ECON 1120 F2015 MAKEUP PRELIM 1 Answers

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1 ECON 1120 F2015 MAKEUP PRELIM 1 Answers 1 E This is the only answer that involves making a judgment about the right thing to do. The other answers are all positive predictions that do not address the appropriateness of the policy. 2 E A is not correct because the price of a complement in consumption does not enter into the supply function it s in the demand function. B is not correct because the number of consumers in the market is positively related to quantity demanded. C is not correct because the cost of factors of production is negatively related to quantity supplied. D is not correct because the price of a substitute is positively related to quantity demanded. E is correct because own-good price is positively related to quantity supplied. 3 B When demand increases and supply decreases at the same time, price rises unambiguously. However, since they are going in the opposite direction (in terms of going right and left, which measure quantity), the effect on the equilibrium quantity is uncertain. Depending on the relative degree of shift in the demand curve and the supply curve, equilibrium quantity may increase, decrease, or stay the same. 4 B 30,000=50,000-5P which can be solved to yield P=$ C The price ceiling is set below the market equilibrium price, so it is binding (E is incorrect). A price ceiling will generate a shortage of 40 pounds since only 20 are supplied but 60 are demanded. 6 D B is incorrect because the PPF is not a straight line. C is an unattainable point. E is a normative statement: we do not know enough about this economy to know what output mix would be best. This leaves either A or D as options. As we go from point A to E, the production of cars is going up while the PPF is growing steeper. In other words, as the economy produces each additional unit of cars, the amount of wine that must be given up as a result is increasing. This means that the marginal opportunity cost of cars is increasing, and D is the correct answer. 7 D A, B, C and E are not correct because they are used to produce some other goods or services. They are all examples of intermediate goods. 8 A The employment rate includes part-time work, so Annabel would still be considered employed. She is not a discouraged worker (B) because she did not stop searching for work upon not being able to find a job post-retirement. She is not unemployed (C) because she is currently has a job. As someone who is employed, Annabel is definition in the labor force (D). Annabel is not part of structural unemployment (E) because she did not lose her job on account of, for instance, broader changes in technology that rendered her current position obsolete. 9 B The visors were imported, so they are not part of our GDP. 10 B Find the answer in Google, though you could not do that in the exam. 11 A GDP measures the total market value of all final goods and services produced within a given period by factors of production located within a country, whereas GNP is the market value of all final goods and services produced during a given period by factors of production owned by a country s citizens. Because there are no foreign citizens producing in BadLand, but many of the BadLand s citizens produce abroad, BadLand s GNP should be greater than its GDP. 12 C The index in base year is 100. The index in year 2002 is 95. Therefore, C is correct. Webworld experienced deflation between 2001 and A

2 The CPI in 2010, with 2011 as the base year, is defined as the base year bundle evaluated at 2010 prices divided by the base year bundle evaluated at 2011 prices, then multiplied by 100. [(8* 2.00) + (5 * 2.50) + (3 * 3.00)]/[(8 * 2.10) + (5 * 2.50) + (3 * 3.50)] * 100 = C Structural unemployment: the portion of unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries. An introduction of new technology in production process could be a cause of structural unemployment.

3 Part II: Make sure you read and do ALL parts of each question. Show as much work as possible. TRY to get started on every question. Show us something. Write legibly and remember to label all graphs and axes in diagrams. 1. Suppose the supply and demand curves for milk in Cortland are described by the following equations (where Q is measured in gallons and P is price per gallon): Demand: Q D = 20-2P Supply: Q S = P a. Graph the demand and supply curves using the axes on the next page (remember to label everything in your graph including endpoints of demand and supply). b. Determine the proper equation for the demand curve as illustrated on your graph. c. Determine the proper equation for the supply curve as illustrated on your graph. d. Determine the equilibrium price and quantity values and label them on your graph. e. Suppose Brian Tobin, the mayor of Cortland, gets the local government to enact a milk price floor of $6 a gallon in the Cortland milk market. Indicate the impact of this law on your diagram and briefly discuss. Calculate any shortage/surplus due to the policy. f. Considering demanders & suppliers in this market and the government, who wins and who loses as a consequence of this policy? Briefly defend your position. Answer Space a. b. Demand: P = - ½ Q D + 10 c. Supply: P = ¼ Q S + 1

4 d. To get the equilibrium price and quantity, we can equate supply and demand equations: - ½ Q + 10 = ¼ Q + 1 ¾ Q = 9 Q* = 12 By plugging Q* back into any of the equations, we can get P*: P* = ¼ * P* = 4 Thus, the equilibrium price and quantity is $4 and 12 gallons, respectively. e. In this market, since P* = $4, the price floor of $6 binds. At $6, Q D = 8 and Q S = 20, which means we will have the surplus of 12 gallons of milk as a result of imposing the price floor. f. The one who loses for sure is consumers, because they now have to pay the higher price ($6 > $4). In addition, the quantity demanded is reduced (12 to 8), which implies that there are some consumers who used to be willing to buy milk at $4, are now not buying milk because of the artificially raised price. This means resources are not efficiently allocated to consumers who need them, so consumers worse off. Supplier s story is a bit more complicated. At a first glance, suppliers look like winners, because now they can charge the higher price, but notice that out of 20 gallons they supply in total, only 8 gallons will be purchased by consumers. In fact, total revenue is unchanged ($4*12 gallons = $6* 8 gallons = $48). Thus, as a whole, suppliers would neither better off nor worse off because their total revenue is the same. However, if we have multiple suppliers in the economy, there must be some individual suppliers who cannot sell out their milk, because of the surplus. Thus, in an individual supplier s perspective, they would better off if they sell out their milk, and would probably not if they do not sell out (depending on the change of the individual supplier s revenue). If government purchases the surplus of milk created by the price floor, then suppliers sell all of the milk they supply, so suppliers become the definite winners (greater revenue for every supplier).

5 2. Abe and Betty are the only producers/consumers in a small (American) football loving economy. Abe and Betty produce and consume only two things: NFL(National Football League) logo T-shirts and pins. Given 60 hours of work in a week, Abe can produce a maximum of 4 T-shirts or 12 pins, or any combination along a straight line PPF between the two. Given 60 hours of work in a week, Betty can produce a maximum of 5 T-shirts or 20 pins, or any combination along a straight line PPF between the two. Hours Required for One Unit of Output Person T-shirts Pins Abe 15 hours 5 hours Betty 12 hours 3 hours 60/4 = 15 hrs 60/12 = 5 hrs a. Fill in the missing numbers in the table. 60/5 = 12 hrs 60/20 = 3 hrs b. Who has the absolute advantage in T-shirt production? Who has the comparative advantage in T- shirt production? c. Assume that Abe and Betty have not taken Econ 1120, and hence don t know the wonders of trade. That is, they insist on self-producing everything they consume. If Abe wants to consume 2 T-shirts, how many pins, at most, can Abe have per week? If Betty wants to consume 16 pins, how many T-shirts, at most, can she consume per week? When Abe and Betty do this, what is the total number of pins and total number of T-shirts made summing over the two of them? d. Assume Abe and Betty take Econ 1120 and see the light and realize they should be efficient. Putting PINS ON THE HORIZONTAL and T-SHIRTS ON THE VERTICAL, illustrate the efficient combined production possibility frontier and on this graph AND illustrate the point that represents their combined output from question (c) above. e. If Abe and Betty specialize and trade with each other, what would be the bounds of an international exchange rate between T-shirts and Pins between Abe and Betty? Answer Space b. Betty has the absolute advantage in T-shirt, because it takes less for her to produce one T-shirt than Abe (12 hrs < 15 hrs). On the other hand, Abe has the comparative advantage in T-shirt, because the opportunity cost of producing 1 T-shirt is lower for Abe than Betty (3 pins < 4 pins) Abe Betty OC of producing 1 T-shirt in terms of pins 15/5 = 3 pins 12/3 = 4 pins

6 c. If Abe consumes 2 T-shirts, it takes 30 hours of work. Since they both are given 60 hours of work in a week, 30 hours are left for him for further production. If he uses up the remained hours for producing pins, he can produce 30/5 = 6 pins at most. Similarly, if Betty consumes 16 pins, 38 hours of work have to be used. If she uses up the remained hours for producing T-shirts, then she can produce 12/12 = 1 T-shirt at most. As a result, there will be 2+1 = 3 T-shirts and = 22 pins in total in this self-producing economy. d. e. The bounds of the exchange rate between T-shirts and Pins between Abe and Betty will be between 3 pins/t-shirt and 4 pins/t-shirt (or equivalently, between 1/4 T-shirt/pin and 1/3 T-shirt/pin). To see this, consider the exchange rate, 2 pins / T-shirts. Abe, specializing in T-shirt production, will not be willing to trade with Betty, because the opportunity cost of producing 1 T-shirt by himself is 3 pins, which is higher than the exchange rate. In other words, he can consume more pins from selfproduction (3 pins = 1 T-shirt) than from trading with Abe (2 pins = 1 T-shirt). Similarly, consider the exchange rate, 5 pins / T-shirts. Betty, specializing in pin production, will not be willing to trade with Abe, because she only need to give up 4 pins to get 1 T-shirt if self-produce. However, if the rate is between 3 and 4 pins/t-shirt, then they both can consume more from trading than self-producing. For instance, if the rate is 3.5 pins/t-shirt, Abe gets 3.5 pins/t-shirt by trading but only gets 3 pins/t-shirt from self-production. Also Betty only gives up 3.5 pins to get 1 T-shirt when trading, but she has to give up 4 pins when self-producing. Therefore, it is a valid exchange rate.

7 3. Consider the simple closed economy of WonderLand with only four goods: computers, bread, apples and apple juice. There is no government, and no international sector and no investment by firms. Note the following very important information: i) Computers, bread and apple juice are final goods and final goods only. ii) Apples are consumed by households as a final good AND used as an intermediate good by firms in the production of apple juice. iii) It takes 2lbs of apples to make each gallon of apple juice. This is the case in both years. iv) The apple juice industry buys all the apples it needs from the domestic apple industry. The table below provides ALL the information you need to know on prices and total output/production in two consecutive years: 2010 and Year 2010 Year 2011 Items Price per unit Quantity Price per unit Quantity Computers $ $ Bread (loaf) $ $ Apple (lbs.) $ $ Apple Juice (gallons) $ $ a. Calculate nominal G.D.P. in year b. Calculate nominal G.D.P. in year 2011 c. Calculate real G.D.P. in 2011 assuming 2010 is the base year. d. How much did the economy grow or shrink in real terms between 2010 and 2011? Defend your answer. e. What is the implicit G.D.P. deflator index in 2011, assuming 2010 is the base year? f. Calculate how much inflation there was between 2010 and 2011 according to the implicit G.D.P. deflator index, using 2010 as the base year. g. Identify and briefly discuss two reasons why the way in which we calculate G.D.P. for this economy (or any economy, for that matter) might lead us to conclude that G.D.P. is not really an accurate indicator of social welfare. First of all, each year, 2 lbs of apple is used for producing 1 gallon of apple juice, so the amount of apple as a final good is *2 = 600 lbs for 2010 and is *2 = 600 lbs for 2011 as well. a. nominal GDP 2010 = $800*100 + $2.5* $1.5*600 + $4*200 = $84,200. b. nominal GDP 2011 = $900*100 + $2* $2*600 + $5*300 = $95,700. c. real GDP 2011 (base year=2010) = $800*100 + $2.5* $1.5*600 + $4*300 = $85,850

8 d. In real terms, the economy grew 85,850 84,200 = $1,650, or 1,650/84,200 = 1.96%. e. implicit GDP DI 2011 = ($95,700 / $85,850)*100 = f. inflation between 2010 and 2011 : ( ) / 100 = 11.5% g. 1. GDP does not take into account household production and work. 2. It does not take into account black market transactions. 3. Increase of GDP mainly through the increase of price level does not necessarily mean that the economy has greater production / greater social welfare. 4. GDP does not take into account income redistribution. And so on