Eco100Pesando_PT1solutions

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Unformatted text preview: © Prep101 http://www.prep101.com/freestuff Student Last Name: ________________ Student First Name: ________________ Student Number: __________________ Solutions to Economics 100 (Pesando) Practice Test 1 Students Must Answer All Questions in the Space Provided. No Aids Allowed. I. (5 points) To promote their new line of formal wear, Bugo Hoss offers free ties at their new product’s launch. News spreads quickly, and at the launch there’s a huge line up for the free samples. In fact, customers end up waiting in this line for 45 minutes. Economically speaking, what is the cost of the “free” tie? Ensure your explanation includes a numerical example that justifies your response. Solution: The economic price is the opportunity cost of waiting 45 minutes. Since each person’s time is worth different amounts for different people (i.e. Sony’s CEO’s time is arguably more “valuable” than that of a high school student), the opportunity costs differ from person to person. If the opportunity cost of a given person’s time is $20 per hour, the economic price of the “giveaway” is $15. II. (5 points) New research shows that the consumption of beef causes liver disease; consequently, there is a reduction in the demand for beef products. Both the quantity sold and total industry revenue fall. Is the demand for beef elastic? Explain your answer. Solution: From the given information, we cannot definitely decide the elasticity of beef. The reduction in demand drives a fall in price AND quantity sold, regardless of the product’s elasticity. This also causes a decrease in industry revenue. This process would be true for both elastic and inelastic demands for beef. 1 © Prep101 http://www.prep101.com/freestuff III. (5 points) In order to make up for losses caused by the proliferation of MP3s, music companies increase the price of CDs. How will this impact the market price for CD players? Ensure your explanation includes an appropriately labelled diagram. Solution: CD players are a complement of CDs, therefore shocks to the market of one affects the other. In this case, the increase in CD prices causes a drop in the quantity demanded for CDs. With this fall in quantity of CDs demanded, the demand for CD players also falls, causing a decrease in the price and quantity demanded of CD players. IV. (16 points) Guyana and Jamaica produce calculators and telephones. Guyana produces 15 calculators or 10 telephones per hour. Jamaica produces 20 calculators or 15 telephones per hour. 1. Draw the PPF for both Guyana and Jamaica based on 1 hour of labour input Solution: 2 © Prep101 http://www.prep101.com/freestuff 3 © Prep101 http://www.prep101.com/freestuff 2. What is the opportunity cost of producing these 2 products (provide answers for both countries)? Solution: The opportunity cost of producing 1 (unit)… Calculator Telephone Guyana The opportunity cost of The opportunity cost of producing 1 producing 1 calculator = telephone = 15/10== 1.5 calculators 10/15=2/3 telephones Jamaica The opportunity cost of The opportunity cost of producing 1 producing 1 calculator =15/20=: telephone =20/15=: 1.33 calculators 3/4 telephones 3. If Guyana and Jamaica decided to trade, which of the products would Jamaica export? Solution: Jamaica has a comparative advantage in the production of telephones. If they trade with Guyana, they’d be able to trade one hour worth of telephone production for more calculators than they could produce in the same hour. Therefore, Jamaica is more likely to export telephones. 4. If the terms of trade were 1:1 (1 telephone in exchange for 1 calculator), which country would benefit? Solution: Jamaica would not benefit from these terms of trade (1:1). From the diagram below, we can see that the proposed terms shrink their PPF – they are better of producing on their own. Guyana would benefit from these terms. In exchange for 15 calculators (in which they have a comparative advantage) they’d get 15 phones, much more than the 10 they could produce at home (for the fixed amount of labour input). 4 © Prep101 V. http://www.prep101.com/freestuff (15 points) Suppose the following schedule depicts the supply and demand for jeans in Toronto (thousands per year): Price ($) 50 60 70 80 90 100 Quantity Demanded 160 150 140 130 120 110 Quantity Supplied 130 140 150 160 170 180 1. What is the equilibrium price and quantity? Solution: Equilibrium price – $65 Equilibrium quantity – 145 thousand 2. To protect Canadian suppliers from international competition, the government imposes a price floor of $80. a) How many jeans will be sold at this price? Make sure to include a diagram in your explanation. Solution: At this price, only 130 thousand units will be sold (taken from table) b) What term can be used to describe the disparity between supply and demand at this price? Solution: At $80 there is an excess supply – the Store is willing to sell more units than consumers are willing to buy. c) Given this change in price, what is the elasticity of demand? Solution: Demand is inelastic (Q is relatively unresponsive to changes in P) ∆Q P1 + P2 −15 80 + 65 ED = = × = −0.527 × ∆P Q1 + Q2 15 130 + 145 5 © Prep101 VI. http://www.prep101.com/freestuff (20 points) Consider the following supply and demand schedule for cigarettes (thousands of packs). Initially the market is in equilibrium at $9 per pack. Price($) Quantity Demanded Quantity Supplied 7 1,000 600 8 900 700 9 800 800 10 700 900 11 600 1,000 12 500 1,100 1. Suppose the Government imposes a $2/pack tax, to be paid by suppliers. What is the new price, quantity-sold, and tax revenue? ($) 7 8 9 10 11 12 Solution (taken from table): new price: $10 new quantity: 700 Tax revenue: $2 x 700 = $1,400 (thousand) Qty Dmd 1,000 900 800 700 600 500 Qty Sup 600 700 800 900 2. Suppose the Government imposes a $2/pack tax, to be paid by suppliers. Using a diagram, show the new producer surplus, tax revenue, deadweight loss, and consumer surplus. S1 P $10 $9 S0 Consumer Surplus B Tax Revenue $8 DWL A C Producer Surplus D 700 800 Q (thousands) 6 © Prep101 http://www.prep101.com/freestuff 3. What is the new price paid by consumers and that received by producers? How much of the $2 tax is paid by consumers and producers? Solution (based on the previous diagram): Consumers now pay $10/ pack (point B), $9 they used to pay before the tax + $1 of the $2 tax Producers receive $8/pack (point C), $9 they used to receive before the tax - $1 of the $2 tax 4. What is the largest increase in price which could occur as a result of this tax? When would this occur? Make sure your explanation includes a thoroughly labelled diagram. Solution: The largest possible increase in price is $2. The maximum increase in price would occur if the demand curve was perfectly inelastic or the supply curve was perfectly elastic. P P Dmd S + tax S $11 $11 $9 $9 S + tax S Dmd Q Q Perfectly Inelastic Demand Perfectly Elastic Supply 7 © Prep101 VIII. http://www.prep101.com/freestuff (34 points) 1. Which of the following statements about the income elasticity of demand is true? a) if disposable income were to increase and consumers purchased more of Product A, then the income elasticity for Product A would be negative b) if disposable income were to decrease and consumers purchased more of Product A, then income elasticity for Product A would be positive c) if disposable income were to increase and Product A had a positive income elasticity, then consumers would purchase fewer units of Product A d) if disposable income were to decrease and Product A had a negative income elasticity, then consumers would purchase fewer units of Product A e) none of the above are correct Answer: E. ηY = (% change in quantity demanded)/(% change in income) In a), ηY for product A would be positive; in b), ηY for product A would be negative; in c), consumers would purchase more units of product A; in d) consumers would purchase more units of product A. 2. The price of mangoes at the grocery increases from $2.95 to $3.05 per pound, and as a result the quantity of oranges that households purchase increases from 3,950 to 4,050 lbs/week. The cross-price elasticity is: a) -1.33 b) -0.75 c) 0.75 d) 1.33 e) insufficient information to know Answer: C ηXY = (% change in quantity demanded of good X) / (% change in price of good Y) = [(4050 – 3950)/(3950+4050)/2] / [(3.05 – 2.95)/(2.95+3.05)/2] = (100/4000) / (0.1/3) = 0.75. 8 © Prep101 http://www.prep101.com/freestuff 3. At a pawn shop, Andy purchases a record player for $50 when he was willing to pay $75. If a new record player costs $325, Andy’s consumer surplus would be _____. a) $25 b) $120 c) $145 d) $170 e) $0 Answer: A The consumer surplus is the value of a good (i.e. the price on the demand curve) minus the price paid for it. The price paid for the record player is $50. The value of the used record player for Andy is $75. So Andy’s consumer surplus is $75-$50=$25. The price of a new record player is irrelevant. 4. An increase in the supply of tuna, along with an increase in the demand for it, is predicted to: a) raise the price of tuna, but either raises or lowers the equilibrium quantity; b) raise the quantity of tuna, but either raises or lowers the equilibrium price; c) lower the price of tuna, but either raises or lowers the equilibrium quantity; d) lower the quantity of tuna, but either raises or lowers the equilibrium price; e) none of the above. An increase in supply causes the supply curve to move to the right. An increase in the demand causes the demand curve to move to the right. When we put these together, we see that the equilibrium quantity necessarily increases, but the change in price depends on the relative size of the shift in demand versus supply 9 © Prep101 http://www.prep101.com/freestuff 5. Which of the following would not cause a shift in the demand curve for corn? a) An increase in consumers’ incomes; b) An increase in the price of peas; c) A large decrease in the price of potatoes; d) A decrease in the price of corn; e) A decrease in the price of green beans. Answer: D The change of the price of corn only causes a movement along the demand curve, but not a shift of a demand curve 6. The price of good X is $1.50 and that of good Y $1. If a consumer considers the marginal utility of Y to be 30 units, and is in equilibrium with respect to purchases of X and Y, then he or she believes the marginal utility of X to be: a) 15 units b) 20 units c) 30 units d) 45 units e) none of the above necessarily-information given is insufficient to tell Answer: D MU x MU y = . Px Py 30 MU x = ==> MU x =45 1 1 .5 This is an example of the requirement of equality between two options’ marginal utility per dollar spent in equilibrium/utility maximization. Utility-maximizing condition: 10 © Prep101 http://www.prep101.com/freestuff 7. Consider the following supply-demand schedule. Now suppose the demand for good X decreases by 10 units at each price. Simultaneously, the production costs for good X increase such that supply falls by 20 units at each price. Price ($) of good X 10 20 30 40 50 60 Quantity Demanded Quantity supplied of good X of good X 55 50 45 40 35 30 25 30 35 40 45 50 What are the new equilibrium price and quantity? a) $30; 45 b) $50; 25 c) $60; 50 d) $40; 40 e) $20; 50 Solution: B $50; 25 After the shifts in the demand and supply curves, the new equilibrium occurs at the price of $50, where the quantity demanded= quantity supplied= 25. 8. Which of the following is true if a decrease in the price of good X causes the supply curve for Y to shift to the left? a) Goods X and Y are substitutes in production b) Goods X and Y are complements in production c) X is a normal good and Y is an inferior good d) Goods X and Y are complements in consumption e) a) and d) Solution: B Goods X and Y are complements in production A decrease in the price of good X leads to a reduction in the quantity supplied of good X (suppliers are not willing to supply at the original level at this lower price). If this (as given in the question) causes a reduction (a leftward shift) in the supply of good Y, then goods X and Y must be complements in production. 11 ...
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This note was uploaded on 11/29/2011 for the course ECO 100 taught by Professor Indart during the Fall '08 term at University of Toronto- Toronto.

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