Answer all five questions. Time allowed: Three hours
Explain and illustrate the difference between a positive and normative approach to the study of government measures designed to influence the behaviour of industrial companies. (10 marks)
What connection, if any, can be established between the growth in government spending and the following variables:
Population growth.
Growth in GDP per head.
The proportion of government employees in total employment? (10 marks)
Define and illustrate the meaning of any two of the following terms:
Natural monopoly.
Contestable markets.
‘RPI − X’.
A Demsetz auction. (10 marks – 5 marks for each component)
A firm is considering two mutually exclusive investment projects. The following comparative information is available:
| Project I | |
| Capital cost (incurred immediately) | £5 million |
| Operating costs per year | |
| Employment: | 100 |
| Average wage: | £25 000 per year |
| Maintenance and raw materials | £l.5 million per year |
| Capacity output per year | 1 million units |
| Price of output per unit | |
| (in the absence of regulation): | £5 per unit |
| Project II | |
| Capital cost (incurred immediately) | £9.33 million |
| Operating costs per year | |
| Employment: | 50 |
| Average wage: | £25 000 per year |
| Maintenance and raw materials | £2.35 million per year |
| Capacity output per year | 1 million units |
| Price of output per unit | |
| (in the absence of regulation): | £5 per unit |
In answering the following question assume (for ease of computation)
A 50-week year.
An indefinitely long life for each project (assume that the capital does not depreciate or that the yearly expenditure on maintenance is sufficient to maintain its value constant).
That revenues and operating costs relating to each year occur on the last day of that year.
A discount rate used by the firm for investment appraisal of 10 per cent.
The firm is assumed to undertake the project with the higher net present value.
Description of Regulatory System
The firm is restricted to a rate of return on capital invested not exceeding 15 per cent. A higher rate of return will result in regulatory intervention and a reduction in the price of the output until the 15 per cent limit is satisfied. Assume that the regulators are not concerned about possible shortages or queues which may develop at controlled prices.
Question
Using the above information, examine the effect of rate of return regulation on the firm's investment decision. Is the result consistent with the existence of an Averch-Johnson effect? (10 marks)
Explain what is meant by the ‘asymmetric information problem’ and show how it arises in the case of any two of the following;
Government purchasing contracts.
Selective government subsidies to industry.
Government bureaucracy.
Control of environmental damage. (10 marks – 5 marks for each component)
How close is the parallel between monopolistic and bureaucratic behaviour? Use a diagram in answering this question. (10 marks)
Distinguish a public enterprise as an economic entity from
A ‘bureau’.
A private enterprise. (5 marks)
Analyse the problems that arise in attempts to compare the productivity of public and private enterprises. (5 marks)
Use principal-agent analysis to illustrate the difficulties encountered by government in seeking to impose ‘rules’ on the operations of public enterprises. (10 marks)
Using examples, distinguish between
Privatization.
Deregulation.
Liberalization. (5 marks)
Define and illustrate the difference between
Technical efficiency.
Productive efficiency.
Economic efficiency. (5 marks)
A certain good can be produced using three possible processes. Each process involves a different capital to labour ratio. Below are recorded the number of units of capital and labour required to produce a single unit of output for each of the three processes.
| Capital | Labour | |
| Process A | 4 | 1 |
| Process B | 2 | 2 |
| Process C | 1 | 4 |
The wage rate is £10 and the rental rate on capital (i.e. the price to hire a unit of capital per time period) is also £10.
Company I uses process C. Its labour costs are £600 per unit time and its capital costs are £150 over the same time period. It produces 10 units of output. Company II uses process B. Its labour costs are £200 and its capital costs are £200. Output is also 10 units.
Compare Companies I and II with respect to both technical and productive efficiency.
Suppose that some policy change results in a new, more competitive, environment. The price of labour falls to £5. Company I continues to use process C and produces 10 units of output. Labour costs are £300 and capital costs £150.
Does the fall in measured costs of production represent an improvement in either technical or productive efficiency? Explain your answer.
(10 marks)
