ECO 105 Midterm Practice Problems Opportunity Costs

Transcription

1 ECO 105 Midterm Practice Problems Opportunity Costs 1. Chris can bake either 8 pies or 4 loaves of bread per hour. For Chris, the opportunity cost of baking an extra pie is A. 2 loaves of bread B. 1/2 a loaf of bread C. 2 pies D. one loaf of bread E. 12 loaves 2. What is the opportunity cost of buying a new car? A. The value of other goods and services you could have purchased with the money you spent on the car B. The price you paid for the car C. The cost of operating and maintaining the car D. The difference between what the car costs now and what a similar car like it will cost a year from now E. The difference between the price of the car and the price of a used car 3. For a business producing shirts and dresses, the opportunity cost of a dress is A. the market price that the business can obtain for a dress. B. the cost of the labour and raw materials used in making the dress. C. the shirts that could have been produced with the resources used to make the dress D. the total cost of all the resources used to make one dress. 4. A government spends $100 million on employing extra teachers instead of extra nurses. What will be the opportunity cost of this? A. $100m B. the cost of training extra teachers C. the extra nurses D. the reduction in unemployment among teachers

2 Production Possibilities Frontier Use the PPF below to answer the following questions. NOTE: THAT CURVE BB IS THE CURRENT FRONTIER FOR THIS ECONOMY. 1. Suppose massive new sources of oil and coal are found within the economy and there are major technological innovations in both sectors of the economy. Which curve in the diagram would represent the new production possibility curve? (Indicate the curve you choose with two letters.) C C 2. Suppose that a new government comes into power that forbids the use of automated machinery and modern production techniques in all industries. Which curve in the diagram would represent the new production possibility curve? (Indicate the curve you choose with two letters.) A A 3. Suppose there is a major technological breakthrough in ONLY the consumer goods industry, and the new technology is widely adopted. Which curve in the diagram would represent the new production possibilities curve? (Indicate the curve you choose with two letters.) B D 4. If BB represents a country s current production possibilities frontier, what can you say about a point like x? (Write a brief statement.) Point X is the point that is unattainable because the country doesn t have enough resources to produce at that point. 5. If BB represents a country s current production possibility frontier, what can you say about a point like y? (Write a brief statement.) Point y is attainable but inefficient. If a country was producing at point y, it means they aren t utilizing their resources to the full extent (B B curve represents all points where country is utilizing ALL available resources).

3 Price Ceilings and Price Floors 1. A store sells cheddar cheese by the pound. The chart reflects the quantity demanded and the quantity supplied for the different prices the cheese could be sold. Price Quantity Demanded Quantity Supplied $ $ $ $ $ $ $ On a separate piece of graph paper, use the data to plot demand and supply curves. 3.Answer the following question: a. What is the market price? $4.50 $4.50 b. What is the quantity demanded at the market price? c. What is the quantity supplied at the market price? On your graph, draw a line across your graph at the price of$4.00. a. If the government were to set a price no higher than $4.00, this would be called a price ceiling ceiling b. Use your answer in (a) to label the line on your graph at the price of $4.00. c. At a price of $4.00, the quantity demanded would be 300 d. At a price of $4.00, the quantity supplied would be 240 e. Is there a surplus or shortage of cheese? Shortage hortage 5. On your graph, draw a line across your graph at the price of $5.50. a. If the government were to set a price no lower than $5.50, this would be called a price floor b. Use your answer in (a) to label the line on your graph at the price of $5.50. c. At a price of $5.50, the quantity demanded would be 240

4 d. At a price of $5.50, the quantity supplied would be 360 e. Is there a surplus or shortage of cheese? Surplus Shifting Demand and Supply 1. Indicate whether the following statement is true or false and explain why. An increase in the price of bananas will shift the demand curve for bananas to the left False because an increase in the price of bananas is a movement along the demand curve, not a factor that shift demands. 2. Draw typically shaped supply and demand curves for hot dogs and indicate the equilibrium price and quantity. Use the graph to illustrate what will happen to the equilibrium price and quantity of hot dogs if there is an increase in income in the economy and explain. A hot dog is a normal good (as income increases, demand will increase). An increase in income shifts the demand curve up, resulting in an increase in the equilibrium price and increase in the equilibrium quantity. However, some may think a hot dog is an inferior good. If this is the case, the demand curve would shift down. 3. Suppose a fleet of alien vessels carries away a large percent of the beef cattle on earth. Use supply and demand to illustrate the impact of this on the following. Label your diagrams clearly and explain each briefly. a. The price and quantity of beef on earth.

5 If an alien vessel took away most of the beef cattle, the supply for beef would decrease. This would lead to a higher price and a lower quantity. (WHY? If supply is less, sellers will attempt to sell items for more!) b. The price and quantity of hamburger buns. Hamburger rolls are a complement of beef (you buy hamburger rolls when you buy beef to make hamburgers). Since beef is now scarce, there is a decrease in demand for hamburger rolls (you wouldn t buy hamburger rolls without beef). Thus, price and quantity both decrease. c. The price and quantity of chicken (assuming that chicken is a substitute for beef). The demand for chicken will increase since it is a substitute for beef (now that beef is scarce, you can easily use chicken instead of beef when cooking). Quantity and price both increase d. The price and quantity of vegetable beef soup. Since the production of vegetable beef soup involves beef as an input and now beef is scarce, there is a decrease in supply. So the price of beef soup increases but the quantity

6 decreases. 4. Suppose that the profitability of growing corn to produce ethanol rises sharply. Use supply and demand to illustrate the impact of this on the market for wheat. Label your diagram clearly and explain. Farmers will choose to plant more corn (versus planting wheat). This decreases the supply for wheat which will increase the price of wheat and decrease the quantity. Elasticities 1. Yesterday, the price of envelopes was $3 a box, and Julie was willing to buy 10 boxes. Today, the price has gone up to $4 a box, and Julie is now willing to buy 8 boxes. Is Julie's demand for envelopes elastic or inelastic? What is Julie's elasticity of demand? %ΔQD = _ 8 10_ x 100% = 22.2% 9 %ΔP = 4 3 x 100% = 28.6% % = 0.78 inelastic 28.6% 2. Flu vaccinations cost $19 per shot. If the industry decided to sell them for $20 a shot what do you think would happen to the elasticity of demand? Flu vaccinations are extremely inelastic, they are not very responsive to change. Flu vaccinations would stay inelastic because the change in price would not affect consumers decisions to buy vaccinations as much.

7 . 3. Assume that the current price is $70. The seller wants to increase its revenues and has decided to increase the price to $80. Is this a good idea? This good falls in the elastic portion of the demand curve (see above). This means if a seller increases its price, consumers are EXTREMELY responsive to change. So if they were to raise the price, consumers demand would most likely increase BY A LOT. It is not a good idea to increase price because it would not increase revenues because you d have less consumers willing to buy the good. 4. It was estimated that 2003 milk had an income elasticity of demand of 0.6. What can be concluded about milk from this information? If the income elasticity is negative, this means that if income increases, demand decreases (or vice versa). This is the definition of an inferior good. We can conclude that milk at that time was considered an inferior good. 5. The price of good X falls by 15%. As a result, the demand for good Y rises by 30%. What is the cross price elasticity of demand? Are goods X and Y complements or substitutes? +30% / 15% = 2 Because we get a negative number, we know that the goods are complements (as price decreased for good X, you bought more of good X and consequently also bought more of good Y). Consumer Theory 1. What is utility? Why is utility important?

8 Utility is consumer s satisfaction or happiness. It is important because it tells us how consumers make decisions (to maximize their utility!). 2. Write the equation to calculate marginal utility. 3. What is the rule of rational life? % TU / % Q RLL = Consume up to where your MB=MC *Remember that MU is the same as MB (it s the benefit of your satisfaction) 4. Ashley sees that chocolate is being sold for $2/bar and decides she wants to eat some. Using the chart given below, what is Ashley s optimum consumptions of chocolate? Quantity TU MU MC Ashley s optimum consumption of chocolate is 4 bars (where MB=MC) 5. In the above chart, where does the rule of diminishing marginal utility kick in? Why? The rule of diminishing marginal utility kicks in at Ashley s 3rd chocolate bar. This is where marginal utility begins to decline. It kicks in because at a certain point, you begin to get sick of your consumption (i.e. too full, don t feel well, etc).