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## Department of Economics Prof. Gustavo Indart

University of Toronto June 5, 2009

ECO 100Y
INTRODUCTION TO ECONOMICS
Midterm Test # 1

LAST NAME

FIRST NAME

STUDENT NUMBER

Check your section of the course: L0201 (T/R from 2:00 to 4:00 PM)
L5101 (T/R from 6:00 to 8:00 PM)

INSTRUCTIONS: 1. The total time for this test is 1 hour and 50 minutes.
2. Aids allowed: a simple calculator.
3. Write with pen instead of pencil.

DO NOT WRITE IN THIS SPACE

Part I /40
Part II 1. /10
2. /10
3. /9
4. /9
5. /12
6. /10

TOTAL /100

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PART I (40 marks)

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 you class section on the SCANTRON sheet either L0201 or L5101 where it says
DO NOT WRITE IN THIS SPACE.
Each question is worth 2.5 marks. No deductions will be made for incorrect answers.
Write your answers to the multiple choice questions ALSO in the table below. You may
use this question booklet for rough work, and then transfer your answers to each multiple
choice question to the table AND 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 2 3 4 5 6 7 8
E D B B B E E C
9 10 11 12 13 14 15 16
B A B A A D D E

1. Which one of the following would cause the demand curve in an industry to increase?
A) The price of a substitute decreased.
B) Disposable income increased and the good was an inferior good.
C) The price of a complement increased.
D) Disposable income decreased and the good was a normal good.
E) None of the above.

2. Under which one of the following circumstances would the industry supply curve shift
down?
A) The price of labour increases.
B) The government imposes a quota on the industrys output.
C) The government introduces a specific commodity tax on the industry.
D) Energy prices decrease for each firm.
E) The government imposes an effective price floor.

3. If Michelle used \$1,000 from her savings account, which was paying 6 percent interest
annually, to invest in her brothers new sporting-goods store, the opportunity cost of her
investment on an annual basis would be
A) her share of the stores profits.
B) \$60.
C) \$1,000.
D) \$1,060.
E) None of the above.

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4. At a garage sale, Heba purchases a used bicycle for \$40 when she was willing to pay \$75.
If the bicycle costs \$200 new, Hebas consumer surplus is
A) \$0.
B) \$35.
C) \$115.
D) \$160.
E) None of the above is correct.

5. If per capita income increases by 10 percent and household expenditures on fur coats
increase by 15 percent, one can conclude that the price elasticity of demand for fur coats is
A) positive.
B) not determinable from the information given.
C) elastic.
D) unity.
E) inelastic.

6. Price elasticity of demand
A) is greater than one if the percentage increase in the commoditys price is greater
than the percentage decline in quantity demanded.
B) is higher for an entire group of related products than it is for a particular product in
that group.
C) is a positive number because price and quantity demanded move in the same
direction.
D) is very small when close substitutes are readily available for the commodity.
E) usually increases over time.

Diagram 1: Production Possibility Curve

Quantity
of good Y

PPC
1
PPC
2

Quantity of good X

7. In Diagram 1, the shift of the production possibility curve from PPC
1
to PPC
2
might be the
result of
A) an increase in the quantity of resources available for production.
B) an increased preference for good X.
C) an increase in the quantity of resources combined with a technological improvement
in the X industry.
D) technological improvement throughout the economy.
E) None of the above is true.

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Diagram 2: Production Possibility Curve

A
Quantity
of good Y
B
PPC

Quantity of good X

8. If a country were producing at point B as shown in Diagram 2,
A) the opportunity cost of moving to point A is to give up some units of good X.
B) the opportunity cost of moving to point A is to give up some units of good Y.
C) the opportunity cost of moving to point A is zero.
D) this is the maximum output possible with existing resources.
E) it is not possible to move to point A without technological progress.

9. Because bagels and cream cheese are often eaten together, they are complements. We
observe that both the equilibrium price of bagels and the equilibrium quantity of cream
cheese have risen. What could be responsible for this pattern?
A) An increase in the price of milk (used to produce cream cheese).
B) A fall in the price of milk.
C) A fall in the price of flour (used to produce bagels).
D) An increase in the price of flour.
E) A decrease in the price of muffins, a close substitute for bagels.

10. When the price of flour used to produce bread falls, the consumer surplus associated with
the consumption of bread
A) will definitely increase.
B) will definitely decrease.
C) will increase if bread is a normal good.
D) will decrease if bread is an inferior good.
E) None of the above is true.

11. A museum increases its admission price by 10 percent. As a result, total revenues
decrease by 10 percent. This implies that, ignoring its sign, the price elasticity of demand
A) less than one.
B) greater than one.
C) equal to one.
D) unaffected by price changes.
E) is not determinable from the information given.

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Diagram 3: Price Elasticity of Demand

A

Price B

C

D
1

Quantity

12. In Diagram 3, the price elasticity of demand
A) at point A is greater than at point C.
B) is equal at points A, B, and C.
C) at point A is less than at point C.
D) at point A is equal to that at point C.
E) is not determinable from the information given.

Diagram 4: Price Elasticity of Demand

A

B
Price

D
1

D
2

Quantity

13. In Diagram 4, the price elasticity of demand
A) at point A is greater than at point B.
B) is equal at points A and B.
C) at point A is less than at point B.
D) at point A cannot be compared to that at point B.
E) is not determinable from the information given.

14. Bad weather causes a serious crop failure and reduces output in the California orange
industry, however the total revenue of California orange growers increases. Which one of
the following statements is correct given these circumstances?
A) The supply curve for oranges is inelastic.
B) The supply curve for oranges is elastic.
C) The demand curve for oranges is elastic.
D) The demand curve for oranges is inelastic.
E) None of the above.

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15. Consumers will bear a larger burden of a unit-tax if
A) demand is relatively elastic and supply is relatively inelastic.
B) the tax is collected by firms rather than remitted directly to the government by
consumers.
C) both demand and supply are relatively elastic.
D) demand is relatively inelastic and supply is relatively elastic.
E) both demand and supply are relatively inelastic.

TABLE 1

16. Sandys demand schedule for soccer games is given in Table 1 above. Suppose the game
is sold out and Sandy cannot buy tickets except from a scalper. The scalper offers her one
ticket at \$20 and a second ticket at \$10. If Sandy accepts this offer, what is the value of her
consumer surplus?
A) \$10.
B) \$20.
C) \$30.
D) More than \$30, but less than \$32.
E) \$0.

Price
Per Ticket
Quantity
Demanded
\$1 4
\$2 3
\$10 2
\$20 1

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PART II (60 marks)

Instructions: Answer all questions in the space provided.

Question 1 (10 marks)
Richards weekly demand for playing tennis is given by the following table:
Price per hour (for each
player) of court time
5 4 3 2 1 0
Hours of tennis
demanded per week
0 1 2 3 4 5
a) The only tennis courts available are at The Annex Tennis Club where each player is
charged \$2 per hour (independently of whether the player uses the court for the whole hour
or not). How much tennis does Richard play per week? (1 mark) What is, in money terms,
his weekly consumer surplus from playing tennis? Briefly explain. (3 marks)
i) If P = 2, then Q = 3
ii) Consumer surplus is the difference between the maximum price the consumer is willing to
pay for each hour of court time and the price he is actually paying. Richards weekly
consumer surplus for the first hour is \$4 \$2 = \$2, for the second hour is \$3 \$2 = \$1, and
for the third hour is \$2 \$2 = \$0. Therefore, his total weekly consumer surplus is \$3.

b) The Annex Tennis Club is considering a pricing scheme whereby individuals still pay \$2 per
hour of court time, but in addition they must also pay a mandatory membership fee. What is
the largest fee The Annex Tennis Club could charge for a weekly membership without losing
Richard as a customer? Briefly explain. (3 marks)
The membership fee will reduce Richards consumer surplus. Therefore, the maximum
membership fee Richard might be willing to pay is equal to his total consumer surplus (\$3).

c) As an alternative pricing scheme, suppose that The Annex Tennis Club introduces a
membership fee but does not charge members for court time (i.e., members are entitled to
unlimited use of the facility). What is the maximum fee Richard is willing to pay for a weekly
membership under these circumstances? Briefly explain. (3 marks)
If P = 0, then Q = 5. Richards weekly consumer surplus is thus as follows: \$4 for the first hour,
\$3 for the second hour, \$2 for the third hour, \$1 for the fourth hour, and \$0 for the fifth hour, for
a total \$10. Therefore, Richard will be willing to pay up to \$10 for the membership fee.

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Question 2 (10 marks)
Last week you purchased a non-refundable ticket for todays baseball game. Although you paid
only \$15 you were willing to pay up to \$30 for this ticket. Your father was to give you a ride to
the ballpark but his car broke down and now your only option is to take a taxi.
a) Suppose the taxi ride to the ballpark will cost you \$10 each way (i.e., a total of \$20). Further
assume that the best alternative to attending the game is to stay home (which you value at
\$0). Assuming you are a rational individual, will you go to the game (and pay for the taxi
ride) or stay home (and lose your ticket for the game)? Explain your answer in economic
terms. (5 marks)

You value attending this game to the equivalent of \$30 (i.e., the maximum price you were willing
to pay for a ticket). Therefore, you will attend the game as long as the opportunity cost of going
to the game is less than \$30. Whats your opportunity cost of attending the game? It includes
the value of the best alternative forgone staying home, which has a value of \$0 and the
\$20 of the cost of the taxi ride. It does not include the cost of the ticket itself because this is
sunk cost, i.e., you already paid for this ticket and you cannot recover this expenditure by
staying home. Therefore, as a rational individual you will decide to attend the game because the
opportunity cost (\$20) is less than the value you assign to this activity (\$30).

b) While you are still deciding whether to go to the game or not, your friend Rob drops by
unexpectedly and you invite him to come with you to the game. Rob who enjoys baseball
almost as much as you do is willing to pay up to \$20 for a ticket but he can buy it at the
door for \$15. You tell Rob that he must pay half of the cost of the taxi ride (i.e., he must pay
\$10). Will Rob also a rational individual agree to split the cost of the taxi ride and
attend the baseball game or will he prefer to go home which he also values at \$0? Explain
your answer in economic terms. (5 marks)

Rob values attending this game to the equivalent of \$20, the maximum price he is willing to pay
for a ticket. Therefore, he will attend the game as long as the opportunity cost of going to the
game is less than \$20. Whats his opportunity cost of attending the game? It includes the \$0
value of the best alternative forgone (staying home), the \$10 of his share of the cost of the taxi
ride, and the \$15 of the cost of the ticket at the door. Robs opportunity cost of attending the
game is thus \$25, which is higher than the value he assigns to this activity (\$20). Therefore, as
a rational individual, Rob will decide not to attend the game.

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Question 3 (9 marks)
Suppose that the market for tomatoes is in equilibrium at P = 1,000 and Q = 4,000 tons, where
P is price in dollars of one ton of tomatoes and Q is tons of tomatoes per week.
a) What is the price elasticity of demand at the point of equilibrium if the slope of the demand
curve is -0.2 at this point? (3 marks)
= (P
0
/Q
0
) / (P/Q) = (1000/4000) / (-0.2) = -1.25 [or 1.25 in absolute value]

b) Suppose that a tomato disease causes a shift in supply that results in a new equilibrium at
P = 1,400 and Q = 2,000 tons. What is the arc price elasticity of demand between the pre-
disease equilibrium of part a) and this new equilibrium? (3 marks)

= (Q / Q
ave
) / (P / P
ave
) = (-2000 / 3000) / (400 / 1200) = -2

where P
ave
= (1000 + 1400)/2 = 1200 and Q
ave
= (4000 + 2000)/2 = 3000

c) Go back to the initial equilibrium of part a) above. Suppose now that the price of lettuce a
complement of tomatoes increases by 10%. If the cross-price elasticity of demand
between lettuce and tomatoes is equal to 4, what will the new equilibrium quantity of
tomatoes sold in the market be? (3 marks)

TL
= % Q
T
/ % P
L
% Q
T
= (% P
L
) (
TL
) = (10%) (4) = 40% [or 0.4]

Accepted as correct if your answer is as follows:

Q
2
= Q
1
0.4 Q
1
= 0.6 Q
1
= 0.6 (4000) = 2400

A bonus of 2 additional marks (for a total of 5 marks) if your answer is as follows:

% Q
T
= [(Q
2
Q
1
) / Q
ave
] = 0.4 where Q
ave
= (Q
2
+ Q
1
) / 2

Therefore, 0.4 Q
ave
= Q
2
Q
1
) 0.4 (4000 + Q
2
) / 2 = Q
2
4000

800 0.2 Q
2
= Q
2
4000 1.2 Q
2
= 3200 Q
2
= 2666

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Question 4 (9 marks)
Jessica always spends one-third of her income on books.
a) What is her income elasticity of demand for books? Explain your answer. (3 marks)

Y
= % Q / % Y

If Jessica always spends one-third of her income on books, then % Q = % Y. Indeed, if her
income increases by 10%, for instance, she will spend 10% on books and thus, all else equal,
she will by 10% more books.

Therefore,
Y
= 1.

b) What is her price elasticity of demand for books? Explain your answer. (3 marks)

= % Q / % P

If Jessica always spends one-third of her income on books, then as P changes her total
expenditure remains unchanged, which means that Q changes in the same proportion as P but
in the opposite direction. In other words, in absolute value % Q = % P and thus = 1.

c) If Jessicas tastes change and she decides to spend only one-fourth of her income on
books, how does her demand curve for books change? What are her income elasticity and
price elasticity for books now? Explain your answer. (3 marks)

If now Jessica decides to spend always one-fourth of her income on books, then as before
% Q = % Y and
Y
= 1.
Also as before, as P changes her total expenditure on books remains unchanged at the new
level, which means that Q changes in the same proportion as P but in the opposite direction and
thus = 1.
What will happen to her demand curve? Since she decides now to spend less on books (1/4
instead of 1/3 of her income), then at each price level she will be buying fewer books than
before. That is, her demand curve will shift inwards.

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Question 5 (12 marks)
The demand and supply schedules for milk are shown in the table below, where price is
expressed in dollars per unit and quantities are expressed in thousands of gallons per week.
Price 1 2 3 4 5 6 7 8 9 10
Quantity
demanded
14 13 12 11 10 9 8 7 6 5
Quantity
supplied
6 7 8 9 10 11 12 13 14 15
a) What is the equilibrium price and quantity? Briefly explain. (2 mark)

The equilibrium price is \$5 and the equilibrium quantity is 10 units since at this price level (\$5)
the quantity demanded is equal to the quantity supplied (10 units).

b) Draw the demand (D) and supply (S) curves in the diagram below and clearly show the
market equilibrium (point A). (1 mark)

8
5
20
3
15
10
Q
S
12
P
D
A
4
10 15
7
Excess
demand
S
5
6
Subsidy

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c) The government now imposes a price ceiling of \$3 per gallon. What is the new quantity
demanded? What is the new quantity supplied? Is there a shortage or a surplus of milk?
Clearly show your answer below and in the above diagram. (3 marks)

When the price is \$3, the quantity demanded is 12 thousand gallons per week while the quantity
supplied is 8 thousand gallons per week. There is, therefore, a shortage of 4 thousand gallons
per week.

d) If a black market for milk were to arise, what would be minimum price of a gallon of milk in
such a market? Show this price in the above diagram. (1 mark)

Since the quantity produced is only 8 thousand gallons, some consumers will be willing to pay at
least \$7 for a gallon of milk.

e) Go back to the initial equilibrium of part a). Suppose now that the government, instead of
imposing a price ceiling, gives a subsidy of \$2 per gallon of milk to producers. Fill in the new
quantities supplied in the table below and draw the new supply curve in the above diagram.
What is the new equilibrium quantity transacted in the market? What price will consumers
pay per gallon of milk? What price will producers receive per gallon of milk? Show these
results in the above diagram. (5 marks)

Price paid by
consumers
1 2 3 4 5 6 7 8 9 10
Quantity
demanded
14 13 12 11 10 9 8 7 6 5
New quantity
supplied
8 9 10 11 12 13 14 15 16 17

This subsidy allows producers to ask consumers a lower minimum price per gallon of milk, i.e.,
a price \$2 lower per gallon. For instance, the minimum price required to produce the 10
th
gallon
was \$5 and it is now only \$3. The new quantities supplied at each price level are now as shown
in the table above.
The new equilibrium market price is \$4 and the equilibrium quantity is 11 units since at this price
level (\$3) the quantity demanded is equal to the quantity supplied (11 units).
While consumers pay a price of \$4, producers receive the amount paid by consumers plus the
subsidy for a total of \$6.
These results are also shown in the above diagram.

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Question 6 (10 marks)
Anastasia enjoys attending both baseball games (X-axis good) and football games (Y-axis
good). She has a budget of \$200 to attend baseball and football games over the summer.
Baseball tickets sell for \$10 and football tickets sell for \$5. Suppose that Anastasia, whose
indifference curves for baseball and football games have the usual convex shape, buys 5
baseball tickets and 30 football tickets per season. With this consumption bundle, her marginal
rate of substitution (MRS) of baseball games for football games is 3.
Is Anastasia maximizing her utility with this consumption bundle? If not, what should she do to
maximize her utility? Explain your answer with the help of a clearly labelled diagram.

Anastasia is not maximizing her utility at her present consumption combination of baseball (BG)
and football games (FG) point A in the above diagram. Indeed, two conditions must be
satisfied for utility maximization 1) the bundle must lie on the consumers budget line; and 2)
at that bundle the MRS must be equal to the relative prices of the two goods, i.e., MRS = P
BG
/
P
FG
and Anastasias consumption bundle satisfies only the first of these two conditions.
The MRS is equal to the absolute value of the slope of the indifference curve, and at point A it is
equal to 3. The relative price of the two goods is equal to the absolute value of the slope of the
budget line: P
BG
/ P
FG
= \$10 / \$5 = 2. Therefore, MRS > P
BG
/ P
FG
at point A and Anastasia must
change the combination of BG and FG in order to increase and eventually maximize her utility.
We have seen that the MRS can be expressed as the ratio of the marginal utilities of the two
goods, i.e., MRS = MU
BG
/ MU
FG
. We have also seen that the MU of a commodity decreases as
the quantity consumed of the commodity increases. Therefore, in order to increase her level of
utility until its maximized, Anastasia must substitute BG for FG. As BG increases, the MU
BG
falls
while as FG decreases, the MU
FG
rises, and thus the MRS decreases. This process of
substitution of BG for FG must continue until the MRS becomes equal to the ratio of the relative
prices of the two goods and utility is maximized i.e., at point B in the diagram above.
5 20
30
BG
40
FG
B
A