UNIVERSITY OF TORONTO

Faculty of Arts and Science

August Examinations 2009

ECO 100Y1 Y

Duration: 3 hours

Examination Aids allowed: Non-programmable calculators only




INSTRUCTIONS:

Students are required to answer Part I [multiple choice] for 18% of the exam mark,
Part II [short answer questions] for 32% of the exam mark, and either Part III
[Professor Hares Section L0101] or Part IV [Professor Indarts Sections L0201 and
L5101] for 50% of the exam mark.

Record all your answers for Part I on the SCANTRON sheet provided and, in addition,
on the first page of the examination booklet for Part II for verification. The answer on
the SCANTRON sheet will be selected if there is a difference.

Answer Part II in a separate examination booklet.

Answer Part III or Part IV in a separate examination booklet.




PART I To be answered by all students
PART II To be answered by all students
PART III To be answered ONLY by Professor Hares students [Section L0101]
PART IV To be answered ONLY by Professor Indarts students [Sections L0201 and L5101]

Page 2 of 7

PART I [18 %]
MULTIPLE CHOICE QUESTIONS
(To be answered by all students)
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! Write the
name of your instructor on the SCANTRON sheet (in the area where it says DO NOT
WRITE IN THIS SPACE).
Each question is worth 1 mark. No deductions will be made for incorrect answers.
Write your answers to the multiple choice questions ALSO on the first page of the
examination booklet used for Part II [short answer questions]. Then transfer your
answers to each multiple choice question onto the separate SCANTRON sheet. Your
answers must be on the SCANTRON sheet. In case of a disagreement, the answer to be
marked is the one on the SCANTRON sheet.


1. Desmond is attending university as a full time student this year. Desmond therefore had to give up
his full time job in which he earned $25,000 per year. He also had to move away from his parents
home where he was paying $5,000 per year for room and board and is now enrolled in a university
residence which costs $12,000 per year. In addition, Desmond must pay tuition of $5,000 and buy
text books for $1,000. The opportunity cost for Desmond to become a full-time university student
is
a) $25,000.
b) $36,000.
c) $38,000.
d) $40,000.
e) none of the above.
2. Assume that hot dogs and hamburgers are substitute goods. Given the initial positively-sloped
supply and negatively-sloped demand curves for hamburgers, a reduction in the price of hot dogs
will tend to
a) increase the demand for hamburgers.
b) decrease the price of hamburgers.
c) increase the demand for hot dogs.
d) decrease the demand for hot dogs.
e) increase the price of hamburgers.

Page 3 of 7
3. The price of apples at a local market rises from $2.85 to $3.15 per kilo, and as a result the quantity
of oranges that households purchase increases from 3,900 to 4,100 kilos/week. The cross-price
(arc) elasticity is
a) -2.0.
b) -0.5.
c) 2.0.
d) 0.5.
e) none of the above.
4. Margarine, an inferior good, has a positively-sloped supply curve. A decrease in household income
will cause
a) the equilibrium price to increase and the equilibrium quantity of margarine to decrease.
b) both the equilibrium price and the equilibrium quantity of margarine to decrease.
c) the equilibrium price to decrease and the equilibrium quantity of margarine to increase.
d) both the equilibrium price and the equilibrium quantity of margarine to increase.
e) none of the above.
5. If Rachel always spends one-half of her income on books, which one of the following statements is
correct?
a) Books are an income independent good for Rachel.
b) Rachels income elasticity of demand for books is elastic.
c) Rachels price elasticity of demand for books is inelastic.
d) Rachels price elasticity of demand for books is elastic.
e) Rachels price elasticity of demand for books is unitary elastic.
6. Land is a fixed factor and labour is a variable factor of production. The law of diminishing
marginal productivity [returns] starts at the labour input where
a) total product is at a maximum.
b) marginal product is at a maximum.
c) total product starts to decrease.
d) average product equals marginal product.
e) marginal product is zero.
7. If the average product for six workers is 16 and the marginal product for the seventh worker is 14,
then we can conclude that
a) marginal product is rising.
b) marginal product is falling.
c) average product is rising.
d) average product is falling.
e) both marginal product and average product are falling.
8. Which one of the following would NOT cause an increase in GDP?
a) Sean sold his old car, originally purchased in 2000, to Evan.
b) Simon started a new company which produced bicycles only for export.
c) Susan started selling a new drink to customers in her region.
d) Sterling produced 500 computers and sold 400 to local customers.
e) Seeley imported motor cycles and sold half of them for a profit to local customers.
Page 4 of 7
9. Assume the market for coffee is perfectly competitive. If there is a decrease in the wages of farm
workers who harvest coffee beans, the equilibrium quantity of coffee will
a) fall.
b) rise.
c) remain unchanged.
d) rise or fall, depending upon the relative shifts of the demand and supply curves.
e) none of the above.
10. 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 total cost equals marginal cost, both of which are $12.
Average variable cost is $8. In order to profit-maximize, firm A should
a) reduce output.
b) expand output.
c) leave output unchanged.
d) shut down.
e) change the price of the product.
11. Assume an economy where GDP (Y) is equal to consumption (C) plus investment (I). Further
assume that the consumption function is C = 100 + 0.8Y and the investment function is I = 200. In
this economy the equilibrium level of income will be
a) 500.
b) 600.
c) 750.
d) 1000.
e) 1500.
12. In a simple economy with no trade and no government, it is found that desired investment exceeds
actual investment at the present level of GDP. Which one of the following explanations would
explain this situation?
a) The actual level of investment does not equal the actual level of saving.
b) There are unintended inventory increases.
c) There are unintended inventory decreases.
d) Desired investment equals desired saving.
e) None of the above.
13. A perfectly competitive industry is in long-run equilibrium with a constant cost industry supply
curve. The government now provides a permanent subsidy to every firm of $5 per unit of output.
As a result, which one of the following statements is correct in the long run?
a) Consumer price will decrease by $5, each firms output will rise, and industry output will
rise.
b) Consumer price will decrease, but not by $5, and industry output will rise.
c) Consumer price will decrease by $5, industry output will rise but each firms output will
remain constant.
d) Industry output will increase and consumer price will increase.
e) None of the above.
Page 5 of 7
14. A $20 billion increase in government spending on goods and services has
a) no effect on aggregate demand [or aggregate expenditure] if this amount is spent on
imports.
b) the same effect on aggregate demand [or aggregate expenditure] as a $20 billion cut in
taxes.
c) a smaller effect on aggregate demand [or aggregate expenditure] than a $20 billion cut in
taxes.
d) the same effect on aggregate demand [or aggregate expenditure] as a $20 billion increase in
government transfer payments (e.g., welfare payments).
e) None of the above is correct.
15. If the Bank of Canada purchases government bonds in the bonds market,
a) the money supply will decrease.
b) the reserves of the chartered banks will increase.
c) the bank rate will be forced up.
d) the deposits of the public in the chartered banks will decrease.
e) none of the above.
16. Gains from trade results in
a) one country gaining while another country losing.
b) both countries gaining by expanding their production possibilities [curve] frontier.
c) gains only for a country with higher labour productivity in the production of both goods.
d) both countries being able to consume beyond [above] their production possibilities [curve]
frontier.
e) none of the above.
17. Country A and Country B produce only hats and meat pies with labour as the only factor of
production. All industries exhibit constant returns to scale. In Country A, 100 units of labour can
produce either 100 hats or 100 meat pies; in Country B, 100 units of labour can produce either 25
hats or 50 meat pies. Under these conditions, which one of the following statements is correct?
a) Country B has an absolute advantage in hats.
b) Country A has a comparative advantage in meat pies.
c) Under international trade, both countries could achieve gains from trade.
d) Country B, with trade, would specialize in hats.
e) None of the above is correct.
18. In 1997, Thailands baht was devalued by 50% relative to the American dollar. Which one of the
following actions could NOT have caused the devaluation of the baht?
a) Non-resident owners of Thailand stocks took their funds out of Thailand.
b) Thailands imports increased.
c) Thailand raised short term interest rates to attract international portfolio investment.
d) Fewer tourists visited Thailand.
e) Thailands exports decreased.

Page 6 of 7
PART II [32 %]
SHORT ANSWER QUESTIONS
(To be answered by all students)
Answer ALL of the EIGHT questions in a separate examination booklet.
Analyze the situation in each question, using a well-labelled diagram
when relevant and provide a brief explanation.
Each question is worth 4 marks.

1. Esmeralda spends all her disposable income on video games [x-axis good] and books [y-axis
good]. The price of video games increases. Esmeralda has a negative income elasticity for video
games and her substitution effect is always greater than her income effect.
Statement: Tina believes that Esmeralda will purchase fewer video games after the price increase,
her income-consumption line will be negatively sloped, and her demand curve for video games will
have a positive slope.
Position: Do you agree with Tinas beliefs? Use a proper consumer indifference curve diagram to
analyze this situation and indicate, with reasons, whether you agree or disagree with Tinas beliefs.

2. Mohammed owns a small firm in a perfectly competitive market. His firm generates the following
short-run information at the current level of output: the market price is $40; the average total cost is
$60; the marginal cost is $30; and the average fixed cost is $20.
Statement: Mohammed believes his firm is making economic losses and should, therefore, shut
down production. Nataliya, a good friend of Mohammeds and an ECO100 student, advises him
not only not to shut down but to hire more workers to expand production.
Position: Do you agree with Nataliyas advice? Use a proper diagram to analyze this situation and
indicate, with reasons, whether you agree or disagree with Nataliyas advice.


3. A perfectly competitive industry is in long-run equilibrium with initially n identical firms. The
industry has a constant cost long-run supply curve. There is now a permanent decrease in the
demand for this industrys product.
Statement: Nigel claims that this decrease in demand will cause the following long-run impacts:
the industry output will decrease; the industry price will increase; each firm will produce a smaller
output; and some firms will leave the industry.
Position: Do you agree with Nigels claim? Use a proper diagram to analyze this situation and
indicate, with reasons, whether you agree or disagree with Nigels claim.

Page 7 of 7
4. A pure monopolist is in short-run equilibrium with economic profits of $500,000. The presidents
annual salary is increased by $200,000.
Statement: Liam takes the position that, as a result of this pay increase, the monopolists price will
increase; the monopolists output will decrease; and the monopolists level of economic profits will
decrease but by less than $200,000.
Position: Do you agree with Liams position? Use a proper diagram to analyze this situation and
indicate, with reasons, whether you agree or disagree with Liams position.

5. Suppose that the cash reserve ratio in the Canadian banking system is 10 percent and that Nicole
deposits $100 in Bank of Canada bills in her Canadian bank account.
Statement: Joanne takes the position that the cash reserves of the Canadian banking system will
increase by $1,000 and the M1 money supply will also increase by $1,000.
Position: Do you agree with Joannes position? Analyze this situation and indicate, with reasons,
whether you agree or disagree with Joannes position.

6. A pure [unregulated] monopolist is in short run equilibrium with economic profits.
Statement: Sean suggests that this monopolist would maximize profits at an output where price
equals marginal cost. Natasha suggests that this monopolist would maximize profits at an output
associated with the minimum point of the average total cost curve.
Position: What is your position regarding the suggestions of Sean and Natasha? Use a diagram and
justify your answer.

7. Canada imports 1000 motor cycles from Germany at an import cost of $20,000 Canadian each.
Seven hundred of these motor cycles are sold to Canadian families at a cost of $30,000 each; two
hundred are exported at an export price of $25,000 each; and the remaining one hundred are held in
inventory at their import price.
Statement: Oscar reviews these transactions and suggests that Canadas GDP would increase by a
total of $26 million.
Position: Do you agree with Oscars suggestion? Analyze this situation and calculate the specific
change in GDP in support of your position.

8. Suppose that the Canadian economy experienced price stability but suffered from too severe a level
of unemployment.
Statement: Oliver suggests that the Bank of Canada should engage in open market operations
which would increase interest rates but would also increase output and reduce unemployment.
Position: Do you agree that the suggested monetary policy would produce the results which Oliver
predicts. Use a diagram, or set of diagrams, to assist in your explanation.


PART III [50 %]

To Be Answered only by Students in Professor Hares Section, L0101

Use a Separate Examination Booklet[s] for PART III

PART III is Divided into Two Sections

Answer the single question in Section A [10 marks]

Answer FIVE out of SIX Questions in Section B [8 marks each]



Section A [10 marks]

Answer Question 1

1. Gregory has read the compulsory readings related to the importance of technological change and
to productivity increases. This means that Gregory has included the readings by Easterly [about
Solow], Krugman, Lipsey and William Lewis.

Required: Write an analytical essay on the importance of technological change and
productivity growth as a driver of economic growth and higher standards of
living. You are expected to include the contributions by Solow, Krugman,
Lipsey and William Lewis in this essay. In your answer, differentiate between
total factor productivity and labour productivity. Finally, explain why
Canadians should be concerned by the widening of the dual deficits between
Canada and the United States.










Professor Hare
Page 2 of 6

Section B [40 marks]

Answer Any FIVE out of SIX Questions [8 marks each]

Note: Mark clearly which questions you wish answered or
the marks for the first five questions answered will be recorded.



2. Peter wants you to show how there would be an increase in labour productivity under two
independent situations using two totally separate models. The increase in labour productivity could
be achieved through either a shock to the model or through the evolution of the model.

Required: Your separate models showing clearly that the result is an increase in labour
productivity. Use separate diagrams in each case you select.



3. Anthony observes that Australia and Brazil only produce beef and wheat with the factor labour.
Constant returns to scale exists. In Australia, 100 units of labour can produce either 500 units of
beef or 1,000 units of wheat. In Brazil, 100 units of labour can produce either 1,000 units of beef or
4, 000 units of wheat. Anthony claims that with at the international terms of trade of 1,500 units of
beef for 4, 000 units of wheat, only Brazil will be able to achieve gains from trade. In addition,
Anthony wants you to show the aggregate trade flows and the gains from trade in Brazil in a new
diagram assuming that there were 2 million units of labour in Brazil.

Required: Your analysis, explanation and position Anthonys initial conclusion. In addition,
present a diagram which shows the aggregate trade flows and gains from trade which Brazil could
attain at the given international terms of trade ratio. [Note: Assume the same international terms
of trade are used as stated in the problem and mark the intercepts of the aggregate
production possibilities curve with specific numbers.]



4. Cynthia spends all her disposable income on bacon omelettes [x-axis good] and tuna steaks [y-
axis good]. It is known that bacon omelettes has a negative income elasticity for Cynthia, but her
substitution effect is always greater than her income effect. Cynthia faces a loss in commission
income in these troubled times. As a result, Robin takes the position, that when Cynthia maximizes
her level of consumer satisfaction after the reduction in disposable income she would wish to buy
more bacon omelettes; her income consumption curve would be positively sloped and her demand
curve for bacon omelettes would have a negative price elasticity of demand [formula calculation].

Required: Your position, analysis and reasoning. Use a consumer indifference curve diagram to
assist your answer.




Professor Hare
Page 3 of 6

5. A perfectly competitive agricultural industry, with n identical firms, is in short run equilibrium.
Each firm is initially making economic losses but is producing a positive output. The government
introduces a production quota system, whereby the industry, and each firm within the industry,
must reduce their production levels by exactly 85%. Peter, who reviews the characteristics of this
industry, suggests that, as a result of this government initiative, the industry price would increase,
the industry output would decrease to 85% of its previous output; each firm would also produce
85% of its previous output; the firms economic losses would either be reduced or economic profits
would be made and some firms would leave the industry in the short run as a result of the
initiative.

Required: Your assessment of Peters findings. An industry-firm set of diagrams is required to
support your answer.



6. Suppose that the Canadian economy experienced a 9% unemployment rate with price stability.
Kimberley suggests that the best way to achieve full employment is to undertake an easy
monetary policy. Oliver suggests that this may not work because of the elasticities in the liquidity
preference curve and in the marginal efficiency of investment curve. Instead of using monetary
policy, Oliver recommends the use of an expansionary discretionary fiscal policy which features
heavy investment in infrastructure.

Required: Your assessment of the positions of Kimberley and Oliver, with your rationale. Use a
transmission mechanism model set of diagrams in your answer and an AD/SRAS diagram to show
the impact of an expansionary discretionary fiscal policy.



7. Write short explanatory notes on the economic significance of each of the following three
independent parts. Your answer, in each case, should provide your position and a sufficient
explanation. Use a diagram, if useful, in each part.

a. Adam suggests that if a country has a balance-of-payments deficit, then it cannot balance its
balance-of-payments statement.

b. Marion wants you to explain the Greenspan hypothesis which supports the continuation of
price stability in the American economy while at the same time unemployment rates were
achieving historic lows and real economic growth was continuing. A clearly labelled diagram
is essential.

c. Clancy wants to know more about the meaning of Solows Surprise presented by Easterly in
the Readings.
Professor Hare
Page 4 of 6
PART IV [50 %]

To be answered only by students in Professor Indarts sections L0201 and L5101.

Use a separate examination booklet(s) for Part IV.

Answer ALL five questions.


1. (10 marks) Consider the perfectly competitive market for widgets. The widget industry is in long
run equilibrium and is characterized by a constant-cost long-run supply curve. The demand curve
for widgets has the usual negative slope and the industry short-run supply curve is positively
sloped. There is a very large number of firms in this industry; they are all identical and their
average total cost curves have the usual U-shape.
a) (3 marks) In a set of clearly labelled diagrams, show this long-run equilibrium for the industry
as a whole and for the representative firm.
i) In the industry diagram, draw the market demand (D), short-run supply (S), and long-run
supply (LRS) curves, clearly indicating the industry equilibrium price (P
1
) and output (Q
1
).
ii) In the representative firm diagram, draw the firms long-run average cost (LRAC), short-
run average cost (AC), and short-run marginal cost (MC) curves, clearly indicating the
firms equilibrium output (q
1
).
iii) Are firms making economic profits? Briefly explain why or why not. If firms are making
economic profits, show the profits of the representative firm in your diagram.
b) (3 marks) Suppose now that the demand for widgets increases.
i) Draw the new demand curve (D) in your diagram, clearly indicating the industry new
short-run equilibrium price (P
2
) and output (Q
2
) as well as the representative firms new
short-run equilibrium output (q
2
).
ii) Are firms making economic profits? Briefly explain why or why not. If firms are making
economic profits, show the profits of the representative firm in your diagram. (3 marks)
c) (4 marks)
i) Explain how the industry, after the increase in demand, will move towards its new long-run
equilibrium.
ii) How do the industry price and output in the new long-run equilibrium differ from their
values in the initial long-run equilibrium? And what about the representative firms new
long-run equilibrium output? Briefly explain.
iii) Clearly indicate in you diagrams the new long-run equilibrium price (P
3
), industry output
(Q
3
), and firms output (q
3
).
iv) Are firms making economic profits? Briefly explain why or why not. If firms are making
economic profits, show the profits of the representative firm in your diagram.


Professor Indart
Page 5 of 6
2. (10 marks) The demand curve of an unregulated, single-price monopolist is P = 100 Q, where P
is the dollar-price and Q is the number of units. The monopolists marginal cost is constant at $20
per unit. The monopolists fixed cost is $400.
a) What is the equation for the monopolists MR curve? And for the monopolists average total
cost (AC) curve? (2 marks) In a clearly labelled diagram, draw the monopolist demand (D),
marginal revenue (MR), average variable cost (AVC), average total cost (AC), and marginal
cost (MR) curves. (2 marks)
b) What are the monopolists equilibrium price and equilibrium output? What is the monopolists
level of economic profits? Show how you obtained these figures (1 mark) In your diagram,
show the monopolists price, output and profits. (2 marks)
c) Suppose now that the monopolist is able to perfectly price discriminate (i.e. charge each
customer the maximum price that the customer is willing to pay). What output will this
perfectly price-discriminating monopolist produce? (2 marks) What is the monopolists level
of economic profits now? Show how you obtained these figures. (1 mark)

3. (12 marks) The table below shows the Republic of Atlantidas domestic demand schedule and
domestic supply schedule for widgets, where price is in dollars per unit and quantities are in
thousands of units. Suppose that the world price of widgets is $5 per unit. Atlantida is a very small
country that takes the world price as given (constant).
Price 10 9 8 7 6 5 4
Quantity demanded 0 2 4 6 8 10 12
Quantity supplied 12 10 8 6 4 2 0
a) In the absence of international trade, what is this countrys equilibrium price and equilibrium
quantity of widgets? Briefly explain. In a neat and clearly labelled diagram, draw Republic of
Atlantidas domestic demand curve (D) and domestic supply curve (S) and indicate this
equilibrium (point A). (2 marks)
b) Suppose now that this country starts trading with the rest of the world. Given that the
international price of widgets is $5, will this country become an importer or an exporter of
widgets? Briefly explain. How many widgets will this country import or export? Briefly
explain. In your diagram, draw the international supply curve (S
W
) for widgets and show the
quantity demanded and the quantity domestically supplied after this country starts trading in the
international market. (4 marks)
c) The government of Atlantida wants this industry to grow and, to that end, introduces a subsidy
to domestic producers of $4 per widget produced. In your diagram, show the change caused by
the introduction of this subsidy to the equilibrium of part b) above. How many widgets will
domestic producers supply now? How many widgets will Atlantida import or export now? (3
marks)
d) Go back to the equilibrium of part b) above. The government is now considering alternative
methods to facilitate the growth of the domestic widget industry and decides to impose an
import tariff of $2 per widget. In your diagram, show the change caused by the introduction of
this tariff to the equilibrium of part b) above. How many widgets will domestic producers
supply now? Explain. How many widgets will Atlantida import or export now? Explain. (3
marks)
Page 6 of 6
4. (10 marks) Consider the following hypothetical economy:

Consumption C = 26 + 0.8YD Government Purchases G = 20
Exports X = 50 Investment I = 10 + 0.2Y
Personal Taxes T = 20 Imports IM = 10 + 0.25Y
Disposable Income YD = Y T Full Employment Y
fe
= 368

a) What is the equilibrium level of income? What is the value of the expenditure multiplier (
AE
)?
Show all your work. (3 marks)
b) What is the level of private saving when the economy is in equilibrium? What is the balance in
the trade account (NX) when the economy is in equilibrium? Show all your work. (2 marks)
c) What is the size of the recessionary gap? By how much should the government increase its
expenditure on goods and services to eliminate the recessionary gap? Show all your work. (2
marks)
d) If the government decides to reduce taxes to increase aggregate expenditure, by how much
should it reduce (lump-sum) taxes to eliminate the recessionary gap? Show all your work. (3
marks)


5. (8 marks) The banking system of a hypothetical economy consists of only one commercial bank,
and this commercial bank does not hold any reserves above the desired level. The public also holds
the desired combination of currency and bank deposits. The balance sheets (T-accounts) of the
public and this commercial bank look as follows:
Public Commercial Bank
Currency
Deposits
Other assets
150
1,000
1,350

Loans
Equity
800
1,700
Currency
Deposit at B of C
Loans
Govt bonds
50
150
800
200
Deposits
Equity
1,000
200
Note: Publics Deposits refers to demand (chequable) deposits only, and Deposit at B of C
represents the deposits that this commercial bank holds at the Bank of Canada.
Given the information in the above balance sheets and considering only the M1 definition of
money supply, answer the following questions:
a) What is the value of the banks target or desired reserve ratio? Assuming no cash drain on the
banking system, what is the value of the money multiplier? Show all your work. (2 marks)
b) Suppose that the Bank of Canada purchases $100 million worth of government bonds from the
public. Assuming no cash drain on the banking system, what are the final changes in: 1) the
banks reserves; 2) the money supply; and 3) the banks loans to the public? Show all your
work. (3 marks)
c) Go back to the initial monetary equilibrium depicted in the table above. Suppose now that the
desired reserve ratio of the commercial bank changes to v = 0.1. Assuming no cash drain on the
banking system, what are the final changes in: 1) the banks reserves; 2) the money supply; and
3) the banks loans to the public? Show all your work. (3 marks)
Professor Indart