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Department of Economics Prof. Gustavo Indart

University of Toronto J une 14, 2013



ECO 100Y
INTRODUCTION TO ECONOMICS
Midterm Test # 1



LAST NAME


FIRST NAME


STUDENT NUMBER


Check your section of the course: L0101 (M/W from 2:00 to 4:00 PM)
L0201 (T/R from 2:00 to 4:00 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 /20
Part II 1. /10
2. /10
3. /10
4. /14
5. /8
6. /8
TOTAL /80

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PART I (20 marks)
Instructions: Write your answers to the multiple choice questions on the table below. Each
question is worth 2 marks. No deductions will be made for incorrect answers.

1 2 3 4 5 6 7 8 9 10

1. It has been observed that university enrolment in Canada is higher during periods of high
unemployment. Which one of the following might help to explain this observation?
a) During periods of high unemployment, tuition fees are reduced.
b) During periods of high unemployment, teachers work harder.
c) When prospects for getting a job are poor, the opportunity cost of going to university
is lower.
d) When prospects for getting a job are poor, the opportunity cost of getting a job is
lower.
e) None of the above.

2. A welder makes $25 an hour and must take two hours off work (without pay) to go to the
dentist for a filling. The welder uses public transportation to go to the dentist at a cost of $5.
The dentist charges $100. The welders opportunity cost of going to the dentist is:
a) $50.
b) $55.
c) $105.
d) $150.
e) none of the above.

3. Assume a person reveals the following demand conditions: at a price of $10 quantity
demanded is zero and at a price of $1 quantity demanded is 10 units. Which one of the
following is correct?
a) The consumer surplus is zero at a price of $10.
b) The consumer surplus is the area under the entire demand curve.
c) The consumer surplus is zero at a price of $1.
d) Demand decreases as the price decreases.
e) None of the above is correct.


Use this space for rough work.



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4. Assume that apples and oranges are substitute goods. If the supply and demand curves for
apples have the usual slopes, a reduction in the price of oranges will tend to
a) increase the price of apples.
b) increase the demand for apples.
c) increase the demand for oranges.
d) decrease the price of apples.
e) none of the above.

5. Assume that lettuce and tomatoes are complementary goods. If the supply and demand
curves for lettuce have the usual slopes, an increase in the price of tomatoes will tend to
a) decrease the price of lettuce.
b) increase the demand for lettuce.
c) increase the demand for tomatoes.
d) decrease the demand for tomatoes.
e) none of the above.

6. Suppose all farmers grow both wheat and oats for sale. If the price of oats increases, we
can predict that farmers will react in such a way that:
a) the demand for wheat will increase causing the price of wheat to fall.
b) the supply of wheat will decrease causing the price of wheat to rise.
c) the price of wheat will not be affected.
d) the price of wheat might rise or fall but the supply of wheat will definitely fall.
e) the price of wheat will fall and the supply of wheat will decrease.

7. If wheat farmers were faced with a demand curve of unit elasticity, then
a) a shift in the supply curve of wheat would have little effect on wheat prices.
b) a poor wheat harvest would cause a drop in total revenues for farmers.
c) a good wheat harvest would cause a drop in total revenues for farmers.
d) the total revenues of farmers would not change due to shifts in the supply curve for
wheat.
e) none of the above would be correct.


Use this space for rough work.



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8. If the price elasticity of demand for CDs is 0.5, then a 20% increase in price will
a) reduce quantity demanded by 40%.
b) reduce quantity demanded by 5%.
c) increase total expenditure.
d) increase quantity demanded by 40%.
e) increase quantity demanded by 10%.

9. The supply of oats is completely inelastic at 100 million units per year. The government
estimates that it would have to buy 10 million units to maintain the price at $5 per unit. It also
estimates that the market would be cleared, without government intervention, if the price
were allowed to fall to $4. If the governments estimates are correct, the price elasticity of
demand for oats must be:
a) Zero.
b) Greater than zero but less than one.
c) One.
d) Greater than one but less than five.
e) Five or more.

10. A consumer buys both pizza and colas. Their prices are $3 and $1 respectively. At the
goods.


Use this space for rough work.


a) She likes pizzas more than colas no matter how many of each she consumes.
b) She is maximizing her total utility at the current consumption point.
c) She should buy more pizzas and fewer colas to maximize satisfaction.
d) She should buy fewer pizzas and more colas to maximize satisfaction.
e) Nothing can be determined until we know whether pizzas and colas are normal
current consumption point (which exhausts income), her marginal utility of pizza is 21 utils
and her marginal utility of colas is 10 utils. What can be concluded from the above?

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PART II (60 marks)
Instructions: Answer all questions in the space provided.
Question 1 (10 marks)
A commodity is a healthy choice for consumers (label it G for good). Another commodity,
which is a substitute for G, is a less healthy, poorer choice (label it B for bad.) Both are legal
and available in the marketplace at equal prices. The government wishes to encourage the
consumption of G.
Statement: A consumer advocate proposes that the government should impose a price ceiling
on G, in order to reduce its price, thereby making it more affordable for consumers, who would
then buy more of it and less of B.
Position: Do you agree with this policy advice? With the help of proper diagrams, analyze the
implications of this advice in the markets for both G and B. In your analysis, assume that
resources cannot be transferred between G production and B production.

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Question 2 (10 marks)
The Toronto Star informs that there has been technological improvement in the production of
widgets.
Statement: J ustin argues that, as learned in ECO 100, productivity improvement will lead to a
lower price for widgets. He further states that a lower price will lead to higher demand, and a
higher demand will lead to a higher price. Therefore, J ustin concludes that productivity
improvement could result in a lower price of widgets, a higher price of widgets, or the same
price for widgets.
Position: Do you agree with J ustins analysis about the impact of innovation in widget
production? Explain your position with the help of a proper diagram.

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Question 3 (10 marks)
J ason spends all his income on two normal goods, X and Y (consuming always some of each).
The two goods are substitutes. The price of good X falls while the price of good Y remains
unchanged. His indifference curves are convex.
Statement: Rachel, an ECO100 student, concludes that as a result of the fall in the price of
good X, J ason will necessarily end up buying more of both goods X and Y.
Position: Do you agree with Rachels conclusion? Explain your position with the help of a
proper diagram.

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Question 4 (14 marks)
Consider the following demand and supply curves for sunglasses:
Demand: P =80 2Q
Supply: P =8 +Q



a) (3 marks) What are the equilibrium price (P*) and equilibrium quantity (Q*)? What is the
value for the consumer surplus (CS)? Show all your work (i.e., clearly show how you
obtained all these values).




b) (2 marks) Suppose now that an effective price floor is set at $40. What quantity will be
bought and sold in the market? Will there be an excess demand or supply? If so, how much
is this excess demand or excess supply? Show all your work (i.e., clearly show how you
obtained all these values).






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c) (2 marks) In a fully labelled diagram (including all values), clearly show your answers to part
a) and part b) above.
























d) (3 marks) Suppose now that there is no price floor, but a tax of $6 per unit is introduced on
the producers. What is the new equilibrium price that consumers will pay (P
C
)? What is the
(net of tax) price received by producers (P
P
)? What is the new equilibrium quantity? Show all
your work (i.e., clearly show how you obtained all these values).
80
Q
CS
D
P
8
24 32
40
40 20
32
ES
S

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e) (2 marks) How is the cost of the unit tax shared between the consumers and producers?
What is the total tax amount received by the government? Show all your work (i.e., clearly
show how you obtained all these values).












f) (2 marks) In a fully labelled the diagram (including all values), clearly show below the initial
equilibrium of part a) above and your answer to part d) above. Also, show the area of
Deadweight Loss (DWL) i.e., the loss in Economic Surplus from the imposition of the unit-tax
(you need not calculate its value).

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Question 5 (8 marks)
Bob lives in the Kingdom of Scrooge. He has a fixed income which he uses to consume cakes
(C) and other goods (Y). He faces given fixed prices of C and Y. His indifference curves are
convex. He always maximizes his satisfaction.
a) (1 mark) Show his initial equilibrium in each diagram below, labeled Point A, when he
consumes some of both C and Y.


Diagram #1 Diagram #2

Y Y












C C


b) (4 marks) There is an interesting development in the Kingdom the price of cakes falls. But
The Great King Scrooge is determined not to let Bob get any benefit from this development.
He calls in two of his economists for advice:
Economist #1 recommends that Scrooge impose a tax on income that leaves Bob at
the same satisfaction as he had before the price of cakes changed. Show the result
of this policy in the left diagram, labelling the new equilibrium as Point B.
Economist #2 recommends that Scrooge impose a tax on income that permits Bob to
just buy, if he wished to do so, the very same quantities of C and Y as he had before
the price of cakes changed. Show the result of this policy in the right diagram,
labelling the new equilibrium as Point C.
c) (3 marks) To confirm what your diagrams are showing, circle the proper answer below:
i) As compared to #1, the tax required in #2 is (higher / same / lower).
ii) As compared to Point A, consumption of cakes in #1 will be (higher / same /
lower).
iii) Which diagram above illustrates the Substitution Effect (SE) as developed in class?
(#1 / #2 / both #1 and #2 / neither #1 nor #2)

BL
1 BL
1
BL
2
BL
2
I
1
I
1
A
B
A
C
I
2

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Question 6 (8 marks)
Rachel consumes only two goods: pizza (Z) and cola (C). Her marginal rate of substitution
(MRS) between these two goods is given by the equation MRS =Z / 2C. For example, if Rachel
consumes 2 pizzas and 2 colas, her MRS at that point would be 2/4 =0.5. The price of pizza is
$2 and the price of cola is $1. Rachel has a daily budget of $12 for pizza and cola.

a) (2

b) (2 marks) What is Rachels equilibrium combination of pizza and cola? Show all your work
(i.e., clearly show how you obtained these values).
c) (2 marks) Suppose there is a special on pizzas and its price falls to $1. What is Rachels
new equilibrium combination of pizza and cola? Show all your work (i.e., clearly show how
you obtained these values).
d) (2 marks) Given your answers to parts b) and c), draw Rachels demand curve for pizza.
(Note: You must fully label the diagram and clearly indicate all relevant points.)
marks) What is the expression for Rachels budget line?