Eastern Mediterranean University Faculty of Business and Economics Department of Economics 2015 16 Spring Semester ECON101 Introduction to Economics I First Midterm Exam Duration: 90 minutes Answer Key 20 April 2016 Name: Student ID: Group No: Part A: Multiple Choice Questions (1.5 points each, total 49.5 points) Please mark your answers on both the exam paper and the optic sheet. 1. Candice is planning her activities for a hot summer day. She would like to go to the local swimming pool and see the latest blockbuster movie, but because she can only get tickets to the movie for the same time that the pool is open she can only choose one activity. This illustrates the basic principle that a. people respond to incentives. b. rational people think at the margin. c. people face tradeoffs. d. improvements in efficiency sometimes come at the expense of equality. 2. When computing the opportunity cost of attending a basketball game you should include a. the price you pay for the ticket and the value of your time. b. the price you pay for the ticket, but not the value of your time. c. the value of your time, but not the price you pay for the ticket. d. neither the price of the ticket nor the value of your time. 3. A rational decision maker takes an action only if the a. marginal benefit is less than the marginal cost. b. marginal benefit is greater than the marginal cost. c. average benefit is greater than the average cost. d. marginal benefit is greater than both the average cost and the marginal cost. 4. If the United States decides to trade with Yemen, we know that a. Yemen will benefit, but trade with a less developed country could not benefit the United States. b. it will not benefit Yemen because workers in the United States are more productive. c. Yemen and the United States can both benefit. d. it will not benefit either country because their cultural differences are too vast. 5. One advantage market economies have over centrally planned economies is that market economies a. provide an equal distribution of goods and services to households. b. establish a significant role for government in the allocation of resources. c. solve the problem of scarcity. d. are more efficient. Page 1 of 8
6. Which of the following observations was made famous by Adam Smith in his book The Wealth of Nations? a. There is no such thing as a free lunch. b. People buy more when prices are low than when prices are high. c. No matter how much people earn, they tend to spend more than they earn. d. Households and firms interacting in markets are guided by an "invisible hand" that leads them to desirable market outcomes. 7. Which of the following statements is correct? a. Economists almost always find it easy to conduct experiments in order to test their theories. b. Economics is not a true science because economists are not usually allowed to conduct experiments to test their theories. c. Economics is a social science rather than a true science because it cannot employ the scientific method. d. Economists are usually not able to conduct experiments, so they must rely on natural experiments offered by history. 8. If an economy is producing efficiently, then a. there is no way to produce more of one good without producing less of another good. b. it is possible to produce more of both goods without increasing the quantities of inputs that are being used. c. it is possible to produce more of one good without producing less of another good. d. it is not possible to produce more of any good at any cost. 9. Suppose a nation is currently producing at a point inside its production possibilities frontier. We know that a. the nation is producing beyond its capacity, so inflation will occur. b. the nation is not using all available resources. c. the nation is producing an efficient combination of goods. d. there will be a large opportunity cost if the nation tries to increase production of any good. 10. Suppose a gardener produces both tomatoes and squash in his garden. If he must give up 8 bushels of squash to get 5 bushels of tomatoes, then his opportunity cost of 1 bushel of tomatoes is a. 0.63 bushels of squash. b. 1.6 bushels of squash. c. 3 bushels of squash. d. 5 bushels of squash. 11. Suppose Jim and Tom can both produce baseball bats. If Jim s opportunity cost of producing baseball bats is lower than Tom s opportunity cost of producing baseball bats, then a. Tom must have an absolute advantage in the production of baseball bats. b. Jim must have an absolute advantage in the production of baseball bats. c. Tom has a comparative advantage in the production of baseball bats. d. Jim has a comparative advantage in the production of baseball bats. 12. Absolute advantage is found by comparing different producers a. opportunity costs. b. payments to land, labor, and capital. c. input requirements per unit of output. d. locational and logistical circumstances. 13. The "invisible hand" refers to a. the government. b. the free market. c. central planners. d. large businesses. 14. Suppose roses are currently selling for $20 per dozen, but the equilibrium price of roses is $30 per dozen. We would expect a Page 2 of 8
a. shortage to exist and the market price of roses to increase. b. shortage to exist and the market price of roses to decrease. c. surplus to exist and the market price of roses to increase. d. surplus to exist and the market price of roses to decrease. 15. Assume Leo buys coffee beans in a competitive market. It follows that a. Leo has a limited number of sellers from which to buy coffee beans. b. Leo will negotiate with sellers whenever he buys coffee beans. c. Leo cannot influence the price of coffee beans even if he buys a large quantity of them. d. None of the above is correct. 16. A movement upward and to the left along a demand curve is called a(n) a. increase in demand. b. decrease in demand. c. decrease in quantity demanded. d. increase in quantity demanded. 17. Other things equal, when the price of a good rises, the quantity demanded of the good falls, and when the price falls, the quantity demanded rises. This relationship between price and quantity demanded a. applies to most goods in the economy. b. is represented by a downward sloping demand curve. c. is referred to as the law of demand. d. All of the above are correct. 18. When a surplus exists in a market, sellers a. raise price, which increases quantity demanded and decreases quantity supplied, until the surplus is eliminated. b. raise price, which decreases quantity demanded and increases quantity supplied, until the surplus is eliminated. c. lower price, which increases quantity demanded and decreases quantity supplied, until the surplus is eliminated. d. lower price, which decreases quantity demanded and increases quantity supplied, until the surplus is eliminated. 19. Which of the following would not shift the demand curve for mp3 players? a. a decrease in the price of mp3 players b. a fad that makes mp3 players more popular among 12 25 year olds c. an increase in the price of digital music downloads, a complement for mp3 players d. a decrease in the price of satellite radio, a substitute for mp3 players 20. The sum of all the individual demand curves for a product is called a. income demand. b. equilibrium demand. c. complementary demand. d. market demand. 21. Another term for equilibrium price is a. dynamic price. b. market clearing price. c. quantity price. d. maximum price. 22. Suppose the government wants to encourage Americans to exercise more, so it imposes a binding price ceiling on the market for gyms. As a result, a. the demand for gyms will increase. b. the supply of gyms will decrease. c. a shortage of gyms will develop. d. All of the above are correct. 23. Price controls are usually enacted Page 3 of 8
a. as a means of raising revenue for public purposes. b. when policymakers believe that the market price of a good or service is unfair to buyers or sellers. c. when policymakers tax a good. d. All of the above are correct. 24. If a price ceiling is not binding, then a. the equilibrium price is above the price ceiling. b. the equilibrium price is below the price ceiling. c. it has no legal enforcement mechanism. d. None of the above is correct because all price ceilings must be binding. 25. Welfare economics is the study of how a. the allocation of resources affects economic well being. b. a price ceiling compares to a price floor. c. the government helps poor people. d. a consumer s optimal choice affects her demand curve. 26. Willingness to pay a. measures the value that a buyer places on a good. b. is the amount a seller actually receives for a good minus the minimum amount the seller is willing to accept. c. is the maximum amount a buyer is willing to pay minus the minimum amount a seller is willing to accept. d. is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. 27. Consumer surplus is a. the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. b. the amount a buyer is willing to pay for a good minus the cost of producing the good. c. the amount by which the quantity supplied of a good exceeds the quantity demanded of the good. d. a buyer's willingness to pay for a good plus the price of the good. 28. Producer surplus measures the a. benefits to sellers of participating in a market. b. costs to sellers of participating in a market. c. price that buyers are willing to pay for sellers output of a good or service. d. benefit to sellers of producing a greater quantity of a good or service than buyers demand. 29. Tom sells pictures in his spare time for extra income. Buyers of his pictures are willing to pay $155 per picture. One particular week, Tom is willing to sell the first picture for $120, the second picture for $125, the third picture for $140, and the fourth picture for $160. Assume Tom is rational in deciding how many pictures to sell. His producer surplus is a. $95. b. $80. c. $75. d. $60. 30. Most labor economists believe that the supply of labor is less elastic than the demand a. therefore, firms bear most of the burden of the payroll tax. b. therefore, workers bear most of the burden of the payroll tax. c. therefore, they share it equally. d. None of the above. 31. Suppose the government has imposed a price ceiling on laptop computers. Which of the following events could transform the price ceiling from one that is not binding into one that is binding? Page 4 of 8
a. Improvements in production technology reduce the costs of producing laptop computers. b. The number of firms selling laptop computers decreases. c. Consumers' income decreases, and laptop computers are a normal good. d. The number of consumers buying laptop computers decreases. 32. If the government removes a binding price ceiling from a market, then the price paid by buyers will a. increase, and the quantity sold in the market will increase. b. increase, and the quantity sold in the market will decrease. c. decrease, and the quantity sold in the market will increase. d. decrease, and the quantity sold in the market will decrease. 33. A tax levied on the sellers of blueberries a. increases sellers costs, reduces profits, and shifts the supply curve up. b. increases sellers costs, reduces profits, and shifts the supply curve down. c. decreases sellers costs, increases profits, and shifts the supply curve up. d. decreases sellers costs, increases profits, and shifts the supply curve down. Part B: Essay Questions (60.5 points) Question 1. The demand and supply schedules for shoes are: Price ($) Quantity Demanded Quantity Supplied Shortage / Surplus 20 90 30 Shortage 30 80 40 Shortage 40 70 50 Shortage 50 60 60 Equilibrium 60 50 70 Surplus 70 40 80 Surplus 80 30 90 Surplus A. Fill the table above. (3 pts.) B. Draw the demand and supply curves below and show the equilibrium price and equilibrium quantity on the same diagram. (6 pts.) C. How will the market adjust if the price is above or below the equilibrium price? Briefly explain. (Hint: Two cases must be explained) (5 pts.) Page 5 of 8
Answer: If the price is above the equilibrium price then there will be market forces to drop the price, since there is excess supply (Q S > Q D ) (surplus) until it reaches to equilibrium. If the price is below the equilibrium price, then there will be market forces to increase the price, since there is excess demand (Q D > Q S ) (shortage) until it reaches to equilibrium. D. Give at least two reasons that cause demand to increase. What will happen to the equilibrium price and equilibrium quantity if demand increases? (6 pts.) Answer: If (i) income increases (goods should be normal good) or (ii) population increases, then demand increases. If demand increases and all other things remain constant, then both equilibrium price and equilibrium quantity increases. Question 2. Refer to the following information where Brazil produces ethanol from sugar, and the land used to grow sugar can be used to grow food crops as well. Suppose that Brazil s production possibilities for ethanol and food crops are as follows: Ethanol Food crops Combinations (barrels per day) (tons per day) 70 and 0 A 64 and 1 B 54 and 2 C 40 and 3 D 22 and 4 E 0 and 5 F A. Draw a graph of Brazil s PPF ( food crops on X axis and Ethanol on Y axis ). (4 pts.) B. If Brazil produces 40 barrels of ethanol a day, how much food must it produce to achieve production efficiency? Briefly explain. (3 pts.) Page 6 of 8
Answer: When 40 barrels of ethanol a day are produced, 3 tons of food crops must be produced in order to achieve production efficiency. As shown by point D, the combination of (3, 40) would be on the PPF curve, on which all points suggest efficient production. C. If Brazil increases its production of ethanol from 40 barrels per day to 41 barrels per day, what is the opportunity cost of the additional ethanol? (3 pts.) Answer: As we move from combination D to C (see the table above), we increase the production of ethanol from 40 barrels per day to 54 barrels per day (increase by 14 units) while that of food crops decreases from 3 tons per day to 2 tons per day (decreases by 1 unit). Therefore, the opportunity cost of increasing the production of ethanol from 40 to 41 units is equal to 1/14 units of food crops. D. If Brazil increases its production of food crops from 2 tons per day to 3 tons per day, what is the opportunity cost of the additional food? (3 pts.) Answer: The table above shows that increasing the production of food crops from 2 tons per day to 3 tons per day is possible only if we give up the production of ethanol by 14 units. Therefore, the opportunity cost of the additional food is 14 units of ethanol. E. Does Brazil face an increasing opportunity cost of food crops? If so, what feature of Brazil s PPF illustrates increasing opportunity cost? Briefly explain. (4.5 pts.) Answer: Brazil faces an increasing opportunity cost of food crops which can be seen from the fact that the PPF is getting steeper as the country produces more food crops. Question 3. Brazil and Vietnam both produce coffee and rice. The following table describes the production possibilities of these two countries: Tons of coffee per worker per year Tons of rice per worker per year Brazil 3 1 Vietnam 4 2 To keep the things simple, assume that each country has 1000 workers, and there is constant marginal product of labor for both countries. A. Graph the production possibilities frontiers for the Brazilian and Vietnamese economies. (3 pts) B. For Brazil, what is the opportunity cost of a coffee? Of rice? For Vietnam, what is the opportunity cost of a coffee? Of rice? Put this information in the table below. (3 pts) Page 7 of 8
Ton of coffee Opportunity Cost of: Ton of rice Brazil 1/3=0.33 tons of rice 3/1=3 tons of coffee Vietnam 2/4=0.50 tons of rice 4/2=2 tons of coffee C. Which country has an absolute advantage in producing coffee? Vietnam Which country has an absolute advantage in producing rice? Vietnam Explain briefly. (4 pts) Answer: Vietnam has an absolute advantage in producing both coffee and rice because it is more productive (greater output per worker). D. Which country has a comparative advantage in producing coffee? Brazil Which country has a comparative advantage in producing rice? Vietnam Explain briefly. (4 pts) Answer: Because Brazil has a lower opportunity cost of coffee in terms of rice, and Vietnam has a lower opportunity cost of rice in terms of coffee. E. Without trade, half of each country s workers produce coffee and half produce rice. What quantities of coffee and rice does each country produce? What quantities of coffee and rice does each country consume? Explain briefly. (4 pts) Answer: Brazil produces and consumes 1500 tons of coffee and 500 tons of rice. Vietnam produces and consumes 2000 tons of coffee and 1000 tons of rice. Without trade production possibilities frontiers for these countries will coincide with consumption possibilities frontiers, so they consume what they have produced only. F. If Brazil and Vietnam decided to trade, which commodity will each country export? Explain briefly. (4 pts) Answer: Brazil will export coffee. Vietnam will export rice. Because they have comparative advantage in production of these goods, so they will specialize in production of these goods. Page 8 of 8