UNIVERSITY OF VICTORIA Midterm EXAM

October 16, 2013 V1 Solutions

Course Name & No.: Sections(s): CRN: Instructor: Duration: NAME: STUDENT NUMBER: V00 Economics 203 A02 10941 Betty J. Jones Johnson 60 minutes

This exam has a total of _11_ pages including this cover page. Students must count the number of pages and report any discrepancy immediately to the Invigilator. This exam is to be answered: on the exam paper.
Marking Scheme: 1) 25 marks 2) 10 marks 3) 10 marks

Materials Allowed:
Non-programmable calculator

Solutions to Part 1:

Question Answer 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Part I: Select the BEST answer. 1. You decide to go skiing this weekend. It costs $40 for transportation, $60 for lodging, $30 for ski lift tickets and you could have earned $100 as a waiter at a job you love so much you would do it as a volunteer. What is the total cost of the ski weekend? A) $30 B) $90 C) $130 D) $230 Ans: D

2. If scarcity didn't exist A) we wouldn't have to choose. B) we wouldn't need to study economics. C) prices of all goods would be zero. D) A and B. E) all of the above. Ans: E 3. The marginal benefit of a good x is given by the equation MB = 40 2x, and its marginal cost MC = 10 + x, with x in kilograms and MB and MC in $/kilogram. The optimal level of x (in kilograms) is A) 0 B) 10 C) 15 D) 20 E) 30. Ans: B 4. Which is not true of market equilibrium? A) All sellers who want to sell at the equilibrium price can find a buyer to sell to. B) The highest possible welfare is achieved when many positive externalities exist. C) All buyers who want to buy at the equilibrium price can find a seller to buy from. D) Sudden unforeseen changes in circumstances can alter the equilibrium position. Ans: B 5. The "law of demand" states that A) scarcity can never be solved. B) supply creates its own demand. C) when the price of a product falls, people buy more of it. D) prices will continue to rise as long as the population grows. Ans: C 6. The real price of a product on any given day is A) its absolute level on that day

B) its absolute level on that day divided by the cost of its inputs. C) its absolute level on that day minus any external costs resulting from production of the good. D) its price on that day relative to the prices of other goods and services. Ans: D 7. Which of the following statements would most economists agree with? A) Rent control hurts everyone. B) Rent control hurts some people and helps others. C) On balance, rent control hurts. D) Both A and C. E) Both B and C. Ans: E 8. If the number of suppliers in the microcomputer industry increases, other things unchanged, what would we expect to happen? A) The number of microcomputers sold will rise. B) The price of microcomputers will fall. C) The supply curve will shift to the right. D) Movement along the demand curve will occur. E) All of the above will happen. Ans: E 9. In the market for chocolate-covered strawberries, the equilibrium price has decreased, and the equilibrium quantity exchanged has increased. Which of the following could not have occurred?: A) Demand has increased and supply has increased. B) Demand has decreased and supply has increased. C) Demand has remained constant and supply has increased. D) Demand has increased and supply has remained constant. E) Neither C nor D could have occurred. Ans: D 10. The budget constraint shown here is consistent with a pricing policy that involves:
y

A) a reduction in the price of x for large quantities purchased B) an increase in the price of x for large quantities purchased. C) a reduction in the price of y for large quantities purchased. D) a price change of x and a nominal income increase for the consumer.

E) A and C. Ans: B 11. The marginal rate of substitution between two goods is A) the absolute value of the slope of the indifference curve. B) the tradeoff between the two goods under consideration at any particular point. C) the total utility derived at any point. D) all of the above. E) A and B. Ans: E 12. Diminishing marginal rate of substitution implies that indifference curves are A) convex with respect to the origin. B) concave with respect to the origin. C) downward-sloping straight lines. D) closer together as the quantities of both goods increase. Ans: A 13. In the standard case, with X on the horizontal axis and Y on the vertical axis, if the MRS exceeds the ratio of the price of X to the price of Y and the consumer is on her budget line, then the consumer is A) purchasing too much X for utility maximization. B) purchasing too much Y for utility maximization. C) spending more money than exists in her budget. D) doing both A and C. E) doing both B and C. Ans: B 14. Given the demand function P = 24 - 0.5Q, with price P in $/kg and quantity Q in kilograms, A) demand is elastic when P = $16/kg. B) demand is elastic when P = $12/kg. C) demand is elastic when P = $2/kg. D) demand is elastic at all positive prices. Ans: A 15. The price consumption curve tells us the change in A) consumer equilibrium as the price of one commodity changes. B) a consumer's nominal income as relative prices change. C) prices caused by a given change in the pattern of consumption. D) none of the above. Ans: A 16. An Engel curve A) always slopes up. B) always slopes down. C) may slope up or down.

D) will slope up first and then slope down for normal goods. Ans: C 17. Comparing the income effects of a given proportional increase in the prices of salt and housing, A) the income effect for salt will be greater. B) the income effect for housing will be greater. C) the two income effects will be precisely the same. D) the two income effects will be approximately the same, but will work in opposite directions. Ans: B 18. For a Giffen good A) the income effect is greater than the substitution effect. B) the income effect is less than the substitution effect. C) the income effect is in the opposite direction from the substitution effect. D) A and C. E) B and C. Ans: D 19. If the demand for widgets is inelastic, then when the price of widgets increases, revenues will: A) decrease. B) remain the same. C) increase. D) increase, unless there are substitutes for widgets. Ans: C 20. The income elasticity of demand for an inferior good is A) positive and greater than 1. B) positive, but less than 1. C) negative. D) zero. Ans: C 21. Which of the following goods are likely to have a negative cross-price elasticity of demand? A) butter and margarine B) Coke and Pepsi C) left and right shoes D) peanut butter and tuna fish Ans: C 22. Given these two individual demand curves, what is the equation for the market demand curve? i. P = 100 - 5Q ii. P = 100 - 3 Q
10

A) P = 100 - 2Q B) P = 200 - 8.33Q C) P = 100 - 8.33Q D) P = 100 - 1.67Q E) none of the above. Ans: A

23. Your income rises from $1,000 to $10,000 per year and your purchases of beer increase from 10 to 20. Your income arc-elasticity of demand for beer over this range is approximately: A) .4 B) 1 C) 2.5 D) 4 Ans: A 24. The income elasticity of demand for a Giffen good is A) positive. B) negative. C) zero. D) indefinite, since a Giffen good is defined by its price elasticity of demand. Ans: B 25. The cross-price elasticity of demand for perfect complements is A) positive. B) zero. C) negative. D) infinite. Ans: C Part II: Answer both questions. Question 1: A). Sketch the income and substitution effects of a price increase for good X. Ans:

Good Y 100

23

46 50

100

Good X

Question 1: A) Sketch the income and substitution effects of a price increase for good X. (8 marks) Ans:

Rotate the budget line around the higher indifference curve from its original tangency until it reaches a slope of -2. The new tangency point will divide the overall change in quantity between the substitution and income effects. The longer arrow above is the substitution effect and the shorter arrow is the income effect.

Refer To: Graph 4-3 B. Based on your sketch, is good X a normal or inferior good? (2 Marks) Ans: Good X is a normal good, because as nominal income drops with prices constant, the quantity is reduced. Question 2: (10 marks) Explain why the equilibrium point in a perfectly competitive market is considered to be the socially efficient point. Sketch in a graph a situation where a government price ceiling below equilibrium leads to inefficiency. Explain in words why the inefficiency exists and shade in on your graph the lost benefit that results from the inefficiency. Ans:

At the competitive equilibrium, all units for which benefit equaled or exceeded cost would be produced. Thus, net benefit is maximized. At the ceiling equilibrium, output is under-produced, in the sense that some units for which benefits exceed the cost are not produced.