2018 Sept - Q10,15,21 & 26

[ominming]

For Q10, why do firms have to reduce the price on all previous units sold in order to sell the additional unit? From what I understand, monopolist always earn more than normal profit, thus do not reduce the price.

Q10 When a monopolist maximises profits, price exceeds marginal revenue. The difference between price and marginal revenue occurs because:

A. the firm has to charge a price higher than the marginal cost of producing the last unit.
B. any decision by the monopolist to sell an additional unit of output does not affect price.
C. the firm has to reduce the price on all previous units sold in order to sell the additional unit.
D. the law of diminishing returns directly affects the price of an imperfectly competitive firm’s product.​

For Q15, may I know which graph, theories or principles should I refer to get the correct answer (A)? I used equation of exchange MV=PY, but it is wrong.

Q15 The aggregate demand curve slopes downwards because at higher price levels the real money supply:

A. decreases and national income is lower.
B. decreases and national income is higher.
C. increases and national income is lower.
D. increases and national income is higher.​

For Q21, how does lowering the reserve requirements on commercial banks increases broad money supply? What is the effect of the second option, B?

Q21 Which of the following policies undertaken by the central bank will have an expansionary effect on the broad money supply measure other things being equal?

A. The sale of Treasury Bills in the financial markets.
B. A demand for special deposits from the commercial banks to be placed with

the central bank.​

C. A rise in the central bank lending rate.
D. A lowering of the reserve requirements on commercial banks.​

For Q26, why is the answer C?

Q26 The “crowding out” effect associated with an increase in government borrowing could be reduced or eliminated by an accommodating increase in:

A. government expenditure.
B. taxation.
C. money supply.
D. transfer payments.
​

Thank you in advance for clearing up my queries.

 

[Gresham Arnold]

Hi ominming

For Q10, why do firms have to reduce the price on all previous units sold in order to sell the additional unit? From what I understand, monopolist always earn more than normal profit, thus do not reduce the price.

Q10 When a monopolist maximises profits, price exceeds marginal revenue. The difference between price and marginal revenue occurs because:

A. the firm has to charge a price higher than the marginal cost of producing the last unit.
B. any decision by the monopolist to sell an additional unit of output does not affect price.
C. the firm has to reduce the price on all previous units sold in order to sell the additional unit.
D. the law of diminishing returns directly affects the price of an imperfectly competitive firm’s product.​

A monopoly typically faces a downward-sloping demand curve (due to the law of diminishing marginal utility). This means that it will need to reduce its price in order to sell more units. (Assuming that it is charging a single price for all units sold ie it is not doing some form of price discrimination)

Suppose it drops its price a little in order to sell exactly one more unit. Then the marginal revenue of this extra unit will be equal to the additional revenue received from selling that particular unit (ie the new and reduced selling price) less the loss of revenue from all of the previous units, which are now being sold for a lower price than before. It is this loss of revenue from the previous units which means that the marginal revenue must be less than the price.

Gresham

 

[Gresham Arnold]

For Q15, may I know which graph, theories or principles should I refer to get the correct answer (A)? I used equation of exchange MV=PY, but it is wrong.

Q15 The aggregate demand curve slopes downwards because at higher price levels the real money supply:

A. decreases and national income is lower.
B. decreases and national income is higher.
C. increases and national income is lower.
D. increases and national income is higher.​

​

We need to use the Aggregate Demand-Aggregate Supply (AD-AS) model here. The aggregate demand schedule is plotted on a graph of price vs national income. You have been told that it is downward sloping, and hence higher price levels will be associated with lower levels of national income (and vice versa). This rules out Options B and D.

The real money supply is equal to the nominal money supply less inflation. Higher prices correspond to higher levels of inflation, so for a given nominal money supply, higher prices will lead to a decreased real money supply. This rules out Options C and D. So Option A is the correct answer.

 

[Gresham Arnold]

For Q21, how does lowering the reserve requirements on commercial banks increases broad money supply? What is the effect of the second option, B?

Q21 Which of the following policies undertaken by the central bank will have an expansionary effect on the broad money supply measure other things being equal?

A. The sale of Treasury Bills in the financial markets.
B. A demand for special deposits from the commercial banks to be placed with

the central bank.​

C. A rise in the central bank lending rate.
D. A lowering of the reserve requirements on commercial banks.​

Each time a bank receives deposits from savers it holds a proportion as a reserve and loans the rest of the deposit out to borrowers. By doing so the bank creates credit and increases the broad money supply. If the amount that the bank has to hold as a reserve is decreased, this means that (all other things being equal) the bank can loan out more money and so the broad money supply will increase.

I would expect that a new requirement for a special deposit to be placed with the central bank to reduce the amount of money that commercial banks have available to lend and so reduce their ability to create credit and so reduce the broad money supply.

 

[Gresham Arnold]

For Q26, why is the answer C?

Q26 The “crowding out” effect associated with an increase in government borrowing could be reduced or eliminated by an accommodating increase in:

A. government expenditure.
B. taxation.
C. money supply.
D. transfer payments.
​

Crowding out arises when an increase in government spending leads to an increase in interest rates, which in turn results in a decrease in consumption and investment.

Recall that the money market model suggests that the interest rate is the rate at which demand for money and supply of money is equal. So, the way to avoid such crowding out is to offset an increase in interest rates by the central bank increasing the money supply. So Option C is the correct answer.

I hope that helps
Gresham

 

[ominming]

Hi Gresham,

Thank you very much for the explanation.