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1 VANCOUVER ISLAND UNIVERSITY ECON211: PRINCIPLES OF MICROECONOMICS Total Marks: 70 MIDTERM EXAM II Duration: 75 Minutes Name (Last, First): ID #: Signature: THIS EXAM HAS TOTAL 12 PAGES INCLUDING THE COVER PAGE Use of any electronics device except calculator is strictly prohibited during the exam your cell/mobile phone could be your enemy!! Instructions: a) Please answer your MCQs in the table on additional answer sheet supplied and short question answers in the space provided. b) For short answer questions o You must show your all work to get full marks. If you do not show work, you may not get full marks even for a correct answer. o Use the marks assigned to each question as a guide to allocating your time across questions. Good luck on your exam

2 2 PART A: MCQ (There will be 30 MCQs in this section which is worth 30 marks) 1. The term "marginal utility" is to describe the a. total satisfaction received from consumption of a good b. average utility of each unit of a good consumed c. inverse of the measure of total utility d. price paid for every unit consumed e. change in total satisfaction caused by consumption of an additional unit of a good 2. The opportunity cost of any factor of production is a. the benefit forgone by not using it in its best alternative b. its explicit cost c. the benefit forgone by not using it in its worst alternative d. the money actually paid to the factors of production e. its accounting cost 3. If the price of apple is $5 per kilogram and price of apple juice is $10 per bottle, then the relative price of apple juice is a. 2 dollars b. 2 kilogram of apple c. 0.5 apple d. 10 dollars 4. Labour productivity is defined as a. the efficient use of technology b. the cost of a unit of output c. a measure of output per unit of labour used d. output per combination of two or more inputs e. a measure of input used 5. If a consumer is consuming products X and Y and is maximizing his utility, the following is true a. b. c. d. 6. The idea that the utility a consumer derives from successive units of a good diminishes as total consumption of the good increases is known as a. diminishing total utility b. utility maximization c. the paradox of value d. diminishing marginal utility e. the utility theory of demand

3 3 7. Refer to the table. The table below shows 4 alternative production techniques for producing 1000 widgets per month. Which production technique is NOT technically efficient? a. b. D Technique A B C D c. A d. C Labour e. B f. All four techniques are Capital inefficient 8. Few Louis Vuitton Patchwork bags are available, so the price of a bag is high, the marginal utility from owning a bag is and the consumer surplus is. a. high; high b. high; low c. low; low d. low; high 9. A change in the relative price, and a change in real income a. shifts the budget line; has no effect on the budget line b. changes opportunity cost and shifts the budget line; changes the slope of the budget line c. changes the opportunity cost and changes the slope of the budget line; shifts the budget line d. has no effect on the budget line; changes the cost of the budget line 10. The key assumption about the marginal rate of substitution is that it is a. constant b. negative c. increasing as you move down along the indifference curve d. diminishing a you move down along the indifference curve 11. The "law" of diminishing marginal utility implies that the a. first unit of a good consumed will contribute most to the consumer's satisfaction b. marginal utility of a good diminishes over time c. total utility is negative d. last unit of a good consumed will contribute most to the consumer's satisfaction e. total utility is constant as more units are consumed 12. We know that the demand curve for a normal good is downward sloping because of a. the substitution effect b. the combination of the income and substitution effects c. the income effect d. neither the substitution effect nor the income effect e. none of these responses is correct

4 4 13. The figure below illustrate the law of a. Maximizing utility b. Diminishing total utility c. Diminishing marginal utility d. Increasing marginal utility e. Increasing total utility 14. Marginal utility is negative when total utility is a. increasing b. Equal to marginal utility c. at its maximum d. deceasing e. Equal to zero 15. The statement "The most important goal of firms is to maximize profits" a. is a normative statement and thus cannot be tested b. has been proved by empirical testing to be always true c. applies only to corporations d. is an unrealistic assumption, and therefore of little use to economists e. is an assumption used by economists to predict the behaviour of firms 16. Suppose that a better way to produce a good is discovered, thus lowering production costs for the good. This will cause a. no change in the supply curve, only a change in price b. a decrease in supply (a leftward shift of the supply curve) c. an increase in supply (a rightward shift of the supply curve) d. a movement down the supply curve e. a movement up the supply curve

5 5 17. A benefit of a partnership is that a. owners have limited liability b. it has perpetual life c. it can survive withdrawal of a partner d. the principle-agent problem is eliminated 18. A firm that hires specialists to work on a range of projects experiences a. economies of scale b. increasing economic profit c. economies of scope d. increasing normal profit 19. Choose the statement that is incorrect a. The firm in monopoly is protected by a barrier preventing the entry of new firms b. Monopoly arises when there is one firm, which produces a good/service that has no close c. Product differentiation is a key component of goods produced by monopolies d. substitutes e. Monopoly is the most extreme absence of competition 20. A single proprietorship is a form of business organization which a. allows easy transferability of ownership by the trading of shares b. has limited liability c. has one owner-manager who is personally responsible for the firm's actions and debts d. has unlimited access to money capital e. has a single owner but has directors who are responsible for the firm's debts 21. A firm can raise capital without incurring debt by issuing new shares and/or a. investing in new capital equipment b. issuing bonds c. increasing its bank loans d. reinvesting profits e. making extra dividend payments 22. A preference map is a series of a. demand curve b. indifference curves that display a diminishing marginal rate of substitution c. indifference curves d. points that that have the marginal rate of substitution equal to the relative price 23. Starting from a point of consumer equilibrium, a rise in income a. increases marginal utility of normal goods b. increases total utility c. decreases marginal utility for all goods d. increases consumption of all goods

6 6 24. The opportunity cost to a firm of using an asset is zero if a. the asset has no alternative uses b. the asset was given to the firm for free c. the asset is already owned by the firm d. no money was spent to acquire the asset e. the asset has zero sunk costs associated with it 25. A firm's depreciation costs a. are irrelevant to an accounting of the firm's total costs b. are an estimate of the loss of value of the firm's physical capital c. measure payments to those outside the firm d. are the cost of money borrowed to buy a durable asset e. are a measure of the depreciation of financial assets of the firm 26. A demand schedule is drawn under all of the following conditions EXCEPT: a. the distribution of income of the consumers is held constant b. the price of the commodity is held constant c. the tastes of consumers are held constant d. the income of consumers is held constant e. the prices of related commodities are held constant 27. Indifference curves a. shift rightward when income increases b. never have a slope equal to zero c. do not intersect d. are bowed away from the origin 28. Marginal utility per dollar a. increases as the price of a good rises b. increases as we consume more of a good c. is the increase in total utility that results from consuming one more unit of a good d. is the marginal utility from a good that results from spending one more dollar on it 29. Marginal utility theory shows us that a rare gem which we value highly has a marginal utility and a total utility a. Large; small b. Small; large c. Small; small d. Large; large 30. The opportunity cost for you to attend college a. may be equal to, or less than, the money cost b. is determined by what you could earn if you did not go to college c. is greater than the money cost d. depends on the income you can earn after graduation

7 7 PART B: SAQ (This section contains short answer questions, worth 40 marks) Question 01 (5 marks) What two conditions are met when a consumer maximizes utility? The following two conditions are met when a consumer maximizes utility: a) The consumer spends all of his income allocated for the consumption purpose,. b) The marginal utility per dollar for every goods he consumes is equal: which is equivalent to the slope of the indifference curve and slope of the budget line equality or marginal rate of substitution (MRS) is equal to the relative price condition:

8 8 Question 02 (12 marks) Jon has $90 a week to spend on magazine and movie. The price of magazine is $10 a copy and the price of movie ticket is $15. a. What is Jon s real income in terms of movie ticket? Jon s real income in terms of movie tickets is how many tickets he can purchase with his income: b. What is the relative price of magazine? The relative price of magazine is how many movie ticket he can purchase if he gives up one magazine: c. Calculate the equation for Jon s budget line Expenditure on movie at the price $15 Expenditure on magazine at the price $10 He is constrained by a budget and according to maximization rule he has to spend the entire amount on these two goods So, his total expenditure on both goods is

9 Magazine Magazine ECON211; Midterm Exam II 9 d. Draw the budget line (consumption possibility curve) for Jon (with movie on the horizontal axis) 9 Budget line: 6 Movie e. What is the slope of the budget line? Slope of the Budget line: Or solving the equation: f. Show the impact on the budget line if the price of movie ticket goes up to $18 If the price of ticket increases to $18, his real income $2, her real income in terms of movie will fall he now purchases 5 tickets only. But there is no change with respect to magazine affordability. The budget line will pivot inward on the movie side in the diagram 9 Budget line, New Budget line, 5 6 Movie Coffee

10 10 Question 03 (10 marks) If the price of toffee bars is $1 each, bags of cashews are $2 each, and this consumer has $7 per week to spend on these two snacks, how many of each will he/she purchase to maximize utility? Toffee Bars Cashew Bags Units Total utility Marginal utility Total utility Marginal utility a. Calculate all the marginal utilities Filled up the table. b. Showing appropriate condition, determine the equilibrium combination of Toffee bars and Cashew bags Utility maximizing conditions are: i. All income, $7 must be spent, and ii. The marginal utility per dollar of Toffee bar and Cashew bag are equal: When 3 units of toffee bar are consumed the marginal utility is 5, and When 2 units of cashew bar are consumed the marginal utility is 10, and So, for 3 toffee bars and 2 cashew bars the equilibrium condition is satisfied, which is the utility maximizing combination of two goods

11 11 Question 04 (7 marks) What are the constraints that a firm faces? How does each constraint limit the firm s profit? The three types of constraints a firm faces are technology constraint, information constraint and market constraint. Technology is any specific method of production a good and it advances over time. Using the available technology, the firm can produce more only if it hires more resources, which will increase its costs and limit the profit of additional output. Information is never complete, for the future or the present. A firm is constrained by limited information about the quality and effort of its work force, current and future buying plans of its customers, and the plans of its competitors. The cost of coping with limited information itself limits profit. Market constraints means that what each firm can sell and the price if can obtain are constrained by its customers willingness to pay and by the prices and marketing efforts of other firms. The expenditures a firm incurs to overcome the market constraints limit the profit of the firm can make.

12 12 Question 05 (6 marks) What is the difference between a firm and the market? What are the basic assumptions for a competitive market to exist? A firm is a production unit produces any goods/services, whereas the market/industry is the combination of all similar type of firms where goods are traded. For instance, in Canada, Ford is a car manufacturing firm and there are several other car manufacturing firms as well. Altogether we call it car market or industry. For a competitive market to exist: a) There are a large number of firms and each firm produces a homogeneous good. b) Free entry/exit: any firm can enter the market any time and leave if cannot survive c) Information is symmetrical *END OF EXAMINATION*

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