DEPARTMENT OF ECONOMICS

ECON1000: Principles of Economics

Past Final Exam Questions: Up to May 2019

Unit 1: The Foundation

May 2018 [D]
1. One of the fundamental principles of economics is that “returns eventually diminish”. Explain
what this means and show how it applies to consumption, production, and at least one other
area (unrelated to consumption or production). [10 points]
The principle of diminishing returns in economics suggests as more units of a variable input
(such as labour, capital, or effort) are added to a fixed input, the additional output or benefit
gained will eventually start to diminish.
Production:
In production, the law of diminishing returns implies that if you keep adding more units of a
variable input (like labor) while keeping other inputs constant (like machinery or raw materials),
at some point, the additional output gained from each additional unit of input will decrease. For
example, if a factory has a fixed amount of machinery and adds more workers to produce goods,
at first, each new worker might significantly increase output. However, beyond a certain point,
having too many workers might lead to inefficiencies, overcrowding, or difficulties in
coordination, resulting in diminishing returns. The additional output per additional worker would
start to decrease.

Consumption:
Similarly, the principle applies to consumption. Consider the enjoyment gained from consuming
a specific item, let's say a favourite food or a type of entertainment. Initially, consuming the first
few units of the item can bring significant satisfaction or utility. However, as more units are
consumed, the additional satisfaction gained from each additional unit will gradually decrease.
For instance, the first slice of pizza might be extremely enjoyable, but after several more slices,
the enjoyment per additional slice might diminish as you become full or tire of the taste.

Education:
Another area where diminishing returns can be observed is in education. Initially, each additional
year of education may lead to a substantial increase in knowledge, skills, and earning potential.
However, beyond a certain point, further education might not yield as much incremental benefit.
For instance, obtaining multiple degrees or certifications might not significantly increase job
prospects or earning potential compared to the earlier degrees attained. The law of diminishing
returns in education highlights that there's a point where the additional investment in education
might not generate proportional returns in terms of career advancement or income.

Understanding the principle of diminishing returns is crucial in decision-making, as it helps

individuals and businesses evaluate when the marginal benefit of additional input or
consumption starts to decline, allowing them to optimize resource allocation and make more
informed choices.
 December 2017 [D]
2. A fundamental principle of economics is that “people respond to incentives”.
a) Explain what this means. [6 points]
b) Identify and explain the different kinds of incentives. [4 points]
a- The principle "people respond to incentives" signifies that individuals, whether consumers,
producers, or participants in any economic activity, are motivated to act or behave in a certain
way based on the incentives they perceive. An incentive can be anything that encourages or
motivates individuals to take a particular action. It's a crucial concept in economics as it helps in
understanding and predicting human behaviour in various economic situations.

b-The types of incentives are:

Moral
Material- earnings and costs
Social- praise and criticism Material
Moral- right and wrong
Emotional/Physiological- joy and pain sociational
December 2011 [B]
3. Identify and explain the foundation principles of economics? [10 points]
Incentives ,
Scarcity Real value matters prices reflect scarcity , returns
,
,
eventually diminish
December 2010 [B]
4. Students who drive to the campus complain that they are not allowed to park close enough to
their classrooms and that the parking provided in the main car park beside Sherlock is too far.
How would an economist view this problem? How could it be solved? [10 points]
From an economist's perspective, the issue of insufficient parking close to the classrooms
represents a case of mismatched supply and demand, potentially leading to inefficiencies. The
demand for parking close to the classrooms exceeds the available supply. This scarcity of
parking spaces leads to dissatisfaction among students who drive to campus. Long distances to
park signal an imbalance in supply and demand. This can lead to non-monetary costs for students
(e.g., time wasted walking) or potential loss of productivity, affecting their overall satisfaction.

Potential Solutions:
~
Pricing Mechanisms: Implementing a pricing system for parking closer to the classrooms could
help manage the demand. By charging a higher fee for spots nearer to the classrooms and a lower
fee for spots farther away, it can incentivize those who highly value proximity to classrooms to
pay more, while others opt for more affordable options further away.

Alternative Transportation Incentives: Encouraging alternative modes of transportation, such as

biking, carpooling, or using public transportation, could reduce the overall demand for parking
spaces. Offering incentives like discounted parking passes for carpoolers or providing secure
bike racks closer to the classrooms could be beneficial.

~Infrastructure Improvement: Investing in additional parking facilities or adjusting existing

parking spaces to accommodate more vehicles closer to the classrooms could help alleviate the
shortage. However, this might involve significant costs and space considerations.
 Time-of-Day Parking: Implementing variable pricing or availability based on the time of day
could optimize parking usage. For instance, during peak class hours, prices could be higher, and
availability could be more restricted, while during off-peak times, parking closer to classrooms
could be more accessible and affordable.

In essence, an economist would approach this issue by considering mechanisms that balance
supply and demand, considering both economic incentives and infrastructure adjustments to
optimize the allocation of parking spaces efficiently. The goal would be to address the concerns
of students while ensuring an economically viable and efficient solution to the parking problem.

Unit 2: Specialisation and Trade

May 2019 [D]
5. What is a production possibilities frontier? What is it good for? [10 points]
A production possibilities frontier (PPF) is a graphical representation that shows the maximum
potential output combinations of two goods or services that an economy can produce, given its
available resources and technology at a certain point in time. It typically illustrates the trade-offs
between producing different goods when resources are limited.

The PPF is usually depicted as a curve on a graph, with one good or service on the x-axis and the
other on the y-axis. It showcases the limits of production within an economy, demonstrating the
maximum attainable quantities of two goods or services given the available resources and
technology.
makethat allocationurese outcome outward shift of the PPF
PPF policyThe PPF is beneficial because: OPI , efficiency , economic growth , shows allocation of resources
allocation of
-

Opportunity Cost: It highlights opportunity costs by showcasing the trade-offs between

resources
-
OPL
producing different goods. Moving along the PPF involves reallocating resources from one good
-
efficiency to another, leading to an opportunity cost as the production of one good increases at the expense
- economic of the other.
growth
Efficiency: Points on the PPF represent efficient utilization of resources, where an economy is
producing at its maximum capacity. Points inside the curve denote inefficiency, showing that
resources are not fully utilized.

Economic Growth: Changes in the PPF over time can illustrate economic growth. If an economy
experiences technological advancements or increases in available resources, the PPF can shift
outward, indicating an increase in potential production levels.

Allocation of Resources: It helps policymakers, businesses, and individuals make decisions

about resource allocation. Understanding the PPF can guide decisions on how to best allocate
resources to achieve desired outcomes.

In summary, the PPF is a valuable tool in economics as it visualizes the trade-offs, efficiency,
and potential for growth in an economy, aiding in decision-making and resource allocation.
 May 2015 [P]
6. Suppose that in an hour an American worker can produce 100 shirts or 20 computers, while a
Chinese worker can produce 100 shirts or 10 computers. If each country has 4 hours available,
a) Graph the production possibilities frontier for the United States. [2 points]
The United States can produce 100 shirts in an hour or 20 computers in an hour. With 4
hours available, the maximum output for shirts is 4×100=400 shirts, and for computers,
it's 4×20=80 computers
US Computers
In Ihr >
-
20 COMP 80 -

shirts
4hr > 80
-
compo

> 100
shirts
In Ihr-
O comp 40
4hr- > 400 shirts

Half their time

Ihr >20 comp

2hr-
> 40 comp
200 or
Ihr- > 100 shirts Shirts
2hr- > 200 shirts

b) Suppose that without trade the labour in each country spend half their time producing
each good. Identify this point on your graph. [1 points]
c) If these countries were open to trade, which country would export shirts? Explain. [2
points]
US To determine which country would export shirts, compare the opportunity costs. The U.S.
100 shirts
Ihr- >
has a comparative advantage in computers (it can produce more computers per unit of labour
> 20 Comp
Ihr- compared to China), while China has a comparative advantage in shirts (it can produce more
shirts per unit of labour compared to the U.S.). Therefore, the United States would export
China computers, and China would export shirts.
1 >
- 100 shirts

1 hr-
> 10 Compd) Assume that the two countries trade at a price of $5 per shirt and $30 per computer. Graph
Loss/Gain the budget line for the United States. [2 points]
OPC =

S : C Shirts
$2000
American Budget Line

US 100 : 20
10
China 100 :
0 2
1/s
.

us shirts
5 S
COMP

China
Shirts'/10 0 . 1

COMP 18

0 1 L
. $240 AMP
e) Explain how both countries would benefit from trade. [2 points]
Both countries would benefit from trade due to specialization based on comparative advantage.
The United States focuses on producing computers, exporting them in exchange for Chinese
shirts. China, in turn, specializes in producing shirts and trades them for U.S. computers. This
allows both countries to consume beyond their individual production possibilities, obtaining
goods at a lower opportunity cost than if they were producing both goods domestically. Thus,
trade allows for a more efficient allocation of resources and a higher overall level of
consumption for both countries.

December 2013 [B]

7. Explain the concept of comparative advantage and use it to show why it is advantageous for
countries to trade. [10 points]
Comparative advantage is a fundamental economic concept that illustrates how countries can
benefit from specializing in the production of goods and services in which they have a lower
opportunity cost compared to other countries. When countries specialize in producing goods
where they have a comparative advantage, they can maximize their production efficiency. By
allocating resources to the production of goods they are relatively better at, they can produce
more output with the same number of resources. Through specialization based on comparative
advantage, each country can focus on what it produces most efficiently. This specialization leads
to increased total output and efficiency in resource utilization. When countries specialize and
trade based on their comparative advantages, they can obtain goods and services at a lower
opportunity cost than if they attempted to produce everything domestically. As a result, both
countries can consume more of both goods by trading than they could have by producing
independently. Comparative advantage encourages efficient allocation of resources globally. It
allows countries to concentrate on what they do best and import goods that other countries
produce more efficiently. This leads to a more optimal use of global resources.

For example, considering two countries, Country A and Country B

Country A can produce 1 ton of wheat in 5 hours or 1 ton of corn in 3 hours.
Country B can produce 1 ton of wheat in 4 hours or 1 ton of corn in 2 hours.
Country A has a lower opportunity cost in producing wheat (5 hours vs. 4 hours in Country B),
while Country B has a lower opportunity cost in producing corn (2 hours vs. 3 hours in Country
A). Here, Country A has a comparative advantage in producing wheat, and Country B has a
comparative advantage in producing corn. By specializing in the production of the good they
have a comparative advantage in and trading with each other, both countries can consume more
of both goods than if they had tried to produce both goods domestically. In summary,
comparative advantage highlights the benefits of specialization and trade between countries,
leading to increased efficiency, higher total output, and mutual gains for all involved parties.

December 2012 [P]

8. Northistan contains 200 acres of agricultural land on which it can grow rice or peas. Each acre
can yield either 4 pounds of rice or 3 pounds of peas annually. In neighbouring Southland,
with 400 acres of crop land, the yields are 3 pounds of rice or 1 pound of peas per acre.
a) Explain what is a production possibilities frontier. [2 points]
A production possibilities frontier (PPF) is a graphical representation that shows the
maximum potential output combinations of two goods or services that an economy can
produce, given its available resources and technology at a certain point in time.
b) Sketch and label the annual production possibilities frontier for both countries. (Place
peas on the horizontal axis.) [3 points]
For Northistan:
200 acres * 4 pounds of rice per acre = 800 pounds of rice
200 acres * 3 pounds of peas per acre = 600 pounds of peas

Peas
For Southland:
400 acres * 3 pounds of rice per acre = 1200 pounds of rice
400 acres * 1 pound of peas per acre = 400 pounds of peas

Peas

c) Which product should each country specialize in and why? [2 points]

Northistan's opportunity cost of producing 1 pound of rice is 3/4 pounds of peas (4 pounds of
rice per acre / 3 pounds of peas per acre). Southland's opportunity cost of producing 1 pound of
rice is 1/3 pounds of peas (3 pounds of rice per acre / 1 pound of peas per acre).
Comparing the opportunity costs:
Northistan: Has a comparative advantage in producing rice because it has a lower opportunity
cost of producing rice compared to Southland therefore they should specialize in rice production
Southland: Has a comparative advantage in producing peas because it has a lower opportunity
cost of producing peas compared to Northistan therefore they should specialize in peas
production.
 d) If the world market price of rice is $10 per pound and for peas is $20 per pound,
demonstrate how Northistan is better off by trading. [3 points]
Given the prices in the world market:
Rice: $10 per pound
Peas: $20 per pound
Northistan can produce 800 pounds of rice or 600 pounds of peas. If Northistan specializes in
rice and trades it at $10 per pound, they can earn $8,000 (800 pounds * $10 per pound) from rice.
Meanwhile, if Northistan produces 600 pounds of peas and trades them at $20 per pound, they
can earn $12,000 (600 pounds * $20 per pound) from peas.

By specializing in peas (which it can produce at a lower opportunity cost compared to rice) and
trading at the world market price, Northistan earns more than by producing rice alone. Hence,
Northistan is better off by trading and specializing in peas. This trade allows Northistan to
acquire more rice than it could produce domestically, leading to increased overall welfare.

December 2010 [P]

9. The labour force of ten persons in the tiny economy of Jamrock can produce only Rum and
Coffee. Each worker is capable of producing either 3 gallons of rum or one pound of coffee
per day. [2 points each]
a) Sketch the economy’s production possibilities frontier.
Each worker can produce either 3 gallons of rum or 1 pound of coffee per day. With 10 workers,
the maximum daily output can be 30 gallons of rum (10 workers * 3 gallons) or 10 pounds of
coffee (10 workers * 1 pound).

b) Explain what it is showing.

The PPF illustrates the maximum combinations of rum and coffee that Jamrock can produce
given its labor force and production capabilities. It shows the trade-off between producing rum
and coffee when resources (in this case, labor) are limited.

() + (M X) (G T) = I
(Y
-
-

-
T - -

.
 c) Is the combination of 7 gallons of rum and 7 pounds of coffee attainable? Is it efficient?
What about 15 gallons of rum and 10 pounds of coffee?
Seven gallons of rum and 7 pounds of coffee: Yes, this combination is attainable and lies within
the production possibilities frontier. It's an efficient use of resources since it fully utilizes the
available labour to produce goods. 15 gallons of rum and 10 pounds of coffee: This combination
is not attainable within Jamrock's current production capabilities as it lies beyond the PPF. It
exceeds what the labor force can produce given their current efficiency and resources.

* d) Suppose the neighbouring island of Cube-land is willing to sell each pound of its coffee for
1½ gallons of rum. Sketch Jamrock’s consumption possibilities.
If Jamrock trades with Cube-land at a rate of 1½ gallons of rum for each pound of coffee, it
changes the consumption possibilities. The trade ratio indicates that Jamrock can acquire coffee
from Cube-land at a lower opportunity cost than it can produce domestically.

e) Given the option of trading with Cube-land, what should Jamrock produce and trade in
order to attain the consumption of 15 gallons of rum and 10 pounds of coffee?
To attain 15 gallons of rum and 10 pounds of coffee:
Jamrock should specialize in producing rum since it has a comparative advantage in producing
rum over coffee. Then, trade some of its rum with Cube-land for coffee to make up for the coffee
shortfall. By trading, Jamrock can obtain the additional coffee it needs beyond its domestic
production of coffee, enabling it to reach the desired consumption combination. This strategy
allows Jamrock to optimize its production by focusing on its comparative advantage in
producing rum and trading for the coffee it needs to achieve its consumption target.

Unit 3: The Market Model

May 2018 [P]
10. In the last few months, internal conflict in Syria has negatively affected their oil production
capacity, resulting in a sharp rise in the price of oil on the world market.
a) Use the market model to illustrate what has happened in the oil market. [5 points]
With the internal conflict in Syria negatively affecting their oil production capacity, the supply of
oil on the world market decreases. This shift in supply causes the supply curve to shift leftward,
indicating a decrease in the quantity of oil supplied at every price level leading to an increase in
the equilibrium price of oil.
D Si
Price
So

↑ *

D
F

Osa osd
Quantity
 b) How and why have users of oil reacted to the developments in the oil market? Be sure to
show and describe that reaction in your diagram of the market model. [3 points]
With the rise in the price of oil due to decreased supply, users of oil would likely react by
seeking alternatives or reducing their consumption of oil. This reaction is illustrated as a
movement up the demand curve and a decrease in the quantity demanded in response to the
increased price.

c) Oil being currently the main source of energy production, what do you expect to happen
in the oil market when cheap alternative energy sources, such as renewables, become
more widely available? [2 points]
As cheap alternative energy sources like renewables become more widely available, the demand
for oil is likely to decrease. Consumers and industries would shift towards these cheaper and
more sustainable energy sources, reducing their reliance on oil. This would result in a leftward
shift of the demand curve for oil in the market model, indicating a decrease in the quantity
demanded at every price level. Consequently, this shift would likely lead to a decrease in the
equilibrium price of oil as the demand for oil diminishes due to the availability and adoption of
alternative energy sources.

December 2014 [D]

11. Explain and illustrate the concepts of consumer surplus and producer surplus. Why are these
concepts important? [10 points]
Consumer surplus represents the difference between what consumers are willing to pay for a
good or service (as indicated by their demand) and what they actually pay for it in the market. It
is the area above the market equilibrium but below the demand curve. Producer surplus is the
difference between the price at which producers are willing to sell a product (as indicated by
their supply) and the actual price they receive in the market. It is the area below the market
equilibrium but above the supply curve. Imagine a market where consumers are willing to pay
$50 for a product but can buy it for $30. The difference ($50 - $30 = $20) represents the
consumer surplus for each unit of the product purchased. Suppose producers are willing to sell a
product for $20, but the market price is $40. The difference ($40 - $20 = $20) represents the
producer surplus for each unit of the product sold.

Consumer and producer surplus together represent the total welfare or economic efficiency
within a market. When both consumer and producer surplus are maximized, it indicates an
efficient allocation of resources.
Price

CS

PS
Understanding consumer and producer surplus helps in evaluating the impact of policies or
interventions in a market. For instance, taxes or subsidies affect prices, which can alter consumer
and producer surplus.

When examining trade between countries or regions, analyzing consumer and producer surplus
helps in understanding the distribution of benefits between trading partners and the overall gains
from trade.

The concepts highlight the benefits and gains that accrue from market transactions, emphasizing
the importance of markets in facilitating exchanges that improve societal welfare.

In summary, consumer and producer surplus are vital concepts in economics as they provide
insight into the gains and benefits received by consumers and producers in a market, aiding in
assessing efficiency, policy formulation, trade analysis, and understanding market functioning.

December 2011 [D]

12. The questions below relate to the market for pay parties.
a) Sketch a demand and supply diagram to represent the market, indicating the equilibrium
price and quantity. [3 points]
D S

S D

Quantity
The equilibrium price and quantity occur at the point where the demand and supply curves
intersect

b) Explain what the demand curve shows and why it slopes downward. [3 points]
The demand curve illustrates the relationship between the price of pay parties and the quantity
demanded by consumers. It slopes downward due to the law of demand, which states that as the
price of a good or service increases, the quantity demanded by consumers decreases, assuming
other factors remain constant.
 c) Discuss what developments might cause the demand curve to shift and show how it would
shift. [2 points]
Several factors can cause the demand curve to shift:
Income Changes: If there's an increase in consumer income, the demand for pay parties might
increase, shifting the demand curve to the right. Tastes and Preferences: Changing consumer
preferences towards pay parties (for example, due to trends or cultural shifts) could shift the
demand curve. Complementary or Substitute Goods: If there's a change in the availability or
price of substitute goods (like concerts or movies), it could impact the demand for pay parties.
The shift of the demand curve would be to the right (increase in demand) or left (decrease in
demand) depending on the nature of the change.

d) Suppose the government starts to enforce the Night Noises Act (a restriction on loud music
late at night) as a result of which the parties still go on, but the police now have to be
bribed to ignore the breach. Show and describe what effect this will have on the market. [3
points]
Enforcing the Night Noises Act, while parties continue but require bribes to avoid legal issues,
affects the market for pay parties: The cost of organizing parties increases due to the need for
bribes, which reduces the quantity supplied at every price level. This shifts the supply curve to
the left, indicating a decrease in the quantity of pay parties supplied. With a decreased supply
and constant demand, the equilibrium price of pay parties increases, and the equilibrium quantity
decreases. This shift reflects a decrease in the availability of pay parties due to increased costs
for organizers, leading to higher prices for consumers and a reduction in the number of pay
parties held in the market.

Unit 4: Interfering in the Market

May 2015 [P]
13. Suppose that the government imposes a tax on $12 per unit on cigarettes.
a) Draw a supply and demand diagram of the market for cigarettes without the tax. Show the
price paid by consumers, the price received by producers and the quantity of cigarettes
sold. [2 points]
Without the tax, the equilibrium price (P) and quantity (Q) are determined by the intersection
of the demand and supply curves. The price received by producers equals the price paid by
consumers at this equilibrium point.
 b) Draw a supply and demand diagram for the cigarette market with the tax. Show the price
paid by consumers, the price received by producers and the quantity of cigarettes sold. [4
points]
With the tax of $12 per unit imposed, the supply curve shifts upwards by the amount of the tax
($12). This shifts the equilibrium price paid by consumers and received by producers, and it
reduces the equilibrium quantity sold.

c) Compare the price paid by the consumer, the price paid by the producer and the quantity
of cigarettes sold in parts a and b. [2 points]
In part a (without tax), the price paid by consumers is equal to the price received by producers
(the equilibrium price), and a certain quantity of cigarettes is sold. In part b (with tax), the price
paid by consumers is higher due to the tax, but the price received by producers is lower. The
quantity of cigarettes sold decreases from the initial equilibrium quantity.

d) What is the impact on welfare due to the imposition of the tax on cigarettes? [2 points]
The imposition of the tax reduces the overall welfare or total surplus in the market for cigarettes.
Both consumer and producer surplus decrease due to the tax. Consumer surplus decreases as
consumers pay a higher price for cigarettes. Producer surplus decreases as producers receive a
lower price for their product. However, tax revenue is generated for the government from the tax
imposed on each unit of cigarettes.

May 2014 [P]

14. The government has decided that the free market price of milk is too low.
a) Suppose the government imposes a binding price floor in the market. Draw a supply and
demand diagram to show the effect of this policy on the price of milk and the quantity of
milk sold. [4 points]
The price floor creates a situation where the floor price is higher than the equilibrium price. This
leads to a surplus, as the quantity supplied exceeds the quantity demanded at the price floor.
 b) Farmers complain that the price floor has made them worse off. Is this possible? Explain.
[4 points]
Yes, it's possible for the price floor to make farmers worse off. When the government imposes a
price floor above the equilibrium price, it results in a surplus. In this surplus situation, although
farmers are selling more milk at the price floor, they might not be able to sell all the milk they
produce due to reduced demand at the higher price. As a result, some of their milk remains
unsold, creating a surplus that can lead to additional costs for storage or disposal. This surplus
situation can ultimately reduce the overall income and welfare of the farmers.

c) In response to farmers’ complaints, the government agrees to purchase all the surplus
milk at the price floor. Who benefits from this new policy? Who loses? [2 points]
Farmers benefit from the government purchasing the surplus milk at the price floor. They are no
longer facing the challenge of unsold surplus milk, and their income is supported by the
government purchase. Taxpayers or the government's budget would incur the cost of buying the
surplus milk. This policy might lead to additional government spending and allocation of
resources to purchase and manage the surplus.

December 2012 [D]

15. There is currently a thriving, unregulated market in phone cases. A typical case sells for
around $500. The government decides to tax consumers of this product by imposing a $100
tax. How is this proposed tax going to affect the market for smartphone cases – that is, how
will it affect the price of the cases and the amount of cases that are sold? Considering that the
government will earn revenue, overall, do you think that the society benefits from such a
move? [10 points]
The imposition of a $100 tax on consumers of smartphone cases increases the cost for buyers.
Given that the typical case sells for $500, this tax represents a significant increase in the price
paid by consumers. As a result, the price consumers pay for the cases would rise from $500 to
$600 ($500 + $100 tax). With the price for consumers increasing due to the tax, the quantity
demanded for smartphone cases is likely to decrease. The higher price might deter some buyers
from purchasing cases at the increased cost of $600, leading to a reduction in the quantity of
cases sold.

The government earns revenue from this tax. For every smartphone case sold, the government
collects $100 in tax. This revenue could be used for public services or other government
expenditures. The societal benefit is a bit nuanced here. While the government gains revenue
from the tax, the higher cost of smartphone cases for consumers may lead to decreased
consumption. This can negatively impact both buyers (who have to pay more) and sellers (who
might experience reduced sales). Whether society benefits from this move depends on how the
tax revenue is used and whether the benefits of that expenditure outweigh the negative impacts
on consumers and sellers in the smartphone case market.
times
100
goo
pay
000
sellero
insteadsur
or
Unit 5: Market Failures
December 2018 [B]
16. Identify and explain the ways in which markets can fail [10 points]
Market failure occurs when free markets make an inefficient use of scarce resources by failing to
deliver allocative or productive efficiency. Allocative efficiency occurs when scarce resources
are not being used in a way that maximizes consumer satisfaction and productive efficiency is
when firms do not maximize their inputs resulting in a loss of output. There are several reasons
why a market may fail, these include:
Externalities:
Externalities occur when the production or consumption of a good or service affects third parties
who are not directly involved in the transaction but incur costs or benefits. For instance,
pollution from manufacturing processes affects the environment and public health, but the costs
aren't borne by the producer or consumer. This results in overproduction or overconsumption of
goods with negative externalities and underproduction or underconsumption of goods with
positive externalities.

Public Goods:
Public goods are non-excludable and non-rivalrous, meaning that individuals cannot be excluded
from using them, and one person's use doesn't diminish its availability to others (e.g., national
defense, street lighting). Private markets may underprovide public goods because there's no
profit incentive for firms to produce them due to the free-rider problem. Individuals might
benefit without paying, leading to underinvestment by private sectors.

Market Power and Monopolies:

Market power arises when a single seller or a small group of sellers (monopoly or oligopoly)
have substantial control over the market, influencing prices and quantity supplied. Monopolies
can result in higher prices, lower output, reduced innovation, and limited consumer choices due
to lack of competition.

Incomplete Information:
When buyers or sellers don't have access to all relevant information about a product or service, it
can lead to asymmetric information, where one party has more information than the other (e.g.,
in used car markets). Asymmetric information can lead to adverse selection (e.g., in insurance
markets) or moral hazard (e.g., in financial markets), leading to inefficient outcomes.

May 2016 [P]

17. In each case, identify the type of market failure, explain why it occurs, and suggest a solution.
a) A club opens next door to your apartment and plays loud music till 4am. [3 points]
This is a negative externality. The loud music creates a negative externality by imposing costs
(disturbance, lack of sleep) on nearby residents who are not part of the transaction. Regulations
or noise ordinances could be implemented that limit the noise level or operating hours of the
club to mitigate the negative externality and ensure a better balance between the club's operations
and residents' well-being.
 b) Everyone in your community would benefit if an empty lot were to be converted into a
park but no entrepreneur will come forward to finance the project. [3 points]
This is a case of lack of a public goods. Parks provide benefits to the entire community, but there
is no private incentive for an entrepreneur to invest in this public good due to the inability to
charge individuals for its use. The government can step in to finance and build the park,
recognizing its social benefits despite the lack of profitability. They could also provide subsidies
or grants that might incentivize private investors to contribute to such projects.

c) An electronics technician insists that you should purchase a new keyboard for your laptop
which would cost $6,000 when in fact the keyboard you had needed only to be cleaned. [4
points]
This is a case of Asymmetric Information causing market failure. The technician has more
information about the keyboard's condition, leading to asymmetric information. This situation
can encourage overconsumption or unnecessary purchases due to the lack of complete
information by me, the consumer. Improving transparency and consumer education can mitigate
asymmetric information issues. Consumer protection laws, certifications for technicians, or
independent assessments can ensure that consumers receive accurate information and avoid
unnecessary spending on repairs or replacements.

December 2015 [D]

18. Explain the problem of asymmetric information and how it causes markets to break down. [10
points]
Adverse selection occurs when buyers or sellers have more information about the quality or
characteristics of a product than the other party. This disparity in information can lead to market
failures and breakdowns due to several reasons. In markets with adverse selection, higher-quality
goods might be driven out of the market. For example, in the used car market, sellers might have
more information about the condition of the car than buyers. Consequently, buyers might be
wary of purchasing any used car, assuming they're all of lower quality, even though some might
be good. Asymmetric information can also lead to a breakdown in markets because it disrupts the
efficiency of transactions. The party with less information might make suboptimal decisions,
leading to inefficiencies. This can result in reduced trade, adverse selection problems, higher
costs, and a loss of trust between buyers and sellers, ultimately hindering the functioning of the
market. Additionally, asymmetric information can discourage transactions from happening
altogether. For instance, sellers might fear that buyers won't appreciate the true value of their
product, leading to under-trading or no trade at all. Consequently, fewer transactions occur in the
market, reducing economic activity and potentially causing a market failure. Moral hazard may
also arise, which is when one party changes their behaviour after the transaction based on
asymmetric information. For instance, in insurance markets, individuals might take on riskier
behaviour after purchasing insurance because the insurer doesn't have full information about the
insured's behaviour. This can lead to higher costs for the insurer and affect premiums for
everyone. Asymmetric Information may be mitigated by government regulations, such as
mandating disclosure of information, certifications, or standardized disclosures, can help
mitigate information asymmetry.
 December 2013 [D]
19. What are public goods and why must they be provided by a government? [10 points]
Public goods are goods or services that possess two key characteristics: non-excludability and
non-rivalry. Non-excludability means that individuals cannot be excluded from using the good or
service, regardless of whether they paid for it or not. It's challenging or impossible to prevent
individuals from benefiting from the good once it is available. Non-rivalry means that the
consumption of the good by one individual does not diminish its availability or utility for others.
Examples of public goods include national defense, street lighting, public parks, and basic
scientific research. Public goods face a fundamental problem in the market due to their
characteristics. Because of non-excludability, individuals can benefit from the good without
paying for it resulting in a free rider problem, where people have an incentive to enjoy the
benefits without bearing the cost.. Due to the free rider problem, there is a lack of profit incentive
for private firms to invest in providing these goods as they cannot effectively charge consumers
for their usage. As such, governments are essential in providing public goods because they can
overcome the free rider problem and ensure their provision for the welfare of society.
Governments can fund and provide public goods through taxation and public expenditure. They
can collect taxes from citizens to finance the production and maintenance of public goods that
benefit society as a whole.

Unit 6: Output and Growth

December 2014 [B] Several factors contribute to higher GDP per Capita indication why
20. Some countries in the world have much higher levels of GDP per capita than others. What their citizens
could it be about those countries that may explain why their citizens are able to be so much are more
more productive? capital , technology and institutions [10 points]
Several factors contribute to higher levels of GDP per capita in certain countries, indicating why
Education
their citizens are more productive. Here are key factors that can explain this discrepancy:
and Human
Education and Human Capital:
Capital Countries with higher GDP per capita often have robust education systems that invest in human
·

Technological capital. A well-educated workforce is more skilled, adaptable, and innovative, contributing to
Advancements higher productivity. A higher level of education equips individuals with skills that are directly
transferable to the workplace, leading to increased productivity across various industries.
InstitutionsTechnological Advancements and Innovation:
·

good governance
Nations that invest in research, development, and technological infrastructure tend to be more
creates a productive as opposed to those that do not. Access to advanced technology and innovation
conducive fosters efficiency and competitiveness in industries making them more productive. Countries that
environmentencourage innovation and entrepreneurship often have higher levels of productivity due to
for economiccontinuous improvements and advancements in products and processes.
activities Efficient Institutions and Governance:
Lower tion Good governance, rule of law, property rights protection, and efficient institutions create a
comp conducive environment for economic activities. Stable political systems and well-functioning
legal frameworks attract investment and foster economic growth. When nations have certain
rules put in place there will be lower levels of corruption making more efficient markets and
governance, enabling businesses to operate more effectively.
May 2013 [B]
21. What is economic growth? Discuss the factors that would help a country achieve it. [10 points]
Economic growth refers to the sustained increase in an economy's production of goods and
services over time, leading to a rise in the real GDP (Gross Domestic Product). It's a crucial
indicator of an economy's health and prosperity, reflecting improvements in living standards,
employment, and overall economic well-being. The factors contributing to economic growth are
investment in capital, technological innovation and effective institutions. Increased investment in
physical capital such as infrastructure, factories, machinery, and technology boosts productivity,
leading to economic expansion. In addition to investment in physical capital, investments should
be made to human capital. A well-educated and skilled workforce enhances productivity and
innovation, contributing to economic growth. Additionally, adopting and developing new
technologies drives productivity improvements, facilitating economic growth across all sectors.
Effective institutions, rule of law, and protection of property rights foster a conducive
environment for investment, entrepreneurship, and economic activity, contributing to economic
growth.

December 2011 [B]

22. Discuss the factors that are responsible for causing economic growth. [10 points]
Institutions

C apital
Technology

Unit 7: Prices and Inflation

December 2018 [P]
23. The diagram shows the demand for money in an economy
90
Value of Money

(where the horizontal axis is in billions of dollars and

80
vertical axis is an index of the purchasing power value of 70
money). 60
a) If the supply of money in this economy is $3 billion, 50
sketch the supply of money curve. [3 points] 40 >
-

30
The supply of money is illustrated by a vertical line 20 MD
drawn at 3 on the x axis. 10
b) Illustrate on your diagram a 50 percent increase in the
1 2 3 4 5 6 7 8 9
money supply. [2 points] Quantity of Money
A 50 percent increase in the money supply is illustrated by a shift of the line drawn in part a
to the right at 4.5 on the x axis.
c) What is the new value of the index of the value of money? [2 points]
20 Where money demand =
money supply

d) If there are no other changes in the economy, how much will be the ensuing increase in
the price level? [3 points]
30 20
10/30
-
=

in the
33 33 decrease
.

value of
and
money
33 3 % increase in
consequently a
.

the price level

 December 2014 [D]
24. Whereas other forms of wealth (such as stocks, bonds, and savings accounts) promise a
financial return, money does not.
a) Why, then, do people keep money at all? [5 points]
People keep money for transaction purposes. Money is essential for daily transactions to
purchase goods and services, pay bills, and cover immediate expenses. They also keep money for
liquidity preference. Holding money provides liquidity, ensuring quick access to funds in case of
emergencies or unforeseen expenses without relying on selling assets or borrowing.

b) Discuss the factors that determine the amount of money people hold and the way each of
those factors affect money demand. [5 points]
The factors that determine how much money people hold are interest rates, price level and the
reliance on other forms of money. Higher interest rates incentivize people to hold less money as
the opportunity cost of holding non-interest-bearing money increases. Lower interest rates may
lead to a higher demand for money due to reduced opportunity cost. Higher expected future
prices (inflation) can increase money demand as people hold more money to hedge against rising
prices. Conversely, stable or falling prices might reduce the need for higher money balances.
Advancements in technology (e.g., online banking, mobile payments) can affect money demand.
More efficient financial systems might reduce the need for holding physical cash, altering money
demand patterns.

December 2012 [B]

25. Why is there inflation? [10 points]
Inflation refers to the sustained increase in the general price level of goods and services in an
economy over time and a decrease in the value of money. There are several factors that
contribute to the occurrence of inflation:
Central banks might increase the money supply through measures like lowering interest rates or
purchasing government securities. This increased money supply can lead to more spending,
driving up prices. By increasing the supply of money within the economy, the value of money
will decrease while the price level increases resulting in inflation. Another factor that may cause
inflation is excess demand for a good or service causing an increase in their price level. When
aggregate demand (total demand for goods and services) exceeds aggregate supply in an
economy, it creates excess demand pressures. This excess demand leads to increased competition
for goods and services, allowing suppliers to raise prices to meet the higher demand resulting in
demand-pull inflation. Additionally, when the cost of production for goods and services
increases, such as rising wages or raw material costs, it leads to higher prices for
consumers. Producers pass these increased costs onto consumers by raising prices, causing
inflationary pressure resulting in cost push inflation. Events like natural disasters, geopolitical
tensions, or trade disruptions can disrupt supply chains, leading to shortages and price increases
also resulting in inflation. Inflation can result from a combination of these factors, and its causes
can vary across different economies and time periods. Central banks and governments often use
monetary policy, fiscal measures, and regulations to manage inflation and maintain price stability
within an optimal range conducive to economic growth and stability. MV PQ =

of money falls
Central bank increase money supply > value
-

lower interest
rates
and prices increase
or

securities
purchasing govt in the price level. More money
in M S
. leads to overall increase
increase demand pull
.

inflation
in the short run resulting in
results in
higher prices
chasing the same amount of goods
Unit 8: Interest Rates and Finance
December 2017 [B]
26. Explain why interest rates in Jamaica have fallen over the last two years? [10 points]
corid-fall in investment > in order to incentivize people to invest they
-
reduced the
December 2015 [D] interest rate for loanable funds thus
27. How is the rate of interest in an economy determined? The Jamaican government has recently
balanced it’s budget, instead of running the fiscal deficits that it used to. What should be
happening to the rate of interest? Is it happening? [10 points]
The rate of interest in an economy is determined by the interaction of various factors within the
financial system and broader economic conditions. While it's influenced by multiple elements,
the two main factors impacting interest rates are: Supply and Demand for Loanable Funds:
Savings and Investment: The supply of loanable funds comes from household savings, corporate
savings, and foreign capital inflows. The demand for funds arises from businesses and
individuals seeking capital for investments, consumption, or other purposes.
Effect: When the supply of funds is high relative to demand, interest rates tend to decrease.
Conversely, when demand exceeds supply, interest rates rise.
Govt no longer borrowing from financial sector so this increases
of loanable funds
December 2014 [P] the supply
28. Your search of publicly-available data for last year for the island of Nevis reveals the
following: nominal GDP = $85m; consumption = $35m; imports = $20m; exports = $16m;
government expenditure = $40m; and the government’s budget is balanced.
a) Calculate the level of investment. [4 points]
GDP= Consumption + Investment + Government Spending + (Exports-Imports)
85=35+x+40+(16-20)
85=71+x
x=85-71
x=14m
b) Suppose now that the government decides to spend $5m on a new assembly building.
What will be the new level of (private) investment if nothing else changes? [2 points]
If the government spends an additional $5m on a new assembly building and assuming
nothing else changes, private investment remains the same as before ($14m). Private
investment is not directly affected by this specific government spending.

c) If you allow interest rates to adjust, draw a diagram to show what this development would
look like in the market for funds and explain what your diagram is showing. [4 points]

Unit 9: The Exchange Rate and External Linkages

May 2019 [B]
29. How is the exchange rate determined? [10 points]
The exchange rate is defined as the rate at which one currency is exchanged for another
country’s currency in the foreign exchange market.
December 2018 [D]
30. We often distinguish real from nominal variables.
a) Explain the difference between the nominal and the real exchange rate. [5 points]
The nominal exchange rate is the rate at which one currency is exchanged for another. It
represents the price of one currency in terms of another currency. Nominal exchange rates are
quoted in the foreign exchange market and can fluctuate due to market forces like supply and
demand, interest rates, inflation, and geopolitical events. The nominal exchange rate focuses
solely on the value of currencies in the foreign exchange market, representing the rate at which
currencies are exchanged. The real exchange rate is adjusted for changes in price levels or
inflation between two countries. It reflects the relative purchasing power of two currencies. The
real exchange rate helps understand the actual purchasing power of one country's currency
concerning another, accounting for changes in relative price levels. The real exchange rate offers
a more accurate measure of purchasing power across countries as it adjusts the nominal rate to
reflect changes in price levels or inflation. Price of one currency in terms
Nominal The which one
currency is
exchanged for another
·

rate at of another
level
Real-The purchasing power of two and adjusted
currencies is
changes in the price
for
b) If the local economy experiences a higher rate of price inflation than the United States and
the nominal exchange rate doesn’t adjust, what happens to the real exchange rate? [3
points]
If the local economy experiences a higher rate of price inflation compared to the United States
and the nominal exchange rate doesn't adjust, the real exchange rate will decrease.When the
nominal exchange rate remains fixed, a higher rate of price inflation in the local economy
compared to the United States leads to a decline in the real exchange rate. This signifies a
reduction in the local currency's actual purchasing power in relation to the U.S. currency.

c) Explain why and how this change in the real exchange rate affects the level of the
country’s imports and exports. [2 points]

·
A decrease in the real exchange rate, indicating a depreciation of the local currency, tends to
reduce imports due to increased costs for foreign goods and potentially increase exports due
to greater competitiveness of local goods in foreign markets.
Decrease in ER- > Imports increased EXPOAS decreased
December 2017 [P]
31. Identify where each of the following transactions would be entered in the balance-of-
payments accounts.
a) A European managed investment fund buys some of the shares offered in Wysinco’s initial
public offering (IPO) of shares on the stock market. Capital Account [2 points]
b) The Caribbean Cement Company in Jamaica exports bulk cement to the Bahamas. [2
points] Current Account
c) The locally-owned Sandals hotel chair builds a new hotel in Dominica. [2 points] Capital
Account
For any one of the above,
d) show how the transaction would affect the market for foreign exchange (in the short run)
and state whether the real exchange rate should rise or fall as a result. [4 points]
The export of bulk cement to the Bahamas results in an inflow of foreign currency (Bahamian
dollars) to the Caribbean Cement Company in Jamaica. Initially, this creates an excess supply of
Bahamian dollars in the foreign exchange market as the Caribbean Cement Company receives
payment in Bahamian currency. The increased supply of Bahamian dollars in the foreign
exchange market may lead to a short-term depreciation of the Bahamian dollar against the
Jamaican dollar.

May 2014 [D]

32. In 2013, the inflation rate in Jamaica was 9.1% while in the United States it was 1.7%. What is
the effect on the Ja/US$ real exchange rate (before any adjustment in the nominal exchange
rate occurs)? Based on the Purchasing Power Parity theory, what do you think is likely to
happen to the nominal exchange rate in the long run? [10 points]
Jamaica experienced a higher inflation rate (9.1%) compared to the United States (1.7%) in
2013. The higher inflation in Jamaica relative to the U.S. implies a decrease in the real value of
the Jamaican dollar compared to the U.S. dollar. This indicates a decline in the purchasing power
of the Jamaican currency relative to the U.S. currency. PPP theory suggests that in the long run,
the nominal exchange rate between two countries should adjust to reflect the differences in price
levels or inflation rates. According to PPP theory, with higher inflation in Jamaica compared to
the United States, the nominal exchange rate should adjust to reflect the difference in inflation
rates. Specifically, the nominal exchange rate should change to compensate for the difference in
price levels and restore parity in purchasing power between the two currencies.

May 2013 [B]

33. What is the impact of a persistent budget deficit on the real interest rate, investment, the
exchange rate and the trade balance. [10 points]

Unit 10: Economic Statistics

May 2019 [P]
34. A household consumption survey reveals that the
2018 2019
typical household pays rent on one small flat, takes
Housing (monthly rent) $3,000 $2,100
10 taxi rides, and eats 20 meals outside the home,
each month. The prices for these consumption items Transportation (per ride) $300 $350
at the end of each year are shown in the table. Meals $500 $600

a) Using 2018 as the base year, calculate the value of

the consumer price index for each year. [2 points] 3000 + 10 000 +
,

The formula for CPI = (Cost of Basket in Current Year / Cost of Basket in Base Year) × 100
For 2018 (Base Year):
Cost of Basket = ($3000 + $300 + $400) = $3700
CPI (2018) = ($3700 / $3700) × 100 = 100
For 2019:
Cost of Basket = ($2100 + $350 + $600) = $3050
CPI (2019) = ($3050 / $3700) × 100 = 82.43 Current/Base X 100

b) What is the inflation rate in 2019. [6 points]

Formula for Inflation Rate: ((CPI in Current Year - CPI in Previous Year) / CPI in Previous
Year) × 100
Inflation Rate(2019) = ((82.43 - 100) / 100) × 100 ≈ -17.57%

CPIX100
Current CPI-Previous
-
CPI
Previous
 c) If your salary went from $1 million in 2018 to $1.08 million, show whether you have had a
real increase. [2 points]
Salary went from $1 million in 2018 to $1.08 million in 2019.
Real Salary Increase Calculation:
Real Salary in 2019 = Salary in 2019 × (CPI in Base Year / CPI in 2019)
Real Salary in 2019 = $1.08 million × (100 / 82.43) ≈ $1.308 million
Your salary increase from $1 million in 2018 to $1.08 million in 2019 is not a real increase in
purchasing power. Adjusted for inflation using CPI, the real value of your salary in 2019 is
approximately $1.308 million, showing a real increase in income.

December 2015 [P]

35. The entire economy of the small, rural community of Balaclava consists of an accountant and
two farms. The accountant does the books for both farms and gets paid $100 each for his
services. The corn farm annually sells $200 worth of corn to the market and delivers another
$300 worth to the dairy farm which is used as cattle feed. The dairy farm sells $500 of milk
each year at the market. Corn $200 Milk $500 = $700

a) Explain the difference between nominal and real GDP. [3 points]

Nominal GDP refers to the total value of all goods and services produced within an economy
during a specific time period, measured at current market prices. It doesn't account for changes in
price levels over time. Real GDP, on the other hand, measures the total value of goods and
services produced within an economy over a specific time period, adjusted for changes in price
levels or inflation. Real GDP is calculated by removing the effects of price changes from
nominal GDP to reflect changes in the economy's output accurately.

b) Explain why GDP refers to ‘final goods’ [3 points]

GDP includes only the value of final goods and services produced within an economy. Including
only final goods in GDP ensures that the value of intermediate goods (which are used in the
production of other goods) isn't counted multiple times. This practice avoids double-counting
and accurately represents the total value added at each stage of production.

c) Calculate the GDP of Balaclava using both the final goods methods and the value added
approach. [4 points]
Final Goods Method:
Corn farm sells $200 worth of corn to the market.
Dairy farm sells $500 worth of milk.
Total Final Goods Value = $200 (corn) + $500 (milk) = $700 (Final Goods)

Value Added Approach:

Corn farm sells $200 worth of corn to the market.
Dairy farm uses $300 worth of corn as cattle feed.
Dairy farm sells $500 worth of milk.
Value Added by Corn Farm = $200 (value of corn sold to market)
Value Added by Dairy Farm = $500 (value of milk) - $300 (value of corn used as feed) = $200
Total Value Added = $200 (Corn Farm) + $200 (Dairy Farm) = $400
ACC -

$200
corn -
$200
dairy farm
-
$300 corn
sells $500
dairy
-

corn = 200
value added by
500-300 = 200/
value added by dany
=

added is 400
Total value
May 2015 [P]
36. For each of the following, say whether they are normally included in the measure of Gross
domestic product and explain why.
a) The sale of a current year model used car. [2 points]
Generally, the sale of used goods, including used cars, is not included in GDP. GDP measures
the total value of goods and services produced within an economy in a given period. The sale of
used goods does not represent newly produced goods.
used - newly produced
b) The services of manicurists given in the current year. [2 points]
Yes, services provided by manicurists and other service providers are typically included in GDP.
GDP accounts for the total value of goods and services produced within an economy. Services,
such as those provided by manicurists, represent productive activities that generate income and
contribute to economic output.

c) The profits of a foreign owned corporation operating in the domestic economy. [2 points]
Profits earned by foreign-owned corporations operating within the domestic economy are
included in GDP. GDP includes all income generated within the domestic economy, regardless
of the ownership of the business.

d) The work done in other countries by the normal residents of a country. [2 points]
Typically, work done by the normal residents of a country in other countries is not included in
the domestic GDP. GDP measures the economic activity that occurs within the borders of a
specific country.

e) The cooking of meals for home consumption. [2 points]

No, the cooking of meals for home consumption is not included in GDP. GDP measures the
value of goods and services produced for market transactions. Activities such as cooking meals
at home for personal consumption are not sold in markets, so their value is not counted in GDP.

December 2013 [P]

37. The entire economy of the small, rural community of Belleville consists of an accountant and
two farms. The accountant does the accounting for both farms and gets paid $50 by each for
his services. The corn farm annually sells $200 worth of corn at the market and delivers
another $150 to the dairy farm to be used as cattle feed. The dairy farm sells $300 of milk at
the market each year.
a) Explain why the definition of gross domestic product (GDP) refers to “final goods”. [3
points]
GDP includes only the value of final goods and services produced within an economy. Including
only final goods in GDP ensures that the value of intermediate goods (which are used in the
production of other goods) isn't counted multiple times. This practice avoids double-counting
and accurately represents the total value added at each stage of production.

b) Explain the final goods and value added methods of calculating GDP. [3 points]
The final goods method calculates GDP by adding up the total value of final goods and services
produced within an economy during a specific period. It involves directly summing the value of
 all final goods and services sold to end-users or consumers in the market. The value added
method calculates GDP by summing the value added at each stage of production. It involves
considering the value added by each firm or sector in the production process. This value added is
the difference between the firm's output value and the value of intermediate inputs used.

c) Calculate the GDP of Belleville using both the final goods and the value added methods,
demonstrating clearly how each method provides your answer. [4 points]
To calculate GDP using the final goods method, we add the values of all final goods and services
sold in the market.In Belleville, this involves summing the values of corn sold in the market
($200), milk sold in the market ($300), and the value of corn used as cattle feed ($150).
Calculation: $200 (corn) + $300 (milk) = $500 (Final Goods)
To calculate GDP using the value added method, we add the value added at each stage of
production. In Belleville, the corn farm adds value by growing corn and selling it ($200). The
dairy farm adds value by using corn as cattle feed and selling milk ($300 - $150 = $150).
Calculation: $200 (Value Added by Corn Farm) + $150 (Value Added by Dairy Farm) = $350

May 2011 [D]

38. Discuss the suitability of GDP as a measure of the general welfare of the residents of a
country. [10 points]

Gross Domestic Product (GDP) is a widely used measure to gauge the economic activity and
output of a country. However, while GDP provides valuable insights into economic performance,
its suitability as a comprehensive measure of the general welfare of a country's residents is
subject to several limitations. GDP predominantly focuses on market-based economic activities,
excluding non-market transactions (e.g., household work, volunteer work) which contribute
-environment significantly to well-being but are not monetized. Neglecting non-market activities understates
GPP incre the overall contribution to welfare, especially in terms of social and community welfare.
but at GDP does not consider income distribution among the population. It doesn't differentiate
What costwhether the economic gains are evenly distributed or concentrated among a few, impacting
overall welfare. Even with a high GDP, unequal income distribution can lead to disparities in
-income letionliving standards and diminish overall welfare. GDP growth does not account for environmental
GDP degradation or natural resource depletion caused by economic activities. While economic growth
high may elevate GDP, it might come at the expense of environmental sustainability, affecting long-
but I
coverty term welfare due to ecological damage. GDP doesn’t directly measure the quality of life aspects
Still
exists like education, healthcare, life expectancy, or personal satisfaction. Improvements in these
economy
Within aspects might not reflect in GDP despite significantly enhancing residents' well-being. er
deg.

S
·

income ineq
GDP tends to exclude the value of unpaid work (e.g., household chores) and the informal of 5 0 /
economy. Many crucial contributions to welfare, especially in developing countries, are aspects
.
.

- since
economic
GDP only disregarded as they occur outside formal market transactions.
activities only
measures
the value While GDP serves as an essential economic indicator, relying solely on it to measure the general
of
rods and welfare of residents is inadequate. Complementary measures like the Human Development Index
I it
services (HDI), Genuine Progress Indicator (GPI), or measures that incorporate income distribution,
not
does environmental factors, health, education, and subjective well-being provide a more holistic
take into understanding of a population's welfare and should be considered alongside GDP for a
ach aspects
comprehensive evaluation of societal well-being.

ofthequalitlocation
healthcare and life expectan,
,
work of
market based activities so volunteer
on
focuses suciety's wellbeing are not added to the country's
-

only add to
of the total Welfare
which not
an accurate measure
GDP is
GDP as such of a society