UNIVERSITY OF MAURITIUS

YEARLY EXAMINATIONS

MAY 2009

PROGRAMME BSc (HONS) ECONOMICS – YEAR 1

BSc (HONS) ECONOMICS AND FINANCE – YEAR 1
BSc (HONS) ECONOMICS WITH MANAGEMENT – YEAR 1

MODULE NAME INTRODUCTION TO ECONOMIC ANALYSIS

DATE (to be filled by Exam MODULE CODE ECON 1005Y(1)

Section)

TIME (to be filled by Exam DURATION 3 HOURS

Section)

NO. OF 8 NO. OF 4
QUESTIONS SET QUESTIONS TO
BE ATTEMPTED

INSTRUCTIONS TO CANDIDATES

There are 2 Sections in this paper: Section A and Section B.

Section A consists of 4 questions. Answer any 2 questions from Section A.

Section B consists of 4 questions. Answer any 2 questions from Section B.

Answer 2 questions from each Section.

All questions carry equal marks.

 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

SECTION A

Answer 2 questions from this Section.

Question 1

(a) Suppose that the demand function for corn is Q d = 10 − 2 P and supply
function is Q s = 3P − 5 . The government is concerned that the market
equilibrium price of corn is too low and would like to implement a price
support policy to protect the farmers. Thus the government sets a support
price Ps = 4 and purchases the extra supply at the support price.

(i) At the support price Ps = 4, find the quantity supplied by the farmers,
the quantity demanded by the market and the quantity purchased by
the government.
[3 marks]

(ii) Calculate the change in producer surplus and change in consumer

surplus due to the implementation of the price support policy.
[6 marks]

(ii) Calculate how much it costs the government to implement the price
support policy.
[3 marks]

(iii) Suppose now the government switches from the price support policy to
a subsidy policy. For each unit of corn produced, the government
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subsidises the farmer s = . Find the new equilibrium price under the
3
subsidy policy. How much money will the government spend to
implement this policy?
[7 marks]

(b) Explain the factors that govern the size of the coefficient of price elasticity of
demand. Support your answer with appropriate examples.
[6 marks]

Question 2

(a) Suppose a consumer’s preferences for commodities X and Y are represented

by the utility function U ( X , Y ) = X 2 Y 3 . Given the price of good X is Px and
the price of good Y is Py, using the lagrangian method, derive the demand
functions for X and Y.
[10 marks]

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 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

(b) Explain the link between the income consumption curve and the Engel curve.
[8 marks]

(c) Compare and contrast the Hicks substitution effect with the Slutsky
substitution effect of a fall in the price of a normal good.
[7 marks]

Question 3

(a) Compare and contrast the long run profit maximising output and efficiency
aspect of the firm under monopolistic competition with that of a firm
operating as a monopolist.
[10 marks]

(b) An industry consists of two mineral springs, each of which has variable costs
of $20 per unit of water produced and no fixed costs. The industry demand
curve is P = 164 - 2Q, where P is price set in the industry and Q is industry
demand.

(i) If the firms compete under the Cournot assumptions, find the price
under Nash equilibrium.
[6 marks]

(ii) Graph the reaction function of each firm.

[3 marks]

(iii) Now suppose that one firm is a Stackelberg leader while the other firm
is a follower. Assume that the follower behaves like a Cournot
duopolist, calculate the price it charges.
[6 marks]

Question 4

Consider the following production functions Q = Lα K β and Q = αL + βK , where Q is

the quantity of output per period of time, L and K are inputs of labour and capital
per period of time.

(a) Explain the features of each production function.

[4 marks]
(b) Define the marginal rate of technical substitution (MRTS). Derive the MRTS
for each production function.
[6 marks]

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 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

(c) Assume that α = β = 1 . Let the cost of a unit of L be w=1 and the cost of a
2
unit of K be r=4, calculate and show graphically the optimal capital-labour
ratio for each production function. How are your answers different?
[8 marks]

(d) Derive the long run average cost function of the production function
Q = L1 / 2 K 1 / 2 .
[3 marks]

(e) Explain the following statement: ‘The long-run average cost curve is the
envelope of the firm’s short-run average cost curves’.
[4 marks]

SECTION B

Answer 2 questions from this Section.

Question 5

Consider a closed economy with fixed wages and prices, with the aggregate price
level P = 1 . Suppose the consumption function is C = 80 + 0.8(Y − T ) where C is
consumption, Y is income and T denotes lump-sum taxes. The investment function
takes the form I = 90 − 15r , where I is investment and r is the real interest rate.
Government spending is denoted by G. Money market equilibrium is given by the
equation M = 250 + 0.6Y − 30r where M is the nominal money supply. Note that M is
also the real money supply since P = 1 .

(a) Explain the above consumption and investment functions.

[4 marks]

(b) Suppose that the government is initially running a balanced budget, with
government spending and taxes given by G = T = 400 . Assume that the central
bank adjusts the money supply M to ensure the interest rate is r = 2 . Find the
equilibrium value of output Y and show that the equilibrium money supply M
is 850.
[5 marks]

(c) Now suppose that the government increases spending to G = 475 , financed by
issuing bonds (there is no change in taxes). Find the new equilibrium level of
output if the Central Bank continues to hold the interest rate at r = 2 . What is
the fiscal-policy multiplier?
[4 marks]
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 INTRODUCTION TO ECONOMIC ANALYSIS – ECON 1005Y(1)

(d) Consider again the increase in government spending from 400 to 475 with no
change in taxes, but now suppose the Central Bank keeps the money supply
fixed at its initial level M = 850 . Find the equilibrium level of output and the
new value of the fiscal-policy multiplier. Explain why your answer is
different from that in part (c).
[6 marks]
(e) Under this closed economy, how does a rise in the sensitivity of investment to
interest rates affect the slope of the IS curve and the effectiveness of an
expansionary monetary policy?
[6 marks]

Question 6

(a) Use the AD-AS model to show how an improvement in production

technology will affect real wages, output and employment.
[10 marks]

(b) Explain the Fisher or Modigliani life-cycle hypothesis and Friedman

permanent income hypothesis in predicting consumption smoothing.
[15 marks]

Question 7

(a) The inflation rate of the Mauritian economy stands at 9.7% in 2008. What
measures will you suggest to reduce inflation in Mauritius?
[9 marks]

(b) ‘The trade off between inflation and unemployment is a short-run

phenomenon’. Explain this statement.
[6 marks]
(c) Discuss the role of expectations and the role of credibility of government
decision in determining the outcome of a monetary policy initiated by the
Central Bank.
[10 marks]

Question 8

(a) Mauritius is a small island economy and is vulnerable to exchange rate

volatility. Discuss the factors that may influence its exchange rate and explain
the net impact on the Balance of Payments of the country.
[13 marks]
(b) Distinguish between the impact of the imposition of a tariff and a quota on
international trade.
[12 marks]
END OF QUESTION PAPER

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