Eco - Nov 2001

Foundation Level

Economics for Business

3a

FECB 19 November 2001 Day 1 – morning

INSTRUCTIONS TO CANDIDATES Read this page before you look at the questions

You are allowed TWO hours to answer this question paper. Answer the ONE question in section A (this has 26 sub-questions and is on pages 2 – 7). Answer THREE questions ONLY from section B (these questions are on pages 8 – 12). Write your examination number in the boxes provided on the front of the answer book. Write FECB on the line marked "Subject" on the front of the answer book. Write your examination number on the special answer sheet for section A. Detach the sheet from the booklet and insert it into your answer book before you hand this in. Do NOT write your name or your student registration number anywhere on your answer book. Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered.

© The Chartered Institute of Management Accountants 2001

SECTION A — 52 MARKS ANSWER ALL TWENTY-SIX SUB-QUESTIONS – 2 MARKS EACH Each of the sub-questions numbered from 1.1 to 1.26 inclusive, given below, has only ONE correct answer.

Question One 1.1

Which ONE of the following would lead directly to an outward shift in a country’s production possibility frontier?

A

A rise in the population of working age.

B

A fall in unemployment.

C

An increase in outward migration.

D

A rise in the school leaving age.

1.2

The cost of one good or service measured in terms of what must be sacrificed to obtain it is called

A

real cost.

B

potential cost.

C

opportunity cost.

D

social cost.

1.3

All of the following are supply side policies which would promote economic growth EXCEPT which ONE?

A

Increased expenditure on education and training.

B

A reduction in marginal rates of taxation.

C

Deregulation of industry and finance.

D

Increased social welfare expenditure.

1.4

All of the following are essential features of a market economy EXCEPT which ONE?

A

Private ownership of productive resources.

B

Allocation of resources by the price mechanism.

C

Absence of entry and exit barriers to and from industries.

D

Prices determined by market forces.

FECB

2

November 2001

1.5

The profit-maximising output will always be where

A

average cost = marginal revenue.

B

marginal cost = marginal revenue.

C

average cost = average revenue.

D

marginal cost = average revenue.

1.6

If a business currently sells 10,000 units of its product each month at $10 each unit and the demand for its product has a price elasticity of -2∙5, a rise in the price of the product to $11 will

A

raise total revenue by $7,250.

B

reduce total revenue by $17,500.

C

reduce total revenue by $25,000.

D

raise total revenue by $37,500.

1.7

In the kinked demand curve model of oligopoly, the kink in the firm’s demand curve is due to the firm’s belief that competitors will

A

set a price at the kink of the demand curve.

B

match all price increases and price reductions.

C

match any price increases, but not any price reductions.

D

match any price reductions, but not any price increases.

1.8

Which ONE of the following is a natural barrier to the entry of new firms into an industry?

A

Large initial capital costs.

B

The issuing of patents.

C

A government awarded franchise.

D

The licensing of professions.

1.9

A good which is characterised by both rivalry and excludability is called

A

a public good.

B

a private good.

C

a government good.

D

an external good.

November 2001

3

FECB

1.10

The burden of an indirect tax on a good will fall more heavily on the producer when

A

demand for the good is price elastic.

B

demand for the good is price inelastic.

C

demand for the good has unit elasticity.

D

supply of the good is price elastic.

1.11

In practice, a monopoly may have its market power limited by all of the following EXCEPT which ONE?

A

Countervailing power from its customers.

B

The market may be contestable.

C

There may be close substitutes for the good.

D

The firm’s long-run average cost curve may be falling.

1.12

All of the following are examples of where externalities are likely to occur EXCEPT which ONE?

A

A business providing training schemes for its employees.

B

Government expenditure on vaccination programmes for infectious diseases.

C

Attending a concert given by a government-funded orchestra.

D

Private motorists driving cars in city centres.

1.13

Whenever government intervention prevents prices from reaching their equilibrium level, the result will always include ALL of the following EXCEPT which ONE?

A

Shortages or surpluses.

B

Demand and supply not equal.

C

Reduced profits for producers.

D

Resources not allocated by price.

1.14

Which ONE of the following would cause the value of the multiplier to fall?

A

A fall in the level of government expenditure.

B

A rise in the marginal propensity to consume.

C

A fall in business investment.

D

A rise in the marginal propensity to save.

FECB

4

November 2001

1.15

The linking of net savers with net borrowers is known as

A

the savings function.

B

financial intermediation.

C

financial regulation.

D

a store of value.

1.16

The recession phase of the trade cycle will normally be accompanied by all of the following EXCEPT which ONE?

A

A rise in the rate of inflation.

B

A fall in the level of national output.

C

An improvement in the trade balance.

D

A rise in the level of unemployment.

1.17

According to the new classical school, in order to manage the economy, governments should

A

use active fiscal and monetary policy.

B

adopt a laissez faire approach and leave everything to market forces.

C

announce monetary rules to control inflation, and liberalise product and factor markets.

D

use only monetary policy to increase output and employment.

1.18

All of the following will normally lead to a fall in the level of economic activity in an economy EXCEPT which ONE?

A

A rise in cyclical unemployment.

B

A fall in business investment.

C

A decrease in government expenditure.

D

A rise in interest rates.

1.19

International trade is best explained by the fact that

A

all countries have an absolute advantage in the production of something.

B

all countries have specialised in the production of certain goods and services.

C

no country has an absolute advantage in the production of all goods and services.

D

all countries have a comparative advantage in the production of something.

November 2001

5

FECB

1.20

All of the following will encourage the process of the globalisation of production EXCEPT which ONE?

A

Reductions in international transport costs.

B

Higher levels of tariffs.

C

Reduced barriers to international capital movements.

D

Increased similarity in demand patterns between countries.

1.21

Intra-industry trade occurs when a country

A

exports and imports different products.

B

exports and imports the same products.

C

imports materials to be used by its domestic industry.

D

exports materials for use in industries in other countries.

1.22

Which ONE of the following shows the lowest degree of international mobility?

A

Unskilled labour.

B

Financial capital.

C

Technical knowledge.

D

Management.

1.23

A deficit on a country’s balance of payments current account can be financed by a surplus

A

of exports over imports.

B

of invisible exports over invisible imports.

C

on the capital account.

D

of taxes over expenditure.

1.24

A fall in the exchange rate for a country’s currency will improve the balance of payments current account if

A

the price elasticity of demand for imports is greater than for exports.

B

the price elasticity of demand for exports is greater than for imports.

C

the sum of the price elasticities for imports and exports is less than one.

D

the sum of the price elasticities for imports and exports is greater than one.

FECB

6

November 2001

1.25

All of the following are benefits which all countries will gain from the adoption of a single currency such as the Euro, EXCEPT which ONE?

A

Reduced transactions costs.

B

Increased price transparency.

C

Lower interest rates.

D

Reduced exchange rate uncertainty.

1.26

Compared to a fixed exchange rate system, an economy will benefit from a flexible exchange rate system because

A

it enables businesses to vary their export prices.

B

the government will not have to deflate the economy when balance of payments deficits occur.

C

it reduces the cost of acquiring foreign exchange.

D

it ensures that businesses never become uncompetitive in international markets.

(Total = 52 marks)

November 2001

7

FECB

SECTION B – 48 MARKS ANSWER THREE QUESTIONS ONLY Question Two The following is based on a journal article. The price of oil has increased dramatically. A barrel sold for $11 in December 1998, but the price in March 2000 reached $29. As a consequence of this price rise, some commentators are worrying that the US economy may be facing an "oil price shock" similar to those in the 1970s and 1980s. Following these earlier shocks, the US economy saw its general price level rise while national output fell – a combination known as "stagflation". Is the US economy facing a similar threat? A closer look at the data suggests not.

Dollars per Barrel

Percentage of GDP

The darker line on the chart shows the price of oil deflated by the consumer price index – the real price of oil. In inflation-adjusted terms, today's oil prices are roughly the same as they were in the second half of the 1980s. Also, the share of oil in GDP has fallen sharply since the 1970s (shown by the lighter line) and so changes in oil prices have less effect on the economy. The decreasing share of oil in the economy reflects both changes in economic structure and increased energy efficiency.

Required: Use both your knowledge of economic theory and the data above to answer the following.

(a) With respect to the price of oil, (i)

explain the meaning of the real price of oil;

(ii)

describe the changes in the real price of oil since 1980.

(2 marks) (2 marks)

(b) Using a simple aggregate demand (AD) and aggregate supply (AS) model, explain (i)

what is meant by the term stagflation;

(ii)

how an oil price shock could cause stagflation.

(2 marks) (4 marks)

(c) Discuss TWO reasons why oil has become less important in the US and developed economies.

(6 marks) (Total = 16 marks) FECB

8

November 2001

Question Three The following is based on a newspaper article. British cod – the staple of fish and chips – is on the verge of becoming an endangered species, according to the Worldwide Fund for Nature (WWF), the conservation group. It stressed that the crisis in the fishing industry was due to poor management and to overfishing. The total weight of cod caught in the North Sea had halved since the 1960s. Similar falls in catches had occurred for other types of fish. The WWF proposes the establishment of fishing-free zones to protect areas where young fish grow and develop. The WWF said that such a strategy would lead to increased fish stocks and a larger fishing catch for fishermen within five years. However, the problem may become less urgent as consumer demand for this type of fish may decline in the long run. Some observers believe that for many consumers fish and chips may be an inferior good and, in any case, faces a growing number of alternatives.

Required: Use both your knowledge of economic theory and the information above to answer the following.

(a) Using a supply and demand diagram, explain: (i)

the impact of falling stocks of fish on the prices and sales of fish;

(ii)

the possible long-term benefits of the WWF conservation plan.

(2 marks) (2 marks) (b) Explain the role of price elasticity of demand and supply in determining the extent to which fish prices would rise as the supply of fish fell.

(6 marks) (c) Discuss THREE possible reasons why the demand for fish may decline over the long run. (6 marks) (Total = 16 marks)

November 2001

9

FECB

Question Four The minimum efficient scale (MES) refers to that level of output for a business at which most economies of scale have been gained and the long-run average cost curve is becoming horizontal. The following data refers to the MES of factories for a variety of industries in the UK and the USA, expressed as a percentage of the domestic market for the product. It also shows how much average costs (AC) would rise if factory size was only one third of the MES. MES as a % of US market

MES as a % of UK market

1∙7

6∙1

Steel

2∙6

15∙4

11∙0

Fibres

0∙2

1∙8

7∙6

14∙1

83∙3

6∙5

Oil refining

1∙9

11∙6

4∙8

Cigarettes

6∙5

30∙3

2∙2

Shoes

0∙2

0∙6

1∙5

Cement

Refrigerators

% increase in AC at 1 3 MES 26∙0

Required: Use both your knowledge of economic theory and the data above to answer the following.

(a) Using the above table: (i)

identify one industry that exhibits strong economies of scale and one industry that shows weak economies of scale, explaining your choice in each case;

(4 marks) (ii) explain why the MES in each industry is at a lower percentage of the US market than of the UK market.

(2 marks) (b) Explain the differences between: (i)

internal and external economies of scale;

(3 marks) (ii) economies arising from the size of the business and economies of scale arising from the size of the factory.

(3 marks) (c) Using examples from the table, discuss how you would expect the number and size of firms in those industries to vary.

(4 marks) (Total = 16 marks)

FECB

10

November 2001

Question Five The following diagram is known as the economic diamond and is used to illustrate how well an economy is performing in terms of the major objectives of economic policy. 0 2

Inflation, %

4 6 8 4

2

0

-2

-4

10

8

6

2

Current account, % of GDP

4

2

0

Unemployment, %

4 6 8

Economic growth, %

10

Required: Use both your knowledge of economic theory and the diagram above to answer the following.

Note: Candidates are not required to draw further diagrams.

(a) Explain how the economic diamond for a country would change if it improved its overall economic performance.

(2 marks) (b) Describe how, other things being equal, a rise in the rate of economic growth would affect the other three indicators of economic performance shown in the diamond.

(6 marks) (c) State TWO reasons why a reduction in inflation is normally regarded as economically beneficial.

(4 marks) (d) Explain how a typical business organisation would be affected if the government were to adopt a deflationary monetary policy.

(4 marks) (Total = 16 marks)

November 2001

11

FECB

Question Six The following table shows some of the economic characteristics of a group of countries. The data shows total population, gross national product (GNP) and imports and exports. This data shows that the trade ratio (the ratio of exports or imports to GNP) varies considerably. Population (million) 249

GNP ($ billion) 5,200

Imports ($ billion) 493

Exports ($ billion) 364

62

941

270

341

123

2,843

210

274

UK

57

839

198

152

Netherlands

15

223

104

108

1,111

422

58

52

USA Germany Japan

China Singapore Brazil

3

29

50

45

144

338

20

34

Required: Use both your knowledge of economic theory and the data above to answer the following.

(a) Explain what is meant by the term the trade ratio and identify the FOUR countries which have the lowest trade ratios.

(4 marks) (b) (i)

Using examples from the table, explain ONE reason why some countries have low trade ratios.

(2 marks) (ii)

Explain how government policy might lead to a country having a low trade ratio.

(2 marks) (c) Discuss TWO ways in which the business sector of a country may suffer as a result of the imposition of tariffs on imports by the government of that country.

(8 marks) (Total = 16 marks)

End of paper

FECB

12

November 2001