SchoolofSocialSciences EconomicStudies

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.

EC11002

Question 1: (a) Explain why a firms profit maximising strategy might not be best served by offering the lowest wage levels possible. [10 marks] Definition of concept rock bottom wages and efficiency wage (reference to shirking and efficiency), explanation of declining marginal labour productivity and profit maximising position of firm MPL=wage rate (ideally graphically shown as equilibrium). (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 the firm make if the price of its output is 50 per unit and it faces labour costs of 25 per hour. [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 no change Question 2: In an education system whereby students pay all their costs of education the demand and supply 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 places at university. a. What is the equilibrium price for education and quantity of places at university traded? Equilibrium occurs when Qd=Qs 48000 - 4P = 4P 48,000 = 8P P=48,000/8 P=6,000 Qd = 48,000 - 4(6,000) Qd = 48,000 - 24,000 = 24,000 Qs = 4(6000) = 24,000 b. If the government imposes a maximum price universities are allowed to charge of 5,000 will there be an excess of demand or supply? Qd = 48,000 - 4(5,000) = 28,000 Qs = 4(5,000) = 20,000 Therefore 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?

EC11002

Subsidy changes the supply equation such that QS= (4P+8) Now Qd=Qs 48000 - 4P = 4(P+8) 48000 - 4P = 4P+32000 48,000 -32,000 = 8P P=16,000/8 P=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 fixed capital costs 100,000. The investor also makes additional capital available at the beginning of the period for raw materials 10,000, labour costs 21,000 and marketing costs 9,000. At the end of the period the investor decides to sell the business and incurs a further 1,000 selling costs. The resale value of the fixed capital is determined to be 80,000 the turnover from sale of the output (all gained at the end of the period) is 71,000. If the interest rate was 5 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 the business. [30 marks] Definition of risk premium and link to idea of probability, recognition that if risk premium was above ERR then purchase would not take place but if risk premium was below ERR then purchase would take place.

EC11002