?

a) C=2 and S=3.

b) C=4 and S=2.
c) C=2 and S=2.
d) C=4 and S=3.

5. Choose the correct statement. The labour supply curve IS:

a) Always downward sloping.

b) Always upward sloping.
c) Upward sloping for monopsonies.
d) Perfectly elastic.

6. Choose the correct statement. Potential output IS:

a) The output demanded by households as consumption and by firms as

investment.
b) The output obtained when there is no unemployment.
c) The output obtained by trading with other countries.
d) The output obtained when all inputs are fully employed.

7. Although investors in a given economy take into consideration the nominal

interest rates when they make investment decisions, in the IS-LM model we
express the level of investment (and so the IS curve) as depending on the real
interest rate. Why is this the case?

a) Because the nominal interest rates are less volatile than the real ones.
b) Because nominal interest rates are determined by the Central Bank.
c) Because prices are fixed in the short-run and so the nominal interest rate is
the same as the real one.
d) Because we focus on policy tools that affect the real (non-monetary) side of
the economy.

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8. In a time of political instability investments fall because of lack of confidence from
consumers. With no change in fiscal policy and no change in the interest rate the
IS-LM model still predicts some adjustments. Assume that this is a closed
economy. Which of the following statements IS NOT correct?

a) Investments will be lower for any given interest rate.

b) Income will fall because of a rightward shift in the IS curve.
c) The new interest rate will be lower.
d) The LM curve will not shift.

9. Which of the following statements IS correct?

a) The real exchange rate cannot be equal to the nominal exchange rate.
b) The real exchange rate depends only on the rates of inflation in the two
countries.
c) The purchasing power parity exchange rate is the path of the nominal
exchange rate that maintains a constant real exchange rate.
d) The purchasing power parity exchange rate can be computed by looking at
the market for one good.

10. What does the convergence theory in the Solow model imply?

a) Rich nations will stop growing.

b) Poor nations will grow slower than rich nations.
c) Growth will only arise if a nation is not in steady state.
d) Poor countries will grow faster than rich countries.

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SECTION B: Microeconomics
Candidates should answer ONE of the following long questions. It is essential that you
explain your answers.

11.
a) What is the difference between a normal and an inferior good? Is leisure a
normal good? What about hours worked (i.e. labour)? (4 marks)

b) Why is the slope of the demand for inferior good steeper than for a normal
good? What happens to a normal and an inferior good when the price goes
up? Show this graphically and explain. (6 marks)

c) What is the effect of a wage rise on consumption and labour supplied? Show
this on an indifference curve graph and explain. (8 marks)

d) How does labour mobility affect the slope of the industry's labour supply
curve? List at least one type of labour mobility. (6 marks)

e) Does a minimum wage always create unemployment? Explain. (6 marks)

12.
a) Define a dominant strategy and Nash equilibrium. Can two firms interacting
with each other have no Nash equilibria if both have a dominant strategy?
(4 marks)

b) Consider two phone producers: Orange and Star. They have two possible
strategies, improving cameras (IC) or improving battery life (BL). The profits
that each firm makes from those strategies are reported in the following table:

Players Star
Orange IC BL
IC -200,-200 200,300
BL 300,200 -100,-100

Is there a dominant strategy for any of the firms? Find all the Nash equilibria
in the game. (6 marks)

c) Now consider a market with the same two firms, Orange and Star, competing
in quantity to maximise their individual profits. The market demand is P=200-
9(Q₁+Q₂), where Q₁ is the quantity produced by Orange and Q₂ is the
quantity produced by Star. The total cost for Orange (firm 1) is TC₁=92Q₁,
while the total cost for firm 2 is TC₂=92Q₂. What are the firms' reaction
functions? What are the Cournot-Nash outputs, price and profits? (12 marks)

d) Orange and Star now decide to merge as they realise that profits will be
higher if they do. What will be the output, price and profit if they do?
(8 marks)

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SECTION C: Macroeconomics

Candidates should answer ONE of the two following long questions. It is essential that
you explain your answers.

13.

a) There is some consensus that following Brexit house prices will drop in
London. If prices do fall, how are banks' balance sheets affected? Why? How
do you expect this to affect the ability of banks to borrow from each other,
depositors and financial markets? (8 marks)

b) Does the fall in house prices affect only house owners and banks? Discuss
the impact of the price decrease on the economy. (6 marks)

c) Now assume that the Central Bank would like to foster investments by
lowering interest rates. What happens if interest rates are already very low?
Will the policy be effective? (6 marks)

d) Some analysts suggest that there might be a bubble in the financial market.
They suggest using a policy mix to reduce the impact of the bubble. Explain
why this might work and show the appropriate shifts in the IS-LM model. Does
the effectiveness of the policy mix depend on the exchange rate regime?
(10 marks)

14.

a) What does the Phillips curve represent? Is there a difference between the
Phillips curve in the short-run and long-run? Explain and show it in a diagram.
(6 marks)

b) What is the impact of a short-term negative shock on output, unemployment

and inflation? Explain and draw a diagram. (6 marks)

c) What is the relationship between the current and capital accounts in a flexible
exchange rate regime? (4 marks)

d) What is Okun's law? (4 marks)

e) Assume that we are in a floating exchange rate regime. The price of oil went
up, driving the economy to a much higher unemployment rate. Use a standard
IS-LM-BP model to explain what happens to income, interest rates and the
balance of payment if the central bank uses monetary policy to stabilise the
economy at potential output. (10 marks)

END OF PAPER

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