SOLUTIONS ECO 100Y L0101 INTRODUCTION TO ECONOMICS. Midterm Test #1 LAST NAME FIRST NAME STUDENT NUMBER. University of Toronto October 22, 2004

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1 Department of Economics Prof. Gustavo Indart University of Toronto October 22, 2004 SOLUTIONS ECO 100Y L0101 INTRODUCTION TO ECONOMICS Midterm Test #1 LAST NAME FIRST NAME STUDENT NUMBER INSTRUCTIONS: 1. The total time for this test is 50 minutes. 2. This exam consists of two parts. 3. This question booklet has 6 (six) pages. 4. Aids allowed: a simple calculator. 5. Use pen instead of pencil. DO NOT WRITE IN THIS SPACE Part I /15 Part II 1. /20 2. /15 TOTAL /50 /100 Page 1 of 6

2 PART I (15 marks) Instructions: Multiple choice questions are to be answered using a black pencil or a black or blue ball-point pen on the separate SCANTRON sheet being supplied. Be sure to fill in your name and student number on the SCANTRON sheet! When you finish your examination, place the SCANTRON sheet inside the question booklet. Each question is worth 3 (three) marks. No deductions will be made for incorrect answers. Write your answers to the multiple choice questions ALSO in this examination booklet by circling the answer of your choice. Then transfer your answers to each multiple choice question onto the separate SCANTRON sheet. Make sure that all your answers are transferred onto the SCANTRON sheet. In case of a disagreement, the answer to be marked is the one in the SCANTRON sheet. 1. Assume that apples and oranges are substitute goods. Given the initial supply and demand curves for apples, a reduction in the price of oranges will tend to a) increase the price of apples b) increase the demand for apples c) increase the demand for oranges d) decrease the demand for oranges e) decrease the price of apples 2. With a given supply curve for sirloin steak, a normal good, a rise in household income will cause a) both the equilibrium price and the equilibrium quantity of sirloin steak to increase b) the equilibrium price to increase and the equilibrium quantity of sirloin steak to decrease c) both the equilibrium price and the equilibrium quantity of sirloin steak to decrease d) the equilibrium price to decrease and the equilibrium quantity of sirloin steak to increase e) none of the above 3. The price of apples at a local market rises from $2.95 to $3.05 per kilo, and as a result the quantity of oranges that households purchase increases from 3,950 to 4,050 kilos/week. The cross-price elasticity is a) b) c) 0.75 d) 1.33 e) insufficient information to know 4. If demand is inelastic, a plentiful crop will cause farm receipts to a) increase because of the increase in quantity that farmers can sell b) remain unchanged, because the increase in the quantity that can be sold will be matched by an equal decrease in price c) increase because of the downward movement along the supply curve, encouraging an increase in demand d) decrease because the percentage fall in price is greater than the percentage increase in quantity sold e) decrease because the percentage fall in price is less than the percentage increase in quantity sold 5. The burden of a sales tax [that is, a specific commodity tax] will be higher on consumers a) the more elastic the demand curve is b) the more inelastic the supply curve is c) the more inelastic the demand curve is d) the more elastic both the demand and the supply curves are e) the more elastic the demand curve and the more inelastic the supply curve are Page 2 of 6

3 PART II Question 1 (35 marks) (20 marks) The following data show what combinations of corn and beef can be produced annually from a piece of land of a given area. A B C D E Corn (bushels) 10,000 8,000 6,000 4,000 0 Beef (pounds) ,200 1,400 1,500 Corn 16,000 A 14,000 12,000 B 10,000 8,000 A B C 6,000 C D PPC 2 4,000 D 2,000 PPC Beef a) On the diagram above, draw the production possibility curve for this piece of land and indicate all relevant points. Label this curve PPC 1. (4 marks) b) Can this area of land produce with the combination of 5,000 bushels of corn and 500 pounds of beef? Explain. What does this combination suggest about the use of this land? (3 marks) Yes, this combination can be produced because it lies below the PPC. Being below the PPC, this combination indicates that some resources either are not used efficiently or are unemployed. E Page 3 of 6

4 c) Can this area of land produce with the combination of 8,000 bushels of corn and 1,200 pounds of beef? Explain. (3 marks) No, this combination lies outside the PPC, and thus it s not feasible. d) What is the opportunity cost of expanding beef production from 900 to 1,200 pounds per annum, assuming that the land is fully utilized? (3 marks) The opportunity cost of expanding beef production from 900 to 1,200 pounds per annum is 2,000 bushels of corn that must be forgone. e) What would be the opportunity cost of producing 400 additional pounds of beef if this land were currently producing 8,000 bushels of corn and 500 pounds of beef? Explain. (3 marks) The opportunity cost would be zero, since no corn would be foregone. The current production combination implies inefficient use of land. f) What happens to the production possibility curve if a new fertilizer is developed that will allow a 50% increase in the productivity of corn production. Draw the new curve in the diagram above and label it PPC 2 and indicate all relevant points. (4 marks) More corn will be produced with any given amount of resources, that is, the PPC curve will shift out to PPC 2 in the diagram. Page 4 of 6

5 Question 2 (15 marks) The demand and supply of widgets are given by Q = 400 P and Q = P. a) On the diagram below, draw the demand and supply curves. Label the diagram and indicate all relevant points. (2 marks) P 400 S Excess Supply D D Q b) Solve algebraically for the equilibrium price and quantity. Show the equilibrium values in your diagram. (4 marks) D = S 400 P = P 1.5P = 300 P* = 200 Q* = 400 P* = = 200 Page 5 of 6

6 c) Now suppose that the supply curve is unchanged, but the demand curve changes to Q = P. Draw the new demand curve in you diagram and indicate all relevant points. (2 marks) d) At the initial equilibrium price you found in b), is there now any excess demand or excess supply in the market? How much? Show this in your diagram. (4 marks) At p = 200, the quantity demanded is Q D = (200) = 100, while the quantity supplied is Q S = 200. Therefore, there is an excess supply of 100 widgets. e) Solve algebraically for the new equilibrium price and quantity. Show the new equilibrium values in your diagram. (3 marks) D = S P = P 2P = 300 P* = 150 Q* = P* = = 175 Page 6 of 6