UNIVERSITY OF TORONTO

Faculty of Arts and Science

August Examinations 2010

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 discrepancy.

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]
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. Kelly consumes only salmon steak and pork chops. Assume that the price of salmon steaks
increased. As a result, which one of the following statements is correct?
a) If salmon steaks were a normal good for Kelly, then the substitution and income effects
would work in opposite directions.
b) If salmon steaks were a normal good for Kelly, then the income elasticity for salmon steaks
would be negative.
c) If salmon steaks were an inferior good for Kelly, then the income elasticity for salmon
steaks would be positive.
d) If salmon steaks were an inferior good for Kelly, then the substitution and income effects
would work in the same direction.
e) None of the above is correct.


2. Country A produces two products, bicycles and pizza, with factors labour and capital. Which one
of the following statements is correct concerning the production-possibilities curve?
a) If labour migrated [left] Country A, there would be no change in the PPC.
b) If Country A engaged in international trade, then the PPC would shift outwards at all
points.
c) If an innovation occurred only in the bicycle industry, then the PPC would shift outwards at
all points.
d) If the Country achieved a positive level of net investment, then the PPC would shift
outwards at all points.
e) None of the preceding statements is correct.

3. Which one of the following statements is correct?
a) If the price of a product increases and total revenue is unchanged, then the demand curve is
relatively inelastic.
b) If the price of a product increases and total revenue rises, then the demand curve is
relatively elastic.
c) If the price of a product falls and total revenue falls, then the demand curve is relatively
inelastic.
d) If the price of a product falls and total revenue rises, then the demand curve has unitary
elasticity.
e) None of the above is correct.


4. Which one of the following statements is correct for a firm in a perfectly competitive industry?
a) In the short run, the firm would produce a positive output if average revenue were less than
average variable costs.
b) In the short run, the firm would make economic profits if average revenue equalled average
fixed costs.
c) In the long run, the firm would make normal profits if the industry price equalled marginal
cost.
d) In the long run, the firm would produce a positive output even if average revenue were less
than average total cost.
e) None of the preceding statements is correct.


5. A perfectly competitive industry is in short run equilibrium and each firm is initially making
normal profits. The price of a substitute good falls. As a result, which one of the following
statements is correct?
a) The industry price and output would both increase and each firm would produce a smaller
output and make economic losses.
b) The industry price and output would both increase and each firm would produce a larger
output and make economic profits.
c) The industry price and output would both decrease and each firm would produce a larger
output and make economic profits.
d) The industry price and output would both decrease and each firm would produce a smaller
output and make economic losses.
e) More firms would enter the industry.


6. Because hamburgers and French fries are often eaten together, they are complements. We observe
that both the equilibrium price of hamburgers and the equilibrium quantity of French fries 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) An increase in the price of beef.
c) An increase in the price of potatoes, an input in the production of French fries.
d) A fall in the price of potatoes.
e) None of the above is responsible for this pattern.

7. Suppose the demand and supply curves for eggs have the usual negative and positive slopes,
respectively. Suppose also that as average household income decreases we observe a rise in the
price of eggs. We can conclude that eggs are a(n)
a) substitute good.
b) inferior good.
c) normal good.
d) luxury good.
e) necessity good.


8. Suppose there are only three things you can do rather than attend a community social event: read a
novel (you value this at $20), go to work (you could earn an extra $15), or watch videos with some
friends (you value this at $10). What is the monetary value of your opportunity cost of attending
the community social event?
a) Zero, because you cannot be in two places at the same time.
b) $45, because this is the total dollar amount of the three alternatives forfeited.
c) $20, because this is the highest valued alternative forfeited.
d) $10, because this is the lowest valued alternative forfeited.
e) $15, because going to work is the only alternative involving a genuine monetary payment.


9. Suppose that when the price of Good X increases by 10 percent the quantity demanded of Good X
also increases by 15 percent. All else equal, one can conclude that
a) the demand for Good X is elastic.
b) the demand for Good X is inelastic.
c) Good X is a normal good.
d) Good X is an inferior, non-Giffen good.
e) none of the above is correct.


10. If the average product curve is falling, then the marginal product curve
a) must lie above the average product curve over this range and must also be falling.
b) must lie above the average product curve over this range.
c) can be either above or below the average product curve, although it must be falling over the
entire range.
d) must lie below the average product curve over this range.
e) might either be rising or falling over this range.


11. A perfectly competitive industry is in short run equilibrium. Each firm is making normal profits at
this equilibrium. Now a drop in the price of some raw materials reduces the average cost of
production by $5 at all levels of output. As a result, which one of the following statements is
correct in the short run?
a) The industry price will fall by $5 and output will increase.
b) The industry price and output will both remain unchanged.
c) The industry price will fall by more than $5 and output will increase.
d) The industry price will fall by less than $5 and output will increase.
e) None of the above is correct.

12. A pure (unregulated) monopolist is currently producing an output level where price equals
marginal cost, and profits are positive. In order to maximize profits, this monopolist should
a) reduce price and let output adjust to the new price.
b) increase price and leave output unchanged.
c) leave price and output unchanged.
d) decrease output and increase price.
e) increase output and reduce price.


13. Assume an economy where GDP (Y) is equal to consumption (C) plus investment (I), and the
expression for consumption is given by C = 100 + 0.75Y and the expression for investment is given
by I = 100. In this economy the equilibrium level of income will be and the simple
multiplier will be .
a) $750; 5.
b) $850; 4.5.
c) $750; 4.
d) $800; 4.
e) $800; 5.


14. Which one of the following would be considered a contractionary [restrictive] monetary policy?
a) A decrease in the exchange rate.
b) An increase in personal income taxes.
c) The Bank of Canada encourages banks to make loans.
d) The Bank of Canada sells government bonds.
e) The Bank of Canada buys government bonds.


15. Suppose that a country had new imports of 20 tractors at an import cost of $20,000 each and that
10 of the tractors were sold to farmers at $30,000 each, 5 of the tractors were re-exported at
$25,000 each, and the remaining 5 tractors were in inventory at their imported price at the end of
the year. As a result of these transactions, by how much would the countrys gross domestic
product increase?
a) $400,000.
b) $425,000.
c) $300,000.
d) $125,000.
e) None of the above is correct.


16. Which one of the following statements about investment is correct?
a) Net investment may be negative.
b) Net investment includes the total of all machinery and equipment produced during the year.
c) Gross investment must equal net investment.
d) Gross investment plus depreciation equals net investment.
e) None of the above is correct.


17. Monetary policy would be more effective under which one of the following set of conditions:
a) The more elastic the liquidity preference curve [demand for money] and the more inelastic
the marginal efficiency of investment curve.
b) The more elastic the liquidity preference curve and the more elastic the marginal efficiency
of investment curve.
c) The more inelastic the liquidity preference curve and the more inelastic the marginal
efficiency of investment curve.
d) The more inelastic the liquidity preference curve and the more elastic the marginal
efficiency of investment curve.
e) None of the above.


18. Which one of the following impacts would cause an increase in the value of the full/spending
(expenditure) multiplier?
a) The marginal rate of taxation in the country increased.
b) The marginal propensity to import decreased.
c) The marginal propensity to invest decreases.
d) The marginal propensity for government spending decreases.
e) None of the above is correct.

PART II [32 %]
SHORT ANSWER QUESTIONS
(To be answered by all students)
Answer ALL of the EIGHT questions in a separate examination booklet.
Write the name of your instructor (i.e., Prof. Hare or Prof. Indart) and your course section
number (i.e., L0101, L0201 or L5101) on the cover page of your 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. Maureen consumes only tuna [X-axis product] and lamb chops [Y-axis product]. Maureen receives
an increase in her commission income. As a result, in order to maximize her level of consumer
satisfaction after the increase in commission income, Maureen chooses to purchase fewer units of
tuna.
Statement: Sally is of the view that Maureens behaviour is not consistent with consumer
behaviour analysis.
Position: Do you agree with Sallys view? Use a consumer indifference curve diagram to analyze
this situation and indicate, with reasons, whether you agree or disagree with Sallys view.

2. Natalie spends all her disposable income on video games [Y-axis good] and books [X-axis good].
The price of books decreases. Natalies income elasticity for books is negative and her substitution
effect is always greater than her income effect.
Statement: Hilary suggests that Natalies demand curve for books has a positive slope.
Position: Do you agree with Hilarys suggestion? Use a proper diagram to analyze this situation
and indicate, with reasons, whether you agree or disagree with Hilarys suggestion.

3. Antonia owns a small firm in a perfectly competitive market. Her firm generates the following
short-run information: current level of output is 100 units; total revenue is $3,500; total cost is
$5,000; marginal cost is $35; and total fixed cost is $2,000.
Statement: Nataliya believes Antonias firm is making economic losses and should, therefore, shut
down production. Rishikesh a good friend of Antonias advises her not to shut down but to
lay off some workers to decrease production.
Position: Do you agree with Rishikeshs advice? Use a proper diagram to analyze this situation
and indicate, with reasons, whether you agree or disagree with Rishikeshs advice.

4. Statement: Diminishing marginal productivity [returns] starts at the quantity of labour input at
which a straight line through the origin is tangent to the total (physical) product curve.
Position: With the help of a proper diagram explain whether you agree or disagree with the
statement.

5. In the short-run production period, a pure (unregulated) monopolist generates the following
information at its current level of output: the industry price is $40; the marginal revenue is $20; the
average total cost is $44; the marginal cost is $20; and average fixed cost is $12.
Statement: Kelly reviews this information and concludes that the firm is making economic losses
and that it should increase the price of its product to $44 to eliminate these economic losses.
Position: Do you agree with Kellys conclusion? Use a proper diagram to analyze this situation
and indicate, with reasons, whether you agree or disagree with Kellys conclusion.


6. A pure (unregulated) monopolist is in short run equilibrium with economic profits. Disposable
incomes decrease. The product has a positive income elasticity. With the help of a diagram, explain
the full impact of this shock on the pure (unregulated) monopolists short-run equilibrium.

7. Suppose the marginal propensity to consume out of disposable income (c) is 0.8 and that taxes do
not depend on income (i.e., the marginal propensity to tax is zero). The government now increases
its expenditures on goods and services by $1,000,000 while increasing at the same time
autonomous taxes also by $1,000,000.
Statement: Chunyue suggests that, together, these actions will have no impact on equilibrium
GDP and that they will leave the governments budget deficit also unchanged.
Position: Do you agree with Chunyues suggestion? Analyze this situation and indicate, with
reasons, whether you agree or disagree with Chunyues suggestion.

8. Suppose that the cash reserve ratio in the Canadian banking system is 5 percent. Nicole holds some
of her money in cash and the rest in her chequing account. She now decides to hold $500 more in
cash and withdraws these $500 from her bank account.
Statement: Katherine takes the position that the cash reserves of the Canadian banking system will
decrease by $10,000 and the M1 money supply will also decrease by $10,000.
Position: Do you agree with Katherines position? Analyze this situation and indicate, with
reasons, whether you agree or disagree with Katherines position.


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 [15 marks]

Answer FIVE out of SIX Questions in Section B [7 marks each]



Section A [15 marks]

Answer Question 1

1. Mary has read the compulsory readings related to the importance of technological change, to
productivity increases and to economic growth. This means that Mary has included the readings by
William Easterly [related to Robert Solows analysis], Paul Krugman, Richard Lipsey, William
Lewis and the Canadian Institute for Competitiveness and Prosperity.

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 in Canada. You are expected to include the contributions by Solow,
Krugman, Lipsey, Lewis and the Institute for Competitiveness and Prosperity
in this essay. In your answer, differentiate between total factor productivity
and labour productivity. In addition, explain why Canadians should be
concerned by the widening of the dual deficits between Canada and the
United States.









Professor Hare

Section B [35 marks]

Answer Any FIVE out of SIX Questions [7 marks each]

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



2. Simon 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 analysis should clearly identify the model and how the evolution of the model, or
shocks to the model, would generate an increase in labour productivity. In the course, there are four
separate and independent circumstances in which labour productivity could be increased. Use
separate diagrams in each case that you select.


3. In the Extracts, Paul Krugman established the following circumstances. We have two countries:
East and West each of which produce automobiles and buses with only the factor of production,
labour. In East, it requires 100 hours of labour to produce one automobile and 200 hours of labour
to produce one bus. In West, it requires 600 hours of labour to produce one automobile and 300
hours of labour to produce one bus. Assume that the two countries agree to conduct international
trade at 1 bus for 1 automobile.

Required: Which country has a comparative advantage and in what product? Will both countries
achieve gains from trade at the preceding international terms of trade ratio, as quoted above? Use a
diagram and explain your answer. Specific gains [losses] from trade are to be derived for each
country in your analysis.


4. Natasha spends all her disposable income on two goods: tuna fish steaks [x-axis good] and salmon
pasta [y-axis good]. Natasha has a negative income elasticity for tuna fish steaks. For tuna fish
steaks, Natashas substitution effect is greater than her income effect. The price of tuna fish steaks
increases. As a result, Alexander suggests that, after the price increase, Natasha would want to
purchase the same quantity of tuna fish steaks to maximize her level of consumer satisfaction: that
Natashas income consumption curve would be perfectly inelastic and that Natashas demand curve
for tuna fish steaks would also be perfectly inelastic.

Required: Your positions, consumer indifference curve diagram [clearly labeled] and
explanations.

Professor Hare


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 the deficiency payment plan, which establishes a price floor at a level which will
ensure that each firm just makes normal profits in the short run. Tracy suggests that as a result of
this price floor programme, the industry would increase its output; that each firm would produce an
unchanged output and make normal profits; that some firms would leave the industry in the short
run and that the government would require a sizeable transfer payment [subsidy] to farmers to
guarantee the plans revenue requirements for farmers.

Required: Your full assessment of Tracys findings. A clearly labelled industry-firm set of
diagrams in the short run is required to support your answer. Explanations are required.


6. Suppose that the Canadian economy experienced a 10% unemployment rate with price stability.
Cy suggests that the best way to achieve full employment is to undertake an easy monetary
policy. However, Oscar 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, Oscar recommends the use of an expansionary discretionary fiscal policy which features
heavy investment in infrastructure.

Required: Your assessment of the positions of Cy and Oscar, 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 surplus, then its balance-of-
payments statement would not balance.

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
AD/SRAS diagram is essential.

c) Sean wants you to present two reasons why the Aggregate Demand curve is downward
sloping.

Professor Hare
Page 12 of 15
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.

Write your course section number (i.e., L0201 or L5101) on the cover page
of your examination booklet.

Answer ALL five questions. Each question is worth 10 marks.


1. (10 marks) Consider the market for milk in the small country of Las Piedras. This market demand
and supply schedules are shown in the table below, where the price of milk is expressed in pesos
per litre and the quantity of milk in millions of litres per month:

Price 10 9 8 7 6 5 4 3
Quantity demanded 2 4 6 8 10 12 14 16
Quantity supplied 11 10 9 8 7 6 5 4

a) Assuming there is no government intervention in this market, what are the equilibrium price
and the equilibrium quantity? Briefly explain. (2 marks)
b) Now suppose the government of Las Piedras guarantees milk producers a price of 9 pesos per
litre and promises to buy any amount of milk that the producers cannot sell. What are the
quantities demanded and supplied at this guaranteed price? Briefly explain. (1 mark) How
much milk would the government be buying (per month) with this system of price support?
Briefly explain. (1 mark)
c) What is, in pesos, the cost of this price support system (to the government)? Briefly explain. (1
mark) Who pays for the milk that the government buys? Who is helped and who is harmed by
this policy? Briefly explain. (2 mark)
d) Suppose that the price of milk in Ontario is equal to the equilibrium price you determined for
Las Piedras in part a) above, i.e., equal to the equilibrium price in Las Piedras before the
intervention of the government. Further suppose that the government of Las Piedras exports to
Ontarioat a price of 6 pesos per litrethe milk it purchased through the pricing system of
part c) above. What is now, in pesos, the cost of this price support system (to the government of
Las Piedras)? Briefly explain. (1 mark) Who is helped and who is harmed by this policy in
Ontario? Briefly explain. (2 mark)

Professor Indart
Page 13 of 15

2. (10 marks) Grandslam Unlimited owns all the tennis courts in Barracuda Island. This monopolists
demand curve is given by the expression P = 90 0.1 Q, where P is the rental price of a tennis
court per hour and Q is the number of rental hours of tennis courts per week. Grandslams marginal
cost curve is given by the expression MC = 0.1Q.
a) What is the expression for Grandslams marginal revenue curve? (1 mark) What is the
monopolists profit-maximizing number of rental hours of tennis courts per week? (1 mark)
What price would it charge? (1 mark)
b) In a neat and clearly labelled diagram, draw the monopolists demand curve (D), marginal
revenue curve (MR), and marginal cost curve (MC), and indicate the monopolist equilibrium
price and quantity of part a) above. (1 mark) Clearly show in your diagram the deadweight loss
that measures the degree of allocative inefficiency of the monopolist. Briefly explain. (1 mark)
c) If the monopolists average total cost (ATC) at the profit-maximizing level of output is $30,
what profits will it make? Briefly explain. (1 mark) Draw the monopolists ATC curve in your
diagram assuming the usual U-shape and clearly indicate the area representing the monopolists
economic profits. (1 mark)
d) If the government implements a marginal cost pricing policy to achieve allocative efficiency,
what price ceiling would be imposed on the monopolist? What output would the monopolist
produce? Briefly explain. (1 mark) Would the monopolists profits increase, remain the same,
or decrease? Briefly explain. (1 mark) Show in your diagram the area representing the
regulated monopolists economic profits. (1 mark)

3. (10 marks) Greg owns a small business that produces apple pies for the local market. His total
fixed cost (TFC) is the cost of his baking ovens, while his total variable cost (TVC) is the cost of
apples, flour and labour required for the production of pies. The table below shows Gregs cost of
producing 100, 200 and 300 pies per day with different combination of his fixed and variable
factors of production.

Quantity
of ovens
Total Fixed
Cost
Total Variable Cost
100 pies 200 pies 300 pies
1 $400 $200 $500 $1,100
2 $600 $180 $280 $750
3 $800 $150 $160 $400

a) If Greg has only one oven at the present time, what is his short-run average total cost (ATC) of
producing 100, 200, and 300 pies per day? Show all your work. (3 marks)
b) Suppose that Greg is currently producing 200 pies per day and he believes the demand for his
pies will not increase in the foreseeable future. Nonetheless, he is considering the possibility of
buying one or two more ovens. Should he buy more ovens? If so, how many more? Briefly
explain (marks will be given entirely for your explanation). (4 marks)
c) Given the information in the table above, what is Gregs long-run average total cost (LRATC)
of producing 100, 200, and 300 pies per day? Show all your work. (3 marks)
Professor Indart
Page 14 of 15

4. (10 marks) Consider the following closed economy:

Aggregate expenditure AE = C + I + G
Consumption expenditure C = 200 + 0.75 YD
Investment expenditure I = 450
Government expenditure on goods and services G = 500
Taxes TA = 200 + 0.2 Y
Disposable income YD = Y TA

a) What is the level of equilibrium income (Y)? (2 marks) What is the size of the expenditure
multiplier? Show all your work. (1 mark) At the level of equilibrium income, is the
government running a deficit or surplus? What is the size of the government deficit or surplus?
(1 mark)
b) Suppose that at the level of equilibrium income there is a recessionary gap of $250. By how
much should government purchases (G) increase in order to eliminate this recessionary gap? (2
marks) At the level of full-employment income, what would be the size of the government
deficit or surplus? (1 mark)
c) If, instead of increasing G, the government were to reduce autonomous taxes (i.e., those taxes
which are independent of Y), by how much should the government reduce autonomous taxes to
eliminate the $250 recessionary gap? (2 marks) At the level of full-employment income, what
would be the size of the government deficit or surplus in this case? (1 mark)



(Question 5 is on the next page)
Professor Indart
Page 15 of 15

5. (10 marks) The table below shows the balance sheet of the only commercial bank of a hypothetical
country. Assume that this bank has achieved its target reserve ratio.
Public Commercial Bank
Assets Liabilities Assets Liabilities
Currency
Deposits
Other assets
150
3,000
1,300
Loans
Equity
2,850
1,600
Currency
Deposit at C.B.
Loans
Govt bonds
25
125
2,850
400
Deposits
Equity
3,000
400
Note: Publics Deposits refers to demand (chequable) deposits, and Deposit at C.B. represents the deposits
that this commercial bank holds at the central bank.

a) What is the money supply of this country? What is the value of the banks target or desired
reserve ratio (v)? (2 marks)
b) Assuming no cash drain on the banking system, what is the value of the money multiplier
(mm)? Show all your work. (2 marks)
c) Suppose that the central bank 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)
d) 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