Name ________________**SOLUTIONS**________________

Economics 280
Health Economics
Professor Eric Jamelske

Pre-Test (63 points)

Part 1: Multiple Choice

2 points each

(24 points)

Mark your answers to the multiple choice questions directly on this exam.

1. Economics is primarily the study of

a. money and the stock market.
b. how society manages its scarce resources.
c. determining what to produce, how to produce it, and how to distribute what is produced.
d. both b and c are correct.
e. a, b and c are all correct.

2. The economic problem is a result of

a. scarcity.
b. taxes that are too high and too much government spending.
c. too few resources to satisfy society's wants and desires (and needs).
d. both a and c are correct.
e. a, b and c are all correct.

3. Which of the following is one of the four economic principles of individual decision making?
a. Rational people make decisions based on average costs and benefits.
b. Rational people respond to incentives.
c. The cost of something is the amount of money you pay to get it.
d. both b and c are correct.
e. a, b, and c are all correct.

4. To say that people make decisions at the margin means that they:
a. wait until the last minute before making a decision.
b. weigh the additional costs and additional benefits of small changes.
c. make decisions that determine whether or not they will live their lives on the edge of subsistence.
d. make decisions on issues that are relatively unimportant for their economic well-being.
e. There is not enough information to answer this question.

5. Normative economics is most closely associated with

a. a description of a particular situation.
b. observation and empirical analysis of a particular situation.
c. the making of policy prescriptions to improve a particular situation.
d. both a and b are correct.
e. a, b and c are all correct.

6. In the production possibilities model, an economy is said to be inefficient if

a. it is possible to produce more of one good without producing less of another.
b. it is possible to produce more of all goods with an advancement in the available technology.
c. it is not possible to produce more of one good without producing less of another.
d. both b and c are correct.
e. there is not enough information to answer this question.

For questions 7 & 8, assume a competitive labor market for nurses and use standard S & D analysis.
7. Suppose the number of nursing graduates increases. Which of the following statements is true in the labor market
for nurses?
a. The demand curve will shift to the left.
b. The supply curve will shift to the left.
c. The supply curve will shift to the right.
d. The demand curve will shift to the right.
e. There is not enough information to answer this question.

8. Again assuming that there is an increase in the number of nursing graduates and there is also a simultaneous
increase in the average age of the population, and therefore there is an increased need for nurses to meet the rising
demand for medical services. Relative to the initial situation (before either change occurred), which of the following
statements is true in the labor market for nurses? The wage paid to nurses
a. must fall.
b. must rise.
c. will fall if the demand for nurses rises more than the supply of nurses rises.
d. will rise if the demand for nurses rises more than the supply of nurses rises.
e. There is not enough information to answer this question.

9. Consider a situation in which there is a quantity less than the competitive market equilibrium quantity being
bought and sold. Such an outcome is inefficient because
a. all transactions that could benefit market participants have taken place.
b. all transactions that could benefit market participants have not taken place.
c. markets are always inefficient unless they are regulated.
d. both b and c are correct.
e. there is not enough information to answer this question.

10. In a competitive free market, ____________ determines how much of a good will be sold and the price at which
it is sold?
a. producers.
b. consumers.
c. the government.
d. both consumers and producers.
e. both c and d are correct.

11. In 1992 a family had an income of $20,000 and had an average of $50 in health care expenditures, while in the
year 2000 this family had an income of $40,000 and had an average of $500 in health care expenditures. Assuming
there was no inflation, this shows that on average
a. health care is a normal good.
b. health care is a necessity good.
c. health care is a luxury good.
d. both a and b are correct.
e. both a and c are correct.

12. Feeling that prescription drug prices are far too high, the government wishes to implement a policy designed to
improve both the accessibility and affordability of prescription drugs for consumers. Which of the following policies
would most likely achieve this goal? Hint: Assume a competitive market for prescription drugs and use standard S
& D analysis.
a. A binding price floor.
b. A binding price ceiling.
c. A tax on producers.
d. A subsidy to either producers or consumers.
e. There is not enough information to answer this question.

Part 2: True / False

2 points each

(22 points)

Next to each statement, write a T if the statement is True and write an F if the statement is False.

1. The economic way of thinking uses models to simplify reality in order to improve our understanding of the world.
True

2. Normative economic analysis provides a description of the way the world works through observation and
description.
False

3. Positive economic analysis uses the information provided from normative economics to prescribe public policy
designed to improve a particular decision.
False

4. The law of supply states that (all else equal) there is a positive relationship between the price of a good and the
quantity of that good that producers will wish to supply.
True

5. The law of demand states that (all else equal) there is a positive relationship between the price of a good and the
quantity of that good that consumers will wish to purchase.
True

6. All else equal, if Coke and Pepsi are substitutes, an increase in the price of Coke will cause an increase
in both the equilibrium price and quantity in the market for Pepsi.
True

7. All else equal, an advance in the technology employed to produce roller blades will cause a decrease in
the equilibrium price and an increase in the equilibrium quantity in the market for roller blades.
True

8. All else equal, an increase in the supply of coffee accompanied by an decrease in the demand for coffee
will cause a decrease in both the equilibrium price and quantity in the market for coffee.
False

9. When the price of a good is below the equilibrium price, it causes a surplus (excess supply) in the market
for that good.
False

10. If there is a shortage (excess demand) in the market for a good, then the price of that good will tend to
rise as a result of market forces.
True

11. If the price elasticity of demand for blue jeans is -0.3, a 10% increase in the price will cause the
quantity demanded to rise by 0.3%.
False

Part 3: Short answer / analysis

(17 points)

Answer these questions in the space provided.

Please be neat and organized and answer each question completely and show all of your work.

1. The Opportunity Cost of Travel (10 points)

Assume that travel from Eau Claire to Minneapolis (a distance of 80 miles) takes 1.5 hours by car or 2.5 hours by
train. The price of a train ticket is $12, while the price of the car ride is $4 in gasoline plus the depreciation of your
vehicle which is $0.10 per mile traveled. The going wage for work in Minneapolis is $10 per hour worked (use this
as a measure of the opportunity cost of time).
Hint: Although this question is about what you are giving up and getting, it is not quite as literal as the PPF example
where opportunity cost is strictly defined as a fraction where opportunity cost = (what you give up / what you get).
For this question you must consider the activity of getting to Minneapolis and you have a choice of two alternative
modes of travel. The benefit of each mode of travel is the same.you get to Minneapolis. However, the cost of each
mode of travel is different. All I am asking you for here is what is given up to get to Minneapolis under each travel
method.
In the end, you would choose the option with the lowest cost. I am asking you to calculate the total opportunity cost
(in $) of each mode of travel. Hint: Keep it simple and basic.

a. What is the opportunity cost of traveling to Minneapolis (one way) under each mode of travel? Hint: I need a
specific calculation of dollar amounts. Keep it simple and basic. What method of travel would people choose?
(4 points)

Opportunity cost of train = ($12) + (2.5) * ($10) = $37

ticket price + forgone wages

Opportunity cost of car = ($4) + ($0.10) * (80) + ($10) * (1.5) = $27

gas + depreciation + forgone wages

People would choose to travel by car because the opportunity cost is lower.

Note: This is somewhat reflective of reality although it is a simple example. For a variety of reasons, mostly time
and convenience most people prefer their own car to public transportation options.

b. What effect would speeding up the train ride have on the opportunity cost of train travel to Minneapolis? How
much shorter (in hours) would the train ride need to be to induce travelers to take the train? Hint: Be very specific.
(3 points)

The opportunity cost of the train would decrease because it would take less time.
If the speed of the train was increased so that it only took 1.5 hours then the total opportunity cost of the train
would be reduced by $10 which would be equal to the cost of traveling by car.

All else equal, speeding up the train (or making it more convenient would decrease the opportunity cost of train
travel.

c. Alternatively, what effect would a toll or fee on travel between Eau Claire and Minneapolis have on the
opportunity cost of car travel to Minneapolis? How much would the toll need to be (in $) to induce travelers to take
the train? Hint: Be very specific. (3 points)

The opportunity cost of the car would increase because of the extra money paid for the toll.
If the toll were $10 then the total opportunity cost of the car would be increased by $10 which would be equal to
the cost of traveling by train.
All else equal, charging a toll (or raising the price of gas, increasing parking fees) would increase the cost of cat
travel.

2. Supply & Demand Analysis (7 points)

The following graph gives the market demand and supply for ground beef with Q in millions of pounds per year and
P in $ per pound.

a. Label the supply curve (S) and the demand curve (D) and clearly illustrate the equilibrium price (P1) and quantity
(Q1) on your diagram? (2 points)
P

Ground Beef
S'
S

P2

P1
D
Q2

Q1

b. Suppose there is a drought which decreases the supply of corn. Assuming corn is the most common grain fed to
cattle as they are raised for market. Illustrate the effect of this drought in your diagram of the market for ground
beef. Be sure to label any new curves that you draw and clearly identify the new equilibrium price (P2) and quantity
(Q2). (2 points)

In the corn market, the S and the P due to the drought (not shown here).
In the cattle market, P as the S shifts to the left due to the higher cost of raising cattle (not shown here).

In the market for ground beef, the S curve shifts left due to an increase in the price of an input to the production
process (shown above).
7

c. Very briefly explain the disequilibrium caused by this shock as well as the process of adjustment to a new
equilibrium. (3 points)

The shift of the S curve to the left means less will be supplied at all prices creating a shortage as Qd > Qs at P1.
There will be upward pressure on the P to ration the limited quantity among the many who want to buy.
As the P Qd as buyers respond and the market will eventually settle in at the new equilibrium.

Shortage

Qd

Law of Demand (as consumers respond to higher price)

The new equilibrium price will be higher

The new equilibrium quantity will be lower