FINAL EXAMINATION

Name of Student: ________________________________________________________ Student Number: ________________________________________________________

INSTRUCTIONS: This exam is in two parts. PART A (multiple choice questions) is to be answered on the examination paper itself. PART B should be answered in the exam book provided. Print your name clearly and give your normal signature and student number above and on the cover of the exam book(s) used. PART A: Multiple Choice Questions (30%) 1. Market supply curves tend to be more price elastic if the time period is long rather than short because a. Firms are better able to adapt their output rates to price changes in the long run. b. External economies will be realized. c. Consumers are better able to find substitute goods. d. Input prices would be expected to increase with the length of the time period. e. Economic profits are reduced to zero in the long run. Marginal product exceeds average product when a. Total product is increasing. b. Average product is increasing. c. Average product is decreasing. d. a and b. e. a and c. A frequently cited reason for increasing returns to scale is a. Increased input prices. b. Greater specialization. c. External diseconomies. d. Larger fixed costs with a larger plant size. e. Difficulty of managing a huge enterprise.

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In determining whether to add an additional flight to an established airline, which of the following costs are irrelevant? a. Depreciation on the existing aircraft. b. The salary of the president. c. Insurance on the aircraft. d. Administrative costs. e. All of the above. If the two assumptions of profit maximization and freedom of entry and exit are satisfied, then in the long run each firm will operate where a. Price equals short-run and long-run average cost. b. Price equals short-run and long-run marginal costs. c. Long-run average total cost is a minimum. d. Both a and b. e. All of the above. A natural monopoly is characterized by a. Decreasing returns to scale. b. Patent protection of certain basic processes. c. The firm having exclusive control over a basic input. d. A decreasing long-run average cost curve over the feasible range of output. e. A firm producing environmentally safe products. If average total cost for the first unit of production is 11 and for the second and third units are 6.5 and 5 respectively, then the production process exhibits a. increasing returns to scale. b. decreasing returns to scale. c. constant returns scale. d. both increasing and decreasing returns to scale. When a firm charges two distinct prices for a product or service (an initial fee plus a usage fee, for example), the firm may be practicing a. Price discrimination. b. A two-part tariff technique. c. Bundling. d. Bad business e. None of the above. A group of companies that act jointly to divide the industry and maximize profits is called a. A monopoly. b. A monopsony. c. A cartel. d. An antitrust. e. None of the above.

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Marginal revenue for the firm with a kinked demand curve a. Is greater than in monopoly. b. Is less than in monopoly. c. Has a jump at the level of current output. d. None of the above. If net foreign investment is positive a. exports must be positive. b. exports must be negative. c. the trade balance must be positive. d. the trade balance must be negative. If the purchasing-power parity theory is true a. the net export schedule is very steep. b. all changes in the real exchange rate result from changes in price levels. c. all changes in the nominal exchange rate result from changes in price levels. d. changes in saving or investment influence only the real exchange rate. The price of computers has remained unchanged while the quantities purchased have increased. This implies that a. the demand for computers has decreased while the supply of computers increased. b. the demand for computers has increased. c. the demand for computers has decreased while the supply of computers has decreased. d. the demand for computers has increased while the supply of computers has increased. e. the demand for computers has become more volatile. One argument favouring a floating exchange rate system is that it a. makes international trade less difficult. b. minimizes destabilizing speculation by international investors. c. allows monetary policy to be used for other purposes. d. helps prevent excessive growth in the money supply. Starting from a small open economy with balanced trade, if large foreign countries increase their domestic government purchases, this policy will tend to a. increase investment in the small open economy. b. increase saving in the small open economy. c. increase exports by the small open economy. d. increase imports by the small open economy. A shift in the demand curve for electricity to the right may be the result of a. consumers becoming more energy conscious. b. a decrease in per capita income. c. a decrease in the price of electricity. d. an increase in the price of natural gas.

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A manufacturer has estimated that the demand for its product is

QX = 6,748 - 3.0 PX + 2.72 I + 1.68 PY

where QX is the quantity demanded of X, PX is the price of X, I is the average annual income in the region ($17,500), and PY is the price of a related good Y ($14,500). Which of the following statements is accurate? a. the demand for good X is not very sensitive to changes in its own price. b. good X is for an inferior good. c. good X and Y are substitute goods. d. good Y is a normal good. e. None of the above. 18. In a small open economy with a floating exchange rate, if the government imposes a tariff on foreign goods, in the new short-run equilibrium a. imports will decrease while exports remain constant, leading to a rise in net exports. b. imports will decrease and exports will increase, leading to a rise in net exports. c. imports will decrease and exports will decrease an equal amount. d. both imports and exports will remain unchanged. The adoption of an investment tax credit in a small open economy is likely to lead to a. no change in either domestic investment or domestic saving in the small open economy. b. an increase in both domestic investment and domestic saving in the small open economy. c. an increase in domestic saving, but no change in domestic investment in the small open economy. d. increase in domestic investment, but no change in domestic saving in the small open economy. All of the following, except one, are true of rent controls. Which is the odd one out? a. they create a shortage of rental accommodation and make it difficult to find vacant apartments b. they create a greater shortage of rental accommodation the longer they are in effect c. they keep rents artificially low for those who already have or can find apartments d. they discourage people from giving up rental accommodation and thereby restrict labour mobility e. their harmful effects are soon recognized by governments, which quickly remove them.

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Frictional unemployment occurs when workers a. are out of work as part of the normal transition from one job to another b. are out of work because their job is only available at certain times of the year c. no longer register themselves as unemployed because they have given up any hope of finding work d. are out of work because their skills do not match those required for newly created jobs e. are out of work because the economy is mired in a recession When the rate of inflation varies unpredictably a. lenders are better off and borrowers are worse off b. both borrowing and lending become riskier c. lenders are worse off and borrowers are better off d. there is no impact on borrowing or lending a. both lenders and borrowers are better off Aggregate demand is a. downward-sloping because an increase in the price level reduces households real wealth, and hence their consumption b. upward-sloping because an increase in the price level increases households real wealth, and hence their consumption c. downward-sloping because an increase in the price level increases households real wealth, and hence their consumption d. upward-sloping because an increase in the price level reduces households real wealth, and hence their consumption e. downward-sloping because a reduction in the price level reduces households real wealth, and hence their consumption In a closed economy, budget deficits a. increase the real interest rate and lower private investment b. increase both the real interest rate and private investment c. have no effect on either the real interest rate or private investment d. lower both the real interest rate and private investment e. lower the real interest rate and increase private investment The full employment deficit is a. the level of the deficit at the time the economy last reached full employment b. what the deficit would be if there was full employment c. always zero d. the deficit necessary to stimulate the economy to full employment e. the unemployment rate that would occur if the federal budget were balanced The inflation tax refers to the loss due to inflation suffered by a. holders of currency b. taxpayers c. lenders d. borrowers e. the government

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At the natural rate of unemployment, inflation is a. zero b. increasing c. falling d. stable e. positive Rightward shifts in aggregate demand cause _______________ inflation; leftward shifts in aggregate supply cause _______________ inflation. a. cost-pull; demand-push b. cost-push; demand-pull c. increase in; reductions in d. demand pull; cost-push e. demand push; cost-pull All of the following statements, except one, describe effects of efficiency wages. Which is the odd one out? a. workers are motivated b. they attract higher quality workers c. unemployment is reduced d. it is easier to retain high quality workers e. labour turnover is reduced Suppose the real interest rate equals 5% and the expected inflation is 10%. Also suppose that you borrow $1,000 for one year. What will you repay in one year is a. $1150 b. $1015 c. $869.56 d. $850

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PART TWO (70 marks) 1. True/False questions. Briefly evaluate each question (5 marks each). a) Many economists find deflation a more serious problem than inflation. Their argument is that whereas a central bank can push nominal rates higher to combat inflation, it is constrained in lowering them in the case of a deflation. In a two-country comparison, the interest rate in the country whose currency is expected to depreciate in the future must be lower than that in the country whose currency is expected to appreciate. (10 marks)

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Suppose that your job is advising the governor of the central bank of your country on how to maintain money supply at its current target level. One day on the way to work, you hear on the radio that a change in the earths magnetic field has rendered all credit cards and ATM cards (debit cards) permanently useless by destroying the date on their magnetic strips. What would you advise the governor? Why? (5 marks) Explain in detail the key mechanism by which central banks conduct monetary policy. What does determine whether and to what extent long-term interest rates get affected by the central banks actions? (7 marks) Assume a model of aggregate demand/aggregate supply. In this model, analyze the impact of the following events on the price level, GDP and the unemployment rate in the short run and long run a. b. An increase in government spending. An appreciation of domestic currency. (10 marks)

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Consider the following table. CPI (% change at annual Rate) 2.1 3.0 3.5 Currency Units Per $ Latest 1.48 1.05 Year ago 1.45 0.96

Canada U.S. Euro-12 a.

Calculate and compare the actual rate of change of the exchange rate (C$/$, euro/$) with those predicted (implied) by the Purchasing Power Parity theory. Which currency is undervalued/overvalued? According to your findings, what should happen to C$ and euro in the future? (Rise or fall; Why?)

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(8 marks) 6. Suppose you are in an aide to a US senator who is concerned about the impact of a recently proposed excise tax on the welfare of her constituents. You explained to the senator that one way of measuring the impact on her constituents is to determine how the tax change affects the level of consumer surplus enjoyed by the constituents. Based on your arguments, you are given the go-ahead to conduct a formal analysis, and obtain the following estimates of demand and supply: Qd = 500 - 5P and Qs = 2P - 60. a. Graph the supply and demand curves. b. What are the equilibrium quantity and equilibrium price? c. How much consumer surplus exists in this market? d. If a $2 excise tax is levied on this good, what will happen to the equilibrium price and quantity? e. What will the consumer surplus be after the tax? (12 marks) 7. The demand for Wanderlust Travel Services (X) is estimated to be QX = 22,000 - 2.5PX + 4PY + 1I + 1.5AX, where AX represents the amount of advertising spent on X, and the other variables have their usual interpretations. Suppose the price of good X is $450, good Y sells for $40, the company utilizes 3,000 units of advertising, and consumer income is $20,000. a. Calculate the own price elasticity of demand at these values of prices, income, and advertising. b. Is demand elastic, inelastic, or unitary elastic? (5 marks) 8. It is sometimes said that a manager of a monopoly can charge any price and customers will still have to buy the product. Do you agree or disagree? Why? (5 marks) 9. You are a manager in a perfectly competitive market. The price in your market is $35. Your total cost curve is C (Q) = 10 + 2Q + .5Q2. a. b. c. d. What level of output should you produce in the short-run? What price should you charge in the short-run? Will you make any profits in the short-run? What will happen in the long-run? (8 marks)

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