Cork Institute of Technology (Institiuid Teicneolaiochta Chorcai) Alternative Semester 1 Examination 2007/2008 (Winter 2007) EC1010 Introduction to Micro Economics (Econ 6003) (Time: 2 Hours) External Examiner: Dr. N Timoney. Internal Examiners: Mr. K Crilly, Name: Class Group: College ID Number: Lecturer: Instructions Please read carefully! Sections Numbers of Questions to be attempted Percentage of Total Marks Available A 20 20 B 3 60 C 1 20 Section A: Section B: Section C: Red Ink: For each question in this section, you should circle the letter opposite the answer that you consider to be correct. In the event of there appearing to be more than one correct answer, you should circle the letter opposite the particular answer that you consider to be most correct. There is no negative marking for incorrect answers in this section. The answer to each question in this section must be answered in the space(s) provided within each question. This question must be answered on the lined pages attached at the end of this question paper. You may not use red ink. Non-compliance with the above instructions will result in some of your answers not being graded.
Section A A1. Which of the following will not cause a shift in the supply curve for good A? A change in the price of the good A itself; A change in the prices of inputs used to produce good A; A change in the rate of sales tax charged on good to A; None of the above. A2. An increase in supply accompanied by a decrease in demand, other things being equal, will cause: Price to increase, with effect on quantity uncertain; Both price and quantity to decrease; Both price and quantity to increase; Price to decrease with the effect on quantity uncertain. A3. If the prices of close complements for beer should rise dramatically and nothing else changes, then: The demand for beer will increase; The supply of beer will increase; The demand for beer will fall; The demand for, and supply of, the close substitutes will fall. A4. The price of wine will tend to increase if: There is a surplus at the prevailing price; The current price is below the equilibrium price; Quantity demanded is greater than the quantity supplied at current prices; Both and above will cause the price of wine to increase. A5. If at the same time as input prices fall the government lowers the rate of VAT charged on a product then the supply will tend to: Decrease; Increase; Have no affect on the supply as one will cancel out the other; Either rise or fall depending on which is the greater change.
A6. Two goods are defined as being substitute products if: Their respective PEDs are both greater than one; Their respective YEDs are both equal; Their respective PEDs and YEDs are negative; Their XPED is positive. A7. Economists define superior products as: Goods that are non-defective; Goods with a minute positive income effect; Goods with a negative income effect; Goods for which YED is greater than one. A8. The price elasticity of supply is defined as: % change in quantity supplied divided by the % change in income; % change in price divided by the % change in quantity supplied; % change in quantity supplied divided by the % change in price; % change in income divided by the % change in quantity supplied. A9. If a segment of a demand curve is elastic then: The elasticity coefficient is equal to infinity; The demand curve for the good is vertical; The elasticity coefficient, in absolute terms, is greater than 1; Both and above are correct. A10. Demand is likely to be less elastic due to all but one of the following: There are many close substitutes for the product available; Consumers spend a very small proportion of their income on the product; Consumers have a short period of time to adjust to the new prices; The product is an intermediate product rather than a final product.
A11. Economists use the term marginal cost to mean: The value of a product before it has been advertised; The contribution that a good or service makes to social cost; The satisfaction that a producer obtains from selling a good or service; None of the above. A12. A consumer should buy less of a good if the value of the good s: TU is less than price; MU is less than price; MU is greater than price; TU is greater than price. A13. If a household s money income is decreased, all other things being the same: The budget line is not affected; The budget line will swivel at the vertical axis intercept; The budget line will shift inwards in a parallel fashion; The budget line will shift outwards in a parallel fashion. A14. To calculate the marginal utility one should use the formula: TUn TUn-i; VUn VUn-i; TU VU; Either or could be used. A15. Which of the following is the odd one out? Total revenue; The cost of producing the next unit of output; The extra output produced by one additional unit of labour; The reduction in revenue that results from a cut in sales of one unit.
A16. The mainstream orthodox treatment of the firm is based on the assumption of: Sales maximization; Revenue maximization; Cost minimization; None of the above. A17. In the short run: All of the firm s costs are fixed costs; All of the firm s costs are variable costs; Some costs are fixed and some are variable; None of the above. A18. In a production process when all inputs are doubled the resulting output is more than doubled. This means that the firm is experiencing: Decreasing returns to scale; Constant returns to scale; Increasing returns to scale; Either increasing or decreasing returns to scale. A19. Which of the following statements about the Euro in its trading with Sterling and the Dollar is true? The Euro is below parity with Sterling and above with the Dollar; The Euro is below parity with the Dollar and above with Sterling; The Euro is above parity with both Sterling and the Dollar; The Euro is below parity with both Sterling and the Dollar. A20. If in December 2007 1 = 0.7268 St. a good costing 54 St would cost: 39.25; 74.30; 78.49; 108.00.
Section B B1. The table below describes the supply and demand conditions for product A. Price ( ) 0 10 20 30 40 50 60 Qs 0 15 30 45 60 75 90 Qd 100 90 80 70 60 50 40 Required: Sketch the supply and demand curves and identify the equilibrium price and quantity. (5 marks) Explain the market outcome if the initial price is 50. (5 marks) What would the government have to do if they wish to maintain the price of 50 as a minimum (floor) price? (5 marks) If the level of sales tax is reduced by 10 per unit for this product, how will this affect the answer you have given in above? 5 marks)
B2. Define and explain Income Elasticity of Demand (YED): (6 marks) Interpret what a value of YED = 2.5 means: (5 marks) What is the connection between the very heavy sales taxation of alcohol, tobacco and petroleum products and the PED concept? (5 marks) If the price of one good increases by 5% and the quantity demanded of a second good reacts by falling 10%, the two product should be classified into which category of XPED? (4 marks)
B3. The table below sets out the levels of total utility (TU) for each of three products depending on the quantity purchased and consumed. The table also gives the prices for the 3 products. The consumer has a budget of 200 to spend and wishes to maximize utility. There is no utility to be derived by saving any of the budget. CVs LSs MO P = 10 P = 20 P = 30 Q TU MU MU/P TU MU MU/P TU MU MU/P 0 0 - - 0 - - 0 - - 1 25 45 80 2 45 87 155 3 60 127 220 4 70 161 280 5 75 187 330 6 76 202 360 Complete the table by filling in the values for MU and MU/P for each good; (12 marks) Identify from the completed table, the combination of the 3 products that yield the maximum level of total utility (TU), calculating as part of your answer the level of maximum TU and the cost of achieving this level of TU; (8 marks)
B4. The following table shows values for total cost (TC), variable cost (VC) and average revenue (AR=P), corresponding to various levels of output (TPP): TPP 0 1 2 3 4 5 6 7 8 TC 10 20 35 45 50 51 55 65 85 VC 0 10 25 35 40 41 45 55 75 AR 20 18 17 15 13 12 10 8 ATC AVC AFC MC TR MR Complete the above table. (15 marks) Calculate the maximum level of profit and the level of output (TPP) at which the maximum profit is earned. (5 marks)
Section C C1. Study the following table and then answer the questions below: Labour costs of production (hours) 1 unit of wine 1 unit of cloth Portugal 6 8 England 12 10 (e) (f) Use the information above to construct a table showing the quantities of both goods that could be produced in the two countries per 120 hour time period. Which country has the absolute advantage in wine? Explain. What is the opportunity cost of a unit of wine in Portugal? Explain. What is the opportunity cost of a unit of cloth in England? Explain. Which country has the comparative advantage in wine? Explain. At what international trade price(s) would both countries stand to gain from specialization and exchange? C2. Explain how the equilibrium price and quantity are determined in a competitive market and what happens to this equilibrium if the supply should increase, all other things being unchanged? What, if anything, would be different in your answer in above were the demand to be more or less elastic (i.e. less or more steep) than the one you have used? C3. Explain each of the following: The difference between Marginal Cost (MC) and Marginal Revenue (MR). Economies and diseconomies of scale. A Floating exchange rate?
Solutions Terminal Semester 1 Exam (EC1010): MCQs: 1 a 11 d 2 d 12 b 3 c 13 c 4 d 14 a 5 b 15 a 6 d 16 d 7 d 17 c 8 c 18 a 9 c 19 c 10 a 20 b
B1. This is the standard Supply and Demand graph with price on the vertical axis, and the quantity on the horizontal axis. If drawn correctly the two lines should intersect at P = 40 and Q = 60. Thus Pe is equal to 40 and Qe is equal to 60 units per period of time. This is also directly visible in the table. If the initial price is 50 the market outcome will be that at that price the consumers would wish to buy and consume 50 units per period of time. However, the suppliers will wish to offer 75 units at that same price with the result that there is an excess supply of 25 units. If this is a free, or competitive, market the price and quantity will adjust towards their equilibrium values. To cope with the excess supply and stop the price falling government will have to introduce some device to eliminate the excess demand. It could buy up the surplus, or as an alternative, seek to stimulate demand with subsidies. It could seek to export the good in sufficient quantities to offset the excess demand.. The best, and easiest, way to deal with this new situation is to shift the supply curve downwards by the amount of the tax cut as this is easier than other ways of arriving at the answer. The suppliers will be able to charge 10 less at each and every price as the tax cut of 10 is, effectively, a decrease in production costs from their perspective, hence shifting the Supply curve downwards by 10. If you do this you can now read from the graph that the curves intersect at a new price of 34 and the new quantity is 66. Thus Pe = 34 and Qe = 66.
B2. Income Elasticity of Demand is defined as YED = % Q/% Y and it measures how sensitive the demand for a good is to changes in income. The value of YED can be positive, negative or zero. If YED > 0 we say the good is a normal good, if YED > 1 we say the good is a superior good and if YED < 0 we say the good is an inferior good. You should also consult below for more information If YED = 2.5 the good is a superior good. If income changes by 1% the quantity demanded will react by changing by 2.5%, i.e. if income goes up by 1% the Qd increases by 2.5% and vice-versa. The three products are each highly in-elastically demanded, i.e. PED << 1. When Demand is inelastic an increase in price yields more sales revenue. This is due to the extra revenue created by the higher price exceeding the revenue that is lost due to the smaller quantity now being bought. The governments tend to tax such goods much more heavily because of this revenue implication. Food is another good that has a low PED value but a government that taxes food rarely gets re-elected to government. XPED = % Qa/% Pb = -10%/5% = -2 and because this value is a negative result the goods should be classified as complements.
B3. Goods A B C Quantity Price = 8 Price = 4 Price = 2 TU MU MU/P TU MU MU/P TU MU MU/P 0 0 - - 0 - - 0 - - 1 25 25 2.5 45 45 2.25 80 80 2.7 2 45 20 2.0* 87 42 2.1 155 75 2.5 3 60 15 1.5 127 40 2.0* 220 65 2.2 4 70 10 1.0 161 34 1.7 280 60 2.0* 5 75 5 0.5 187 26 1.32 330 50 1.7 6 76 1 0.1 202 15 0.75 360 30 1.0 Consumer should buy: 2A + 3B + 4C Because: MUA/PA = MUB/PB = MUC/PC = 2 Total Utility = 45 + 127 + 280 = 452 Expenditure = 200 (i.e. 2@10 + 3@20 + 4@30)
B4. TPP 0 1 2 3 4 5 6 7 8 TC 10 20 35 45 50 51 55 65 85 VC 0 10 25 35 40 41 45 55 75 AR - 20 18 17 15 13 12 10 8 ATC - 20 17.5 15 12.5 10.2 9.2 9.3 10.6 AVC - 10 12.5 11.7 10 8.2 7.5 7.8 9.4 AFC - 10 5 3.3 2.5 2.0 1.7 1.43 1.25 MC - 10 15 10 5 1 4 10 20 TR 0 20 36 51 60 65 72 70 64 MR - 20 16 15 9 5 7 (2) (6) Profit (10) 0 1 6 10 14 17 5 (21) The maximum profit occurs at an output level of 6 units and equals 17.
C1. Production Possibilities: Wine Cloth Portugal 20 15 England 10 12 Portugal, in actual fact, has the absolute advantage in both products. In the case of wine it requires only 6 hours of labour per unit produced whereas England requires 12 hours of labour per unit of wine produced. Opportunity Costs: Wine Cloth Portugal 0.75* 1.3 England 1.2 0.88* In Portugal the opportunity cost of wine is 0.75 as each unit of wine requires 6 labour hours and those same 6 labour hours could be used to produce 0.75 units of cloth. In England each unit of cloth requires 10 labour hours, which as an alternative could be used to produce 0.83 units of wine. Hence the opportunity cost of cloth in England is 0.83 units of wine. (e) Portugal has the comparative advantage in wine because it need only sacrifice 0.75 units of cloth per unit of wine produced. England has a greater sacrifice of 1.2 units of cloth per unit of wine produced. (f) Portugal will gain if it can purchase cloth through trade for less than 1.3 units of wine, this being its domestic price. England benefits if it can purchase more than 0.83 wine for each unit of cloth paid, this being England s domestic price. Thus a trade price of 1.3C 1W 0.83C will mutually benefit both. Similarly, which is the same thing but stated in terms of the trade price for cloth both gain from the trade if: 1.2W 1C 0,75W