Download Answers to First Midterm

Economics 101
Name ________________________________
Summer 2008
Day and Time of Discussion Section _______
First Midterm
Student ID Number _____________________
6/5/08
Version 1
DO NOT BEGIN WORKING UNTIL THE INSTRUCTOR TELLS YOU TO DO SO.
READ THESE INSTRUCTIONS FIRST.
You have 90 minutes to complete the exam. The exam consists of three parts: Part I is 10 Binary
Choice Questions worth 1.5 points each for a total of 15 points; Part II is 18 Multiple Choice Questions
worth 2.5 points each for a total of 45 points; and Part III is 3 Problems worth 10 points each for a total
of 30 points. The total point value of the exam is 90 points. Parts I and II should be answered on the
scantron sheet that we will provide. Please answer all questions on the scantron sheet with a #2 pencil.
No cell phones, calculators, or formula sheets are allowed.
PICK THE BEST ANSWER FOR EACH QUESTION IN PARTS I AND II.
How to fill in the scantron sheet:
1. Print your last name, first name, and middle initial in the spaces marked "Last Name," "First Name," -,
and "MI." Fill in the corresponding bubbles below.
2. Print your student ID number in the space marked "Identification Number." Fill in the bubbles.
3. Write the number of the discussion section you are enrolled in under "Special Codes" spaces ABC, and
fill in the bubbles. You can find the discussion numbers below on this page.
4. Write the version number of your exam booklet under "Special Codes" space D, and fill in the bubble.
The version number is on the top of this page.
5. If there is an error on the exam or you do not understand something, make a note on your exam booklet
and the issue will be addressed AFTER the examination is complete. No questions regarding the exam
can be addressed while the exam is being administered.
6. When you are finished, please get up quietly and bring your scantron sheet and this exam booklet to
the place indicated by the instructors.
Discussion sections are as follows:
Discussion Section 301
Discussion Section 302
Discussion Section 303
11:30 – 12:45 Wednesday
4:25 – 5:40 Thursday
11:30 – 12:45 Thursday
I. Binary Choice Questions: (Worth 1.5 points each)
1. Susie has collected data on stock prices from local companies traded on the New York
Stock Exchange, interest rates, and employment numbers for a project describing her
local economy. Her data includes measurements from the first of each month for a five
year period. This information is an example of
a. Cross sectional data since Susie is collecting information about many different
companies and many different interest rates.
b. Time series data since Susie is collecting information about different variables and
their values at different points in time.
2. In the mid 1990s welfare reform resulted in the implementation of a program offering
support to poor families with young children. Families that qualified for this program
were allowed to receive aid from the government for a limited amount of time and then
they had to find work to support their families. Which of the following statements is a
positive statement given this information?
I. This welfare program should reduce the number of people who stay on welfare
even though they are capable of working.
II. This welfare program resulted in a reduction in the number of welfare
recipients.
a. Statement I is positive.
b. Statement II is positive.
3. Suppose George is considering his options for Friday night. He can either pay $5 and
go to a movie or he can join some friends for pizza and a card game. What is the
opportunity cost of going to the movie for George?
a. The opportunity cost of going to the movie for George is equal to $5 plus the pizza and
card game he must give up if he goes to the movie.
b. The opportunity cost of going to the movie for George is equal to the pizza and card
game he must give up if he goes to the movie.
4. Popcorn is an inferior good. If the price of corn (a necessary input in the production of
popcorn) increases while at the same time people's incomes decrease then the price of
popcorn will
a. Increase.
b. Decrease.
5. Popcorn is an inferior good. If people's incomes decrease at the same time that the
price of soda decreases (assume soda is a complement to popcorn) then the quantity
demanded of popcorn will
a. Be indeterminate since there are two changes occurring and we do not know the
magnitude of the changes.
b. Increase relative to its initial level.
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6. A price ceiling is imposed by the government on the price of housing. This price
ceiling is effective and results in an excess demand for housing of 20 units. If the demand
for housing is given by the equation P = 100 – 2Q and the supply of housing is given by
the equation P = 2Q, then the price ceiling must be equal to
a. $40
b. $30
7. Gilligan’s Island, a small economy, knows that its current domestic price of wheat is
greater than the world price of wheat. If Gilligan’s Island opens its wheat market to trade
a. Consumer surplus will increase while producer surplus will decrease.
b. Consumer surplus will decrease while producer surplus will increase.
8. Air conditioners and fans are substitutes. If the price of air conditioners goes up, what
will happen to the demand curve for fans?
a. Demand for fans shifts left
b. Demand for fans shifts right
9. In a model with two countries and two goods, it is possible for one country to have a
comparative advantage in the production of both goods.
a. True
b. False
10. A certain market has perfectly elastic demand and an upward sloping supply curve. If
the government imposes an excise tax on producers in this market, who bears the
economic incidence of the tax?
a. Producers
b. Consumers
II. Multiple Choice Questions: (Worth 2.5 points each)
11. Fruitland currently produces cherries and peaches. A new organic compound is
discovered in Fruitland that enables Fruitland to increase its production of cherries by
50%. This compound does not alter Fruitland’s ability to produce peaches. Which of the
following statements is true given this information?
a. Fruitland’s production possibility frontier is unaffected by this change since its
resources and the time of production of cherries and peaches has not been changed.
b. The production possibility frontier will shift out away from the origin along both axes
since Fruitland with this new compound will be able to produce more cherries and more
peaches.
c. The production possibility frontier will shift out away from the origin along the axis
measuring cherries since Fruitland can now produce more cherries than it could initially.
d. The production possibility frontier will shift in toward the origin along the axis
measuring cherries since Fruitland can now produce more cherries than it could initially.
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12. The demand for Campbell’s soup is given by the equation P = 30 – 3Q. If
Campbell’s wishes to maximize the revenue they receive from soup sales, what price
should they set per can of soup?
a. $9
b. $15
c. $21
d. $27
13. Consider the market for shirts, which is currently in equilibrium. Suppose the
population increases and, at the same time, the invention of a new sewing machine
increases the productivity of all firms which make clothing. Which of the following
describes what will happen to the equilibrium price and quantity in the shirt market?
a. Equilibrium price goes up, equilibrium quantity is ambiguous
b. Equilibrium price goes down, equilibrium quantity is ambiguous
c. Equilibrium price is ambiguous, equilibrium quantity goes up
d. Equilibrium price is ambiguous, equilibrium quantity goes down
14. In the market for cereal, demand is given by D: P = 10 – Q and supply is given by S:
P = Q + 2. If the government institutes a price support at a price of $4, then the cost to
the government of this program will be
a. $0
b. $16
c. $24
d. $40
15. Which of the following changes will NOT result in a shift of a country’s PPF?
a. An increase in the country’s population
b. A decrease in the country’s land area
c. A technological advantage which improves worker productivity
d. An increase in the country’s amount of international trade
Use the graph below to answer the next two questions.
The graph portrays the production possibility frontier for Sam for 2006. Sam produces
novels and oil paintings.
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16. The opportunity cost of Sam choosing to produce at Point D instead of Point E is
equal to
a. X3 – X4
b. X4 – X3
c. Y4 – Y5
d. Y5 – Y4
17. Given the points in the above graph, the most efficient point for Sam to produce at is
a. Point D since it includes about the same amount of oil paintings as novels.
b. Point E since Sam’s oil paintings often sell for more than his novels.
c. Point C since Sam’s novels are artistically superior to Sam’s oil paintings.
d. any of the points on his production possibility frontier since all of these points are
equally efficient.
18. Mary and Allen both clean houses and mow lawns. Mary can clean a house in three
hours or mow a lawn in 1.5 hours. Allen can clean a house in four hours or mow a lawn
in 2 hours. Mary and Allen have available the same amount of labor time for mowing
lawns and cleaning houses. Furthermore, the production possibility frontiers for Mary
and Allen with respect to mowing lawns and cleaning houses are linear. Currently Mary
and Allen work separately and both produce some cleaned houses as well as some
mowed lawns. Which of the following statements is correct?
a. Mary and Allen will be able to increase the total production of mowed lawns and
cleaned houses from their available resources by specializing in producing that good that
they can produce at lower opportunity cost and then trading with one another.
b. Mary and Allen will be able to increase the total production of mowed lawns and
cleaned houses from their available resources by specializing in producing that good that
they can produce at higher opportunity cost and then trading with one another.
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c. Mary and Allen will not be able to benefit from specialization and trade in this
example since their opportunity costs of producing mowed lawns or clean houses is the
same for both of them.
d. Trade is always beneficial and so Mary and Allen will find that a decision to trade will
help both of them.
19. Mary and Allen both clean houses and mow lawns. Mary can clean a house in three
hours or mow a lawn in 1.5 hours. Allen can clean a house in four hours or mow a lawn
in 2 hours. Mary and Allen have available the same amount of labor time for mowing
lawns and cleaning houses. Furthermore, the production possibility frontiers for Mary
and Allen with respect to mowing lawns and cleaning houses are linear. Currently Mary
and Allen work separately and both produce some cleaned houses as well as some
mowed lawns. Which of the following statements is correct?
a. Since Mary can absolutely clean more houses than Allen in the available time, Mary
should clean houses and Allen should mow lawns.
b. Since Allen can absolutely clean more houses than Mary in the available time, Allen
should clean houses and Mary should mow lawns.
c. Although Mary can absolutely clean more houses and mow more lawns than Allen in
the available time, Mary does not have a comparative advantage in cleaning houses or
mowing lawns.
d. Although Allen can absolutely clean more houses and mow more lawns than Mary in
the available time, Allen does not have a comparative advantage in cleaning houses or
mowing lawns.
20. Which of the following statements is true?
I. Two goods are substitutes for one another if the quantity demanded of Good Y
increases when the price of good X increases.
II. Two goods are complements for one another if an increase in the price of Good
A reduces the quantity demanded of Good B.
III. A good is an inferior good if an increase in the price of Good C causes the
individual to demand more of Good D.
a. Statement I is true.
b. Statement II is true.
c. Statements I and II are true.
d. Statements I, II and III are true.
21. Suppose a market for mangoes is composed of three consumers: Joe, Mary, and Hon
Ho. Joe’s demand for mangoes is equal to QJ = 10 – P; Mary’s demand for mangoes is
equal to QM = 5 - (1/2)P; and Hon Ho’s demand for mangoes is equal to QHH = 20 – 2P.
Which of the following equations is the market demand equation for the mango market?
a. The market demand curve that results will have three linear segments: P = 10 – (1/2)Q
for quantities less than 10 units; P = 20 – Q for quantities between 10 and 20 units; and P
= 10 – (1/4)Q for quantities greater than 20 units.
b. The market demand curve that results will have three linear segments: P = 30 – 2Q for
quantities less than 5 units; P = 25 – Q for quantities between 5 and 15 units; and P = 40
– 2Q for quantities greater than 15 units.
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c. The market demand curve will be equal to Hon Ho’s demand curve, or P = 10 –
(1/2)Q, since Hon Ho’s demand curve is further from the origin than either Joe or Mary’s
demand curve.
d. The market demand curve is equal to P = 10 – (2/7)Q.
22. Suppose you are told that Sarah is willing to spend $40 to purchase a sweater; Suzie
is willing to spend $35 to purchase a sweater; Jean is willing to spend $25 to purchase a
sweater; and Rosie is willing to spend $20 to purchase a sweater. Suppose these four girls
are the only consumers in the sweater market and that sweaters currently sell for $28.
What is the value of consumer surplus in this market?
a. It is impossible to calculate consumer surplus in this market without being told the
market demand curve.
b. Consumer surplus is equal to $19.
c. Consumer surplus is equal to $16.
d. Consumer surplus is equal to $8.
Use the graph below to answer the next two questions.
The graph depicts the market for corn in Sweetcorn, a small economy. The government
of Sweetcorn is debating instituting a price support program with a price floor of P1 or a
price subsidy program with a guaranteed price of P1. Assume this graph accurately
depicts both the demand and supply curves for corn in Sweetcorn: base your answer
solely on your interpretation of this graph. Furthermore, assume that there is no cost to
storing corn in Sweetcorn.
23. The cost to the government of implementing the subsidy program is
a. Greater than the cost of the price support program and the subsidy per unit of corn will
be equal to (P1 – P2).
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b. Greater than the cost of the price support program and the subsidy per unit of corn will
be equal to (P1 – P3).
c. Less than the cost of the price support program and the subsidy per unit of corn will be
equal to (P1- P2).
d. Less than the cost of the price support program and the subsidy per unit of corn will be
equal to (P1 – P3).
24. The cost of the price support program (excluding any storage costs) for the
government of Sweetcorn is equal to
a. (P1 – P3)(Q3)
b. (P1 – P2)(Q3)
c. (1/2)(P1 – P3)(Q3 – Q1)
d. (P1)(Q3 – Q1)
25. Suppose the demand for a good is perfectly inelastic (that is, the market demand
curve for this product is a vertical line) and the supply of the good is upward sloping. If
an excise tax is placed on this good and producers are legally responsible for paying the
tax then
a. The economic incidence of the tax will fall solely on producers of this good and the
deadweight loss due to this tax will be equal to zero.
b. The economic incidence of the tax will fall solely on consumers of this good and the
deadweight loss due to this tax will be equal to zero.
c. The economic incidence of the tax will fall solely on producers of this good and the
deadweight loss due to this tax will be some positive number since excise taxes result in
an efficiency cost measured by this deadweight loss.
d. The economic incidence of the tax will fall solely on consumers of this good and the
deadweight loss due to this tax will be some positive number since excise taxes result in
an efficiency cost measured by this deadweight loss.
26. Suppose the absolute value of the percentage change in the quantity demanded of a
good is greater than the absolute value of the percentage change in income. Which of the
following statements is true?
a. The good is a normal good.
b. The good is an inferior good.
c. We cannot know whether the good is a normal or an inferior good without knowing the
direction of change in the quantity demanded and in the level of income. If income
increases and the quantity demanded decreases then the good is an inferior good.
d. We cannot know whether the good is a normal or an inferior good without knowing the
direction of change in the quantity demanded and in the level of income. If income
increases and the quantity demanded increases then the good is an inferior good.
27. Suppose the city of Madison is currently losing money operating the bus system. The
directors of the bus system meet to discuss the financial crisis that they are facing.
Several directors argue that the bus system should increase the price of a bus ticket since
the bus system is losing money. A few directors argue that the bus system should
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decrease the price of a bus ticket since the bus system is losing money. Which of the
following statements is true, holding everything else constant?
a. The bus system should increase the price of the bus tickets if the quantity effect of a
change in the price of a bus ticket is greater than the price effect of a change in the price
of a bus ticket.
b. The bus system should increase the price of the bus tickets if the quantity effect of a
change in the price of a bus ticket is positive.
c. The bus system should increase the price of the bus tickets if the extra revenue from
selling the tickets at a higher price is greater than the loss in revenue from selling fewer
tickets.
d. The bus system could never improve their financial position by raising the price of the
bus tickets.
28. Suppose a country knows that if it opens its economy to trade that it will import
bananas. Which of the following statements is true?
I. The world price of bananas must currently be lower than the domestic price of
bananas when this country has a closed economy.
II. Both domestic consumers and domestic producers will benefit from opening
this economy to trade since trade is always beneficial.
III. Domestic consumers will be better off if this country opens to trade.
a. Statement I is true.
b. Statement II is true.
c. Statement III is true.
d. Statements I and III are true.
e. Statements I, II, and III are true.
III. Problems (Worth 10 points each)
General Instructions: Please place a box around each of your answers so that your
answers are easier for the grader to find. Please work in a logical, orderly fashion.
1. The chart below shows a production function for wine and cloth for England and
Portugal. In both England and Portugal, wine and cloth are made using labor as the only
input.
Wine
Cloth
England
2 bottles/labor hour
3 yards/labor hour
Portugal
0.75 bottles/labor hour
1 yard/labor hour
Assume that both countries have the same total number of labor hours available for
producing these two goods.
a) (2 points) Assume that if England devotes all its available resources to cloth
production, it can make 60 total yards of cloth. How many labor hours does Portugal
have available for production?
We know that in England, Total Cloth Production = (3 yards/labor hour)(Labor Hours
Used). Since total cloth production = 60 yards, we have
60 = 3(Labor Hours Used), so Labor Hours Used = 20 hours, which we are told is the
total amount of labor hours England has at its disposal. Since both countries have the
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same number of labor hours available for production, the total number of labor hours
available for Portugal to use is also 20 hours.
b) (2 points) Which country has the absolute advantage in the production of wine?
Which country has the absolute advantage in the production of cloth?
Absolute advantage in production of a good means that a country can make more of that
good using the same amount of resources. In this case, England is more productive in
making both wine and cloth, so England has the absolute advantage in the production of
both goods.
c) (2 points) Which country has the comparative advantage in the production of wine?
Which country has the comparative advantage in the production of cloth?
To find the comparative advantage, we must find the opportunity cost of making each
good in each country. This yields the following chart:
England
OC of 1W = 3/2 C
OC of 1C = 2/3 W
Portugal
OC of 1W = 4/3 C
OC of 1C = 3/4 W
From this chart, we see that Portugal gives up less cloth to make a bottle of wine than
England, so Portugal has the comparative advantage in wine production. Similarly,
England gives up less wine to make a yard of cloth than Portugal, so England has the
comparative advantage in cloth production.
d) (2 points) An ambassador from England approaches Portugal with the following offer:
England will give Portugal 7 yards of cloth in exchange for 6 bottles of wine. Will
Portugal accept the offer? Explain why or why not.
Portugal will not accept the offer. When Portugal makes 1 bottle of wine, they give up
the production of 4/3 yards of cloth. Thus, when Portugal makes 6 bottles of wine, they
give up the production of 6(4/3) = 8 yards of cloth. So instead of trading 6 bottles of
wine to England for 7 yards of cloth, Portugal could give up producing 6 bottles of wine
and instead make 8 yards of cloth themselves. Thus, this offer is below the minimum
amount which Portugal would accept in exchange for 6 bottles of wine.
e) (2 points) Portugal’s ambassador counters with an offer for England: Portugal will give
England 5 yards of cloth in exchange for 3 bottles of wine. Will England accept the
offer? Explain why or why not.
England will accept the offer. When England makes 1 bottle of wine, they give up 3/2
yards of cloth, so making 3 bottles of wine means giving up 4.5 yards of cloth. So if
England can get 5 yards of cloth for 3 bottles of wine, they are getting more than their
opportunity cost of making those 3 bottles. Thus, they will accept the offer.
2. The market for TVs in Wisconsin is described by the following supply and demand
curves:
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Demand: P = 280 – 5Q
Supply: Q = P – 40
a) (2 points) Find the equilibrium price and quantity in this market using the given supply
and demand curves.
We rearrange our supply curve to solve for P, so S: P = Q + 40. Now setting supply =
demand, we get
280 – 5Q = Q + 40, so 240 = 6Q, so Q = 40. Plugging back into our supply equation,
we get P = Q + 40 = 40 + 40 = 80.
So our equilibrium is (40, 80) = (Q*, P*).
b) (2 points) Find the elasticity of demand at the equilibrium point using the point
elasticity of demand definition.
The elasticity of demand at a point is given by (-1/slope)(P/Q), so we can plug in the
numbers from part a) to get
elasticity of demand = (-1/-5)(80/40) = (1/5)(2) = 2/5, or 0.4. Remember that by
convention the price elasticity of demand is reported as a positive number.
c) (4 points) In order to encourage people to spent more time exercising, the government
imposes an excise tax of $60 per television purchased which must be paid by consumers.
On a well-labeled graph, illustrate the market for TVs after the tax has been imposed.
Your graph should clearly indicate the areas on the graph which correspond to consumer
and producer surplus, the revenue raised by the tax, and the deadweight loss caused by
the tax, and you should be sure to label the price paid by consumers, the price received by
sellers, and the quantity sold after the tax is imposed. Also label all axes and curves.
Feel free to use a qualitative graph – it’s not important to put numbers on everything you
label, but it is important to make your graph clear and easily readable.
The picture is illustrated below. PCT is the price paid by consumers, PST is the price
received by sellers, and QT is the amount sold in the market after the tax is put in place.
P* and Q* denote the original equilibrium price and quantity, before the imposition of
the tax.
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d) (2 points) Compute the numerical values of the tax revenue and deadweight loss
caused by the tax.
A $60 tax on consumers causes the demand curve with the tax to shift down 60, so the
new demand curve is given by Dtax: P = 220 – 5Q. Using this curve, we can solve for the
quantity sold under the tax and the price sellers receive as:
220 – 5Q = Q + 40, so 180 = 6Q, so QT = 30, PST = 70.
Since consumers pay a $60 tax on each TV and 30 TVs are sold, Tax Revenue =
($60)(30) = $1800.
Similarly, deadweight loss is the triangle indicated above in part c), which has a base
equal to the amount of the tax and height equal to the difference between Q* and QT.
Thus, DWL = (1/2)($60)(10) = $300.
3. The nation of Lewistan is a small, closed economy. In Lewistan, the domestic market
for baseballs is given by the following equations:
Domestic Demand: P = 30 – 2Q
Domestic Supply: P = 3 + Q
a) (2 points) Find the equilibrium price and quantity in this market using the given
domestic supply and domestic demand curves.
We set demand = supply to get
30 – 2Q = 3 + Q, so 27 = 3Q, so Q* = 9. Plugging this back into the supply equation,
P* = 3 + Q* = 3 + 9 = 12.
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b) (2 points) The world price of baseballs is $6. If the Lewistan government allows free
trade in baseballs, determine how many baseballs Lewistan will import or export. Be
sure to indicate in your answer whether Lewistan will be importing or exporting in the
equilibrium under free trade.
At a price of $6, domestic consumers demand 6 = 30 – 2Q, so 2Q = 24, so Q = 12. Thus,
domestic consumers wish to purchase 12 baseballs. Domestic suppliers provide 6 = 3 +
Q, so domestic suppliers supply 3 baseballs. Thus, Lewistan will import 9 baseballs.
c) (3 points) The Lewistan government decides to help producers by charging a $2 tariff
on every baseball imported. Find the new level of imports or exports under the tariff and
calculate the revenue raised by the tariff.
With the $2 tariff, consumers must now pay $8 for each baseball they import. Under this
new price, domestic consumers demand 8 = 30 – 2Q, so 2Q = 22, so Q = 11. Similarly,
domestic producers supply 8 = 3 + Q, so Q = 5. Since consumers demand 11 baseballs
and domestic suppliers provide 5 baseballs, Lewistan imports 6 baseballs under the
tariff. Since the tariff is $2 on each imported baseball, the total tariff revenue is ($2)(6)
= $12.
d) (3 points) Eventually the Lewistan government decides to replace the tariff with a
quota. However, they wish to impose a quota which will not change the level of
consumer or producer surplus which exists under the tariff. Find the size of the quota
which the government should impose, as well as the level of consumer and producer
surplus under the quota.
In order to maintain the same equilibrium as existed under the tariff, the quota should be
set to the same size as the number of imports which took place under the tariff. Thus, the
quota should be set at 6 baseballs to maintain the equilibrium established under the
tariff.
We know that CS is the triangle under the demand curve and above the equilibrium price.
Since the y-intercept of the demand curve is 30, the equilibrium price is $8, and the total
quantity consumed is 11, we have
CS = (1/2)($30-$8)(11) = ($11)(11) = $121.
Similarly, since the y-intercept of the supply curve is 3 and the total quantity domestically
supplied is 5, we have
PS = (1/2)($8-$3)(5) = (1/2)($25) = $12.5
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