MANKIW, G., TAYLOR, M.; Economics,, 4ed.

Possible test/exam questions

Why is an Optimum Currency Area (OCA) a prerequisite for a well functioning Single Currency in all the countries of that area? Is Euro Zone an OCA? Discuss.

Reflect on the economics of pandemics such as Covid-19 (30min)

The Solow-Swan model provides a way of predicting that the capital-output ratio of economies will eventually converge to the steady state. Please explain. How can government policies try to influence economic growth and what does this mean for business?

About money (max 4 points each > total max 20 points).

• Identify and explain the main features of money.
• What are the main economic benefits to be gained from a (well run) banking system?
• Identify the important risks that banking regulation seeks to manage.
• Are banks regulated by liquidity or capital adequacy? Is this a problem?
• Identify and explain the main motives for holding money.
   

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Theory suggests that trade is beneficial. However, governments intervene

quite frequently with a set of policies restricting trade. Please elaborate.

Since tariffs amongst the members are abolished, regional integration (for instance in form of a Free Trade Area) is about trade creation and, therefore, beneficial. Discuss.

<30 minutes for the following tasks>

1) There are 4 different types of unemployment. State how the following would be classified (20)

Aggregated demand and supply analysis (40)

You are in an economy where consumption is given by the following function

C = 65 + 0.8Y

The economy has no government expenditure and does not have any foreign trade at present but it does have investment expenditure, which is constant at €150.

• Complete the following table (15)

• Determine the equilibrium level graphically. (15)
• Calculate the equilibrium level of income. (10)

3) Regulation of the banking system (30)

• Explain the different possible types of regulation (20)
• Discuss reasons why regulation may fail. (10)

4) Why is the multiplier higher for investments than for Government expenditure? Explain. (10)

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Polonius advises his son in Shakespeare’s Hamlet: “Neither a borrower nor a lender be.” Please discuss. Explain the market of loanable funds and how government policy can influence it. 

The following figure shows the short-run cost curves for a perfectly competitive firm (max 4 points each > total max 20 points).

• What is the shutdown price for the firm? 
• At what price would the firm just make normal profits?
• What area would represent total fixed cost at this price?
• Within what range of prices would the firm choose to operate at a loss in the short run?
• Within what range of prices would the firm be able to make short-run supernormal profits?
•  

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School-run drivers face shock on road pricing (max 5 points each > total max 20 points).

From an article in the newspaper:

“Last-minute changes to the blueprint for a Greater Manchester congestion charge were revealed yesterday, in a bid to defuse business opposition only days before an important vote by council leaders. The plan to form Britain's biggest congestion charging zone has divided Manchester's business community and led to concerns that individuals and tradesmen who cannot use public transport to get to work will face far higher costs. If the changes are approved, lorries will be spared the charge for its first year in operation, pending a study to investigate the savings from reduced congestion. People working in Trafford Park, the large business centre close to the outside of the charging zone, will not have to pay the charge until the tram network reaches the area. The maximum daily charge will also be cut from £10 to £5, with a pledge that no user will pay more than once for entering or leaving a charging zone while the charge is in operation, no matter how many times they cross the boundary. And people on the minimum wage would be given a 20 per cent discount on public transport fares and the congestion charge. The concessions have been tabled in advance of a city-wide referendum on the scheme, which would allow the city to draw on £1.5bn of government funds to upgrade its transport facilities and to complete the Metrolink tram network. The result will be followed closely by Whitehall which wants to extend road charging. It will also be scrutinised worldwide because congestion charges normally cover much smaller areas."

• What are the different elasticities that influence demand for road usage in a mixed market system? How might we expect elasticity to change in the long term as a result of the introduction of congestion charging?
• What are the short-term options for reducing road congestion?
• What are the other longer-term options for reducing road use?
• Congestion charging is an example of price discrimination. Can you think of other examples and what effect they have?

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About growth (max 5 points each > total max 20 points).

Source: World Bank, Development Indicators

• What does the table show?
• What evidence, if any, does the table provide in support of the convergence hypothesis?
• What factors, if any, might be associated with improved economic growth?
• Economic growth and the exploitation of non-renewable resources are incompatible.Discuss.

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Measuring macroeconomic variables and policy issues (max 4 points each > total max 20 points).

• What are the key macroeconomic variables for an economy?
• What key macroeconomic variables can a government or central bank control? How have these changed for your economy during the last 5 years?
• Draw circular flow of income for an economy that has a government sector and is open to international trade.
• Identify the leakages, injections and components of aggregate expenditure in your circular flow diagram.
• Explain why there is a negative relationship between inflation and aggregate demand.

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The following report appeared in The Telegraph on 13 January 2009

 “The goods-trade gap was £8.3bn, compared with £7.6bn in October, the Office for National Statistics said today. Economists predicted £7.5bn, according to a Bloomberg News survey.

The Bank of England last week cut the benchmark interest rate to 1.5pc, the lowest in its history, to combat the recession. Policy makers said that the world economy ``appears to be undergoing an unusually sharp and synchronised downturn'' which will hurt global trade. “We see another rate cut in February,'' said David Page, an economist at Investec Securities. ``The bank is aware that we're going through a particularly sharp adjustment in global demand.'' Exports fell 5.8pc on the month while imports dropped 1.8pc, the statistics office said. Overseas sales of oil, chemicals, cars and other commodities slipped. The goods trade gap with countries outside the European Union widened to 5.3bn pounds in November, the most on record. The trade surplus with the U.S. narrowed to £301m, the smallest since February 2007, the statistics office said today. Oxford, England-based Electrocomponents Plc, a supplier of 350,000 products from cables to calculators, said last month sales worsened on weaker demand in Europe, the Asia-Pacific region and the U.S. The International Monetary Fund forecasts recessions in the US, Japan and the euro area. The UK economy contracted 0.6pc in the third quarter after stalling in the second, government data show.”

Questions

• What has been the recent performance of the UK trade balance?
• What has been the reaction of the Bank of England to the current economic recession?
• Which was the economic rationale behind the BoE decisions?
• How effective was monetary policy?

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The following is an extract from an article that appeared in The Economist on 1^st July 2012.

“Fifteen years ago this month, Thailand at last allowed its currency, the baht, to fall against the dollar, abandoning a long, losing battle with market forces…..What followed was a five-year nightmare for emerging markets, as the financial crisis spread to Thailand’s neighbours, then to Russia and Brazil, before eventually claiming Argentina and Uruguay in July 2002. After the tossing and turning of 1997-2002, the next decade went like a dream. In 2003, China resumed double-digit growth; India’s economy expanded by 8%, a feat it would surpass in four of the next six years; Brazil’s new president, Luiz Inacio Lula da Silva, appeased the IMF and the bond markets by cutting public debt and achieving the first of five annual current account surpluses. Goldman Sachs released the first of its 2050 projections……suggesting that the big emerging economies would eventually inherit the Earth…… 

But after a dream decade, something is amiss. China is now struggling to grow as fast as 8%.....India a country that once aspired to double-digit growth, can now only dream of ridding itself of double-digit inflation. None….stand on the edge of a dramatic financial precipice….but their economic prospects have nonetheless started to head downhill….. Some of this slowdown can be blamed on events elsewhere. Europe’s pain, for example, has spread far beyond its immediate neighbours.….Some of the slowdown was also orchestrated by governments nervous about price pressures or property bubbles….

But there is more to this story. The slowdown is not simply a demand-side phenomenon, the result of weak exports and past tightening dragging growth below its long-run potential. The underlying sustainable growth may also be less impressive than previously thought. As the IMF pointed out this week, the last decade or so may have ‘generated overly optimistic expectations about potential growth’…. High commodity prices boosted some emerging economies, such as Brazil, Russia and South Africa…… The dream decade was also sweetened by rapid credit growth, according to the fund. The ratio of bank credit to GDP has risen steeply in many emerging economies over the past ten years… 

The upturn in the financial cycle may flatter growth, as easy credit encourages spending and speculation….This may have lulled emerging economies into thinking they could grow faster than they really can….. The big emerging economies may never again grow as they did after 2003….”

Questions

• Who are the emerging economies and why have they enjoyed such rapid growth?
• How has the growth of these economies contributed to globalisation?
• Is the growth of these economies a threat to the western industrialised countries or a boon?
• Why has the growth of these economies slowed somewhat in recent years?

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“Federal Reserve Vice Chairman Donald Kohn's question-and-answer session at a conference here was going as countless others have in his years as a top policy maker. Until Paul Volcker raised his hand.

Then, the former Fed chairman grilled Mr. Kohn over the Fed's effort to convey that it considers a 2% inflation rate to be appropriate for the U.S. economy in the long term. Mr. Volcker, who led the Fed in conquering double-digit inflation in the 1980s, questioned how the Fed can talk about both 2% inflation and price stability. "I don't get it," Mr. Volcker said, leading to a lively back-and-forth between the two central-bank heavyweights at a conference on Saturday at Vanderbilt University. By setting 2% as an inflation objective, the Fed is "telling people in a generation they're going to be losing half their purchasing power," Mr. Volcker said. Mr. Kohn, who worked as a staffer to Mr. Volcker in the 1980s, replied that aiming at 2% inflation gives the Fed "a little more room...to react to an adverse shock to the economy" because it is easier to get its key short-term interest rate below the inflation rate, the usual remedy for recession. "Your problem is [2%] becomes three becomes four," Mr. Kohn told Mr. Volcker. But other central banks with a roughly 2% target haven't had that problem, he said.Fed officials, Mr. Kohn added, "need to be clear about why we're choosing the number we're choosing." He also said that while he doesn't think deflation is much of a risk, "I can't say the risk is zero," and the Fed must be mindful of the possibility that inflation expectations fall to the point that real interest rates rise. Messrs. Kohn and Volcker fought to a rhetorical draw, each conceding that he wasn't going to persuade the other. The two men spoke at a conference honoring former Fed Governor J. Dewey Daane. Fed Chairman Ben Bernanke, in a speech earlier this month, noted that "most members" of the Fed's policy committee "have indicated that they would like to see an annual inflation rate of about 2% in the longer term." "Right now," Mr. Bernanke said, "because of weakness in economic conditions...inflation has been running less than that, and our best forecast is that inflation will remain quite low for some time." By being explicit about its inflation target, the Fed hopes to assure consumers, businesses and investors that it will prevent both deflation,or falling prices, and rising inflation.”

Questions

• Explain what inflation targeting is.
• Mention the case of other central banks that have adopted inflation targeting.
• Which advantages and disadvantages would you expect the Fed might gain from adoption of inflation targeting?

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The following is an extract from article that appeared in The Economist on 1^st September 2012.

“They work while we sleep, unloading planes and lorries, feeding packages and letters into huge sorting machines, and reloading them for raid delivery to four corners of the earth. Each item is coded and tracked on its dizzying journey through many hands. Four companies dominate this express-package business: FedEx and UPS, based in America, and DHL and TNT Express in Europe. They own and run airlines, and fleets of lorries and vans; they operate hubs at airports where the sorting is done.

TNT is the outsider in the group, being smaller and more competitive on price. It is the market leader in two big European countries, Britain and Italy, reckons Transport Intelligence, a research firm. FedEx and UPS are a near duopoly in the United States. DHL has 32% of the German market, around 40% in Asia and over 50% in central Europe, the Middle East and Africa. That may already appear a worrying level of concentration, with a risk of tacit collusion or at least ‘soft competition’ on price. So reducing the number of  ‘global integrators’ – as they are called in the trade – from four to three might seem a step in the wrong direction. But USP eager to beef up its presence in Europe made a bid for TNT in February; a month later they agreed on a price €5.2 billion ($6.8 billion). If allowed to proceed without any disposals, the planned combination would have more than a quarter of the market in Britain and Italy, and nearly a quarter in France. The European Commission is investigating these sort of concerns….. All four firms are adapting to diminished traffic in letters and important documents because of email, and the growing demand for parcel delivery to end-consumers generated by e-commerce sites such as Amazon. The average size of parcels sent from business to business is also growing, as global firms increasingly depend on speedy supply; and guaranteed delivery times, of parts and supplies. That has blurred the line between express services and air freight, and led to increasing use by integrators of spare hold capacity on passenger planes. DHL has seen these types of business flourish even as recession bites in Europe… Last year TNT was reeling….The first half of 2012 saw the start of a turnaround…. TNT’s business model, like that of DHL, relies on partnerships with other services, such as airlines and haulage companies. Around half of its operating expenses are incurred with subcontractors. TNT has made acquisitions in Brazil, Chile and China, but its strategy, before the merger was announced, was to extend its coverage through partnerships. UPS and FedEx operate more centrally from their headquarters in Atlanta and Memphis, though they do use agents in far flung countries. DHL would benefit from a UPS-TNT merger in at least two ways. First, there would be one less competitor in Europe… Second, UPS would be kept busy integrating TNT. UPS might also be hampered by ‘remedies’ demanded by the EC to satisfy competition concerns….. The needs of the market change constantly, and the integrators have to be flexible and innovative to keep up. But it is harder to imagine such traits in a merged Leviathan. And barriers to entry are high. The integrators own airlines and lorry fleets and operate expensive hubs. They have built relationships with customs authorities that let them save time by clearing items while they are still airborne. Such a company would be difficult to replicate quickly….”

Questions

• What type of market is the market in which global express-package firms operate?
• What barriers of entry exist within the market?
• Apply the concept of contestable markets to the global-express package industry.
• Explain the concept of tacit collusion referred to in the article and explain why this is more likely to occur in a concentrated industry.
• Why and how do firms act strategically in such industries?

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The following article is taken from a Special Report entitled “State Capitalism”, which appeared in The Economist on 21st January 2012.

“Beatrice Webb grew up as a fervent believer in free markets and limited government. Her father was a self-made tycoon and her mother an ardent free-trader. One of the family’s closest friends was Herbert Spencer, the leading philosopher of Victorian liberalism. Spencer took a shine to young Beatrice and treated her to lectures on the magic of the market, the survival of the fittest and the evils of the state. But as Beatrice grew up she began to have doubts. Why should the state not intervene in the market to order children out of chimneys and into schools, or to provide sustenance for the hungry and the unemployed or to rescue failing industries? In due course Beatrice became one of the leading architects of the welfare state – and a leading apologist for Soviet communism. The argument about the relative merits of the state and the market that preoccupied Beatrice has been raging ever since. Between 1900 and 1970 the pro-statists had the wind in the sails. Governments started off by weaving social security nets and ended up nationalising huge chunks of the economy. Yet between 1970 and 2000 the free-marketeers made a comeback. Ronald Reagan and Margaret Thatcher started a fashion across the West for privatising state-run industries and pruning the welfare state. The Soviet Union and its outriggers collapsed in ruins. The era of free market triumphalism has come to a juddering halt, and the crisis that destroyed Lehman Brothers in 2008 is now engulfing much of the rich world. The weakest countries, such as Greece, have already been plunged into chaos. Even the mighty United States has seen the income of the average worker contract every year for the past three years……

The crisis of liberal capitalism has been rendered more serious by the rise of a potent alternative: state capitalism, which tries to meld the powers of the state with the powers of capitalism. It depends on government to pick winners and promote economic growth. But it also uses capitalist tools such as listing state-owned companies on the stock market and embracing globalisation. Elements of state capitalism have been seen in the past, for example the rise of Japan in the 1950s and even of Germany in the 1870s, but never before has it operated on such a scale and with such sophisticated tool.

State capitalism can explain the world’s most successful big economy for its camp. Over the past 30 years China’s GDP has grown at an average rate of 9.5% a year and its international trade by 18% in volume terms….The Chinese state is the biggest shareholder in the country’s 150 biggest companies and guides and goads thousands more…. State capitalism can also claim some of the world’s most powerful companies. The 13 biggest oil firms….are all state backed. So is the world’s biggest natural gas company, Russia’s Gazprom. But successful state firms can be found in almost any industry…

State capitalism is on the march, overflowing with cash and emboldened by the crisis in the West. State companies make up 80% of the value of the stock market in China, 62% in Russia and 36% in Brazil….”

Questions

• Distinguish between a free market economy and a state planned economy.
• How and why have attitudes towards the free market changed in the past fifty years?
• What is meant by state capitalism and how does it differ from free-market capitalism?
• Compare and contrast the economic performance of free market and state capitalist economies. What does this tell us about the relative merits of the two systems?

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Current GDP is $100 bn, MPS = 0.1, MPT = 0.2, MPM = 0.2. Government’s GDP target is $150 bn. How much does government need to increase their spending by to reach the target? How will the budget be affected?