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Department of Economics Prof. Gustavo Indart

University of Toronto June 8, 2012



ECO 100Y
INTRODUCTION TO ECONOMICS
Midterm Test # 1



LAST NAME


FIRST NAME


STUDENT NUMBER



Check your section of the course: L0101 (M/W from 2:00 to 4:00 PM)
L0201 (T/R from 2:00 to 4:00 PM)


INSTRUCTIONS:
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 /40


TOTAL /75
Part II 1. /13
2. /13
3. /9
SOLUTIONS

Page 2 of 12
PART I (40 marks)
Instructions:
Multiple choice questions are to be answered using a black pencil or a black or blue ball-
point pen on the separate SCANTRON sheet being supplied.
Be sure to fill in your name and student number on the SCANTRON sheet!
Each question is worth 2 marks. No deductions will be made for incorrect answers.
Write your answers to the multiple choice questions ALSO on the table below, but the
answers to be marked are the ones entered on the SCANTRON sheet.

1 2 3 4 5 6 7 8 9 10
C A E A D D A C B D
11 12 13 14 15 16 17 18 19 20
B C D C D E B A B B

1. Rachel has $10,000 in her savings account, which is paying 4 percent interest annually.
She is now thinking of withdrawing this $10,000 and either investing it in her brothers new
sporting-goods store or lending it to Amy at an annual interest of 6 percent. What is, on an
annual basis, Rachels opportunity cost of investing this $10,000 in her brothers store?
A) Her share of the stores annual profits.
B) $400.
C) $600.
D) $10,400.
E) None of the above.

2. Consider an economy at full employment producing only two goods (cotton and wool) with
only one factor of production (labour). Suppose that the production of 1 unit of cotton
requires 0.5 units of labour while the production of 1 unit of wool requires 2 units of labour.
What is the opportunity cost of producing 1 additional unit of cotton?
A) 0.25 units of wool.
B) 4 units of wool.
C) 0.5 units of wool.
D) 2 units of wool.
E) None of the above.


Use this space for rough work.



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3. As a self-employed tax accountant, Joanna makes $100 an hour preparing tax returns at
home. She is very efficient and can prepare an average of 8 tax returns per hour. She is
considering hiring an assistant who can prepare an average of 2 tax returns per hour. Given
the above, which one of the following statements would be correct?
A) Joanna should only hire an assistant who can prepare more tax returns per hour
than she can.
B) Joanna should only hire an assistant who can prepare as many tax returns per hour
as she can.
C) Joanna should not hire this assistant because he is too slow preparing tax returns.
D) Joanna should hire this assistant as long as she pays him less than $100 per hour.
E) Joanna should hire this assistant as long as she pays him less than $25 per hour.

4. If the legal beer-drinking age is raised from 19 to 21, which one of the following statements
best describes the likely change in the equilibrium price and quantity of beer?
A) Both price and quantity will fall.
B) Price will rise and quantity will fall.
C) Price will fall and quantity will rise.
D) Both price and quantity will rise.
E) No change in price or quantity will occur.

5. If you always spend one-half of your income on food, then your income elasticity of food is
A) 0.5.
B) elastic.
C) inelastic.
D) equal to 1.
E) not determinable with the information provided.


Use this space for rough work.



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6. Although bad weather conditions caused a serious reduction in the production of Colombian
coffee, the total revenue of Colombian coffee growers increased. Which one of the following
statements is correct given these circumstances?
A) In this range, the supply curve for Colombian coffee is inelastic.
B) In this range, the supply curve for Colombian coffee is elastic.
C) In this range, the demand curve for Colombian coffee is elastic.
D) In this range, the demand curve for Colombian coffee is inelastic.
E) In this range, both the supply curve and the demand curve for Colombian coffee are
elastic.

7. A museum increases its admission price by 10 percent. As a result, total revenues increase
by 10 percent. This implies that, ignoring the sign, the price elasticity of demand for
admission is
A) 0.
B) less than 1 but greater than 0.
C) greater than 1.
D) 1.
E) none of the above.

8. Consider the market for widgets. The market demand curve for widgets is negatively sloped
and the supply curve is positively sloped. If the government introduces a $1 unit-tax to be
paid by the seller, which one of the following statements is true in the short run?
A) The price of widgets will increase by $1 and consumer surplus will fall.
B) The quantity of widgets bought and sold will decrease and producer surplus will rise.
C) The price of widgets will increase by less than $1 and producer surplus will fall.
D) Consumer surplus will increase while producer surplus will fall in this market.
E) Producer surplus will increase while consumer surplus will fall in this market.

9. All else equal, an effective price ceiling will cause a greater shortage when
A) both supply and demand are inelastic.
B) both supply and demand are elastic.
C) supply is elastic, but demand is inelastic.
D) supply is inelastic, but demand is elastic.
E) None of the above is correct since a price ceiling will not cause a shortage.


Use this space for rough work.



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10. At a garage sale, Sari purchased a backpack in very good condition for $30. She was
willing to pay $55 for it. The seller paid $200 for the backpack recently. On this transaction,
Saris consumer surplus was
A) $170.
B) $145.
C) $120.
D) $25.
E) none of the above.

11. Assume that apples and oranges are substitutes and that both have negatively-sloped
demand curves and a positively-sloped supply curves. Given the initial supply and demand
curves for apples, a reduction in the price of oranges will
A) decrease the demand for oranges.
B) decrease the price of apples.
C) increase the price of apples.
D) increase the demand for oranges.
E) both b) and d).

12. A good has a negatively-sloped demand curve and a positively-sloped supply curve.
Suppose the government decides to eliminate an effective price floor it had previously
established on this good. As a result, it can be expected that
A) the price will increase, the quantity demanded will decrease and the quantity
supplied will increase.
B) the price will increase, the quantity demanded will increase and the quantity supplied
will decrease.
C) the price will decrease, the quantity demanded will increase and the quantity
supplied will decrease.
D) the price will decrease, the quantity demanded will decrease and the quantity
supplied will increase.
E) no changes in price, quantity demanded or quantity supplied will occur.


Use this space for rough work.



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13. Suppose an effective price ceiling for a particular good is in place. Further suppose that the
demand for this good now increases. Which one of the following statements best describes
a likely consequence of this change in demand?
A) The quantity exchanged in the marketplace will increase.
B) The amount of excess demand will decrease.
C) The amount of excess supply will increase.
D) The quantity exchanged in the marketplace will remain constant.
E) The quantity exchanged in the marketplace will decrease.

14. The price of apples at a local market rises from $2.95 to $3.05 per kilo, and as a result the
quantity of oranges that households purchase increases from 3,950 to 4,050 kilos/week.
The cross-price elasticity is
A) -1.33.
B) -0.75.
C) 0.75.
D) 1.33.
E) not determinable with the information provided.

15. If buyers believe that the price of milk (an input used in the production of cheese) will rise
next month, the most likely immediate result will be
A) a decrease in the supply of cheese.
B) a decrease in the demand for cheese due to a shift to a substitute.
C) a decrease in the quantity demanded due to a decrease in supply.
D) an increase in the demand for cheese due to a change in expectations.
E) none of the above.

16. An effective price ceiling creates economic inefficiency because
A) it reduces producer surplus in the market.
B) it reduces consumer surplus in the market.
C) it reduces producer surplus and increases consumer surplus.
D) it reduces consumer surplus by more than it increases producer surplus.
E) the last unit transacted in the market provides an additional benefit to consumers that
exceeds the additional cost of producing it.


Use this space for rough work.



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17. The deadweight loss resulting from the introduction of a unit-tax will be the greatest when
A) Supply is elastic and demand is inelastic.
B) Both supply and demand are elastic.
C) Supply is inelastic and demand is elastic.
D) Both supply and demand are inelastic.
E) None of the above is correct since elasticities and deadweight loss are not related.

18. Because hamburgers and French fries are often eaten together, they are complements. We
observe that both the equilibrium price of French fries and the equilibrium quantity of
hamburgers have risen. What could be responsible for this pattern?
A) A fall in the price of beef, an input in the production of hamburgers
B) A fall in the price of potatoes, an input in the production of French fries.
C) An increase in the price of potatoes.
D) An increase in the price of beef.
E) A decrease in the price of hot dogs, a close substitute for hamburgers.

19. Good X has a negatively-sloped demand curve and a positively-sloped supply curve. A
reduction in the price of an input used to produce good X will
A) not affect consumer surplus.
B) increase consumer surplus.
C) increase the price of good X.
D) reduce the quantity bought and sold of good X.
E) shift the demand for good X to the right.

20. Suppose that the incomes of buyers in a market for a normal good decline and there is a
reduction in input prices. What would you expect to occur in this market?
A) Equilibrium price would increase, but the impact on the equilibrium quantity would be
ambiguous.
B) Equilibrium price would decrease, but the impact on the equilibrium quantity would
be ambiguous.
C) Both equilibrium price and equilibrium quantity would increase.
D) Equilibrium quantity would increase, but the impact on the equilibrium price would be
ambiguous.
E) Equilibrium quantity would decrease, but the impact on the equilibrium price would
be ambiguous.


Use this space for rough work.


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PART II (35 marks)

Instructions: Answer all questions in the space provided.

Question 1 (13 marks)
The weekly demand and supply for widgets is given in the following table:
Price ($) 2 4 6 8 10 12 14
Quantity demanded 14,000 12,000 10,000 8,000 6,000 4,000 2,000
Quantity supplied 2,000 4,000 6,000 8,000 10,000 12,000 14,000

a) What is the equilibrium price and quantity in the market for widgets? Briefly explain. (2
marks)
The equilibrium price is $8 and the equilibrium quantity transacted in the market is 8,000 units
because at P = $8 the quantity demanded and the quantity supplied are equal.





b) In the diagram below, carefully draw the weekly demand and supply curves for widgets and
show the equilibrium price and quantity of part a). (2 marks)
15
Quantity of widgets (thousands)
P
r
i
c
e

(
$
)

5 20 10
10
6
15
5
8
D
S
8 6
Price ceiling
Black
market
price
S
Subsidy

Page 9 of 12
c) To protect the consumers of widgets, suppose that the government imposes a price ceiling
of $6. Is there now a market shortage or a surplus? What is the size of this shortage or
surplus? (1 mark) What is the new quantity transacted in the market? (2 marks) Briefly
explain.

As shown in the diagram, at P = $6 the quantity demanded is 10,000 units while the quantity
supplied is 6,000 units. Therefore, there is an excess demand (i.e., a shortage) equal to 4,000
units.
The quantity transacted in the market is determined by the lesser of the quantity demanded and
the quantity supplied and, therefore, it is 6,000 units.





d) If those consumers who were able to buy widgets at the price ceiling of $6 were to resell
these widgets in the black market, what price would they obtain? Briefly explain and show
this price in your diagram above. (2 marks)

Those who were able to obtain widgets at $6 a piece would be able to sell them in the black market to
those who did not at a minimum price of $10. Indeed, in the absence of a price ceiling, at Q = 6,000 the
market would determine a price of $10.









e) Suppose now that the government is committed to keep the price of widgets at $6 but also
wants to eliminate the shortage or surplus of part c) above and, to this end, decides to
introduce a unit-subsidy to be given to producers. What is the required size of this unit-
subsidy? Briefly explain. (2 marks)

In order to eliminate the shortage of 4,000 units, producers must increase output to 10,000
units. To do so, producers require a minimum price equal to $10 as determine by the supply
curve. Therefore, since consumers are paying a price of only $6, the required subsidy is of $4
per unit (i.e., the supply curve should shift down exactly by $4 at each level of output).







f) Show the equilibrium of part e) in the diagram above (2 marks)

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Question 2 (13 marks)
A country produces manufactured goods and agricultural goods using three factors of
production land, capital, and labour. The following table describes this countrys Production
Possibilities Curve:




























a) In the diagram above, carefully draw the production possibilities curve (PPC
1
) described in
the table above. (2 marks)

b) Given the information provided in the table above, what is the opportunity cost of adding the
30th unit of agricultural goods? What is the opportunity cost of increasing manufactured
goods output from 25 to 30 units? Briefly explain how you obtained these figures. (2 marks)

The opportunity cost of the 30
th
unit of agricultural goods is 0.5 units of manufactured goods.
Indeed, increasing agricultural output from 20 to 30 units requires a transfer of resources away
from the manufactured goods industry which will reduce manufactured goods output by 5 units
(i.e., from 20 to 15 units). Therefore, assuming constant opportunity cost along this segment,
the opportunity cost of the 30
th
unit of agricultural goods is 5/10 = 0.5 units of manufactured
goods.
In turns, increasing manufacture goods output from 25 to 30 units requires a transfer of
resources away from the agricultural goods industry which will reduce agricultural goods output
by 10 units (i.e., from 10 to 0 units). Therefore, the opportunity cost of increasing manufactured
goods output from 25 to 30 units is 10 units of agricultural goods.
Option A B C D E F G
Manufactured Goods (Units) 30 25 20 15 10 5 0
Agricultural Goods (Units) 0 10 20 30 40 50 60
Agricultural Goods (Units)
M
a
n
u
f
a
c
t
u
r
e
d

G
o
o
d
s

(
U
n
i
t
s
)


50
50
25 75 30
20
25
15
20 60
30
PCC
1
PCC
2
PCC
3

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c) Given the information provided in the table above, what is the opportunity cost of increasing
output from 15 manufactured goods and 20 agricultural goods to 20 manufactured goods
and 20 agricultural goods? Briefly explain. (2 marks)

In this case, the opportunity cost of increasing manufactured goods output from 15 to 20 units is
zero because it does not require any transfer of resources away from the agricultural goods
industry. Indeed, the initial point of production of 15 manufactured goods and 20 agricultural
goods is below the Production Possibilities Curve which implies either that some resources
remain idle (i.e., unemployment) or that the best available technologies are not being used.
Therefore, we are not facing a situation of scarcity and we can increase the manufactured
goods output to 20 units without having to reduce the output of agricultural goods industry.


d) In the diagram above, carefully draw the production possibilities curve (PPC
2
) that results
from technological change that increases manufactured goods production by 50% without
affecting agricultural goods output. (2 marks)

e) Consider the production possibilities curve PPC
1
. Suppose now that a war destroys half the
country's land, capital, and labour. In the diagram above, carefully draw the new production
possibilities curve (PPC
3
). (2 marks)

f) Consider the production possibilities curve PPC
1
. Without drawing any new curves, briefly
explain how the production possibilities curve PPC
1
would most likely change as a result of
each of the following events taken separately:

i) The minimum retirement age is increased from 65 to 67 years of age. (1 mark)

This will cause the quantity of labour available in the economy to increase (i.e., the labour force
will increase) and thus the PPC will shift out to the right. Note that both the horizontal and the
vertical intercepts will increase.


ii) 10 percent of the workers in the agricultural goods industry are laid off. (1 mark)

This means that the point of production will fall below the PPC but the position of the PPC will
not change since the quantity of resources and the technology have not changed.



iii) 20 percent of the workers currently employed in the manufactured goods industry are
reallocated to the agricultural goods industry. (1 mark)

This means that the point of production will move down along the PPC but the position of the
PPC will not change since the quantity of resources and the technology have not changed.



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Question 3 (9 marks)
Rachel an elite athlete works full time as a landscaper and earns an income of $40,000
per annum. Her annual expenses consist of $15,000 for rent, $12,000 for food, $5,000 for
clothing, and $3,000 for other expenditures. Her accumulated savings are presently $50,000.
Rachel is now considering taking a year off from her job in order to train full time for the
Olympics. As an elite athlete she will receive a grant of $12,000 per year from Sports Canada,
but her training expenses will be $10,000 per year.
a) What is the dollar value of Rachels opportunity cost of training for the Olympics? Show all
your work. (3 marks)

Rachels opportunity cost of training for the Olympics includes any forgone income plus any
additional direct cost. She will have to quit her current job and thus she will stop earning
$40,000 per annum but she will receive a grant of $12,000 and thus she will actually forgo an
income of $28,000. In addition, she will incur training costs of $10,000. Therefore, her
opportunity cost of training for the Olympics is $40,000 $12,000 + $10,000 = $38,000.
Note that she will continue having annual expenses of $15,000 for rent, $12,000 for food,
$5,000 for clothing, and $3,000 for other expenditures and thus they are not part of the equation
when estimating her opportunity cost of training for the Olympics.

b) If Sport Canada were to eliminate its grants to athletes, how would this affect Rachels
opportunity cost to train for the Olympics? Briefly explain. (3 marks)

In this case Rachels opportunity cost of training for the Olympics would include her forgone
income of $40,000 plus her training expenses of $10,000, i.e., her opportunity cost would be
$40,000 + $10,000 = $50,000.




c) If Sport Canada were to eliminate its grants to athletes, how would this affect the number of
Canadians who would choose to train for the Olympics? Briefly explain. (3 marks)

Since the grant represents only a relatively small reduction in the opportunity cost of training full
time for the Olympics, it would be safe to conclude that it does not play an important role in the
athletes decision whether to train full time or not for the Olympics. Therefore, it could be
expected that the elimination of such a grant would have only a small impact on the number of
Canadians who would choose to train for the Olympics.