University of Toronto

Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
Term Test 2: Form Code: A: 20132014
Solutions: Full
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General Instructions
1. 110 minutes. 111 points. Allocate your time wisely!
2. Aids allowed: a simple (i.e., non-graphing, non-programmable) calculator.
3. Non-Multiple Choice questions: write answers in pen in this test booklet.
Scantron Instructions
Answer MULTIPLE CHOICE questions on supplied Scantron sheet (bubble form).
Fill in all information on both sides of the form.
Your Form Code is A.
Pencil recommended for Scantron. Black or blue ink can be used, but not erased!
Each Multiple Choice question is worth 3 marks. No deductions for incorrect answers.
Multiple choice marks are based entirely on the Scantron.
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20131213A 1 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
Part I / 61 Marks Page 12. / 10 Marks
Page 10. / 10 Marks Page 13. / 10 Marks
Page 11. / 10 Marks Page 14. / 10 Marks
Total /111 Marks
20131213A 2 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
FORM CODE A
I. [61 Marks] Multiple Choice Questions: Indicate answer on Scantron.
1. [1 Marks] What is your Form Code?
A. A
B. B
C. C
D. D
2. [3 Marks] Assume no externalities. Rahul is willing to pay $100 for a tuba. Bob values
his tuba at $70. What is the Total Surplus if Bob sells his tuba to Rahul?
A. $30.
B. $70.
C. $100.
D. $170.
E. Unable to determine without knowing the tuba price.
3. [3 Marks] If the price decreases from P
0
to P
1
, what area represents the change in
consumer surplus?
A. B.
B. B+C.
C. C+E.
D. B+C+E.
E. None of the above.
20131213A 3 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
4. [3 Marks] The table indicates a surplus-maximizing consumers marginal willingness
to pay for an item. The price is $75 for [each of] the rst two units, and $50 for each
additional unit. What is her consumer surplus if she maximizes surplus?
Quantity 1 2 3 4
MWTP $100 $70 $60 $40
A. $25.
B. $30.
C. $35.
D. $100.
E. $230.
5. [3 Marks] Assume a perfectly competitive market without interventions where all ben-
ets accrue to the buyer and all costs are borne to the seller. What is the additional
(total) surplus created by a shift in the supply curve from MC
0
to MC
1
?
A. D.
B. E+F.
C. C+D.
D. D+F.
E. C+D+E+F.
6. [3 Marks] What area represents the minimum reduction in total surplus as a result of
the implementing a binding price ceiling in an otherwise competitive market?
20131213A 4 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
A. A.
B. B.
C. C.
D. D.
E. D+E.
7. [3 Marks] A market is perfectly competitive with all rms having the same LRATC
curve and input prices do not depend on market quantity. Over all relevant prices, the
absolute value elasticity of demand is 0.75. What is the long-run change in the price
that buyers pay (P
b
) as a result of a $1 per-unit tax paid by the seller?
A. P
b
= 0.
B. $0 < P
b
$0.50.
C. $0.50 < P
b
< $1.00.
D. P
b
= 1.
E. Unable to determine with the information available.
8. [3 Marks] Which of the following is true after the introduction of a binding price oor
in an otherwise perfectly competitive market for a private good without externalities?
A. CS=; PS=; TS=.
B. CS=; PS= or ; TS=.
C. CS=; PS= or ; TS= or .
D. CS= or ; PS= or ; TS=.
20131213A 5 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
E. CS= or ; PS= or ; TS= or .
9. [3 Marks] A prot-maximizing monopolist constrained to charging the same price for
each unit produces at a constant marginal cost of $20 and faces demand MWTP(Q) =
100
Q
4
. How many units does the monopolist produce?
A. 400.
B. 320.
C. 200.
D. 160.
E. 60.
10. [3 Marks] Which of the following is an example of arbitrage?
A. A monopolist using student status as an indicator of willingness to pay.
B. Senior citizens taking a bus from Vermont to Montreal to take advantage of lower
prices for prescription drugs in Canada.
C. Requiring customers wait in line for hours in order to purchase at a lower price.
D. Requiring that a students parents provide proof of income in order to receive a lower
tuition.
11. [3 Marks] A monopolist constrained to charging the same price for all units faces demand
curve MWTP(Q) = 100Qand a constant marginal cost equal to $20. She is considering
a price equal to $55.
A. Because demand is inelastic at P = $55, she should increase price.
B. If she lowers price a little (i.e., increases quantity), the price eect will be larger in
magnitude than the quantity eect.
C. If she increases her price a little, the revenue she loses will be less than the costs
that she saves.
D. The marginal revenue from lowering price to $54 is $54.
E. None of the above.
12. [3 Marks] A monopolist textbook manufacturer produces at a constant marginal cost
equal to 5. At every price, demand is more elastic in China than in Europe. If the
monopolist can charge a dierent price in China than in Europe, what will be true at
the quantities in Europe and China that maximize prots?
20131213A 6 Term Test 2: Solutions: Full
E. A drug maker charging a lower price for veterinary use than for human use.
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
A. P
China
> P
Europe
. MR
China
> MR
Europe
B. P
China
> P
Europe
. MR
China
= MR
Europe
C. P
China
< P
Europe
. MR
China
< MR
Europe
.
D. P
China
< P
Europe
. MR
China
= MR
Europe
.
E. P
China
< P
Europe
. MR
China
> MR
Europe
.
13. [3 Marks] Consider the simultaneous move game depicted in the following payo matrix.
Player 2
L C R
Player 1
T 5,5 8,20 5,3
M 4,2 6,20 1,21
B 2,18 7,20 2,12
A. Neither player has a dominant strategy.
B. Player 1 has a dominant strategy.
C. Player 2 has a dominant strategy.
D. Both players have a dominant strategy.
E. We cannot determine whether any player has a dominant strategy.
14. [3 Marks] Consider the simultaneous move game depicted in the following payo matrix.
Which of the following is a Nash equilibrium?
Player 2
L C R
Player 1
T 20,20 1,25 10,5
M 15,1 3,2 9,2
B 10,10 2,9 9,9
A. Player 1 chooses T. Player 2 chooses L.
20131213A 7 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
B. Player 1 chooses T. Player 2 chooses C.
C. Player 1 chooses M. Player 2 chooses C.
D. Player 1 chooses B. Player 2 chooses L or R.
E. None of the above is a Nash equilibrium.
Player 2
L C R
Player 1
T 20,20 1,25 10,5
M 15,1 3,2 9,2
B 10,10 2,9 9,9
Graphically, in the payo matrix above, I have underlined each players best responses.
Both payos are underlined for the cell corresponding to player 1 choosing M and player
2 choosing C.
15. [3 Marks] Assume Samsung and Apple are duopolists in the tablet market. What would
be the result of successful collusion between Samsung and Apple?
A. CS=; PS=; TS=.
B. CS=; PS=; TS= or .
C. CS= or ; PS=; TS= or .
D. CS=; PS= or ; TS= or .
E. CS=; PS=; TS=.
16. [3 Marks] Consider market for an undierentiated good where rms choose output and
the price adjusts to sell all units. Currently, each of two duopolists is producing 50 units
in a market where a monopolist would produce 100 units. What would happen if 1 rm
increased production from 50 to 51 units? (Note: PS refers to the sum of the duopolists
producer surplus.)
A. CS=; PS=; TS=.
B. CS=; PS= or ; TS=.
C. CS=; PS=; TS=.
D. CS=; PS=; TS= or .
E. None of the above.
17. [3 Marks] There are 3 rms in the market: each period, A produces 10 units, while both
B and C each produce 5 units. With demand characterized by P(Q) = MWTP(Q) =
2005Q, what is rm Cs marginal revenue of increasing production by 1 unit (assuming
neither A or B changes production).
20131213A 8 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
A. 25.
B. 45.
C. 58
1
3
.
D. 70.
E. 95.
18. [3 Marks] Assume Oscar in no way cares about his neighbours and does not currently
own a piano. He is willing to pay $1200 for a piano, and he purchases one which cost $750
to produce. The production of the piano produced pollution whose harm is estimated at
$80, while the caf neighbouring Oscars apartment receive a benet equal to $100 from
Oscars practicing. How much surplus is created from this piano purchase?
A. $450.
B. $470.
C. $550.
D. $630.
E. Unable to determine without knowing the price Oscar paid for the piano.
19. [3 Marks] Neither supply nor demand is perfectly elastic or inelastic. To correct a
negative externality, the government implements the optimal Pigovian tax (or subsidy).
What is the result?
A. CS=; PS=; TS=.
B. CS=; PS=; TS=.
C. CS=; PS=; TS= or .
D. CS=; PS=; TS=.
E. CS= or ; PS= or ; TS= or .
20. [3 Marks] Assume production of a good generates a marginal external cost equal to
MEC =
1
10
Q, where Q is the amount produced. The government implements a per-unit
tax resulting in the ecient quantity of 100 units. What is true?
A. Government revenues will certainly be greater than the total external cost.
B. Government revenues will certainly be less than the total external cost.
C. Government revenues will be exactly equal to the total external cost.
D. Government revenues will be exactly equal to the total external cost only if sellers
pay the tax.
E. None of the above must be true.
20131213A 9 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
21. [3 Marks] Assume that quantities must be in whole tons. Each of two rms, A and B,
emits pollution into a lake. The following table gives the benet of each ton of pollution:
Ton 1 2 3 4 5
Marginal Benet A $20 $16 $12 $8 $4
Marginal Benet B $10 $8 $6 $4 $2
If the marginal external cost of pollution is $9 and the government implements a cap-
and-trade program, which initial allocation of pollution permits (one permit equals one
ton) maximizes total surplus?
A. Firm A gets 4 permits. Firm B gets 0 permits.
B. Firm A gets 4 permits. Firm B gets 1 permits.
C. Firm A gets 4 permits. Firm B gets 2 permits.
D. Firm A gets 4 permits. Firm B gets 3 permits.
E. Firm A gets 4 permits. Firm B gets 4 permits.
20131213A 10 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
USE A PEN FOR THE FOLLOWING SECTIONS
II. [20 Marks] For each of the following, indicate True, False or Uncertain and concisely
explain. All of the marks are earned for the explanation.
(1) [5 Marks] Consider a perfectly competitive market. A shift in one of the curves (either
a demand or supply) causes a decrease in consumer surplus in this market. TFU:
Consumers must be worse o overall.
Gee, this looks a lot like the iPad questions from tutorial.
(2) [5 Marks] A monopolist constrained to charging the same price is considering a price,

P, where own-price elasticity of demand equals 1. TFU:

(3) [5 Marks] TFU: If everyone, in equilibrium, stands at a concert, it must be that
everyone standing maximizes the sum of everyones payos.
Gee, this looks a lot like the the example from the textbook.
(4) [5 Marks] Neonicotinoids are a class of pesticides
1
with widespread agricultural use.
They are linked to honey-bee colony collapse disorder. Assume that in fact, farmers
use of neonicotinoids does in fact destroy valuable bee colonies owned by non-farmers.
Assume further that the Coase Theorem does not hold. TFU: A complete ban on
neonicotinoid use will maximize total surplus.
III. [10 Marks] Assume a perfectly competitive market characterized by MWTP(Q) = 100
Q
2
and MC(Q) = 10 +
Q
2
. There is a marginal external benet equal to
Q
4
.
(1) [6 Marks] What is the deadweight loss resulting from the perfectly competitive market
without government intervention?
1
Chemical designed to kill crop-destroying insects.
20131213A 11 Term Test 2: Solutions: Full
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
IV. [14 Marks] Tsegayes car holds $20 worth of gas and currently has $10 worth of gas. Buzunesh
benets by $20 if she borrows Tsegayes car, and uses $5 of gas she borrows the car.
(1) [6 Marks] Use a game tree to depict the strategic interaction where Tsegaye rst decides
whether or not to lend Buzunesh his car, and Buzunesh then decides whether or not to ll
the gas tank. (To make matter easy, we are restricting Buzunesh to either not purchasing
any gas or returning the car with a full tank of gas.)
20131213A 12 Term Test 2: Solutions: Full
(2) [4 Marks] What tax or subsidy will result in total surplus maximization? (For full
marks, you must specify not only the amount, but whether it is a tax or a subsidy!)
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
(2) [4 Marks] Identify a Nash equilibrium of the strategic interaction, briey explaining
why the strategy proles you specied constitute a Nash equilibrium.
V. [6 Marks] Short answer.
(1) [6 Marks] Give an example of second-degree price discrimination (what Frank & Bernanke
call the hurdle method), briey explaining the relationship between the price a particular
buyer pays and her elasticity of demand.
Solution: There are, of course, a near innite
2
2
Of course, near innite is a phrase that makes no sense.
20131213A 13 Term Test 2: Solutions: Full
(3) [4 Marks] Without changing the specied dollar values, give a realistic modication to
the above situation that makes Buzuneshs promise credible, and briey explain why this
may result in an equilibrium they both prefer to the equilibrium you identied above.
University of Toronto
Department of Economics
ECO100: Introductory Economics
Robert Gazzale, PhD
20131213A 14 Term Test 2: Solutions: Full