Instructions to candidates

Indicative time to complete: Two hours

You must submit your answers in a single Word or PDF document via the

Assignment Submission link provided on 4021ECN Principles of Economics 2

2122JANMAY Virtual Learning Environment page (i.e. AULA) in the

Assessment folder.

Answer four questions.

You must answer one question from each of the four sections.

Each question in Section A and Section C is worth 30 marks.

Each question in Section B and Section D is worth 70 marks.

The total marks for this paper is 200

IMPORTANT: Please ensure that you save your work regularly. Please

submit your work using Microsoft Word or PDF.

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Section A – Microeconomics

Explain, using a numerical example and a diagram where relevant, one of the

following microeconomic concepts:

A1. Oligopoly (30 marks)

A2. Price discrimination (30 marks)

A3. Marginal rate of substitution (30 marks)

Section B – Microeconomics

You must answer one of the following three questions.

Question B1

A monopolist faces the following market demand function: 𝑄𝐷 = 100 − 2𝑃 .

The total cost (TC) function of the monopolist is given by:

𝑇𝐶 = 1 + 5𝑄𝐷 .

where 𝑄𝐷 denotes the quantity sold and P is the selling price per unit.

(a) Calculate the profit maximising quantity, price and profit of the monopolist.

(20 marks)

(b) Sketch the optimal solutions for your answers in part (a) on a graph

displaying the market demand function, marginal revenue and marginal cost

functions. (10 marks)

(c) Discuss the view that perfect competition is a more desirable market

structure than monopoly. Use a diagram to support your arguments. (40

marks)

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Question B2

Jeffrey divides his income of £20 between hamburgers and wine. Assume the

price of hamburgers is £1 each and the price of wine is £1 per bottle. Given that

his preferences for hamburger and wine can be described by the following utility

function:

𝑈(𝑋, 𝑌) = 𝑋𝑌

where X represents the quantity of hamburger consumed each week and Y

denotes the number of bottles of wine consumed each week.

(a) Write down Jeffrey’s budget equation and illustrate it with a diagram. (10

marks)

(b) What quantities of the two goods will Jeffrey consume per week to maximise

his utility? Show your reasoning carefully. (20 marks)

(c) Suppose the price of hamburger increases to £2 each while the price of wine

remains unchanged at £1 per bottle. Calculate and explain the income and

substitution effects of this price change, using the Hicksian decomposition.

What type of good is hamburger based on your answers for the substitution

and income effects? (40 marks)

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Question B3

It is often suggested that competing firms in an oligopolistic market structure

engage in a prisoners’ dilemma when setting the price for their product.

(a) Draw a pay-off matrix to illustrate a duopolistic market in which the

producers must simultaneously set their prices as either low or high. Put in

payoffs that give this game a prisoner’s dilemma structure, and determine

the Nash equilibrium of the game. (20 marks)

(b)Suppose the players must now make their decisions sequentially, draw the

extensive form of the new game using a game tree. Find the subgame

perfect equilibrium of the game. Provide reasons for your answer. (30

marks)

(c) Using the pay-off matrix from part (a) and your knowledge of economics,

discuss the difficulties involved in implementing a cartel between the two

firms. (20 marks)

Section C – Macroeconomics

You must answer one of the following three questions

C1. Derive and illustrate the LM schedule algebraically and graphically. (30

marks)

C2. Derive and illustrate the IS schedule algebraically and graphically. (30 marks)

C3. Discuss the causes of equilibrium unemployment. (30 marks)

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Section D – Macroeconomics

You must answer one of the following three questions

Question D1

(a) With reference to relevant examples, explain and illustrate the following:

(i) The transactions demand for money (15 marks)

(ii) The precautionary demand for money (15 marks)

(iii) The speculative demand for money (15 marks)

(b) Using the Money market diagram, illustrate and explain the impact on the

demand for money/Liquidity of the following:

(i) Expectation that the pound £ is about to appreciate (12 marks)

(ii) There is a reduction in propensity to invest (13 marks)

Question D2

(a) Explain and illustrate the effect of the following changes on the LM curve:

(i) Consumers become less sensitive to changes in income when

demanding for money (15 marks)

(ii) There is a reduction in the level of inflation (15 marks)

(iii) Due to increase in inflation there is a rise in demand for money

(15 marks)

(iv) There is a reduction in the level of interest rate (15 marks)

(b) Explain the limitations of the ISLM analysis (10 marks)

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Question D3

(a) With relevant diagram, discuss how exchange rate of a currency is

determined (20 marks)

(b) With relevant examples, discuss five factors that may cause the

exchange rate to change (50 marks)