Multiple Choice Part II, A Part II, B Part III Total

SIMON FRASER UNIVERSITY ECON 103 (2007-2) MIDTERM EXAM NAME Student # Tutorial # Multiple Choice Part II, A Part II, B Part III Total PART I. MULTIPLE CHOICE (56%, 1.75 points each). Answer on the bubble sheet. Use a soft lead pencil. 1. Which of the following is NOT a characteristic of a perfectly competitive market. a. a large number of sellers and buyers. d. constant returns to scale. b. easy entry and easy exit. e. firms are price takers. c. a homogenous (standardized) product. 2 Which of the following is a normative statement? a. Canada imports most of its cameras from Asia. b. A decrease in the price of digital cameras will decrease the demand for camera film. c. Canada ought to reduce its dependence on imported cameras. d. An increase in the price of cameras will decrease the number of cameras sold. e. Technological advance has resulted in lower prices for digital cameras. 3. The figure to the right is the 2007 production possibilities curve for a country named Alphaland. Production at which point in 2007 is most likely to lead to economic growth (i.e., the biggest shift out of the future production possibilities curve)? a. Point A. b. Point B. c. Point C. d. Point D. e. Point E. 4. Exchanges taking place in a market system a. will benefit one party at the expense of another. b. involve no transaction costs. c. are inefficient. d. are monitored by the government to ensure that scarce resources are being used wisely. e. are voluntary. 5. An opportunity cost arises a. only when the wrong decision is made. d. whenever any choice is made. b. only when a time cost is incurred. e. only when an explicit cost is incurred. c. only when a monetary cost is incurred. 6. Assume that in the market for widgets both demand and supply shift out (i.e., shift to the right). As a result of these shifts total expenditures on widgets increase. We can conclude that, a. demand for widgets is elastic. d. both the supply and demand of widgets is elastic. b. demand for widgets is inelastic. e. we cannot make any of these conclusions. c. supply of widgets is elastic but demand is inelastic. 7. If the cross-price elasticity of demand between product X and product Y is 5 this would suggest that a. products X and Y are complements. b. products X and Y are strong substitutes. c. products X and Y are weak substitutes. d. products X and Y are neither substitutes nor complements. e. somebody made a mistake because this elasticity cannot be negative. capital goods A E D consumer goods B C

2 8. If two variables are inversely related, then as the value of one variable: a. increases, the value of the other may either increase or decrease. b. decreases, the value of the other decreases. c. increases, the value of the other decreases. d. increases, the value of the other increases. e. changes, the value of the other might or might not change. 9. If a firm's revenues just cover all its opportunity costs, then which of the following is NOT true? a. Normal profit will be greater than zero. b. Economic profit will be zero. d. explicit costs could equal zero. c. Accounting profit will be zero. e. implicit costs would be greater than zero. 10. Refer to the figure to the right that refers to the market for corn. If government sets a. a ceiling price at P3 there will be a shortage. b. a ceiling price at P3 there will be a surplus. c. a floor price at P2 there will be a surplus. d. a floor price at P2 there will be a shortage. e. a ceiling price at P2 there will be a shortage. P3 P1 P2 D S 11. The circular flow model indicates that Q1 a. in product markets households provide businesses with money and resources. b. in factor markets businesses provide households with money and goods and services. c. in product markets businesses provide households with goods and services and households provide businesses with money. d. government has no role in a market economy. e. businesses provide the economy with factors of production. 12. Which of the following statements is NOT true. With the passage of time a. demand generally becomes more own-price elastic. b. supply generally becomes more own-price elastic. c. coordination problems in command economies become more severe if the economy expands. d. production possibilities curves generally shift out as the population grows. e. demand generally becomes more income elastic. 13. The basic difference between the "short run" and the "long run" is that: a. in the short-run more than 50% of a firm s factors of production are fixed. b. own-price elasticity of demand is inelastic in the short-run. c. the firm cannot vary the amount of any capital goods it uses in the short-run. d. economies of scale may be present in the short run, but not in the long run. e. none of the above. 14. Refer to the figure to the right. By inspecting the position of these two demand curves we can conclude that a. at price P1, D1 is more elastic than D2. b. at every point on D2 demand is more own-price elastic than at every point on D1. c. at price P1, D2 is more own-price elastic than D1. d. At P1, own-price elasticity is unitary for both D1 and D2. e. none of the above are true. P1 D1 D2 15. In the short run, if total product is increasing, marginal product a. must exceed average product. d. will be increasing at an increasing rate. b. must also be increasing. e. may be either positive or negative. c. is positive, but may be either increasing or decreasing.

3 16. If the supply of a product increases (shifts out) and the demand for that product simultaneously increases, we can conclude that equilibrium: a. price must rise, but equilibrium quantity may either rise, fall, or remain unchanged. b. quantity must increase, but equilibrium price may either rise, fall, or remain unchanged. c. price and equilibrium quantity must both increase. d. price and equilibrium quantity must both decline. e. we do not know with certainty the direction of change of either equilibrium price or quantity. 17. Assume the short-run cost curves to the right refer to a firm with a single variable input, labour. Which of the following statements is $ NOT true? a. The marginal product of labour is increasing up to an output level of Q1. b. The average product of labour is increasing up to an output level of Q2. c. If production is pushed beyond Q1 the firm will experience diminishing returns to the fixed factor of production. d. The firm should hire Q2 units of labour to achieve technical (productive) efficiency. e. Total product is increasing at an increasing rate up to an output of Q1. Q1 Q2 MC Quantity AVC 18. The demand for fruit is less own-price elastic than is the demand for apples. This is best explained by the fact that: a. fruit is a luxury. b. apples are a necessity. c. expenditures on fruit are small relative to consumers' budgets. d. consumption of fruit as a whole is greater than consumption of apples. e. there are more substitutes for apples than for all fruits. 19. Ceteris paribus (everything-else-equal), the more rapidly marginal utility falls for a product a. the more own-price elastic will be demand for the product. b. the less own-price elastic will be demand for the product. c. the more likely the product is a necessity. d. the more likely the product is a luxury. e. the more likely the product has many substitutes. 20. The costs of using the market (i.e., transaction costs) to acquire product X, would NOT include; a. search costs d. the costs of enforcing contracts. b. the costs of negotiating contracts. e. the costs of policing contracts. c. the price of product X. 21. Economists typically depict the production possibilities frontier as a bowed curve rather than as a straight line in order to show that a. resources used in production of one good cannot be used in production of another. b. opportunity cost is always present. c. the opportunity cost of producing a good rises as more is produced. d. the opportunity cost of producing a good declines as more is produced. e. production beyond the frontier is not possible. 22. The long-run supply curve for a constant cost, perfectly competitive industry is a. perfectly elastic b. perfectly inelastic c. unitary elastic d. inelastic e. we cannot tell 23. The market system corrects a shortage by: a. lowering product price to decrease production. d. raising product price to decrease production. b. lowering product price to decrease consumption. e. raising product price to increase production. c. lowering product price to increase production.

Kgs of Chicken 4 The figure to the right refers to a perfectly competitive, profit-maximizing supplier of X. Answer the next five questions based on this diagram. 24. Which of the following statements is true? a. This represents the long-run. b. Accounting profits are zero. c. The firm is achieving productive efficiency. d. The market is not in long-run equilibrium. e. Market price is 0e. 25. The firm will achieve minimum efficient scale at production of a. 0z b. 0y c. 0x d. 0w e. none of these f e d c b $ t MC k n ATC AVC MR 26. The firm is earning economic profits of a. eftk b. 0ftw oekw c. kt times 0w d. (0f 0e) times 0w e. all of these. a 0 z y x w Q 27. The minimum price that would induce this firm to produce is a. 0a b. 0b c. 0c d. 0d e. 0f. 28. The market demand for product X is own-price a. perfectly elastic b. perfectly inelastic c. unitary elastic d. elastic e. we don t know. The figure to the right represents Joe s budget line for the purchase of meat. His total budget is $36. Answer the next two questions based on this diagram. 18 16 29. Which of the following statements is NOT true? a. The price of chicken is $2/kg. b. The price of beef is $1.50/kg. c. The opportunity cost of 1 kg. of chicken is 1.33 kg of beef. d. The opportunity cost of 1 kg of beef is 0.75 kg of chicken. e. The MU of chicken is greater than the MU of beef. 30. Which of the following statements is true? a. The slope of the budget line is 1.3 b. Consumption of 6 kgs of chicken and 16 kgs of beef achieves allocative efficiency. c. If the price of beef changed so that it was now equal to the current price of chicken, Joe could not afford 10 kgs of chicken and 10 kgs of beef. d. If the price of beef changed so that it was now equal to the current price of chicken, Joe could afford 10 kgs of chicken and 10 kgs of beef. e. If the price of beef changed so that it was now equal to the current price of chicken, this could be represented by a parallel shift in of the budget line. 31. If we say that a prevailing price is "too high to clear the market," we mean that: a. quantity demanded exceeds quantity supplied. d. quantity supplied exceeds quantity demanded. b. the equilibrium price is above the current price. e. the price of the good is likely to rise. c. consumers cannot obtain the quantity they want at the prevailing price. 32. The term "mixed economy" refers to an economy that: a. is comprised of both product and resource markets. b. is engaged in both domestic and international trade. c. is comprised of both extensive private markets and government involvement in the economy. d. functions primarily on the basis of custom and tradition. e. produces both consumer goods and capital goods. 14 12 10 8 6 4 2 2 4 6 8 10 12 14 16 18 20 22 24 26 Kgs of Beef

5 PART II. PROBLEM A. Answer in the space below the question and on the back of this page (if you need the space). Show your work. (18%) Raj is interested in consuming just two products, CDs and Ringtunes. The marginal utility schedules for these two goods are shown in the table. The blank columns are for your convenience. CD Ringtune Q of A MU Q of B MU 1 48 1 24 2 32 2 15 3 24 3 12 4 16 4 8 5 8 5 6 6 4 6 4 1. Assume Raj has an income of $24 to spend on CDs and Ringtunes. The price of a CD is $8, and the price of a Ringtune is $2. 1.a. What is the utility maximizing combination of CDs and Ringtunes that Raj will purchase? 1.b. Show, using the utility maximizing formula, that this combination satisfies the utility maximizing rule. 1.c. What is Raj s total utility when consuming this combination? 2. Assume Raj has an income of $24 to spend on CDs and Ringtunes. The price of a CD drops from $8 to $4, and the price of a Ringtune remains $2. 2.a. What is the utility maximizing combination of CDs and Ringtunes that Raj will purchase? 2.b. What is the own-price elasticity of demand for CDs for the price change from $8 to $4? 2.c. Show that the elasticity you have calculated is consistent with the total revenue test. 3. Assume at the outset that Raj has an income of $24, the price of a CD is $8 and the price of a Ringtune is $2 (i.e., the situation is exactly as described in question 1). Now assume Raj s income drops from $24 to $14. 3.a. What combination of CDs and Ringtunes should Raj purchase? 3.b. What is the income elasticity of demand for CDs? 3.c. Are CDs a normal good or an inferior good? How do you know?

6 PART II, PROBLEM B. Answer in the space below the question and on the next page (if you need the space). Show your work. (11%) This is the cost schedule for a firm in a perfectly competitive industry. The blank columns are for your convenience. 1. How much will this firm produce at a price of: $26, $36, $51, $71. 2. What is the shutdown price? How do you know? Quantity Total Cost 0 $50 1 $95 2 $115 3 $130 4 $150 5 $175 6 $210 7 $260 8 $330 3. Assume there are 1,000 firms in the industry. The market demand is shown in the table at the right. 3.a. What will be the short-run equilibrium price and quantity in this market? 3.b. Will this be a stable equilibrium or with there be entry or exit in the longrun? How do you know? Price Quantity Demanded $26 5,000 $36 4,000 $51 3,000 $71 2,000 PART III. SHORT ESSAY. ANSWER BELOW. (15%) 1. When a perfectly competitive market is in long-run equilibrium, price = marginal cost. a. From the standpoint of economic efficiency, explain the significance of the equality of price and marginal cost. b. Using a diagram of a perfectly competitive market in long-run equilibrium, show the consumers surplus and the producers surplus. c. Now assume that the cost of inputs to suppliers increases. Show the impacts of this change on equilibrium price and quantity. Show on your diagram what happens to consumers surplus.

7 ANSWERS Ques. ans Note 1 d 2 c 3 a x 4 e 5 d 6 e 7 a 8 c 9 c x 10 e 11 c 12 e 13 e x 14 c x 15 c 16 b 17 d 18 e 19 b x 20 c 21 c 22 a 23 e 24 d 25 e x 26 e 27 b 28 e 29 e 30 c 31 d 32 c 3. POINT A IS THE ANSWER BECAUSE EVEN THOUGH IT IS INSIDE THE PP CURVE, MORE CAPITAL GOODS ARE PRODUCED AT THIS POINT THAN AT ANY OF THE ALTERNATIVES. IT IS CAPITAL GOODS THAT LEAD TO INCREASED OUTPUT IN THE FUTURE. 9. NORMAL PROFIT IS AN IMPLICIT COST. SINCE ALL OPPORTUNITY COSTS ARE COVERED THE FIRM MUST HAVE A POSITIVE NORMAL PROFIT, BUT THIS WILL APPEAR AS A POSITIVE ACCOUNTING PROFIT (SO c is not true). 13. MANY STUDENTS ANSWERED c. IT IS NOT CORRECT BECAUSE MANY CAPITAL GOODS CAN BE VARIED IN THE SHORT RUN (HAMMERS FOR EXAMPLE). REMEMBER IN THE SHORT RUN ONE INPUT MUST BE FIXED BUT IT DOES NOT HAVE TO BE CAPITAL (OUR EXAMPLE IN CLASS WAS LAND). 14. MANY STUDENTS ANSWERED b. ELASTICITY CHANGES ALONG A LINEAR DEMAND CURVE. AT A HIGH PRICE ELASTICITY ON D2 MIGHT WELL BE LESS THAN ELASTICITY AT A LOW PRICE ON D1. 19. THINK OF IT THIS WAY. IF MU DROPS VERY QUICKLY, THE NEXT UNIT IS WORTH MUCH LESS TO YOU. PRICE WILL HAVE TO FALL A LOT TO GET YOU TO BUY A LITTLE MORE. A LARGE PERCENTAGE CHANGE IN PRICE AND A SMALL PERCENTAGE CHANGE IN QUANTITY DEMANDED ARE CHARACTERISTICS OF A LOW ELASTICITY OF DEMAND. 25. THIS WAS A LITTLE TRICKY. SCALE ECONOMIES ARE A LONG-RUN PHENOMENEN WHILE THIS IS OBVIOUSLY THE SHORT-RUN (THERE ARE FIXED COSTS). YOU CAN T SHOW MES ON THIS DIAGRAM.

8 PART II. PROBLEM A. CD Ringtune Q of A MU MU/$8 MU/$4 Q of B MU MU/$2 1 48 6 12 1 24 12 2 32 4 8 2 15 7.5 3 24 3 6 3 12 6 4 16 2 4 4 8 4 5 8 1 2 5 6 3 6 4 0.5 1 6 4 2 1.a. with $24, buy 2 CDs and 4 ring tunes 1.b., MU/$ = 4 for both goods. 1.c., 48 + 32 + 24 + 15 + 12 +8 = 139 2.a., buy 4 CDs and 4 Ringtunes 2.b., elasticity = [2/(2+4)*.5]/[4/(8+4)*.5] = 1 2.c., show that your elasticity is consistent with the total revenue test 3.a. buy 1 CD and 3 Ringtunes 3.b. elasticity = [-1/(2+1)*.5]/[10/(24+14)*.5] = +1.25 3.c., normal good because income elasticity > 0 PART II, PROBLEM B Profit or loss Quantity Total Cost MC AVC 16 21 26 36 51 71 0 50 1 95 45 $ 45.00-79 -74-69 -59-44 -24 2 115 20 $ 32.50-83 -73-63 -43-13 27 3 130 15 $ 26.67-82 -67-52 -22 23 83 4 150 20 $ 25.00-86 -66-46 -6 54 134 5 175 25 $ 25.00-95 -70-45 5 80 180 6 210 35 $ 26.67-114 -84-54 6 96 216 7 260 50 $ 30.00-148 -113-78 -8 97 237 8 330 70 $ 35.00-202 -162-122 -42 78 238 1. How much will this firm produce at a price of: $26, $36, $51, $71. 2. What is the shutdown price? How do you know? Ans: shutdown is minimum AVC = $25 3.a. What will be the short-run equilibrium price and quantity in this market? Ans: SR equilibrium will be $26 and q = 5,000 P Q $26 5 $36 6 $51 7 $71 8 3.b. Will this be a stable equilibrium or with there be entry or exit in the long-run? How do you know? Ans. not stable in long run, all firms making a loss of ($45), there will be exit.

9 PART III. SHORT ESSAY 1. When a perfectly competitive market is in long-run equilibrium, price = marginal cost. a. From the standpoint of economic efficiency, explain the significance of the equality of price and marginal cost. b. Using a diagram of a perfectly competitive market in long-run equilibrium, show the consumers surplus and the producers surplus. c. Now assume that the cost of inputs to suppliers increases. Show the impacts of this change on equilibrium price and quantity. Show on your diagram what happens to consumers surplus. (a) This question comes DIRECTLY from the homework. The diagram is not essential, but it helps. The equality of P and MC means the industry is producing the right product in the right amount based on society s valuation of that product and other products.. More technically, allocative efficiency is achieved when P = MC. This is because each P on the demand curve represents the value of the marginal unit demanded at that price Each point on the supply curve represents the marginal cost of the last unit produced Thus when P = MC, we have produced every unit that is more valuable than its cost (i.e., we have maximized net benefits). Production at less than Qc means that some units that would contribute to net benefits are not being produced. Production beyond Qc means that some units that generate negative net benefits (i.e., marginal social cost exceeds marginal social benefit) are being produced, thereby reducing total net benefits. (b). Consumer surplus is ABC, and producer surplus is 0AC. P P B P > MC each additional unit is worth more than its resource cost Qc P < MC Supply Demand Q each additonal unit is worth less than its resource cost Supply (marginal cost) A C Demand (marginal benefit) 0 Qc Q P (c) An increase in the cost of inputs will shift the supply curve in. Equilibrium price will rise, equilibrium quantity will fall. Consumer surplus falls by ADEC. B D A 0 E Q* C Qc Supply (with increased costs) Supply Demand Q