Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

ECON1012
Principles of Economics II
Tutorial Sheet Answers
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Table of Contents
Problem Set 1: Elasticity......................................................................................................................... 3
Problem Set 2: The Consumption Decision ............................................................................................ 5
Problem Set 3: The Production Decision .............................................................................................. 13
Problem Set 4: Market Power ............................................................................................................... 16
Problem Set 5: Strategic Behaviour ...................................................................................................... 18
Problem Set 6: Money and Banking ..................................................................................................... 22
Problem Set 7: Employment ................................................................................................................. 24
Problem Set 8: Fluctuations ................................................................................................................. 31
Problem Set 9: Inequality ..................................................................................................................... 34
Problem Set 10: Public Finance ........................................................................................................... 39
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 1: Elasticity

1. Calculate the price elasticity of demand.

a) When the price of a phone call increases from $8 to $12, the volume of calls falls
from 25,000 per hour to 15,000.

PED= ∆Q/∆P= (-10,000/20,000)/ (4/10) = -1.25

b) New car dealers currently sell approximately 1,650 vehicles annually at an

average price of $4 million. They have told the government that if the proposed
higher import duty raises the price of new cars by $½ million, they expect their
sales to fall by about 300 per year.

PED= ∆Q/∆P= (-300/1,500)/ (500,000/4,250,000) = -1.7

2. Reflecting on the factors that influence elasticity of demand, put the commodities in each
set in order of their likely price elasticities (from highest to lowest).

a) Beverages, orange drinks, box drinks, Juicily orange drinks.

- Juiciful Orange Drinks, Orange Drinks, Box Drinks, Beverages
- Above was sorted based on substitutability

b) Shoes, rent, pens, transportation

- Rent, Transportation, Shoes, Pen
- Above was sorted based on Budget Share

c) Electricity consumption, weekends at beach resorts, eating out with friends,

kitchen appliances
- Weekends at Beach Resorts, Eating Out with Friends, Kitchen
Appliances, Electricity Consumption
- Above was sorted based on Necessity Vs. Luxury
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

3. Suppose an economist estimates that the demand for movie tickets exhibits price
elasticity of 0.75. How would you respond to Palace Cineplex’s enquiry about the
wisdom of a contemplated increase in the price of tickets?

- When price increases, and the good is inelastic, the revenue increases.
Therefore, since PED<1, the movie tickets are inelastic. Therefore,
Palace Cineplex would benefit from the increase in price as they would
face an increase in revenue.

4. For each of the following product pairs, what is the likely sign of the cross price elasticity
of demand?

a) Ackee and salt fish: complements XED -

b) Patty and coco bread: complements XED -
c) Pants and skirts: substitutes XED +
d) Books and photocopying: substitutes XED +
e) Petrol and phone calls: substitutes or complements

5. When the price of widgets was reduced from $600 to $450, the quantity of tingdeers went
from 9,000 to 11,000 per month. Calculate the cross price elasticity? Are widgets and
tingdeers substitutes or complements?

- XED= ∆Qa/∆Pb= (2000/10,000)/ (-150/525) = -0.7

- The Goods Are Complements

6. Average real incomes in Dominica last year increased by 4 percent, while taxi ridership
went up by 3 percent. What is the income elasticity of demand of taxi transportation? Is it
a normal or an inferior good?
- YED= %∆Q/%∆Y=0.03/0.04= 0.75
- Taxi Transportation is a normal good, and it is inelastic as well
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 2: The Consumption Decision

1. Gertrude had a weekly income of $9. At that time, a bulla sold for $1 and a drink for
$1.50.
a) What is Gertrude’s real income in terms of bullas?
- $9/$1= 9 Bullas
b) What is her real income in terms of drinks?
- $9/$1.50= 6 Drinks
c) What is the relative price of a drink (in terms of bullas)?
- Amount of Bulla one has to give up for One Drink: 1.5 Bulla
d) Sketch Gertrude’s budget constraint (placing drinks on the vertical axis).

GERTRUDE’S BUDGET CONSTRAINT TABLE

Drinks Bullas
0 9
2 6
4 3
6 0

Gertrude's Budget Constraint Graph

7

4
Drinks

0
0 2 4 6 8 10
Bullas

e) Suppose she chooses to consume 3 bullas and 4 drinks per week. Is she
satisfying her budget constraint?
- Yes, she is, as she is allocating her income efficiently, and this point is
also a point on the Budget Line
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

f) Sketch the budget line if the price of bullas rises to $2 and all other values
remain unchanged.
GERTRUDE’S BUDGET CONSTRAINT TABLE

Drinks Bullas
0 4.5
2 3
4 1.5
6 0

Gertrude's Budget Constraint Graph

7

4
Drinks

0
0 1 2 3 4 5
Bullas
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

g) Sketch the budget line if the price of drinks rises to $3 and all other values
remain at their original levels.

GERTRUDE’S BUDGET CONSTRAINT TABLE

Drinks Bullas
0 9
1 6
2 3
3 0

Gertrude's Budget Constraint Graph

3.5

2.5

2
Drinks

1.5

0.5

0
0 2 4 6 8 10
Bullas
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

h) Sketch the budget line if Gertrude gets a raise to earn $18 a week and prices
remain at their original levels.

GERTRUDE’S BUDGET CONSTRAINT TABLE

Drinks Bullas
0 18
4 12
8 6
12 0

Gertrude's Budget Constraint Graph

14

12

10

8
Drinks

0
0 5 10 15 20
Bullas

i) Supposes all changes take place together: the price of bullas rises to $2, the price
of drinks rises to $3, and Gertrude gets a raise to earn $18 a week. How does the
new budget line compare to the original one?
- It will be the original budget line, as although the income doubled, the
prices of the goods doubled as well. Therefore, the original budget line
will be the same as the new one.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

2. Sketch the budget constraint for a prisoner at the general penitentiary who has been
smuggled a pack of cigarettes (with 20 cigarettes) if one cigarette can be traded for two
cell-phone calls.
PRISONER’S BUDGET CONSTRAINT TABLE

Cigarette Phone Call

20 0
16 8
12 16
8 24
4 32
0 40

Prisoner's Budget Constraint

45
40
35
30
Phone Call

25
20
15
10
5
0
0 5 10 15 20 25
Cigarette
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

3. Consider the consumption bundles indicated on the

diagram. For each of the following pairs, determine
if one is preferred to the other (i) with certainty, (ii)
likely but not with certainty, or (iii) can’t say at all.
Explain your reasoning. [Hint: sketch some possible
indifference curves]

a) D and E
- D is preferred to E, as it is the bundle
of goods with more of each, with
certainty.
b) C and D
- D is preferred to C with certainty,
as one can get more pants than in C.
c) A and C
- This depends on the consumer. If the consumer
prefers shoes, then they may prefer A. However,
if the consumer is indifferent or the rational
consumer, it is likely that they will pick C.
Therefore, C likely but not with certainty.
d) B and C
- B and C are likely on the same indifference curve,
so cannot say at all.
e) C and E
- This depends on the consumer. If the consumer
prefers pants, then they may prefer E. However,
if the consumer is indifferent or the rational
consumer, it is likely that they will pick C.
Therefore, C likely but not with certainty.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

4. Suppose your preferences are reflected in the indifference

map shown. A burger costs $100 and a slice of pizza sells for
$50. You have a food budget of $500 per week.
a) How many burgers and slices of pizza will you
consume in a typical week? Explain your choice.
- Where the budget line and the indifference
curve meet, at the highest point, that is where
the consumer will consume.
- 6 Pizzas and 2 Burgers
b) Demonstrate the effect on your consumption choice if
pizza falls in price.
- The consumer will likely buy more pizza; the budget line will pivot to
represent that more pizza will be bought. It will pivot more upwards, or
become steeper given the graph above. The consumption of burgers may
also fall, as it has become more expensive. Additionally, now that the
consumer has more real income, they may also buy more burgers.
Therefore, the effect on burgers is not known.

5. Your budget is spent on either food or entertainment, both being normal goods. Suppose
there is a rise in the price of food.
a) In what direction would the substitution effect push the consumption of food?
[Hint: The substitution effect measures the effect of what on what? What is the sign of the effect? In
which direction has the relative price of food changed? So in what direction will the consumption
of food change?]
- Since the price of food increases, the consumption of food will decrease.

b) In what direction would the income effect push the consumption of food?
- Since the consumer has less real income or purchasing power, therefore,
the consumption of food will decrease.

c) In what direction would the substitution effect push the consumption of

entertainment?
- Since price of food increases, people will buy less food and shift to more
entertainment. Therefore, consumption of entertainment will increase.

d) In what direction would the income effect push the consumption of entertainment?
- Now that a consumer’s real income is less, they may consume less
entertainment.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

e) If you know that consumption of entertainment falls, what would you conclude
about the relative magnitudes of the income and substitution effects?
- This shows that the income effect is greater than the substitution effect.
This is so as the consumption of entertainment has fallen, and the
income effect is larger than the substitution effect.

6. Assume both goods are normal goods. On a diagram

similar to the one at right, show the location of the new
consumption choice when there is a fall in the price of…
a) good X, if the substitution effect dominates.
b) good X, if the income effect dominates.
c) good Y, if the substitution effect dominates.
d) good Y, if the income effect dominates

Answer
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 3: The Production Decision

1. The diagram provides isoprofit and demand curves for a
typical firm.
a) On the Q axis, identify the profit-maximizing level
of output. Point A
b) On the $ axis, indicate the average revenue per unit
sold. Point B (AR= TR/Q= (PQ)/Q=P)
c) On the $ axis, indicate the average cost per unit
sold. Point C (wherever, at Point A, touches AC)
d) On the $ axis, indicate the profit per unit.
The Area shaded in Blue between B and C

2. Draw an isoprofit map and demand curve for a firm that is making a loss

Average Cost

AC Curve
AR

3. Calculate and sketch the corresponding isoprofit curve over the range one to six units per
month for a business that wants to make a profit of $600 per month where
a) it has a constant cost per unit of $400

Avg Profit Avg Cost Price

1 600 400 1000
2 300 400 700
3 200 400 600
4 150 400 550
5 120 400 520
6 100 400 500
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Isoprofit Map
1200

1000

800

600

400

200

0
0 1 2 3 4 5 6 7

b) It has fixed costs of $300 and variable cost of $50 for the first unit which then
rises by $50 for each additional unit produced.

Avg Profit Avg FC Avg VC Price

1 600 300 50 950
2 300 150 100 550
3 200 100 150 450
4 150 75 200 425
5 120 60 250 430
6 100 50 300 450

Isoprofit Map
1000
900
800
700
600
500
400
300
200
100
0
0 1 2 3 4 5 6 7
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

4. In the short run, which of the following costs for StayFresh Bakery Company are likely to
be fixed costs and which variable?
a) Flour: Variable
b) Wages for workers in the bakery: Variable
c) Rental for the executive offices: Fixed
d) Rental for the bakery plant: Fixed
e) The salary of the Chief Executive Officer: Fixed
f) Plastic bags in which the bread is packaged: Variable
g) Advertising and Marketing expenses: Variable
h) Petrol for the delivery trucks: Variable and Fixed

5. Suppose the pan chicken man pays protection money of $500 a night to the area leader,
fuel for a night’s worth of flame is $200, and chicken parts and spices for one serving of
chicken cost $100.
a) Which costs are fixed and which are variable?
- Protection Money is Fixed
- Fuel Fee is Fixed
- Chicken Parts and Spices are Variable
b) For the first through the fifth customers, calculate the vender’s (i) total cost, (ii)
average cost, and (iii) marginal cost.
Output FC VC TC AC MC
1 700 100 800 800 -
2 700 200 900 450 100
3 700 300 1000 333 100
4 700 400 1100 275 100
5 700 500 1200 250 100

c) Speculate on what will happen to his average cost as the number of customers
keep growing.
- As the number of customers keep growing, the Average Cost will reduce
until it falls to 100 or the MC.

6. Why is the average cost curve U-shaped?

- The average cost curve is U Shaped as initially; costs will fall until a
certain point. This is where Economies of Scale are setting in. After a
certain point, diminishing returns set in, diseconomies of scale start and
then the AC will increase, which shows the upward sloping section.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 4: Market Power

1) Identify and differentiate the different types of market structures. For each type, suggest a
market (different from the examples used in class) that exemplifies each type.
Name Suppliers Substitutes Entry/Exit Price Examples
Perfect Many Identical None Price Taker FOREX
Monopolistic Many Similar Low Price Maker Hairdresser
Oligopoly Few Dominant Similar Difficult/High Price Maker Media
Industry
Monopoly One Unique Almost Price Maker Utility
Good Impossible Providers

2) Consider the market and cost structure represented in the diagram.

a) Does the firm have market power? How do you know?
- Yes, because the demand curve is downward
sloping and there is an inverse relationship
between Price and Quantity
b) What would be the amount of output supplied if the
market were being served by a monopolist?
- This is where profit is being maximized, or
where the isoprofit is tangential to the demand
curve. Q=6
c) What would be the price?
- P= $60
d) Calculate the amount of consumer surplus.
- CS=Max Price – Min Price = ½ bh = ½ (6) (90-60) = $90

3) Use the diagram to show that a price discriminating

monopolist earns more profit than one charging a
single price. Show further that he enjoys a greater
profit the more he can discriminate (that is, the more
different prices he can charge).

Profit Max is where MR=MC

Marginal Profit = MR-P = 50-40= $10 Per Unit
Total Profit = Price x Quantity = 10 x 8= $80
4 Units @ 70 and 4 Units @ 50
- 4(70-40) + 4(50-40) = $160
2 Units @ 80, 2 Units @ 70, 2Units @ 60, 2 Units @ 50
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

- 2(40) + 2(30) + 2(20) + 2(10) = $200

Therefore, Price Discrimination Allows to Earn More Profit

4) At the current price of $63, firms in this (perfectly

competitive) market are each producing 8.4 million widgets
each year. (The quantities on the horizontal axis are
measured in millions.) What will be the price and the
typical firm’s level of output in the long run?
- In the short run and at the current level of
output, P>AC= Economic Profit
- In the long run, P=40 and 8 is the output.
P=AC, where they will be making a normal profit
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 5: Strategic Behaviour

1. In preparing for the School’s Challenge contest against each other, both Wolmer’s and
Merl Grove estimate that a win is worth 20 units (of some measure of happiness), a tie is
worth 5, and a loss is zero. But preparation is costly. Preparing “a lot” incurs a cost of 10
units; “a little” preparation costs only 6. Whichever school prepares more than the other
will win. If they prepare the same amount, they will tie. [adapted from Frank &
Bernanke]
a) Construct the payoff matrix for this game.
b) Do the schools have a dominant strategy?
c) Is there a Nash equilibrium? From the school’s perspective, is it the best
outcome?
Answer (a)
Payoff Matrix
Wolmer’s
Merl Grove A Lot A Little
-5 -6
A Lot -5 10

A Little 10 -1
-6 -1

Explanation
- If both schools prepare “A Lot”, they will tie, so therefore, they both face a cost of 10
units, but get 5 units as well
- If Merl Grove prepares a lot, but Wolmer’s prepares a little, Merl Grove will win, and
face a cost of 10 units. Wolmer’s will face a cost of 6 units
- If Wolmers prepares a lot and Merl Grove prepares a little, Wolmers will win, and face
a loss of 10 units, and Merl Grove will face a loss of 6 units
- If both schools prepare “A Little” they will tie, and face a loss of 6 units, while gaining
5 units.
Answer (b)
The Dominant Strategy is Prepare a Lot for Both
 If Wolmers Prepares a lot, Merl Grove will also prepare a lot and if Wolmer’s prepares a
little, Merl Grove will also prepare a lot and vice versa
Answer (c)
The Nash Equilibrium occurs when they both prepare a lot, and it is at (-5, -5). Both schools will
not want to deviate, as they will receive less payoff.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

2. Javon and Roxanne want to celebrate the first anniversary of their relationship and plan to
meet after work. As Javon is leaving work, he realizes that he does not remember which
of two options they had finally agreed on to attend – the movies or the football match,
both of which start at the same time. Roxanne could not be reached by phone and would
be waiting at one of them. Both Javon and Roxanne prefer to spend their anniversary
together rather than at separate events. Javon prefers the football match and Roxanne
prefers the movies.
a) Construct a payoff matrix to reflect Javon’s problem. You may use numbers (0,
1, 2, 3) to represent the levels of satisfaction associated with each outcome.
b) Does either person have a dominant strategy?
c) Identify the Nash equilibria

Answer (a)
Payoff Matrix
Javon
Roxanne Football Movie
3 0
Football 2 0

Movie 1 2
1 3

Answer (b)
 If Roxanne is at Football, Javon would prefer the Football, and if Roxanne is at the
Movies, then Javon would prefer the movies and vice versa
 Therefore, there is no dominant strategy
Answer (c)
 The Nash equilibrium is Football and Football and Movies and Movies
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

3. The owner of a Kingston business wants to open a branch in Port Antonio. If the manager
he hires is honest, the owner can afford to pay that person $4m a year, which is $1m more
than he can earn elsewhere, and still earn a gross profit of $2m. The alternative use of the
capital for the owner is to put in on deposit and earn $1m in interest. The owner’s
concern is that, because he cannot directly monitor the business, the hired manager will
be able to embezzle money. If the branch is managed dishonestly, the manager can
embezzle $1m a year and the effort to mask the embezzlement will end up creating a loss
to the business of $1m a year. [Note that this game is not symmetrical. The players do not
have parallel strategies.]
a) Set up the payoff matrix.
b) Should the owner open the business?
c) The owner is told by the police’s Fraud Squad that all managers know of the
squad’s perfect record of catching and convicting embezzlers, who then have
to pay a $2m fine. How does this change the matrix? Will the owner now open
the business?

Answer (a)
Payoff Matrix
Owner
Manager Open Branch Don’t Open
2 1
Be Honest 4 3

Embezzle -1 1
5 3

Answer (b)
If the owner decides to open a new branch, the manager will embezzle. If the owner does not
open the branch, the manager will not embezzle from him. So the owner should not open the
branch.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Answer (c)
Payoff Matrix
Owner
Manager Open Branch Don’t Open
2 1
Be Honest 4 3

Embezzle -1 1
3 3

4. Since the marginal cost of transmitting a call when call traffic is low is zero, the cellular phone
companies would earn higher profits by charging for calls made between midnight and 6am, yet
both Digicel and Flow offer “free nights”. Why?

- “If one didn’t then persons are going to move from them & they’re going
to end up losing market share. They’re always trying to undercut each
other”

5. “Advertising is a waste of resources that could otherwise be used to produce useful goods and
services.” Use a game theoretic argument to discuss this statement.
- If firms that are competing for the limited budget of customers don’t
advertise, they will share the market without having to spend on
advertising and so, earn higher profits. If they all advertise, they will still
share the same market, but with the cost of advertising, thus having low
profits. So, no advertising is the most profitable outcome for all parties.
But it is not a Nash equilibrium. If no one is adventuring, any firm can
increase its profit by advertising and thereby gaining market share. It will
then suit the other firm to also advertise so as to not lose market share.
So, competitive advertising, while it does not constitute part of the actual
product cost of goods and services and so it is wasteful in that respect, is
a Nash equilibrium
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 6: Money and Banking

1. A banking system has $500m in chequing deposits, $600m in savings deposits, $950m in
loans to consumers and businesses, $400m in government securities, and $50m in
currency. Private individuals are holding $100m in cash.
a) What is the value of reserves?
b) What is the value of the money supply?
c) What is the reserve ratio on chequing deposits?

Answer
a) $50 Million- Currency
b) Money in Holding + Demand Deposits= $100 + $500= $600 M
c) (Reserves/Checking Deposits) x 100= 10%

2. Visit the Bank of Jamaica web site at www.boj.org.jm. Go to: Statistics / Economic Data
/ Monetary Authorities / Monetary Survey Local Currency Only. Download and open the
spreadsheet.
a) Which of those columns reflect the “M1” definition of the money supply?
b) How much was the money supply in June 2016?
c) What portion of M1 was made up of currency in August, October, and December
2016? Does that pattern exist in previous years? Why do you think that is?
Answer
a) Currency in Circulation and Local Currency Demand Dep.
b) $151,270.4 M
c) 44.8%, 44.7%, 47.2% (August, October, December), Christmas season, therefore, there
would be more money in circulation

3. Calculate the value the money supply (assuming the public holds no currency) if
a) the amount of reserves is $4,000 and the reserve ratio is 25%.
b) The amount of reserves is $45.6b and the reserve ratio is 14%.
c) The amount of reserves is $45.6b and the reserve ratio is 100%

Answer
Money Supply= MM x R; MM= 1/rr
a) 1/0.25; MS= 16,000
b) 1/01.4; MS=325.71
c) 1/1; MS=45.63
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

4. Look again at the information in question 1 above. Suppose the central bank conducted
an open market purchase of $50m. After the banking system had time to fully adjust, and
assuming there is no change in the reserve ratio, the desire to put money in savings
accounts, or the amount of cash that people desire to hold.
a) What is the value of reserves?
b) By how much will the money supply have expanded?

Answer
a) Reserves Increase by $50 Million, so Reserves are now $100M
b) 1/rr=1/0.1=10=MM
MS=M x R= 10 x 50= $500 M

5. What do you expect to happen to the money supply if…?

a) The central bank sells securities on the open market.
b) The central bank raises the rate of interest it is offering on its 30-day certificates-of-
deposit.
c) The central bank lowers the reserve requirement from 12% to 10%.
d) Due to a widespread expectation of hard times ahead, banks choose to limit their
exposure to bad debts and increase their holdings of excess reserves.
e) The central bank raises the borrowing rate for commercial banks at its discount
window.
f) The government receives a U.S. dollar loan and exchanges it for local currency at the
central bank so it can pay public sector salaries in Jamaican dollars.
g) People withdraw money from their bank accounts to have cash for Christmas
shopping.
h) The use of debit cards grows in popularity.
Answer
a) Reserves Decrease, Money Supply Decrease, Loans available to give out Decreases
b) Reserves Decrease, Money Supply Decrease, People Save More
c) Money Supply increases, Loans available to give out Increases
d) Money Supply decreases, Less Loans available to give out
e) There will be less borrowing by the Commercial Bank, Money Supply decreases
f) Money Supply increases, Foreign Exchange Increases, More Loans Available to Give out
g) Money Supply decreases, Less Reserves
h) Money Supply increases, since money needs to be in the bank to use the debit card, more
lending occurs, more reserves as well
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 7: Employment

1. The table shows the number of coconuts that can be picked daily for each staff
complement. Coconuts sell for $70 each and the prevailing daily wage is $500.
a) Calculate the marginal product of labour schedule.
b) Calculate the value of marginal of product schedule.
c) Sketch the farm’s labour demand curve.
d) How many workers will the farm hire? How many coconuts will it sell?
e) Suppose the Ministry of Labour sets a minimum wage of $800 per day, how many
workers will be hired?
Answer (a)
Number of Workers Output Marginal Product
1 25 25
2 45 20
3 60 15
4 72 12
5 80 8
6 85 5

Answer (b)
Number of Workers Output Marginal Product Value of Marginal
Product (P x MP)
1 25 25 1750
2 45 20 1400
3 60 15 1050
4 72 12 840
5 80 8 560
6 85 5 350
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Answer (c)

Labour Demand Curve

2000
1800
1600
1400
1200
1000
800
600
400
200
0
0 1 2 3 4 5 6 7

Answer (d)
Firms will hire 5 workers and sell 80 coconuts
Answer (e)
Firms will hire 4 workers
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

2. A garment factory’s production function is provided in the table. The gross profit per unit
(difference between selling price and material cost, but not including the cost of labour)
is $100.
a) If the wage rate is $1,000 a week, how many workers should the factory hire?
b) If a surge in popularity for the factory’s brand allows them to raise the product
price such that the gross profit rises to $150, how many workers will the factory
hire now?
c) c) Calculate the number of garments produced in each of the two cases above.

Answer (a)
Number of Workers Output Marginal Product Value of MP
1 20 20 2000
2 36 16 1600
3 48 12 1200
4 56 8 800
5 60 4 900
6 62 2 200

Firm should hire 3 Workers

Answer (b)
Number of Workers Output Marginal Product Value of MP
1 20 20 3000
2 36 16 2400
3 48 12 1800
4 56 8 1200
5 60 4 600
6 62 2 300

Firm should hire 4 Workers

Answer (c)
P=$100; 48 and P=$150;56
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

3. Wickerama hires weavers to make wicker chairs that it sells to Courts for $2,500 each.
The wicker for each chair costs $500. The company currently has three employees. Ras
Niah can make five chairs per week; Ras Binghi can complete seven, and Ras Tamman
can produce ten each week. If the labour market is competitive, how much (at most) is
the weekly wage in this economy?

Answer
Workers Marginal Product VMP
1 10 20,000
2 5 14,000
3 7 10,000

Value Added or Gross Profit= 2500-500= $2,000

The Wage is $1000 at Most

4. Show on a diagram of the labour market how each of the following events will affect the
equilibrium wage and level of employment. (Sketch the labour market diagram and
determine whether one of the curves is affected by each stimulus and in which direction it
shifts.)
a) Boatloads of Haitian migrants arrive in the country.
b) Worldwide demand for our exports surge.
c) The income tax rate is increased from 25 percent to 35.
d) Fundamentalist Islamic law is adopted which prevents women from being
allowed to drive.
e) Improvements in education and training raise the general level of productivity.
f) The real minimum wage is raised
Answer (a)

This causes an increase in Labour Supply (Supply Curve Shift to the Right) and a decrease in
the wage rate
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Answer (b)

This causes an increase in demand for labour (Shift of Demand Curve to the Right), which
increases the wage rate as well.
Answer (c)

This causes a decrease of supply for labour (Shift of Supply Curve to the Left), which
increases the wage rate as well.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Answer (d)

This causes a decrease of supply for labour (Shift of Supply Curve to the Left), which
increases the wage rate as well.
Answer (e)

This causes an increase in demand for labour (Shift of Demand Curve to the Right), which
increases the wage rate as well.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Answer (f)

5. The labour force is 1.5 million people and the latest employment survey finds that 1.35
million of them are currently employed. Calculate the unemployment rate.

Unemployment Rate= (Unemployed/Labour Force) x 100

Unemployment Rate= ((Labour Force-Employed)/Labour Force) x 100
= (1.5-1.35)/1.5 x 100 = 10%

6. Identify which category of unemployment each of the following persons would belong to.
a) Rahul’s wife is transferred to the Santa Cruz branch of her bank, so he has to
leave his job as a teacher at Campion and is trying to get a job a school near to
Santa Cruz.
b) A global economic slump reduces Caribbean tourist traffic.
c) Digicel buys out Claro Jamaica and lays off Claro’s now redundant administrative
staff.
d) The contraction of the sugar industry idles cane cutters while the demand for IT
workers remains unsatisfied.
e) As production processes become more sophisticated, people who leave school
without CXC subjects are unable to find employment.
Answer
a) Frictional
b) Cyclical
c) Frictional
d) Structural
e) Structural
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 8: Fluctuations

1. Explain why and show how each of the following events will disturb the aggregate
demand / aggregate supply model. (Which curve is shifted? In what direction? And
why?)
a) Jamaica becomes a popular destination for Asian tourists.
b) A new, cheaper source of energy is developed.
c) The central bank conducts an open market purchase of securities.
d) The central bank raises the lending rate at its discount window.
e) Jamaica opens its borders to large scale immigration of Haitians.
f) The government employs people to sweep already clean streets as a way to create
employment, financed by additional taxation.
g) The government employs people to sweep already clean streets as a way to create
employment, financed by borrowing.
Answer
a) AD shifts to the right; Increase in exports of services
b) AS shifts to the right; More Production Since Costs have fallen
c) AD shifts to the right; Reserves IncreaseMoney Supply IncreasesLoans
Increases Consumption / Investments Increase
d) AD shifts to the left; Less LendingLess Consumption/Investments Increase
e) AS shifts to the right; More LabourMore Production
f) AD shifts to the right; Government Spending Increases
AD shifts to the left; More TaxesLess Consumption
g) AD shifts to the right; Government Spending Increases
AD shifts to the left; Less LendingLess Consumption/Investment “Crowding Out
Effect”

2. Consider the goods market for the economy represented in the diagram. The full-
employment level of output in this economy is 4 units of output.
a) How much is the equilibrium level of output in the
short run.
b) Suppose the loss of a major export market reduces
aggregate demand by 2½ units at the existing price
level. Shift the appropriate curve and show the new
equilibrium level of output in the short run?
c) Shift the appropriate curve and show the new
equilibrium level of output in the long run?
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Answer
a) 5 at Price 7
b) The shift will now be the AD curve to the left, to 3 units at Price 5
c) Current Employment Level=3, Full Employment Level= 4
Recession  Unemployment Fall in Prices including wagesFirms hire more
labourMore ProductionAS shifts to the right

3. Starting from a position of effective full employment, suppose there is a housing market
contraction that reduces the value of the housing stock. What effect will this event have
on the price level and on GDP in the short run? What do you expect to happen in the long
run?
Answer
Housing Market Contraction  Fall in the
Value of Housing Stock Fall in the Price of
HousingReduces WealthReduces
Consumption and Investment Shift of AD
to the Orange Curve (Short Run, So Price
Level Falls and GDP Falls)

In the Long Run, the AS curve will shift to

the Blue one, at the Blue Point, representing
more production

4. The construction of highways in Jamaica over the last few years has increased the
productive capacity of the economy (that is, the full employment level of output). Use the
goods market model to describe the sequence of events that should follow such a
development.
Since there as increase in the productive
capacity following the construction of
highways, there is a shift towards the right
from LRAS to the blue curve. As a result,
higher production levels are attainable,
therefore, there is a shift towards the right of
the SRAS curve to the orange. The Blue point
represents the new equilibrium.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

5. Suppose a slowdown in the world economy precipitates a decline in the demand for our
exports. The local economy will slip into a recession. Can a policy-maker do anything to
ameliorate this situation?
Answer
Decline in exports AD shifts to the left
Monetary Policy
 Reducing Interest Rates Increases Money Supply
 Increases Consumption and Investment
 AD increases and shifts to the right
Fiscal Policy
 Increasing Government SpendingIncreases AD
 Reducing TaxesIncreases Disposable Income, Consumption and Investment
 AD increases and shifts to the right
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 9: Inequality

1. State whether each variable is a stock or flow: (a) GDP, (b) the public debt, (c)
expenditure, (d) your electricity usage, (e) tuition fees.
Answer
a) Flow
b) Stock
c) Flow
d) Flow
e) Flow

2. The island of St Claire has ten residents. Four are small scale farmers, each of whom
earns an income of $200 per year. Four are businesswomen, each of whom earn $500 per
year. One resident owns a large factory and makes $1,200 per year and one is
unemployed. Construct a table with the distribution of income by quintiles (fifths of the
population).
Answer
Residents Income Share Quintiles
Unemployed 0 0
Farmer 1 200 5% 5
Farmer 2 200 5% 10
Farmer 3 200 5%
Farmer 4 200 5%
Business 1 500 12.5% 17.5
Business 2 500 12.5%
Business 3 500 12.5% 25
Business 4 500 12.5%
Factory Owner 1200 30% 42.5

3. After a comprehensive survey is conducted, you are presented with the accompanying
data on the total incomes of the “upper class”, the “middle class”, and the “lower class”
in five parishes. Rank them in order of inequality? How did you make your
determination?
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Answer
Parish Share of Upper/Lower Share of Upper/Total
St. Andrew 880/440 = 2 880/1980 x 100 =44.4%
St. Bernard 812/290= 2.8 812/1653 x 100 =49.1%
St. Cecelia 1144/520= 2.2 1144/2496 x 100 =45.8%
St. Dominic 9.88/380= 2.6 988/2052 x 100 =48.1%
St. Michael 384/160= 2.4 384/816 x 100 =47.1%

4. Consider an economy in which: unskilled labour is paid $10,000 per week; a university
education allows a person to get a professional job that adds a premium of $15,000 per
week on top of that; and the typical business pays a weekly profit dividend of $40,000. A
small community in this economy consists of three households. The first household
consists of a single mother who works as receptionist; the second is professional couple,
the husband being a doctor and the wife works as an actuary; in the third household, a
retired man lives off the dividend from his business while his wife lectures at the local
university. Draw the Lorenz curve for this community.
Answer
1st Household= 1 x $10,000= $10,000
2nd Household= (2 x 10,000) + (2 x 15,000) = $50,000
3rd Household= (1 x $10,000) + (1 x $15,000) + (1 x $40,000) = $65,000
Total Income= $125,000
1st Household = 8%
2nd Household= 40%
3rd Household= 52%

Lorenz Curve
120

100

80

60

40

20

0
0 0.5 1 1.5 2 2.5 3 3.5
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

5. Explain how each of the following events is likely to affect the distribution of income in a
country.
a) The country, a poor one, withdraws from the World Trade Organization and erects
high tariff barriers. As a result, the level of both imports and exports fall.
b) A successful public education campaign reduces the incidence of unmarried
pregnancies and more children are raised in households with both parents present.
c) A devastating earthquake damages all the buildings in Kingston.
Answer
a) Increases unequal distribution
b) Decreases unequal distribution
c) Decreases unequal distribution

6. The income of the five residents of a small rural community range from $100 to $500 in
increments of $100. Use as a measure of inequality, the ratio of the earnings of the top
40% of the population to that of the bottom 40%.
a) If there are no taxes of any kind, calculate the value of the inequality index.
b) Suppose an income tax is introduced at a uniform rate of 10%. Calculate the
inequality index based on the residents’ disposable (after tax) income. What do
you conclude about the effect of proportional taxes on inequality?
c) Suppose instead that incomes less than $300 are exempt from income tax while
higher incomes are taxed at 20%. What kind of tax is this and what do your
calculations tell you about its effect?
d) Using the uniform 10% income tax rate, suppose that the proceeds from the tax
are distributed in equal portions to all citizens as a transfer payment. (This would
be equivalent to it being used to subsidise a good consumed in equal amounts by
everyone.) What is the value of the inequality index after the tax and transfer?
e) Now instead of an indiscriminate distribution of the income tax proceeds, put it
into a transfer program that benefits only the poorest two households. (This would
be equivalent to a cash transfer program such at Jamaica’s PATH programme).
Which type of redistribution reduces inequality more?
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Answer
a) Total Income= $1,500
Top 40%= 400+500=900
Bottom 40%= 200+100=300
Inequality Index=900/300= 3

b) Table for Answer

Residents Gross Income Tax Disposable Income
1 100 10 90
2 200 20 180
3 300 30 270
4 400 40 360
5 500 50 450

Top 40%= 360+450=810

Bottom 40%= 90+180=270
Inequality Index=810/270= 3

Does Not Have an Effect on Inequality

c) Table for Answer

Residents Gross Income Tax Disposable Income
1 100 0 100
2 200 0 200
3 300 60 240
4 400 80 320
5 500 100 400

Top 40%= 400+320=720

Bottom 40%= 100+200=300
Inequality Index=720/300= 2.4

Progressive Tax, Fall in Unequal Distribution of Income

Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

d) Table for Answer

Residents Gross Income Tax Disposable Income
+Transfer
Payment of
(150/5=30)
1 100 10 120
2 200 20 210
3 300 30 300
4 400 40 390
5 500 50 480

Top 40%= 390+480=870

Bottom 40%= 120+210=330
Inequality Index=720/300= 2.64

e) Table for Answer

Residents Gross Income Tax Disposable
Income+ Transfer
Payment of
(75=150/2, for the
Two Poorest
Households)
1 100 10 165
2 200 20 255
3 300 30 270
4 400 40 360
5 500 50 450

Top 40%= 360+450=810

Bottom 40%= 165+255=420
Inequality Index=810/420= 1.93
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Problem Set 10: Public Finance

1. Which of the following examples of public expenditure do you think is economically
valid and why?
a) A new highway connecting the north and south of the island, given that a
narrower roadway already exists.
b) A new training facility for the national cricket team
c) A new school in a rapidly urbanizing community
d) Payments to cover the losses at a garment factory disinvested by a foreign entity
and taken over by the government
e) A subsidy to an international airline to keep it from closing its unprofitable flight
into the country, in order to support the tourist industry
f) A cash transfer programme to provide a minimum income to the poorest families.
g) Government loans to businesses during the economic contraction caused by the
Covid-19 pandemic.
Answer
a) Economically Valid
o This enables producers to reach markets more cheaply, increases size of market area. It
allows workers to choose among a wider array of employment opportunities. Enables
producers to have a broader choice of input suppliers. As it relates to the reduction of
costs, it increases the speed at which producers can reach markets or inputs.
b) Economically Valid
o Allows the team to have better training facilities, improving their skills, may even lead to
world recognition. Additionally, it creates jobs, boosts tax revenue and more
c) Economically Valid
o Since society is growing, the future generation needs to develop as well. Therefore,
children can now be educated within the spaces of their community and grow positively.
This increases human capital and productivity.
d) Not Economically Valid
o Given that the foreign entity has disinvested, the old owners have left the factory.
Therefore, this does not pose any profitability for the local government
e) Not Economically Valid
o Given that this flight is unprofitable, an investment into this company would be draining
finances, and would not yield any returns. There are other airlines and investment
opportunities present in order to support the local industry.
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

f) Economically Valid
o This boosts economic equality and morale to move forward and build income, assets,
finances etc.
g) Economically Valid
o This stops companies from shutting down and in the long run builds the country’s GDP.
Additionally, this retains employment and ensures that the country’s businesses do not
spiral.

2. In Jamaica, income up to $1.5 million per year is exempted from income tax. Income
above that threshold is taxed at a uniform rate of 25%. Is Jamaica’s income tax structure
progressive, proportional, or regressive?
Answer
Progressive Taxation, since people with higher incomes are taxed more

3. What is the relative size of revenue from direct and indirect taxes in the country in which
you live? How does it compare to the shares for India?
Answer
India Shares
Taxes on Income 44%
Property Taxes 0%
Production and Consumption Taxes 31%
Taxes on Trade 5%

Direct Taxes: Taxes on Income and Wealth so 44%

Indirect Taxes: Taxes on Production, Consumption and Trade so 36%
Jamaica Shares
Taxes on Income and Profit 24%
Other 12%
Production and Consumption Taxes 31%
Taxes on International Trade 33%

Direct Taxes: Taxes on Income and Wealth so 24%

Indirect Taxes: Taxes on Production, Consumption and Trade so 64%
Mohitha Chindepalli Compilation of Tutorial Sheet Answers 2023

Jamaica collects a higher share from indirect taxes since imports/GDP ratio is higher in smaller
economies. Therefore, the trade is much more.

4. Consider the following tax types generally used in the Caribbean: income tax, property
tax, general consumption tax, import duty, petrol tax, stamp duties, and transfer tax.
Classify each as either direct or indirect and speculate on which equity principle applies
to each.

Answer
 Income Tax: Direct
 Property Tax: Direct
 GCT: Indirect
 Import Duty: Indirect
 Petrol Tax
 Stamp Duty
 Transfer Tax

5. You are provided with the information in the table, in

billions of dollars, on the government’s budget for the
current fiscal year. Calculate the following

a) Recurrent expenditure
b) The fiscal balance
c) The primary balance

Answer
a) Recurrent Expenditure= All Expenditure (Not Capital Expenditure or Amortisation)
Recurrent Expenditure= Programmes + Interest Payments + Administration= $450 B
b) Fiscal Balance=Revenues-Expenditure
= (Income+VAT+Import Duties+User Fees) – (Recurrent Expenditure + Cap. Exp.)
=530-510= $20 B
c) Primary Balance= Fiscal Balance (excluding the Interest Payment)
=Revenue-(Expenditure-Interest Payment) =530-410= $110B