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Department of Economics University of Toronto

Department of Economics University of Toronto ECO 100Y INTRODUCTION TO ECONOMICS Midterm Test # 2 Prof.

ECO 100Y INTRODUCTION TO ECONOMICS

Midterm Test # 2

Prof. Gustavo Indart July 26, 2013

LAST NAME

FIRST NAME

STUDENT NUMBER

Check your section of the course:

INSTRUCTIONS:

L0101 (M/W from 2:00 to 4:00 PM)

L0201 (T/R from 2:00 to 4:00 PM)

1. The total time for this test is 1 hour and 50 minutes.

2. Aids allowed: a simple calculator.

3. Write with pen instead of pencil.

DO NOT WRITE IN THIS SPACE

Part I

/25

3. /10

Part II

1.

/10

4. /10

2.

/10

5. /10

TOTAL

/75

PART I

(25 marks)

Instructions: Write your answers to the multiple choice questions on the table below. Each question is worth 2.5 marks. No deductions will be made for incorrect answers.

1

2

3

4

5

6

7

8

9

10

1. The average product for five workers is 20. If the marginal product for the seventh worker is 18, which one of the following statements is correct?

A) Both marginal product and average product are rising.

B) Marginal product is falling and average product is rising.

C) Marginal product is rising and average product is falling.

D) Both marginal product and average product are falling.

E) Not enough information to determine how marginal product and average product might be changing.

2. Suppose that in a perfectly competitive industry, the market price of the product is $10. Firm A is producing the output level at which average variable cost equals marginal cost, both of which are $12. To maximize its profits in the short run, Firm A should

A) reduce output.

B) expand output.

C) leave output unchanged.

D) shut down.

E) increase the price of its product.

3. Suppose fixed costs are $1000 and average variable costs are constant regardless of output. Which one of the following statements is then true?

A) Marginal cost will equal average variable cost.

B) Average total cost will be constant.

C) Average total cost will decrease when output is increased.

D) Marginal cost will be less than average variable cost.

E) Both A) and C) are true.

Use this space for rough work.

4.

Comparing the short run and long run profit-maximizing positions of a perfectly competitive firm, which one of the following statements is true?

A) Price will equal marginal cost in the short run, but not necessarily in the long run.

B) Economic profits may exist in the short run and in the long run.

C) In order to maximize profits, the firm must always produce at the minimum of average total cost in both the short run and the long run.

D) The price must equal average total cost in the long run, but not necessarily in the short run.

E) None of the above is true.

5. A perfectly competitive industry is in short run equilibrium with ‘n’ identical firms and each firm is earning zero economic profits. The firms’ ATC, AVC, and MC curves have the usual U-shape. Under these circumstances, which one of the following statements is correct in the short run?

A) With a decrease in fixed costs, each firm would suffer losses and firms would exit the industry.

B) With an increase in variable costs, each firm would make economic losses and would produce a lower output.

C) With a decrease in industry demand, each firm would make economic losses and would produce a higher output.

D) With a decrease in variable costs, each firm would make economic profits and would produce a lower output.

E) With an increase in industry demand, each firm would make economic profits and would produce a smaller output.

6. Consider an increasing cost, competitive industry. A typical firm in this industry has the following data in the short run equilibrium: price = $10; output = 100 units; ATC = $12; AVC = $7. Which of the following statements would be correct?

A) In the long run the industry will expand because of economic profits.

B) In the long run the industry will contract because firms are suffering economic losses.

C) The size of the industry will remain the same in the long run.

D) Price will decrease in the long run.

E) Both B) and D) are correct.

7. A firm has fixed costs of $500, and it finds that the total costs for 10 units of production are $3,500 and that total costs for 11 units of production are $3,800. As a result,

A) the average variable cost at 10 units of production is $350.

B) the marginal cost of the 11 th unit is $500.

C) the average total cost at 10 units of production is $300.

D) the marginal cost of the 10 th unit is $300.

E) none of the above is correct.

Use this space for rough work.

8.

Under the expenditure approach, Gross Domestic Product does not include

A) paving of roads.

B) sale of new cars.

C) sale of bonds.

D) imports of motorcycles.

E) renovations of old houses.

9. A car dealer imported of 10 cars at a cost of $20,000 each in March of 2012 and sold seven of these cars by the end of the year at $30,000 each. The remaining three cars were left in inventory at their imported price at the end of the year but were then sold in February 2013 also at $30,000 each. As a result of these transactions, the country’s GDP would increase in 2012 by

A) $210,000.

B) $100,000.

C) $300,000.

D) $70,000.

E) none of the above.

10. In Shoetown, a rancher produces animal skins with $0 worth of inputs, which she sells to the tanner for $400. The tanner then makes leather with these skins, which he sells to the shoemaker for $700. The shoemaker makes $1200 worth of shoes with this leather, which he sells to consumers. The value added from all these transactions is

A) $2500.

B) $1000.

C) $800.

D) $2300.

E) $1200.

Use this space for rough work.

PART II (50 marks)

Instructions: Answer all questions in the space provided.

Question 1

A perfectly competitive, increasing-cost industry is initially in long run equilibrium. There are ‘n’ identical firms in this industry. As the industry expands or contracts, the firms’ minimum efficient scale of production does not change.

Shock: The industry demand decreases.

Statement: Nadine analyzes this situation and concludes that price will fall, industry output will decrease, the number of firms will decrease, and each firm will produce an unchanged output in the new long-run equilibrium.

Position: Do you agree with Nadine’s conclusion? Explain your position with the help of proper diagrams. Clearly explain the short-run and long-run adjustment processes.

(10 marks)

Question 2

(10 marks)

A monopolist is currently producing 3,000 units of output and earning $24,000 in total revenue.

Its marginal revenue at the current level of output is $3. Its total cost is presently $30,000, its fixed cost is $9,000, and its marginal cost is $3.

Statement: Madison argues that the monopolist should reduce its output and increase the price

of its good in order to eliminate the economic losses in the short run.

Position: Do you agree with Madison’s argument? Explain your position with the help of a proper diagram. Your well-labelled diagram must clearly show the initial situation described above.

Question 3

(10 marks)

Megan offers her mowing services in the perfect competitive lawn mowing industry. Megan’s Total Fixed Cost is $7 per day (the cost of renting the mower) and her Total Variable Cost (TVC) schedule and Average Variable Cost (AVC) schedule are provided in the table below.

a) In the table below, fill in the values for Total Cost (TC), Average Total Cost (ATC) and Marginal Cost (MC). (2 marks)

Quantity

TVC ($)

TC ($)

AVC ($)

ATC ($)

MC ($)

0

0

7.00

---

---

---

1

2.00

9.00

2.00

9.00

2.00

2

3.50

10.50

1.75

5.25

1.50

3

5.50

12.50

1.83

4.17

2.00

4

8.00

15.00

2.00

3.75

2.50

5

11.00

18.00

2.20

3.60

3.00

6

15.00

22.00

2.50

3.67

4.00

7

21.00

28.00

3.00

4.00

6.00

8

28.00

35.00

3.50

4.37

7.00

b) If the market price of mowing the lawns is $6 per lawn, how many lawns will Megan mow in order to maximize profits? What economic profits will Megan earn? Show how you obtained these numbers. (2 marks)

c)

If the market price of mowing the lawns is $3 per lawn, how many lawns will Megan mow in order to maximize profits? What economic profits will Megan earn? Show how you obtained these numbers. (2 marks)

d) If the market price of mowing the lawns is $1.50 per lawn, how many lawns will Megan mow in order to maximize profits? What economic profits will Megan earn? Show how you obtained these numbers. (2 marks)

earn? Show how you obtained these numbers. (2 marks) e) Go back to the equilibrium of

e) Go back to the equilibrium of part b) above and suppose that the rental cost of mowers increases to $10 per day. How many lawns will Megan mow in order to maximize profits? What economic profits will Megan earn? Show how you obtained these numbers. (2 marks)

Question 4

(10 marks)

Consider the perfectly competitive market for trucks. Suppose that the pollution created by the manufacture and use of trucks imposes a cost to society of $3,000 per truck. The market supply and demand for trucks are as follows:

Price (thousand $) 19 20 21 22 23 24 25 Quantity supplied 480 540 600
Price (thousand $)
19
20
21
22
23
24
25
Quantity supplied
480
540
600
660
720
780
840
Quantity demanded
660
630
600
570
540
510
480

a) What are the equilibrium price and output? Briefly explain your answer. In the diagram below, graph the demand curve and the supply curve for the industry. (2 marks)

P

24

23

21

S’ = MCS S = MCP Deadweight Loss // //
S’ = MCS
S = MCP
Deadweight
Loss
//
//

D = MBS = MBP

540

600

Q

b) In the table below, fill in the values for the social marginal cost (MC S ) curve. (2 marks)

MCS (thousand $)

19

20

21

22

23

24

25

Quantity supplied

             

c)

Graph the social marginal cost (MC S ) curve. Will the private market outcome be allocatively efficient? Explain. Show the degree of allocative inefficiency (deadweight loss) the private market outcome in your diagram. (2 marks)

d) What can the government do to have firms “internalize” the cost of pollution (i.e., for firms to take the external cost of pollution into production decisions)? What would be the new price and output as a result of this government action? (2 marks)

P (thousand $) 19 20 21 22 23 24 25 Quantity supplied Quantity demanded 660
P (thousand $)
19
20
21
22
23
24
25
Quantity supplied
Quantity demanded
660
630
600
570
540
510
480

e) Who would bear the cost of the government action of part c) above, buyers or manufacturers of trucks? Would this new level of output be allocatively efficient? (2 marks)

Question 5

(10 marks)

Below are data from the national accounts for the country of Utopia, measured in dollars. Assume that all relevant items you need to answer the questions have been provided.

Transfer Payments to Households

75

Wages and Salaries

500

Personal Income Taxes

225

Undistributed Corporate Profits

200

Gross Investment

200

Interest

50

Imports

??

Indirect Taxes minus Subsidies

50

Rent

150

Dividends

100

Corporate Income Taxes

100

Net Investment

100

Net Income of Unincorp’d Businesses

100

Consumption Expenditure

600

Exports

450

Government Spending on G&S

350

a) Calculate Gross Domestic Product (GDP). (4 marks)

b) Calculate Imports (IM). (3 marks)

c) Calculate Personal Income (PI). (3 marks)