UNIVERSITY OF TORONTO Faculty of Arts and Science. August Examinations 2007 ECO 100Y1 Y. Duration: 3 hours

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1 UNIVERSITY OF TORONTO Faculty of Arts and Science August Examinations 2007 ECO 100Y1 Y Duration: 3 hours Examination Aids allowed: Non-programmable calculators only INSTRUCTIONS: Students are required to answer Part I [multiple choice] for 20% of the exam mark, Part II [short answer questions] for 30% of the exam mark, and either Part III [Professor Hare s Section L0101] or Part IV [Professor Indart s Sections L0201 and L5101] for 50% of the exam mark. Record all your answers for Part I on the SCANTRON sheet provided and, in addition, on the first page of the examination booklet for Part II for verification. The answer on the SCANTRON sheet will be selected if there is a difference. Answer Part II in a separate examination booklet. Answer Part III or Part IV in a separate examination booklet. PART I To be answered by all students PART II To be answered by all students PART III To be answered ONLY by Professor Hare s students [Section L0101] PART IV To be answered ONLY by Professor Indart s students [Sections L0201 and L5101] Page 1 of 9

2 PART I [20%] MULTIPLE CHOICE QUESTIONS (To be answered by all students) INSTRUCTIONS: Multiple choice questions are to be answered using a black pencil or a black or blue ballpoint pen on the separate SCANTRON sheet being supplied. Be sure to fill in your name and student number on the SCANTRON sheet! Write the name of your instructor on the SCANTRON sheet (in the area where it says DO NOT WRITE IN THIS SPACE ). Each question is worth 1 mark. No deductions will be made for incorrect answers. Write your answers to the multiple choice questions ALSO on the first page of the examination booklet used for Part II [short answer questions]. Then transfer your answers to each multiple choice question onto the separate SCANTRON sheet. Your answers must be on the SCANTRON sheet. In case of a disagreement, the answer to be marked is the one on the SCANTRON sheet. 1. Sean has received a $2,000 scholarship to attend university as a full time student this year. Sean therefore had to give up his full time job in which he earned $20,000 per year. In addition, Sean must pay tuition of $5,000; buy text books for $500 and enrol in a university residence which costs $5,000 more per year of what he s currently spending for this concept. The opportunity cost for Sean to become a full-time university student thus becomes: a) $8,500. b) $20,000. c) $28,500. d) $10,500. e) $30, Kelly consumes only salmon steak and pork chops. Assume that the price of salmon steaks increased. As a result, which one of the following statements is correct? a) If salmon steaks were a normal good for Kelly, then the substitution and income effects would work in opposite directions. b) If salmon steaks were a normal good for Kelly, then the income elasticity for salmon steaks would be negative. c) If salmon steaks were an inferior good for Kelly, then the income elasticity for salmon steaks would be positive. d) If salmon steaks were an inferior good for Kelly, then the substitution and income effects would work in the same direction. Page 2 of 9

3 3. Assume that apples and oranges are substitute goods in consumption. 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. 4. The demand for shrimp would decrease if a) the price of shrimps increases. b) disposable incomes increase and shrimp was a normal good. c) disposable incomes decrease and shrimp was an inferior good. d) the price of white wine (a complementary good) decreases. e) the price of salmon (a substitute good) decreases. 5. In a short-run production process, the marginal cost is rising and the average variable cost is falling as output is increased. Thus, a) average fixed cost is constant. b) marginal cost is above average variable cost. c) marginal cost is above average fixed cost. d) marginal cost is below average variable cost. e) None of the above. 6. For a certain firm, total cost is $10 at 5 units of output and $13 for 6 units. In that range of output, marginal cost is a) decreasing. b) less than average variable cost. c) greater than average total cost. d) equal to average variable total cost. e) less than average total cost. 7. If a profit-maximizing firm in perfect competition is earning economic losses in the short run, then it must be producing a level of output where a) price is greater than marginal cost. b) price is greater than marginal revenue. c) marginal cost is greater than marginal revenue. d) average total cost is greater than marginal cost. e) average variable cost is greater than price. Page 3 of 9

4 8. In a perfectly competitive industry, all firms in the short run are currently making economic profits. At the current output, the marginal cost for each firm is $8 and the industry price is $9. According to this information, which one of the following statements is correct when the goal of each firm is to maximize profits? a) Each firm should maintain its present output. b) Since the marginal cost for each firm would be reduced at lower outputs, each firm should produce a smaller output. c) Each firm should produce a larger output to a point where average total cost equals industry price. d) Each firm should produce a larger output until marginal cost equals industry price. 9. A perfectly competitive industry is in short-run equilibrium. Each firm is initially making economic profits of $100,000 per year. Now, each firm faces an increase in property taxes of $40,000 per year. As a result of this shock, which one of the following statements is correct? a) Each firm will shut down. b) Each firm will produce an unchanged output and make economic profits of $60,000. c) Each firm will produce an increased output and make economic profits of more than $100,000. d) Each firm will produce a lower output and make economic profits of less than $100, Suppose a pure [unregulated] monopolist can sell 20 units of output per day for a price of $10 each, and 21 units of output per day for $9.80 each. The marginal revenue for the 21st unit sold is equal to a) $0. b) $0.20. c) $5.80. d) $7.60. e) $ A fall in the price of raw milk, used in the production of ice cream, will a) decrease the supply of ice cream, causing the supply curve of ice cream to shift up to the left. b) increase the supply of ice cream, causing the supply curve of ice cream to shift down to the right. c) have no effect on the supply curve of ice cream. d) cause a downward movement along the supply curve of ice cream. e) cause an upward movement along the supply curve of ice cream. Page 4 of 9

5 12. When the average product is increasing, marginal product a) equals average product. b) is increasing. c) exceeds average product. d) is decreasing. e) is less than average product. 13. Which one of the following statements is correct? a) If the price of a product increases and total revenue is unchanged, then the demand curve is relatively inelastic. b) If the price of a product increases and total revenue rises, then the demand curve is relatively elastic. c) If the price of a product falls and total revenue falls, then the demand curve is relatively inelastic. d) If the price of a product falls and total revenue rises, then the demand curve has unitary elasticity. 14. Which one of the following statements is correct for a firm in a perfectly competitive industry? a) In the short run, the firm would produce a positive output if average revenue were less than average variable costs. b) In the short run, the firm would make economic profits if average revenue equalled average fixed costs. c) In the long run, the firm would make normal profits if the industry price equalled marginal cost. d) In the long run, the firm would produce a positive output even if average revenue was less than average total cost. 15. Which one of the following statements would be correct? a) If the income elasticity for a product is positive, the product is an inferior good. b) Normal goods have downward sloping demand curves. c) If the price elasticity of demand were greater than one [absolute value], then the demand curve would be relatively inelastic. d) If the cross elasticity of demand were negative, then the two products would be substitutes. e) Both b) and d) are correct. 16. Which of the following government expenditures is not included in GDP? a) Federal defence spending. b) Salaries of municipal employees. c) Federal child benefit payments. d) Provincial environmental expenditures. e) All of the above are included. Page 5 of 9

6 17. Suppose that the consumption function is C = 2, Y. Investment is 500. There is no government and no international trade. The full employment level of GDP [Y] is 12,000. By which one of the following would autonomous investment have to increase in order to achieve full employment in this economy? a) 2,000. b) 4,000. c) 400. d) 200. e) Which one of the following statements about investment is correct? a) Net investment may be negative. b) Net investment includes the total of all machinery and equipment produced during the year. c) Gross investment must equal net investment. d) Gross investment plus depreciation equals net investment. 19. Assume that Japan has a flexible foreign-exchange rate. Which one of the following statements would allow for a depreciation of the Japanese currency? a) Japanese exports to Australia increased. b) More Asian visitors vacationed in Japan. c) More American parent companies have increased their foreign direct investment in subsidiaries in Japan. d) Brazil places new restrictions on imports from Japan. 20. Which one of the following transactions would cause the level of Gross Domestic Product [Y] to decrease? a) Consumers purchased more computers from domestic producers. b) The government increased the size of its civil service. c) The country increases its exports to other countries. d) Consumers purchased all the automobiles which were in inventory at the start of the year and there was no inventory of unsold new automobiles at the end of the year. e) None of the above. Page 6 of 9

7 PART II [30%] SHORT ANSWER QUESTIONS (To be answered by all students) Answer ALL of the TEN questions in a separate examination booklet. Analyze the situation in each question, using a well-labelled diagram when relevant and provide a brief explanation. Each question is worth 3 marks. 1. Maureen consumes only tuna [x-axis product] and lamb chops [y-axis product]. Maureen receives an increase in her commission income. As a result, Maureen, in order to maximize her level of consumer satisfaction after the increase in commission income, chooses to purchase fewer units of tuna. Statement: Sally believes that Maureen s decision is not consistent with consumer behaviour analysis. Position: Do you agree with Sally s view? Draw a consumer indifference curve diagram to analyze this situation and indicate, with reasons, whether you agree or disagree with Sally s view. 2. A firm in the short run production period generates the following information at its current level of output: the industry price is $40; the marginal revenue is $20; the average total cost is $44; the marginal cost is $20; and average fixed cost is $12. Statement: Kelly reviews this information and suggests that the firm is not in perfect competition and should shut down to minimize its economic losses. Position: Do you agree with Kelly s conclusion? Use a proper diagram to analyze this situation and indicate, with reasons, whether you agree or disagree with Kelly s conclusion. 3. A perfectly competitive industry [Industry Z, which produces Product Z] is in long run equilibrium with n identical firms. The industry has a constant cost long run supply curve. Disposable incomes increase. Product Z has negative income elasticity. Statement: Natasha holds that, in the new long run equilibrium, the industry price would be unchanged; industry output would increase; each firm would produce a smaller output; and firms would enter the industry. Position: Do you agree with Natasha s conclusion? Use a proper diagram to analyze this situation and indicate, with reasons, whether you agree or disagree with Natasha s conclusion. Page 7 of 9

8 4. A perfectly competitive industry is in long run equilibrium with a constant cost long run supply curve. The government imposes a specific commodity tax of $2.00 per unit of output on this industry. Statement: As a result, Alberto concludes that the long run industry price would increase by $2.00; industry output would fall and the full burden of the tax would fall on producers. Position: Do you agree with Alberto s conclusion? Use a proper diagram to analyze this situation and indicate, with reasons, whether you agree or disagree with Alberto s conclusion. 5. An unregulated pure monopolist is in long-run equilibrium making economic profits. The monopolist s average revenue curve is above the minimum of the average cost curve. The government introduces an average-cost pricing action. Statement: Timothy believes that this interventionist action will result in the elimination of the monopolist s economic profits and the achievement of allocative efficiency. Position: Do you share Timothy s belief? Use a proper diagram to analyze this situation and indicate, with reasons, whether you agree or disagree with Timothy s belief. 6. A pure monopolist is in short run equilibrium with economic profits. The manager s annual salary is increased by $50,000. Statement: As a result, Igor concludes that the monopolist s price will rise, its output will fall, and its profits will decrease. Position: Do you agree with Igor s conclusion? Use a proper diagram to analyze this situation and indicate, with reasons, whether you agree or disagree with Igor s conclusion. 7. Assume that Spain and Argentina produce only two goods: lamb and wine, with labour as the only factor of production. In Spain, 100 units of labour can either product 400 units of lamb or 1,000 units of wine. In Argentina, 100 units of labour can either product 200 units of lamb or 200 units of wine. Statement: Sam reviews this data and takes the position that only one country has an absolute advantage in both products. Therefore, Sam concludes that the country, which does not have an absolute advantage in either product, could achieve gains from international trade. Position: Do you agree with Sam s conclusion? Indicate, with reasons, whether you agree or disagree with Sam s conclusion. 8. Carol, who rented her home last year for $30,000, purchased this same home this year for $300,000. Statement: As a result, Cindy, Carol s friend, takes the position that there would be an increase in GDP and an increase in net domestic income in this year s national income accounts. Position: Do you share with Cindy s position? Indicate, with reasons, whether you agree or disagree with Cindy s position. Page 8 of 9

9 9. Using the expenditure approach [the final goods approach] to measure GDP, calculate the specific changes in each component of GDP (i.e, consumption, investment, etc.) and the final change in GDP when the following transactions are considered: 1) Canada imports 1,000 major computers from Japan for $10,000 Canadian each; 2) six hundred of these computers are sold to consumers in Canada for $14,000 each; 3) one hundred of these computers are re-exported to Europe for $12,000 each; and 4) the remaining three hundred computers are held in inventory at their imported price. All the above figures are in Canadian dollars. 10. Ryan deposits $500 into his regular Canadian banking account. Assume that there is a cash reserve ratio of 12 ½ %. Calculate the final change in the cash reserves of the banking system and the M1 money supply. Assume that there are no excess cash reserves initially. Page 9 of 9