Question One
a. Discuss the practical importance of the concept of income elasticity for
i. Business organizations in South Africa
ii. The South African Government
(10 Marks)
b. Discuss the circular flow diagram with four markets players (household, Firms, the
Government and the rest of the world)
(10 Marks)
c. The market for gasoline is in equilibrium. OPEC, one of the principal producers (with
the power to displace the supply curve) decides to increase the size of the revenue of
its members by increasing the supply. Assuming the supply of gasoline is fairly
inelastic, analyze ( graphically, with comments on the results that you acquire) how this
decision will decision will affect the total revenue of the gasoline producers if:
i. Demand for gasoline is perfectly elastic
ii. Demand for gasoline is perfectly inelastic
iii. Demand for gasoline is unit elastic
(15 Marks)
Question two
a. Suppose X ( bread ) and Y ( eggs) are two goods that the prices are given and there is
a consumer with R ( Income)
i. Illustrate using a diagram how it is possible to split the effects of the price
reduction on good X into income and substitution effects if both goods are
normal goods.
ii. Illustrate using the diagram how it is possible to split the effect of the reduction
of the price of both goods
iii. Illustrate using a graph the effect of the increase in the price of one item and
then the increase in the income level of the consumer.
(10 Marks)
b. Consider a couple’s decision about how many children to have. Assume also that over
a life time a couple has 325000 hours of time to either work or raise children. The wage
is 10 Rand per hour. Raising a child takes 25 000 Hours of time.
i. Draw the budget constraint showing the trade-off between lifetime consumption
and number of children. (Ignore the fact that children come only in whole
numbers) Show indifference curves and an optimal choice for the couple.
ii. Suppose the wages decrease from 10 Rand to 8 Rand per hour. Show how the
budget constraint shifts. Using income and substitution effects, discuss the
impact of the change on number of children and lifetime consumption.
iii. Consider now that the wage is a normal good, answer with a graph (10 Marks)
Question 3
a. Evaluate the idea that government intervention in the form of price ceiling and price
floors is well intentioned, but often leads to undesirable side effects. Use an example to
illustrate. (10 Marks)
b. Before trade, the domestic equilibrium price of sugar in Zimbabwe was R10 per Kg and
that for South Africa R 15 per Kg. Assume South Africa only trade with Zimbabwe and
the transport cost does not exist.
? Using diagrams, explain which country becomes an exporter or an importer
when trade is allowed between the two countries. Identify the pre-trade
consumer and producer surplus for each country.
? If free trade is permitted, illustrate the change in the surplus of consumers and
producers for each country. Will each country’ total surplus increase or
decrease?
? Truck drivers who cart goods across these two countries go on a short strike
Analyze how this strike may affect the free trade consumer and producer surplus
enjoyed by both countries
