Mid-term Exam Principles of microeconomics

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1 Mid-term Exam Principles of microeconomics Uni ID: Name: Notes: The exam is between 8:40-10:10 AM. After 10:10 AM, if you write anything in the exam paper, 30 points will be subtracted from your final test score. If you cheat in anyway, you can only get 0. If you need more space, please write in the other side of the paper. 1. Ture of False. Write F or T in the parentheses after the statement. (20 points totally, and 2 for each) a) Demand curve is drawn downward sloping to show that price and quantity demanded will move in opposite directions as long as other relevant factors remain unchanged. ( T ) b) An increase in the price of compact discs would shift the demand curve for DVD players to the left. ( T ) c) A rise in supply is illustrated by an upward shift in the supply curve. d) The supply curve for a commodity will shift to the right when the costs of production rise. e) If the demand for a good is high, then there will be a shortage of that good. f) Suppliers of a commodity are better off whenever the legal incidence of a tax is shifted away from the suppliers to the demanders. g) If a rise in supply and a rise in demand occur at the same time, then we know that the price must also rise. h) A farmer has a comparative advantage at growing wheat if his cost of growing wheat is less than the cost of another farmer growing wheat. i) By definition, someone who has an absolute advantage must also have a

2 comparative advantage. j) Tom can make one table or mow 20 lawns in a 10 hour work day. Because Tom is more productive mowing lawns, we conclude that he has an absolute advantage in that activity. 2. Multiple choice (10 points totally, and 2 points for each). a) When the price of a barrel of crude oil rises, what will be the immediate effect on the market for home heating fuel produced from crude oil? ( c ) (a) The demand for the fuel will fall. (b) The quantity demanded of fuel will rise. (c) The supply of fuel will fall. (d) The quantity supplied of fuel will fall. b) Which of the following would cause the demand curve for rice to shift to the left? ( c ) (a) A rise in the price of rice. (b) A blight that destroyed 75% of the rice harvest. (c) A report claiming that the starch in rice causes heart disease. (d) A tariff that doubles the price of imported spaghetti. c) At the equilibrium point of a market, ( c ) (a) Supply equals demand. (b) Neither demanders nor suppliers are satisfied. (c) The quantities supplied and demanded are equal. (d) Suppliers will refuse any price increases offered by demanders. d) New safety regulations increase manufacturers' costs of producing insulation. What happens in the market for insulation? ( b ) (a) The demand falls as buyers refuse to bear the higher production costs. (b) The supply falls, resulting in a higher equilibrium price and lower equilibrium quantity. (c) Both supply and demand fall, resulting in less insulation being bought and sold. (d) The supply rises as manufacturers attempt to use higher sales to offset their lower profit margins. e) Assume that the demand curve for oranges is downward-sloping and the supply

3 curve for oranges is upward-sloping. If the government imposes an excise tax of 10 cents per orange, then the total price (including the tax) that demanders must pay for an orange ( b ) (a) Remains unchanged. (b) Rises by less than 10 cents per orange. (c) Rises by exactly 10 cents per orange. (d) Rises by more than 10 per orange. 3. Draw a circular-ow diagram. Identify the parts of the model that correspond to the ow of goods and services and the ow of dollars for each of the following activities (10 points) : a) Sam pays a shopkeeper $1 for a litre of milk. b) Terry earns $4.50 per hour working at a fast-food restaurant. c) Uma spends $7 to see a film. d) Violet earns $10,000 from her 10 per cent ownership of Acme Industrial. Solution: 4. You won a free ticket to see Guo Degang Talk Show (which has no resale value). TF boys are performing on the same night and is your next-best alternative activity. Tickets to see TF boys cost 400 RMB. On any given day, you would be willing to pay 500 RMB to see TF boys. Assume there are no other costs of seeing either performer. Please answer the following questions (10 points): a) Define opportunity cost (in one or two sentences).(5 points)

4 Solution: Opportunity cost is the value of the next best alternative forgone as a result of making a decision. b) Based on the information, what is the opportunity cost of seeing Guo Degang? (5 points) Solution: The correct answer is 100 RMB, the net value to you of buying a ticket and attending the Guo Degang talk show, which is your next best alternative. 5. Consider the market for station wagons ( 旅行车, 大空间 ). For each the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether demand or supply is increased or decreased. (20 points) a) People decide to have more children (4 points). Solution: If people decide to have more children, they'll want larger cars, so the demand for station wagons will increase. Supply won't be affected. The result is an increase in both price and quantity. b) A strike by steel workers raises steel prices (4 points). Solution: If a strike by steel workers raises prices, the cost of producing a station wagon rise (a rise in input prices), so the supply of station wagons decreases. Demand won't be affected. The result is a rise in the price of station wagons and a decline in the quantity.

5 c) Engineers develop new automated machinery for the production of station wagons (4 points). Solution: The development of new automated machinery for the production of station wagons is an improvement in technology. The reduction in firm's costs results in an increase in supply. Demand isn't affected. The result is a decline in the price of station wagons and an increase in the quantity. d) The price of mini-vans rises (4 points). Solution: The rise in the price of mini-vans affects station wagon demand because mini-vans are substitutes for station wagons. The result is an increase in the demand for station wagons. Supply isn't affected. In equilibrium, the price and quantity of station wagons both rise.

6 e) A stock market crash lowers people's wealth (4 points). Solution: A reduction by people's wealth caused by a stock market crash reduces their income, leading to a reduction in the demand for station wagons, since station wagons are a normal good. Supply isn't affected. As a result, both price and quantity decline. 6. Suppose that your demand schedule for compact discs is as follows (10 points): a) Calculate your price elasticity of demand as the price of compact discs increases from $8 to $10 if (i) your income is $10,000, and (ii) your income is $12,000 (5 points).

7 Solution: (i) If your income is $10,000, your price elasticity of demand as the price of compact discs rises from $8 to $10 is [(40-32)/36]/[(10-8)/9] = 1. (ii) If your income is $12,000, the elasticity is [(50-45)/47.5]/[(10-8)/9] = 9/19 = 0.47 b) Calculate your income elasticity of demand as your income increases from $10,000 to $12,000 if (i) the price is $12, and (ii) the price is $16 (5 points). Solutions: (i) If the price is $12, your income elasticity of demand as your income increases from $10,000 to $12,000 is [(30-24)/27]/[( )/11000] = 11/9 = (ii) If the price is $16, your income elasticity of demand as your income increases from $10,000 to $12,000 is [(12-8)/10]/[(12, , 000)/11,000] = 11/5 =2:2. 7. For each of the following pairs of goods, identify which one you would expect to have more own-price elastic demand. Please explain your reasoning. (20 points) a) (5 points) Computers (generally) vs. Apple MacBook Pro laptops. Solution: Apple MacBook Pro, because it is a specific brand and has more substitutability. b) (5 points) Stereo headphones (generally) vs. hearing aids. Solution: Stereo headphones, since they tend to be less of a necessity good than hearing aids. For each of the following goods, identify whether you would expect demand to be more (own-price) elastic in the short run or the long run. As above, please briefly explain your reasoning. c) (5 points) Retail gasoline in the suburbs of Wulumuqi, Xinjiang. Solution: More price elastic in the long run, because people cannot effectively adjust to necessity goods like gasoline in the short run, while in the long run, people can substitute it with electricity (hybrid cars), diesel, public transportation, etc. d) (5 points) Air conditioning (A/C) units in Guangzhou. Solution: More price elastic in the short run, because there are other good

8 substitutes in the short run, such as fans. If there were a sudden increase in the price of A/C units, people could delay their purchase of a unit for a few days or weeks. But in the long run, there is no good substitute for A/C.