1) a) Economics is the study of the principles governing the allocation of scarce means among competing ends, when the

objective of the allocation is to maximize the attainment of the ends. Explain Resources are Land, labour, capital, entrepreneur Land mineral, sand, oil and timber Labour human resource productivity eg: gold miner etc Capital financial resources and blant and building it can provide Entrepreneur Person that takes the risk to set up a business, make decisions. Adam Smith - Wealth of nations - Consequence of economic freedom is summarized - Covered concepts like division of labour and the function of markets - Invisible hand which demonstrates how self interest guides the most efficient use of resources Karl Marx - Criticises everything and exercised communism. - Das Kapital - Marx & long life friend worked out theory for socialism and communism Keynes - Govt must help the economy during deficits and govt makes back money when things are good. - Balance budget in medium run but not in short run.

b) i)

ii)

iii)

at 1, cut taxes, boost govt spending at 4, increase taxes, cut govt spending iv) Ricardo - Concerned about population growth affecting economic resources (GDP)

c) Explain the circular flow model in a market-oriented system of how firms and individual participate and interact in the resource and product market - Individuals and firms are the fundamental participants in the market economy. - Households provide labour services to the factor markets - Firms provide goods and services to households through the product market - Payment for goods and services flows from households to firms through product market - Payment for labour services flows from firms to households in the factor market - People earn income in the factor market, spend it on goods in the product market and firms use profit they earn to invest. - The firms production and input costs determine the supply conditions while consumer preferences and the ability to pay determine the demand conditions. Product Market

Goods and services

Goods and services

Household
Economic resources Income Economic resources

Firm

Factor Market

Factor Payments

2) a) Describe the difference between the accounting and the economic concept of profit Profits = revenue costs Difference is in what costs is. Accounting uses monetary costs like rent, wages etc Economics use implicit and explicit costs. (take into account opportunity costs that was forgone). Accounting:profit = revenue expenses Economic: profit = revenue (expenses + opportunity costs) Change accounting practices by implementing economic profit method while performing calculations because this includes implicit and explicit costs.

b)

A recent engineering graduate turns down a job offer at $30,000 per year to start his own business. He will invest $50,000 of his own money, which has been in a bank account earning 7 percent interest per year. He also plans to use a building he owns that has been rented for $1,500 per month. Revenue in a new business during the first year was $107,000, while other expenses were Advertising $5,000 Rent $10,000 Taxes $5,000 Employees salaries $40,000 Supplies $5,000 --------------------------------------------------Prepare two income statements, one using the traditional accounting approach and one using the opportunity cost approach to determine profit.

Accounting Approach Total revenue = $107,000 Total expenses = $65,000 Net income = $107,000 - $65,000 = $42,000 Opportunity Cost Approach Total revenue = $107,000 Total expenses = $65,000 + Job Offer 7% interest p/a rent

$30,000 50000 * 0.07 = $3,500 $1,500 * 12 = $18,000

Total expenses = $65,000 + $30,000 + $3,500 + $18,000 = $116,500 Net Income = $107,000 - $116,500 = -$9,500

3)

Explain the characteristic of the following market model i) Pure Competition ii) Monopolistic Competition iii) Oligopoly iv) Pure Monopoly For each market model identify the number of firms, type of product, control over prices, condition of entry, non price competition and an example of industry. Characteristic s # of firms Type of product Pure Competiti on Very large No. of firms standardize d Monopolist ic Competitio n many differentiate d Oligopoly Pure Monopoly one Unique No close substitute Consderabl e amount Blocked Mostly public relations Local utilities

few Standardize d or differentiate d Mutual understandi ng obstacle Product differentiati on Household applicances, steel

Control over price Condition for entry Non price competition Example

none Very easy No obstacle none Agriculture

Some, with a narrow limit Relatively easy Considerabl e amount Retail trade

4)

a) i)

What are the functions of money? Medium of exchange work in bagel factory, expects money, not cows etc. Measure of value Gives an item relative value e.g, shirt is $20 and not 2.5 cows etc. Store of value even though, money is the most liquid, can store it in the form of land, car, buy bonds, safety deposit etc gain interest. What items contribute the M1 and M2 Money supply? M1 currency and checkable deposits M2 M1 + MMDA + small time deposits (<100,000) + MMMF + non checkable deposists M3 M2 + large time deposits (>100,000)

ii)

iii) b)

i)

Distinguish between explicit and implicit costs, giving examples of each Explicit expenses cost of goods sold, utilities cost etc. Implicit forgone costs forgone wages, forgone rent etc. implicit costs are 20,000, 1,000 and 5,000 = 26,000 55,000 26,000 = 29,000

ii)

5) a) Explain the concept of equilibrium price in a perfectly competitive market? - Draw surplus/shortage diagram - price vs qty - show equilibrium price/quantity - Keep price fixed b) Explain the concept of equilibrium output in a perfectly competitive market? - Draw surplus/shortage diagram - price vs qty - show equilibrium price/quantity - Keep quantity fixed c) A new pizza place, M&Ms open in New Kingston. The average price of a medium pizza in Neww Kingston is $10 and because of the large number of pizza sellers, this price will not be affected by the new entrant in the market. The owner of M&Ms estimates that monthly total cost, including a normal profit will be TC = 1000 + 2Q + 0.01Q2 1) To maximize total profit, how many pizzas should be produced each month? 2) In the short run, how much economic profits will the business earn each month? MC = 2 + 0.02Q P = MC 10 = 2 + 0.02Q Q = 400 units TR = PQ = 10 x 400 = 4000 profit = TR TC = 4000 ( 1000 + 2(400) + 0.01(4002) ) = 4000 3400 = $600 6) a) Explain the principal agent problem

b) -

Shareholders hire managers to maximize profits Shareholders do not monitor managers constantly Managers have goals other than profit maximizing. Only way to improve this is by providing incentives to executives like stock options based on performance etc. Explain the role of profit in a free-market economic system Profit acts as a signal to change the rate of output, or to enter or leave an industry Profit is a reward that encourages entrepreneurs to organize factors of production to take risk Funeral Home Service monopolistically competitive business in Chicago. The manager of Browns Funeral Home has determined that the firms demand equation is given by P = 309.75 Q and the long run total cost equation is TC = 400Q 20Q2 + Q3, where Q is the number of funerals per month. What is the long run equilibrium price and quantity and how much economic profit will the firm earn? TC = 400Q 20Q2 + Q3 P = 309.75 Q TR = PQ TR = 309.75Q Q2 MC = 400 40Q + 3Q2 MR = 309.75 2Q At equilibrium, econ. Profit, MR = MC 309.75 2Q = 400 40Q + 3Q2 90.25 38Q = 3Q2 3Q2 38Q + (-19)2 = 90.25 + (-19)2 (3Q 19)2 = 270.75 3Q 19 = 270.75 3Q 19 = 16.4 3Q = 19 16.4 Q = (19 16.4) / 3 Q = 3.9 or Q = 0.9 Q = 3.9, price = 309.75 3.9 = $305.90

c)

7)

Of the decision made by manager, none is more critical to the success of a firm than setting the price of output. Explain in relation to the major factors in determining the short-run and long-run profit maximization effect base on three types of market structures.

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2) 3)

What is GDP? Gross domestic product (GDP) measures total market value of all final goods and services produced within an economy in a specific year. GDP includes GNP (Gross National Product) GNP consists of total output produced by land, labour, capital and entrepreneurial talents. GDP consists of total goods and services within the boundaries of the company. Difference between GDP and GNP consists of net foreign factor income earned GDP = C + Ig + G + Xn C personal consumption expenditure Ig gross private domestic investment G government purchases Xn Net export Declining, static and expanding economy

- Expanding economy Gross investment > Net Investment Depreciation - Static economy Gross investment = Depreciation - When net investment is positive, the economys production capacity expands. - When investment is negative, economys production capacity erodes. MONETARY POLICIES 4) 6) Social accounting concepts from GDP Net Domestic Product (NDP) Market value of annual output net of consumption of fixed capital National Income (NI) income earned by the supplied factor of production for their current contributions to production Personal Income (PI) income received by households which is before personal taxes Disposable Income (DI) income received by households less personal taxes How banks create money? Banks create money when they make loans. Money vanishes when loans are repaid. New money is created when banks buy government bonds from the public. Money disappears when banks sell government bonds to the public. Banks borrow and lend temporary excess reserves on an overnight basis in the Federal funds market. Interest rate on these loans is the Federal funds rate. On return of loan, public pays back principal + interest. Interest paid is the money that is created.

8) Cause effect of using monetary instruments to control inflation and money supply Easy money policy is increasing money supply Tight money policy is decreasing money supply Easy Money Policy Tight Money Policy

Problem: unemployment and recession Federal reserve buys bonds, lowers reserve ratio, or lowers the discount rate Money supply rises Interest rate falls Investment spending increases Aggregate demand increases Real GDP rises by a multiple if the increase in investment -

Problem: inflation Federal reserve sells bonds, increases reserve ratio, or increases the discount rate Money supply falls Interest rate rises Investment spending Decreases Aggregate demand Decreases Inflation declines

Easy money policy Buy government bonds, decrease reserve ratio, decrease discount rate. Tight money policy Sell government bonds, increase reserve ratio, increase discount rate.

PRICING POLICIES 10) 11) Profit maximization, quantity output, marginal cost. Equilibrium prices/quantity and shut-down.