Download solution 24/01/03

SOLUTION 24/01/03
INTRODUCTION TO ECONOMIC ANALYSIS
1. a) Agree. The competitive equilibrium price and/or quantity lead to a maximum
consumer’s and producer’s surplus. Any deviation from that equlibrium will
disminish these two surpluses.
b) Agree. This is a just a straight application of the definition of the concept of
elasticity of demand. In this case, the corresponding elasticity is 1.5, so demand
curve is elastic.
c) Disagree. The supply curve is the segment of the marginal curve above the
average variable costs curve. Not above the average fixed costs curve, as the
statement says.
2.
i)
ii)
iii)
The drawing is straighforward: a straight line with an intersection of 20 in
both the Y and X axis. If the price of X increases to 10 €, the Y intersection
stays put and the X intersection moves inwards to 10 units of X.
The budget line does not move. The change considered is just a neutral
nominal change that does not alter at all real values. Since consumption
theory is ab out relative prices and about the real value of money, it is
natural that real opportunities for this consumer have not changed.
At the new prices the consumer can still buy the old bundle of goods. The
price change is a “compensated” price change.
3. Among the reasons that may justifythe exisytence of a monopoly, we can cite
the follonwing: a) exclusive ownership of key resources (e.g. possession of a
mine of diamonds); b) licence or exclusive rights given by government (e.g.
patents,copyrights); and c) efficiency advantage over potential competitors
(lower costs) that leads to natural monopoly (e.g. utilities such as gas, elictricity,
etc.).
The equilibrium of the monopolist includes, first, the consideration of the
difference between average and marginal revenue that a monopolist faces. This is a
fact that differenciates the monopolist from the price-taking firm.
4) a) Disagree. GDP is not the product obtained anywhere by nationals of a country,
but the product achieved by nationals and others within the geographical boundaries
of a given country. The reference to nationals gives in fact, the definition of Gross
National Product (GNP) rather than Gross Domestic product (GDP).
b) Agree. If the economy is closed, then Y = C+I+G. Or Y– C – G=I,
or S=I.
c) Disagree. In general, the statement is wrong because an increase in money
supply, for given conditions of money demand, will lower the interest rate, and this
will increase investment.
5)
i) Nominal GDP
First, we calculate nominal GDP:
1995 Nominal GDP = 1 x 100 + 1 x 100 + 1 x 100 = 300
2000 Nominal GDP = 1.20 x 120 + 1.4 x 150 + 0.8 x 110 = 442
Real GDP
Second, we calculate real GDP:
Real GDP 1995 is the same a nominal GDP 1995, for the base year (1995), always,
both nominal and real are the same, so real GDP = 300.
Real GDP 2000: 1995 prices x 2000 quantities:
1 x 120 + 1 x 150 + 1 x 110 = 380,
GDP deflator = ( Nominal GDP/ Real GDP ) 100
Then GDP deflator will be: (442/380) 100 = 116.32
Growth of GDP deflator between 1995 and 2000:
[(116.32 – 100)/100] 100 = 16.3%
ii) CPI base1995
1995 = 100
2000 (base 1995) = 2000 prices x shares A,B, C.
1.2 x40 + 1.4 x 30 + 0.8 x30 = 114
Growth of CPI between 1995 and 2000:
[(114 – 100)/100] 100 = 14%
iii) None is better than the other. The two are good depending on the purpose for
which they are to be used. The GDP deflator is the adequate index to correct
nominal figures of output, in order to isolate real growth of this output. The CPI is
good to identify the evolution of the prices of the goods and services we consume.
The main differences between the two indices are:
a) The GDP deflator is an index of prices with variable weights (the extent of
production of each year), the CPI, on the other hand, is an index with fixed
weights (the consumption shares of the base year) and it is a Laspeyres index.
b) CPI includes the price of imports and excludes the prices of exports. GDP
deflator, on the other hand, includes the price of exports and excludes the price
of imports.
6. The price of money is (1/P). Therefore, if there is an increase in the money
supply, for given conditions of demand, there will be a fall in the price of money. A
fall in (1/P) and thus an increase in P. This is the basic relation between money
supply and the price level.
The quantity equation puts forward this relationship by means of the definition of
the Velocity of Money. According to this definition,
Velocity of money = Nominal value of output/Money supply
V= (PY)/M
From this definition we derive the following identity:
MV=PY
In rates of growth, this read,
% M + %V = %P + %Y
Or, % P = %M + %V - %Y
This expression gives a theory of inflationn in the sense that it establishes a
relationship between inflation and three factors: the rates of growth of money,
velocity and output. Put like this, this is a tautology. The tautology gets transformed
into a theory when we say that velocity is a parameter that, given its estructural
nature, is likely to remain constant, and that in the lon run output (abstracting from
the growth of resources or productivity) is likely to be constant at its potential level.
If this is so, then
% M = %P
which says that in the long run inflation will be exclusively determined by the
growth of the money supply.