Economics Exam Questions And Answers 2018

Economics is a subject that deals with the production, distribution, and consumption of goods and services. In 2018, as in any other year, economics exams tested students' understanding of various economic principles and their application to real-world scenarios. This article provides a comprehensive overview of potential economics exam questions from 2018, along with detailed answers, covering microeconomics, macroeconomics, and international economics.

Microeconomics Questions and Answers

Microeconomics focuses on the behavior of individual agents, such as households and firms, and their interactions in specific markets.

Question 1: Elasticity of Demand

Question: Explain the concept of price elasticity of demand. How is it calculated, and what factors influence it? Provide examples to illustrate different types of elasticity.

Answer:

Price elasticity of demand (PED) measures the responsiveness of the quantity demanded of a good or service to a change in its price. It is a crucial concept for businesses and policymakers alike, helping them understand how changes in price will affect revenue and consumer behavior.

Calculation:

PED is calculated using the following formula:

PED = (% Change in Quantity Demanded) / (% Change in Price)

Factors Influencing Price Elasticity of Demand:

1. Availability of Substitutes: Goods with close substitutes tend to have higher price elasticity because consumers can easily switch to an alternative if the price increases.
2. Necessity vs. Luxury: Necessities, such as food and medicine, tend to have inelastic demand because people need them regardless of price changes. Luxuries, on the other hand, have elastic demand.
3. Proportion of Income: Goods that represent a significant portion of a consumer's income tend to have higher elasticity.
4. Time Horizon: Demand tends to be more elastic over a longer time horizon because consumers have more time to adjust their consumption habits.
5. Brand Loyalty: Strong brand loyalty can reduce price elasticity as consumers are less likely to switch brands even if the price increases.

Examples of Different Types of Elasticity:

• Elastic Demand (PED > 1): A 1% increase in price leads to a more than 1% decrease in quantity demanded. Example: Luxury cars.
• Inelastic Demand (PED < 1): A 1% increase in price leads to a less than 1% decrease in quantity demanded. Example: Gasoline.
• Unit Elastic Demand (PED = 1): A 1% increase in price leads to a 1% decrease in quantity demanded.
• Perfectly Elastic Demand (PED = Infinity): Any increase in price leads to zero demand. Example: Identical products in a perfectly competitive market.
• Perfectly Inelastic Demand (PED = 0): Demand remains constant regardless of price changes. Example: Life-saving medication.

Question 2: Market Structures

Question: Compare and contrast the characteristics of perfect competition, monopolistic competition, oligopoly, and monopoly. Provide real-world examples for each market structure.

Answer:

Understanding market structures is essential for analyzing how firms behave and how prices and output are determined in different industries. Each market structure has unique characteristics that affect competition, efficiency, and consumer welfare.

1. Perfect Competition:

   • Characteristics:
     • Large number of buyers and sellers.
     • Homogeneous products.
     • Free entry and exit.
     • Perfect information.
     • Price takers.
   • Example: Agricultural markets (e.g., wheat, corn).

2. Monopolistic Competition:

   • Characteristics:
     • Large number of buyers and sellers.
     • Differentiated products.
     • Free entry and exit.
     • Imperfect information.
     • Some control over price.
   • Example: Restaurants, clothing stores.

3. Oligopoly:

   • Characteristics:
     • Small number of large firms.
     • Homogeneous or differentiated products.
     • Barriers to entry.
     • Interdependence among firms.
     • Potential for collusion.
   • Example: Automobile industry, telecommunications.

4. Monopoly:

   • Characteristics:
     • Single seller.
     • Unique product with no close substitutes.
     • Significant barriers to entry.
     • Price maker.
   • Example: Local utility companies (e.g., water, electricity).

Comparison Table:

Feature	Perfect Competition	Monopolistic Competition	Oligopoly	Monopoly
Number of Firms	Many	Many	Few	One
Product	Homogeneous	Differentiated	Homogeneous/Diff	Unique
Barriers to Entry	None	Low	High	Very High
Price Control	None	Some	Considerable	Significant
Examples	Agriculture	Restaurants	Auto Industry	Utility Company

Question 3: Production Costs

Question: Explain the different types of costs incurred by a firm in the short run and the long run. How do these costs affect the firm's production decisions?

Answer:

Understanding the different types of costs is critical for firms to make informed production decisions. Costs can be categorized based on their behavior and the time frame in which they are incurred.

Short-Run Costs:

In the short run, at least one factor of production is fixed. Short-run costs include:

• Fixed Costs (FC): Costs that do not vary with the level of output. Examples include rent, insurance, and salaries of permanent staff.
• Variable Costs (VC): Costs that vary directly with the level of output. Examples include raw materials, direct labor, and utilities.
• Total Cost (TC): The sum of fixed costs and variable costs (TC = FC + VC).
• Average Fixed Cost (AFC): Fixed cost per unit of output (AFC = FC / Q).
• Average Variable Cost (AVC): Variable cost per unit of output (AVC = VC / Q).
• Average Total Cost (ATC): Total cost per unit of output (ATC = TC / Q).
• Marginal Cost (MC): The additional cost of producing one more unit of output (MC = ΔTC / ΔQ).

Long-Run Costs:

In the long run, all factors of production are variable. Long-run costs include:

• Long-Run Average Cost (LRAC): The average cost of producing each level of output when all factors are variable. The LRAC curve is often U-shaped, reflecting economies and diseconomies of scale.

Economies of Scale:

Economies of scale occur when the LRAC decreases as output increases. This can be due to factors such as:

• Specialization of Labor: Increased efficiency as workers become more specialized.
• Technological Efficiencies: Use of advanced technology to increase output.
• Bulk Purchasing: Lower input costs due to buying in large quantities.

Diseconomies of Scale:

Diseconomies of scale occur when the LRAC increases as output increases. This can be due to factors such as:

• Management Difficulties: Coordination and communication problems in large organizations.
• Worker Alienation: Reduced motivation and productivity due to lack of personal connection.

Impact on Production Decisions:

• Firms use cost information to determine the optimal level of output. In the short run, firms will produce where marginal cost equals marginal revenue (MC = MR).
• In the long run, firms will adjust their scale of operations to minimize LRAC and maximize profits.
• The shape of the cost curves influences the firm's supply curve.

Macroeconomics Questions and Answers

Macroeconomics deals with the performance, structure, and behavior of the entire economy, including topics such as inflation, unemployment, and economic growth.

Question 1: Aggregate Demand and Supply

Question: Explain the concepts of aggregate demand (AD) and aggregate supply (AS). What factors can shift the AD and AS curves, and how do these shifts affect the equilibrium level of output and prices?

Answer:

Aggregate Demand (AD) represents the total demand for goods and services in an economy at different price levels. Aggregate Supply (AS) represents the total quantity of goods and services that firms are willing to supply at different price levels. The interaction of AD and AS determines the equilibrium level of output and prices in the economy.

Aggregate Demand (AD):

AD is the sum of all planned expenditures in the economy:

AD = C + I + G + (X - M)

Where:

• C = Consumption
• I = Investment
• G = Government Spending
• X = Exports
• M = Imports

Factors That Shift the AD Curve:

1. Changes in Consumer Spending (C):

   • Increased Consumer Confidence: Shifts AD to the right.
   • Tax Cuts: Shifts AD to the right.
   • Increased Wealth: Shifts AD to the right.

2. Changes in Investment Spending (I):

   • Lower Interest Rates: Shifts AD to the right.
   • Increased Business Confidence: Shifts AD to the right.
   • Technological Advancements: Shifts AD to the right.

3. Changes in Government Spending (G):

   • Increased Government Spending: Shifts AD to the right.
   • Decreased Government Spending: Shifts AD to the left.

4. Changes in Net Exports (X - M):

   • Increased Exports: Shifts AD to the right.
   • Decreased Imports: Shifts AD to the right.
   • Currency Depreciation: Shifts AD to the right.

Aggregate Supply (AS):

AS can be divided into short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS).

• Short-Run Aggregate Supply (SRAS): The SRAS curve is upward sloping because some input costs are fixed in the short run.
• Long-Run Aggregate Supply (LRAS): The LRAS curve is vertical at the potential output level, indicating that output is determined by the economy's resources and technology, not the price level.

Factors That Shift the AS Curve:

1. Changes in Input Costs:

   • Increased Wages: Shifts SRAS to the left.
   • Increased Raw Material Prices: Shifts SRAS to the left.
   • Increased Energy Costs: Shifts SRAS to the left.

2. Changes in Productivity:

   • Technological Advancements: Shifts both SRAS and LRAS to the right.
   • Increased Education and Training: Shifts both SRAS and LRAS to the right.

3. Changes in Government Regulations:

   • Increased Regulations: Shifts SRAS to the left.
   • Decreased Regulations: Shifts SRAS to the right.

Effects of Shifts in AD and AS:

• Increase in AD: Leads to higher output and higher prices (inflation).
• Decrease in AD: Leads to lower output and lower prices (deflation).
• Increase in SRAS: Leads to higher output and lower prices.
• Decrease in SRAS: Leads to lower output and higher prices (stagflation).
• Increase in LRAS: Leads to higher potential output and lower prices in the long run.

Question 2: Fiscal and Monetary Policy

Question: Compare and contrast fiscal policy and monetary policy. How are these policies used to stabilize the economy, and what are their limitations?

Answer:

Fiscal policy and monetary policy are the two main tools governments use to influence macroeconomic conditions. Fiscal policy involves changes in government spending and taxation, while monetary policy involves managing the money supply and interest rates.

Fiscal Policy:

Fiscal policy is implemented by the government and involves changes in:

• Government Spending (G): Direct purchases of goods and services by the government.
• Taxation (T): Levying taxes on individuals and businesses.

Types of Fiscal Policy:

• Expansionary Fiscal Policy: Used to stimulate economic growth during a recession. It involves increasing government spending and/or decreasing taxes.
• Contractionary Fiscal Policy: Used to reduce inflation during an economic boom. It involves decreasing government spending and/or increasing taxes.

Limitations of Fiscal Policy:

• Time Lags: Implementation can be slow due to legislative processes.
• Crowding Out: Increased government borrowing can lead to higher interest rates, reducing private investment.
• Political Constraints: Policy decisions can be influenced by political considerations rather than economic needs.

Monetary Policy:

Monetary policy is implemented by the central bank and involves managing:

• Interest Rates: The cost of borrowing money.
• Money Supply: The amount of money in circulation.

Tools of Monetary Policy:

• Open Market Operations: Buying or selling government bonds to increase or decrease the money supply.
• Reserve Requirements: The fraction of deposits that banks are required to hold in reserve.
• Discount Rate: The interest rate at which commercial banks can borrow money directly from the central bank.
• Quantitative Easing (QE): A special tool used during financial crises to inject liquidity into the market by purchasing assets.

Types of Monetary Policy:

• Expansionary Monetary Policy: Used to stimulate economic growth during a recession. It involves lowering interest rates and/or increasing the money supply.
• Contractionary Monetary Policy: Used to reduce inflation during an economic boom. It involves raising interest rates and/or decreasing the money supply.

Limitations of Monetary Policy:

• Time Lags: The effects of monetary policy can take time to materialize.
• Liquidity Trap: Lowering interest rates may not stimulate investment if businesses and consumers are pessimistic.
• Global Factors: The effectiveness of monetary policy can be affected by global economic conditions.

Comparison Table:

Feature	Fiscal Policy	Monetary Policy
Implementer	Government	Central Bank
Tools	Government Spending, Taxes	Interest Rates, Money Supply
Goal	Economic Stabilization	Economic Stabilization
Advantages	Direct Impact	Quick Implementation
Limitations	Time Lags, Crowding Out	Time Lags, Liquidity Trap

Question 3: Unemployment and Inflation

Question: Explain the different types of unemployment and the causes of inflation. How are these macroeconomic problems measured, and what are their consequences for the economy?

Answer:

Unemployment and inflation are two of the most closely watched macroeconomic indicators. High unemployment can lead to social unrest and economic hardship, while high inflation can erode purchasing power and create economic instability.

Types of Unemployment:

1. Frictional Unemployment:

   • Definition: Unemployment that arises from the process of matching workers with jobs.
   • Cause: Workers are temporarily between jobs, searching for better opportunities, or new entrants to the labor force.
   • Example: Recent college graduates looking for their first job.

2. Structural Unemployment:

   • Definition: Unemployment that arises from a mismatch between the skills of workers and the requirements of jobs.
   • Cause: Changes in technology, industry structure, or consumer preferences.
   • Example: Workers who lose their jobs due to automation.

3. Cyclical Unemployment:

   • Definition: Unemployment that arises from fluctuations in the business cycle.
   • Cause: Economic downturns (recessions) leading to decreased demand for goods and services.
   • Example: Workers laid off during a recession.

4. Seasonal Unemployment:

   • Definition: Unemployment that arises from seasonal variations in employment.
   • Cause: Some industries, such as tourism and agriculture, have peak seasons followed by periods of reduced activity.
   • Example: Ski resort employees during the summer months.

Measurement of Unemployment:

• Unemployment Rate: The percentage of the labor force that is unemployed.

  Unemployment Rate = (Number of Unemployed / Labor Force) * 100
  

  • Labor Force: The sum of employed and unemployed individuals who are actively seeking work.

Causes of Inflation:

1. Demand-Pull Inflation:

   • Cause: Occurs when there is too much money chasing too few goods, leading to an increase in the general price level.
   • Factors: Increased government spending, tax cuts, increased consumer confidence, and expansionary monetary policy.

2. Cost-Push Inflation:

   • Cause: Occurs when the cost of production increases, leading to firms raising prices to maintain profit margins.
   • Factors: Increased wages, increased raw material prices, and increased energy costs.

3. Built-In Inflation:

   • Cause: Occurs when workers demand higher wages to maintain their real income in anticipation of future inflation, leading to a wage-price spiral.
   • Factors: Expectations of future inflation.

Measurement of Inflation:

• Consumer Price Index (CPI): Measures the average change over time in the prices paid by urban consumers for a basket of consumer goods and services.
• GDP Deflator: Measures the average price level of all goods and services produced in an economy.

Consequences of Unemployment and Inflation:

• Consequences of Unemployment:
  • Loss of Income: Reduced purchasing power and lower living standards.
  • Social Problems: Increased crime rates, mental health issues, and social unrest.
  • Reduced Economic Growth: Underutilization of resources and decreased productivity.
• Consequences of Inflation:
  • Erosion of Purchasing Power: Decreased real income and reduced living standards.
  • Uncertainty: Difficult for businesses to plan and invest.
  • Redistribution of Wealth: Favors borrowers over lenders.
  • Menu Costs: Costs associated with changing prices.
  • Shoe Leather Costs: Costs associated with frequent trips to the bank to withdraw cash.

International Economics Questions and Answers

International economics deals with the economic interactions between countries, including trade, finance, and investment.

Question 1: Comparative Advantage

Question: Explain the principle of comparative advantage and how it forms the basis for international trade. Provide an example to illustrate the benefits of trade based on comparative advantage.

Answer:

The principle of comparative advantage is a fundamental concept in international economics that explains why countries engage in trade. It states that a country should specialize in producing and exporting goods and services that it can produce at a lower opportunity cost than other countries.

Opportunity Cost:

The opportunity cost of producing a good is the amount of another good that must be sacrificed.

Example:

Consider two countries, A and B, producing wheat and cloth. The following table shows the amount of labor required to produce one unit of each good in each country:

Good	Country A	Country B
Wheat	10 hours	20 hours
Cloth	20 hours	30 hours

Analysis:

1. Opportunity Cost of Wheat:
   • In Country A, producing one unit of wheat requires 10 hours of labor, which could otherwise be used to produce 0.5 units of cloth (10/20).
   • In Country B, producing one unit of wheat requires 20 hours of labor, which could otherwise be used to produce 0.67 units of cloth (20/30).
2. Opportunity Cost of Cloth:
   • In Country A, producing one unit of cloth requires 20 hours of labor, which could otherwise be used to produce 2 units of wheat (20/10).
   • In Country B, producing one unit of cloth requires 30 hours of labor, which could otherwise be used to produce 1.5 units of wheat (30/20).

Comparative Advantage:

• Country A has a comparative advantage in producing wheat because its opportunity cost of producing wheat (0.5 units of cloth) is lower than Country B's (0.67 units of cloth).
• Country B has a comparative advantage in producing cloth because its opportunity cost of producing cloth (1.5 units of wheat) is lower than Country A's (2 units of wheat).

Benefits of Trade:

If Country A specializes in wheat production and Country B specializes in cloth production, both countries can benefit from trade. For example:

• Without trade, Country A might produce 5 units of wheat and 2.5 units of cloth using 100 labor hours.
• Without trade, Country B might produce 3.33 units of wheat and 1.11 units of cloth using 100 labor hours.

With specialization and trade:

• Country A can produce 10 units of wheat using 100 labor hours and export some of it to Country B in exchange for cloth.
• Country B can produce 3.33 units of cloth using 100 labor hours and export some of it to Country A in exchange for wheat.

This allows both countries to consume beyond their production possibilities frontier, leading to higher overall welfare.

Question 2: Exchange Rates

Question: Explain the concept of exchange rates and the factors that determine their value. How do exchange rate fluctuations affect a country's trade balance and economic performance?

Answer:

An exchange rate is the price of one currency in terms of another. It is a crucial determinant of a country's international competitiveness and trade flows.

Types of Exchange Rates:

1. Fixed Exchange Rate:

   • The value of a currency is pegged to another currency or a basket of currencies.
   • Maintained by central bank intervention in the foreign exchange market.
   • Examples: Some countries peg their currency to the US dollar or the euro.

2. Floating Exchange Rate:

   • The value of a currency is determined by market forces of supply and demand.
   • Central banks may intervene to smooth out volatility but do not maintain a fixed value.
   • Examples: US dollar, euro, Japanese yen.

3. Managed Float:

   • A hybrid system in which the central bank intervenes to influence the exchange rate but does not maintain a fixed value.
   • Examples: Many emerging market economies.

Factors That Determine Exchange Rates:

1. Relative Inflation Rates:

   • Higher inflation in one country leads to depreciation of its currency.
   • Purchasing Power Parity (PPP) theory suggests that exchange rates adjust to equalize the purchasing power of currencies.

2. Relative Interest Rates:

   • Higher interest rates in one country attract capital inflows, leading to appreciation of its currency.

3. Economic Growth:

   • Stronger economic growth in one country can lead to increased demand for its currency, causing it to appreciate.

4. Current Account Balance:

   • A current account surplus (exports > imports) leads to increased demand for a country's currency, causing it to appreciate.
   • A current account deficit (imports > exports) leads to decreased demand for a country's currency, causing it to depreciate.

5. Government Policies:

   • Central bank intervention, fiscal policies, and trade policies can influence exchange rates.

6. Market Sentiment:

   • Speculative trading and investor expectations can cause short-term fluctuations in exchange rates.

Effects of Exchange Rate Fluctuations:

1. Impact on Trade Balance:

   • Depreciation: Makes a country's exports cheaper and imports more expensive, leading to an improvement in the trade balance (exports increase, imports decrease).
   • Appreciation: Makes a country's exports more expensive and imports cheaper, leading to a worsening of the trade balance (exports decrease, imports increase).

2. Impact on Economic Performance:

   • Depreciation: Can stimulate economic growth by boosting exports but can also lead to inflation if import prices increase.
   • Appreciation: Can reduce inflation by making imports cheaper but can also hurt export-oriented industries.

3. Impact on Investment Flows:

   • Exchange rate fluctuations can affect the profitability of foreign investments.
   • Unstable exchange rates can deter foreign investment.

Question 3: Trade Policies

Question: Compare and contrast the effects of free trade and protectionism. What are the arguments for and against trade barriers, such as tariffs and quotas?

Answer:

Free trade and protectionism represent opposing approaches to international trade policy. Free trade involves the removal of barriers to trade, while protectionism involves the imposition of trade barriers to protect domestic industries.

Free Trade:

• Definition: A policy of allowing goods and services to flow freely across national borders without tariffs, quotas, or other restrictions.
• Benefits:
  • Increased Efficiency: Specialization based on comparative advantage leads to higher productivity and lower costs.
  • Lower Prices: Increased competition forces firms to lower prices, benefiting consumers.
  • Greater Variety of Goods: Access to a wider range of products from around the world.
  • Economic Growth: Increased trade leads to higher output and employment.
• Costs:
  • Job Losses: Domestic industries that cannot compete with foreign firms may experience job losses.
  • Income Inequality: Some workers may benefit from trade, while others may be harmed.
  • Environmental Concerns: Increased production and transportation can lead to environmental degradation.

Protectionism:

• Definition: A policy of protecting domestic industries from foreign competition through the use of trade barriers.
• Types of Trade Barriers:
  • Tariffs: Taxes on imported goods.
  • Quotas: Limits on the quantity of imported goods.
  • Subsidies: Government payments to domestic producers.
  • Non-Tariff Barriers: Regulations, standards, and other measures that restrict trade.
• Arguments For Protectionism:
  • Protecting Infant Industries: Allowing new industries to develop without foreign competition.
  • Protecting Domestic Jobs: Shielding domestic workers from job losses due to imports.
  • National Security: Protecting industries that are vital for national defense.
  • Retaliation: Responding to unfair trade practices by other countries.
• Arguments Against Protectionism:
  • Higher Prices: Trade barriers increase the cost of imported goods, leading to higher prices for consumers.
  • Reduced Choice: Trade barriers limit the variety of goods available to consumers.
  • Inefficiency: Protectionism shields inefficient domestic industries from competition, reducing productivity.
  • Retaliation: Trade barriers can lead to retaliation by other countries, resulting in trade wars.

Comparison Table:

Feature	Free Trade	Protectionism
Definition	No trade barriers	Trade barriers to protect domestic industries
Benefits	Increased efficiency, lower prices, greater variety	Protecting infant industries, protecting domestic jobs
Costs	Job losses, income inequality, environmental concerns	Higher prices, reduced choice, inefficiency

In conclusion, economics exams in 2018 covered a wide range of topics in microeconomics, macroeconomics, and international economics. These questions and answers provide a comprehensive overview of the key concepts and principles that students were expected to understand. By studying these materials, students can gain a solid foundation in economics and prepare for future exams.