Econ103SolutionstoPracticeExam - Solutions to Econ103...

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Unformatted text preview: Solutions to Econ103 Practice Exam PART I. MULTIPLE CHOICE. (60 Marks) Q1: Solution: E Opportunity cost refers to the cost of giving up the highest‐valued alternative. In this case, $15 is the highest value. Q2: Solution: A Choice a) is about ‘what is’ whereas the other choices are about ‘what should be’.. Q3: Solution: A If 15 units of good A are produced, the remaining resources will allow the production of only 3 units of good B. Currently, 10 units are produced. So, the production of good B must be reduced by 7 units to produce 15 units of A. Q4: Solution: E TV and stereos want to be consumed only in fixed quantities. If the price of stereos increase, the quantity demanded of stereos will decrease and as a result so will the demand for HD TV’s. Q5: Solution: C An increase in supply causes the supply curve to move to the right. A decrease in demand causes the demand curve to move to the left. We can see from the diagrams that the new equilibrium price would decrease from p0 to p1. But we don’t know how the equilibrium quantity changes. Q6: Solution: B Because demand is inelastic, when supply increases price will fall more than quantity demanded increases. So receipts (= P × Q) will decrease. Q7: Solution: C The change in total revenue depends on the elasticity of demand. • If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent and total revenue increases; • If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent and so total revenue does not change. • If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent and total revenue decreases. In this question, the demand curve is of unit elasticity. So the change of supply does not affect the total revenue. Q8: Solution: D A price ceiling set above the equilibrium price has no effect on the market quantity supplied equals quantity demanded. Q9: Solution: D MU B 5 MU B Utility‐maximizing condition: MU x = MU y . = ==> =10/6=5/3 MU A 3 MU A Px Py Q10: Solution: B Harry receives 20/5 = 4 units of utility from the last dollar he spends on shrimps. Since he is not consuming any lobster he should be getting less than 4 units of utility for a dollar spent on lobster, i.e. MUlob/10 < 4. So the marginal utility from the first kilogram of lobster must be less than 4. Q11: Solution: B PxQx + PyQy = I (income) Qy = I/Py – (Px/Py)Qx Change in the relative price (Px/Py) changes the slope; change in real income does not affect the slope, bur shifts the budget line. Q12: Solution: A The substitution effect: consume more of the cheaper good. The income effect: falling price increases income (purchasing power) and increases the quantity demanded for a normal good and decreases the quantity demanded for an inferior good. Q13: Solution: A ATC = AFC + AVC. Even though AVC are constant regardless of output, average fixed costs (= TFC / Q) will decrease as output increases. So ATC will decrease when output increases. Q14: Solution: D The increase in total cost resulting from the one‐unit increase in output from 2 to 3 units is $400 ‐ $300 = $100. Q15: Solution: B LRAC is downward sloping if there are increasing returns to scale; upward sloping if there are decreasing returns to scale; constant if there are constant returns to scale. Q16: Solution: B We know the firm is not in perfect competition because price is not equal to MR. However MR = MC at the current level of output and P>AVC, so the firm produces at profit maximizing output. (AVC = ATC – AFC = 13). Q17: Solution: E The decrease in demand causes the price of the good to fall, and firms are making a loss in the short run. Because of these negative profits some firms will leave the industry and the price will be back to the original price in the long run. Industry output will have decreased because fewer firms are present. Q18: Solution: D All firms maximize profits by producing where MR = MC in both the short and long‐ run. Q19: Solution: E Marginal cost pricing rule MC = P Q= 80 and P = 10< ATC economic loss to the natural monopoly. Q20: Solution: A Profit maximization requires that MC equals MR. If MR<MC the last unit of production brings less revenue to the producer (MR) than the cost of producing that additional unit (MC). So the firm should decrease output to maximize profits. Because the demand is downward sloping, the price will increase. Q21: Solution: C Under monopolistic competition, firms have some control over the price. Their market power comes from the differentiated goods that they produce. Only in perfect competition, firms have no control over price. Q22: Solution: A The firm has an incentive to increase output at the given price, thus increasing that firm’s level of profits. Q23: Solution: B When firms collude, they restrict the output to charge a higher price. Without colluding, they compete against each other and decrease prices, leading to increased output. Q24: Solution: E Firms in oligopoly always follow the price cut but not price rise. Therefore, when one firm increases its price (in other word, the demand curve of the firm above the current price), the demand curve must be very flat (elastic) because other firms who do not follow the price increase will take some of the market share of this firm. When the firm reduces the price, other firms will simply follow it, and result in no change in any firm’s market share but their quantity demanded will increase. Therefore, the demand curve below the current price would be relatively steep (inelastic). Q25: Solution: E Two profit maximizing conditions: MC=MR and MRP=Pfactor MRP= MR*MP and since MC=MR MRP= MC*MP PF = MRP Pfactor = MR*MP Q26: Solution: E The marginal product of labour decreases demand for labour decreases the demand curve for labour shifts leftward along the labour supply curve wage falls and the quantity of labour employed decreases. Q27: Solution: B MRP = change in TR / change in L. MRP=93 is the maximum. units of units of Price per unit of TR MRP labour output output 0 0 0 1 5 15 75 75 2 12 14 168 93 3 18 13 234 66 4 22 12 264 30 5 25 11 275 11 Q28: Solution: A Since there is a movement of accountants into the banking industry attracted by higher wages, their labour supply decreases for other industries, i.e. other industries see leftward shifts in their labour supplies. Q29: Solution: D Efficient level is achieved when MB = MSC 4 tonnes Nitrogen dioxide (tons) Total Benefit ($) Marginal Benefit 1 $160 2 $300 140 3 $420 120 4 $520 100 5 $600 80 6 $660 60 Q30: Solution: B Marginal Social Cost ($) 40 60 80 100 120 140 No costs to the industry MC = 0 Marginal externalcost = MSC Need to tax or impose emission charge equal to MSC emission charge = $100 Q31: Solution: B The economy can move to any point inside or on the PPF with no increase in resources. On the PPF curve, the economy produces efficiently; inside the curve the economy is inefficient. Q32: Solution: A The opportunity cost of milk (opportunity cost of producing 1 litre of milk) in Canada = 500/200= 2.5 lb of fish The opportunity cost of (1 litre of) milk in the USA = 300/400= 0.75 lb of fish Milk is more expensive in Canada USA should specialize in milk production Q33: Solution: D P=$4 PS= (4 – 2) + (4 – 3) + (4 – 4) = 3 P=$5 PS= (5 – 2) + (5 – 3) + (5 – 4) + (5 – 5) = 6 Q34 Solution: D Firm A’s dominant strategy is to downsize If firm A anticipates firm B to downsize, 1) A will make $20 if it, too, downsizes, 2) A will incur a loss of $100 if it expands Firm A should downsize. If A anticipates B to expand, 1) A will make $200 if it downsizes, 2) A will make $100 if it expands A should downsize. The dominant strategy for A is to downsize. Q35 Solution: D Both firms A and B downsize Solution to question 1 revealed that a dominant strategy for firm A is to downsize. If firm B anticipates A to downsize, 1) B will make $50 if it, too, downsizes, 2) B will incur a loss of $100 if it expands B should downsize If firm B anticipates firm A to expand, 1) B will make $250 if it downsizes, 2) B will make $200 if it expands B should downsize. The dominant strategy for firm B is to downsize. Both firms have the same dominant strategy‐‐ downsize. Q36 Solution: B The income effect is greater than the substitution effect; the income effect is smaller than the substitution effect When the wage rate is low, as the wage rate increases, more labour is supplied SE >IE. When the wage rate is high, income increases and thus, demand for normal goods increases demand for leisure (normal good) increases consume more leisure and work less until IE>SE and labour supply curve starts to bend backward. Q37 Solution: C Profit is maximized when D=MC Q = 40 units and P = $5 Q38 Solution: D Efficient level is achieved when D = MSC Q = 60 and P = $15 At Q= 60, MPC = $9 tax = $15 ‐ $9 =$6 Q39 Solution: D %ΔQ 10% εd = = = 2 %ΔP =5% %ΔP %ΔP Q40 Solution: B With no tax, 60 units are sold and the sellers get $8 per unit. With tax, 50 units are sold at $10, but the sellers get only $7 per unit $1 per unit is taxed away from sellers. PART II. SHORT ANSWER. (40 Marks) Q1: Solution: a) X is an inferior good; the incomes of the purchasers of Good X rise. S P1 P2 D1 D2 Q2 Q1 b) X is a normal good; the price of Good Y, a substitute for X, rises. S P2 P1 D2 D1 Q1 Q2 c) X represents the quantity of Canadian dollars in the foreign exchange market; foreigners become concerned about Canada's never‐ending constitutional debates, leading to increased capital outflows. S S2 P1 P2 D Q1 Q2 d) X is an agricultural product; an effective quota system is established at a quantity less than Q1. e) X is initially a legal good; then the government decrees that both the production and consumption of X is illegal, yet a market in X continues to exist. Q2: Solution: 2 + 2P = QS = QD = 35 ‐ P P* = 11 Q* = 2 + 2*(11) = 24 Q3: Solution: a) What is the equilibrium price and quantity of a carton of eggs? Price=$10 per carton; quantity = 4,000 cartons per week b) To protect consumers, the government imposes a price ceiling of $6 on each carton of eggs. What is the new quantity demanded? The new quantity supplied? Is there a surplus or a shortage of eggs? Illustrate your answer with a diagram. Quantity demanded = 8,000 cartons per week; quantity supplied = 2,000 cartons per week. There is a shortage of 6,000 cartons per week. P S $10 $6 D Shortage Q 2000 4000 8000 Q4 : Solution : a) Using indifference theory, show her initial equilibrium in the diagram below. Label the equilibrium point as A. Haddock 15 6 h A IC BL 6 Cod 10 b) Substitution Effect (SE) = A → I, QC↓. Income Effect (IE) = I → B, QC↑. Since SE>IE, the overall quantity of Cod consumed decreases. Haddock 15 I h A 6 h B h IC2 BL2 6 c) From the above diagram, I conclude that: Cod is an inferior good Haddock is a normal good d) Price 20 15 •A D 2 6 Q5 : Solution : IC BL1 Cod 10 Quantity P MC AC 0 Consumer surplus PM PPC DW Producer surplus D QM Q QPC MR Q6: Solution: If A anticipates B to charge $3 per unit, 1) A will make $300 if it charges $3, 2) A will make $500 if it charges $2 A should charge $2. If A anticipates B to charge $2 per unit, 1) A will make $500 if it charges $3, 2) A will make $600 if it charges $2 A should charge $2. Therefore, A has a dominant strategy and the best way of action is always to charge $2. The same result holds for firm B. Q7: Solution: a) Number of workers 0 1 2 3 4 5 6 7 8 9 10 Total product 0 95 180 255 320 375 420 455 480 495 500 Marginal product NA 95 85 75 65 55 45 35 25 15 5 Value of the marginal product NA $237.50 $212.50 $187.50 $162.50 $137.50 $112.50 $87.50 $62.50 $37.50 $12.50 b) Sam will hire 8 workers. The value of the marginal product of the eighth worker is $62.50, while the cost of the worker is $50. Sam will not hire the ninth worker because that worker will only add $37.50 to total revenue but will cost $50 to hire. c) If the price of a sandwich rises to $5.00, Sam will hire 9 workers. The value of the marginal product of the ninth worker is now $75 and the cost of that worker is still $50. Sam will not hire the tenth worker because the value of the marginal product of that labour is $25 and the cost would be $50. d) If workers were paid by $100 daily and the price of a sandwich stayed at $2.50, then Sam will hire only 6 workers, because the 7th worker’s value of marginal product is $87.50, which is below $100. Q8: Solution: a) Q* = Q1, P* = P1 b) The profit is positive and the area for profit is P1 P2BA. c) There will be more firms enter this market because they are attracted by the positive profit earned by the exiting monopolistic competitive firms. d) In the long‐run equilibrium all firms in this industry will be earning zero economic profit. ...
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