Download Third Hour Examination - Department of Agricultural Economics

Macroeconomics of Agriculture
Agricultural Economics 430
Fall 2009
Penson
Third Hour Examination
NAME:_____ANSWER KEY______________________________________
This examination consists of two questions. Please read each question carefully. The
term “describe fully” asks that you answer all aspects of the question. Avoid giving
extraneous information (i.e., “filler”). Use graphs whenever possible to help tell your
story. There are several extra pages available for answering question 2. Good luck!
Question 1 _____ of 20 points
Question 2 _____ of 80 points
TOTAL
_____ of 100 points
Make sure you complete the
team evaluation form on the last
page of this exam. Both the test
and your team evaluation will be
kept in strict confidence!
2
1.
Please define and/or illustrate the following macroeconomic concepts. Label any
graphs you may draw (20 points; 5 points each):
a.
Market interest rate versus required rate of return
The market rate of interest is the rate of interest given by the intersection of
the demand and supply of money curves in the nation’s money market. The
required rate of return reflects the risk free rate of return (which we assumed
was the market rate of interest) plus a business and financial risk premium.
b.
Economic capacity versus engineering capacity
Economic capacity is given by the intersection of the market’s supply and
demand curves where bottlenecks in supply do not exist. It represents where
firms in the market desire to produce. Engineering capacity on the other
hand represents the maximum the firms in the market can produce in the
current period, and is represented by the perfectly inelastic portion of the
marginal cost curves and hence supply curve in the market.
c.
Money market equilibrium versus product market equilibrium
Money market equilibrium is given by the intersection of the demand and
supply of money curves in the nation’s money market. Product market
equilibrium is given by the intersection of the aggregate demand and
aggregate supply curves in the nation’s product market.
d.
Tax depreciation versus capacity depreciation
Tax depreciation is the expensing or writing off the purchase of depreciable
assets like machinery and buildings over the life of the property. Capacity
depreciation represents the loss in productive capacity of an asset due to wear
and tear from use.
3
2.
Assume you are an agricultural economist with the sole canner of fruit juice in
Lower Slobovia. Because of the closed nature of the economy, your firm does not
experience competition from companies outside the country. Your firm is currently
running at 100 percent capacity. Assume the own price elasticity of demand for fruit
juice is -.5612 and its income elasticity is 1.1254.
The economy of Lower Slobovia is currently experiencing an interest rate of 8% and
a real GDP of $2,000. This level of GDP puts it in the perfectly elastic (Keynesian)
range of the country’s aggregate supply curve and perfectly elastic range of the
country’s labor supply curve.
The government recently announced its intent to achieve a target rate of interest of
6% and a real GDP level of $3,000 in the economy, which would increase economic
activity in the nation’s product and labor markets, but still leave it in the perfectly
elastic ranges of the aggregate product and labor market supply curves.
Assume you have been asked to make a presentation to the company’s board of
directors assessing the effects these macroeconomic targets will likely have on your
firm, including the need to expand its existing capacity (80 points)
Use Blank Pages When Answering These Questions
(a)
Initially, please identify and fully discuss the specific monetary and fiscal
policy actions you expect the government to take in achieving these new
macroeconomic targets. As a part of your discussion, draw the IS and LM
curves before and after the change, carefully labeling all graphs. (20 points)
Draw the IS and LM curves for the two sets of macroeconomic policy,
showing the drop in interest rates from 8% to 6% and an increase in GDP
from $2,000 to $3,000. Indicate what expansionary fiscal policies (cut taxes
or increase government spending) and expansionary monetary policies
(lower reserve requirements, buy government bonds or lower the discount
rate) you would use to shift these curves.
(b)
What impact will the change in the general economy have upon the market
equilibrium for fruit juice in Lower Slobovia? Draw the demand and supply
curves for fruit juice before and after the change, carefully labeling these
graphs. Please fully discuss the underlying theory that influence shifts in the
demand and supply curve, and why they shifted the way it did. (20 points)
The market in this instance is represented by a monopoly structure. Draw
the monopoly graph before and after the policy shock, illustrating the shift in
the demand curve, marginal revenue curve, average total cost curve and the
determination of QE on the quantity axis indicted by the intersection of the
MC and MR curves and PE on the price axis given by reading up to the
4
demand curve and over to the price axis. The demand and marginal revenue
curves are shifting because the level of national income increased in the
economy and the firm is selling a luxury good (income elasticity is greater
than 1.0). The cost curves are shifting because interest rates fell.
(c)
Discuss the impact you expect these new macroeconomic policies will have on
your firm’s average and total profit? Please illustrate this effect graphically.
Make sure you use all appropriate labels. (20 points)
Using the graphs in part (b), illustrate the levels of average profit (P - ATC)
and total profit (P - ATC) x Q. The firm should have experienced an increase
in profits based upon higher prices, quantity sales, and lower costs.
(d)
What impact will your answers above have upon the firm’s capacity utilization
and decision to expand the size of its operations? Fully describe the details of
the economic process you would use to determine if your firm should expand
its existing manufacturing capacity and the criteria you would use in making
this recommendation to the board. (20 points)
The canned fruit monopoly was said to be operating at 100% capacity before
the change to more expansionary macroeconomic policy. This is represented
by the firm operating on the perfectly inelastic portion of its MC curve. An
increase in the demand for its product indicated by the shift in the demand
curve in part (b) suggests the need for expansion. The criterion used in this
course for evaluating the economic feasibility of expansion is the net present
value, or NPV, capital budgeting model. This involves discounting the
annual net cash flows and remaining terminal value back to the present and
comparing it to the cost of the project. A positive NPV suggests the project is
economically feasible.
5
Extra page for Question 2
6
Extra page for questions 2
7
Extra page for question 2
8
Macroeconomics of Agriculture
Agricultural Economics 430
Fall 2009
CONFIDENTIAL
Team Evaluation Form
Please list the members of your team and assess each individual’s
performance on a 0-10 basis (10 being the highest grade possible).
Your Team Name: _____________________________________
Member 1 – Name:
_______________________.
Score: _____
Member 2 – Name:
_______________________.
Score: _____
Member 3 – Name:
_______________________.
Score: _____
Myself – Name:
_______________________.
Score: _____
In addition, please share any insights you might have on the unique
contributions of your team members: