DEPARTMENT OF ECONOMICS

ECONOMICS 144
MAIN ASSESSMENT A1: 31 AUGUST 2022
Time: 2 hours Marks: 60

EXAMINERS: Ms L Boltman Ms O Ezeobi Ms M Ngwenya

Ms C Pengelly Ms C Smit Mr M Visser

INTERNAL MODERATOR: Ms L Nieuwoudt

PLEASE NOTE: ONLY NON-PROGRAMMABLE CALCULATORS ARE ALLOWED.

ANSWER ALL THE QUESTIONS. ROUND ALL ANSWERS TO ONE DECIMAL UNLESS OTHERWISE
INDICATED.

Time management: Given that this assessment counts 60 marks and the time available is 120 minutes, it
averages to about 2 minutes per mark; however, use your discretion.

MARK ALLOCATION:

Statements 1 to 10 in Section A count 2 marks each. ¼ mark will be subtracted for every incorrect answer.

Key
AD = Aggregate demand N = Employment
C = Consumption expenditure NX = Net exports
FF = Feasible frontier P = Price level
G = Government expenditure SARB = South African Reserve Bank
GDP = Gross Domestic Product W = Nominal wage
I = Investment w = Real wage
IC = Indifference curve X = Export expenditure
M = Import expenditure Y = Income
MRS = Marginal rate of substitution

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 SECTION A
MULTIPLE CHOICE STATEMENTS
(20 Marks)

ANSWER THIS SECTION ON THE SUPPLIED ANSWER SHEET. INDICATE YOUR CHOICE BY MAKING A
CROSS NEXT TO THE NUMBER OF THE STATEMENT.

1. The planet Zorg had a population of 92 720 people and a working-age population of 75 000
people in 2021. The narrow labour force was 65 034 and the employment rate was 72.68%
in 2021. There were 3 485 discouraged work-seekers. Based on this information, how many
employed people were there on planet Zorg in 2021?

a) 47 267
b) 49 800
c) 54 510
d) 61 549

2. Identify which of the following statements are TRUE:

Statement 1: More competition amongst firms will lead to a lower mark-up and shift the
price-setting curve upwards.
Statement 2: The price-setting curve gives the real wage necessary at each level of
employment to provide workers with incentives to work hard and well.
Statement 3: If the mark-up remains unchanged, higher labour productivity will shift the
price-setting curve upwards.

a) Only Statement 1.
b) Only Statements 1 and 3.
c) All of the statements.
d) None of the statements.

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3. The figure below shows the wage-setting curve for and the real wage (w*) in the country
Zootopia in 2021. Which one of the following statements is CORRECT?

Broad labour force

Real wage

w=

w*

Wage-setting curve

0
0.1 0.6 0.9 1
Proportion of working-age population

a) The broad unemployment rate was 30% in 2021.

b) The employment rate was 50% in 2021.
c) The broad unemployment rate was 33.33% in 2021.
d) The narrow participation rate was 90% in 2021.

4. Which one of the following statements is CORRECT?

a) The equilibrium wage is the result of employers minimising the wage cost of effort and the
employee maximising wage per effort.
b) The firm's decision about how many workers to hire is a combined decision taken by the Hu-
man Resources and Production departments.
c) At a high unemployment rate in the economy, the employee's reservation wage is low, and
they will not put in much effort unless the wage is high. The firm's profit-maximising wage is
therefore higher.
d) Labour productivity is split into nominal profit per worker and the real wage.

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5. Betty receives an endowment of R240 in period 1. In the low interest rate case, Betty
decides to consume a portion of her endowment in period 1 and lends out the remainder at
10%. In the high interest rate case, Betty decides to consume a portion of her endowment in
period 1 and lends out the remainder at 40%.

Which of the following statements are TRUE?

Statement 1: The substitution effect of a higher interest rate would make Betty's
consumption in period 1 relatively more expensive, which would reduce her
current consumption.
Statement 2: The income effect of a higher interest rate increases Betty's income, which
would increase her current consumption.
Statement 3: The substitution effect of a higher interest rate would make Betty's future
consumption relatively more expensive, which would decrease her future
consumption.
Statement 4: The income effect of a higher interest rate decreases Betty's income, which
would decrease her future consumption.

a) Only Statements 1 and 2.

b) Only Statements 1 and 4.
c) Only Statements 2 and 3.
d) Only Statements 3 and 4.

6. Henry, Igor, and Juno all apply for a loan at Enterprise Bank to start their own businesses.
Enterprise Bank is willing to issue a loan to Henry at an interest rate of 12% and is willing to
issue a loan to Juno at an interest rate of 28%. Enterprise bank is not willing to issue a loan
to Igor. Which one of the statements below is TRUE?

a) It is correct to say that Igor is "credit constrained" because the bank does not want to issue
a loan to him.
b) It is most likely that Juno is wealthier than Henry because the bank is willing to give Henry a
loan at a relatively lower interest rate.
c) It is most likely that Henry is wealthier than Juno because the bank is willing to give Henry a
loan at a relatively lower interest rate.
d) Enterprise Bank's decision to issue loans to Henry and Juno at different interest rates is
likely to lower inequality in the economy.

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7. Consider Monica's choice of consumption in this year (c 1) and consumption next year (c2),
respectively. c1 is the horizontal axis variable and c 2 is the vertical axis variable. You are told
that her preferences exhibit diminishing marginal returns to consumption. Which one of the
following statements is CORRECT?

a) Monica's marginal rate of substitution of c2 for c1 is decreasing in c1.

b) If Monica receives an endowment in this year, her reservation indifference curve will
intersect the y-axis at some point.
c) If Monica's MRS is 2.5 when c1 is R10, then her MRS would be larger than 2.5 when c1 is R20.
d) If Monica consumes R20 in both years and is willing to give up R1 of consumption this year
for R0.80 of consumption next year, she is purely impatient.

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8. The figure below depicts Anathi's choice of consumption in periods 1 and 2. He has no in-
come in period 1 and receives R200 worth of grain in period 2. Anathi can borrow at a given
interest rate to consume in the current period. The figure below shows two possible feasible
sets, each corresponding to a specific interest rate at which Anathi can borrow. Point A and
Point B are his optimal consumption choices for the two different interest rates, respect -
ively. Based on this figure, which of the following statements are CORRECT?

I. In both schemes, Anathi chooses not to consume all his grain in period 1 because he is purely
impatient.
II. At point B, Anathi's marginal rate of substitution is 1.1.
III. The higher interest rate at which Anathi can borrow is 85%.
IV. At point A, the interest rate is 23%.

a) I, II and III are correct.

b) II and IV are correct.
c) II and III are correct.
d) II, III and IV are correct.

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9. Which one of the following statements is CORRECT?

a) There will always be a strong correlation between South African business cycle fluctuations
and fluctuations in South African exports.
b) Investment expenditure is less volatile than consumption expenditure because investment
expenditure can be postponed, unlike consumption expenditure which cannot be post-
poned.
c) A German company has a factory in Johannesburg which implies that the output produced
there will not form part of South African GDP.
d) Investment expenditure is more volatile than government expenditure because investment
expenditure is dependent on business confidence.

10. Arthur is a cattle farmer supplying cattle to the local abattoir monthly from which he re -
ceives a stable income to satisfy his and his dependents' financial needs. Arthur is therefore
not credit constrained. The day before this month's delivery, some of the cattle are stolen
from the collection pen on his farm. His household income drops by 50% for the following
two months only. Assume that he has an infinite planning horizon (lifetime consumption).
Choose the CORRECT option describing Arthur's next plausible actions.

a) According to the consumption smoothing model, he will reduce his monthly household con-
sumption indefinitely.
b) According to the consumption smoothing model, he will keep his monthly household con-
sumption constant, even in the two months where his income is less.
c) This is a temporary shock to his household income, but one with long term effects on his
lifetime consumption.
d) According to the consumption smoothing model, he will reduce his monthly household con-
sumption only for the two months where income is lower.

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 SECTION B
DESCRIPTIVE QUESTIONS
(40 Marks)

QUESTION 1 (5 Marks)

The diagram below graphically illustrates unemployment at labour market equilibrium and unem-
ployment when there is cyclical unemployment (deficient demand). Point X denotes the labour mar-
ket in equilibrium and point B denotes the labour market when there is deficient demand in the eco -
nomy.

Real wage Broad labour force

w=

wPS B X
Price-setting curve

Wage-setting curve G

0
Employment, N (whole economy)

1.1 Describe how automatic adjustments in this economy may decrease unemployment in the
labour market by moving from point B to point X. [3]

1.2 Explain two reasons why automatic adjustments in the economy may not work smoothly in
practice. [2]

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QUESTION 2 (5 Marks)

The figure below depicts Firm X's demand curve given the economy-wide demand, and several of its
iso-profit curves. Firm X faces a linear demand curve. The workers' average product of labour, λ,
equals 1.

Isoprofit curves

A
Price, p ($)

B
p*

C
W
Wage
Demand curve

q*

Units of output, q (and hours of labour, n)

2.1 Would Firm X prefer to operate at point A or at point C? Give a reason for your answer. [1]

2.2 Now consider the full labour market model and answer the following questions:

2.2.1 At a given mark-up, if labour productivity decreases, what will happen to equilibrium
employment? [2]

2.2.2 Explain why the following statement is FALSE:

"If the price level in the economy increases, then real wages will always decrease."
[2]

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QUESTION 3 (4 Marks)

The table below includes information about the labour market of the Republic of Velen in 2021. Sup -
pose the Republic of Velen uses the same labour market definitions and formulae as South Africa.

Population of working-age 350 000

Number of people employed A
Number of people narrowly unemployed B
Number of people in the narrow labour force 73 000
Number of people in the broad labour force C

Narrow unemployment rate 8%

Broad unemployment rate 14%
Narrow participation rate 20.857%

Calculate the values for the missing numbers A, B and C respectively. Round your answers to the
nearest integer, where applicable. [4]

QUESTION 4 (7 Marks)

Braxton-Lee receives an endowment of R500 worth of grain today. If she decides to invest her full
endowment, she can borrow to consume today.

If Braxton-Lee stores her grain it will depreciate at a rate of 35% between now and later. She can
both lend and borrow at an interest rate of 17%, and if she invests her endowment, she will realise a
return of 45%.

IV.1 Draw two curves on two separate graphs showing Braxton-Lee's feasible frontiers for con-
sumption now and consumption later if she decides to:

IV.1.1 Consume now and store whatever remains of her endowment. Round all values to the
nearest integer.
[2]
IV.1.2 Invest the full endowment and borrow to consume now. Round all values to the nearest
integer. [2]

IV.2 Assume that the interest rate at which Braxton-Lee can lend and borrow increases from
17% to 20%. Explain the substitution effect of this interest rate increase on current con-
sumption if Braxton-Lee borrows to finance her current consumption. [2]

IV.3 If Braxton-Lee invests her full endowment and borrows to consume now, she will choose to
consume R250 now. Calculate her discount rate. [1]

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QUESTION 5 (6 Marks)

5.1 The figure below shows Claire's indifference curve (IC).

Consumption later, R

53 A
B
50

Claire's IC

0 49 50

Consumption now, R

5.1.1 Explain why Claire's indifference curve illustrates that she has pure impatience. [1]

5.1.2 Briefly explain one reason for pure impatience. [1]

5.2 Suppose Aphiwe is more impatient than Lwazi.

5.2.1 Draw an intertemporal (consumption now and consumption later) indifference curve for
Aphiwe and one for Lwazi on the same graph. Clearly indicate which indifference curve
belongs to Aphiwe and Lwazi, respectively. You do not need to include feasible frontiers
on your graph. [3]

5.2.2 Does Aphiwe or Lwazi have a higher discount rate? Briefly explain your answer.
[1]

QUESTION 6 (3 Marks)

6.1 Commercial banks provide the service of maturity transformation. Briefly explain what is
meant by the concept "maturity transformation". [2]

6.2 Commercial banks borrow money from the central bank at the policy interest rate. What is
South Africa's policy interest rate called? [1]

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QUESTION 7 (4 Marks)

Data from 1970 to 2013 for Germany's economy indicates that Okun's Law can be written as:

y = -0.205x + 0.533

where:
y is the change in the unemployment rate, and
x is the real GDP growth rate.

7.1 Explain why the following statement is FALSE:

"When the real GDP growth rate is 0%, the unemployment rate in Germany remains stable."
[2]

7.2 Compared to Germany, the correlation between output and unemployment in Brazil is
much smaller. Explain how Okun's coefficient and steepness of the regression line for Brazil
will compare to that of Germany. [2]

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QUESTION 8 (6 Marks)

The graph below shows the natural log of real GDP per capita for South Africa between 1985 and
2015. The dashed line shows the average annual growth rate.

11

f(x) = 0.00966092186027869 x + 10.6010853019499

10.9
Natural log of Real GDP per capita

10.8

10.7

10.6

10.5

10.4
85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19
19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20

8.1 Referring to the above graph, explain why the following statement is FALSE:

"Real GDP per capita growth between 2005 and 2015 was higher than the average annual
growth rate". [2]

8.2 Define the concept of "GDP". [2]

8.3 Investment spending accounted for 14.1% of total South African real GDP in 2020, and the
change in investment contributed to -5.9% of the total -7.1% change in real GDP.
What was the percentage change in investment spending in 2020? Show your calculations.
[2]

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