Trial exam additional questions

Trial exam additional questions - University of Amsterdam...

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Unformatted text preview: University of Amsterdam Faculty of Economics and Business Name:___________________________________ EXAM EUROPEAN ECONOMIC INTEGRATION <date> <time> You are allowed to answer in English or in Dutch language Instructions regarding the organisation of the exam • • • • • • • • Only the following items are allowed on your table: the exam and other materials provided by the invigilators (e.g., writing paper), your student card, a pen, pencil and eraser. Electronic equipment must be switched off and kept in your bag or coat. Bags must be closed and put next to your table. Before the exam you must bring your coat to an indicated central place, where you will also get it back after the exam. You should put your valuables in your bag; the invigilators are not responsible for your belongings. It is not allowed to go to the toilet. It is not allowed to leave the exam room within half an hour after the start of the exam, and after that first half hour students can no longer enter the exam room. When handing in your answer sheets, you should also hand in the exam itself. If these instructions are not obeyed, you can be excluded from the exam. Instructions for answering the exam questions • Read the question carefully and make sure that you give an answer to the question. Do this briefly, but ALWAYS CLARIFY YOUR ANSWER, unless explicitly stated otherwise. So do not digress too much: incorrect or irrelevant remarks could cost you points. Write legibly; text that is difficult to read will not yield points. Write down your name and student identification number on every answering sheet, as well as the front page of this exam (see top of this page). Make sure that the margins are wide enough to facilitate the assessment. Redraw graphs on your answering sheet if that is needed for answering the question. The exam grades will become available on Blackboard on Friday July 16 at 18.00 hrs. at the latest. At the same time the date on which you can look into your graded exam will be announced as well. • • • • • GOOD LUCK! 
 1
 Question
1
(20
points)
 Whether
the
economics
 behind
it
are
sound
or
not,
the
EMU
founding
Maastricht
Treaty
marked
a
 spectacular
 step
 in
 the
 European
 integration
 process.
 An
 irrevocable
 decision
 to
 launch
 the
 single
 currency
by
January
1999
was
made.
This
was
not
done
without
giving
proper
thought
to
who
should
 be
able
to
join
the
EMU.
 a. Discuss
 the
 economic
 reason
 for
 imposing
 convergence
 criteria
 and
 trial
 period
 for
 EMU
 admission.
 b. Discuss
five
convergence
criteria.
Which
distinctions
can
be
made
between
them.
 The
 relationship
 between
 government
 deficit
 and
 government
 debt
 is
 described
 by
 the
 following
 simple
formula
of
the
fiscal
policy
rule:
 (1) def
=
g
/
(1+g)
b

 Whereby
 def
 =
 government
 deficit
 as
 a
 fraction
 of
 GDP
 and
 b
 =
 government
 debt
 as
 a
 fraction
 of
 GDP,
g
=
the
nominal
growth
rate
of
GDP.
The
rule
for
the
EMU
is
that
a
3%
deficit
is
allowed
as
well
 as
a
60%
government
debt.
 c. Calculate
 the
 growth
 rate
 required
 for
 this
 formula
 to
 hold.
 Make
 a
 distinction
 between
 nominal
an
real
growth
using
the
ECB’s
official
inflation
target.
 
 Financial
markets
 are
currently
worried
about
the
government
debt
levels
across
the
 EMU
and
are
 actually
demanding
reduction
of
government
debt
levels.

 
 d. Assume
 that
 a
 government
 debt
 is
 at
 80%.
 Use
 the
 formula
 above
 to
 calculate
 the
 deficit
 given
 the
 growth
 rate
 calculated
 under
 c.
 Use
 the
 formula
 to
 discuss
 two
 ways
 to
 restore
 reduce
 the
 government
 debt
 to
 60%.
 Argue
 which
 one
 is
 realistic
 (use
 the
 official
 ECB
 inflation
target).
 e. Briefly
 discuss
 the
 historic
 reason
 why
 this
 fiscal
 policy
 rule
 is
 so
 important
 for
 monetary
 policy.

 
 Question
2
(20
points)
 The
Treaty
of
Rome
bans
state
aid
that
provides
firms
with
an
unfair
advantage
and
therefore
distort
 competition.
 The
 EU
 founders
 considered
 this
 so
 important
 that
 they
 empowered
 the
 European
 Commission
with
enforcement.

 Baldwin
and
Wyplosz
develop
a
model,
based
on
work
of
Nobel
laureate
Paul
Krugman,
that
provides
 an
 economic
 foundation
 for
 this.
 
 The
 model
 is
 represented
 in
 the
 diagram
 below.
 The
 left
 hand
 diagram
 represents
 the
 downward
 sloping
 demand
 curve
 for
 an
 industry
 in
 a
 (home)
 country.
 In
 addition
 the
 marginal
 cost
 (MC)
 curve
 for
 firms
 is
 drawn;
 it
 is
 assumed
 to
 be
 perfectly
 elastic.
 The
 right
hand
diagram
depicts
a
downward
sloping
COMP
curve,
representing
the
relationship
between
 the
mark‐up
(Price‐MC)
and
the
number
of
firms
and
an
upward
sloping
BE
curve,
where
firms
break‐ 
 2
 even
(P
=
AC,
AC
=
average
cost
per
firm
=
MC
plus
fixed
cost
per
unit
sold).

Point
E
represents
the
 initial
home
country
equilibrium
where
all
firms
break‐even.

 The
 BEFT
 curve
 represents
 the
 BE
 curve
 after
 markets
 are
 liberalized
 in
 the
 sense
 that
 firms
 from
 another
country
with
the
same
size
and
characteristics
are
allowed
in
the
home
country.

 a. Explain
why
the
BE
curve
shifts
rightward
after
liberalization.
Why
is
EFT
not
an
equilibrium.
 Briefly
describe
the
adjustment
process
that
is
put
in
motion.
 Now
 assume
 that
 the
 government
 of
 the
 home
 country
 will
 provide
 state
 aid
 to
 all
 firms
 in
 the
 market.
This
state
aid
equals
the
difference
between
the
mark‐up
at
point
EFT
 and
at
point
A,
so
μ
 ‐

 μ´
for
every
firm
in
the
right
hand
diagram.

 b. Use
 the
 left
 hand
 diagram
 to
 discuss
 the
 welfare
 effect
 of
 the
 state
 aid
 for
 consumers
 and
 producers.
Determine
the
overall
welfare
gain.

 c. Briefly
discuss
the
reason
why
state
aid
is
still
not
a
good
idea.

 d. Mention
two
reasons
why
state
aid
is
sometimes
allowed
by
the
European
Commission.


 e. State
aid
for
banks
in
the
credit
crisis
(IP/08/1495)
was
conditioned.
Mention
two
conditions

 that
were
imposed.
 
 Price
 
 
 
 
 
 Mark‐up
(μ)
 




















Demand
curve






















































































BE
 
 

































E
 
P











a


















b
 
P´


















































A































μ´











































A





COMP











































 
 













c




















d



 




























































MC
curve



































n
















n´






Number
of
firms 
 

































C














C´




Total
sales
 
 
 
 
 
 
 
 
 
































μ
 
 


E
 




EFT
 







BEFT
 
 
 3
 Answers:
 


 Question
1
 a. 
(3
 points)
 Immediate
 tensions
 in
 the
 system:
 if
 the
 joining
 country
 does
 not
 meet
 certain
 criteria
 it
 is
 not
 competitive,
 leading
 to
 internal
 adjustment
 pressure
 and/or
 immediate
 pressure
on
the
ECB
to
use
monetary
policy.
 b. (5
 points)
 Inflation
 level,
 fiscal
 deficit,
 government
 debt,
 long
 term
 interest,
 exchange
 rate
 stability.
Monetary
and
fiscal
policy;
performance
and
performance
sustainability.
 c. (4
points)
g
=
5.26%
and
real
growth
is
3.25%,
given
2%
inflation
target.
 d. (5
points)
4.2%.
Reducing
the
deficit
and
increasing
growth.
The
latter
should
be
7.52%.
The
 later
is
very
high
given
2%
inflation.
 e. (3
points)
Historically
inflation
has
come
with
runaway
public
deficits
and
debts.
 Question
2
 a. (6
points)
After
liberalization
there
will
be
twice
the
number
of
 firms
for
every
level
of
mark‐ up.
 EFT
 is
 not
 an
 equilibrium
 because
 the
 number
 of
 firms
 in
 the
 market
 has
 doubled,
 implying
that
the
competitive
forces
will
drive
down
the
mark‐up.
But
if
that
is
the
case,
firms
 will
no
longer
be
break
even
and
a
restructuring
will
occur.


 b. (6
 points)
 Producers
 obtain
 compensation
 for
 the
 loss
 of
 operating
 profit
 which
 is
 a
 +
 d
 so
 they
 are
 neutral,
 but
 this
 is
 
 cost
 of
 subsidy
 at
 the
 same
 time.
 Consumers
 win
 a
 +
 b.
 
 The
 welfare
gain
is
b
+
d.

 c. (3
points)
The
industry
is
prevented
from
healthy
restructuring.
In
the
long
run
it
will
lose
its
 ability
to
adapt
and
innovate.
 d. (3
 points)
 Social
 policy,
 natural
 disaster,
 economic
 development
 aid
 to
 regions,
 serious
 disturbance
in
the
economy.
 e. (2
 points)
 not
 to
 give
 rise
 to
 disproportionate
 distortions
 of
 competition
 (no
 aggressive
 marketing),
 limited
 in
 time
 (renewed
 and
 adjusted
 as
 market
 conditions
 permit)
 and
 adequate
contribution
from
the
private
sector
(no
unjustified
gains
by
shareholders).
 
 
 
 
 4
 ...
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This note was uploaded on 04/18/2011 for the course ECON 102 taught by Professor Rossana during the Spring '08 term at University of Michigan.

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