University of South Australia Division of Business MICROECONOMICS [ECON 1006] FINAL EXAMINATION – Study Period 5, 2006 WRITING TIME: EXTRA TIME: (3 hours) (10 minutes) (30 minutes for ENTEXT students ) READING TIME: GENERAL INSTRUCTIONS TO CANDIDATES: Write your answers in the examination booklet provided. This is a closed-book examination. Notes are not permitted. Language translation or English dictionaries are permitted. Electronic dictionaries and programmable calculators are not permitted. No writing is allowed in the examination booklet during reading time, however, notes may be made on the scribble paper provided. Be sure to hand this question booklet, your answer booklet and your scribble sheet to the invigilators prior to leaving the examination room. Section Marks Suggested time allocation Part A 40 one hour Part B 30 one hour Part C 30 one hour TOTAL 100 Three hours WRITE ALL ANSWERS IN THIS BOOKLET CAREFULLY DETACH THIS FRONT PAGE AND COMPLETE PAGE 2 BEFORE BEGINNING YOUR READING THIS BOOKLET CONTAINS 14 PAGES (13 PAGES PLUS A ONE PAGE VOLUNTARY SURVEY TO BE DONE IF TIME PERMITS). MAKE SURE YOU HAVE THEM ALL.Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. MICROECONOMICS [ECON 1006] STUDENT ID STUDENT NAME PROGRAM CODE I testify that the work presented here is my own. I also understand the university policy on examinations and that breaches of examination rules by me (i.e. cheating) could result in my enrolment being terminated. Date Signed For marker’s use only: Marks Section A Section B /40 /30 /30 Section C Total this exam /100 Other comments: 2Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. SECTION A This section is worth 40 marks. You should allow approximately one hour. Record your answers on the sheet provided (page 10). 1. The production possibilities curve is bowed out from the origin because: (a) of increasing opportunity cost. (b) economic resources are perfectly substitutable in the production of the two products. (c) of underemployment (d) equal quantities of both products are produced at each possible point on the curve. 2. The production possibilities curve illustrates the basic principle that: (a) as the production of one good increases, smaller and smaller sacrifices of other goods will be required (b) an economy will automatically achieve that level of output at which all its resources are fully employed (c) if all the resources of an economy are employed, and productive efficiency is achieved, more of one good can be produced only if less of another good is produced (d) combinations of goods and services indicated by points outside the frontier will never be achieved over time. 3. An increase in the price of a product will reduce the amount of it purchased because: (a) supply curves are upward sloping. (b) the higher price means that real incomes have risen. (c) consumers will substitute other products for the one whose price has risen. (d) consumers substitute relatively high-priced products for relatively low-priced products. 4. Which of the following statements is incorrect? (a) If demand increases and supply decreases, equilibrium price will rise. (b) If supply increases and demand decreases, equilibrium price will fall. (c) If demand decreases and supply increases, equilibrium price will rise. (d) If supply declines and demand remains constant, equilibrium price will rise. 5. The idea of ‘allocative efficiency’ refers to: (a) the use of the least-cost method of production (b) the production of the product-mix most wanted by society. (c) the full employment of all available resources. (d) production, at some point, inside of the production possibilities curve. 6. If firms in a competitive industry are realising substantial economic profits, we can expect that in the long term, output will: (a) diminish, product price will fall, and economic profits will tend to disappear. (b) diminish, product price will rise, and economic profits will tend to disappear (c) expand, product price will fall, and economic profits will tend to disappear. (d) expand, product price will fall, and economic profits will tend to rise. 7. The major benefits of the competitive market system are that it: 3Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. (a) (b) (c) (d) allocates resources efficiently and allows economic freedom. results in an equitable personal distribution of income and always maintains full employment. results in price level stability and a fair personal distribution of income. eliminates discrimination and minimises environmental pollution. 8. Assume the demand for product Y increases and the subsequent market system response results in the production of more Y. This illustrates: (a) that the concept of derived demand is inapplicable. (b) that consumer sovereignty is inoperative in this economy. (c) the scarcity function of prices. (d) the directing or guiding function of prices. 9. If demand is elastic and supply decreases, the total revenue of sellers will: (a) increase but only if demand stays elastic. (b) decrease (c) decrease only if supply is elastic. (d) increase only if supply is inelastic. 10. Normal profits are: (a) a cost, because any excess of total receipts over total costs will accrue to the businessperson. (b) a cost, because they represent payments made for the resources that the businessperson owns and supplies in his or her own enterprise. (c) not a cost, because a firm can avoid these payments by temporarily closing down. (d) not a cost of production, because they need not be realised, in order for a firm to retain entrepreneurial ability. 11. The price of product an music player is reduced from $100 to $90 and, as a result, the quantity demanded increases from 50 to 60 units. From this we can conclude that the demand for the music player in this price range: (a) has declined. (b) is unit elastic. (c) is inelastic. (d) is elastic 12. Suppose the price elasticity coefficients of demand are 1.43, 0.67, 1.11, and 0.29 for products W, X, Y, and Z respectively. A 1% decrease in price will result in an increase in total revenue in the case of: (a) W and Y (b) Y and Z (c) X and Z (d) Z and W 4Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. 13. If the price elasticity of demand for a product is 2.5, then a price cut from $2.00 to $1.80 will (a) increase the quantity demanded by 2.5%. (b) decrease the quantity demanded by 2.5%. (c) increase the quantity demanded by 25%. (d) do none of the above. 14. If the supply of product X is perfectly elastic, an increase in the demand for it will increase: (a) equilibrium quantity, but reduce equilibrium price. (b) equilibrium quantity, but equilibrium price will be unchanged. (c) equilibrium price, but reduce equilibrium quantity. (d) both equilibrium quantity and equilibrium price. 15. The larger the positive cross elasticity coefficient of demand between products X and Y, the: (a) greater is the degree to which we can say they are complementary goods. (b) greater their substitutability. (c) smaller the price elasticity of demand for both products. (d) less sensitive purchases of each are to increases in income. 16. Other things being the same, the shortage associated with a price ceiling will be greater, the: (a) smaller the elasticity of both demand and supply. (b) greater the elasticity of both demand and supply. (c) greater the elasticity of supply and the smaller the elasticity of demand. (d) greater the elasticity of demand and the smaller the elasticity of supply. 17. The main determinant of elasticity of supply is the: (a) number of close substitutes for the product available to consumers. (b) amount of time the producer has to adjust inputs in response to a price change. (c) urgency of consumer wants for the product. (d) number of uses for the product. 18. Which of the following statements concerning the relationships between total product (TP), average product (AP) and marginal product (MP) is not correct? (a) AP continues to rise so long as TP is rising. (b) AP reaches a maximum before TP reaches a maximum. (c) TP reaches a maximum when the MP of the variable input becomes zero. (d) MP cuts AP at the maximum AP. 19. Assume that in the short run, a firm which is producing 100 units of output has average total costs of $200 and average variable costs of $150. The firm's total fixed costs are: (a) $5 000. (b) $500. (c) $0.50. (d) $50. 5Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. 20. Normal profit is: (a) determined by subtracting implicit costs from total revenue. (b) determined by subtracting explicit costs from total revenue. (c) the return to the entrepreneur when economic profits are zero. (d) the average profitability of an industry over the preceding 10 years. 21. The following is the total output and cost data for a firm: Total Output Total Cost($) 0 24 1 33 3 41 3 48 4 5 61 6 69 Refer to the cost data above. The marginal cost of producing the sixth unit of output is: (a) $24 (b) $16 (c) $8 (d) unknown without more information. 22. Suppose that a business incurred implicit costs of $200 000 and explicit costs of $1 million in a specific year. If the firm sold 4 000 units of its output at $300 per unit, its accounting profits would be: (a) $100 000, and its economic profits would be zero. (b) $200 000, and its economic profits would be zero. (c) $100 000, and its economic profits would be $100 000. (d) zero, and its economic loss would be $200 000. 23. If a technological advance reduces the amount of variable resources needed to produce any given level of output, this will cause: (a) the AVC curve to shift downward. (b) the MC curve to shift downward. (c) the ATC curve to shift downward. (d) all of the above. 24. If a firm doubles its output in the long run and its unit costs of production decline, we can conclude that: (a) technological progress has occurred. (b) economies of scale are being realised. (c) the firm is encountering diminishing returns. (d) diseconomies of scale are being encountered. 6Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. 25. As successive units of labour are applied to a set of fixed resources, the marginal product of labour: (a) diminishes at all levels of production. (b) may initially increase, then diminish, but will never become negative. (c) may initially increase, then diminish, and ultimately become negative. (d) is always less than average product. 26. Roses Inc. sells flowers in a purely competitive market. The current production of 500 bunches sells on the market for $5 a bunch. The cost of production of the 500th bunch is $5 and the cost of the 501st bunch is $5.10. If Roses Inc. wants to maximise its profit it should: (a) restrict the number of flowers that it sends to market in order to get a higher price (b) send exactly 500 bunches to market (c) increase the number of bunches to the market so that increased revenue offsets increased costs (d) reduce the number of bunches it sends to market to bring its costs down 27. You notice that the price obtained for the output in a perfectly competitive industry is constant over the long run. From this you conclude that the industry’s long-run supply curve is (a) horizontal and that it is an increasing costs industry (b) horizontal and that it is a decreasing costs industry (c) downward sloping and that it is a decreasing cost industry (d) horizontal and that it is a constant cost industry 28. The ‘dilemma of regulation’ refers to the notion that: (a) the regulated price, which achieves allocative efficiency, is also likely to result in persistent economic profits. (b) the regulated price, which results in a ‘fair return’, restricts output by more than would unregulated monopoly. (c) regulated pricing does not achieve ‘dynamic efficiency’. (d) the regulated price, which achieves allocative efficiency, is also likely to result in losses. 29. A natural monopoly occurs when: (a) long-run average costs decline continuously through the range of demand. (b) a firm owns or controls some resource that is essential to production. (c) long-run average costs rise continuously as output is increased (d) economies of scale are quickly exhausted. 30. A perfectly discriminating pure monopolist will charge each buyer (a) different prices, in order to compensate for differences in the characteristics of the product (b) the same price if per-unit cost is constant for each unit of the product. (c) that price which equals the buyer’s marginal cost. (d) the maximum price each would be willing to pay. 7Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. 31. When total revenue is increasing: (a) marginal revenue may be either positive or negative. (b) the demand curve is relatively inelastic. (c) marginal revenue is positive. (d) marginal revenue is negative. 32. A pure monopolist should never produce in the: (a) elastic segment of its demand curve, because it can increase total revenue and reduce total cost by lowering price. (b) inelastic segment of its demand curve, because it can increase total revenue and reduce total cost by increasing price. (c) inelastic segment of its demand curve, because it can always increase total revenue by more than it increases total cost by reducing price. (d) segment of its demand curve where the price elasticity coefficient is greater than one. 33. In the long run, a monopolistically competitive firm’s economic profits: (a) will be maximised where price equals average cost. (b) may be positive, zero, or negative. (c) are always positive. (d) tend towards zero. 34. By using advertising and other forms of non-price competition, a firm hopes to shift its: (a) demand curve to the left and make it more elastic. (b) demand curve to the left and make it less elastic. (c) demand curve to the right and make it more elastic. (d) demand curve to the right and make it less elastic. 35. The likelihood of a cartel being successful is greater when: (a) cost and demand curves of various participants are very similar. (b) firms are producing a differentiated, rather than a homogeneous, product. (c) the number of firms involved is relatively large. (d) the economy is in the recession phase of the business cycle. 8Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. 36. Refer to the diagram above. If price is set independently, the profits of firms A and B, respectively, will be: (a) $1 000 and $1 000 (b) $1 500 and $300 (c) $300 and $1 500 (d) $700 and $700 37. The kinked demand curve model helps to explain price rigidity because: (a) there is a gap in the marginal revenue curve, within which changes in marginal cost will not affect output or price. (b) demand is inelastic above and elastic below the ‘going’ price. (c) the model assumes firms are engaging in some form of collusion. (d) the associated marginal revenue curve is perfectly elastic at the ‘going’ price 38. If the production of a good or service entails rather sizeable spillover benefits, government might correct the: (a) underallocation of resources to its production by imposing an excise tax. (b) overallocation of resources to its production by imposing an excise tax. (c) underallocation of resources to its production by granting a subsidy. (d) overallocation of resources to its production by granting a subsidy. 39. External benefits refer to: (a) benefits that accrue to parties other than the producer and buyer of a good. (b) the benefits that resource suppliers obtain from the production and sale of a good. (c) the benefit that a consumer receives from buying a good. (d) the combined benefits that the buyer and seller receive from a voluntary market transaction 40. The ‘free-rider’ problem is associated with: (a) the structure of airline fares. (b) the production of public goods. (c) all market goods. (d) the overallocation of resources to the production of transportation facilities. THIS IS THE END OF SECTION A 9 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Answer sheet for Section A Colour in the square you think represents the correct answer to each question. If you make a mistake, write your final answer in the far right column on the same line as the question you are answering. a b c d correction Question 1 X Question 2 X Question 3 X Question 4 X Question 5 X Question 6 X Question 7 X Question 8 X Question 9 X Question 10 X Question 11 X Question 12 X Question 13 X Question 14 X Question 15 X Question 16 X Question 17 X Question 18 X Question 19 X Question 20 X Question 21 X Question 22 X Question 23 X Question 24 X Question 25 X Question 26 X Question 27 X Question 28 X Question 29 X Question 30 X Question 31 X Question 32 X Question 33 X Question 34 X Question 35 X Question 36 X Question 37 X Question 38 X TOTAL Question 39 X Question 40 X Name:_____________________________________ ID:_________________ 10 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. SECTION B SECTION B: Short Answers. Note: [..] indicates examiner edits. Answer ONE (1) of the following TWO (2) questions in your answer booklet. This section is worth 30 marks. Section B should take approximately one hour. EITHER Question B1 Read the news excerpts from the Star, \"Chilli supply may run out very soon\" and answer ALL of the following questions (Please provide question numbers on your answer sheet): Monday October 2, 2006 Chilli supply may run out very soon AFTER reports of sugar shortage and dearer chicken prices, consumers are now faced with depleting supplies of chillies. The Vegetable Sellers Association of Malaysia predicts that the markets would totally run out of chillies by Oct 16 if the rainy season prevails and supplies from Thailand and Indonesia stop coming. The wholesalers' attitude in preferring Singapore markets has not helped the situation, the association said. Association vice-president Chong Tek Keong said it would not be a surprise if the prices of chillies went up soon because demand had exceeded supply due to the festive season. The current ceiling price of red chillies is RM8 per kg. Chong said the continuing wet season would result in crops of red and green chillies being spoilt or damaged. He said imports from Thailand and Indonesia were likely to be cut since the two countries, which are also in the midst of the festive season, would give priority to their domestic markets. [….] 11 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Question B1(1) 1. Use a supply and demand model to explain what is meant by the statement: “it would not be a surprise if the prices of chillies went up soon because demand had exceeded supply due to the festive season\". (5 marks) Markers Guide: For a P2 • Students can use either (a), (b) or (c) to show why P should rise. For a P1. • Students need to discuss the reasons for the shifts • Key feature is the SHORTAGE at the original equilibrium Pe. For a Credit (C) • All the above clearly illustrated and discussed • Clear understanding about the role of shortage in equilibration process For a Distinction (D): • Clear discussion of model (c) above including all elements above • For HD students may show exceptional insights, clarity or unusual elements e.g. observation that P rise is inevitable but quantity trade is indeterminate & dependent of relative DD and SS shifts 12 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Question B1(2) 2. Use the same supply and demand model to analyse the consequences for the market of a “ceiling price of red chillies” set at Rm8 per kg. (5 marks) For a P2 • Must show ceiling below equilibrium. Students can use either (a), (b) or (c). For a P1. • Students should identify the SHORTAGE at Ps as a key feature of ceiling. • Ceiling price prevents price rising to 12. For a Credit (C) • All the above clearly illustrated and discussed • Some explanation of why ceiling may be set e.g. equity considerations, desire to win political favour with consumers in electorate. • Clear understanding about the obvious implications of the shortage i.e. excess demand that market cannot resolve through higher prices For a Distinction (D): • Clear discussion of model (c) above including all elements above • Clear understanding of non-obvious implications of the model e.g. excess demand implies ‘queues’, blackmarkets, smuggling etc. Also there may be need for government action e.g. rationing to hotels only, imports etc. • For HD students may show exceptional insights, clarity or unusual elements e.g. vertical supply curves indicating inelasticity of supply 13 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Question B1(3) 3. Outline why you would expect the demand for chillies to be price inelastic. Explain the impact on revenues that would result if the government were to remove the price ceiling and allow the market to operate freely. You should continue to assume that the demand for chillies is price inelastic after the removal of the price ceiling. (10 marks) For a P2 • Mechanical reproduction of Ed determinants and some attempt to explain rise in revenue when DD is price inelastic. Poor answers will discuss revenue and Ed for all values of Ed. Graph not needed. For a P1 (graph still not essential but difficult to see how a clear answer could avoid using one!). • Discussion of determinants of price inelasticity of demand with specific reference to chillies. • Demonstrate understanding that removal of ceiling implies a rise in price. • Link high price to increase in revenue. For a Credit (C) • All the above clearly illustrated and discussed using a diagram.. For a Distinction (D): • Exceptionally clear exposition. • For HD students may show exceptional insights, clarity or unusual elements.e.g why it was necessary for question to specify “that the demand for chillies is price inelastic after the removal of the price ceiling”. . 14 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Question B1(4) 4. Explain the impact of the higher price on a single chilli producer. In framing your answer, assume pure competition and a situation of long-run equilibrium prior to the price rise. (10 marks) For a P2 • Graph not essential for a P2 but answer must identify LR equilibrium as one where normal profits prevail and then convey the idea that a rise in market price will create economic profits. For a P1 (graph still not essential but difficult to see how a clear answer could avoid using one!). • Use of graphical analysis as per diagram above; discuss meaning of LR equilibrium as P=minATC and then show profit situation wheren price goes up.. For a Credit (C) • All the above clearly illustrated and graph clearly described... For a Distinction (D): • Exceptionally clear exposition. • For HD students may show exceptional insights, clarity or unusual elements.e.g. meaning of normal profits; clear identification of shaded area; clear understanding of why individual firm is a price taker. 15 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. OR Question B2 Read the news excerpts from the Star, \"Full steam ahead for little cookie factory\" and answer ALL of the following questions (Please provide question numbers on your answer sheet): Tuesday September 26, 2006 Full steam ahead for little cookie factory With the festive season getting closer, some 20 employees of May De Cookies are working around the clock to get their goodies ready. The company is well known for its festive cookies or kuih raya, and orders have been on the rise, with many coming from across the Causeway. Owner Mayzatul Jaafar [….] said she produced up to 2,000 cookies each day. “The orders have been placed even before the start of [the festive season] and the cookies are sold out way before [it ends]”, she said. […..] “Hazelnut cornflakes and blueberry tarts are the customers' favourites,” she said, adding that the shop produced 18 types of kuih raya. She has been in business for over a decade and her cookies are a hit with not only Malays but those from other races as well. [….] Her shop is made up of two semi-detached houses. Mayzatul said she started her business from one unit and later bought the adjoining one as the business expanded. 16 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Question B2(1) 1. An economist would probably argue that May De Cookies operates in a monopolistically competitive market. Explain the characteristics of such a market making sure you describe how a monopolistically competitive market differs from a purely competitive one. (5 marks) Mark Guide: See Table 8.1 For a P2 • Answer must discuss characteristics of monopolistic competition vs pure competition For a P1 • Relate characteristics to May De Cookies For a Credit (C) moving to a Distinction (D) and HD • Exceptionally clear exposition. 17 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Question B2(2) 2. Use a model to show how a monopolistically competitive firm such as May De Cookies would go about setting its price so as to maximise profits. (10 marks) For a P2 • Graph with minimal discussion/description. For a P1 • Discuss profit maximising condition • Show profit max price and Q For a Credit (C) • All the above clearly illustrated and discussed. • Clear understanding of why MC>MR and MR>MC cannot be profit maximizing For a Distinction (D): • Exceptionally clear exposition. • For HD students may show exceptional insights, clarity or unusual elements.e.g awareness that AR curve is “share of market curve”; how clever non-price competition may yield profits into the long-run – only a tendency to normal profits; discussion of the gap between price and MC. 18 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Question B2(3) 3. Imagine that the 20 employees manage to negotiate a wage increase as a consequence of the heavy workload they are expected to undertake during the festive season. Explain the impact of this wage rise on May De’s profitability on the assumption that the firm starts out in long-run equilibrium earning normal profits. Make sure you use diagrams to explain your answer. (10 marks) For a P2 • Discussion of how wage increases will feed into costs and produce losses For a P1. • Use of graphical analysis as per diagram above; discuss meaning of LR equilibrium as P=ATC and then show loss situation when costs rise. For a Credit (C) • All the above clearly illustrated and graph clearly described... For a Distinction (D): • Exceptionally clear exposition. • For HD students may show exceptional insights, clarity or unusual elements.e.g. meaning of normal profits; clear identification of shaded area; clear understanding of why rise in costs means a rise in price; firm may also attempt to expand demand through non-price competition. 19 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Question B2(4) 4. Mayzatal explains that her business has grown in scale since it initially started operations. Explain the impact of economies of scale on the firm's long-run average costs. Make sure you explain the possible sources of such economies. (5 marks) For a P2 • Answer should show awareness of the meaning of economies of scale and possible sources of increasing returns to scale. Should also show awareness that economies of scale imply falling long run average costs For a P1 • Clear demonstration that student understands the above For a Credit (C) moving to a Distinction (D) and HD • Exceptionally clear exposition targeted specifically at May De Cookies THIS IS THE END OF SECTION B 20 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. SECTION C This section is worth 30 marks. It should take approximately one hour. Answer the following question in your answer booklet. This section is worth 30 marks and each question carries 10 marks. \"The outstanding feature of a competitive market system is the attainment of economic efficiency. This is achieved because businesses employ resources until the marginal cost of production equals the price of the product. This not only maximises the profits of the individual producers but also results simultaneously in a pattern of resource allocation that maximises the satisfaction of consumers\". (Jackson, J. and McIver, R (2004), page 278.) \"The conclusion that the unfettered [=unhindered or free] operation of competitive markets automatically results in allocative efficiency relies on the assumption that all costs and benefits associated with the production and consumption of each product are fully reflected in the market demand and supply curves.\" (Jackson, J. and McIver, R (2004), page 436.) Answer both questions QC1 and QC2 and either QC3 or QC4 below (i.e. 3 questions in total) 21 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. QC1. Using a model of pure competition to assist you, explain the concepts of productive and allocative efficiency. (10 marks) For a P2 • Attempt to define productive and allocative efficiency; relate to pure competition and the role of the entry and exit of firms For a P1. • Use of graphical analysis as per diagram above; discuss meaning of LR equilibrium as P=minATC and the role of entry and exit of firms so as to ensure normal profits For a Credit (C) • All the above clearly illustrated and graph clearly described. Also awareness of the link between allocative efficiency and the P=MC condition For a Distinction (D): • Exceptionally clear exposition. • For HD students may show exceptional insights, clarity or unusual elements.e.g. equilibrium P is on both DD and SS curve which shows consumer utility maximised as well as profits maximised for producers. 22 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. QC2: Explain how firms in imperfect competition may maximise their profits but how this will not result “simultaneously in a pattern of resource allocation that maximises the satisfaction of consumers.” (10 marks) In Graph1, profits are maximised at Qm at a price of Pm. Consumers place a value of Pm for the marginal unit Qm.but this marginal unit only costs mc. Consumer satisfaction would be a price of Pc where P = MC. This suggests that not enough resources are allocated from a consumers’ viewpoint because Qm would require fewer resources to produce than would be the case if Qc was produced. The monopolistically competitive outcome also implies a ‘waste of resources’ because excess capacity always occurs and so productive efficiency not achieved as normal profits are to left of minATC. In Graph 2 , the situation is exacerbated if some non-price method (such as successful product differentiation) is used to successfully shift demand to a new AR which will create economic profit equal to the shaded area. For a P2 • Students need to get over the idea that allocative efficiency is not achieved because P>MC. Also need to somehow show that resources are allocated sub-optimally. For a P1. • Use of graphical analysis as per diagram above; discuss gap between P and MC and argue that this is not allocatively efficient. For a Credit (C) • All the above clearly illustrated but also show that resources are under-allocated as compared to the pure competition pairing of Pc and Qc. For a Distinction (D): • Exceptionally clear exposition. • For HD students may show exceptional insights, clarity or unusual elements.e.g. discussion of excess capacity and/or use of non-price competition to gain economic profits as per Graph 2.. 23 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. AND ANSWER EITHER : QC3. Explain, using diagrams where applicable, the reasons why purely competitive markets may fail to attain allocative efficiency. (10 marks) The idea that purely competitive market attain allocative efficiency is contingent on the assumptions of given income distribution, the absence of the need for public goods and the absence of externalities. Market outcomes may not be allocatively efficient if the distribution of income is highly skewed. Markets do not allocate resources adequately to public goods and there are often positive and negative externalities which suggests that there society would prefer a different allocation of resources to that suggested by the operation of a purely competitive market. In Graph 1 the good produced or service provided produces a cost externality (negative spillover) e.g. pollution. If the cost were internalised then the price would be higher at P1. The externality suggests that too much of the good or service is being produced. (i.e. there is an over-allocation of resources at Qe ) and the optimal social outcome would be less production at Q1. In Graph 2 the opposite occurs. The good produced or service provided produces a benefit externality (positive spillover) e.g. education. A subsidy needs to be paid so as to raise the quantity of the good or service being produced to Q1. The externality suggests that too little of the good or service is being produced. At the market price Pe (i.e. there is an under-allocation of resources at Qe ) and the optimal social outcome would be greater production at Q1. For a P2 • Answers need to show some awareness of the meaning of allocative efficiency and some knowledge of externalities. For a P1. • Some attempt at a more precise analysis as well as an awareness of why markets may under- or over-allocate resources.. For a Credit (C) 24 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. • All the above clearly illustrated and well described For a Distinction (D): • Exceptionally clear exposition. • For HD students may show exceptional insights, clarity or unusual elements.e.g. discussion of other reasons why markets are not allocatively efficient e.g.. income distribution , public goods etc. 25 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. OR QC4. Explain how the government can intervene to remedy any one of the inefficiencies associated with market failure. (10 marks) Answer should define what is meant by ‘market failure’ and students can choose to discuss any of the following: • Public goods • Imperfect competition • Externalities In each case students should discuss the rationale for government intervention: • Public goods under-provided by the market system (reasons for under-provision should be outlined.) • imperfect competition fails to achieve allocative and/or productive efficiency. If students choose this then answers should spell out why this is the case (P>MC, no min LATC attained etc) The answer should then explain how trade practices law can move towards a more competitive outcome. • Externalities – as per QC3 THIS IS THE END OF SECTION C 26 Microeconomics Econ 1006 – Study Period 5 2006. Examination Paper. Student ID number Optional feedback sheet – only complete if you have time. Overall I found this examination paper to be (circle one): (a) Extremely difficult (verging on the unfair) (b) Very difficult (not unfair, but much harder than I was expecting) (c) Difficult (challenging, but not unreasonable) (d) Reasonable (fair and in line with what I was expecting) (e) Quite easy (I was prepared for a harder paper) (f) Very easy (this paper didn’t really test my level of understanding) Trying to give an honest assessment of my performance today, (circle your choice of option) I feel that in this examination I will I feel that the amount of time I devoted achieve: to preparation for the exam was (a) very low – other priorities (a) High Distinction (> 85%) intervened on my preparation (b) low – I simply ran out of time (b) Distinction (75% - 84%) (c) Credit (65%-74%) (d) P2 (55%-%) (e) P1 (50%-%) (f) F1 (45%-49%) (g) F2 (40%-44%) (h) F3 (<40%) (c) adequate – but I would have liked more swot vac time (d) adequate - fair enough (e) good - I had enough time (f) very good- I did past papers and prepared quite thoroughly (g) excellent – I couldn’t have done more and I was really ready Any other comment on this examination? These response sheets are to be collected separately and held by the Head of School until after the examination results have been posted. They will not influence your mark in any way. Thank-you for your feedback which we will use to improve the examination process. 27
