Practice Questions for Midterm Exam 1 (Solutions) ECON1900 – Principles of Economics Section 1: True or False 1. A rational decision-maker takes an action if and only if the marginal cost exceeds the marginal benefit. False 2. Positive statements can be evaluated using data alone, but normative statements cannot. True 3. If a country has the comparative advantage in producing a product, then that country must also have the absolute advantage in producing that product. False 4. Prices allocate a market economy’s scarce resources. True 5. A decrease in supply will cause an increase in price, which will cause a decrease in quantity demanded. True 6. Rational people act only when the marginal benefit of the action exceeds the marginal cost. True 7. Normative statements can be refuted with evidence. False. 8. Talented people that are the best at everything have a comparative advantage in the production of everything. False. 9. If Coke and Pepsi are substitutes, an increase in the price of Coke will cause an increase in the equilibrium price and quantity in the market for Pepsi. True. 10. If all countries have the same opportunity costs of production, then there are no gains from trade. True. 11. If wages for accountants rose, then accountants’ leisure time would have a lower opportunity cost. False. 12. Suppose one county in Missouri decides it wants to reduce alcohol consumption, so the county passes a law that raises the price of a bottle of beer by $1. As a result, people drive to other counties to drink alcohol, which results in an increase in drunk driving. This illustrates the principle that people respond to incentives. True. 13. All scientific models, including economic models, simplify reality in order to improve our understanding of it. True. 14. It takes Ross 6 hours to produce a bushel of corn and 2 hours to wash and polish a car. It takes Courtney 6 hours to produce a bushel of corn and 1 hour to wash and polish a car. Courtney and Ross cannot gain from specialization and trade, since it takes each of them 6 hours to produce 1 bushel of corn. False. 15. If something happens to alter the quantity demanded at any given price, then the demand curve shifts. True. 16. Economics is the study of how society allocates its unlimited resources. False 17. Economic models can help us understand reality only when they include all details of the economy. False 18. It is possible for the U.S. to gain from trade with Germany even if it takes U.S. workers fewer hours to produce every good than it takes German workers. True 19. In a competitive market, there are so few buyers and so few sellers that each has a significant impact on the market price. False 20. If a person expects the price of socks to increase next month, then that person’s current demand for socks will increase. True Section 2: Multiple Choice 1) When computing the opportunity cost of attending a concert you should include A) the price you pay for the ticket and the value of your time. B) the price you pay for the ticket, but not the value of your time. C) the value of your time, but not the price you pay for the ticket. D) neither the price of the ticket nor the value of your time. 2) Which of the following would not result from all countries specializing according to the principle of comparative advantage? A) The size of the economic pie would increase. B) Worldwide production of goods and services would increase. C) The well-being of citizens in each country would be enhanced. D) Each country would become more self-sufficient 3) One thing economists do to help them understand how the real world works is A) make assumptions. B) ignore the past. C) they try to capture every aspect of the real world in the models they construct. D) All of the above are correct. 4) Ben bakes bread and Shawna knits sweaters. Ben and Shawna both like to eat bread and wear sweaters. In which of the following cases is it impossible for both Ben and Shawna to benefit from trade? A) Ben cannot knit sweaters and Shawna cannot bake bread. B) Ben is better than Shawna at baking bread and Shawna is better than Ben at knitting sweaters. C) Ben is better than Shawna at baking bread and at knitting sweaters. D) Both Ben and Shawna can benefit from trade in all of the above cases. 5) Mike and Sandy are two woodworkers who both make tables and chairs. In one month, Mike can make 4 tables or 20 chairs, where Sandy can make 6 tables or 18 chairs. Given this, we know that the opportunity cost of 1 chair is A) 1/5 table for Mike and 1/3 table for Sandy. B) 1/5 table for Mike and 3 tables for Sandy. C) 5 tables for Mike and 1/3 table for Sandy. D) 5 tables for Mike and 3 tables for Sandy. 6) If Shawn can produce more donuts in one day than Sue can produce in one day, then A) Shawn has a comparative advantage in the production of donuts. B) Sue has a comparative advantage in the production of donuts. C) Shawn has an absolute advantage in the production of donuts. D) Sue has an absolute advantage in the production of donuts. 7) High-school athletes who skip college to become professional athletes A) obviously do not understand the value of a college education. B) usually do so because they cannot get into college. C) understand that the opportunity cost of attending college is very high. D) are not making a rational decision since the marginal benefits of college outweigh the marginal costs of college for high-school athletes. 8) If the price of visiting a doctor were fixed below the current price, then we would expect A) an increase in the number of visits people want to make and an increase in the number of visits health care providers want to provide. B) an increase in the number of visits people want to make and a decrease in the number of visits health care providers want to provide. C) a decrease in the number of visits people want to make and an increase in the number of visits health care providers want to provide. D) a decrease in the number of visits people want to make and a decrease in the number of visits health care providers want to provide. Table 3-1 Assume that Sardi and Tinaka can switch between producing corn and producing pork at a constant rate. Minutes Needed to Make 1 Bushel of Pound of Corn Pork Sardi 20 12 Tinaka 15 10 9) Refer to Table 3-1. Assume that Sardi and Tinaka each has 360 minutes available. If each person divides his time equally between the production of corn and pork, then total production is A) 10.5 bushels of corn and 16.5 pounds of pork. B) 21 bushels of corn and 33 pounds of pork. C) 35 bushels of corn and 22 pounds of pork. D) 42 bushels of corn and 66 pounds of pork. 10) Refer to Table 3-1. What is Tinaka’s opportunity cost of producing one bushel of corn? A) 2/3 pound of pork B) 3/4 pound of pork C) 5/6 pound of pork D) 3/2 pounds of pork 11) Assume the market for tennis balls is perfectly competitive. When one tennis ball producer exits the market, A) the price of tennis balls increases. B) the price of tennis balls decreases. C) the price of tennis balls does not change. D) there is no longer a market for tennis balls. 12) You love peanut butter. You hear on the news that 50 percent of the peanut crop in the South has been wiped out by drought, and that this will cause the price of peanuts to double by the end of the year. As a result, A) your demand for peanut butter will increase, but not until the end of the year. B) your demand for peanut butter increases today. C) your demand for peanut butter decreases as you look for a substitute good. D) your demand for peanut butter shifts left today. 13) The market for ice cream is A) a monopolistic market. B) a highly competitive market. C) a highly organized market. D) both (b) and (c) are correct. 14) The demand curve for textbooks shifts A) when a determinant of the demand for textbooks other than income changes. B) when a determinant of the demand for textbooks other than the price of textbooks changes. C) when any determinant of the demand for textbooks changes. D) only when the number of textbook-buyers changes. 15) Last year, Sheila bought 6 pairs of shoes when her income was $40,000. This year, her income is $50,000 and she purchased 10 pairs of shoes. Holding other factors constant, it follows that Sheila A) considers shoes to be a necessity. B) considers shoes to be an inferior good. C) considers shoes to be a normal good. D) has a low price elasticity of demand for shoes. 16) Rational people make decisions at the margin by A) following marginal traditions. B) behaving in a random fashion. C) thinking in black-and-white terms. D) comparing marginal costs and marginal benefits. 17) Economists, like mathematicians, physicists, and biologists, A) make use of the scientific method. B) try to address their subject with a scientist’s objectivity. C) devise theories, collect data, and then analyze these data in an attempt to verify or refute their theories. D) All of the above are correct. 18) When an economist points out that you and millions of other people are interdependent, he or she is referring to the fact that we all A) rely upon the government to provide us with the basic necessities of life. B) rely upon one another for the goods and services we consume. C) have similar tastes and abilities. D) are concerned about one another’s well-being. 19) Which of the following is not a reason people choose to depend on others for goods and services? A) to improve their lives B) to allow them to enjoy a greater variety of goods and services C) to consume more of each good without working any more hours D) to help others because they don’t profit from it 20) Suppose that a worker in Radioland can produce either 4 radios or 1 television per year and a worker in Teeveeland can produce either 2 radios or 5 televisions per year. Each nation has 100 workers, and each country specializes according to the principle of comparative advantage. If Radioland trades 100 televisions to Teeveeland in exchange for 100 radios each year, then each country's maximum consumption of new radios and televisions per year will be A) higher than it would be in the absence of trade because of the gains from trade. B) the same as it would be in the absence of trade. C) less than it would be in the absence of trade because neither country is specializing in the product in which it has a comparative advantage. D) less than it would be in the absence of trade because Teeveeland has an absolute advantage in both goods and so it cannot benefit by trading with Radioland. Section 3: Short Answer 1) What is the difference between a "change in demand" and a "change in quantity demanded?" Graph your answer. Answer: A) A change in demand refers to a shift of the demand curve. A change in quantity demanded refers to a movement along a fixed demand curve. B) A change in price causes a change in quantity demanded. All of the other changes listed shift the demand curve. A change in quantity demanded price A change in demand price D D quantity D' quantity 2) For each of the following changes, determine whether there will be a change in quantity demanded (QD) or a change in demand (D). A) a change in the price of a related good D B) a change in tastes D C) a change in the number of buyers D D) a change in price QD E) a change in income D 3) What do you think is the elasticity of supply for a Goya painting? Why? If there is a sudden increase in demand for Goya paintings, would you expect to see a relatively large or small price change result? Graph your answer. Finally, give two reasons why there might be an increase in demand for Goya paintings. Since Francisco Goya died nearly 200 years ago, the supply is fixed. (There are only so many paintings in existence, and that cannot change.) As such, the elasticity of supply will be highly or even perfectly inelastic. For a given increase in demand, we should expect a large increase in price for Goya paintings. Demand can increase in response to any change in a non-price determinant of demand. So, either there is 1) an increase in preference for Goya paintings, 2) an increase in income (assuming Goya´s are normal goods), 3) a decrease in the price of complementary goods (galleries, etc.), 4) an increase in the price of substitute goods (Rembrandt paintings, etc.), 5) an increased number of buyers or 6) any change to an expectation of the aforementioned reasons. 4) During the last few decades in the United States, health officials have argued that eating too much beef might be harmful to human health. As a result, there has been a significant decrease in the amount of beef produced. Which of the following best explains the decrease in production? Individual consumers, concerned about their own health, decreased their demand for beef, which lowered the equilibrium price of beef, making it less attractive to produce. 5) The price of taxis has recently increased in Madrid. Give 4 separate explanations for why this may be the case. (Be specific.) The rise in price can only be explained by either a decrease in supply or an increase in demand. Increases in demand come from: 1. Increase in income 2. Decrease in price of complement 3. Increase in price of substitute 4. Increase in preferences 5. A change in expectations concerning any one of these determinants 6. More people demanding taxis Decreases in supply can only come from: 1. Increased cost of taxi operation 2. Decrease taxi technology 3. Decrease in the number of taxi producers 4. Change in expectations concerning any of these determinants. It is insufficient to say that a price decrease caused the price to decrease – you must use a nonprice determinant of demand. 6) What is the difference between a "change in supply" and a "change in quantity supplied?" Graph your answer. Answer: A) A change in supply refers to a shift of the supply curve. A change in quantity supplied refers to a movement along a fixed supply curve. B) A change in price causes a change in quantity supplied. All of the other changes listed shift the supply curve. A change in quantity supplied A change in supply price price S S quantity S' quantity 7) For each of the following changes, determine whether there will be a change in quantity supplied (QS) or a change in supply (S). A) A change in price QS B) A change in technology S C) A change in the costs of production S D) A change in the expectations concerning the future. S 8) Provide an example of a good that is highly demand inelastic, giving at least two reasons why this is so. Using the equation that defines demand elasticity, give an explanation for what it means for something to be demand inelastic. Finally, do you think that the fact that this good is demand inelastic necessarily means that its price must be high or low? Why? Answer: Any good that 1) is a necessity as opposed to a luxury, 2) has few substitutes, 3) is a broadly defined good or 4) is purchased and consumed over longer as opposed to shorter time horizons, will be inelastic. Eggs are necessities (they are a food staple) and they have few substitutes. Studies repeatedly show that the price elasticity of demand for eggs is one of the lowest (most inelastic) of foods. Since PED=%change in Qd/% change in price, we can rearrange this to read: % change in Qd = PED * % change in price An inelastic good has a very low PED, between -1 and 0. This means that any change in price will only cause a proportionately smaller change to the Qd. (i.e., people buy the same, more or less.) Note that the equilibrium price does not depend on the elasticity. One common error is for people to think that inelastic goods (like necessities) must be expensive since we “need” to have them and will pay anything for them. Price results from the interaction of supply and demand, and the elasticity is just the result of that interaction.
