Practice Final Examination 2

Question 1

A recent government document states that UK society would be better off if UK universities produced more engineers and fewer social scientists (e.g. economists). Which of the following is correct? Assuming the government is right, it follows that

A. the marginal product of engineers is positive and the marginal product of social scientists is negative.

B. the benefit to be gained from using one more unit of resources in order to produce engineers is greater than the benefit of using it to produce social scientists.

C. the opportunity cost of engineers is greater than the opportunity cost of social scientists.

D. at going wage rates, there is excess demand for engineers and excess supply ofsocial scientists.

Answer 1

The correct answer is B. To become better off, a society should undertake any activity for which the marginal benefit exceeds the marginal cost. The government is not arguing that additional social scientists provide no benefits, nor that there is an excess supply of social scientists, but rather that the benefit to society from addi- tional engineers exceeds the benefit to society from additional social scientists.

Question 2

Answer 2

The correct answer is B. TC = FC + TVC
therefore ATC = FC/Q + TVC/Q
and not FC = △TVC/△Q

Question 3

In an electronics company, all assets other than labour, i.e. factories, machinery etc., are constant and valued at £1 million. The annual wage bill for the labour force is £0.25 million. If both output per worker and wages increase at 4 per cent per annum, what happens to the return to all other assets?

A. It remains constant.

B. It increases by 1 per cent per annum.

C. It increases by 3 per cent per annum.

D. It increases by 4 per cent per annum.

Answer 3

Because output per worker increases by 4 per cent, total output increases by 4 per cent and the return to all other factors taken together increases by 4 per cent. The return to each factor input can increase, therefore, by 4 per cent.

Question 4

In perfectly competitive markets, whenever a firm’s short-run profit is being maximised or its short-run loss is being minimised

I. the difference between average cost and average revenue is greatest.

II. marginal cost equals marginal revenue.

III. average cost is at its minimum.

Which of the following is correct?

A. II only.
B. I and II only.
C. II and III only.
D. I, II and III.

Answer 4

The correct answer is A. If the product of an additional unit of output adds more to revenue than it does to cost, it will pay a firm to produce that unit, i.e. it will produce additional units as long as additional revenue exceeds marginal costs. As a consequence, the profit-maximising (loss-minimising) level of output of any firm occurs where marginal revenue equals marginal cost. Thus statement II is correct. The marginal cost curve intersects the average cost curve at its minimum point. Thus, producing at minimum average cost would maximise profit if, and only if, the marginal revenue curve intersected the marginal cost curve at this level of output. Thus statement III is incorrect. If average revenue exceeds average total cost, the greatest difference between them will occur when average total cost is at a minimum, which will not be the profit- maximising output level because marginal cost will not equal marginal revenue. Thus statement I is incorrect.

Question 5

Consider the following average cost schedule for frozen turkeys. These frozen turkeys can be sold in unlimited amounts for £10 each.

To maximise profit, which of the following should be the output level, and why?

A. 60, because the decrease in average cost is maximum.
B. 70, because average cost is minimum.
C. 100, because marginal revenue equals marginal cost.
D. 110, because it is the largest output given for which average cost is less than its price of £10.

Answer 5

The correct answer is C. Since the selling price of each turkey is £10, the marginal revenue, i.e. the revenue gained from one additional turkey, is £10. To maximise profit, marginal revenue must equal marginal cost. Thus marginal cost must be calculated at the different levels of output. The average cost of producing 90 turkeys is £7; therefore, the total cost of producing 90 turkeys is £630. The total cost of producing 100 turkeys is £730. Therefore, the cost of producing the additional 10 turkeys is £100 or £10 per turkey. At this output level, total profit equals £270 (£1000 − £730). The firm would achieve the same profit producing 90 turkeys, since for the additional 10 turkeys marginal revenue equals marginal cost, but an output of 90 is not an option. The same solution can be reached by calculating total revenue and total cost for each level of output.

Question 6

You have been hired by the local shovel works to recommend what actions to take to
maximise profit. Shovels sell for £5.00 each. You can have the 50 employees do overtime; each hour of overtime costs £300 and its marginal product is 50 shovels. Or you can employ more workers; each additional worker hired costs £30 per day and marginal product is 5 shovels per day. Which of the following should your recommendation be so as to maximise profit?

A. Work overtime and hire more workers.
B. Work overtime but do not hire more workers.
C. Hire more workers but do not work overtime.
D. Make no change in working hours or size of labour force.

Answer 6

The correct answer is D. Since each hour of overtime costs £300 and the additional output is 50 shovels, the marginal cost of an ‘overtime’ shovel is £6. This exceeds the selling price of £5. Since each additional worker costs £30 and the additional output is 5 shovels per day the marginal costs of an ‘additional worker’ shovel is also £6, again exceeding the selling price of £5. Thus either course of action will reduce profits. The firm should hire no additional workers and work no overtime.

Question 7

In the woollen industry, labour is a variable factor of production and land and capital are fixed factors of production. Improved relations between our country and Russia have led to a promise of large annual woollen garment sales to Russia for the foreseeable future, commencing immediately. In the short run
I. more factor inputs will be employed in the woollen industry.
II. profits in the woollen industry will increase.
III. land now devoted to other agricultural uses will be switched to the woollen industry.

Which of the following is correct?

A. I only.
B. II only.
C. I and II only.
D. I, II and III.

Answer 7

The correct answer is C. In the short run, an increase in demand will lead to a higher equilibrium price. The short-run supply curve of a firm is its marginal cost curve, and firms will expand output by hiring additional variable factors of production, incurring additional marginal cost, and will maximise profit by producing that level of output where marginal revenue equals marginal cost. Because the average cost curve does not change in the short run, the firm will experience increased profit as it expands output and hires additional variable inputs. Thus statements I and II are correct. However, since the question specifies the short run, no additional fixed factors, such as land, will be involved. Thus statement III is incorrect.

Question 8

‘In the USA the labour market works like any highly competitive market; the demand for and supply of labour are like textbook demand and supply curves; when unemployment appears, wages fall and the economy tends towards full employment continuously.’ Assume the above situation exists. Which of the following must happen in the US labour market if a minimum wage (i.e. a wage below which no firm could legally hire workers) were introduced that was significantly higher than the lowest wage rate for unskilled workers?
A. Total wages payments to all workers would rise.
B. Total wages payments to unskilled workers would rise.
C. Some people would lose their jobs.
D. The supply curve of labour would shift to the right.

Answer 8

The correct answer is C. Given traditional demand and supply curves in an efficient market, the imposition of a price floor – in this case through a minimum-wage law – will result in excess supply of labour, in this case unemployment. There are two causes of this unemployment: a larger number of workers offering labour services at the (higher) minimum wage rate (i.e. a shift along the supply curve), and reduced demand for labour (i.e. a shift along the demand curve). Thus some people would lose their jobs.

Question 9

In order to make the most efficient use of a country’s telephone system, how should
charges for telephone calls vary?

A. They should be relatively low during business hours to reduce costs for the large number of people making calls.

B. They should be relatively high during business hours to ensure that people who value the service most highly can make calls.

C. They should be the same at all times to avoid making calls at inconvenient times to save money.

D. They should be relatively low during business hours because that is when the poor make calls to businesses, employment agencies, doctors etc.

Answer 9

The correct answer is B. In order for resources to be used efficiently, it is necessary that the prices of goods and services produced be equal to their marginal costs. The social cost of telephone calls is higher during business hours when telephone circuits are being used at or near their capacity and each user prevents other users from making calls. Thus prices should be set during peak hours to ensure no excess demand. This will ensure that the people who make calls at that time value them most.

Question 10

Suppose all Brazilian coffee growers agreed to restrict the supply of coffee and thereby force up the price. The coffee growers as a result will experience an increase in income only if

I. the demand for Brazilian coffee is price-inelastic.

II. world income is rising.

III. there are no economies of scale in growing coffee beans.

Which of the following is correct?

A. I only.
B. III only.
C. II and III only.
D. I, II and III.

Answer 10

The correct answer is A. An increase in the price of a good is associated with a decrease in the quantity bought. But if the demand for Brazilian coffee is price- inelastic, the decrease in quantity bought will be proportionately smaller than the increase in price, leading to an increase in total expenditure and revenue. Thus the coffee growers will be better off, and statement I is correct. Rising world income does not guarantee increased revenue to Brazilian coffee growers at higher prices; thus II is incorrect. Economies of scale affect production costs, not revenue; thus III is incorrect.

Question 11

If the government were to increase sales tax on new cars from 15 per cent to 25 per cent, the effect on the second-hand car market would be

I. the average price of second-hand cars would increase.
II. the quantity of second-hand cars sold would decrease.

Which of the following is correct?

A. I only.
B. II only.
C. I and II.
D. Neither I nor II.

Answer 11

The correct answer is A. The increase in the sales tax on new cars would increase the demand for used cars by people who do not own any car but wish to acquire one. Simultaneously, the increased sales tax on new cars would encourage car owners to keep their current cars rather than buy new ones, thereby decreasing the supply of second-hand cars. The increase in demand coupled with the decrease in supply will cause the price of second-hand cars to rise. The quantity bought and sold, however, could increase, remain constant or decrease.

Question 12

An imperfectly competitive firm discovers that at its present level of output its average total cost curve is at its minimum point and equal to £6.00; average revenue equals £5.00, marginal revenue equals zero. What should the firm do to maximise profit?

A. Decrease price and increase output.
B. Decrease price and decrease output.
C. Increase price and decrease output.
D. Nothing; profit is already being maximised.

Answer 12

The correct answer is C. The diagram below exhibits the data: at output level 0q1 average total cost is at a minimum and equals £6, average revenue equals £5, and marginal revenue equals zero. The upward-sloping marginal cost curve must pass through the minimum point of the average total cost curve and therefore must intersect the marginal revenue curve at an output level less than 0q1. Since profit maximisation requires that marginal revenue equals marginal cost, the firm should reduce output to 0q2, and charge a higher price p2.

Question 13

In capitalist economies, market forces play a significant role in determining wages. In the absence of market imperfections, it is argued that wages would equal the value of the marginal product of labour. In communist economies, planners sometimes pay attention
to market forces in setting wages, but wages are often determined by central committees.
Which of the following is inconsistent with marginal productivity theory?

A. The imposition of a minimum wage rate without guaranteed employment for all job seekers.

B. From each according to his ability, to each according to his needs.

C. If productivity gains are 5 per cent and workers are paid an additional 5 per cent, nothing is left for the state.

D. Ice hockey players, politicians and ballet dancers are often paid high salaries in command economies.

Answer 13

The correct answer is B. In competitive markets it will always pay an employer to hire workers until the wage rate equals the value of the marginal product of labour. If a worker is paid less than the value of his/her marginal product, he/she will move to another firm. Thus the worker’s contribution to output will determine his/her wage and not his/her wants/needs. Thus ‘from each according to his ability, to each according to his needs’ is inconsistent with marginal productivity. A, C and D are all consistent with marginal productivity.

Question 14

Which of the following would make the UK balance of payments deficit larger than it otherwise would be?

A. Purchase of a UK government bond by a foreigner.

B. An additional UK government grant to a foreign country.

C. Dividend payments to UK stockholders by foreign companies.

D. A decrease in imported goods to the UK from EU countries.

Answer 14

The correct answer is B. An increase in imported goods or services and/or an increase in capital outflows will make a balance of payments deficit larger than it otherwise would have been. The only item that falls into this category is the UK grant to a foreign country.

Question 15

Suppose that in India and the UK the costs of producing wool and cars measured in man/days per unit are as given in the table.

Which of the following is correct?

A. The UK has comparative advantage in both wool and cars.
B. The UK has both absolute and comparative advantage in wool.
C. India has comparative advantage in cars.
D. India has comparative advantage in wool.

Answer 15

The correct answer is D. Since the UK can produce both wool and cars with fewer man-days of input, the UK has an absolute advantage in the production of both. In India a car will exchange for three-and-a-third units of wool. In the UK a car will exchange for two-and-a-half units of wool. The UK will export cars to India because of its comparative advantage in cars; India will export wool to the UK because of its comparative advantage in wool.

Question 16

Which of the following transactions would make the demand for pounds (£) higher than it otherwise would have been in the foreign exchange market?

A. A Japanese distillery buys £100 of malt whisky from a Scottish distillery.

B. A UK company pays £100 in dividends to a shareholder living in France.

C. A UK meat processor buys £100 of tin from a company in Bolivia.

D. A Norwegian boy receives £100 for Christmas from his English aunt.

Answer 16

The correct answer is A. When a UK company wishes to buy foreign goods or assets, it must exchange £s for the currency of the foreign country. Such an action would increase the demand for the foreign country’s currency and increase the supply of £s available for exchange. Conversely, when a foreign country wishes to buy UK goods or assets, the demand for £s will be higher than it otherwise would have been.

Question 17

A country has a surplus in its balance of payments and a deficit in its balance of trade. Which of the following is correct?

A. The currency of the country must be depreciating.
B. Net capital inflows must exceed the export–import gap.
C. The country must be lending more abroad than the excess of imports over exports.
D. Gross national product (GNP) of the country must be higher than it would have been if exports and imports had been balanced.

Answer 17

The correct answer is B. The balance of payments is the sum of the trade balance plus net capital flows; thus, if a country had a trade deficit and net capital flows were zero, the country would have a balance of payments deficit. To have a balance of payments surplus in the presence of a trade deficit, net capital inflows must exceed the trade deficit.

Question 18

Answer 18

The correct answer is D. C = 50 + 0.8Y; when Y = 600, C = 50 + 0.8(600) = 530. Therefore S = Y − C = 70, and therefore option A is incorrect. When Y = 0, C = 50, therefore option B is incorrect. When Y = 250, C = 50 +0.8(250) = 250, therefore option C is incorrect. Since C = 50 + 0.8Y, S = –50 + 0.2Y and so the average propensity to save is S/Y = -50+0.2Y/Y As Y increases, S Y increases.

Question 19

The following factors all affect how large the multiplier effect will be:

I. Marginal propensity to consume (MPC).

II. Rate of unemployment (U).

III. Rate of change in the money supply (M). In the absence of offsetting factors, the largest multiplier effects will come from which of the following circumstances?

A. Low MPC, high U and a decrease in M.
B. High MPC, zero U and an increase in M.
C. Low MPC, zero U and a decrease in M.
D. High MPC, high U and an increase in M.

Answer 19

The correct answer is D. The simple multiplier formula is:
multiplier 1/ 1-MPC

Thus the higher the value of MPC, the larger the multiplier. For the multiplier to work fully, the three following conditions must be met: (a) sufficient unemployed resources exist to allow the multiplier process to operate; (b) the additional demand generated by increased expenditure is spent on domestically produced goods and services; and (c) the rate of interest does not increase; an increase in the interest rate would reduce investment and consumption expenditure, with negative multiplier effects partly or fully cancelling out the positive expenditure multiplier.

Question 20

The following would enter the national income accounts under the heading ‘investment’:
I. Building a new house by a family for their own occupation.
II. Purchase of a second-hand car by a family for their own use.
III. Buying shares in BP.

Which of the following is correct?

A. I only.
B. III only.
C. I, II and III.
D. Not I nor II nor III.

Answer 20

The correct answer is A. Additions to the capital stock are classified under the heading ‘investment’. Houses are part of a nation’s capital stock and thus a new house would be classified as an investment in the year in which it was built. If it were subsequently resold, it would not enter the national income accounts in the year of resale since it would already be part of the capital stock. Thus statement I is correct. By the same logic, the purchase of a second-hand car would not enter the national income accounts. Thus II is incorrect. Also by the same logic, buying a share in an existing company is merely transferring ownership of part of that company to another person or institution. Thus III is incorrect.

Question 21

Answer 21

The correct answer is A. If a miller sells £100 worth of flour to a baker who uses it to make bread which sells for £200, including both the flour (£100) and the bread (£200) in the national income accounts would involve double counting of the flour. Thus the costs of raw materials in the question have to be subtracted from total sales, i.e. 200 + 400 – 100 – 60 = 440. Insufficient information is given to calculate total income to all factor inputs since only profit figures are given.

Question 22

A 1585 painting by Annibale Carracci depicting the Holy Family was valued at £400 by one auction house last year but sold by another auctioneer on Tuesday night for £847 000. The painting was bought in 1930 for £5 by the father of the woman who put it up for sale. By how much will the sale of the painting increase this year’s GNP?

A. The auctioneer’s commission for selling the painting.
B. £847000 − £400 − £5.
C. £847 000 plus the auctioneer’s commission.
D. £847 000.

Answer 22

The correct answer is A. A good (service) enters the national income accounts in the year in which it is produced (performed). In the case of the sale of any antique or second-hand good, the only element of the sale that enters the national income accounts is the service(s) of the agent(s) facilitating the exchange between the owner and the new owner – in our question the auctioneer’s services, the value of which is the commission.

Question 23

Gross National Product is a measure of an economy’s total output of final goods and services, which

I. excludes depreciation on capital as part of total output.

II. uses prices as weights in adding together quantities of different goods and services.

III. includes unemployment compensation for the unemployed and supplementary benefits payments to the poor.

Which of the following is correct?

A. II only.

B. I and II only.

C. I, II and III.

D. Not I, nor II, nor III.

Answer 23

Question 24

The data below refer to an economy in Year t and Year t + 10:

Comparing Year t + 10 with Year t, which of the following is true? It follows that real gross national income

A. fell by 25 per cent.

B. was constant.

C. increased by 25 per cent.

D. increased by 50 per cent.

Answer 24

Question 25

If an economy is at full employment, real gross national product (GNP) must always increase when

I. potential (full-employment) GNP increases.
II. nominal (money) GNP increases.
III. the unemployment rate increases.

Which of the following is correct?

A. I only.
B. I and II only.
C. II and III only.
D. Not I, nor II, nor III.

Answer 25

The correct answer is D. Potential output increases when, in the absence of offsetting factors, labour inputs increase and/or the capital stock increases and/or technological change occurs. Such changes can occur independent of what is happening to real GNP; thus statement I is incorrect. Nominal GNP will increase when the average price level increases, real GNP constant; thus statement II is incorrect. The unemployment rate is determined by the gap between potential and actual GNP. Thus, if potential GNP were to increase and actual GNP were to remain constant, the unemployment rate would increase; thus statement III is incorrect.

Question 26

The foreign trade multiplier shows the effect on gross national product (GNP) of an increase/decrease in imports. The foreign trade multiplier will be

I. larger, the lower the marginal propensity to import.

II. larger, the higher the marginal propensity to save.

III. larger, the lower the marginal propensity to consume.

Which of the following is correct?

A. I only.
B. I and II only.
C. I and III only.
D. I, II and III.

Answer 26

The correct answer is A. The size of the multiplier is determined by leakages from the circular flow of income – the smaller the leakages, the larger the multiplier. Saving and expenditures on imported goods are both leakages from the circular flow.

Question 27

In its budget message, the government announced a 2 per cent tax cut and 10 per cent money supply increase, which it declared would lead to full employment without inflation. A group of research economists, reviewing the budget proposals in detail, declared the government had overestimated how much the average consumer would spend out of additional income (marginal propensity to consume, MPC) and had also underestimated how much the average consumer would spend on imports out of additional income (marginal propensity to import, MPI). If the economists are right,
which of the following is correct? To achieve the stated goals, the 2 per cent tax cut and 10 per cent money supply increase is

A. too expansionary: it will cause excess demand and inflation.

B. too expansionary if, and only if, MPC is greater than MPI.

C. not expansionary enough if, and only if, MPC is less than MPI. D. not expansionary enough: it will lead to an employment/output gap.

Answer 27

The correct answer is D. To achieve full employment with the 2 per cent tax cut and the 10 per cent money supply increase, the government had to make assumptions about many variables in the economy, including both the marginal propensity to consume (MPC) and the marginal propensity to import (MPI). The higher the value of MPC, the larger the multiplier effect; and the higher the value of MPI, the lower the multiplier effect. Since the government overestimated the former and underes- timated the latter, the fiscal and monetary policies enacted would not be sufficient stimulation to achieve the desired increase in GNP. Thus unemployment would result.

Question 28

Despite the fact that an economy was at full employment, its government decided to electrify its total railway system. It financed this project by selling government bonds to the general public. Aggregate demand increased in the economy and also the rate of
inflation. After the project was complete, aggregate demand returned to its original level, but the rate of inflation remained higher than its original level, the reasons being

I. potential GNP increased.

II. the initial inflation changed expectations about future inflation.

III. the increase in the money supply caused by the government selling bonds to finance the electrification of the railways.

Which of the following is correct?

A. II only.
B. III only.
C. I and II only.
D. I and III only.

Answer 28

The correct answer is A. Two causes of inflation are excess demand and expectations about higher future inflation. The electrification of the railways while the economy was at full employment would cause inflation due to excess demand. However, when aggregate demand returned to its original level, the excess-demand cause of inflation would disappear; indeed, potential output would be expected to increase, resulting in an output-employment gap. Thus, for the inflation rate to remain higher than its original rate, expectations about future inflation must have increased. Selling bonds to finance the electrification of the railways would not increase the money supply.

Question 29

If the government were to adopt policies that encouraged households to save a higher proportion of their incomes, which of the following would be the effect on national income in the short run, assuming no other offsetting factors affecting the economy?

A. National income would be lower than it otherwise would have been because aggregate demand would be lower than it otherwise would have been.

B. National income would be higher than it otherwise would have been because higher savings means higher investment expenditure.

C. National income would be higher than it otherwise would have been because savings functions show that higher savings are associated with higher levels of national income.

D. National income would not change because the increase in savings (decrease in consumption expenditure) would be matched by an equal increase in investment expenditure.

Answer 29

The correct answer is A. If households were to save a higher proportion of their incomes, by definition they would consume a smaller proportion of their incomes. Thus, in the absence of offsetting factors, total consumption expenditure and aggregate demand would decrease. As a result, national income would be lower than it otherwise would have been.

Question 30

The following data refer to a hypothetical economy:

Comparing Year t +1 with Year t, which of the following is correct?

A. GNP per capita increased.
B. There was inflation.
C. Real GNP decreased.
D. Money GNP increased or was constant.

Answer 30

The correct answer is B. Since no information is given about actual output (GNP), in either real or nominal terms, or the population, we do not know what happened to real GNP, nominal GNP or GNP per capita. Thus, A, C and D are not necessari- ly correct. The price index increased from 100 to 102, indicating an inflation rate of 2 per cent.