FIRST HOUR EXAM ANSWERS

October 10, 2002

Professor Douglas Blair

Test Form A

PART A: Multiple choice. The correct answers are highlighted in blue.

(20 questions ´ 3 points each = 60 points)

1. Pick the normative statement from the list below:

A. If we doubled the size of transfer payments directed toward the poor, we could eliminate poverty.

B. Old age pensions raise the living standard of the elderly.

C. Increased female unemployment is due, in part, to the increased number of women looking for jobs.
D. We need to expand the food stamp program to make the lives of the poor more tolerable.

2. The opportunity cost of building a new civic center in your hometown would be:

A. the money cost of the structure.

B. the necessary increase in tax revenue to finance the building.

C. the highest valued bundle of other goods and services that must be foregone because of the civic center project.

D. the enjoyment that must be foregone because the limited capacity of the current structure prevents many people from attending events.

3. Assume that the supply curve for binnacles shifts to the right. This might be caused by:

A. a decrease in the price of inputs required to make binnacles.

B. an increase in the tax imposed on producers of binnacles.

C. a decrease in income.

D. an decrease in the number of firms in the industry.

4. The number of people seeking to obtain tickets to a Radiohead concert is nearly always greater than the number of available tickets (and seats) to the concert. This is evidence that the price of the ticket is:

A. below the equilibrium level.

B. above the equilibrium level.

C. too high for many to afford.

D. at the equilibrium level because the number of tickets bought always equals the number of tickets for sale.

5. Which of the following circumstances would be likely to produce an upward movement in price?

A. Q_D = 7,800; Q_S = 7,450

B. Q_D = 7,450; Q_S = 7,800

C. Q_D = 7,450; Q_S = 7,450

D. Q_D = 6,800; Q_S = 7,000

6. If both demand and supply were to increase, then equilibrium:

A. quantity would fall and price would rise.

B. quantity and price would both be indeterminate.

C. quantity would rise and price would be indeterminate.
D. quantity would be indeterminate and price would rise.

7. If each 5 percent increase in the price of gasoline reduces by 2 percent the quantity purchased, the price elasticity of demand for gasoline is:

A. -0.4

B. -2.0

C. -2.5

D. -5.0

8. The demand for salt is probably less elastic than the demand for potatoes because:

A. potatoes require salt but salt does not require potatoes.

B. salt will keep longer than potatoes before spoiling.

C. there is so much potential salt in the ocean.

D. salt is cheap relative to most users' incomes and has few good substitutes.

9. The Illinois Central Railroad once asked the Illinois Commerce Commission for permission to increase its hauling rates by 20%. The railroad argued that declining revenues made this rate increase essential. Opponents of the rate increase contended that the railroad's revenue would fall because of the rate hike. It can be concluded that:

A. both groups felt that the demand was elastic.

B. both groups felt that the demand was inelastic.

C. the railroad felt demand for passenger service was inelastic and opponents of the rate increase felt it was elastic.

D. the railroad felt that demand for passenger service was elastic and opponents of the rate increase felt it was inelastic.

10. If the demand curve for product B shifts to the right as the price of product G declines, it can be concluded that:

A. B and G are substitutes in consumption.

B. B and G are complements in consumption.

C. B is an inferior good and G is a normal good.

D. B is a normal good and G is an inferior good.

11. An increase in supply will lower price unless:

A. supply is perfectly inelastic.

B. demand is perfectly inelastic.

C. it is followed by an increase in quantity demanded.

D. demand is perfectly elastic.

12. Assume that the demand curve for product Z shifts to the left. This might be caused by:

A. an increase in the price of X if X and Z are substitutes.

B. an increase in the cost of producing Z.

C. a decrease in income if Z is a normal good.

D. a decrease in the price of Y if Y and Z are complements.

13. All of the following would affect the supply of automobiles except one. Which one would not affect the supply of autos?

A. higher prices for steel.

B. an increase in disposable income.

C. a technological improvement reducing the production cost of autos.

D. increased wages for members of the United Auto Workers.

14. If the Rutgers Theater Company increases ticket prices for its performances and we observe that total ticket revenue decreases, we can conclude that:

A. the demand for performances is elastic with respect to price.

B. the demand for performances is inelastic with respect to price.

C. the demand for performances has unitary elasticity with respect to price.

D. performances are an inferior good.
E. performances are a normal good.

15. If a 1 percent increase in the price of X increases the quantity demanded of Y by 2 percent, then X and Y are:

A. complements and the cross elasticity is 2.

B. substitutes and the cross elasticity is 1/2.

C. substitutes and the cross elasticity is 2.

D. complements and the income elasticity is 2.

16. When effective, both price ceilings and price floors lead to:

A. increased sales.

B. an increase in consumer surplus.

C. a reduction in quantity bought and sold.

D. an increase in product quality.

17. Suppose that the equilibrium wage in the low-skilled labor market is $6.25 per hour. Further, suppose the federal government raises the minimum wage to $6.00 an hour from its present level of $5.15. The government's action of increasing the minimum wage will result in:

A. a decrease in unemployment.

B. an increase in unemployment.

C. a shortage of low-skilled labor.

D. neither a shortage nor a surplus of labor in the low-skilled labor market.

18. A fall in the price of lemons from $10.50 to $9.50 per bushel raises the quantity demanded from 19,200 to 20,800 bushels. The price elasticity of demand in this part of the demand curve is

A. -8.00.
B. -1.25.
C. -0.80.
D. -1.20.

19. By engaging in international trade, nations can, in effect,

A. consume at any point on their production possibility curves.

B. consume inside their production possibility curves.

C. consume outside their production possibility curves.

D. shift their production possibility curves outward.

20. If the price of chicken sandwiches rises, then in the market for hamburgers:

A. supply increases and quantity demanded increases.

B. demand increases and quantity supplied increases.

C. supply decreases and quantity demanded decreases.

D. demand decreases and quantity supplied decreases.

PART B: Answer all questions in the space provided.

1. (20 points) The demand and supply for coin-operated skyhooks are given by the equations:

P = 80 ? 3 Q (demand)

P = 20 + 3 Q (supply)

A. Determine the equilibrium price and quantity in this market. Show your work.

Solve simultaneously the supply and demand functions:

B. Suppose that an improvement in technology increases supply at all prices by 10 units. What is the effect on equilibrium price and quantity?

Solve the supply equation for Q:

To obtain the equation for the shifted supply curve, add 10 to this expression:

[Notice that this expression is NOT the same as would be obtained by adding 10 to the right-hand side of the original supply function. Shifting the supply function UP by $10 at every quantity is not the same as shifting it to the RIGHT by 10 units at every price.]

In the other versions of the exam, either the demand curve or the supply curve is shifted to the left or to the right by 10 units. In each version, the key issue is obtaining the correct expression for the shifted function. In each case it is necessary to solve the appropriate equation for Q before adding or subtracting 10.

Now solve simultaneously this equation for the shifted supply curve and the original demand curve:

C. Does the equilibrium quantity change by 10 units, or by more, or by less? Explain why.

The equilibrium quantity increases only by 5, from 10 to 15. The reason is that price has fallen from 50 to 35. Quantity supplied would increase by 10 only if the supply shift caused no price change?that is, if supply were perfectly elastic.

[Notice that exactly the same issues arise in this question as in Assignment 2, Question 5.]

2. (20 points) The production possibility curves for two countries, Orkney and Shetland, are illustrated below. The only productive resource in each country is labor. Orkney has 100 units of labor, while Shetland has 25 units of labor.

A. Which country, if any, has a comparative advantage in haggis?

Which country, if any, has a comparative advantage in kilts?

The negative of the slope of the production possibility curve in each country is the opportunity cost of the good on the horizontal axis measured in terms of units of the good on the vertical axis. Thus:

Opportunity costs

	Haggis	Kilts
Orkney	4/5 kilt	5/4 haggis
Shetland	2/3 kilt	3/2 haggis

A country has a comparative advantage in a good if it has the lowest opportunity cost for that good. The lower values in each column are highlighted in red. Thus Shetland has a comparative advantage in haggis, while Orkney has a comparative advantage in kilts.

Which country, if any, has an absolute advantage in haggis?

Which country, if any, has an absolute advantage in kilts?

Shetland, which has 25 units of labor, can produce 150 units of haggis if it produces no kilts. Thus the productivity of a single unit of labor must be 150/25, or 6 units of haggis. Similarly, since Shetland can produce using all its labor 100 kilts, the productivity of a single unit of labor in kilt-making must be 100/25 = 4. Applying the same logic to Orkney and gathering the results, we have the following table of productivities:

	Haggis	Kilts
Orkney	2.5	2
Shetland	6	4

The larger values in each column are highlighted in green. Thus Shetland has an absolute advantage in the production of each good.

B. If these countries engage in international trade, would you expect that Orkney exports kilts or Haggis? Why?

Both countries can gain from trade if they specialize in producing the good in which they have a comparative advantage, exporting it in exchange for the good in which they have have a comparative disadvantage. Thus Orkney exports kilts.