Neo-classical school

Question 1

Briefly summarise Marshall’s views on demand and supply

Answer 1

1. Price is determined where D=S
2. Role of demand and supply changes with time. The shorter the period, the larger the role of demand as adjusting capacity in the short term is harder.
3. Introduction of ceteris paribus concept

Question 2

What theories did Marshall introduce on utility and welfare?

Answer 2

1. Rational consumer choice ( demand based on marginal utility concept)
2. Social surplus = consumer surplus + producer surplus

Question 3

What other theories did Marshall contribute?

Answer 3

1. Price elasticity of demand
2. Concept of externalities ( explain downward sloping LR curve in perfect competition)
3. Income distribution also depends on supply and demand.

Question 4

What did Fisher suggest for a monetary policy compared to Wicksell?

Answer 4

Wicksell: As long as prices remain unchanged, bank rate should be unchanged. When prices rise, the bank rate should rise. When prices fall, the bank rate should fall.

Fisher: control quantity of money as to face business cycle fluctuations ( due to inflation)

Question 5

What did Fisher think affected interest rates?

Answer 5

They are influenced by the impatience rate and the investment opportunity rate ( equilibrium = both equal = real interest rate)

Question 6

What is the Fisher Effect?

Answer 6

Nominal interest rate = real rate + expected rate of inflation

Question 7

What does Fisher’s quantity theory of money suggest prices are affected?

Answer 7

Changes in M disturb the optimum, make people adjust their cash/expenditure ratio, and as such changes prices ( direct effect)

Extra info:
Money Supply (M) x Velocity (V) + Liquidable money supply (M') x (V') = Price (P) x Volume of trade (T)

Question 8

Briefly explain Wicksell’s view on interest rates with relation to prices?

Answer 8

Natural rate depends on supply/demand of real capital that is not yet invested

Bank rate is determined by banking system

Bank rate < natural rate - inflation ( people consume more, higher investment > effective demand increases > prices go up)
Bank rate > natural rate - deflation

Question 9

What are the differences between Robinson and Chamberlin’s theories of imperfect competition?

Answer 9

Only Chamberlin discusses the sources of product differentiation

• Robinson paid more attention to the consequences for price formation (monopsony and price discrimination)

Question 10

What type of imperfect market did Chamberlin study and what did he discover?

Answer 10

Monopolistic market - he observed product differentiation ( advertising and product development) and discovered that in SR, there are monopolistic profits since P>MC but in LR there are no profits due to free entry.