Eco - Nov 2003

Examination Question and Answer Book Write your full examination number, your contact ID and your name on a double-sided card, which must be attached to this booklet here.

Foundation Level

Economics for Business

3a

FECB 17 November 2003 Monday morning

INSTRUCTIONS TO CANDIDATES Read this page before you look at the questions THIS QUESTION PAPER BOOKLET IS ALSO YOUR ANSWER BOOKLET. Sufficient space has been provided for you to write your answers, and also for workings where questions require them. For section B questions, you must write your answers in the shaded space provided. Please note that you will NOT receive marks for your notes or workings. Do NOT remove any sheets from this booklet: cross through neatly any work that is not to be marked. Avoid the use of correction fluid. You are allowed two hours to answer this question paper. All questions are compulsory. Answer the ONE question in section A (this has 26 sub-questions and is on pages 2 – 9). Answer the THREE questions in section B (these are on pages 10 – 16). You are advised to spend 10 minutes reading through the paper before starting to answer the questions. You should spend no more than 55 minutes on answering the ONE question in section A, which has 26 sub-questions. You should spend no more than 55 minutes on answering the THREE questions in section B. Hand this entire booklet to the invigilators at the end of the examination. You are NOT permitted to leave the examination hall with this booklet. Do NOT write your name or your contact ID anywhere on this booklet. TURN OVER

For office use only Marks awarded (First marker) for each question Marks awarded (Second marker) for each question © The Chartered Institute of Management Accountants 2003

Total

One

Two

Three

Four

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.

REQUIRED: Place a circle "O" around the letter A, B, C or D that gives the correct answer to each sub-question. If you wish to change your mind about an answer, block out your first answer completely and then circle another letter. You will NOT receive marks if more than one letter is circled. Please note that you will NOT receive marks for any notes or workings to these sub-questions.

Question One 1.1

The cost of one product, measured in terms of what must be given up to produce it, is called the

A

real cost.

B

opportunity cost.

C

total cost.

D

potential cost.

1.2

Which ONE of the following would be most likely to raise economic welfare in a country in the long run?

A

An increase in the country’s trade surplus.

B

An expansion of the country’s social welfare provision.

C

A rise in the rate of growth of labour productivity in the country.

D

An equal reduction in taxation and public spending.

Total

For office use only

1.1

1.2

Marks awarded (First marker) for each sub-question Marks awarded (Second marker) for each sub-question FECB

2

November 2003

1.3

All of the following would lead to an inward shift (to the left) in a country’s production possibility frontier (curve) EXCEPT ONE. Which ONE is the EXCEPTION?

A

A rise in unemployment.

B

A decrease in the size of the labour force.

C

A reduction in the level of business investment.

D

A slower rate of technological progress.

1.4

Which ONE of the following is a supply side policy designed to promote long-term economic growth?

A

Regional aid to reduce structural unemployment.

B

Increasing the rate of growth of the money supply.

C

Tax incentives for business investment.

D

Raising aggregate demand to encourage firms to expand their supply of goods and services.

1.5

Conventional measures of national income fail to give an accurate indication of sustainable economic welfare because they

A

do not allow for inflation.

B

do not allow for improvements in the quality of goods and services.

C

do not allow for increases in productivity.

D

do not exclude defensive expenditure to offset environmental damage.

1.6

Which ONE of the following would be the outcome of a market economy operating with a high degree of competition?

A

The interaction of demand and supply would ensure that resources are equally distributed.

B

Companies would produce only those goods that are desirable for society since only such goods can be sold at a profit.

C

Large differences in incomes would be avoided.

D

Producers would respond to changes in demand and consumers would respond to changes in supply.

TURN OVER Total

For office use only

1.3

1.4

1.5

1.6

Marks awarded (First marker) for each sub-question Marks awarded (Second marker) for each sub-question November 2003

3

FECB

1.7

If the demand for a good has a price elasticity of demand of –2 then

A

a fall in price will lead to a fall in demand.

B

a rise in price will lead to a larger than proportionate fall in sales volume.

C

the good must have no effective substitutes.

D

a fall in price will lead to a fall in total revenue from sales.

1.8

What will be the effect of a rise in the price of cars on the demand curve for petrol?

There will be A

a leftward shift in the demand curve for petrol.

B

a movement down along the demand curve for petrol.

C

a rightward shift in the demand curve for petrol.

D

a movement upward along the demand curve for petrol.

1.9

If the imposition of a congestion charge on the use of cars in cities does not significantly reduce the use of cars for travelling to and from work (commuting), this must be because

A

there are no substitutes for cars.

B

the demand for commuting by car is price inelastic.

C

the supply of alternative means of transport is price elastic.

D

what matters is the marginal cost of driving and this will not be affected.

1.10 Which ONE of the following, in a competitive labour market, would explain differences in wages between occupations in the long run? A

There is geographical immobility of labour.

B

In the long run, everyone has to accept the wage levels determined by the market.

C

The skill and knowledge content of some occupations acts as a barrier to entry.

D

In some occupations, wages may rise above the equilibrium level.

Total

For office use only

1.7

1.8

1.9

1.10

Marks awarded (First marker) for each sub-question Marks awarded (Second marker) for each sub-question FECB

4

November 2003

1.11 Which ONE of the following statements about prices is true? A

An increase in demand will lead to higher prices only if supply is price inelastic.

B

A shortage of goods can occur if prices are above the equilibrium level.

C

The imposition of a minimum price for a good will always lead to a surplus of output over demand.

D

If prices are flexible, there can be no market surpluses or shortages in the long run.

1.12 Oligopolistic competition is often characterised by the avoidance of price competition. Which ONE of the following is the best explanation for this? A

Profit margins are too small to allow price cuts.

B

Most oligopolies are cartels that fix prices.

C

The expectation that rival companies will always reduce prices in response to a price cut.

D

Price reductions would encourage the entry of new competitors into the industry.

1.13 Assuming that pollution reduces economic welfare, which ONE of the following would be most likely to raise long-term economic welfare? A

A total ban on all polluting activities.

B

A tax on all products whose production involves pollution.

C

A tax on the emission of pollutants.

D

Allowing the free market to find the optimal level of pollution.

1.14 Railway companies offering off-peak services at reduced prices must ensure that, in the short run, these reduced prices cover at least A

the variable cost of providing the service.

B

the fixed costs of production.

C

overhead costs.

D

the average cost of providing the service.

TURN OVER Total

For office use only

1.11

1.12

1.13

1.14

Marks awarded (First marker) for each sub-question Marks awarded (Second marker) for each sub-question November 2003

5

FECB

1.15 Goods whose production involves net social costs greater than private costs are normally A

under-produced by the private sector relative to the optimal level of output.

B

over-produced by the private sector relative to the optimal level of output.

C

not produced in the private sector because it would be unprofitable to do so.

D

produced at the optimal level by the private sector.

1.16 Normal profit is the A

average level of profit earned in an industry.

B

level of profit earned by firms in the long run.

C

level of profit required to keep the business operating in an industry.

D

reward to capital as a factor of production.

1.17 In comparing perfect competition with monopoly, which ONE of the following statements is true? A

Monopolies always earn profits; perfectly competitive firms rarely do.

B

In the short run, firms in both monopoly and perfect competition attempt to minimise average fixed costs.

C

In the long run, firms in both monopoly and perfect competition produce where average costs are lowest.

D

Profits in perfect competition will be reduced in the long run by the entry of new firms, but long-run monopoly profits are protected by entry barriers.

1.18 A country’s gross national product (GNP) will be greater than its gross domestic product (GDP) when A

there is a net inflow of factor incomes.

B

exports of goods exceed imports of goods.

C

there is a surplus on the balance of payments current account.

D

the government is running a budget surplus.

Total

For office use only

1.15

1.16

1.17

1.18

Marks awarded (First marker) for each sub-question Marks awarded (Second marker) for each sub-question FECB

6

November 2003

1.19 Each of the following is a source of funds for capital investment for business enterprises EXCEPT ONE. Which ONE is the EXCEPTION? A

The central bank.

B

The stock market.

C

Internally-generated funds.

D

Commercial banks.

1.20 All of the following are effects on a business of a reduction in interest rates EXCEPT ONE. Which ONE is the EXCEPTION? A

Increased credit-based sales.

B

A lower net present value of investment projects.

C

A fall in the cost of servicing bank debts.

D

An increased incentive to undertake investments.

1.21 Other things being equal, which ONE of the following is a typical feature of the recovery phase of the trade cycle? A

A slow down in employment growth.

B

An improvement in the trade balance.

C

A stable rate of growth of GDP.

D

Increased inflationary pressures.

1.22 A significant fall in stock market values in a country will be likely to contribute to a contraction of the circular flow of income because A

the circular flow is one of individual wealth of which shares are a part.

B

reductions in consumer wealth will encourage lower consumption and higher saving.

C

the buying of shares is an injection into the circular flow, and falling share prices will discourage the buying of shares.

D

outflows from the economy increase as investors switch savings to overseas stock markets.

TURN OVER Total

For office use only

1.19

1.20

1.21

1.22

Marks awarded (First marker) for each sub-question Marks awarded (Second marker) for each sub-question November 2003

7

FECB

1.23 All of the following would occur in an economy which experienced a fall in the general level of prices EXCEPT ONE. Which ONE is the EXCEPTION? A

Some consumer expenditure would be postponed.

B

The international competitiveness of the business sector would tend to increase.

C

The real burden of business debts would fall.

D

Government indirect tax revenues would tend to decline.

1.24 The comparative advantage theory of international trade shows that countries can benefit from trade because A

countries can export their surplus output.

B

all countries have an absolute advantage in the production of some goods and services.

C

they can profit by running a trade surplus with the rest of the world.

D

countries can acquire imported goods at a lower opportunity cost than from domestic production.

1.25 A multinational company may wish to locate production in a number of countries for all of the following reasons EXCEPT ONE. Which ONE is the EXCEPTION? A

To secure economies of scale in production.

B

To avoid transport costs.

C

To avoid tariff barriers in overseas markets.

D

To secure a variety of sources of supply of components.

Total

For office use only

1.23

1.24

1.25

Marks awarded (First marker) for each sub-question Marks awarded (Second marker) for each sub-question

FECB

8

November 2003

1.26 If a group of countries forms a regional trading bloc, the long-run economic welfare benefits gained will be smaller if the bloc A

allows the free movement of labour within the bloc.

B

encourages companies to change their location within the bloc.

C

abolishes all internal barriers to trade in goods and services.

D

maintains a high external tariff.

(Total = 52 Marks)

End of section A

Section B starts on the next page

TURN OVER Total

For office use only

1.26

Marks awarded (First marker) for each sub-question Marks awarded (Second marker) for each sub-question November 2003

9

FECB

SECTION B – 48 MARKS ANSWER ALL THREE QUESTIONS IMPORTANT MARKS ARE AWARDED FOR COMPLETING THE SHADED BOXES WITH THE CORRECT ANSWER WHERE A MARK IS INDICATED IN THE RIGHT-HAND COLUMN. DO NOT WRITE IN THE MARGINS NOR IN THE COLUMNS FOR USE BY MARKERS.

Question Two The following diagram shows the long-run average total cost curve (LRAC) for a business. Average total costs LRAC

A

B

C

Output Using your knowledge of economics and the diagram, answer the following:

Required:

Do not write in these columns below

(a) Marks available

For use by the first marker

For use by the second marker

(i) Define, in the shaded area below, the term "economies of scale"

(ii)

Maximum 25 words With reference to the diagram, state, in the shaded boxed below, which part of the long-run average cost curve (A, B or C) refers to each of the following: Description

2

Section of the long-run average cost curve (A, B or C)

Decreasing returns to scale

1

Increasing returns to scale

1 sub-total:

4

Question Two continues on page 11 FECB

10

November 2003

Question Two continued

Required:

Do not write in these columns below

(b) In the shaded boxes below, give an example of each one of the scale effects that a business might experience.

(Maximum 15 words each)

Marks available

For use by the first marker

For use by the second marker

A technical economy of scale

1 A commercial economy of scale

1 A managerial economy of scale

1 A diseconomy of scale

(c)

sub-total: Indicate with a cross (X) in the appropriate box whether each of the following is TRUE or FALSE? TRUE FALSE Statement Economies of scale limit the number of firms in an industry by acting as a barrier to entry.

1 4

1

Even if a firm experiences economies of scale in the long run, its short-run average cost curve will always be U-shaped because of diminishing marginal returns.

1

If a business’s long-run cost curve is falling, it can always increase total profits by raising output.

1

The main source of economies of scale is technological change because this reduces costs over the long run.

1 sub-total:

4

(d) Fill in the gaps in the following statements (Maximum 3 words per gap) (i) Economies of scale tend to lead to industries; here there are a few large firms and competition is often by methods.

2

(ii) For a business, the

is the level of output where almost all economies of scale have been secured. If this is large relative to the total market, a is likely to emerge. sub-total:

2 4

(Total for Question Two = 16 Marks) TURN OVER November 2003

11

FECB

Question Three The following is a list of types of unemployment: •

Structural unemployment;

•

Cyclical unemployment;

•

Real wage (classical) unemployment;

•

Frictional unemployment;

•

Seasonal unemployment.

Using your knowledge of economics and the list given above, answer the following. Do not write in these columns below

Required: (a) Match ONE of the above types of unemployment to each of the following definitions.

Marks available

Definition of unemployment

For use by the first marker

For use by the second marker

Type of unemployment 1

Unemployment associated with industries or regions where the demand for labour and wage rates regularly rise and fall over the year. Unemployment that occurs in particular industries and arises from long-term changes in the pattern of demand or supply. Unemployment that occurs as a result of imperfect information in the labour market resulting in time spent unemployed between jobs Unemployment caused by a general fall in aggregate demand in the economy.

1

1

1 sub-total:

4

(b) Indicate with a cross (X) in the appropriate box whether each of the following is TRUE or FALSE. Statement Unemployment and inflation tend to rise and fall together over the trade cycle.

TRUE

FALSE 1

In a recession, most businesses face falling sales, but this is especially true for those whose products have a high income elasticity of demand.

1

Rising real wages will cause most unemployment when the demand for the product of the business is highly price inelastic.

1

Changes in real wage costs have least effect on employment in those industries that are relatively capital intensive.

1 sub-total:

4

Question Three continues on page 13 FECB

12

November 2003

Required: Do not write in these columns below

(c) For each of the following events, indicate with a cross (X) in the

appropriate box below whether the direct effect for the economy as a whole would be raise the level of unemployment, lower the level of unemployment or to leave the level of unemployment unchanged. Event

Raise unemployment

Lower employment

Marks available

For use by the first marker

For use by the second marker

Leave unemployment unchanged

The imposition of a legal national minimum wage below the equilibrium wage rate.

1

Monetary policies leading to a rise in the real exchange rate for the country’s currency.

1

A reduction in the level of real interest rates.

1

A downturn in economic activity in the country’s trading partner countries.

1 Sub-total:

4

(d) Fill in the gaps in the following (maximum of 3 words per gap). A Keynesian approach to unemployment would emphasise the need to raise

1

by increasing public

expenditure or reducing the level of taxation. Subsequent budget deficits would be financed by

.

In contrast, the

approach

1 1

would focus on reducing both direct taxes and unemployment benefits to make employment more attractive, and on the removal of imperfections in the

market

1

arising from regulations and from the activity of trade unions. Sub-total:

4

(Total for Question Three = 16 Marks)

Section B continues on page 14 TURN OVER November 2003

13

FECB

Question Four The following diagram shows the demand and supply for US dollars on the foreign exchange market and the exchange rate with the Euro. D1

D2

S1

Exchange rate Euros per $

Demand for and supply of dollars

Required: Using the diagram above and your knowledge of economic theory, answer the answer the following:

Do not write in these columns below

(a) Marks available

For use by the first marker

For use by the second marker

(i) State whether the shift in demand curve for dollars from D2 to D1 will

cause the dollar exchange rate to appreciate or depreciate relative to the Euro. 1

(ii) Indicate with a cross (X) in the appropriate box what the effect on the dollar exchange rate will be an increase in imports from Europe into the USA: The demand curve for dollars will

shift to the left. be unchanged. 1

shift to the right. The supply curve for dollars will

shift to the left. be unchanged. 1

shift to the right. The exchange rate for dollars will

rise. be unchanged. 1

fall. sub-total:

4

Question Four continues on page 15 FECB

14

November 2003

Question Four continued:

Required: Do not write in these columns below

(b) Indicate with a cross (X) in the appropriate box whether each of the following processes would lead to a shift in the demand curve for dollars from D1 to D2 Process An increase in the level of capital inflows into the USA.

YES

Marks available

For use by the first marker

For use by the second marker

NO 1

A rise in exports of US services to eurozone countries.

1

A higher level of exports of capital from the USA

1

A reduction in demand in the USA for overseas holidays.

1 sub-total:

4

(c) There is a variety of exchange rate systems. These include Dirty floating Free floating Adjustable peg Fixed Managed floating Exchange rate band Joint float Match each of the following to ONE of the above types. Description

Name of exchange rate system

The government has no exchange rate target, but intervenes in the foreign exchange market to prevent excessively large changes in the exchange rate.

1

The government allows the currency to float, but intervenes to achieve an exchange rate target.

1

The government pegs the exchange rate permanently to another currency and intervenes in the foreign exchange market to maintain that rate of exchange.

1

The government allows the currency to float between an upper and lower exchange rate, but intervenes to prevent the currency moving outside of these limits.

1 sub-total:

4

Question Four continues on page 16 TURN OVER November 2003

15

FECB

Question Four continued: Do not write in these columns below

Required: (d) Assume that the US economy recovers strongly from the recent

recession and inflationary pressures begin to emerge. As a result, the US monetary authorities raise US interest rates. For each of the following statements, indicate with a cross (X) in the appropriate box, whether they would result from the action of the US monetary authorities in raising interest rates. TRUE FALSE Statement There would be increased outflows of capital from the USA to other countries. European businesses would experience increased competition from US businesses because the dollar would tend to depreciate relative to the Euro. Interest rates would tend to rise in other countries. US national income would be lower than otherwise thus reducing the potential market for European exporters.

Marks available

For use by the first marker

For use by the second marker

1

1 1

1 sub-total:

4

Total for Question Four = 16 Marks

End of Question Paper

FECB

16

November 2003

November 2003

17

FECB

FECB

18

November 2003

DO NOT WRITE ON THIS SHEET

November 2003

19

FECB

3a

FECB

Economics for Business

Monday morning

FECB

20

November 2003