:HKEA -AL_MicroEcon

Answering approach provided here are NOT model answers and ABSOLUTELY NOT a marking scheme.
The purpose of posting those approaches is ONLY for DISCUSSION and I DO NOT have the authority to ensure the correctness of those answers.
The followings are ONLY the GUILDLINES of the answers or the lines of thoughts of the explanations. For a complete answer, a much more detail elaboration is obviously required.
Of course, ALTERNATIVE answers or approaches WILL also be appropriate with good reasoning.
Please post your opinion and/or arguments if you have any.

1 - 2000, HKAL, Microeconomics, Paper I, Section B

Explain one chief difference between diminishing marginal use value and diminishing rate of substitution. (8 marks)

Suggested Approach:

MRS is derived from utility/indifference curve analysis, but MUV is not.

Definitions:---

DMRS: The maximum amount of other goods that one is willing to forgo in order to obtain an extra unit of a goods will diminish when one purchases more and more of a good, holding utility constant.

DMUV: The maximum amount of other goods one is willing to give up for an extra unit of a good declines as more of this good is obtained. Graphically, the MUV is downward sloping.

Comparisons:

DMRS is derived from the indifference curve (utility curve) approach which is based on the concept of utility while DMUV does not. DMUV is derived from the use value approach. DMRS describes the change along an indifference curve of which utility is held constant. DMRS shows that the slope of an indifference curve is decreasing which means the IC curve becomes flatter and flatter when one consumes more and more of a good.

Under the postulate of DMUV, an individual may or may not gain consumer surplus (e.g. at the marginal unit, MUV>P => consumer surplus>0) However, under the postulate of DMRS, an individual cannot gain any consumer surplus as utility is kept constant.

Comment: You have to define diminishing MRS and MUV and elaborate the differences of the two ‘approaches’ on consumption decision or the law of demand. This question is difficult to answer because there are NOT many points to elaborate!

2 - 2000, HKAL, Microeconomics, Paper I, Section B

"Even under price control, markets always clear." Why? (8 marks)

Suggested Approach:

A market clears means the market is at equilibrium. (Dis-equilibrium exists only when economists are unable to specify sufficient constraints to explain why a choice is made under the postulate of constrained maximization.) At the unregulated-market-equilibrium price, the quantity demanded equals the quantity supplied and we say the market is cleared. Under the price control, the consumer pays a lower-than-unregulated-market-equilibrium price together with a non-money price due to 'non-price' competition. The 'full price' will also equal to the marginal cost and the market also clears.

Comment: The question implies that the given statement is right already and we have to think according to this approach. This is a question asking for the concept of 'full price'.

3 - 2000, HKAL, Microeconomics, Paper I, Section B

Consider a middleman who buys a good from a producer and resells it to a consumer. Does the contractual relationship between the producer and the middleman constitute a firm? (8 marks)

Suggested Approach:

Criteria for classifying as a firm:

The use of visible hand ? /payment by proxy? /reduction in the numbers of contracts or transactions

No firm constituted if:

The middlemen does nothing more than charging a commission between the producer and the consumer, such that the producer receives a price for the product and the consumer pays the price for the product plus the commission.

A firm exists if:

The factor owner (producer) gets paid hourly or monthly (or any proxy) but not according to their marginal productivity (MRP). They are subject to the direction of the middleman but not according to the market price changes (visible hand instead of invisible hand), so that the middleman would have to monitor or supervise the performance of the producer. As well the consumer pays a price for the product, which has reduced the number of transactions. In such situation, the contractual relationship between the producer and the middleman DOES NOT constitute a firm.

Comment: Some people may think that a ‘firm’ is a ‘middleman’, so there should be a firm. Let's say the 'middleman' is a retailer (a retailing shop) and the works it is doing is purchasing goods from the producer, keep the stock, advertising, selling, etc. The works done within the retailer (a retailing shop) can be organized by instructions or command of which constitutes a ‘firm’. However the transaction between the retailer and the producer is just a ‘market transaction’ (as leading by the invisible hand---market price) because the retailer purchases goods from the producer and it never monitors the production process done by the producer.

4 - 2000, HKAL, Microeconomics, Paper I, Section B

The completion of a construction project is postponed. Explain whether each of the following is a cost to the developer:

a. money already spent on the project plus interest

b. the developer's delayed receipt of the remaining portion of income from the project (8 marks)

Suggested Approach:

a. No, it is because those are sunk costs. As the completion of the project is postponed, the money already spent on it and the interest that could have been derived from it are sunk cost (past or historical cost) as they are not avoidable or cannot be recaptured by any means. Bygones are bygones.

b. Uncertain.

The answer is NO if the delay of the completion of the project is unavoidable, the remaining portion of the income that can be earned is no longer available. It is sunk cost.

The answer is YES if the developer still has the chance or option to prevent the delay of the completion of the project or not, and finally he chose to postpone, then he gave up the opportunity to get the income earlier.

Comments: A simple question asking the concept of ‘opportunity cost’and ‘sunk cost’.

5 - 2000, HKAL, Microeconomics, Paper I, Section B

Consider agricultural production which requires only two inputs, labour and land. Suppose the law of diminishing returns does not hold, so that the marginal product curve of labour is upward rising.

How much land will be used for farming?
Can we determine the rental value of agricultural land? (8 marks)

Suggested Approach:

(a) A tiny piece of land is enough. (b) No, because there is an infinity supply of these ‘tiny’ lands and due to competition, each of them can only claim for an ‘infinitesimal’ amount of rent that is almost zero.

Comment: The question asks for the concept of diminishing MP and competition. Similar questions have appeared for many times over years.

6 - 2000, HKAL, Microeconomics, Paper I, Section C

Currently households pay rates (差餉) to cover the disposal charge for their garbage (rubbish) and the rates depend on the value of their flats. Will there be any change in the amount of garbage disposed of by each household if the disposal charge is calculated according to

(a) the number of people per household instead?

(b) the number of standard garbage bags used by each household instead? (8 marks)

Suggested Approach:

(a) No, it is because:

Originally, the disposal charge for garbage relates to the value of the flats (living space and location). Now the disposal charge relates to the numbers of people per household. In both cases, the disposal charge is a kind of lump-sum fee and does bot relate to the amount of garbage disposed, These two cases of lump-sum fee would affect the fixed cost of garbage disposal only, but not the marginal cost of disposing one extra unit of garbage. As the amount garbage disposed depends on the marginal cost (MC=0 now), there should be no change. (Hint: Do you remember if a lump-sum tax is imposed on a monopolist, the output level will not be affected. The lump-sum tax would affect fixed costs but not the marginal cost curve and so would not change the wealth-maximizing output (where MR=MC).

(b)

There are two possibilities. The answer is no, if originally a household can fill all its garbage in one standard bag. On the other hand, the answer is yes, if originally a household uses two or more standard garbage bags and people will try to squeeze the garbage tightly in the bag to reduce the ‘number’of garbage bag used or simply to dispose less amount of garbage. However, the percentage reduction in the amount of garbage will be less than the percentage reduction in the number of garbage bag used.

Comment: The main theme of part (b) is on measurement. The "unit" here is "bags", but the "amount of garbage" is not necessarily related to the "numbers of bags". Moreover, the word "standard bags" should not be overlooked.

This question asks for how the change in the dimensions (e.g., household size, number of garbage bag used, etc) of measuring payment (rates) affects people’s behaviour/decision.

7 - 2000, HKAL, Microeconomics, Paper I, Section C

Reputable stores with big names (i.e. anchor stores) often pay considerably lower rentals per square foot than other stores in a large shopping mall. Is this a case of price discrimination? Explain. Does a lower rental from an anchor store reflect a lower income received by the landlord? (10 marks)

Suggested Approach:

NOTE that we are confronted with the case that inside a large mall, some stores (reputable ones) pay lower rentals per sq. ft. while others pay higher rentals per sq. ft. We are not asked to compare reputable stores in some locations with large shopping malls in other locations.

Firstly, it is always suggested we cite the definition of price discrimination. It is the practice of charging different prices to different buyers for the essentially the same good. These price differences reflect the differences in demand (or differences in demand elasticity) rather than the differences in the costs of serving of different buyers.

The discussion of whether a case is connected to price discrimination should focus on:

Difference price? Difference buyers? Same type of goods? (the location of the stores inside the shopping mall rather than the goods sold in the stores) Same costs of serving different buyers? (transaction cost, risk, quantity discounts...)

Therefore (i) This is NOT price discrimination because anchor stores usually lease larger areas which reduces the administrative costs of the landlord, and some specific locations (e.g. near the toilets) inside the malls may cost less. Given the renting cost is different, the price differential is NOT a price discrimination.

(ii) A lower rental from an anchor store does not reflect a lower income received by the landlord. A lower rental income from anchor stores would mean a lower income for the landlords only if this action would not bring along any advantages or benefits to the landlords. Actually these benefits exist. As the anchor stores can attract more customers and raise the flows of people inside the mall, they bring more revenue to other stores and attract more shop owners to rent a unit in the mall. The landlord can charge other non-anchor stores within the mall a higher rent to compensate for the lower rent to those anchor stores. The non-anchor stores are willing to pay a ‘higher rent’because they can have more businesses opening inside a mall with the present of other anchor stores. I.e. the so-called "externality" can be internalized by charging different prices.

Comments: We do believe that you can argue that this is a kind of price discrimination providing that you can provide ‘reasonable’explanation on the parity of the cost of renting to anchor and non-anchor stores.

8 - 2000, HKAL, Microeconomics, Paper I, Section C

When the news of China reaching agreement with the United States to enter the World Trade Organization was announced, the stock prices of three industries in China --- finance, automobile, communication --- fell sharply. These are state industries protected as monopolies, and the agreement essentially says this protection will be gradually removed, or phased out, so that the three industries will be open for international competition.

(a) Who gains and who loses from this agreement?

(b) Will China as a whole gain even with the sharp fall in the stock prices of the three industries? (10 marks)

Suggested Approach:

(a) Who gain?

Consumers enjoy lower prices
Business firms enjoys lower costs when using the services of these industries

Who lose?

Special interest groups associated with the state-protected monopolies

Therefore, both the consumers and newcomers of the industry gain and the existing monopolies lose.

(b) There are at least the following sources of gain to China:

facilitate the privatization of the state-owned enterprises, so that the state protection would be removed;
to raise local competition by introducing competition; domestic firms have to strengthen their competitive power by improving efficiency;
help quicken the pace of reform of state-owned enterprises which are losing money and causing a heavy burden to the state;
making China to move into the international market and developing a better judicial system; and
to enable the consumers to enjoy cheaper and better services and products; Mainland Chinese people will be better off.

Comments: This is an open answer question with enormous possibility. You are free to give opinions. Of course, the more awareness of current economic affair you are, the easier to answer this question. However, we do not have many of this type of questions in the past HKAL economics examinations! Useful web-sites:

9 - 2000, HKAL, Microeconomics, Paper I, Section C

At present, most medical practitioners (doctors) in Hong Kong provide consultation as well as medicine (drugs) to patients and charge each patient a lump-sum payment. However, in many countries, doctors usually provide consultation alone; patients have to buy medicines from pharmacists or drugstores. It has been suggested that Hong Kong should follow the practice of these western countries.

(a) If the western practice is adopted, will there be any difference in a patient's total medical expense on both doctor's consultation and medicine

If doctors are price-takers?
If doctors are price-searchers?

(b) How would you explain that why most doctors in Hong Kong choose to provide both consultation and medicine? (You may suggest more than one reason.) (12 marks)

Suggested Approach:

(a) (i) If doctors are price-takers, they can only earn a competitive return on their medical consultation service. Only when they are assumed that they have no monopoly rights on the drugs before and after the western practice is adopted can they earn no more by selling the drugs. Therefore it is less likely that the change of the practice will affect the total medical expense (consultation service and drug) of patients. (However, if before the practice adopted the doctors are assumed they have monopoly rights on the drugs, and after such practice they are assumed to lose the monopolistic rights on the drugs, then there will be change in the total medical expense of the patient as the patient paying less.)

(a) (ii) If doctors are price-searchers, they earn monopoly rents on their part of medical consultation service only if they have only such monopoly power. The patients' total expenses go to the monopoly rent earned by the doctors and the revenue of the drug dealer. The tie of drug sales will not raise their monopoly rents.

Therefore, no matter price-takers or price-searchers, it is also unlikely that the change of the practice will affect the total medical expense of patients if the doctors only do their part of job.

(b) Most doctors in Hong Kong choose the old practice probably because:

Given there are information problems in the medical profession, a bad and dishonest doctor may cheat on the patients of their illness and the drugs they use. In this case a doctor may charge the patient a higher than ‘normal’price.
Providing that the doctors are good and honest, assuming the drugstores are lack of professional pharmacists and fake drugs are common, doctors choose to provide both consultant service and medicine is a way to protect their patients. Moreover, as the doctors act as middlemen, they save a lot of transaction costs and information costs of medicine dealings.

Comment: (b) This is an open answer question as assumptions should be made before hand and you are free to given any reasonable answers. However they must be well explained.

*(An interesting point to consider: Does it matter if drug dealers are price-takers or price-searchers?)

2000, HKAL, Microeconomics, Paper I, Section A---M C Q

Choose the BEST answer.

1. Which of the following statement is NOT refutable?

If price falls, the quantity transacted will fall.
If price falls, the quantity transacted will increase.
If income increases, the quantity transacted will increase.
If the price elasticity of demand for a good is unitary, the percentage change in price will be the same as the percentage change in the quantity demanded.

Topic: Methodology of Economics

Option A to C --These statements are"refutable". For option A, when price falls, one can confirm whether the quantity transacted will fall or not by observations. If the quantity transacted falls, the statement is verified and if the quantity transacted rises or remains unchanged, the statement will be falsified.

Option D is the definition for unitary demand elasticity, and it is true by definition only and hence is non-refutable. This is a tautological explanation.

Answer is D　

2. Which of the following statements about utility is correct?

Utility is assigned by a decision-maker to represent his own preference.
Utility is designed by economists to rank the options of an individual.
Utility determines preference.
Individuals derive utility from consumption.

Topic--- Indifference Curve Analysis ; Sub-topic --- Utility Analysis

According to the great economist, A. Alchain, utility is a concept designed by the economists for the purpose of explaining and predicting human behaviour.

Correct Answer is Option B: This is the nature of an ordinal scale of utility.

3. Speeding increases the risk of car accidents. The observation that some drivers do exceed speed limits implies

Safety is not a good for these drivers.
Safety is a free good for these drivers.
These drivers are willing to substitute speeding for safety.
The postulate of constrained maximization cannot be used to analyze the behaviour of these drivers.

Topic : Supply, Demand & Price ; Sub-topic : Postulates

Correct answer is option C --- This is implied by the postulate of substitution.

Option D --- This choice is not the answer because if we can use it to explain the phenomena, economists would not deny the postulate of constrained maximizatin . The question has mentioned that speeding increases the risk of car accidents, but it does not necessarily imply that drivers would not exceed speed limits. It is because drivers may substitute safety for the enjoyment of speeding. This phenomenon does not violate the postulate of maximization. Moreover, it is implied by the postulate of substitution that assume that people would always sacrifice something to obtain another goods.

According to the postulate of substitution, safety is substitutable at the margin.

4. As money income rises while relative prices remain constant, the income effect for good X may be positive or negative. This implies that

Inferior goods and normal goods exist in equal proportions in the real world.
Normal goods are more common than inferior goods in the real world.
Refutable implications on income effect cannot be derived.
Demand curves are downward sloping.

Topic: Methodology of Economics

Correct answer is option C --- As the income effect can only be either positive or negative, we CANNOT refute the conclusion by observations.

Other things being equal, an increase in income can lead to an indefinite number of possible outcomes on the quantity demanded of a good. Refutable implications on income effect cannot be derived.

5. In the above diagram, basket A is the choice of an individual on the original budget line BB. Suppose indifference curve are downward sloping and convex to the origin. If the budget line changes to B'B' after changes in money income and relative prices,

the individual will consume less of Good X.
the individual will consume more of Good X.
the individual will consume the same amount of Good X.
it is uncertain whether the individual will consume more or less of Good X.

Topic: Indifference Curve Analysis

Correct Answer is Option B: As shown by the diagram

Along sections AB and AB', the consumer will always choose a point on AB' because that would yield him a higher utility level as the IC curves are convex to the origin. He would consumer more X than before.

6. If the indifference curves of an individual are downward sloping and convex to the origin, then

the law of demand can be derived.
the law of diminishing marginal rate of substitution holds.
the individual will consume more than one good at any relative price.
All of the above.

Topic--- Indifference Curve Analysis

Correct Answer is Option B: The law of diminishing MRS implies indifference curves are downward sloping and convex to the origin.

Up to present, the law of demand is still an asserted law. Corner solution may be possibly the optimum consumption if there is no parity (equality) between marginal rate of substitution and relative price.

7. Suppose transaction costs are zero and two people have identical demand curves for a good. Which of the following statements is correct?

Exchange will occur between the two people provided that their initial endowments are different.
The person with more initial endowment would be the seller.
Market equilibrium occurs when the two people have the same quantities of that good.
All of the above.

Topic : Theorem of Exchange

Correct item is D: as explained below:

Option A--- When the two people have different initial endowments, they will have different MUVs as they have identical demand (MUV) curves.

Option B--- Since both of them have identical demand (MUV) curves, the one "with more initial endowment" will have a lower MUV than the other and this one will therefore be the seller.

Option C--- Market equilibrium occurs when both seller and buyer have the same MUV on the last unit of good they possess. Only when they have the same quantities of the good have they the same MUVs on the last unit of goods they possess, because they have identical demand (MUV) curves.

Market equilibrium takes place at the point where MUV among the individuals are the same. Higher MUV users will buy from lower MUV users until the MUV are equalized.

8. Which of the following statements may be consistent with a downward sloping demand curve?

Price and quantity transacted are observed to increase together.
Price rises and quantity transacted falls.
A student is not willing to give up anything for an additional distinction in one other subject.
All of the above.

Topic--- Supply, Demand & Price

Correct item is D: as explained below:

Option A: This may be caused by an upward shift of a 'downward-sloping' demand curve. It refers to an increase in market demand.

Option B: This may be caused by an upward shift of a supply curve along a 'downward-sloping' demand curve. It refers to a fall in market supply.

OptionC: Although a student may not "willing to give up anything for an additional distinction in one other subject" at the margin, it does NOT deny the possibility that this student may still willing to give up some other things to get a higher grade when his/her grades of his/her present subjects are not that high. It is similar to the case that even a person has consumed or possessing so many of a good that the MUV of an additional unit becomes zero, it does not deny the possibility that this person is still willing to give up some other things to obtain additional unit of this good if the amount he/she has consumed or possessing is only a little.

Option C refers to the maximization behaviour of human beings.

9. In a one-man economy,

There is no interest.
There is information cost.
There is no transportation cost.
Rent is part of cost.

Topic --- Transaction Costs & Property Rights

Correct item is B : To acquire information in a one-man economy is still costly. (Remark: Information cost is not necessarily transaction cost, so there is not contradiction with the definition of transaction cost, which is a cost that could not be found in a one-man economy.) Only part but NOT all of the information cost is subject to the category of transaction cost.

A is incorrect: He is also willing to sacrifice some present consumption for more future consumption and the growth portion is also regarded as interest in broad sense.

C is incorrect: Robinson Crusoe may involve information cost and transportation cost in his decision making.

D is incorrect: Rent is part of cost ONLY if there exists an outright sale option and the rent is then captured after the sale.

10. A free good is a good that yields zero

marginal use value.
average use value.
total use value.
consumer surplus.

Topic: Supply, Demand & Price ; Sub-topic: Economic Goods & Free Goods

Option A is correct: A free good is a good of which the quantity available is so large than no one wants to have more. As the MUVs of a good is diminishing, people will not want more of a good when the MUV of a good diminishes to zero.

The quantity available of a free good is so plentiful and abundant that no one is willing to sacrifice anything to get more of it.

11. Consider an exchange between two individuals over a fixed quantity of good X. Which of the following statements is correct?

The buyers and the seller jointly determine the market demand for good X.
The buyer determines the market demand for and the seller determines the market supply of good X.
All of good X must be traded to determine the market price.
None of the above.

Topic :Theorem of Exchange ; Sub-topic: Market Demand

Correct item is A: The market demand is the horizontal summation of the two individual's demand curves.

Option B --- The supply curve of good X is a vertical straight line with the fixed quantity.

The fixed quantity available can be regarded as the market supply curve and the summated MUV curve as the market demand curve. Equilibrium takes place at the point where P=MUV to Mr. A =MUV to Ms. B.

12. An effective price ceiling imposed on a good

leads to shortage.
reduces competition.
encourages the use of non-price competition.
increases consumer surplus.

Topic: Supply, Demand & Price ; Sub-topic Price Control

Correct item is C : An effective price ceiling implies 'temporary' shortage and then induces non-price competition. A price control suppresses price but encourages non-price competitive criteria.

A is incorrect: Although an effective price ceiling can leads to 'shortage', which is a market disequilibrium and is only an intermediate event, the arise of non-price competition will restore the market back to equilibrium. Hence, choice C is better answer.

"Dis-equilibrium exists only when economists are unable to specify sufficient constraints to explain why a choice is made under the postulate of constrained maximization." Therefore there is no shortage if one can specify sufficient constraints that the decision-makers are facing.

13. With sufficiently low transaction costs, a monopolist facing an upward sloping marginal cost curve changes from simple monopoly pricing to perfect price discrimination. For the last unit of output, the monopolist will produce at a____ marginal revenue and charge a ____ price.

higher … higher
higher … lower
lower … higher
lower … lower

Topic : Monopoly ; Sub-topic : Price Discrimination

Correct answer is B. As shown in the diagram.

Refer to the diagram of a price-searcher market as a monopolist facing a downward sloping DD curve and an upward sloping marginal cost curve.

14. In an indifference curve analysis of two goods, X and Y, when the price of X falls and the quantities purchases of both X and Y increase, holding money income constant, the price elasticity of demand for X is

larger than unity.
smaller than unity.
equal to unity.
uncertain.

Topic : Indifference Curve Analysis ; Sub-topic Elasticities

Correct answer is Option B.

Since the fall in price of good X leads to an increase in quantity and total expenditure spent on good Y. Therefore, total expenditure spent on good X must have decreased after the price change, holding money income constant. The demand for X is inelastic (price elasticity is smaller than one) if a fall in price leads to a fall in the total expenditure on good X.

15. Market price

must be measured in money terms.
of a good is determined by its total use value.
is the only feasible competitive criterion.
is the only competitive criterion that does not lead to dissipation of rent.

Topic: Transaction Costs & Property Rights ; Sub-topic : Rent & Profit

D is correct: Only non-price competition leads to rent dissipation. Any non-price competitive criteria, say filling forms, first-come-first-served, seniority etc entail dissipation of rent.

16. Inside a firm, paying workers by the hour is chosen because

workers are not honest.
workers have different levels of productivity.
The activities performed by workers are not easily standardized.
The monitoring cost is low.

Topic: Nature of Firms ; Sub-topic: Contracts

Option C is correct: When "the activities performed by workers are not easily standardized", the measurement cost of the output of workers will be high and it may be more economical to pay the workers by the hour and supervise their inputs.

Time rate is adopted because it is difficult to measure exactly the output of the workers. To pay for the worker, a proxy instead, say working hours is used as a basis.

17. The Pareto condition is violated when

certain constraints are neglected in explaining behaviour.
transaction costs are prohibitively high for market transactions.
property rights are not well-defined.
there is non-price competition.

Topic: Transaction Costs & Property Rights ; Sub-topic : Efficiency

Option A is correct : The Pareto condition (optimality) is directly implied by the postulate of maximization. Therefore it will be violated only when "certain constraints are neglected in explaining behaviour" and those constraints are usually constraints of transaction costs.

When sufficient constraints have been specified, all decisions must be efficient. An "inefficient" outcome would imply "potential gain" with sufficient specified constraints. Dictated by the postulate of constrained maximization, such potential gain would be captured.

Inefficiency would thus exist only when we fail to specify sufficient constraints in explaining human behaviour.

Quoted from S.N.S. Cheung, "Dis-equilibrium exists only when economists are unable to specify sufficient constraints to explain why a choice is made under the postulate of constrained maximization."

18. Which of the following statements about transaction costs is correct?

There may be transaction costs even if there is no market transaction.
Transaction costs can only exist in a society.
The existence of institutions implies the existence of transaction costs.
All of the above.

Topic : Transaction Costs & Property Rights ; Sub-topic : Transaction Costs

Answer is D : As explained below ---

A : Activities with a 'firm' involves transaction costs too.
B : This is one of the definitions of transaction cost.
C : Transaction costs are institutional costs therefore "the existence of institutions implies the existence of transaction costs".

Recall the definition of transaction cost: All those costs inconceivable in a one-man economy. Should there be no transaction cost, choices of contracts and types of institutional arrangement would be totally indifferent.

Therefore, even in a pure command economy (communist society without market coordination), transaction cost still exists.

19. Newspaper and magazine publishers often increase their sales and incomes by reporting personal information about famous movie stars who usually do not receive any financial return from the publishers. However, these movie stars often benefit from these reports which serve as a kind of publicity for them. Which of the following statements is correct regarding this situation?

There must be a divergence between private and social costs.
To attain economic efficiency, the government should force the party who benefits more from these reports to compensate the other party.
The marginal benefits of these reports to the two parties must be the same since neither party pays the other.
The costs of making and enforcing contracts are prohibitively high.

Topic : Divergence of Private & Social Costs ; Sub-topic : Efficiency

Option D is right : Since "the costs of making and enforcing contracts are prohibitively high", so NO private contracting occurs. (It is a TAUTOLOGICAL explanation must be true.)

For option C: If the marginal benefits (MB) of these reports to the two parties are not the same, the parties which has a higher MB will pay to the other which has a lower MB. However the existence of private contracting will still depend on the cost of making & enforcing contracts. If these costs are prohibitively high, private contracting would NOT occur.

Should the transaction cost be sufficiently low, formal contracts between the publishers and the movie stars would be established.

20. When a pianist plays the piano up a point where the marginal value of the unpaid music to his/her neighbour is zero,

private marginal benefit diverges from social marginal benefit.
the total gain to the pianist and his neighbour is maximized.
the property rights to the music has to be defined for economic efficiency.
the time spent on playing the piano is indeterminate.

Topic : divergence of Private & Social Costs ; Sub-topic : Efficiency

Option B is chosen: Since the pianist himself decides the time of playing the piano, he must maximize his own benefit (gain). Moreover, when the MUV of the music to his neighbour is zero, the external benefit to his neighbour is also at maximum. As a result, "the total gain to the pianist and his neighbour is maximized".

In other words, total gain to neighbour will be maximized if the pianist plays up to the point where the external marginal benefit is zero. Likewise, the total gain to the pianist and the neighbour will be maximized.

21. If both income and interest rates fluctuate over time,

consumption may still be constant over time.
wealth cannot be determined.
consumption will necessarily fluctuate over time.
The postulate of income maximization will be preferred to the postulate of wealth maximization.

Topic : Capital, Wealth & Interest ; Sub-topic : Separation Theorem

Option A is the best: When the market of borrowing and lending exists, the decision on consumption would be separated with the decision on production. Therefore even when the income and interest rates fluctuate, it will only affect one's decision on production, but not the decision on consumption.

Wealth can still be determined by discounting the future income, though in a more complicated manner if the income and interest rates fluctuate.

Postulate of income maximization will be preferred to wealth maximization only if wealth becomes ambiguous and cannot be determined, say if interest rate is unknown.

Through borrowing and lending, consumption may still be constant inter-temporally (over time) even income and interest rate both fluctuate.

22. If a uniform per-unit tax on wine is removed, then

the price of high-quality wine will decrease.
the price of low-quality wine will decrease.
the relative price of high-quality wine will increase.
All of the above.

Topic: Supply, Demand & Price ; Sub-topic : Relative Price

All are correct --- D: As explained below.

The money prices of both wines will fall. However, the percentage fall in money price of the low-Q wine will be more than that of the high-Q wines. Thus the relative price of the high-Q wine will rise.

23. If the marginal cost curve of a firm is upward sloping, then under perfect competition the long-run industry supply curve must be

upward sloping.
horizontal.
downward sloping.
None of the above.

Topic: Production ; Sub-topic: Cost Curves

D: The shape of the long-run industry supply curve depends on whether the industry is an increasing, decreasing, or constant cost industry.Therefore option D is the best answer.

However this piece of information has not been provided in the question. (Remark: the question was deleted!)

24. Suppose the alternative earnings of all workers, both existing and new, in a particular trade are identical and constant, and suppose new workers in that trade accept a 15% wage cut. Which of the following statements about the workers in that trade is correct?

Both existing and new workers would definitely earn economic rents.
The cost of quitting the job would remain unchanged for the existing workers.
The transfer earnings of the existing would decrease by 15%.
All of the above.

Topic: Factor Market ; Sub-topic: Rent & Profit

A may be wrong: Since the new workers, which have identical opportunity costs as existing workers, can accept a 15% wage cut, "both existing and new workers would definitely earn economic rents" before wage cut. However, we are not sure whether they still earn economic rents AFTER wage cut.

B is correct : The "cost of quitting the job" depends on the alternative earnings of workers. Since it is identical and constant to all workers, the "cost of quitting the job for the existing workers would remain unchanged", as long as the income unchanged.

The marginal worker does not earn economic rent.

The transfer earnings of the existing workers depend on the income from their highest-valued job given up (highest alternative earning), but not the income of the present job.

25. When convicted for the same crime, a wealthy person is often punished less severely than a poor person by the court because the wealthy person can hire better and more lawyers. However, the total cost of the crime to a wealthy person is higher because

his earning is higher.
his social status is worth more.
he will have a larger decline in future income.
All of the above.

Topic : Supply, Demand & Price ; Sub-topic: Opportunity Cost

All of the above items will affect the total 'opportunity cost' of the crime to a wealthy person.

Therefore option D is accepted.

Cost is the highest-valued option necessarily forgone. In determining the cost of a choice, we need to refer to the totally of all that forgone.

26. A theory with an indefinite number of possible outcomes

is more general in application.
Is easier to refute.
has no refutable implication.
is more realistic.

Topic : Methodology of Economics ; Sub-topic : Economic Theory

Option C is chosen:

A "theory" has an infinitive number of possible outcomes is tautological and is non-refutable. Hence, any observations in reality will be consistent with its implication and therefore the theory "has no refutable implication" and is useless SINCE it has no predicted power.

27. Which of the following statements is testable?

An increase in the available quantity of a good will lead to a reduction in its market price, other things being equal.
When two individuals have different marginal use values over a good, they will trade.
Marginal use values of buyers and sellers are equal in market equilibrium.
The demand curve is downward sloping.

Topic : Methodology of Economics ; Sub-topic : Economic Theory

Correct Answer : A --- Since both "the available quantity of a good" and "its market price" is observable", this hypothesis (statement) is testable.

Option C cannot be true: Since market equilibrium is not observable, we cannot verify the truth of the statement when market equilibrium cannot be justified.
Concepts of MUV and quantity demanded are not observable per usually. Statements with these unobservable concepts cannot be directly tested.

28. A common property

induces non-price competition.
is a free good because it has no market price.
is a good that can be consumed concurrently by more than one individual.
is a good owned collectively by more than one individuals.

Topic : Transaction Costs & Property Rights ; Sub-topic : Common Property

Correct Answer is A : the criterion of competing for the use a common property is non-price competition.

D is wrong since a common property is a property that no one can claim the property rights of it.

A common property has no well-defined property rights. Its uses are subject to non-price competition. Do not confuse common property with public goods.

29. If transaction costs are zero,

there will be no division of labour.
there will not be any consumption and production activities.
The choice of contractual arrangements will be indeterminate.
There is no risk.

Topic: Transaction Costs & Property Rights ; Sub-topic : Forms of Contracts

Option C should be chosen: The choice of contractual arrangements is a result of the existence of transaction costs and in accordance with the criterion of minimization of transaction cost. When there were no transaction costs, the choice of contractual arrangements will be meaningless.

Teachers in schools are paid in time rate but private tutorial teachers are paid in share rate are results of different transaction costs. Should there be no transaction cost, we would not observe different types of contract in the real world.

30. A telephone company raises the monthly charge from $90 to $100. Which of the following is true for a household that continues to use the telephone service of this company?

The average time of telephone calls the household makes will increase.
The household will make more telephone calls.
All of the household's consumer surplus will be fully extracted.
The household's total use value of using the telephone service is at least $100 per month.

Topic : Theorem of Exchange

Correct answer is option D: If his TUV is less than $100, he would discontinue using the service. Since the lump-sum telephone charge would not affect the consumers' decision of making longer time of local phone calls .

The consumer will only continues to use the telephone service given that the total use value of the service is greater than the lump-sum charge. Otherwise they will stop to use the service.

END OF SECTION A

Answer to 2000 AL ECONOMICS --- Section A: MCQ

01D 02B 03C 04C 05B

06B 07D 08D 09B 10A

11A 12C 13B 14B 15D

16C 17A 18D 19D 20B

21A 22D 23D 24B 25D

26C 27A 28A 29C 30D

　

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Things that should be known for answering Section A Multiple Choice Questions:

This section has the broadest coverage in terms of syllabus contents and objectives.
Attempt this section first because it may contain clues, terms or concepts that are relevant for Section B and C.
In general the ordering of the questions follow that of the syllabus with the exception that "negative" questions are to be left to the last few questions.
No deduction of marks for wrong answers, therefore don't leave any question unanswered.
If you are not sure which is the key, do not guess randomly. Try to maximize your chance by eliminating the unlikely ones.
Do NOT spend too much time on a particular question if you've got stuck. Remember that you are constrained by time limit. Moreover, all items in this Section carry equal weighting.
Always RELATE the answer with the stem of the question. Never interpret each option in its own right meaning.
Use economic sense but NOT common sense to arrive at your answer.
Choose the "BEST" instead of the "correct" answer.
There are stereotype questions set every year, going through past papers is a good idea and definitely a productive investment.
Pay attention to the unique meanings of economic terms and jargons.
READ and re-read the stem to avoid careless misinterpretation of questions. It is advisable to underline the key words.

WELL PREPARE YOURSELF AND HOPE YOU A GREAT SUCESS !!!

from WILLIAM, T. C. WONG

June, 2000