Question 1 Answer all questions. Head the following statements and choose the best answer by writing the alphabetical letter on the answer sheets.
Question 21. An entrepreneur is faced with the following investment opportunity: For an investment of $100 today and a further investment of $150 next year, he can earn a return of $300 two years from now. Should he undertake this investment if the interest rate is 5 percent? If the interest rate is 15 percent? Explain.
At5 percent, the NPV=-$100-$150/1.05+$300/(1.05)2=$29.25. The investment is worthwhile.
At 15 percent, the NPV=-$100-$150/1.15+$300/(1.15)2=-$3.59, so the investment is not worthwhile.
Since file benefits are only received in the future, a higher discount lowers the present value of these benefits. Hence, the investment becomes less profitable.
Question 31. (a)Air tickets usually fall into three classes: top class, business class, and economy class. What is the economic rationale for this phenomenon?
(b)What is price discrimination? Are there any necessary requirements for successful price discrimination? Please give two more examples to explain your answer.
(a)Business people or rich people or those who need to fly for urgent things will not care too much about prices. However, travelers or poorer people would switch to alternative transportation means if air tickets were very expensive. In order to maximize profit, airlines usually divide people into different groups according to their price elasticity of demand and charge them differently.
(b)Price discrimination means that monopoly could charge different price for the same goods or service for different people. This may occur when the monopolist can divide the market into two or more segments each independent of the other.
The essential requirements for successful price discrimination are:
· Two or more separate markets-really sub-sections of the one market.
· No arbitrage between markets-i.e. buying in one market and selling in the other.
· Different elasticities in each market.
Other examples: In China, students can take a train by paying half the ticket price on their winter and summer vacations. Foreigners pay more to visit the Palace Museum in Beijing than local people.
Question 41. Suppose you are in charge of a toll bridge that is essentially cost free. The demand for bridge crossings Q is given by P=12-2Q.
a.Draw the demand curve for bridge crossings.
b.How many people would cross the bridge if there were no toll?
c.What is the loss of consumer surplus associated with the charge of a bridge toll of $6?
(a)The demand curve is a straight line with a vertical intercept of P=12 and a horizontal intercept of Q=6 (since Q=6-P/2).
(b)If there were no toll, the price P would be 0, so that Q=6.
(c)If the toll is $6, Q = 3. The consumer surplus lost is the difference between consumer surplus when P=0 and consumer surplus when P=3, or 15.75.
Question 51. What monetary policy tools can a government use to control money supply?
A central bank can use the following monetary policy tools to affect intermediate targets and to achieve the ultimate objectives of monetary policy—the best combination of low inflation, low unemployments, rapid GDP growth, and orderly financial markets.
·Open-market operations: Sales by the central bank of government securities in the open market reduce money supply by lowering hank reserves. Open-market purchases do the opposite, ultimately expanding money supply by increasing bank reserves.
·Discount rate policy: A central bank can also raise or lower the discount rate, which is the interest rate charged on bank borrowings from the central bank, to decrease or increase money supply.
·Reserve requirements: The central bank might require all institutions in the monetary sector with eligible liabilities in the non-operational, non-interest-bearing deposits with the central bank.
·Changing the level and/or structure of interest rates: The government's influence over interest rates can be achieved through open-market operations or through the interest rate imposed by the central bank. However, it is now accepted that the interest rate weapon is more suitably used to control inflation or the exchange rate rather than to control broad money supply growth.
·Direct controls over bank lending: Quantitative controls might be imposed on the growth in volume of either bank lending (i, e. assets) or bank deposits. Qualitative controls may be used to influence the type of bank lending, e.g. favouring the business sector as against the personal sector.
·Special deposits: The central bank may require the commercial banks to lodge non-operational special deposits to reinforce its control over credit. This weapon, which is not often used, can be a sharp and effective means of affecting interest rates.
Question 61. The table below shows the bushels of wheat and the yards of cloth that the United States and Britain can produce with one hour of labor time.
| U.S. | Britain |
Wheat (bushels/man-hour) | 12 | 4 |
Cloth (yards/man-hour) | 12 | 2 |
a.Please identify the commodity in which the U.S. and Britain have an absolute advantage or disadvantage?
b.Indicate the commodity in which the U.S. and Britain have a comparative advantage or disadvantage?
c.If the two countries are to trade with each other, which goods should they expert? Why?
d.Would trade benefit both of them? Why?
(a)The table shows that the U.S. has absolute advantage in producing both goods, six times as efficient as Britain in producing cloth, but only three times in producing wheat.
(b)The U.S. has a relative or comparative advantage in producing cloth. The reason is that the opportunity cost of 1 yard of cloth is 1 bushel of wheat in the U. S., but higher in Britain at 2 bushels of wheat. Similarly Britain has a comparative advantage in producing wheat since the opportunity cost of 1 bushel of wheat is 0.5 yard of cloth in Britain, but higher in the U. S. at 1 yard of cloth.
(c)According to (b), the U.S. should export cloth and Britain wheat if the two commies are to trade with each other. The reason: The law of comparative advantage states that if each country specializes in the products in which it has the greatest comparative advantage, trade will be beneficial to all concerned.
Quextion 71. Who loses from inflation? Please describe carefully.
Inflation hurts all those people who have wealth or income that is fixed in nominal terms. Typical of these people will be the elderly who live on fixed pensions, and workers who lack the industrial might push for cost of living adjustments to their wage packets.
Lenders also lose if their loans are fixed in money terms because they are unable to buy the same amount of goods and services when their loans are repaid. This principle applies as well to the "loans" made to the government by the private sector in the form of government bonds or to the "loans" made to banks by individuals in the form of savings accounts. In most cases the loss occurs because people are unable to anticipate the fact that inflation will outstrip the rate of growth of nominal income. If they were able to anticipate inflation fully they would build the inflation rate into the nominal interest rate. Progressive income tax payers also lose out during inflationary times. Inflation eventually raises nominal incomes and pushes people into higher tax brackets.