SOCS0031: Introduction to Economics II

CORE QUESTION – PLEASE COMPLETE ALL SECTIONS

1. Monopoly

The demand curve faced by a monopolist is p = 100 – x and the marginal cost is MC = 25, where x is the product that the monopolist produces and sells.

(a) (5 marks) Assuming that the monopolist can only charge a single price per unit:

i. On a graph with x on the horizontal axis and p on the vertical axis, draw the demand, the marginal cost, and the marginal revenue

ii. Briefly describe the monopolist’s marginal revenue function: is it increasing or decreasing? By how much? Why?

(b) (5 marks) Assume first that there are no other costs. On the same graph as in (a) or on a new one, show the monopolist’s supply point, the consumer surplus, and the monopolist’s profits

(c) (5 marks) Why is there a market failure? Do you think that there are grounds for intervening in the market? Explain your answer briefly

(d) (5 marks) Suggest a policy that is able to resolve the effects of the market failure. Illustrate your answer with a new graph

(e) (5 marks) Now assume that there are high fixed entry costs in this market. How high should these costs be for this market to be a Natural Monopoly? Show these costs in a new graph and explain your answer

(f) (5 marks) With these new high entry costs, re-evaluate your answers to questions (c) and (d):

i. Do you think there are still grounds for intervening in the market? Why?

ii. If your answer is yes, what policy would you recommend?

CORE QUESTION – PLEASE COMPLETE ALL SECTIONS

2. Keynesian Cross

(Inspired by Case, Fair & Oyster, 2010)

During the lectures and seminars, we saw the devastating impact of the coronavirus pandemic and subsequent lockdowns on the GDPs of several countries around the world. The majority of these economies have suffered a shock that policy makers are now trying to offset using monetary and fiscal policy tools.

Taking into account the following definitions:

• Negative/Positive supply shock: an event that reduces/increases the capacity of an economy to produce goods and services at the given prices

• Negative/Positive demand shock: an event that reduces/increases the consumer’s ability or willingness to buy goods and services at the given prices

(a) (3 marks) Do you think that the pandemic and lockdowns are a demand shock, a supply shock, or both? Briefly explain your answer

(b) (6 marks) In this exercise, we are going to look at the demand side of the economy. Assuming that there is no foreign sector, and that taxes are lump sum, write down the equation for the Keynesian Cross’ Aggregate Demand (AD).

i. Explain which element(s) in the equation is/are most likely to have been impacted by the coronavirus pandemic and the lockdowns

ii. Taking into account your explanation above, in a graph, show the AD before the economic shock (label it AD1), the AD after the shock (label it AD2), and their corresponding equilibrium outputs or GDPs

(c) (15 marks) Policy makers in several economies have resorted to increasing government spending to counteract the shock. To enable such an increase in expenditure, governments and institutions may be considering several options. Starting with your AD2 in question (b)ii above, illustrate each option on a separate new graph (that is, one graph per policy action) and explain briefly the costs and benefits of each:

i. Policy option A: Finance the expenditure increase with an equal increase in taxes

ii. Policy option B: Keep taxes constant and borrow money from the public by issuing bonds

iii. Policy option C: The central bank embarks in Quantitative Easing

(d) (6 marks) Rank the three policy alternatives in question (c) from most expansionary to least expansionary. Considering the benefits and costs of each alternative, which one would you recommend to a policy maker?

(40 points) ESSAY – CHOOSE ONE OF THE TWO OPTIONS

Choose one of the options below and write a short essay of maximum 600 words. The essay must be written in full sentences and be well-structured: each paragraph should deal with one major issue or idea and that these ideas should be developed in a logical sequence. Please include a short introduction, which lays out your main message (ie. the question you will answer or the claim you will argue for throughout the essay). Wrap up your work with a short conclusion.

Note: This an essay. There is not a single good answer. Make sure you state any assumptions you need for your analysis and that your arguments are consistent with those assumptions.

Option 1: Inflation and interest rate

Read the article by Larry Elliot published in The Guardian on 17th March 2022, Bank of England raises interest rates to 0.75% as inflation soars:

Using a graphical representation of the AD/AS model learned in class

(a) Illustrate and explain how the economy may have reached ‘stagflation’ (“weak growth and upward pressure on costs and prices”)

(b) Why does inflation need to be controlled? Some economists believe that the best way to control inflation is to create a recession. Do you agree with them? Explain your answer

Option 2: Inequality and taxes

Read the article published in The Economist on 17th October 2020, Colombia tries to fix a messy and unfair tax[1].

Using economic theory and concepts learned in the module, comment on

(a) What it means that in Colombia “income inequality is highest in the OECD” and do you agree with the director of national planning wanting to ‘correct this unfairness’

(b) What do you think of the Value Added Tax as a tool to reduce income inequality? Would you recommend alternative/additional policies? Explain your answer

[1] Alternative link: the article can be accessed through the UCL library through here