Solutions for 200470Used for Revision

Solutions for 200470used for revision

Part A:

1. B 2. A 3. B 4. C 5. B 6. C 7. D 8. D 9. B 10. D 11. D 12. C 13. B 14. A 15. B 16. C 17. D 18. C 19. B 20. A 21. C 22. D 23. D 24. A 25. C 26. B 27. C 28. B 29. B 30. B 31. A 32. D 33. B 34. C 35. A 36. B 37. B 38. C 39. A 40. A 2

Part B:

Short Answers. Students should attempt any four (4) from the following eight (8) short answer questions. Each short answer question is worth five (5) marks. Use diagrams in your answers (where appropriate).

1. Explain the concept of the production possibility frontier and outline how following events will affect the Production Possibility Frontier (PPF) for good X and Y.

A full explanation – scarcity, increasing opportunity costs, shape of the PPF, and meaning of the points on the PPF- 2.0 marks -

(i) A war depletes some of the resources used to produce X ( 1 mark)

(ii) The labour force grows and the new workers receive specialised training to produce commodity Y (1 mark) Y

X 3

(iii) Technological knowledge increases and both industries producing X and Y benefit from the new technology (1 mark)

2. You are managing director of Metro 5 Cinema, and you are wondering whether or not to cut the price of the cinema tickets to increase your total revenue from sales. Explain how knowledge of the elasticity of demand for the cinema tickets can help you make the decision.

If demand for the ticket is elastic then a decrease in P will lead to an increase in TR. If demand is inelastic then a decrease in P will lead to a decrease in TR. This is because if P decreases when demand is elastic, the extra amount sold will offset the decrease in Price so that TR (P x Q) will increase. When demand is inelastic decrease in P leads to only a smaller proportional increases in Q so overall (P x Q) TR decreases.

3. Explain the leading characteristics of a public good and provide some examples of a public good.

Public goods are non-rival in consumption (meaning more than one person can consume the good at any one time without affecting another’s consumption). They are also non excludable meaning no-one can be excluded from their benefits. Governments usually provide these because of the free-rider problem which makes these goods unattractive to private markets to produce. Examples are national defence.

4. Explain the difference between a monopolist’s demand curve and its marginal revenue curve. 4

Pm ...... D=AR . MR .

Qm Qp

2.5 marks for a graph

2.5 marks for explanation- to say something about marginal revenue –what’s that… etc. The demand curve facing the monopolist slopes downwards- the market demand is the monopolists’ demand; the marginal revenue curves is also downward-sloping and will be below the average revenue curve. The application of the profit maximisation rule means that price is higher than marginal cots for the purely monopolistic firm , causing allocative inefficiency.

5. In the short run, when will a competitive firm decide to shut down?

$ MC

ATC AVC ------P=AR=MR

Q A firm in a perfectly competitive industry will shut down when price falls below AVC. At this price the firm will not even cover costs of production and so to minimise loss the firm should shutdown and incur the loss of the fixed costs.

Graph 2.5 marks, correct explanation 2.5 marks

6. Explain the difference between normal and inferior goods. What is the type of elasticity you are going to use to classify the good as normal or inferior? Provide an example of each. 5

Student should relate this to the concept of income elasticity (1.0 point), and should explain normal goods (where E is positive, with two subcategories) and inferior where elasticity is negative – maximum 2.0 points; appropriate examples – maximum 2.0 points.

7. Under perfect competition, in the long run, only normal profit is earned. Explain.

In the long run firms respond to economic profit and economic loss by entering or exiting an industry. If the firms are making an economic profit, new firms enter the industry. Firms also can respond by changing (increasing) the size of the plants – which would lower its cost. Each of these actions increase industry supply, and shift industry curve to the right; the price falls and the economic profit of each existing firms decreased . The students should show a clear understating of long run adjustments in contrast to profit and loss in the short run (1 point) should the effects of entry and exit (2. 0 points) and ideally use the graphs (2.0 points) .

8. ‘Cigarettes have negative externalities’. Explain what is meant by this comment and outline some examples of those externalities.

Negative externalities: Student can list some of the negative externalities-air pollution in the offices, public places, even within a household, the health costs of second-hand smokers etc. They also should refer to some other well known examples of negative externalities maximum 2.0 points- this is your discretion; students should include a typical graph with negative externalities which would bring a maximum of 3.0 points)

Part C: SECTION C (2 X 10 - 20 marks)

Essay Questions. Students should attempt any two (2) essay questions from the following choice of four (4) essay questions. Each essay question is worth ten (10) marks. Use diagrams in your answers (where appropriate)

1. Consider the market for newly built houses in NSW. Using diagrams explain the likely effects on market equilibrium of : (i) a rise in the price of cement , (ii) a decrease in the price of old houses and units, (iii) an increase in the price of new houses and (iv) the belief that the price of houses will soon rise substantially.

Each sub - question brings 2.5 marks for a clear and adequate graph depicting the changes, plus a full explanation is required. 6

( i) S2

. . . . S1 . . . P2 . . . . .

P 1 . D1

Q2 Q1 Q final

Cement can be considered as an input and therefore all else remaining constant an increase in the price of an input will reduce the supply; supply curve will shift to the left and the equilibrium price will increase and quantity will decrease.

(ii) S1 P1 ...... P2 . . . . . D1 . D2

Q2 Q1 Q

The old houses can be considered as substitutes, as demand for substitutes increases the demand for the good in question decrease. The demand curve will shift to the left and equilibrium price and quantity will both decrease.

(iii)

S1 P1 ......

P2 . . . . . D1

Q1 Q 7

An increase in the price of the new houses will cause the change in the quantity demanded and a movement along the demand curve. For the maximum mark students have to elaborated adjustments- (shortage, reaction of the suppliers, re-adjustments and a move back towards the equilibrium). (iv)

S1 P2 ...... P1 . . . . . D2 . D1

Q1 Q2 Q

Demand will increase. The demand curve will shift to the right and equilibrium price and quantity will both increase.

2. ‘An industry supply curve rests on the opportunity cost profile of each potential individual supplier’. Discuss.

costs MC

The firm’s marginal-cost curve determines how much the firm is willing to supply at any price – the firms’ supply curve. Student should refer this to the rule of the maximisation - Q the firms will be ready to offer at the price = marginal costs. If P

A full explanation- 6.0 A graph of the MC and/or the industry supply curve – 4.0

3.‘Monopoly is always inefficient from an allocative perspective’. Discuss. You should use an appropriate diagram to illustrate your answer.

Graph- 5.0 marks; explanation 5.0 marks

Monopoly structure yields higher price and lower output than if the industry were perfectly competitive.

Reduced Consumer Surplus under monopoly

Pm ...... LRAC . Pp ...... Dead weight social loss ...... D=AR . MR . Qm Qp

The reduction in output from Qp to Qm leads to a dead weight social loss – which is an efficiency loss to the economy as a whole from the direction of resources into monopoly industry.

Students have to clearly outline the equilibrium in competitive industry and how monopoly restricts output and raises price; Student also have to explain that under perfect competition surplus is maximised, deadweight loss is zero and industry profit is zero economic profit in the long run. These three measures of economic efficiency should be discussed – for a maximum mark.

4.. Explain how emission charges can be used by the government to bring about the efficient level of pollution.

Students should provide the correct graph of taxing environment externalities (5.points)

Full explanation (5.0 points) should include:

-reference to market failure 9

-taxes as a means for corrections- to internalise the cots - taxes are imposed on producers of negative externalities ; private costs equal to the social costs -outcomes on supply and demand and market equilibrium ; lower output- higher prices