DSME 1030 G&M

Midterm test
2015 Fall

NAME: SID: SECTION: G / M

Instructions -- Read carefully.

 Do not start this test until you have put your name and student number at the top of this page.
 This test consists of 2 parts. Check that you have 15 pages, including this page. Check to
ensure that your copy is complete.
 You have 2 hours to do this test.
 This is a "closed book and notes" test.
 After you are told that the test is over, you should stop writing unless you have permission
from the invigilator.
 Write your answers on MC bubble sheet (for Part I).
 Unless specified in the question, rounding to 3 significant figures.
 Answer ALL questions.
 Internet access and mobile phone are strictly prohibited.

Do NOT turn over this page untill you are told to do so.

1
Part I Multiple choice questions. Write your answers on MC bubble sheet provided. (40
marks)
1. A tax on gasoline encourages people to drive smaller, more fuel-efficient cars. Which principle of
economics does this illustrate?
A. People face tradeoffs.
B. The cost of something is what you give up to get it.
C. Rational people think at the margin.
D. People respond to incentives.

2. Economics deals primarily with the concept of

A. scarcity.
B. money.
C. poverty.
D. banking.

3. Hamid spends an hour studying instead of watching TV with his friends. The opportunity cost to him of
studying is
A. the improvement in his grades from studying for the hour.
B. the improvement in his grades from studying minus the enjoyment of watching TV.
C. the enjoyment he would have received if he had watched TV with his friends.
D. zero. Since Hamid chose to study rather than to watch TV, the value of studying must have been
greater to him than the value of watching TV.

4. Suppose after graduating from college you get a job working at a bank earning $30,000 per year. After
two years of working at the bank earning the same salary, you have an opportunity to enroll in a one-
year graduate program that would require you to quit your job at the bank. Which of the following
should not be included in a calculation of your opportunity cost?
A. the cost of tuition and books to attend the graduate program
B. the $30,000 salary that you could have earned if you retained your job at the bank
C. the $45,000 salary that you will be able to earn after having completed your graduate program
D. the value of insurance coverage and other employee benefits you would have received if you
retained your job at the bank

5. Which of the following is an example of a positive, as opposed to normative, statement?

A. When the minimum wage is increased, unemployment is a predictable consequence.
B. The income tax rate should be increased to offset the budget deficit.
C. Pharmaceutical manufacturers should not be allowed to patent their products so prescription drugs
would be more affordable.
D. None of the above is positive statement.

2
6. A corporation has been steadily losing money on one of its product lines, plastic flamingo lawn
ornaments. The firm produces plastic flamingos in a factory that cost $20 million to build 10 years ago.
The firm is now considering an offer to buy that factory for $15 million. Which of the following
statements about the decision to sell or not to sell is correct?
A. The firm should turn down the purchase offer because the factory cost more than $15 million to
build.
B. The $20 million spent on the factory is a sunk cost; that cost should not affect the decision.
C. The $20 million spent on the factory is an implicit cost, which should be included in the decision.
D. The firm should sell the factory only if it can reduce its costs elsewhere by $5 million.

7. A rational decision maker

A. ignores marginal changes and focuses instead on “the big picture.”
B. ignores the likely effects of government policies when he or she makes choices.
C. takes an action only if the marginal benefit of that action exceeds the marginal cost of that action.
D. takes an action only if the combined benefits of that action and previous actions exceed the
combined costs of that action and previous actions.

Figure 1

8. Refer to Figure 1. It would be possible for the consumer to reach I2 if

A. the price of Y decreases.
B. the price of X decreases.
C. income increases.
D. All of the above would be correct.

3
Figure 2

9. Refer to Figure 2. Assume that the consumer depicted in the figure has an income of $20. The price
of Skittles is $2 and the price of M&M's is $4. The consumer’s optimal choice is at
A. Point A.
B. Point B.
C. Point C.
D. Point D.

10. Refer to Figure 2. Assume that the consumer depicted in the figure faces prices and income such
that she optimizes at point B. According to the graph, which of the following would cause the consumer
to move to point A?
A. a decrease in the price of Skittles
B. a decrease in the price of M&M's
C. an increase in the price of Skittles
D. an increase in the price of M&M's

11. Refer to Figure 2. Assume that the consumer depicted in the figure has an income of $20. The price
of Skittles is $2 and the price of M&M's is $4. The consumer will choose a consumption bundle where
the marginal rate of substitution is
A. 2.
B. 2/3.
C. 1/2.
D. 1/3.

4
12. Candice is planning her activities for a hot summer day. She would like to go to the local swimming
pool and see the latest blockbuster movie, but because she can only get tickets to the movie for the
same time that the pool is open she can only choose one activity. This illustrates the basic principle that
A. people respond to incentives.
B. rational people think at the margin.
C. people face tradeoffs.
D. improvements in efficiency sometimes come at the expense of equality.

13. If Chad’s labor-supply curve is upward-sloping, then, for Chad,

A. an increase in the wage creates an income effect that is greater than the substitution effect.
B. an increase in the wage creates a substitution effect that is greater than the income effect.
C. leisure and consumption are perfect substitutes.
D. leisure and consumption are perfect complements.

14. Suppose a consumer has preferences over two goods, X and Y, which are perfect substitutes. In
particular, two units of X is equivalent to one unit of Y. If the price of X is $1, the price of Y is $3, and
the consumer has $30 of income to allocate to these two goods, how much of each good should the
consumer purchase to maximize satisfaction?
A. 30 units of X and 0 units of Y
B. 0 units of X and 10 units of Y
C. 15 units of X and 5 units of Y
D. 15 units of X and 0 units of Y

15. When Stanley has an income of $1,000, he consumes 30 units of good A and 50 units of good B. After
Stanley’s income increases to $1,500, he consumes 60 units of good A and 45 units of good B. Which
of the following statements is correct?
A. Both goods A and B are normal goods.
B. Both goods A and B are inferior goods.
C. Good A is a normal good, and good B is an inferior good.
D. Good A is an inferior good, and good B is a normal good.

16. A Giffen good is a good for which

A. an increase in the price raises the quantity demanded.
B. the income effect outweighs the substitution effect.
C. an increase in the price decreases the quantity demanded.
D. Both a) and b) are correct.

5
17. Demand is said to be inelastic if
A. buyers respond substantially to changes in the price of the good.
B. demand shifts only slightly when the price of the good changes.
C. the quantity demanded changes only slightly when the price of the good changes.
D. the price of the good responds only slightly to changes in demand.

18. Which of the following is not a determinant of the price elasticity of demand for a good?
A. the time horizon
B. the steepness or flatness of the supply curve for the good
C. the definition of the market for the good
D. the availability of substitutes for the good

19. Studies indicate that the price elasticity of demand for beer is about 0.9. A government policy aimed at
reducing beer consumption changed the price of a case of beer from $10 to $20. According to the
midpoint method, the government policy should have reduced beer consumption by
A. 30%.
B. 40%.
C. 60%.
D. 74%.

20. When small changes in price lead to infinite changes in quantity demanded, demand is perfectly
A. elastic, and the demand curve will be horizontal.
B. inelastic, and the demand curve will be horizontal.
C. elastic, and the demand curve will be vertical.
D. inelastic, and the demand curve will be vertical.

6
Figure 3. The point labeled B on Figure 3 is the “halfway point” on the demand.

21. Refer to Figure 3. The section of the demand curve from A to B represents the
A. elastic section of the demand curve.
B. inelastic section of the demand curve.
C. unit elastic section of the demand curve.
D. perfectly elastic section of the demand curve.

22. Refer to Figure 3. If the price decreases in the region of the demand curve between points A and B,
we can expect total revenue to
A. increase.
B. stay the same.
C. decrease.
D. first decrease, then increase until total revenue is maximized.

23. If the cross-price elasticity of demand for two goods is -4.5, then
A. the two goods are substitutes.
B. the two goods are complements.
C. one of the goods is normal while the other good is inferior.
D. one of the goods is a luxury while the other good is a necessity.

24. Suppose the income elasticity of demand is -0.5 for good X. This implies that a 5% decrease in income
will cause the quantity demanded of good X to
A. increase by 2.5%, and X is an inferior good.
B. decrease by 2.5% and X is a normal good.
C. increase by 10% and X is an inferior good.
D. decrease by 10% and X is a normal good.

7
25. A decrease in quantity demanded
A. results in a movement downward and to the right along a demand curve.
B. results in a movement upward and to the left along a demand curve.
C. shifts the demand curve to the left.
D. shifts the demand curve to the right.

26. Suppose chocolate-dipped strawberries are currently selling for $30 per dozen, but the equilibrium price
of chocolate-dipped strawberries is $20 per dozen. We would expect a
A. shortage to exist and the market price of chocolate-dipped strawberries to increase.
B. shortage to exist and the market price of chocolate-dipped strawberries to decrease.
C. surplus to exist and the market price of chocolate-dipped strawberries to increase.
D. surplus to exist and the market price of chocolate-dipped strawberries to decrease.

27. What would happen to the equilibrium price and quantity of coffee if the wages of coffee-bean pickers
fell and the price of tea fell?
A. Price would fall, and the effect on quantity would be ambiguous.
B. Price would rise, and the effect on quantity would be ambiguous.
C. Quantity would fall, and the effect on price would be ambiguous.
D. Quantity would rise, and the effect on price would be ambiguous.

28. Which of the following events would cause both the equilibrium price and equilibrium quantity of
number two grade potatoes to increase if number two grade potatoes are an inferior good?
A. an increase in consumer income
B. a decrease in consumer income
C. greater government restrictions on agricultural chemicals
D. fewer government restrictions on agricultural chemicals

8
Figure 4

The graph below pertains to the supply of paper to colleges and universities.

29. Refer to Figure 4. All else equal, an increase in the price of the pulp used in the paper production
process would cause a move from
A. x to y.
B. y to x.
C. SA to SB.
D. SB to SA.

30. Refer to Figure 4. All else equal, a major paper manufacturer filing for bankruptcy and shutting
down as a result of an IRS tax evasion investigation would cause a move from
A. x to y.
B. y to x.
C. SA to SB.
D. SB to SA.

31. A nonbinding price floor

(i) causes a surplus.
(ii) causes a shortage.
(iii) is set at a price above the equilibrium price.
(iv) is set at a price below the equilibrium price.
A. (iii) only
B. (iv) only
C. (i) and (iii) only
D. (ii) and (iv) only

9
32. Rent control
A. is an example of a price ceiling.
B. leads to a larger shortage of apartments in the long run than in the short run.
C. leads to lower rents and, in the long run, to lower-quality housing.
D. All of the above are correct.

33. Celine buys a new MP3 player for $90. She receives consumer surplus of $15 on her purchase if her
willingness to pay is
A. $15.
B. $90
C. $105.
D. $75.

Figure 5

34. Refer to Figure 5. At the equilibrium price, consumer surplus is

A. $100.
B. $200.
C. $50.
D. $450.

35. Refer to Figure 5. At the equilibrium price, producer surplus is

A. $300.
B. $150.
C. $450.
D. $125.

10
36. Refer to Figure 5. If the government imposes a price ceiling of $55 in this market, then total surplus
will be
A. $187.50.
B. $125.00.
C. $250.00.
D. $266.67.

37. Refer to Figure 5. If the government imposes a price floor of $55 in this market, then total surplus
will be
A. $100.00 higher than it would be without the price floor.
B. $50.00 lower than it would be without the price floor.
C. $125.00 lower than it would be without the price floor.
D. $62.50 lower than it would be without the price floor.

38. When a tax is levied on a good,

A. neither buyers nor sellers are made worse off.
B. only sellers are made worse off.
C. only buyers are made worse off.
D. both buyers and sellers are made worse off.

39. Suppose the government places a per-unit tax on a good. The smaller the price elasticities of demand
and supply for the good, the
A. smaller the deadweight loss from the tax.
B. greater the deadweight loss from the tax.
C. less efficient is the tax.
D. more equitable is the distribution of the tax burden between buyers and sellers.

40. When a country is on the downward-sloping side of the Laffer curves, a cut in the tax rate will
A. decrease tax revenue and decrease the deadweight loss.
B. decrease tax revenue and increase the deadweight loss.
C. increase tax revenue and decrease the deadweight loss.
D. increase tax revenue and increase the deadweight loss.

11
Part II Short answered questions. (60 marks)
1. Assume that a person consumes two goods, Coke and Snickers.
a. Use a graph to demonstrate how the consumer adjusts his/her optimal consumption bundle when
the price of Coke decreases. Carefully label all curves and axes. (5 marks)
b. What will happen to consumption if Coke is a normal good? Explain. (5 marks)
c. What will happen to consumption if Coke is an inferior good? Explain. (Remember to explain the
possible change when the income effect dominates and when the substitution effect dominates.) (10
marks)

ANSWER:

a.

b. If Coke is a normal good, the consumption of Coke will increase when the price decreases.
c. If Coke is an inferior good and the substitution effect dominates, the consumption of Coke will
increase when the price decreases.
If Coke is an inferior good and the income effect dominates, the consumption of Coke will
decrease when the price decreases. If consumption decreases, the demand curve is upward sloping,
and Coke would be a Giffen good.

2. You own a small town movie theatre. You currently charge $5 per ticket for everyone who comes
to your movies.
Your friend who took an economics course in college tells you that there may be a way to increase
your total revenue. Given the demand curves shown, answer the following questions.

12
 a. What is your current total revenue for both groups? (5 marks)
b. Use the mid-point method, what is the elasticity of demand between the prices of $5 and $2 in the
adult market? Is this elastic or inelastic? (5 marks)
c. Use the mid-point method, what is the elasticity of demand between $5 and $2 in the children's
market? Is this elastic or inelastic? (5 marks)
d. How would your friend recommend you to increase the total revenue? (5 marks)

ANSWER:
a. Total revenue from children's tickets is $100 and from adult tickets is $250. Total revenue from all
sales would be $350.
b. The elasticity of demand between $5 and $2 is 0.21, which is inelastic.
c. The elasticity of demand between $5 and $2 is 1.0, which is unit elastic.
d. Increase price for adult tickets as it is inelastic. Remain the price for child tickets as it is unit elastic.

13
3. The government may reduce the air pollution and congestion problem by limiting the number of car
permits it issues each year. Assume initially the car permit market is at equilibrium price of $40 and
quantity of 20. Now the government decide to set the quota (which is a numerical limit a government
imposes on the quantity of a good) of number of permits issuing each year to 10 only. The figure
below illustrates the situation.

80
S

60

40

20

D
Q
10 20 30
As shortage occurs, the government is considering two methods in allocating the car permits.
Method 1 is allocation by willingness to pay: here the buyers enter a bid on the right to purchase the
permit by submitting the maximum price they are willing to pay. Their bidding price will be allocated
from high to low, the top 10 buyers with the highest bidding price (i.e. 1st highest bidding price, 2nd
highest bidding price… to 10th highest bidding price) get the permit. The price they pay is the last of
the top 10 buyer’s bidding price (i.e. the 10th highest bidding price).

Method 2 is allocation by lottery: the price of permit is fixed at $20. Buyers submit applications to
government and 10 buyers are selected randomly to get the right to purchase the permit.

a. Determine the size of the consumer surplus and producer surplus under Method 1. (6 marks)
b. Determine the size of the consumer surplus and producer surplus under Method 2. ( (8 marks)
c. Compare the deadweight loss caused by the two methods. Which method is more efficient? (6
marks)

14
ANSWER:
CS=100
a. PS=500
CS=300
b. PS=100
DWL in Method 1=200
c. DWL in Method 2=400
Thus method 1 is more efficient.

Refer to http://econpage.com/301/handouts/priceceiling/ for details.

15