ECON130

ECONOMIC PRINCIPLES AND ISSUES

2014 2/3

Tutorials - introduction
Welcome to the ECON130 tutorials for trimester 2, 2014. Tutorials are a good chance for
you to practice what you have covered in class in small groups with your classmates, to
discuss problems and work through exercises.
What you get out of the tutorials depends on what you put in to your preparation and
participation.
You are expected to prepare for tutorials by keeping up with the prescribed reading and
by attempting the exercises in advance of your session. You should attempt, in writing,
the tutorial questions and the corresponding set of multi-choice questions before attending
your tutorial.
Tutorials will be held in weeks 2, 3, 4, 6, 7, 9, 11, 12 (starting week 2).
See the schedule in the Course Delivery section of the Course Outline to see what lectures
are covered in each tutorial.

ECON130

Tutorial 01

Thinking like an economist

Multi Choice
1. When deciding whether or not to pursue a particular activity any further, individuals
should continue doing the activity:
(a) as long as they like it.
(b) as long as marginal benefits are positive.
(c) as long as marginal costs do not increase.
(d) as long as marginal costs are less than marginal benefits.
b) Suppose Frieda is offered a free voucher for one of the following: a movie, dinner at
a restaurant, or a concert. Frieda values the movie at $15, dinner at $20 and the
concert at $40. Friedas opportunity cost of going to dinner is:
(a) $15.
(b) $20.
(c) $40.
(d) $55.
Q1

Education

A friend is deciding whether to go to university or whether to stick with their current job.
They seek your advice, as a Commerce student. What would you tell them?

Q2

Models

What is a model? Why do economists use models?

Q3

Economic logic

Explain the pitfalls in the following statements.

a Whenever John decides to wash his car, the next day it rains. Johns town is suffering
from a severe drought, so he decided to wash his car and, just as he expected, the next
day the thunderstorms rolled in. Obviously it rained because John washed his car.
b The principal of Hamilton High School found that requiring those students who were
failing algebra to attend an afternoon tutoring programme resulted in a 30 percent
average increase in their algebra grade. Based on this success, the principal decided
to hire more tutors and require that all students must attend after-school tutoring, so
everyones algebra grades would improve.
c People who drive hybrid cars recycle their trash more than people who do not drive
hybrids. Therefore, recycling trash causes people to drive hybrid cars.
Q4

The competitive model

What are the essential elements of the basic competitive model?

ECON130

Tutorial 02

Consumer choice I
Multi Choice
MC1. Suppose consumption bundle A maximises Bens utility, subject to his budget
constraint. Further, consumption bundle B gives Ben less utility than A. From this,
we can infer that:
(a) The cost of B is greater than Bens income.
(b) The cost of B is less than Bens income.
(c) The cost of B is equal to Bens income.
(d) None of the above.
MC2. Suppose Ellen spends all her income on books and food. Following an increase in
the price of books (with income fixed), Ellen consumes fewer books and less food.
From this, we can infer that:
(a) Books are normal goods, to Ellen.
(b) Books are inferior goods, to Ellen.
(c) Food is a normal good, to Ellen.
(d) Food is an inferior good, to Ellen.
MC3. Consider an individual farmer who consumes food and recreation goods. The
farmers income comes from the sale of their endowment of food but is not related to
the price of recreation goods. For the particular individual, both goods are normal.
An increase in the price of food will have a substitution effect, that causes the
demand for food to
and an income effect that causes the demand for food to
.
(a) Decrease; decrease.
(b) Decrease; increase.
(c) Increase; decrease.
(d) Increase; increase.
MC4. Consider an individual who consumes only food and recreation goods. Suppose
that when the individuals income is $100, the price of food is $2 and the price of
recreation goods is also $2, the individual chooses to consume 30 units of food and
20 units of recreation goods. Any consumption bundle that yields
utility
than the individuals chosen plan will
.
(a) lower, be affordable.
(b) higher, be affordable.
(c) higher, not be affordable.
(d) lower, not be affordable.
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Q1

Utility

Why does marginal utility tend to diminish?

Q2

Hotdogs

The only foods Sammy consumes are hotdogs (for $2 each) and cups of coffee (for $4
each). If she has a food budget of $100 per week:
a) What is maximum amount of each that she could choose to consume? Draw her
budget constraint, with hotdogs on the vertical axis and coffee on the horizontal
axis.
b) If she has a utility function such that she will always spend the same amount on
each of hotdogs and coffee, how will her consumption change if the price of a cup of
coffee falls to $2.
Q3

Hotdogs II

Consider a consumer with a fixed income, who only consumes two goods (hotdogs and
coffee). How do they choose the consumption plan that will maximise their utility? Will
they ever spend less than their income? Will they ever consume only hotdogs?

ECON130

Tutorial 03

Consumer choice II
Multi Choice
MC1. Consider an individual who spends all their income on beer and food. Following
an increase in the price of beer (with income fixed), the individual consumes more
beer. From this, we can infer that
(a) Both beer and food are normal goods to the individual.
(b) Beer is normal and food is inferior to the individual.
(c) Beer is inferior and food is normal to the individual.
(d) Both beer and food are inferior goods to the individual.
MC2. The figure below shows an individuals two-period budget constraint before and
after a change in the interest rate. If the individual chose E on the original budget
constraint and E0 on the new budget constraint, this indicates that the
(a) income effect is non-existent.
(b) change in the interest rate decreased savings.
(c) substitution effect dominates the income effect.
(d) substitution effect exactly offsets the income effect.
Spending in period 2
(future consumption)
B
B

E0
E1
E
BC 1
BC 0

Spending in period 1
(current consumption)

MC3. Consider an individual whose only endowment is time and who derives utility
from leisure and consumption. For the individual, consumption and leisure are
both normal goods. If the income effect dominates the substitution effect, then an
increase in the wage rate will cause the individuals supply of labour to
(a) increase.
(b) decrease.
(c) remain unchanged.
(d) None of the above (as it will depend on the circumstances).
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Q1

Discussion

An increase in the price of a good will cause an individual to consume less of it. Discuss.
Q2

Leisure

Tommy works for an income which he then spends on consumption. His original choice
is 8 hours of leisure a day and $40 worth of consumption, which is shown in the figure
below. A second budget line is also illustrated, corresponding to a wage increase. It turns
out that Tommy does not want to alter his hours worked as a result of this change.
a) Draw in an indifference curve consistent with Tommy not changing his desired number of hours to work.
b) Now draw in a third budget line that represents an inheritance that results in the
same income as the wage increase (referred to in the preamble above).
c) Which of these two changes would lead to more time being taken for leisure?

$100

$80

BL2

$60
BL1
$40

$20

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leisure

16

20

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Q3

Borrowing

Sophie consumes today (i.e. the present) and tomorrow (i.e. the future), and earns $100
today and $100 tomorrow. The money prices of goods both today and tomorrow are
fixed. Consumption today and consumption tomorrow are both normal goods.
a) If Sophie is currently a borrower, what does an increase in the interest rate do to
her consumption (today and tomorrow)?
b) If Sophie is currently a lender (i.e. saver), what does an increase in the interest rate
do to her consumption (today and tomorrow)?
c) If Sophie currently chooses to spend $100 today, what does an increase in her income
tomorrow (to $120) do to her saving behaviour (with the interest rate unchanged)?

ECON130

Tutorial 04

Producer choice
Multi Choice
MC1. With only one input, the slope of the production function is the
(a) total product
(b) average product
(c) marginal cost
(d) marginal product
MC1. Consider a price-taking firm with one variable input and (positive) fixed costs. If
the marginal cost is a constant function of output, then the average cost curve will
be
(a) an increasing function of output.
(b) a decreasing function of output.
(c) a constant function of output.
(d) None of the above.
MC1. Consider a firm with a positive fixed cost and a constant marginal cost. As a
consequence, we know that:
(a) average cost is falling (as output increases).
(b) average cost is rising.
(c) average cost is constant.
(d) None of the above, as it depends on the circumstances.

Q1

Costs

Imagine that
labour is the only input of production for a firm, and the production function
is q = 3 L (plotted in the left pane below). Costs are w L, where w = 1 and L is
whatever is required for the desired level of output. Plot the cost function in the righthand pane. If you are confident with maths, you might try to identify the cost function
mathematically. Otherwise just look at q = 0, q = 3, q = 6 and q = 9. Look at the
production function to find out how much labour is needed, multiply by the wage rate
and then plot in the right-hand pane.
10
9
8
7
q 6
5
4
3
2
1

q=3 L

10
9
8
7
6
c(q)
5
4
3
2
1

1 2 3 4 5 6 7 8 9 10
L

1 2 3 4 5 6 7 8 9 10
q

What can you conclude about the cost function?

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Q2

TC and AC

For each of the following four total cost functions, identify the shape of the marginal cost
function and the average cost function.
10
9
8
7
6
5
4
3
2
1

10
9
8
7
6
5
4
3
2
1

c(q)

1 2 3 4 5 6 7 8 9 10

10
9
8
7
6
5
4
3
2
1

1 2 3 4 5 6 7 8 9 10

c(q)

10
9
8
7
6
5
4
3
2
1

1 2 3 4 5 6 7 8 9 10
Q3

c(q)

c(q)

1 2 3 4 5 6 7 8 9 10
Price

Under what conditions will a firms output price equal its marginal revenue? What is the
difference between the concepts of marginal and average revenue, and when will they be
the same?
Q4

One unit

Consider a price-taking firm with a production function that yields output as a function
of labour (as the only input). If the firm makes a positive profit producing one unit of
output, then it will wish to produce more (than one unit of output). Discuss.
Q5

Short run profits

If a firm makes a positive profit in the short run (with capital fixed), then it will desire
to increase its capital stock in the long run. Discuss.

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ECON130

Tutorial 05

Equilibrium
Multi Choice
The following information will be used for questions MC1-MC2.
Consider the market for a particular good in which all buyers and sellers are price takers.
Further, the supply curve slopes up while the demand curve slopes down (with quantity
on the horizontal axis and price on the vertical).
MC1. A shift to the right in the demand curve and a shift to the right in the supply curve
will cause
in the equilibrium price and
in the equilibrium quantity.
(a) An ambiguous change; an ambiguous change.
(b) An ambiguous change; an increase.
(c) An increase; an ambiguous change.
(d) An increase; an increase.
MC2. Which of the following would result in an increase in equilibrium price and an
ambiguous change in equilibrium quantity?
(a) A shift to the right in the supply and demand curves.
(b) A shift to the right in the supply curve and a shift to the left in the demand
curve.
(c) A shift to the left in the supply and demand curves.
(d) A shift to the left in the supply curve and a shift to the right in the demand
curve.
MC3. If the quantity of a product demanded increases at every price (shifting the demand curve rightward) and the supply of the product is perfectly price elastic (i.e.
horizontal), equilibrium quantity will
and equilibrium price will
.
(a) increase; remain constant
(b) increase; increase
(c) decrease; remain constant
(d) remain constant; increase
MC4. Which of the following would result in an increase in equilibrium price and an
ambiguous change in equilibrium quantity?
(a) An increase in supply and demand.
(b) An increase in supply and a decrease in demand.
(c) A decrease in supply and demand.
(d) A decrease in supply and an increase in demand.
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Q1

Changes to demand

Use the following information to answer this question.

Consider the following demand schedule:
Price ($)

10

11

Quantity

450

400

350

300

250

200

150

Also, consider the following supply schedule:

Price ($)

10

11

12

Quantity

100

150

200

250

300

350

400

1. Draw a demand and supply diagram illustrating the information in the tables above.
Clearly label your diagram. What is the equilibrium price and quantity?
2. Suppose that consumer incomes rise and demand increases by 100 units for every
price. Illustrate this change in your diagram from part (1). Clearly label the changes.
What is the new equilibrium price and quantity?
3. Discuss how the market adjusts from one equilibrium to another.
Q2

Supply shocks

Suppose that demand is given by the equation P = 14.5 2Qd , where P is price and
Qd is quantity demanded. Further, let supply be given by P = 0.5 + 1.5Qs , where Qs
represents quantity supplied.
1. Draw a demand and supply diagram based on the equations for demand and supply
above. Clearly label your diagram. What is the equilibrium price and quantity?
2. Suppose that a supply-side shock causes the supply equation to become P = 0.25 +
1Qs . What happens to the quantity supplied, for any price? Illustrate this change in
your diagram from part (1). Clearly label the changes. What is the new equilibrium
price and quantity?
3. Discuss the sorts of change to a factor of supply that would be consistent with the
shock given above.

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ECON130

Tutorial 06

International Trade; the Government

Multi Choice
MC1. A country has a comparative advantage in the production of milk if:
(a) It can produce more milk than another country using the same amount of
resources.
(b) It also has an absolute advantage in the production of milk.
(c) It is relatively more efficient at producing milk than another country.
(d) It is richer and has more resources than another country.
MC2. Suppose New Zealand can produce either one tonne of wheat or 2,000 litres of milk,
while Australia can produce either eight tonnes of wheat or X litres of milk. New
Zealand will have a comparative advantage in the production of milk if, and only if,
X is:
(a) Less than 4,000.
(b) More than 4,000.
(c) Less than 16,000.
(d) More than 16,000.

The information below will be used for the following two questions.
The governments (marginal) income tax rates are:
20% for income up to $50,000.
40% for income above $50,000.

Further, individuals with one or more children receive a payment from the government of $10,000 upon the birth of their first child. This payment is clawed back by
a surcharge of 20% (or 20 cents in the dollar) on income above $40,000, until the
transfer payment is recovered by the government. The tax bill of an individual will
be defined to be their income tax paid less the transfer payment they receive.
MC3. Consider an individual with one child. Their tax bill will be zero when their income
is:
(a) $40,000.
(b) $45,000.
(c) $50,000.
(d) $55,000.

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MC4. Consider an individual with one child. Their maximum marginal tax rate (including
the claw-back of the transfer payment) is 60%. This tax rate is reached for income
greater than
but less than
:
(a) $40,000; $90,000.
(b) $40,000; $100,000.
(c) $50,000; $90,000.
(d) $50,000; $100,000.
Q1

Free trade deal

Suppose New Zealand and Australia consider a free trade deal, and that presently there is
no trade between the two countries (and there are no other countries to trade with). Both
countries currently produce and consume only two goods: wine and wool. The maximum
amount of wine New Zealand can produce is 200, and the maximum amount of wool is
400. The maximum amount of wine Australia can produce is 800, and the maximum
amount of wool is 800. Both countries have linear production possibility curves, i.e. for
each country, the amount of wool that must be sacrificed to produce one extra unit of
wine is constant. The preferences of households in both countries are such that they
spend 50% of their income on wine and 50% on wool.
(a) What is the pre-free-trade equilibrium (the relative price of wine, production and
consumption) in New Zealand? In Australia?
(b) Suppose that the relative price of wine is 1 (i.e. 1 unit of wool trades for 1 unit of
wine). How much wine and wool will New Zealand produce? How much will New
Zealand consume? How much wine and wool will Australia produce? How much
will Australia consume?
(c) Will Australia be better off as a result of the free trade deal?
Q2

Laffer curve

On p.686 of the textbook, a Laffer curve is drawn, which shows the (income) tax revenue
collected by the government falling as the (income) tax rate rises (for high enough tax
rates). Two reasons could explain this shape. First, people could work less as their posttax wage rate falls. Second, people could evade tax more as the tax rate rises. Which
effect do you think will be the largest?
Q3

Taxes and efficiency

If the government taxes households, the resulting equilibrium will not be Pareto efficient.
Discuss.

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ECON130

Tutorial 07

Growth
Multi Choice
MC1. Consider two countries (call them A and B). Country A doubles its real GDP per
capita every ten years. Country B doubles its real GDP per capita every 20 years.
To begin with, assume Country B has four times the real GDP per capita as A.
After 20 years, Country As real GDP per capita will be
of Country Bs.
(a) 25%.
(b) 50%.
(c) 100%.
(d) 150%
MC2. Suppose Countries A and B both have the same real GDP at date 1. Consider
two different scenarios. In Scenario 1, Country As real GDP has a constant annual
growth rate of 0%, while Bs has a constant annual growth rate of 2%. In Scenario
2, Country As real GDP has a constant annual growth rate of 2%, while Bs has
a constant annual growth rate of 4%. At date 10, the ratio of As real GDP to Bs
real GDP is calculated. This ratio will be:
(a) Larger in Scenario 1 than Scenario 2.
(b) Larger in Scenario 2 than Scenario 1.
(c) The same in both Scenarios.
(d) None of the above (as it depends on the circumstances).
MC3. Suppose that in the year 2003, the average worker worked for 50 hours per week
and produced 1,000 units of output. By 2013, the average worker worked 40 hours
per week and produced 900 units of output. From 2003 till 2013, the average output
per worker
, while the average output per hour worked
:
(a) Fell; fell.
(b) Fell; rose.
(c) Rose; fell.
(d) Rose; rose.
MC4. The costs of economic growth include all of the following except the
(a) Loss of existing jobs.
(b) Increased demand for newly skilled workers.
(c) Need to relocate workers.
(d) Damage to the environment.

16

Q1

Productivity

(a) What does productivity mean? How does productivity affect economic growth?
Explain.
(b) If technological change affects productivity, what type of economic policies could
be used?
Q2

Growth

As a country becomes richer, workers will supply more labour. Discuss.

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ECON130

Tutorial 08

Exchange rates
Multi Choice
MC1. Suppose the NZ dollar appreciates against the US dollar. Therefore, the number
of NZ dollars that can be purchased with one US dollar will:
(a) Fall.
(b) Rise.
(c) Remain unchanged.
(d) None of the above.
MC2. Suppose the New Zealand dollar depreciates against the US dollar. As a consequence, we would expect the prices of imports expressed in NZ dollars to:
(a) Fall.
(b) Rise.
(c) Remain unchanged.
(d) None of the above.
MC3. In the foreign exchange market, suppose there is an increase in demand for New
Zealand dollars. As a consequence, we would expect the New Zealand exchange rate
to:
(a) Decrease.
(b) Remain unchanged.
(c) Increase.
(d) None of the above.
MC4. One reason that the demand curve for NZ$ in the forex market slopes downwards
is because when the price of the NZ$ (the exchange rate) falls:
(a) New Zealanders demand more foreign goods because these goods have become
less expensive.
(b) foreigners demand fewer New Zealand goods because these goods have become
more expensive.
(c) foreigners demand more New Zealander goods because these goods have become less expensive.
(d) New Zealanders demand fewer foreign goods because these goods have become
more expensive.

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Q1

PPP

Purchasing power parity implies that if inflation in China increases, then the nominal
exchange rate between Chinese and New Zealand ( /NZ$) will appreciate.

Q2

Arbitrage

With international trade, prices and exchange rates will adjust till all retail firms earn
the same rate of return on assets, no matter where they are located.
Revision
Past tests and exams, especially multi-choice questions done poorly. Refer to the Test
Analysis and Exam Analysis files on Blackboard. These give the correct answer and the
distribution of options chosen for each question.

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