Gianmarco Ottaviano

London School of Economics

EC102 - Economics B MT
Microeconomics

Moodle Test 1 (Lectures 1 & 2)

Question 1:
Saudi Arabia can pump all the oil it needs. Therefore, consumption of oil
is free in Saudi Arabia. This statement is:
a) True
b) False
Explanation:
Oil consumption has an opportunity cost for Saudi Arabia. It is the goods and
services Saudi Arabia could have received by selling, rather than consuming,
the oil.
Question 2:
Suppose the crisis has reduced the extra money high-skill jobs pay
relative to low-skill ones. Accordingly:
a) More people attend school
b) People quit education earlier
c) People quit education later
Explanation:
The reduction of the skill premium reduces the marginal benefit of education
(MB) leaving its marginal cost (MC) unaffected. Graphically, that implies a
downward shift of the marginal benefit curve MB to MB as shown in the
following figure.

Question 3:
1

 If bread and butter must be consumed together, an increase in the price

of butter:
a) Increases the price of bread
b) Increases the number of loaves consumed
c) Has no impact on the price of bread and the number of loaves
consumed
d) Decreases the price of bread and the number of loaves consumed
Explanation:
As shown in the following figure, the increase in the price of butter (a
complement) induces a downward shift in the demand for bread. The price and
quantity both fall, as determined by the intersection of D and S.

Question 4:
Sue can choose between 10 memory sticks and 5 software manuals, or 9
memory sticks and 20 software manuals. If her tastes are complete,
transitive and non-satiated:
a) We can predict she will choose the first option
b) We can predict she will choose the second option
c) We can predict she will be indifferent between the two options
d) We cannot predict her choice
Explanation:
We cannot predict which bundle Sue will choose for the following reasons. The
assumption of completeness requires only that she has a preference (or
expresses indifference). Non-satiation is not violated by the selection of either
bundle in this example.
Question 5:

 Louise is purchasing 150 Russian novels and 30 comic books. She would
be willing to give up 3 Russian novels for 2 more comic books. Her
marginal rate of substitution of Russian novels for comic books is:
a) 1
b) 0.5
c) 1.5
d) 5
Explanation:
Louises marginal rate of substitution of Russian novels for comic books is 3
Russian novels to 2 comic books, so it equals 1.5. The initial levels of
consumption of the two types of book does not matter in this example.
Question 6:
The marginal rate of substitution of 20-cent coins for 50-cent coins is:
a) 1
b) 0.4
c) 2.5
d) 5
Explanation:
The consumer is indifferent between holding (a multiple of) two 50p coins or
(the same multiple of) five 20p coins or any possible combination between.
This fungible property is a key feature of a currency and applies also to
different currencies if they are convertible. For example, if the consumer were
indifferent between holding two 1 bills and five 1$ bills, 2.5 would be the
exchange rate of pounds for dollars.
Question 7:
A university had initially allocated 500k to lectureships and
scholarships, each of which costs 50k and 10k respectively. Its trustees
have later reduced the overall budget to 300k. Hence, the opportunity
cost of a scholarship has:
a) Fallen
b) Increased
c) Remained unchanged
Explanation:
The opportunity cost of a scholarship is 0.2 lectureships (10k/50k) no matter
how large the overall budget is.
To consolidate this point, it is useful to discuss the budget constraint of the
university in detail.
3

The universitys budget constraint is 500,000 = 50,000 f + 10,000 s,

where f is the number of lecturing positions and s is the number of scholarships
offered. As reported above, the opportunity cost of a scholarship is 0.2
lectureships. Graphically, the budget constraint is represented by line B 0 in the
following figure where the slope captures the opportunity cost of a scholarship.

When the budget is reduced to 300k, the universitys budget constraint shifts
in from B0 to B1 maintaining the same slope:

The slope of the budget constraint is only affected by changes in the relative
costs of scholarships to lectureships. For example, with a constant budget of
500k, if the cost of lectureships drops to 25k, the opportunity cost of a
scholarship rises to 0.4 lectureships. The universitys budget constraint pivots
to B2, which marks off a larger feasible set than B0.