a07-part1 - UNIVERSITY OF TORONTO ‘" Faculty of Arts...

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Unformatted text preview: UNIVERSITY OF TORONTO ‘ "' ,. Faculty of Arts and Science - V_ ' _ AUGUST EXAMINATIONS 2007 W ECONOMICS 200Y ? ' Duration: 2 hours Aids Allowed: Non-Programmable Calculator STUDENT INFORMATION: NAME (print) FIRST LAST STUDENT # SECTION (circle): Ritter / Anjomshoa Slasor Wolfson INSTRUCTIONS: The exam consists of three parts. Part A is to be answered by all students. Part B is to be answered by students fi'om Professor Slasor’s and Wolfson's sections. Part C is to be answered by students from Professor Ritter/Anjomshoa's section. All answers are to be written on this examination paper. 2. __ 3. __ 4. __ 5. __ 6. __ 7. __ 8. __ 9. __ 10. Page 2 of 23 Instructions: All students must do all 3 questions in Section A. 1. MULTIPLE-CHOICE ******(All students must do this question)****** Provide the best answer to the following multiple-choice questions by circling your response below. There are 12 questions; choose 10 to answer at 2 marks each. No penalty for incorrect responses. If more than 10 questions are attempted, only the first 10 will be marked. 1. If Jamie’s Marginal Rate of Substitution (MRS) of beer for wine (i.e., Awine/Abeer) is 0.5 (beer is on the horizontal axis), Jamie would give up a) 2, but no more than 2, units of wine for an additional unit of beer b) 2, but no more than 2, units of beer for an additional unit of wine c) 2, but no more than 2, units of wine for an additional 4 units of beer (1) a and b above e) b and c above 2. On the lunch menu, the price of grapes is $5 per bunch and the price of deli sandwiches is $10 each. Harry and Sally have equal lunch budgets, but Sally eats more grape bunches than Harry does. Harry’s Marginal Rate of Substitution (grapes on the x-axis) is ‘/2. Sally’s Marginal Rate of Substitution must be: a) less than ‘/2 (less than Harry’s) b) equal to V2 (same as Harry’s) c) equal to 2 (the inverse of Harry’s) d) greater than 2 (more than the inverse of Harry’s) e) none of the above. 3. An increase in the wage rate a) always increases the opportunity cost of an hour of leisure b) always decreases the opportunity cost of an hour of leisure c) always increases the number of hours worked if leisure is a normal good d) always decreases the number of hours worked if leisure is a normal good e) always results in a positively sloped supply schedule of labour services Page 3 of 23 Assume that Bill’s MRS between cupcakes (the x-axis good) and donuts is 1/2 everywhere. The price of a cupcake is $1 and the price of a donut is $0.50. Bill’s income is $12.00. At the optimal solution, Bill will purchase only cupcakes Bill will purchase only donuts Bill is indifferent between purchasing cupcakes and donuts Bill will purchase both cupcakes and donuts, but more cupcakes than donuts Bill will purchase both cupcakes and donuts, but fewer cupcakes than donuts Consider the following two statements: I. As output increases the difference between a firm’s average total cost and average variable cost curves cannot increase. 11. The average variable cost curve and the marginal cost curve reach their minima at the same level of output. Both I and II are true I is true, and H is false I is false, and II is true Both I and H are false For a firm, the wage rate is $20 per hour, and rental rate of capital is $5 per hour. At the current production point, the marginal product of labour is 5, and the marginal product of the capital is 20. The firm is producing its current output level at the minimum cost could reduce the cost of producing its current output level by employing more capital and fewer workers could reduce the cost of producing its current output level by employing more workers and less capital must be facing a constant returns to scale production function none of the above is correct Page 4 of 23 Consider the following statements for a constant cost perfectly competitive industry: I. If the cost of producing each unit of output falls by $5, then the short run market price falls by $5. H. If the cost of producing each unit of output falls by $5, then the long run market price falls by $5. I and II are true I is true, and H is false I is false, and H is true I and H are false Consider a good whose price elasticity of supply is O and price elasticity of demand is 1. The fraction of a per unit tax that will be passed through to consumers is: 100% 25% 0% 50% 75% Which of following is true in long run equilibrium for a firm in monopolistic competition? MC < AC MC = AC MC > AC MR = AR None of the above In the Cournot model of oligopoly, each firm assumes that: rivals will match price changes rivals will not match price changes the output of its rivals will not change the price of its rivals will not change there are no rivals, as the firm is a price-taker Page 5 of 23 In comparing the Cournot equilibrium with the competitive equilibrium: profit is higher and output is lower in Cournot equilibrium profit is higher and output is lower in competitive equilibrium both profit and output are higher in Cournot equilibrium both profit and output are higher in competitive equilibrium the Cournot equilibrium is the competitive equilibrium For a monopsonist who can hire 9 workers at a wage rate of $15, but has to pay a $16 wage to get 10 workers, the marginal cost of the 10th worker (MCL) [or marginal expenditure for the 10th worker] would be: $15 MCL would equal ACL, which is not given $ 1 6 $25 you need both revenue and productivity data to answer this question. 2. 2.1 b) d) Page 6 of 23 CONSUMER THEORY ******(All students must do this question)****** (12) Hans consumes beer and sausages. His income is $100, the price of beer is $2 per pint, and the price of sausages is $1 each. In order to help the brewery industry, the government subsidizes beer leading to a $1 reduction in its price. Hans has smooth and convex indifference curves. Beer is an inferior good for Hans, but his demand schedule is negatively-sloped. Read a, b, c below before you start. In a well-labeled diagram show Hans’s optimal consumption bundles as follows: point A (before the subsidy) and point B (after the subsidy). Put beer on the x-axis. In the diagram above, decompose the change in beer consumption into a Substitution Effect (SE) and an Income Effect (IE). Label the intermediate point as C or I. |Slasor and Wolfson students: use the Hicks Method.| Now, in order to pay for the subsidy, the government introduces a lump-sum tax. The tax amount is equal to $1 times the number of pints Hans consumed originally at Point A. Show Hans’ new budget line in the diagram and show his resulting optimal consumption bundle (point D). What has happened to Hans’ satisfaction at Point D compared to his initial consumption at point A? (Higher l Lower l Same Level of Satisfaction / Can’t Determine). Briefly explain your answer below. Page 7 of 23 2.2 (8) Emily faces a two-period consumption decision; that is, she must decide how b) much to save or borrow in the current period at the prevailing rate of interest. Her decision about the current period of course has implications for the second period. Consumption in both periods is a “normal good”. In a fully labeled diagram, show Emily’s equilibrium if she decides to save some of her first-year income. Using the diagram above, and applying the concepts of Substitution Effect (SE) and Income Effect (IE), explain whether you agree with the following statement: “A decrease in the interest rate will always increase the amount of income she saves in period one to ensure she has enough money to spend in period two ”. lSlasor and Wolfson students: use the Slutsfl Method| I (agree / disagree). Provide a full explanation below. Page 8 of 23 3. PRODUCTION THEORY ******(All students must do this question)****** 3.1 Cost Curves (8) The following diagram depicts a total cost curve (TC) as a function of quantity produced. a) In the same diagram, draw the total fixed cost curve (TFC) and the total variable cost curve (TVC) associated with the TC curve shown. $ TC Q b) In the diagram below, draw the shape of each of the corresponding average total cost (ATC), average variable cost (AVC) and average fixed cost (AFC) and marginal cost (MC) curves. $/Q Page 9 of 23 3.2 Perfect Competition (12) Consider a perfectly competitive firm maximizing profits in the short run. It uses only one variable input and the associated cost functions have the usual shapes. The following information is given for the current production point: the average product of labour is maximized o the average product of labour is 10 o the market price for its output is $5 0 the firm has positive fixed costs. Use this information to answer the following questions. Illustrate your answers with a diagram of the firm’s costs and demand. This diagram is at the bottom of this page. a) What is the marginal 'cost at the current level of output? Explain. b) What is the average variable cost at the current level of output? Explain. c) Is the firm in a long run equilibrium? Explain. (1) Show diagram below of firm’s costs and demand: Page 10 of 23 Do 2 of 3 questions available to you. Question 4 is for Slasor students only; Question 5 is for Wolfson students only. 4. THIS QUESTION IS FOR SLASOR STUDENTS ONLY. (20) Consider an economy in which all the markets are perfectly competitive and there are no externalities. Also, the government has ample revenue from oil wells on Crown lands and so there is no need for taxes that would cause Pareto inefficiency. Now the government decides to assist people with low incomes by subsidizing their food purchases. What are the implications of this subsidy for Pareto optimality?. Explain your answer with reference to diagrams. more space to answer question 4 is on the following page Page 11 of 23 Solution to Q4 cont’d: 5.1 b) d) Page 12 of 23 THIS TWO-PART QUESTION IS FOR WOLFSON STUDENTS ONLY. (12) Jamie has a house worth $250,000, his only asset. In any given year, there is a 10% chance that it will burn down. If: it does, the scrap value will be $90,000. Jamie has a utility function ofU = w A In the space below, draw the shape of Jamie’s Utility Function. Label the axes. From part a), I know Jamie is (risk neutral / risk averse / risk seeker) because: What is the Expected Value of Jamie’s risky venture? EV= What is the Expected Utility of Jamie’s risky venture? EU= What is the maximum Jamie would be willing to pay to insure his house against loss? Maximum = Suppose ABC Insurance Company (ABC) offers insurance based on the actuarial cost of insurance, plus a $1,000 administrative fee. Between what two prices could a mutually beneficial contract of insurance be made between Jamie and ABC? Between and Page 13 of 23 5.2 (8) Let’s move to indifference theory and uncertainty. Auntie Mame proposes this game: A six-sided die is thrown. If a 1 or 2 shows, she pays $60 to the player; if a 3, 4, 5 or 6 shows, the player pays $30 to Auntie Mame. a) How will risk averse Rhonda respond to the offer to play this game? (Play it / Indifferent / Reject it) How does risk neutral Neil respond to the offer to play this game? (Play it / Indifferent / Reject it) b) In the indifference diagram below, show the equilibrium for Rhonda (label as R). Now show a potential equilibrium for Neil (label as N) that is clearly consistent with your answer to part c). Assume a player can “take either side of the be ” and has $120 available to play. c) Briefly explain why you selected Point R for Rhonda: Briefly explain why you selected point N for Neil: ...
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