EC102 Exam 2009

Ec102 Economics B: Summer 2009 Examination
Suitable for candidates taking 2007/8 and 2008/9 syllabus only
Instructions to candidates:
• Time allowed: 3 hours.
• Write all of your answers on these sheets, in the spaces provided. For multiple choice questions,
enter your answer in the blank. For short answer questions, write your answer in the box
provided. Material written outside of these blanks and boxes will not be considered part of your
answer. Scratch space is provided for the harder questions, but, in general, correct answers can
be found with clear thinking and minimal computation.
• The exam has 3 sections: A: Easy multiple choice (24 questions); B: Harder multiple choice (12
questions); C: Short answer (10 questions).
• Answer all of the questions in all of the sections.
• Calculators are not allowed in this examination.
Enter your candidate number here: ___________________
LSE 2009/Ec102 Page 1 of 25

Section A: Easy multiple choice (24 questions, each worth 1 point). Choose the one alternative that best
completes the statement or answers the question. Write the letter of this alternative in the blank space at the top
of the question.
Question A1: __________ Question A2: __________

The price of peanut butter rises due to a poor peanut What assumptions about preferences were used in our
harvest; peanut butter and jam are complements. lecture (and textbook) to prove that indifference curves
What happens to the equilibrium quantity and price of cannot cross?
jam? a) transitivity.
a) Equilibrium price falls, equilibrium quantity
b) completeness.
increases.
c) nonsatiation (more is better).
b) Equilibrium price rises, equilibrium quantity falls.
d) a and c.
c) Equilibrium price falls, equilibrium quantity falls.
e) b and c.
d) Equilibrium price rises, equilibrium quantity rises.
f) a, b and c.

Geometrically, the average product If the consumer, at her current consumption bundle, on her
a) is the slope of the line joining the origin to the budget constraint, is willing to give up 3 units of food
specified point on the total product curve. (vertical axis) in exchange for 1 unit of shelter
(horizontal axis) and food is priced at 10 and shelter at
b) at any point is the slope of the total product curve at 20, then the consumer is:
that point.
a) purchasing too much food and too little shelter for
c) is that point at which the total product curve begins utility maximization.
to exhibit diminishing returns.
b) purchasing too much shelter and too little food for
d) falls at low levels of input use (due to Smithian utility maximization.
specialization) and rises at high levels of input use
(due to Malthusian diminishing returns). c) purchasing just the right amount of each good for
utility maximization.
e) a and d are both true.
d) not enough information is given to be able to
determine which of a, b, or c above is true.

of the question.

If the demand for real money balances is kY, where k is a If 2 Swiss francs trade for £1, the UK price level equals £1
constant, then velocity is: per good and the Swiss price level equals 2 francs per
good, then the real exchange rate is _____ Swiss
a) k. goods per UK good (fill in the blank):
b) 1/k. a) 0.5
c) kP. b) 1
d) P/k. c) 2
d) 4

If policymakers are free to analyze events as they occur A rise in government purchases by the rest of the world will
and choose whatever policy seems appropriate at the result in the following changes in a small open
time, then this is: economy.
a) policy by rule. a) I ↑, X-M ↓
b) policy by discretion. b) I ↓ , X-M ↑
c) monetary policy. c) I ↑, X-M ↑
d) fiscal policy. d) I ↓ , X-M ↓

of the question.

The demand curve facing a perfectly competitive firm is Let short run total cost be given by TC(Q) = 10 + Q.
a) infinitely elastic. Marginal cost equals:
a) 10.
b) perfectly inelastic.
b) 1.
c) downward sloping.
c) 11.
d) none of the above.
d) it cannot be determined with the information
provided.

For production functions with decreasing returns to scale, a If the price consumption curve of good X, which is on the
proportional increase in output horizontal axis, slopes downward, we can be sure that
a) requires a less than proportional increase in all as the price of good X falls:
inputs. a) consumers spend less money on X even though
they buy more of it.
b) requires a more than proportional growth in all
inputs. b) consumers spend the same proportion of their
budget on X, even though they buy more of it.
c) requires a proportional growth in all inputs.
c) consumers spend more money on X.
d) will produce a less than proportional increase in
total inputs. d) None of the above is necessarily true, because the
information provided does not allow us to determine
what happens to the amount spent on X as the price
of X falls.

of the question.

The ex post real interest rate will be greater than the ex Two economies are identical except that the level of capital
ante real interest rate when: per worker is higher in Highland than in Lowland. The
production functions in both economies exhibit
a) actual inflation is greater than expected inflation. diminishing returns to capital. An extra unit of capital
b) actual inflation is less than expected inflation. per worker increases output per worker:
c) the nominal interest rate is positive. a) by the same amount in Highland and Lowland.
d) the ex ante real interest rate is positive. b) in Highland, but not in Lowland.
c) by more in Highland.
d) by more in Lowland.

If the fraction of employed workers who lose their jobs each When an aggregate demand curve is drawn with real GDP
month (the rate of job separation) is 0.01 and the (Y) along the horizontal axis and the price level (P)
along the vertical axis, if the money supply is
fraction of the unemployed who find a job each month decreased, then the aggregate demand curve will:
is 0.09 (the rate of job findings), then the natural rate of a) shift to the right.
unemployment is:
b) shift to the left.
a) 1 percent (.01).
c) not shift at all, this is a movement down the
b) 9 percent (.09). aggregate demand curve.
c) 10 percent (.10). d) not shift at all, this is a movement up the aggregate

demand curve.
d) about 11 percent (actually, 1/9). e) not shift at all, this will shift the aggregate supply
curve.

of the question.
Question A17: __________

Figure A1: The Situation Facing a Monopolist
In Figure A1, the profit maximizing output level is:
Price
a) A.
MC b) B.
ATC c) C.
4 d) None of the above.
3
2
1
MR D
0 A B C Quantity

In Figure A1, assuming the short run factor input In a short run competitive equilibrium, with labour as the
combination is not optimal in the long run, the firm only variable input, if the increase in output due to an
should: additional unit of labour is greater than the average
a) operate in the short run, but shut down in the long output per unit of labour
run. a) marginal cost is greater than average variable cost.
b) operate in both the short and long run. b) marginal cost is less than average variable cost.
c) operate in the long run, but shut down in the short c) marginal cost is equal to average variable cost.
run.
d) there is no way to infer the relative magnitudes of
d) shut down in both the short run and long run. marginal and variable cost without some information
on the unit cost of labour (i.e. the wage).
e) operate in the short run, but there is not enough
information available to determine what it should do
in the long run.

of the question.

An example of a real variable is:
GNP = £2000, C = £1700, G = £50, X-M=£50, and NFI (net
a) the wage in £ someone earns. factor income) is > 0. Investment (I) is:
b) the quantity of goods produced. a) £200.

b) < £200.
c) the nominal interest rate.
c) > £200.
d) the price level.
d) With the information given, none of the above can
be stated with any certainty.

In a steady-state economy with a saving rate s, population
Suppose the initial exchange rate is $4/£ and the initial UK growth n, and labour-augmenting technological
and US price levels are both 100. After 10 years, the progress g (i.e. the growth rate of the “effectiveness” of
US price level has risen to 300 and the UK price level each unit of labour), the formula for the steady-state
has risen to 200. What new nominal exchange rate ratio of capital per effective worker (k*), in terms of
would be consistent with purchasing power parity output per effective worker (f(k*)), is (denoting the
theory: depreciation rate by δ):
a) $2/£ a) sf(k*)/(n+δ+g).
b) $4/£ b) f(k*)/[s(n+δ+g)].
c) $6/£
c) [s-f(k*)]/(n+δ+g).
d) $8/£
d) nf(k*)/(s+n+g).
e) None of the above.
e) None of the above.

of the question.
Question A24: __________

Box A1: Take the following information as true.
Refer to Box A1. The market for toasters will clear at a
The quantity of toasters supplied and demanded at price:
different prices is given below. The supply curve is a) Between £10 & £12.
always upward sloping; the demand curve is always
b) Between £12 and £14.
downward sloping.
c) Between £14 and £16.
£10 £12 £14 £16 £18 £20 d) Between £16 and £18.
Demanded 10 9 8 7 6 5 e) Between £18 and £20.
Supplied 3 4 5 6 7 8

Section B: Harder multiple choice (12 questions, each worth 3 points). Choose the one alternative that best
completes the statement or answers the question. Write the letter of this alternative in the blank space at the top of
the question.
Box B1: Take the following information as true.

Question B1: __________
Two players, Jack and Jill, are put in separate rooms. Then Refer to Box B1, Jack’s dominant strategy is to pick:
each is told the rules of the game. Each is to pick one of six a) A
letters; A, B, C, D, E, or F. If the two happen to choose the b) B
same letter, both get prizes as follows:
c) C
Letter A B C D E F d) D
Jack’s prize -3 -2 5 6 4 5 e) E
Jill’s prize 6 5 4 3 -2 -1
f) F
g) Jack does not have a dominant strategy.
A negative prize means a player has to pay; a positive prize
means he/she receives a payment. If the two players choose
different letters, each gets 0. The schedule of payoffs is
revealed to both players and both are told that they both know
the whole schedule.
Question B2: __________ Scratch
Refer to Box B1, Jill’s dominant strategy is to pick:

a) A
b) B
c) C
d) D
e) E
f) F
g) Jill does not have a dominant strategy.

the question.

Question B3: __________
Refer to Box B2. Think about whether, given the limited
It is well known that I consume only two products: Haagen information LSE has, LSE should calculate a Laspeyres or
Dazs Ice Cream (IC) and McVitie’s Digestive Biscuits (DB). I a Paasche price index to provide the minimum “no worse
am living in Chicago and LSE invites me to move to London. off” salary offer. Once you have determined which price
The price of IC in London is double that in Chicago, but the index LSE should use, think about the formula for the
index and how it relates to the limited information in the
price of DB is one-half that in Chicago. LSE knows that, in box. Finally, conclude that LSE decides to offer me a
Chicago, I spend ½ of my income on IC and ½ on DB, and it salary equal to the following multiple of my Chicago salary:
knows that I only consume these two products. Otherwise, a) .5
LSE knows nothing about my preferences. b) .75
Given the information it has, LSE wants to make me the c) 1
smallest salary offer that will guarantee that, no matter what d) 1.25
my actual preferences, I am not made worse off by moving to
e) 1.5
London (i.e. I am at least as happy as I was living in Chicago).
f) 2
g) None of the above, i.e. LSE cannot figure out what the
minimum “no worse off” salary multiple is.
Scratch Scratch
LSE 2009/Ec102 Page 10 of 25

the question.
Question B4: __________ Question B5: __________

Refer to Box B2. At an LSE cocktail party, I inadvertently Refer to Box B2. At an LSE cocktail party, I inadvertently
reveal that, to me, IC and DB are perfect reveal that I consider IC and DB to be perfect
complements. LSE now realizes that it needs to offer substitutes. LSE now realizes that it needs to offer me
me the following multiple of my Chicago salary to leave the following multiple of my Chicago salary to leave me
me no worse off: no worse off:
a) .5 a) .5
b) .75 b) .75
c) 1 c) 1
d) 1.25 d) 1.25
e) 1.5 e) 1.5
f) 2 f) 2
g) None of the above, i.e. LSE cannot figure out what the g) None of the above, i.e. LSE cannot figure out what the
minimum “no worse off” salary multiple is. minimum “no worse off” salary multiple is.
Scratch Scratch
LSE 2009/Ec102 Page 11 of 25

the question.

Money demand is given by M/P = kY – hi, where k and h In the AS-AD model with sticky prices, if the fraction of
are positive constants. Given this, in the AS-AD model firms with flexible prices (i.e. which adjust their prices
with sticky prices discussed in lecture, the AD curve within a time period) is zero, then the short run AS
will become steeper (i.e. more negatively sloped) as: curve:
a) k increases and h decreases. a) is horizontal.
b) is vertical.
b) k increases and h increases.
c) has a slope which depends upon the money demand
c) k decreases and h decreases. function.
d) k decreases and h increases. d) has a slope which depends upon the investment
demand function.
e) k increases (h’s value does not influence the slope)
e) has a positive slope of 1.
f) k decreases (h’s value does not influence the slope).
f) None of the above is true.
g) h increases (k’s value does not influence the slope).
h) h decreases (k’s value does not influence the slope).
Scratch Scratch
LSE 2009/Ec102 Page 12 of 25

the question.

Question B8: __________
The Earthly Bliss dating service charges £100 per date that Refer to Box B3. You have a match of quality M (between 0
it arranges. All of their dates will accept an offer of marriage. and 100) in hand. Not counting Earthly Bliss’s fee (i.e.
In your estimation, the quality of the potential spouses offered ignoring the £100 fee), what is the expected gain from an
by the dating service can be measured by an index that runs additional date randomly drawn from the Earthly Bliss
from 0 to 100. The potential spouses are uniformly distributed pool?
over this range. You value a spouse at £50 per index point. a) [(100+M)/2]*[(100-M)*50/2]
For example, you a value a potential spouse with a quality
b) [(100+M)/2]*[(100-M)/2]
index of 25 at £50*25 = £1250
c) [(100+M)/100]*[(100-M)*50/2]
d) [(100-M)/2]*(100-M)
e) [(100-M)/2]*[(100-M)*50]
f) [(100-M)/100]*[(100-M)*50/2]
g) None of the above.

Refer to Box B3. If your dates are drawn at random from
the Earthly Bliss pool, at what value of the index would
you stop searching (i.e. if you get a draw with an index
greater than or equal to this value, you propose
marriage and stop searching).
a) 90
b) 80
c) 70
d) 60
e) 50
f) 40
g) 30
h) None of the above.
LSE 2009/Ec102 Page 13 of 25

the question.

There are three industrial firms in the economy. Their initial Box B4: Continued
pollution levels and individual costs of reducing pollution by one
unit are given in the accompanying table. Assume that the cost Cost of
Initial
of pollution reduction for each firm is constant, i.e. the unit cost reducing
Firm pollution Scratch columns
as given, all the way down to zero pollution. For each firm, pollution by
level
neither negative pollution nor pollution greater than the initial one unit
level is possible.
A 80 units £20
There are two possible policies: (a) Mandated levels, where
each firm is told to reduce its pollution to a level x (i.e. produce
no more than x pollution). Each firm must do so. (b) Tradeable B 70 units £25
permits, where each firm is given x licenses to pollute, with one
license needed for each unit of pollution produced. In this
case, firms may trade (buy and sell) the allowances and C 50 units £10
produce a pollution level equal to the allowances they own after
trading is completed.

Refer to Box B4. With tradeable permits of 30 units per Refer to Box B4. Compare two policies: (a) Mandated levels
firm (90 in total), the equilibrium levels of pollution of 30 units per firm (90 in total); (b) Tradeable permits of
produced, after trading is completed, will be: 30 units per firm (90 in total). Relative to mandated
a) A = 50, B = 0, C = 40 levels, tradeable permits lead to the same amount of
b) A = 50, B = 40, C = 20. pollution reduction at a social cost savings of:
c) A = 30, B = 30, C = 30. a) 50
d) A = 40, B = 50, C = 0. b) 350
e) A = 20, B = 70, C = 50. c) 500
f) A = 50, B = 70, C = 50. d) -50 (i.e. tradeable permits lead to greater costs)
g) None of the above. e) -350 (i.e. tradeable permits lead to greater costs)
f) -500 (i.e. tradeable permits lead to greater costs)
g) None of the above.
LSE 2009/Ec102 Page 14 of 25

the question.

Refer to Box B4. Compare two policies: (a) Mandated levels
of 0 units per firm (0 in total); (b) Tradeable permits of 0
units per firm (0 in total). Relative to mandated levels,
tradeable permits lead to the same amount of pollution
reduction at a social cost savings of:
a) 1650
b) 1700
c) 2150
d) 2200
e) -1650 (i.e. tradeable permits lead to greater costs)
f) -1700 (i.e. tradeable permits lead to greater costs)
g) -2150 (i.e. tradeable permits lead to greater costs)
h) -2200 (i.e. tradeable permits lead to greater costs)
i) None of the above.
LSE 2009/Ec102 Page 15 of 25

Section C: Short answer (10 questions, each worth 4 points). Write your answer to each question in the question
box. You do not necessarily have to fill the entire box.
C1. Manchester United and Wrexham are two football teams. Each has its own stadium. Say that
Manchester United is more famous than Wrexham, i.e. at any price more people will want to see
Manchester United play in the MU stadium than is the case for Wrexham in the W stadium (assume,
unrealistically, that they always play at home, by themselves – i.e. ignore any issues concerning the
opposing team). Manchester United will always fill its stadium at a higher price than Wrexham will.
Knowing nothing more than the information given above, is the last statement true or false? Explain.
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C2. Sir Stelios Haji-Ioannou, founder of Easy Jet, credits his success to his understanding of
economics. Noting that the marginal cost of filling an additional seat on a flight with some remaining
empty seats is zero, he lowered his prices until his planes ran at 85% capacity. Assuming that Easy Jet
did not have the possibility of buying smaller planes or changing the number of available planes, why
didn’t Sir Stelios lower prices until his jets ran at closer to 100% capacity?
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C3. In the 19th century French railway companies deliberately provided two types of carriages: (1) an
expensive carriage with a roof; (2) an inexpensive carriage without a roof. Assuming that the cost of
providing a roof was zero, and that having a roof on the carriage made the trip more pleasant for all
potential passengers, explain why this was a sensible managerial decision. Although not essential, it
may help you to know that in the 19th century poor Frenchmen worked outdoors, while the rich stayed
inside, so that, in sunny France, poor people tended to have darker skin.
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C4. Hypothecation is the promise to use tax revenue to achieve benefits for the group who bear the tax.
For example, health benefits might be provided to smokers or additional transportation infrastructure to
areas that pay a great deal of gasoline tax. In the extreme, if benefits are given to individuals in an
amount exactly equal to the tax they paid, this policy allows one to achieve a socially optimal resolution
of negative externalities, “internalizing the externality” without the deadweight losses of taxes. Is the last
sentence true or false? Explain.
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C5. Taxes always distort, producing socially inefficient allocations and production levels. True or
false? Explain.
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C6. The world is filled with two types of individuals: (1) Scrooges (S), who own all the capital, supply no
labour, and save and invest all of their income; (2) Cratchits (C), who supply all the labour, and consume
all of their income. On a cold winter night, the Ss are haunted by ghosts, and from then on give a
fraction of their income to the Cs. The Ss continue to save all of their remaining income, the Cs continue
to consume all of what they earn and receive. Is this good for all current and future Cs?
LSE 2009/Ec102 Page 21 of 25

C7. As a consequence of the current credit crisis, the services and advice of Britain’s financiers become
less appealing to firms and individuals in other countries. Ignoring any other consequences of the credit
crisis, and assuming that all prices and wages in the UK are flexible, explain what happens to the real
exchange rate and Britain’s trade balance.
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C8. In the AS-AD short run sticky price model, why, precisely, does a rise in consumer savings (i.e. a
reduction in consumer expenditure) lead GDP to fall below full employment output? What I want to
understand here is why the classical analysis of a savings change does not go through in this
framework. You should assume that the money supply, government expenditure and inflation
expectations are constant.
LSE 2009/Ec102 Page 23 of 25

C9. In the AS-AD short run sticky price model, assume that all fluctuations in AD come from fluctuations
in investment demand (i.e. investor confidence and expectations of the future). There are no changes
in inflation expectations, government expenditure or consumer demand. Under these circumstances, the
government can stabilize GDP by targeting the interest rate, i.e. expanding and contracting the money
supply to maintain a constant nominal interest rate. Is the last sentence true or false? Explain.
LSE 2009/Ec102 Page 24 of 25

C10. To achieve a sustained (i.e. long run) inflation rate of zero percent per annum, the money supply
has to stop growing (i.e. also grow zero percent per annum). True or false? Explain.
LSE 2009/Ec102 Page 25 of 25

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EC102 Exam 2009

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Ec102 Economics B: Summer 2009 Examination

Suitable for candidates taking 2007/8 and 2008/9 syllabus only

Enter your candidate number here: ___________________

LSE 2009/Ec102 Page 1 of 25

Question A1: __________ Question A2: __________

Question A3: __________ Question A4: __________

LSE 2009/Ec102 Page 2 of 25

Question A5: __________ Question A6: __________

Question A7: __________ Question A8: __________

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Question A9: __________ Question A10: __________

Question A11: __________ Question A12: __________

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Question A13: __________ Question A14: __________

Question A15: __________ Question A16: __________

c) 10 percent (.10). d) not shift at all, this is a movement up the aggregate

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Question A17: __________

Question A18: __________ Question A19: __________

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Question A20: __________ Question A21: __________

b) the quantity of goods produced. a) £200.

Question A22: __________ Question A23: __________

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Question A24: __________

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Box B1: Take the following information as true.

Question B2: __________ Scratch

Refer to Box B1, Jill’s dominant strategy is to pick:

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Box B2: Take the following information as true.

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Question B4: __________ Question B5: __________

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Question B6: __________ Question B7: __________

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Box B3: Take the following information as true.

Question B9: __________ Scratch

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Box B4: Take the following information as true.

Question B10: __________ Question B11: __________

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Question B12: __________ Scratch

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Question A9: Question A10:

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Question A13: Question A14:

Question A15: Question A16:

Question A18: Question A19:

Question A20: Question A21:

Question A22: Question A23:

Question B4: Question B5:

Question B6: Question B7:

Question B10: Question B11: