Part I. Multiple Choice Questions. Circle the best answers (14 marks).

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1 ECON 201 Mock Mid-term Fall, 2009 Part I. Multiple Choice Questions. Circle the best answers (14 marks). 1. Which of the following statements is normative? (a) If income increases, sales of luxury goods will fall. (b) Scientists should not make normative statements. (c) As the price of compact discs falls, people will buy more of them. (d) All of the above. (e) none of the above. 2. When asked in an interview what she missed the most because of the time she spent training for the Olympics, a rower revealed that she had given up a job that paid $40,000 per year to train full-time. She received a grant of 15,000 per year from Sports Canada, but this could not cover all her training expenses. Her food and rent were $10,000 per year and training expenses were $20,000 per year. What is the annual opportunity cost, expressed in dollars, to this rower of Going for Gold? (a) $35,000. (b) $40,000. (c) $45,000. (d) $25, When an economist refers to choices made "at the margin," the economist is referring to (a) decisions based on the marginal bene ts and marginal costs of small changes in a particular activity. (b) an individual s all-or-nothing choice concerning a speci c good or activity. (c) decisions based only on the bene ts a person receives from an activity. (d) decisions based only on the costs a person incurs from an activity. (e) all of the above. 4. Joe is a carpenter. He receives $100 per hour. He can produce 20 tables per hour. He can hire an assistant who can produce 10 tables per hour. Which of the following statements is true? (a) Joe should not hire an assistant because the assistant cannot type as fast as he. (b) Joe should hire the assistant as long as he pays the assistant less than $100 per hour. (c) Joe should hire the assistant as long as he pays the assistant less than $75 per hour. (d) Joe should hire the assistant as long as he pays the assistant less than $50 per hour. 5. Assume that the market for printers is initially in equilibrium. If there is a signi cant reduction in the price of toner cartrige, we would expect (a) the supply curve for printers to shift down (b) the supply curve for printers to shift up (c) the demand curve for printers to shift up (This is a case of complements; the demand will increase, i.e., shifts right or (we can alternatively say shifts up) (d) the demand curve for printers to shift down 1

2 6. Suppose demand increases and supply increases. Which of the following must happen (a) equilibrium price increases (b) equilibrium price decreases (c) equilibrium quantity increases (d) equilibrium quantity decreases (e) neither equilibrium price nor equilibrium quantity changes 7. Which of the following would NOT cause the demand curve for peaches to shift? (a) an increase in the price of apricots (b) a decrease in the price of nectarines (c) an increase in the price of peaches (d) a change in preference for peaches (e) a decrease in the income of peach buyers 8. If A and B are complementary goods (in consumption) and the cost of an input used in producing A drops, then the price of (a) B will rise but the price of A will fall. (b) both A and B will rise. (c) A will fall and the price of B will remain unchanged. (d) both A and B will fall. (e) B will fall but the price of A will rise. 9. If the demand equation is P = 20 2Q d, and the supply equation is P = 5 + 1Q s, and the price is set equal to 12, there is an (a) excess supply of 7 units. (b) excess demand of 4 units. (c) excess supply of 3 units. (d) equilibrium. 10. Which one of the following will de nitely increase the equilibrium price? (a) A decrease in demand combined with an increase in supply. (b) An increase in demand combined with a decrease in supply. (c) A decrease in both demand and supply. (d) An increase in both demand and supply. 11. You own a lemonade stand and have observed that when you raise the price of lemonade from 10 cents to 25 cents, your total revenue doubles. Using this information, you can conclude that: (a) The demand for lemonade is elastic. (b) The demand for lemonade is inelastic. (c) The demand for lemonade is unit elastic. (d) You should lower prices. 2

3 12. If the price elasticity of demand is -0.5, then a 20% price hike will lead to a (a) 5% drop in quantity demanded. (b) 15% drop in quantity demanded. (c) 20% drop in quantity demanded. (d) 40% drop in quantity demanded (e) 10% drop in quantity demanded. 13. Which of the following will not likely cause a change in the supply of wheat? (a) a government subsidy to farmers who do not grow wheat (b) an increase in the price of soybeans (c) a decrease in the price of fertilizers (d) producers expect product prices to rise 14. If household expenditure on electricity remains constant when the price of electricity increases, the price elasticity of demand for electricity is (a) One (in absolute value). ( Expenditure = P Q and it is constant. To make it constant we require that % 4 P = % 4 Q, which implies that j" d j = 1) (b) Zero. (c) Greater than one (in absolute value). (d) Less than one (in absolute value). (e) Cannot be determined. 15. Oil-producing countries such as Venezuela have been trying to cut down on oil production in order to increase total revenues. Venezuela believes that the price elasticity of oil demand is (a) Elastic. (b) Inelastic. (c) Positive.Unit elastic. (d) None of the above. 16. If the government imposes a price ceiling below the equilibrium price, then (a) The quantity consumed will rise. (b) Consumer surplus will fall. (c) Consumer surplus will rise. (d) Consumer surplus may rise or fall. (e) The price will rise. On Turtle Island, the egg marketing board is considering ways of stabilizing farm prices and farm revenues. Currently the egg market is competitive and the demand for and supply of eggs is as follows Price/dozen Quantity Demanded Quantity Supplied dozens Refer to the previous information in answering questions 17, 18, and The competitive equilibrium price 3

4 (a) 1.20 (b) 1.30 (c) 1.40 (d) 1.50 (e) The egg marketing board introduces a oor price of $1.60 a dozen. What is the surplus of eggs? (a) 1000 dozens (b) 1250 dozens (c) 2000 dozens (d) 2225 dozens (e) 3000 dozens 19. Refer to the initial situation. The egg marketing board decides to introduce a subsidy of 20 cents a dozen. If this occurs, the equilibrium price will be (a) 1.20 (b) 1.30 (c) 1.40 (d) 1.50 (e) Non of the above 20. Suppose you own a small local bakery, and you decided to raise the price of your special bread. This decision re ects your belief that (a) the demand for this bread is elastic (b) the supply is inelastic (c) the demand is unit elastic (d) the demand is inelastic 21. In the following gure, what could cause the movement from point A to point B? (a) An increase in the supply (b) An increase in the price (c) An increase in prices of resources (d) an increase in the price of a substitute product 22. If the government introduces a subsidy into a market, then (a) consumer surplus will rise. (b) the quantity consumed will rise. (c) consumer surplus will fall. (d) both a and b. (e) both b and c. 23. At the e cient quantity of a good, (a) producer surplus exceeds consumer surplus by the greatest possible amount. 4

5 (b) total consumer surplus is zero. (c) the sum of consumer surplus and producer surplus is maximized. (d) total producer surplus is zero. (e) consumer surplus exceeds producer surplus by the greatest possible amount. 24. Suppose that the demand for good x is given by the following equation Q d x = 100 4P then the price where the demand for that good is perfectly elastic is (a) 0 (b) 1 (c) can not be determined from the above information (d) A steel mill produces 40,000 tons of steel per month at a cost of $6 million. For the people in the surrounding community, the production of 40,000 tons of steel causes an increase of $500,000 in health care expenditures, a loss of $200,000 in wages from being sick, and an increase of $200,000 in expenditures on home and auto care due to the dirty air. Based on these gures, the private cost of 40,000 tons of steel is while the social cost is. (a) $5 million; $5.9 million. (Notice that social cost = private + external cost) (b) $5 million; $600,000. (c) $5.6 million; $5 million. (d) $600,000; $5.6 million. Part II: Answer all parts (Total= 36 marks) 26. PPF and Opportunity Cost Consider two individuals, Joe and Mary. They each work eight hours a day, and they can only sh or grow potatoes. The table below shows how much they can produce each hour: Amount produced in 1 hour (kg) Fish Potatoes Joe 1 1 Mary 8 2 (a) Draw the production possibilities frontier for each person. Put "Fish" on the vertical axis and "Potato" on the horizontal axis. (b) What is the slope of Joe s PPF?; what is the slope of Mary s? Explain (c) If Joe is currently producing 4 sh and 3 potatoes. What can you say about this bundle in terms of e ciency? (d) What is the opportunity cost of 1 sh for Joe? what is the opportunity cost of 1 potatoes for Joe? (e) What is the opportunity cost of sh for Mary? What is the opportunity cost of 1 potatoes for Mary? (f) Who has comparative advantage in producing sh? What about in producing potatoes? Explain 27. Price Floor and Subsidies Suppose that the market demand curve for wheat is Q d = 300 5P and the market supply curve is Q s = P: (a) What is the equilibrium price and equilibrium quantity? 5

6 (b) Suppose the government decides to have a price support program with a price oor set at PF = 40. Under a price oor program, the government sets this price and the producers decide how many units they want to sell. The consumers pay the support price for the units they buy, while the government buys up the excess supply. What is the excess supply in this market? What is the cost of this program to the government? (c) Suppose, instead, the government decides to have a government subsidy program with a guaranteed (or target) price of PT = 35. Under this program, the producers decide how many units they want to sell, but they also have to sell all the units to the consumers. There is no excess supply. What is the price to consumers? What is the subsidy per unit the government has to pay? What is the cost to the government for this program? (d) If a government wants to compare the following policies: price-support programs and subsidy programs, which program do you think involves an extra cost compared to the other one? 28. Farm stories for July 26th, 2007 Written by Jim Birchard, Bayshore Broadcasting Corp. The largest winter wheat crop ever produced in Western Canada is set to begin harvesting this week. The Canadian Wheat Board says the 1.45 million acres seeded to the crop will yield record production. Winter-wheat yields are on track to match or surpass last year s record-setting yield results. Based on the above excerpt, would you expect the income of the wheat farmers to increase or decrease? Explain with a demand-supply diagram. Ans: Supply shifts right, pushes down prices, raises quantities, but total revenue may rise or fall. 29. Price Floors, Production Subsidies and Quotas Developed countries often intervene in their agricultural industries, using price oors, production subsidies or quotas (supply management). As an economist in the Department of Agriculture you have estimated the demand to be P = 300 4Q d and supply to be P = Q s for the chicken industry. You have been asked to evaluate three policy choices. Quantities are in tons. (a) To begin with, there are no interventions. Find the equilibrium P and Q. Also nd the total revenue (T R) of the suppliers. (b) Option1:Price oor=$160, the government buys up any surplus (excess supply). Find Q d, Q s, surplus, T R of the suppliers, and the cost to the government. (c) Option 2: Production subsidy. Find the amount of the production subsidy per unit required such that the TR of rms is the same as under the price oor. Also nd how much the consumers pay per unit and the total cost to the government. (d) Option 3: Quota=35. Find the corresponding consumer price and the total revenue of the suppliers at this quantity supplied. (e) In your capacity as an economist working for the government, which of the three options would you recommend? If you were working as an economist for the farmers, which option would you recommend? Explain. 30. Consider a cement manufacturer. The production process releases smokes carbon dioxide into the atmosphere. The marginal private cost (MC) of producing cements is the producer s supply curve MC = Q s The marginal social cost (MSC) as a result of this activity is MSC = 1:5Q s The demand curve for cement (there are no external bene ts) is P = 12 0:5Q d 6

7 (a) In an unregulated market, what is the equilibrium quantity and price of cement? (b) To achieve allocative e ciency, what should be the equilibrium quantity of cement? (c) Compare and describe the unregulated market quantity and price with the allocatively e cient quantity and price. (d) The government wants to impose a tax on Cement producer to achieve the allocatively e cient quantity of output. What should the tax be? (e) Consider the following article: B.C. carbon tax kicks in on Canada Day Last Updated: Tuesday, July 1, 2008 j 12:34 AM ET CBC News Vancouverites line up to ll their gas tanks Monday afternoon before the provincial carbon tax takes e ect on Canada Day. British Columbians will pay more at the gas pump as the provincial government s carbon tax on all fossil fuels takes e ect Tuesday. The carbon tax, introduced in the Feb. 19 budget, taxes carbon-based fuels including gasoline, diesel, natural gas and home heating fuel at a rate of $10 per tonne of greenhouse gases generated. The carbon tax will rise $5 a tonne for the next four years until it hits $30 per tonne in The Tuesday tax increase works out to an extra 2.4 cents a litre on gasoline, increasing to 7.24 cents per litre by The government has said all carbon tax revenue about $1.8 billion over three years will be returned to British Columbians through reductions to income and business taxes. Given the above article, the BC government introduced a carbon tax on fossil fuels. Besides correcting private marginal costs, what other reason(s) can you think of as to why fuels are to be taxed? Would you expect environmental problems to be resolved by taxes? Explain. Solution: (a) The unregulated equilibrium is realized when MP C = MSB or Solving for equilibrium yields (b) Allocative e ciency is realized when or Solving yields Q s = 12 0:5Q d Q = 8; P = 8 MSC = MSB 1:5Q s = 12 0:5Q d Q = 6; P = 9 (c) The unregulated market produces too much and the product sells at a price too low (d) The tax should be set such that the e cient output of 6 units is realized. Notice that at Q = 6 MP C = 6 MSC = MP C + MEC = 9 To internalize the negative externality, a corrective tax equals to the MEC should be imposed on the producer, hence, T = $3 (e) Carbon tax may internalize social costs, but since the demand is inelastic, government revenue will also rise. Given inelastic demand, unlikely quantity demanded will fall much. Cleaner technology, smaller population and more consumer awareness are more e ective. 7

8 31. Consider the following two markets with di erent demand functions but similar supply functions: P = 10 0:1Q 1 D P = 6 0:02Q 2 D P = 0:1Q S Now suppose that government levies a tax of $4 per unit on consumers. (a) Find the initial equilibrium price and quantity in each market. Ans: Before imposing tax, equilibrium price is $5 and equilibrium quantity is 50 in both markets. (b) Which of the two markets is the less elastic one? Explain. Ans: Market 1 is the less elastic than market 2 since the slope of the market 1 demand is 0.1, while the slope of market 2 demand is Market 1 demand is steeper, hence less elastic. (c) Find the new equilibrium consumer price and quantity after the tax in both markets. Ans: Then, we levy the excise tax of $4 per unit. In the rst market the new equilibrium price is $7 and the new equilibrium quantity is 30. In the second market, the equilibrium price is $5.67 and the equilibrium quantity is (d) Which market generates higher tax revenue? Is this consistent with your answer in (ii)? Use the concept of elasticity to relate to the amount of tax revenue collected by the government. Ans: Tax revenue in the rst market is $4*30=$120. Tax revenue in the second market is $4*16.67=$ The rst market generates higher tax revenue. It is consistent with the answer in (i) since tax revenue depends on quantity bought, and with a less elastic demand, quantity demanded drops only a bit, so tax revenue is high. 8