SINGAPORE INSTITUTE OF MANAGEMENT

PRELIMINARY EXAM

PROGRAMME(S) : University of London Degree and Diploma Programmes

(Lead College: London School of Economics & Political Science)

SUBJECT : 02 ECONOMICS

DATE : Monday, 1 March 2010

DURATION : 3 hours

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INSTRUCTIONS :-

DO NOT TURN OVER THIS QUESTION PAPER UNTIL YOU

ARE TOLD TO DO SO.

Answer questions 1 and 5 and TWO more questions; ONE from each section. All
questions carry equal weight.

Total number of pages : 4 (including this page)

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Section A

1. Briefly answer THREE the following questions:

(a) In economy A there are two types of labour (say, skilled and unskilled). The
economy produces two goods (x and y) which can be produced either by skilled
labour or unskilled one. Skilled labour can produce either 400 units of y or 200
units of x (or any linear combination of the two). Unskilled labour can produce
either 200 units of y or 400 units of x (or any linear combination of the two).
Economy B, on the other hand, has only unskilled labour which can produce
either 200 units of y or 200 units of x (or any linear combination of the two). If
the countries traded at all, it would necessarily mean that country A should fully
specialise in the production of x. True or false, explain.

(b) The level of cost at which the short run marginal costs equals the long run
marginal cost will be higher than the corresponding short run and long run
average costs when there are increasing returns to scale and lower when returns
to scale are decreasing. True or false, explain.

(c) A unit tax levied on a competitive industry will always cause an increase in
short run equilibrium price which is the same as the size of the tax. Therefore,
the burden of tax is borne by consumers alone. The same is true for the long run.
True or false, explain.

(d) Competition erodes the monopolistic power of firms in monopolistic

competition only because it reduces the market share of each such firm. True or
false explain.

(e) A general increase in prices will necessarily cause an increase in the supply of
labour. True or false, explain

2. To encourage the consumption of health-food (x) the government considers the

following scheme: there will be a subsidy for the consumption of health-food
beyond a certain minimal level ( x ). For those who cannot demonstrate
consumption above that level, there will be an increase in the national health
insurance contribution.
(a) Describe the initial conditions in the space of health-food (x) and all
other goods (y);
(b) Show the effect that the scheme will have on these conditions;
(c) Would a person who normally consumes more health-food than the
minimum required necessarily become better off?
(d) Would the penalty on those who initially consume less than the minimum
required have the desired effect?
(e) Some argued that to ensure the effectiveness of the penalty (the increased
insurance payment) the government should also tax health food which is
consumed below the minimum level required. Will such a scheme be
more effective?

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 3. A competitive industry is comprised of n identical firms who face the same long-
run cost function of C(x)=cx. The market demand is linear ( p ( X )     X )
where X=nx.
(a) Describe the initial long run equilibrium. What will be the equilibrium
level of price, market output and each firm’s level of production? (You
should express your answers in terms of α, β, c and n which are known
values).
(b) Analyse (diagrammatically) the effects of a decrease in β on the short run
and long run equilibrium?
(c) How many more firms will enter the market?

4. Singapore-Sting-Lah (SSL) which is a special drink made out of a plant which

grows only in Singapore, is produced by a monopolist who faces local demand
and an international demand which has higher price elasticity. The long run
marginal cost of producing SPL is constant.
(a) Draw the demand and marginal revenue which the monopolist faces;
(b) Assuming the monopolist cannot discriminate, what will be the
equilibrium in the market?
(c) Suppose that the monopolist is selling abroad but there is an increase in
the exporting license fees, could this bring about an end to the
monopolists’ sales abroad?

Section B

5. Briefly answer THREE of the following questions:

(a) The Balanced Budget Multiplier of a closed economy with proportional

tax where the government adjusts its spending to the level of tax raised
will be greater than that of a balanced budget multiplier where the tax
rate us adjusted to cover government spending. True or false, explain.

(b) A reduction in the reserve ratio will increase the wealth of the public.
True or false, explain.

(c) When price elasticity of the demand for imports is greater than unity, an
increase in international prices may leave the nominal exchange rate
unaffected. True or false, explain.

(d) An increase in government spending funded by borrowing from the

public will have no effect on a closed economy where wages and prices
are flexible. True or false, explain.

(e) A transfer of income from the rich to the poor will have an expansionary
effect on an open economy without capital mobility and a fixed exchange
rate regime. True or false, explain.

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6. In Sickilandia a debate developed around the question of spending on health by
the government. Proponents of greater spending on health argued that the
increase in spending will lead to a significant reduction in the number of days
lost to illnesses over any given period of time. Opponents argued that while they
accept the connection between spending on health and the amount of days lost,
as wages and prices are flexible, this will only lead to nominal changes. If,
however, the government wishes to be effective, it should raise the pension age
(as longevity increases as well) and so offset the increase in its budget. Assuming
a closed economy with proportional tax and where pensioners’ income is a
fraction of the taxes raised while their marginal propensity to consume is greater:
(a) What will be the economies multiplier?
(b) How will the proposal of the proponents affect the economy when wages
and prices are flexible? Distinguish in your answer between short run and
long run effects. Were the opponents right?
(c) What will be the outcome if the government followed the opponents’
proposal and raised the age of pension?

7. The government decides to crack down on the culture of bonus payments by

corporations. The share of profits in national income is α but only half of the
retained profits are invested locally. The government proposes to levy a special
tax on bonuses. Assuming an open economy with a proportional tax system:
(a) What would be the multiplier and equilibrium conditions before the
imposition of the tax;
(b) How would the introduction of the tax affect the multiplier and the short
run and long run equilibrium under (i) fixed exchange rate regime; and
(ii) flexible exchange rate regime;
(c) If corporations absorbed the tax, how would this affect the analysis in
(b)?

8. In view of recent rises in the internal national debt, the government decides to
raise taxes and to reduce the cost of public provision it removes a ban on
government purchases abroad.
(a) Analyse the effects of the policy on an open economy without capital
mobility and a fixed exchange rate policy;
(b) Analyse the effects of the policy on an open economy with perfect capital
mobility and a fixed exchange rate policy;
(c) How would your answer to (b) change had the exchange rate been
flexible?

End of Paper