QI Explain how a reduction in interest rate might affect the level of investment and, asa result, national income? [12°] Interest rate (r) is the cost of borrowing and the return generated on capital; fluctuations of interest rate can set off changes in the level of investment (I) through the transmission mechanism and, as a result of multiplier effect, changes in national income that is usually measured in terms of Gross Domestic Product (GDP, ie. the currency value of al the final goods and services produced within an economy over a period of time) A fallin interest rate results from an increase in money supply (MS) or, les likely, a decline inmoney.demandl (excess liquidity). As illustrated in Fig. 1, when MS shifts outward, interest rate decreases from r0 down to rl, which causes a downward movement along the marginal efficiency of capital (MEC, i.ecrate of return on each additional unit of capital) curve, Investor will invest as long as MEC>r1, for more investmént projects now become profitable as the cost of borrowing falls. Therefore, investment rises from I0 to and the extent of such a rise depends on the value of interest elasticity of investment Yet, this increase in | may not happen when MEC shifts in, Technological advaneement, for instance, may have greatly enhanced capital productivity and hence less units of 1 is needed: both pessimistic expectations may harm Loo Ceteris paribus, Irises with a fall in r, which then drives up aggregate demand (AD=C++G+NE) In Keynesian economies, planned 1 is component of injections (J). Using Fig. 2, we can see a surge in national income changing from Y0 to Y1 asa result of an increase in J, Which is equivalent to an outshift of AD in cases where there is no spare capacity. The extent of such an inerease.is determined by the multiplier. Let's take mpe = 0.8, making the multiplier = 1/(1-0.8) = 5, meaning if any $1bn'tise int will be followed by a $Sbn rise in Y. This is because improved I can create jobs for the previously:unemployed, which then aids their disposable income and then C. The exact change in C will depend on theit marginal propensity to spend which usually is inversely related to income level, As demonstrated before in this paragraph, AD will shift out due to increased C and I. This then gives more income, forming a cycle known as the multiplier effect. But, when all spare capacity is in use, outshifts of AD only produce inflationary pressure. Also, accelerator theory may reinforee the miipier effect. Assuming a fixed eapital-output ratio and constant state of technology, net 1's positively proportional tothe rate of change in Y. Take the ratio =, i. any increase in Y wil require twice as much as net 1. Bu this hon is limited shat firms have stocks to run down and that technology does improve over time. ne In conelusidn, a fallin interest eate possihly will atracFgpS eT Whee ake eS national income but this is only Viable when the ceteris paribus assumption"Spplite’ However huge the impact of multiplier effect and accelerator effect is, it may well be countered by liquidity trap — when the convegtional monetary pales simply don’t work. ? S wd 7 . fended) JoQ8 Discuss the similarities and differences of using spending cuts or tax increases as a result of solving budget deficit. [13°] ‘Asa budget balance = total revenue ~ total expenditure, both spending cuts and tax increases seek to reduce the 2p, the former by diminishing expenditure and the later by improving receipt. Other similarities they share include that they both dampen AD and growth to some extent and that they both ean be specifically targeted at certain groups of people. ‘Their dampening effects on AD is through the downward multiplier process as illustrated on the RHS, one reduces injections (J) and the other increases withdrawals (W). One way how multiplier works is fiscal tightening that results in rising costs of production and hence private-sector layoff’ and public-sector wage cults. will mean People having less income to spend, leading to a lessened AD and even less job creation and income. While the Keynesian theory suggests that tax multiplier is smaller than spending multiplier, in reality, itis often tax-based policy that prolongs recession more. Spending cuts affect public service provision (both quantity and quality), transféi8} infrastructure, etc. Essential services (e.g. police, hospitals) and vital industries (e., electricity, oil) may get underfunded, causing concern over crime and order and thus standard of living, Iti also likely, however, that the publie sector provision can become more efficient and productive via restructuring and downsizing. While equality issues atise — this policy harms the poor more when infrastructure construction requires less workers and poverty welfare and unemployment benefits are cut ~ this policy certainly can work with specificity. Idle workers can be incentivized to seek jobs and improve their employability, given less unemployment benefits; outsourcing encourages competition, specialization, and thus efficiency — both will then contribute to more tax receipt as workers who are newly employed earn and firms that are newly Founded or expanded produce. This also betters productive capacity and potential growth, and less crowcling out will further this betterment Tax hikes impact inequality less as direct tax usually iS, by taxing wealth and luxuries, indirect tax can be progressive. There are other problems, However. Ineome taxes disincentivize workers who may opt for more leisure or jobs in parallel economy when tax fate goes beyond a certain percentage (60%, e.g.). France is one of the best examples: its 75% highest tax rate causes outflow of wealth and capital in addition to slacking-off. So direct tax hikes can be futile ard even counterproductive, Indirect tax hikes work when the supply and demand of the taxed products are relatively pride,inelastic since area ©) > area®). Yet, avoidance schemes and substitution effects often develop, JeaVing taxsyield unchanged or decreased; widening tax base and taxing necessities like food will have to harm equity too. Jn conclusion, tx-based approach is less preferred wherpas the spending-based alternative has milder side effects and gives way to growth in the long run. tae ag ealQ13 For what purpose do people demand money? [12°] People can hold either money or other assets e.g. houses and bonds. According to Keynes, there are three main purposes for holding money, i.e. transactions demand, precautionary demand, and speculative demand, ‘Transactions demand (T) occurs when money is needed for day-to-day transactions. As money works as a medium of exchange, a unit of account, and a standard for deferred payment, money can facilitate the trading of goods and services, The level of T depends on a range of factors. t increases whenever people have more disposable income (assuming mpe is constant), prices rise, or people are less willing to use credit cards. The frequency of income payment also plays a part: assuming a household earns $6000 every 12 weeks‘afhd uses this Up at @ constant rate, as illustrated in Fig. 1, the average money holdings rises when paid less frequently Precautionary demand (P) is when money is held in case of unexpected emergency, e.g. diseases and ‘unemployment. This is because money is highly liquid and thus suitable for instant use anctadjustment. increases with income and prices as people usually evaluate how much money is needéd basédon how much they am and how much they can potentially purchase; expectations also mater, «-ghen pedple expt prices to rise or joblessness, they'll need more. Speculative demand (S) is the money held in place of other financial assets like borids bécause their prices are expected to fall, Money, as a store of value, is an asset whose demand depends on its rate of return and ‘opportunity cost, While money holdings provide no rate of return, their opporttinity cost is the interest rate (r) forgone on return-generating financial assets, This r, Keynes-argued, is. inyersely related to the bond price. This is because as r rises, an after-market bond's coupon rate (whichtis fixed) becomes less attractive to return maximizing investors: the price of bonds will have to decrease enough to match the same return yielded by the prevailing r. Therefore, at a high r, investors expect it to fall and bond price ot rise and so switch out of money into bonds; conversely, at a low r, they expect the opposite and add to their cash balances to avoid capital loss Not only is $ inversely related to interest rate, but $ also depends on investors? aversion to risk and expectations of future interest rate and inflation, The total demand for money isthe summation of 7; P, and Sas represented in Fig. 2 + "Q14 Is the existence of a trade union likely to be the main factor that affects the supply of labor? [10°] ‘One of the factors that influence the supply of labor to an industry isthe activities of a trade union. The interests of the employees are commonly presented by representatives of a trade union to which the employees belong. It ‘works via collective bargaining with employers, aiming at reaching agreements to regulate working conditions. Its powerfulness varies from case to case, while other factors are at least equally significant; when it comes to individual supply of labor, it hardly has a say. ‘Trade unions can be exclusive and inclusive. Exclusive ones prevent workers from employment unless they become members by making closed-shop agreements, thereby restricting entry into the industry. So, the supply of labor is made to shrink. Inclusive trade unions, however, alters the labor supply in an industry via minimum wage setting. With a minimum wage of W2 set well above the equilibrium wage of W1, the normal supply becomes operative only when W>W2. How significant a union can be depends on how dense its membership is, how tolerant the legal environment is towards industrial actions like strikes and protests, the pattern of employment, etc, all of which differ from place to place. Take China and UK. Having little independence and permit, China’s Unions are literally impotent; In UK, union members’ hourly earnings are.16.7% higher than non-members. In all, there is an ongoing trend of decline in union power. Other factors count too. Some occupations like physicians, professors, and lawyers, demand high entry qualifications that take years to complete, so their supply of labor is terribly constrained and inelastic. High salaries and non-pecuniary (e.g. longer vacations, better working environment, respectable status, and job security) benefits add to the attractiveness of jobs like teachers as they are associated with higher living standard; rewarding jobs therefore reap the benefit of abundant labor supply. Moreover, when skills are transferable among various jobs available, the wage rates and non-monetary benefits of altemative choices become an influential factor. In the long run, all the factors discussed are.contihgent tipon the size of the workforce as a whole. Lastly, individual labor supply is independent ofthe existence of unions. The backward bending curve shows @ labor-leisure tradeoff facing any worker. The decision whether to work or not relies on the interaction between income effect (D) and substitutiot€ffect (®). Below WI with wage increasing, it is more expensive to have leisure because the opportunity cast equals the Wage forgone; the curve is upward sloping (Bis stronger in effect), Above W2, even higher wages would:disincéntive workers as leisure now is more affordable, giving a countervailing shape (@) dierweighs 2) In conclusion, the existence of a traile union is not likely the main factor of labor supply considering the many distinct categories of labor supply and the respective importance of each of the multiple determinants Fempleyrael OG, H enleymet Hous werd Inclusive Thiivideal Labor Suyply Exclusive 2 eeeQI5 Discuss how the theory of wage determination through market forces might need to be altered when trade unions exist in an industry. [15] When trade unions and monopsonists don’t exist, wage depends on the demand and supply of labor to an industry which differ from one market structure to another A perfect market assumes a large number of firms and employees; each firm is a wage taker, ie. it ean hire as many employees as it wishes at any wage but has no influence over the market demand for labor and thus the cquilibrium wage rate; there is perfect knowledge and perfect geographical and occupational mobility that allows people to move between jobs at no cost; all firms are profit maximizers, workers wage maximizers. I. this model, the equilibrium wage (WO) is the value of the marginal revenue product of labor (MRPL) to thé firm, which equals fo marginal physical product of labor (MPP, extra output as a result of new employment of one unit) multiplied by marginal revenue (extra revenue = price), ot MPPXP. MRPL represents the change in tofal revenue eamed by a firm that results from employing one more unit of labor, showing the demand for labor of an individual firm. As each firm is a wage taker, WO is set by the industry demand for and supply of labor (DL and SL) while firms can hire as many as they want fo at WO; as shown in the diagram, a firm’s MRPL deteriifies the level of employment it will provide for jobseekers, i.e. LO, causing wage differentials. ae Ina market where trade unions exist, the labor supply is kinked as the inclusive unions impose minimum wage of WI. The minimum wage forces the normal supply curve to be horizontal, of perfectly wage-elastic, when W MRL, meaning that it costs more to employ than what the recruits can contribute In conclusion, a firm will hire up t6'@ point where MRPL = W = MCL. mor MPPBe rece Q23 Discuss whether the marginal revenue productivity theory of wages is useful in explai [13°] {Adapted from Q15, so please refer to the diagrams in Q15} ing wage determination in an imperfect market where there is a trade union. A perfect market makes a range of assumptions and gives an outcome as demonstrated in Q22. When a trade union is introduced, the marginal revenue productivity theory of wages is hardly useful When the union imposes the minimum wage, it forces the normal supply curve to be perfectly wage-elastic, when W experts thal ove often” i, primary prpbyyets in Orads far L0G, wher offen ringert capt goods yY and Pier, igh value 7 rebattiy sa onde defrst ofen ; rowsened ‘by changes in clitmebeh oad seasond oid ‘uninproved by f Charges in frame bad price pm “irwere phelestic) Lastly , Aaverer Pmportarr FPL aod MNCs for derelapment , the Black of siyperticg systems, act inseititions, aad infrostrodtuce , (he vackitel. bebor foree, teprar (rig covirennank Corine, Meabtheate, Sanitation , tu anal ef facts alia tnay deter MOVES oad iuesfors from enteciy DLE to exploit ater undeecliped rereorces... In cleelyyed conatiles, honeser, Maly per. All hase cifecnes descased obo show the wbiboey useclusyy of Sera crdicctors, Real OP por Capita afistel to pup Fells theame lees lobeineme nations have e Jigen SIS OF am . th ince 7 ME US oad ridedle inesme jin butween ; combined bith nfornstin fm bu, HE cen Penghly sex which Ceteyony on eunarnt Fails mate . Gren detec ndteates ove EP HPL Biles conssts of Poor, (reatieg rber, ond life expestony GPL 1S Ay for the mest comprrhinsnn. , compesing adding household podantion, Hee eae a oe bepeadeioces , ond “ wept tne j bo considers Clivate tm fellvstence fens ov safer Nesters WS), th wrt aavrete ps qurcleping canaries (atk, mony nhl. berg baicened Sth The calcpme dye diy on Prinong sector woh aii oper duloped camines 4 dlafrreency [pn 1 cunemplay ent nagneliy met senmic. tod Souk tencitns silustonted log GPLQ38 As an economy develops, the relative importance of different sectors of production changes. Explain, with examples, why the pattern of employment might change as an economy develops. [12°] (dst espa on (37 tsfine)Q39 Explain the effect on national income when there is an increase in spending on infrastructure. [10°] A chief component of national income, infrastructure spending on projects like road-building can trigger the multiplier process that dramatically improves national income. Such spending provides job opportunities for construction workers, architects, engineers, concrete producers, etc, offering them more disposable income with which they can either spend or save and turn into another person's income. This can make the large number of low-income laborers better off, who have a higher margisial propensity to consume (MPC=delta consumption” delta income), so there may be a significant injection into the whole economy, and, together with increases in government spending, national income rises frontv¥I. to Y2. (See Fig. 1) w Wd t J ; 8 J Yo : Cey,.2 ' ‘The exact increase in income depefids on the size of the multiplier which equals 1/(1-MPC). Assuming MPC=0.8, then multiplier = 1/0.2 = 5, meaning per dollar spent on infrastructure would see a 5 dollar increment in Y eventually. ‘This is understandable because with improved consiimption, aggregate demand is driven up and thereby pushes suppliers to produce more, given spare capacity; then the overall improvement in output gives rise to jobs and income again this cycle continues on and on tll the theoretical 5-times rise is achieved. In conclusion, through the multiplier efféctexplained above, spending on infrastructure can serve as a greate stimulus to national incotne whenever MPC is closer to 1 than to 0 which is usually the case.Q40 Discuss whether the old and new approaches to trade of the developed and developing countries would help achieve the conservation of resources. [13°] Deneoped, canines sucech fnm odtvvating Fair Trade reduerg Unport 11 an atttempt to Cangerve resources, Both eyprisckss , actooly Gn mut this end. Fair Trade eneawages sptecolintion Whidh may realeee abedete. Or Crnpornbrm. advooaropes of he trade awstnig $0 that thy oven Production) centnerption band a5. cnproved With the Same ammomt of Moat tobe resowvers, Far exaanyle , cmnigh ong atther produce Fe haaits of ford or produce | anit of cars ((csustip) Food” Cars ith etch nit input, Guntry & can either produce Funity of trod ov pride 4 wig ANS, maming hos to Saccifite the Preductton uf 2 wits fod for eth unit Gos So BY enjoys 0 comparstive aduontaye th a - fol polactine thas 8 Ast alate Be, abe Bote n bh fod mal ov prodution, Yo! Sino As illistrated, then spostnlisation onees plot, Cash e a Cee, an i ing vad welfare gains of opord production. So rp as the tenisgortation cast plus oxtecnalities (eg. olution and raise) Gor be internslted jn Pricing and wephs (oss than the pater realfove garry fam toudes thy) old ayyrocch can AWK Ce MAXIE Pesousce Utrtlizatran, There tks however, ceiticwonS atwas thy 0 being that it dwounts thous Eee = oy ee may coeur oad onvble industrvey ty denslay FP teaciinptorton sdovstge Il Se Gretel oF sauce, aad fod a. Done Vs sos peages ia EE Afloxt8.” iadustrig. insensirive te aA Taare ee Sheba [Cocrmetins can make, Carport Specialisation f Unpitert tao 7 fe ther, abuartefes dapih jhe Chat 014 srrolevoat~a beter . Pola Corser vafion.- n ov The ree epprovch reduces pesoibces ighsed tin bonged Envvvonrentelty Asempd Prdustion proccses often onplyed bg Os 5e9 kxtrationom |B Pmazonion aad othr uscatanafie oF tnwme geruration). Yor, f has oft own Probing Freda, can be much deArer as dowloyed contres’ Labor 0 opie ‘andj vrebathy wasetiod to Certain production [hat cleperhs om AOWUted Ove Ne ntred to prince Ce provions hy derived " while producers in LDes ave’ Wt wal wnried xcaAS thei tvuld be wasted , Wwhrh rs 4 clone sim 2 es allocstan sod ssaste. Ty ip very baby thet the decone th f wn oad ksposal cost, yp wilh cuauely the Concerning tpmsperts Gott , fhough v3 prsilts fetcken consumer dermondy aad prefers Iny 6 Acsardbing ly vem the-Long run. patel 1 Miploitorien of workers in LOGS andl mismaragerst ; rawurces Gare net eddrased b4 chi's onpra at butt , ggraatel § bore at wurst bease the uk of 6 aiyerts pow heaae He Goorkery iy Des wit even fers crwme and exporting rrdustes pity * aps reve, with whith they auld clenlay better coays to produce , 3 AS Stich, Jive cndgumerts «fe. of ro help aa of prod inthe of \ i In conclusion, the two approaches work in different scenarios that are both possible to conserve resources. Unless the costs of solving pollution and transportation, the time period concerned and changes in demand and supply conditions within, etc, are specified, preferences for the approaches remains uncertain.O41 Assess the effectiveness of economic growth as an indicator of how a country’s standard of living compares with other countries’. [13°] Standard of living (SOL) indicates a nation’s ability to better the social and economic welfare of its citizens resulting in an improvement in the quality of life. Economic growth, adjusted to inflation and Purchasing Power Farity is one ofthe useful measures of this important concept. This essay wil focus more on its ineffectiveness, though, by giving its limitations and some better alternatives like GPI. How can economie growth give usa glimpse of discrepancies in overall well-being of various countries? As SOL is largely composed of material comfort, growth comparisons can give us insights into a country's capability to catalyze growth and improve social-economic welfare. Growth provides citizens with a larger quantity, a fuller ‘ange, and greater choices of products, the consumption of which enables better lives. Alternatively put GDP increases are equivalent to income increases that make quality goods and services affordable and state benefits and subsidies more accessible, Consider South Sudan (real growth «47,5%) and Nigetia (46.6%). I's clear that SOL is significantly higher in Nigeria and the investment in human capitals and infrastructure required for growth is helping SOL too. Yet, this interpretation can problematically distort the picture. First off, pfoductiontand income are never a comprehensive representation of al other important factors of SOL. Grovih may be unfavorable: it may accelerate resource depletion; cleaning up pollution actually adds to GDP and growth. Further, reduced leisure ‘ime brought by lengthened working hours and postponed retirement age increases the quantity of human tssources available for boasting production while inevitably severing comfort and hence SOL. It ignores inequalities and chances are that only the richest few are benetiting from growth, Nowhere js information directly linked to health (eg: life expectanéy), education (eg. literacy ratio, dropouts), and crime found in growth calculation. Further, GDP figures exclide transfer payments (welfare, subsidies, and aids), volunteering work, household production, underground economy, et. all notable in determining SOL differences. Black market, for example, siccounts for more than 40% of Nigeria’s GDP and much less for more developed countries. Also, poorer countries often have Tess developed national statistics schemes, so the income Faures can be unreliable, Compositeindices such as Human Development index (HDI, life expectancy at birth aul literacy rate, gross enrolmeit ratio, and GDP per capita) and Genuine Progress Indicator (GPI, adjusted to inequalities and including al the important bt let-out aspects of SOL like household production, leisure rime, and pollution) are two examples of better alternative indicators of SOL. Moreover, growth'is misleading, USA's growth rate stays at around 3%, China’s 7. .6%; that China is emerging and America stabiliziig does not automatically lead to the conclusion that SOL is higher in China and we don't know the absolute size and vitality of the economy with just growth figures which are but comparative. Growth tls nething abut population size and real GDP per capita; ina globalized world, growth is often a product of Volatile fluctuations in Oil prices and exchange rates, Last butt east} making international comparisons is always inaccurate due to diversity of climates, cultures ete To illustrate: Canada may experience an increase in growth when rigid winters come — heating consumes energy! Another extmple is America vs China. Chinese prefer to save and Americans, ingrained with consumerism, prefer to spend, which is irrelevant to SOL. | conclusion, growth isnot a satisfactory indicator of one country's SOL compared with another’s, because its only remotely related to differences in the level of material well-being and, even worse, barely related to how well People in different nations can enjoy equity and decent health, education, environment, and leisure. Growth is ‘more useful (only marginally, though) in showing if country’s citizens are better off overtime, and HDI and GPI are better choices for intemational comparisons,Q42 Discuss whether the economic theory of wages can explain how workers in a vial industry such as the fire-fighting service can have lower pay than workers in a less vital industry such as entertainment. [12°] The economic theory of wage stated that wage peidto workers equals to the marginal revenue Product of Labor (MAPL]. MRP} is the increase in total revenue by hiring additional unit of labor; itis the result of Marginal Physical product multiplying marginal revenue of product. MPPis the increase in total product by hiring additional labor, which is influenced by labor productivity; ioe ease and MRis the increase in total FeCGhUE by selling Sdditonal unit of product, MR is influenced by the demand for the goods and fervices produced by labor. For any profit maximizing firms, their demand for labor is determjnedt by MRL fAcdording to the theory, wage differs because of different productivity and pi YSIue of their product produced (diagramf{) a Labor ‘the theory AUMCE perfect competitive market in which both demand/side and supply side have no power to influence wage rate; employers are profit maximizey/and workers are wage maximizer. It also assumes labor productivity can be clearly measur Ina world gfjabor bgjag pertectymobile with perfect information’ there should be no wage differentials, because of labor being able to quickly move froprlower paid job to higher paid job immediately. Everybody is paid at the marginal revenue oMfabor of theeconomy. If itis not, which is the reality inreatworld; wages differ from ipddstry to industry because of different MRPLin each industry and different labor supply. wepsoui ape pay o-npstncexpiinans tien woee of singers, Their service isnot as vital ad frenightne, but they mephave crested high marginal revenue for their firms. Especially in 3 fast growing economy, people with rising disposable income would love to spend more on ‘entertainment. Increasing demend for their service leads to higher price of their service, hence higher marginal revenue product of singers. The profit maximizing boss of entertainment firm hence would be willing to pay high wage-or singers as long as their MRP is greater or equal to the wage paid fee rirefighters’ service is vital to the whole society, but their employers are government which is not a profit maximizer, and their service is public goods which is not traded in the market therefore there is no market value. These cause problem to apply theory to analyze fefighter's pay.‘Wage is influenced by the MRPL in market; however, it is not only thing to influence the wage. Many other factors can also cause wage differential among industries 'n theory, supply of labor to an industry ig also an important one, Labor supply to an industry Can be influence by the number of qualified people, the non-wage benefit or cost of a job, if the Barriers of entry to a job are low, thea many People will be qualified, the labor supply will be large, and hence lower the wage rate, in the entertainment industry, the supply of talented Singer's limited, that again might explain the record-high salary of a few famous singers, However, the supply to firefighting industry might be much larger since many people have the Potential to be trained a qualified firefighter. Furthermore, firefighters may often get many non- Waee benefits e.g. sick leave, paid holidays, job security, government paid pension schemes, ‘Large supply of firefighter may explain thei relative low wage, hiring less. (diagram) Government is very possible to be the only employer in firefighting service, cornet Could Bayless than competitive labor market. However, entertainment heme ears seeeats Mth each other to sign contract wth lites pool a talent singe’ by offering attractive wage, we ee Se 7 Labor ORS RR Tater 8 influence wage rate in theory. It could also negotiate a, Trade union is another important 2 mark-up on wage rate through exercising collective bargaining power. In this cas, firefighters threatened to go on strike to achieve a higher pay from the government, If the trade union membership is high and there i a high militancy, itis very possible to get a higher pay, but it subject tothe government budget. verted seevite ror atlomed 0 comiey Forth, wage could be influenced by government policies. Government can impose minimum wage law and raise the wage of those low-paid jobs. Both firefighting and entertainment industry usually won't directly be impacted by this. However, firefighters pay largely depends on government policy regarding the budget allocated to this department. Government may refer to the market payment of similar jobs which requires similar skills and then determine the pay schemes of firefighters’, MRPL theory explains the demand of labor in the market, and partly explains the wage in ers. However, it doesn’t explain the demand for labor in the public sector. Heat ny other factors influence wages in the market, for example, labor supply, nomen pone a union, and the government. Singers’ pay might be the result of high oe ved and lave small and inelastic supply, which could he masty explained by ee : firefighter's lower pay may be a result of government limited budget, its Panny poet an eve rg sup wich ayer exsnd by heyQ43 Explain what might cause unemployment. [12°] Unemployment arises whenever people who are willing and able to work are without jobs despite an active search for one. It can be frictional, structural, classical, or demand-deficient. Frictional unemployment is when people are between jobs. They may be searching for a job opening (search unemployment), waiting for the right season/weather to come as primary sector workers (seasonal unemployment), or temporarily out of job due to the nature of his/her occupation e.g, writers, actors (casual unemployment). All listed above i often sen as voluntary, for people are informed of these situations when they opt for theit vocations. It’s also short-term, 4 Structural unemployment reflects changes in the nature of the economy. This can be because a) resoiiteée depletion causes the decline of certain industries e.g, coal mining in certain areas or countries; b) foreign competition drives domestic suppliers out of market; c) industralization diminishes significance of , say. primary sector production Globalization inevitably adds to this type of joblessness. To illustrate ~ for a long time, Britain's manufacturing industry hs lost jobs as production sited to lower-cost centers in East Buope and-emerging markets in Fa East Asia, It is long-run, 7 Cyclical or demand-deficient unemployment is involuntary and due to a lack of AD, especially in periods of recessions and downturns where closures and downsizing of businesses gives rise to layoffs and redundancies — except in the case of full eapacity. A contraction of AD from AD3 io AD3 willsee'a Q3-Q2 rise in cyclical unemployment. Classical unemployment is caused by real wage being too high, e.g. Gecatise of union power. At WI higher than equilibrium We, job acceptance exceeds demand for labor by Q2-Ql, ie. voluntary classical unemployment. ‘Natural rate of unemployment depends on the supply side of labor market, arising when inflation is correctly anticipated (usually 2-39) and there is no cyclical, i.¢, fill employment, Tn concusion, there ore 5 main types of unemplogmact , cach pointiny & a different: Cauge-Q44 Discuss whether oligopoly is likely to be the most realistic market structure in a mixed economy. [13°] By Maria q In 2 mixed economy, mayiet usually played the main role in the production and consumption activities however, government yy} intervene in the market by setting laws and regulations, tax or subsidize a Productions or consumptions; or government direct provide goods or services. Oligopoly is one of the common market structures in a mixed economy. In this market, there are a few big firms dominant, and those big firms are highly interdependent. The decision made by one firm will influence the decision making by its rivals. For this teason, firms rarely compete on price, but fiercely compete on ‘on-price activities, eg. in car manufacturing industry, top 10 manufacturers count for the majority of the market supply. They spend a lot to set up their brand images, market their products through ads and sales promotions; they introduce different models every one or two years and continuously g_function of products. In this market, firms may also collude on price, or tacitly collude with each other, # practice price leadership and set similer price to raise the overall profit. Eg, recently LED sereen pr 4 were charged for such practices. 2 8 ~ improve quality and ducers # Usually when the production has significant economies of scale, and the market is big enough to allow a few and then this market is very likely to be an oligopoly. Because only big ones to produce at an efficient scal the one grow big can lower the average cost of production and become price competitive, 5 on «SCAG ol gopolistic a wr, 0 expldt the benefit o ‘ough ¢ natural monopoly Sometimes, companies may want to grow even bigger takeover or merge; but it is usually forbidden by government, The only exception is government may take it over or strictly regulate the behaviors. Aationa/ye” Notural A 1 monopoly MES LRAC Monopolistic competition is also a common market structure, There are some businesses, especially service have no significant economies of scale; being large is not he size of those firms are provision like haircut shops, bakeries, restaura an advantage, but offering local and personal service is more important; then usually small, and the market tend:to be monopolistic competition. kel. Perfect competition rately exists because of the imperfect information in the m In all, Oligopoly and monopolistic competition are the most realistic market structure. Government usually doesn’t allow the existence of monopoly, and perfect competition is rare.Q45 Explain the different ways that economists classify profits and consider whether it is possible to make a profit from a newspaper that is distributed free. [12°] By Maria Economists distinguish profit in two ways: economic profit and normal profit. Normal profit basically is an economic cost. In tae eco! cost of the resources es context, cost of production is the opportunity ployed in the production. It is measured by the benefit that could have been gained if the resources had been used in their next mast profitable use. If a firm could have made $Imillion profit by using its resources in the next best manner, then the SImillion profit is an opportunity cost for the firm of doing this business. It is the cost of the entrepreneur just as the cost of other resourees, and itis the minimum retum to keep resources in the present use in long run. Economic profit is the profit over and above normal profit. Total revenue must be higher than total cost to eam economic profit rst Econ profit: PEF normal profit : included in 4 he ADB, fort a . faere Iti possible to make profit for awl clients, The level of total revenue th price and quantity s xtcdto editing, printing, and of advertiser distributing, and fixed cost such is higher than total cost, both revi profit and normal profit are eamed. 1ftotal revenue equel total cost, only normal profit is earned. ee tal cost, normal profit can’t be made and economic loss exists. from advertisement made for their \ nent, The total cost of those newspaper inetudin as the rent and normal profi If total revenue can’t cover 10 sda ane feee newspaper is profitable then is depends on the cost contol inthe production process and eeacaae cyto generate revenues from effective advertisement for clients the cepabQ46 Discuss whether markets are dominated more by the producer or by the consumer. [13°] By Mariaeen pages — ‘6 assess two extreme situations: perfect competitive markets and monopoly and i ‘he two types of imperfeet competition, 's # marke if there are numerous competitors producing dential products, and the barriers 2 REY 's totally ree, both supptiers and consumer have perfect knowledge about the market itis ® perfect competitive mat! et. In this case, everyone is a price taker, which means no one individual will have sufficient power ta influence the price. The demand for individual companies’ Broducts is absolutely elastic and they can only sell their products a the market equilibrium price {inv supemormal profit will aac new entrants come into the industry, and searce resources will Be drawn out of less demanding products production inta move demanding products production Consumer soversigny exists, Consumers’ demand will guide produces ta produce the product they want at low rice. Consumers dominate the market in this case, Howcever, when monopoly exists, producer will dominate the masket, There is only one Supplier in the market producing the products for consumers, and the barriers of entry for new firms are very high. Therefore consumers will have 1 buy what the producer produces atthe price set by the monopolist. Firms will decide what to produce, how mucl to produce, and sell che 4¢ Profit tnaximization price if they wish, Consumers will have to buy what firms wish to mative cho} Producer sove In reality, markets are often imperfect competitive and there is 4 mixture of both consumer and producer sovercigary. In 2 monopolistic competitive marker structure, where there are large number of firms producing slightly differentiated product under low barriers of entry. Even though individual producer ean decide the price and the products to produce, every individual firm's product is a very close substirute to each other, and demand for each form is very elastic. Consumers can play 5 important cole to influence priees and the fete of produet peremsive od, c mare the matket is highly concenraed on several big companies. mn In oligopolis The producers’ influence over the market depends on the! interdependent. If they carry out collusive stegy, they act ike monopoly and will dominates the arts while a nonscollusive strategy wil hamper ths power of control over produetion and price, price competion can be fierce, then consumers will relatively have more impact in the marker, However, consumers have very limited choices, and more often consumer’s consumption is iene ber ino es rman. ering ot haarket, ee sower of consumer is subject to the choice availability and the level of competition. Consumer ; s in a competitive market with profound choices, and producer dominates in a market ete. p dominates .as limited competition, whichQ47 Explain how, according to utility theory, consumers allocate their expenditure between different products as prices change. [12°] By Maria Utility is the measure of satisfaction someone gets from the consumption. Marginal utility is the change in total utility that res its from one unit increase in the quantity of the same good consumed. Marginal utility falls as consumption of the same product increases in a time period. To gain maximum total utility out of given limited budget, consumers have to spent their money on a mixture of GIS. Assume a consumer only consume twp products, there are different Combination of quantities of each product could be purchased. To maximize his total utility, his has to equate the marginal utility per dollar spent for both goods consumed. That is MUs=MUb Pa Pb ‘Then it is impossible to switch consumption from 4 to B to increase TU, and consumer's equilibrium is achieved. If the price of product “A” rises, then MUa/Pa’ is smaller than MUD/PD. As a result, even though the preference of the consumers is unchanged, he will reallocate the expenditure by buying oduct B, and less A; utility loss from less consumption of A will be smaller than the utility ‘otal utility will increase until MUaPa’ equals MUbP. mo: gain from additional consumption of B, If the price of the product A fal, lead to MUa/Pa being greater than MUD/Pb, then the consumer ¢ A and less B, until the manginal tility per dollar spent on both are equa! again ‘At any given price of product A, there will be a specific quantity of A being consumed to : ion, and vice versa, other achieve a consumer equilibrium. Higher price Jeads to less consumpti a things equal. Based on the utility theory, we can generate and downward sloping individual demand curve for a product. a rational consumer who aims to achieve maximum utility will So, according to utility theory, respond to higher price by buyin g less of it and substitute toward the relative cheaper one,Q48 Discuss whether demand schedules and budget lines are similar in the way they represent the effect of i) arise in the price of a good ii) a rise in a consumer's income. By Maria A demand schedule sa table ofthe quantity demanded of gaood at fferent price levels; based on the table, demand of a good at proce Be dawn whlch es auantity demand on the ania rice onthe Yan tells us the different quantity of roduc consumes are wling and able to buy at vatious pga udget line ustratgthe limit of consumption possibilty Wh sven income and price of two products. Each a eprcest the maximum quantity affordable fall money spent ‘on the product. It reflects consumers’ real income, esha "1 When theres ase in price of goo, there wi be movement lng the demand curve If piers rom Pe 2 there quanty demand decreases for to gz according to the law of demand. CeterisParibus, there 9 leverse relationship between price and ‘quantity demand. That means, other things equal, consumers respond 10 the price rise by decreasing the actual consumption of the goods A. (Diagram 2) On budget line, the rise in price of A with the pic of remaining the same, there will be 2 inward shift along the axis from its pivot at point J. it means, with the maximum quantity of 8 affordable unchanged, the maximum ‘quantity of A affordable decreased. The slop of the line change, reflect the rising relative price of product A is terms of product 8. A smalier,mixpure of A and B could be afforded. Without the information about one’s Preference, we aren’t sure about the chenge in real consumption of product A. (Diagram 2) When consumer's income rises, ceteris paribus, consumers now are wibing, and able to buy more of this product at each price, # 8's normal goods. The demand curve shit out parllelly; the actual increase in quantity demand ‘then will depend on the price elasticity of supply (PES. I PES is elastic, then quantity demand increase relative uctisin and curve wil shift inward. {diagram 3) more. However, if the product is inferior goods, the With the pes of two products remaining unchanged te Suge el ht ot parley regardless nature ofthe produce. This rellectsineressed elcome; ger mitre ofboth goods could be afforded. Without te nfornato or (Diagram 4) “preference, again we are not sure the change in actual quantity demand of the products In conclusion, demand curve reflect the inverse relationship of price and quantity demand of a product each point onthe demand curve ineate the consumption t sped pris, shows bth consumers’ preference and eHordabilty Price change cause;movernent along th cure and other factors such as income cause ft shifting Siudgét line shows verious maximum consumption Petites, ands determined by both money income and pes. When price or money income change, WO NOL ors when the change causes real income oF relative price change. reQ49 Analyze what is meant by the equi-marginal principle of consumer demand and whether it can be linked to the derivation of a market demand curve. [13°] UNTY is @ measure of satisfaction in economics, 24 marginal utility is the extra satisfaction derived from the Fansumption of additional unit product. When a product it consumed consecutively in atime period, marginal utlity will fall. Equl-marginai principle of consumer demand means tha for consumers who want to reach moximurn total utility out of sven Income, he/she must spend money in a way that marginal utity per dollars the same for al goods and services consumed, ‘MUa-MUb = Muc Pa Pb Pe when MUs/Pa>MUb/Pb, a consumer could increase his ttl uty by inereasing consumption of product A and reducing ‘he consumption on B, the increased utility from-eda units of Awil.be larger than the utility ass csulting from Iss 8. 2s more Ais consumed, MUS falls, and less consumption of Blend ose in Mb. The adjustment should continue unt total Uulty Belng maximized at. if MUa/Pactalb/Pb, consumers can decrease the consumption of A, and increase the consumption off to increase TU, berause the loss in tity from A wil be smaller than the gai in tlt of B, Only when Mua/Pa=MUb/PB , if impossible for one to switch the cansumption frm product A ta product B or Cte Increase total utlty (TU), TU is maximized anal the consumer isin equilibrium Based onthe equtmarsnal tility theory, we can derive an indus demand cove, At any given price of ene prod there must be a quantity of consumption of that product which is the optimal quantity ~ that is the quantity which wil ‘maximise total utility according to the rule of equailsing the marginal utilities per dollar spent forall goods consumed. If the price of the good changes then there will be a new optimal quantity of consumption. Assume Pa falls, then -MUa/Pa>MUb/Pb, a rational consumer will respond to the price change by switching consumption from B to A, quantity demand for A will then increase. \f Po rise, MUa/PacMUb/Pb, and the consumer will buy more B, but loss A, quantity demand for A decrease. The combinations of prices of the product and the quantities of the product purchased that wil achieved maximum uliliy, is the individual demand curve for that product (diagram 1}, # demonstrates @ downward sloping demand curve. Theoretically, we could sum up all individual demand curves horizontally to form a market demand curve. However, the | market is in a constant changing situation and the quantity demanchby each individual consumer which could lead aoamroneumer’ equllbrium i ako constantly changing. Summing up albindlvidual demand curves to get market demand woes not practical in realty. Furthermore, the equimarginal tity theory has its own imitation. i assumes utility summing up all individual curves is not quite practical.Q50 It is suggested that there are so many benefits from large scale production that all firms should be encouraged to grow in size and there should be no government restriction on such growth. Do you agree with this opinion? [25"] scale production that all benefits from large. ent fi ho in_size_and there should be no governm: Tem shoul be encouraged toon Sa ou a rearction op sash growth, Do you agree with thjsopinion oe restriction pee 608 wpa imgpe had Wy “y snare aretleBse Gita asomages ae fe aesiete oodocion a mY uss, oe RE ing, ee. The cost ledeconomies of scale. eens industries, e.g. manufacturing, airline come advantage due to large scale production is caf it often benefits from technical economies during the inery with high productivity facturer can afford to build 2 t, The container, When a business grows in size, production process, Complex and professional machi could be used at full capacity, e.g. only 2 large car manul complex robotic assembly line and produce large output at lower cos! fe increase much faster than surface area. Larger ships principle indicates that volumt ancial and airplanes are more cost efficient. Large firms may also benefit from fin economies; they are more credit worthy and get loans at lower interest, or they can raise fresh money from stock markets without the need to pay interest. Managerial economies means experts in different fields can be hired in charge of different department; there are greater specialization and expertise in management, Large firms usually buy materials at bulk and get a greater discount, which is purchasing. economies. There are also possible marketing economies and risk bearing economies. {As a firm grow in size and experience these benefit of economies, average cost falls. road LRAC There won't always be a benefit related to large scalé. Firms can be too large to be managed efficiently; there might be decreasing return to scale and diseconomies of scale occur. in 2 large firm, the workers performance evaluation and the products quality control could become more difficult; the coordination with different suppliers and the communication between different departments become complex; workers in some gigantic firms may feel alienated; work morale may be deteriorated and productivity fall All of these factors may lead to lower efficiency and higher average cost. gst 7% _ For firms whose production has economies of scale should be encouraged to grow to exploit all the possible benefits; but firms should stop growth or downsize if experiencing diseconomies of scale, | The cost advantage of economies of scale can benefit a firm only when th en there ae will lead to « ing demand, growth in siz large market demand, In a market with shrinking det ms ra ie ora | overcapacity which is a waste of scarce resources: cameras are not demanded much today. wurant, nomies of scale, ©. restaurant, There are some businesses not having significant economies ofS A age | r sho ley are usual i) and their advantage is bein oe pesonl ool Pega niche, e.g. customized product; 0 ; s. Those firms personal and local services, or they have market ee Provide professional expertise, eg. lawyers, accountants, desisnert. Tr need to be small to be more flexible and better serve the local should not be encouraged to provide large scale production. large ow to very | me firms grow horizontally through takeover or merger. They BF Sarai en Those firms have great * slze and become the major supplier of a specific product. re voductve nefits pt 28S. loi be both allocative an af Pr ie In many countries, governments have fas te prohibit the c. or takeover which could lead to monopolistic power. A competitive market is necessary to achieve greater efficiency. Governments often regulate the behaviors of natural monopolies to prevent consumers from being exploited, Large scale production may also lead to negative externalities. The environment may Not being able to deal with the emissions from large scale factories. Government should restrict such a growth. Firms may grow vertically to secure important supply or improve the distribution of Products. Or firms may grow internationally to explore new markets or take advantage cheaper resources overseas. As long 2s the growth leads to greater competitiveness and efficiency, government should not cestriet