8/3/2019 EC11002 Class Test August 2009 (2) (Answers)

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DEPARTMENT OF ECONOMIC STUDIES

CLASS EXAMINATION

ECONOMIC STUDIES

EC11002

GLOBAL ECONOMIC PERSPECTIVES

August 2009 Time allowed: 2 hours

Answer ALL Questions.

Authorised calculators may be used in this examination.

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School of Social Sciences

Economic Studies

8/3/2019 EC11002 Class Test August 2009 (2) (Answers)

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Question 1:

(a) Explain why a firms profit maximising strategy might not be best served by offeringthe lowest wage levels possible. [10 marks]

Definition of concept rock bottom wages and efficiency wage (reference to shirkingand efficiency), explanation of declining marginal labour productivity and profitmaximising position of firm MPL=wage rate (ideally graphically shown asequilibrium).(b) The firms production function and associated MPL function are given by 200 L and

100/(L) respectively where L is the amount of Labour used. How much profit can thefirm make if the price of its output is 50 per unit and it faces labour costs of 25 perhour. [30 marks]

MPL=200 hence L=40000, Q=200 L hence Q=40,000, TR=Q*P=2,000,000,TC=L*W hence 1,000,000 Profit=2,000,000- 1,000,000= 1,000,000(c) If a government introduces a minimum wage which is set at 20 per hour what would

you expect to happen? [10 marks]Minimum wage is below current wage rate and profit maximising level hence nochange

Question 2:

In an education system whereby students pay all their costs of education the demand andsupply schedules for university places is given by the following equations:

Qd = 48,000 -4P and Qs = 4P where the prices are in 's and the quantities trades are in placesat university.

a. What is the equilibrium price for education and quantity of places at university traded?Equilibrium occurs when Qd=Qs48000 - 4P = 4P48,000 = 8PP=48,000/8P=6,000

Qd = 48,000 - 4(6,000)

Qd = 48,000 - 24,000 = 24,000Qs = 4(6000) = 24,000

b. If the government imposes a maximum price universities are allowed to charge of 5,000will there be an excess of demand or supply?

Qd = 48,000 - 4(5,000) = 28,000Qs = 4(5,000) = 20,000Therefore there is a shortage of 8,000 places.

c. If the government decides to subsidise universities by 8,000 per university place what

will the new equilibrium supply and demand traded be?

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8/3/2019 EC11002 Class Test August 2009 (2) (Answers)

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Subsidy changes the supply equation such that QS= (4P+8)Now Qd=Qs48000 - 4P = 4(P+8)48000 - 4P = 4P+3200048,000 -32,000 = 8P

P=16,000/8P=2,000

Qd = 48,000 - 4(2,000)Qd = 48,000 - 8,000 = 40,000

Qs = 4(2,000 +8,000) = 40,000

Question 3:

An investor provides their own finance capital for a new business. Suppose buying fixedcapital costs 100,000. The investor also makes additional capital available at the beginningof the period for raw materials 10,000, labour costs 21,000 and marketing costs 9,000. Atthe end of the period the investor decides to sell the business and incurs a further 1,000selling costs. The resale value of the fixed capital is determined to be 80,000 the turnoverfrom sale of the output (all gained at the end of the period) is 71,000. If the interest rate was5 per cent;

a. What is the rate of return? [10 marks]ERR = (TR-TC)100/TC hence (80000+71000-1000-7000 ) -(100000+10000+210000+9000)*100/140 hence 2.14%b. If interest rates had been 8 per cent what would have been the rate of return? [10

marks]TC is now 138.8 and ERR = - 0.857%c. Explain, with reference to the idea of a risk premium and the answer in (a) above, the

conditions under which a new investor would decide to buy and not to buy thebusiness. [30 marks]

Definition of risk premium and link to idea of probability, recognition that if riskpremium was above ERR then purchase would not take place but if risk premiumwas below ERR then purchase would take place.

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