Chatfororder3414376.txtIEA2021Exam Tutorial7Solutions20211 IEAexercise9-answers1
Choose 1 question from the Micro section (block a). Choose 1 question from the Macro section (block b). Up to 900 words per question. Define all concepts and key terms Harvard Referencing Give titles to sections of the essays to give clear structure. Use diagrams and graphs where applicable. PLEASE REFERENCE THESE OR MAKE THEM IN EXCEL YOURSELF. I will send you the readings you have to use once you have selected which question you prefer. Also, you need to use your own sources, not just the ones I will give.
Dr P: Hello there
customer-3563218: Hi
customer-3563218: Would you be able to do this well
customer-3563218: as it needs to be done extremely well as is contributing alot towards my grade
Dr P: Yes i will
customer-3563218: If you look at the attachment which questions would you pick?
customer-3563218: 1 from micro (block A) and 1 from macro (block B)
customer-3563218: ?
Dr P: Q3 from block A
Dr P: Q2 from block B. I am better with that since i have discussed it in the past
customer-3563218: current account and national income identity
customer-3563218: ok no problem
customer-3563218: as long as both the questions are done perfectly it is fine
customer-3563218: ok are my instructions clear? do you need me to go over anything?
Dr P: okay thank you
customer-3563218: each question around 900 words
customer-3563218: Please use diagrams and graphs and please reference them
Dr P: okay i will
customer-3563218: I will send you some sources you can use however you will also have to find more
Dr P: Okay please send them right now so that i can begin
customer-3563218: I have uploaded some lecture slides and question & answers that may help for the micro question and the macro question
customer-3563218: for the micro question – Economics 14th edition Lipsey & Chrystal
customer-3563218: Chapter 11 & 14 may be good to use
Dr P: I cannot find the files you uploaded yet
customer-3563218: Optional readings:
Ricardo, D. 1821. chapter 31.
customer-3563218: Optional readings:
Smith, A. 1776. Book 5 chapter 1.
customer-3563218: These readings are for the micro questions
Dr P: Okay those are fine i can access them
customer-3563218: Use others aswell. Not just these
Dr P: Okay
Dr P: I am beginning to work on the paper now.
customer-3563218: For macro Lipsey, R. and A. Crystal (2020), Economics. 14th edition. Chapter 21{z_site_domain_z}24
customer-3563218: Ok no problem
customer-3563218: Let me know if you have any questions
Dr P: Okay in case i find any i will definitely let you know
customer-3563218: Ok. Thanks!
Dr P: You are welcome
SOAS University of London
Open Book Online Examination for Undergraduate students – May/June 2021
INTRODUCTION TO ECONOMIC ANALYSIS
153400003-A20/21
This paper is suitable for current students.
Time Allowed: 48hs from the release time in BLE
The marks for this paper constitute 50% of the total marks for this course.
Permitted materials/equipment
Calculator
Special stationery/equipment required
None
Instructions:
Answer 1 question from the 3 questions in Block A and 1 question from the 3
questions in Block B.
Please write in BLACK ink only and write as clearly as possible. Candidates are
advised that the marking of illegible scripts is at the discretion of the examiner.
Credit will be given for a useful range of relevant illustrations
1/4
BLOCK A: MICROECONOMICS
Answer 1 of the following 3 questions.
1. Consider the following monthly demand and supply schedules for generic AAA
batteries in the UK:
𝑄
𝐷
= 120 − 10𝑃, 𝑄𝑠 = 30𝑃 − 80
where Q is measured in millions of batteries, and P in pound sterling. Answer ALL
parts below.
a) What is the equilibrium quantity, and what is the equilibrium price? Show your
calculations and draw an illustrative diagram.
b) Suppose that the government imposes a unit tax, t, on suppliers equal to 2. Find
the new equilibrium quantity and price.
c) Calculate the price elasticity of demand at the equilibrium price when the tax is
imposed.
d) Explain how the shape of the demand for batteries influences the effectiveness of
the tax. Illustrate your point with an example.
2/4
2. A firm faces the following cost and price structure, with total cost (TC), marginal cost
(MC), total revenue (TR), marginal revenue (MR), average revenue (AR), total profit
(TP), average cost (AC), average variable cost (AVC), and average fixed cost (AFC):
Output TC MC Price TR MR AR TP AC AVC AFC
0 100 – 4.5 – – – – –
10 20 4.0
20 19 3.5
30 18 3.0
40 17 2.5
50 16 2.0
a) Identify what kind of market structure the firm operates in and explain what led to
your conclusion.
b) Fill in the empty cells of the table above.
c) Identify the profit maximizing output and explain what led to your conclusion.
d) Produce a diagram with MR, MC, and AR. Identify the profit maximizing quantity and
price.
e) From your diagram, demonstrate the allocation inefficiencies and identify the
deadweight loss.
f) Explain how price discrimination can reduce the deadweight loss. What are the
implications for producer and consumer surplus?
3. Answer ALL the following questions:
a) What are public goods? Provide TWO examples and explain which properties make
them public goods. Why can these goods not be provided by the market?
b) Explain the concept of negative externalities on the example of air pollution.
c) Suggest TWO policy solutions and carefully explain how they tackle the problem of
negative externalities. Use appropriate diagrams to support your explanation.
3/4
BLOCK B: MACROECONOMICS
Answer 1 of the following 3 questions.
1. Define and explain the multiplier process. Discuss the implications of the multiplier for an
economy in recession.
2. Answer these two questions:
a) How is the current account related to national saving? Explain by using the national
income identity for an open economy.
b) To what extent is a current account deficit problematic?
3. Answer these three questions:
a) Outline the theory of the Phillips curve.
b) Explain the distinction between the short-run and the long-run Phillips curves. What
is the “expectations-augmented Phillips curve”?
c) Discuss the relevance of the Phillips curve for macroeconomic policy making.
© SOAS University of London, 2021
4/4
SOASUniversity of London 2020-2021
Department of Economics
Introduction to Economic Analysis, Term 2, 153400003
Tutorial 7
Solutions
1) What are “global imbalances”, and what are the underlying causes?
a) Which countries have recorded the largest imbalances? You may want to have
a look at the CFR Global Imbalances Tracker (https://www.cfr.org/report/global-
imbalances-tracker)
CA imbalances:
• Surplus: China, Eurozone/Europe, East Asia, MENA (2005-2015)
• Deficits: Anglophone Countries, Eurozone (until 2012)
b) What is the role of domestic savings and investment in driving macroeconomic
imbalances?
• CA = S – I or I = S – CA [See the discussion of “National Income Accounting for an
Open Economy” and especially slides 19-21 in the slides for Lecture 7 on “Exchange
Rates and the Balance of Payments”.]
o Not just private savings but also corporate and government savings.
o Crucial role of Savings and Investments in defining the structural CA balance, and
thus should be the focus of any policy aiming at decreasing a CA deficit (instead
of tariff-related trade policies).
• China vs. US
o Distribution of income affects the savings of an economy.
o Other cultural or institutional factors (need for precautionary savings, social safety
nets, healthcare, pension, …).
o Availability of credit and the role of debt (US debt-driven consumption).
2) Is the Big Mac index a useful tool to analyse exchange rates? Why should we
care about undervaluation or overvaluation of the exchange rate?
• Big Mac Index is based on PPP: useful tool to understand the theory, but limited in terms of
empirical validation.
• PPP signals where XR should be heading in LR, but it says little of today’s Equilibrium.
• Even over the long run, adjustment towards PPP need not come from a shift in exchange rates;
relative prices can change instead.
• Criticisms:
o Big Macs are non-tradable goods, and should serve the local market.
o Price of food at McDonald’s may differ from prices at local restaurants.
o Prices vary with local costs (non-tradable), such as rents and wages, which are lower
in poor countries, as well as with the price of ingredients that trade across borders. For
this reason, PPP is a more reliable comparison for the currencies of economies with
similar levels of income.
o Trade barriers, transport costs and differences in taxes drive a wedge between prices
in different countries.
• An overvaluation of the exchange rate may have an adverse effect on exports and the current
account. An undervalued exchange rate makes imports more expensive and could fuel
inflation (“imported inflation”). While an undervalued exchange rate may help to promote
exports, it reduces pressure on firms to innovate to stay competitive.
3) What are arguments for countries to adopt a fixed or a floating exchange rate?
See next week.
SOAS,Uni London Introduction to Economic Analysis Sophie van Huellen
Module 153400003 Exercise 9 December 2020
1) Your local authority provides a police station, a fire brigade, and a public library.
a. What are the market failures, if any, that each of these seeks to correct?
b. Which of these are closest to being public goods?
c. Which are furthest from being a public good?
d. What would happen if governments were prevented from offering these
services?
Answer
Strictly speaking, police stations and fire brigades are not provided by the local
authority in the UK, but by specialist authorities (with local authority representation).
However, this does not affect the question. Note that a decision is needed as to how
far the police station in the question can really be discussed in isolation from the rest
of the police service.
(a) There is no obvious market imperfection that the provision of police stations
seeks to correct, beyond the wider one of the whole police service as a response to
law and order being a public good. Without a public police service, it is difficult to see
how public laws could be generally and equitably enforced. Individuals might (and in
some circumstances currently do) hire private security personnel to protect their
persons and property, but this is not the same thing as a public service provided to
all.
With fire brigades there is an element of public goods but also a more private benefit
which could in principle be solved by private insurance (as indeed it was in the early
days of the fire brigade). However, many people might choose not to insure their
property, and at least where there are children involved the state is likely to feel the
need to step in. There is also a large externality here, in that many people are at risk
from a fire in their neighbour’s property. In densely populated urban areas, the
negative externality from fires is potentially very large (the Great Fire of London is a
good, if rather extreme, example), so that for many purposes, rapid response to fires
is a public
good.
Public libraries, or rather the books and other materials they house, have a lot of
potential as imperfect public goods. Although two people cannot easily read the
same book at the same time, a given book can be read many times before it is worn
out. Thus, the marginal cost of making a book available to one more person is very
low, and this is an attribute of public goods. One could easily imagine, however,
private lending libraries that charged a small fee to lenders; again, such libraries
operated more widely in the past than they do now. However, the main argument in
practice for public libraries is probably that their product is widely seen as a merit
good: they promote the social goal of making knowledge generally available to
citizens. This, too, can be thought of as a public good. Finally, the existence of some
SOAS, Uni London Introduction to Economic Analysis Sophie van Huellen
Module 153400003 Exercise 9 December 2020
library (for example, the British Library) as a store of knowledge is a nearly pure
public good. But this argues for one central public library, not for many local ones.
(b) In all cases the goods are potentially excludable, although there would be little
point in this for the police station while the rest of the police service remains open to
all. The police station is probably the closest to being a public good, other than
during (short) periods of excess demand, none is rivalrous.
(c) The fire brigade could operate on an insurance basis, and there is an element of
rivalry here insofar as a fire engine attending one call cannot attend another at the
same time. Libraries are clearly excludable, and one person’s borrowing reduces the
service for others, but overall they are probably the furthest from being a public
good.
(d) If governments were prevented from offering all these services, it is likely there
would be extensive private provision (possibly by insurance companies) of a fire
service. Some private libraries might develop, but probably not many. If police
stations were not publicly provided but the rest of the service was then the latter
would be likely to operate much less efficiently. If no police service at all was
provided by the government, one would expect to see some more private security
services instead, at least at the level of local security patrols (where the problem of
free-riding might not be too severe), together with greater investment in burglar
alarms and so on.
SOAS, Uni London Introduction to Economic Analysis Sophie van Huellen
Module 153400003 Exercise 9 December 2020
2) What inefficiencies will be caused by
a. The personal income tax
b. Farm subsidies
c. Free elementary education
d. Welfare payments to non working persons
Explain why such inefficiencies do not provide sufficient reasons to end the activity.
Also explain why one needs neoclassical assumptions about what is the benchmark for
comparison in order to suggest that these phenomena are inefficient in the first place. Does
neoclassical economic theory introduce a market bias?
Answer:
(a) Personal income tax distorts labour supply decisions, as it drives a wedge
between what the employer pays and what the worker receives. As in (a), taxes are
one of life’s certainties, and income may be favoured as a base on distributional
grounds (indirect taxes may be regressive) and because income tax is also relatively
cheap to collect (through the PAYE system in the UK).
(b) Farm subsidies will keep land in agricultural use when the market outcome
would be different or will mean it is used for the “wrong” crop. Prices and quantities
of foods in the shops will also be distorted as a result, and there may well be effects
on trade (such as reducing imports of a subsidized product) with knock-on effects on
producers overseas. There are various possible reasons for maintaining particular
farm subsidies: national security (in case of war), environmental arguments (such as
for hill farms in the Lake District), maintenance of rural employment and populations,
etc.
(c) Free health care might be expected to mean higher resources going into health
care than the private market would provide, but the fact that it is funded by taxation
has tended to keep provision relatively low (the proportion of GDP spent on health
care in the UK is significantly lower than in the USA, for example). Free provision,
particularly for children, may be seen as a social responsibility, or the provision of a
basic (human) right. There are also externality arguments in the case of infectious
diseases, and the relatively low costs of the NHS provide evidence that this may be
an efficient way to provide the service.
(d) Free elementary school education is similar to health care above, although
unless education were to become optional, the main measure of quantity—the
number of children involved—is fixed. Thus, the distortion is probably relatively
small. Again, the need to fund provision by taxes has probably kept costs down.
Again, too, there are social reasons for free, state provision including externality and
paternalism arguments.
SOAS, Uni London Introduction to Economic Analysis Sophie van Huellen
Module 153400003 Exercise 9 December 2020
(e) Welfare payments to non-working persons will distort the labour-leisure decisions
of those receiving them, with fewer people choosing to work as a result. The
argument for not stopping the payments is likely to be a social one again: that
society wishes to maintain certain minimum levels of income for all, especially where
there is some good reason for the welfare recipient not being in work (such as
disability or lack of job opportunities) and/or they have children to support.
The inefficiencies do not mean that these interventions should be removed.
Government activities, such as defence, law and order, health and education, have
to be funded somehow. Also, there is an accepted commitment to some level of
redistribution, so that the worst off are provided with a safety net, and this has to be
paid for by the better off (note from the lecture the discussion of the findings of the
Rapporteur of the UN on how thin this safety net currently is). Non-distortionary
taxes (such as the poll tax) have been tried but then rejected on equity grounds.
Second-best arguments also imply that just removing some distortions and not
others cannot be guaranteed to improve things. This means that while there are any
distortions, it may be optimal to retain some others (See Box 13.2 on page 305).
Additionally: You need neoclassical assumptions about what is the ‘normal’, efficient
situation. Up to you to argue for or against a market bias, but the case for the bias is clear –
markets by themselves are efficient. The Shaikh argument: even if we say there’s pervasive
imperfections in competition, we still acknowledge the ‘perfect’ benchmark.
SOAS, Uni London Introduction to Economic Analysis Sophie van Huellen
Module 153400003 Exercise 9 December 2020
3) Why is the role of government inevitable even in a market economy?
a. Answer from a neoclassical economic point of view.
b. Contrast with Ha Joon Chang’s ‘institutional political economy’ point of view
(in his 2002 article on BLE) of a market economy. Does the question make
sense from this point of view?
Answer:
(a) There is always the minimal (or “night watchman”) role of maintaining basic law
and order—the ―legal monopoly of violence‖ identified at the start of Chapter 13—
and a properly enforced system of property rights is essential to a well-functioning
market economy. Most modern market economies have laws on fair competition,
monopoly power and so on too (for example, “anti-trust” in the USA), and the
government will have to monitor and enforce these rules. There are also health and
safety concerns in most countries—such as pollution controls and the MOT test for
cars in the UK—and these require government involvement. Finally, even market-
oriented countries generally make some provision for those unable to support
themselves, and this responsibility too often tends to fall on government.
This list is by no means exhaustive, and students will no doubt come up with other
reasons. It is worth noting that even strongly pro-market businesses tend not to want
to invest in countries without an effective government (of which there are several
around the world).
(b) This can draw on Ha Joon Chang’s problem that markets are never really free,
but what is ‘free’ is a relative concept. See in particular section 3.1. Moreover,
somehow markets have to be ‘created’ – they do not spring from the ground like
mushrooms, to paraphrase Hobbes. Government is necessary to create and sustain
markets, especially global ones. (Note: Polanyi, and more recently Mazzucato might
give some ammunition too.)
SOAS, Uni London Introduction to Economic Analysis Sophie van Huellen
Module 153400003 Exercise 9 December 2020
4) An industry consists of two firms producing the same product but using different
technologies. Each emits 50 tonnes of pollution each year. One can clean up the first
tonne at a cost of £1,000 and the cost of each additional tonne cleaned up rises by
£1,000 per tonne until the last tonne costs £50,000. The second firm’s cost for the
first tonne cleaned up is £20,000 and the costs rises by £1,000 until the fiftieth tonne
is cleaned up at a cost of £70,000. The government wishes to cut the industry’s total
emissions from 100 to 50 tonnes a year. It gives each firm 25 tradable permits, each
one allowing 1 tonne of pollution.
a. What will be the equilibrium price of a permit to pollute by 1 tonne?
b. How many permits will be traded?
c. By how much will each firm clean up its own pollution?
d. What would you infer if, in a subsequent year, the price of a pollution permit
fell by 50%?
Answer:
This question is based on Figure 13.5 in your textbook and the discussion there.
Assume initially that each firm uses its 25 permits itself and cleans up the rest of the
pollution. Firm A’s marginal cost of abatement is then £25,000 and Firm B‘s is
£45,000. It makes sense for Firm A to sell permits to Firm B until the two costs come
into line. This will occur when 10 permits have been traded; Firm A will now abate 35
tonnes (i.e. produce 15 tonnes) and Firm B will only abate 15 (and produce 35). Both
now have a marginal abatement cost of £35,000 per tonne, which will equal the price
of a permit. The two firms have moved as shown by the arrows on the diagram
below.
Thus, the answers to the questions are as follows:
SOAS, Uni London Introduction to Economic Analysis Sophie van Huellen
Module 153400003 Exercise 9 December 2020
(a) The equilibrium price of a permit to pollute will be £35,000 per tonne.
(b) Ten permits will be traded.
(c) Firm A will clean up 35 tonnes of its own pollution and Firm B 15 tonnes of its
pollution.
(d) If the price of a permit subsequently fell by 50 per cent, the most likely inference
is that
Firm B has improved its technology so that it is closer to Firm A’s. Less likely
alternatives would include the government relaxing its control by issuing more
permits in the first place, so that both firms are lower down in the diagram above.