Summer 2021 Exam

EC100
Economics A

Suitable for ALL Candidates

Instructions to candidates

You must attempt ALL questions. There are 5 questions in Section A, each worth 8 marks, and
three questions in Section B, each worth 20 marks. Where appropriate, make use of graphs and
equations in your answers.

We strongly recommend that students answer the examination paper using a word-processing
software on a computer (e.g. Word). Doing so greatly enhances the accuracy and efficiency of the
marking process, as markers do not have to decipher potentially ambiguous handwriting or other
signs and marks produced by the scanning of handwritten documents. Nevertheless, students who
absolutely feel that using word processing will negatively affect their performance can use pen and
paper (then scanned), or an iPad or tablet. You can draw figures by hand on a separate paper.

We strongly recommend that students answer straight to the point since irrelevant content will be
penalised.

Time Allowed Reading Time: None

Approximate Effort Required: 2 hours

You are supplied with: No additional materials

Additional Material: This is an open book examination
Calculators: Calculators are not expected to be used

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Section A (8 marks each)

A1. The Happy Land is an isolated island with three sectors: agriculture, manufacturing, and
services. This year, the total revenue for the service sector was $20 million of which $5
million was spent on buying raw materials from the agricultural sector. The output of the
agricultural sector was $10 million, and its output was sold to the manufacturing and service
sectors. The total revenue for the manufacturing sector was $25 million. The total labour
income was $25 million and the total consumption expenditure was $20 million. Explain
briefly the three approaches to calculate GDP and their relationship with each other.
Compute the GDP of Happy Land and explain how you can only use one of the approaches
to calculate the GDP of the Happy Land based on the information given.

A2. What are the key properties of the aggregate production function? Explain why these
properties are important for understanding the labour demand and credit demand curves?

A3. Some economists argue that the availability of cheaper and better video games and online
entertainment can influence the labour market. Explain their argument. In your answer
discuss the effects on the key labour market variables such as labour force participation
rate, employment rate and unemployment rate, and point out the key assumptions.

A4. Since the U.K. voted to leave the European Union (Brexit), many economists have expressed
concerns about Brexit’s effect on investment, unemployment, employment, GDP and
welfare. Explain the economic rationale behind their concerns.

A5. Bank A starts with the following balance sheet:

What information on the balance sheet reveals that one of the functions of the bank is
“maturity transformation”? Show the balance sheet after the bank suffer a loss of 5% in the
value of long-term investments. What is the maximum loss the bank can suffer before
becoming insolvent?

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Section B (20 marks each)
Where appropriate, make use of graphs and equations in your answers.

B1. Some economists conducted an accounting exercise to understand why income (GDP) per
worker is different across countries (see Table below).

a. (4 marks) How is each column of the table constructed from the data? Based on the table,
which country has the highest technology level? Explain your answer.

b. (6 marks) According to the Solow growth model, what is the key mechanism for economic
growth? Explain your answer and state the key assumption of the model.

c. (3 marks) Using the Solow model and the table above, explain why an increase in the
saving rate can help to improve the productivity in China and India. Explain why this policy
may not be the best policy.

d. (3 marks) Use the table above to evaluate whether the Solow growth model is a good
model for understanding differences in income per worker across countries.

e. (4 marks) Some economists argue that the table above might not reflect the true
differences in productivity or the differences in living standards across countries. Explain
their argument.

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B2. There are three countries, A, B and C, which trade with each other. Country A and B both
have a flexible exchange rate regime.

a) (7 marks) Suppose country C has some major technological innovation. Explain what
happen to the nominal exchange rate in the three countries under the two scenarios:
(i) if country C has a flexible exchange rate, and

(ii) if country C has a fixed exchange rate with country A. In your answer, discuss
what happens to the foreign reserve in country C.

b) (5 marks) Suppose country C has a fixed exchange rate with country A. The government
of country A argued that Country C had been manipulating the value of its currency,
which has a negative impact on country A’s GDP. Explain the argument.

c) (4 marks) Under the same scenario as in part (b), suppose country A now declares a
trade war on country C by imposing tariffs on imports from country C. Some economists
argue that this policy may not necessarily improve the welfare of Country A. Explain their
argument.

d) (4 marks) The Economist publishes the Big Mac Index regularly. The Big Mac Index
revealed that the U.K. pound Sterling was 28% over-valued in 2008 and 22% under-valued
in 2021 against the U.S. dollar. Explain how they obtain these values and what are their
implications.

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B3. In March 2020, the World Health Organization declared the new coronavirus outbreak as a
pandemic. Many policy makers around the world have started worrying about the economic
impact of the pandemic. The immediate effects were through travel restrictions in a few
countries and isolation of those who were infected.

a. (8 marks) On March 10th 2020, the Bank of England announced an emergency cut of
its interest rate. Explain the economic rationale behind this policy and its limitations.
In your answer discuss expected effects on economic variables such as GDP,
consumption, investment, net export and unemployment.

b. (4 marks) On March 23rd 2020, the UK entered into the first lockdown restricting
business activities in several sectors of the economy. One year later, the U.K.
Chancellor announced the new budget for 2021 incorporating tax cuts and increases
in government spending such as extensions to the furlough scheme. Explain the
economic rationale behind these policies and discuss their effectiveness.

c. (4 marks) Explain how the discovery of a vaccine for Coronavirus can generate an
economic recovery based on the Keynesian theory. In your answer focus on
discussing the effects on macroeconomic variables such as GDP, investment, wages
and unemployment.

d. (4 marks) The U.K. GDP has declined by 10% during 2020, compared to a 4% decline
during the Financial Crisis in 2009. Some economists argue that the difference in
actual aggregate economic activities may be smaller than what the numbers suggest.
Explain their argument.

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