Question 1: Which of the following statements are false? ( 5 points)
(Mark all statements that are false) BE
A. Normative Economics relies on Positive Economics.
B. Positive Economics examines whether policies are fair.
C. Normative Economics relies on value judgements.
D. Positive Economics describes "what is" and normative economics describes "what ought to
be."
E. Positive Economics is based on facts and does not make assumptions whereas normative
economics rests on assumptions and is therefore purely subjective.
Question 2: Which of the following statements does not represents Milton Friedman's views
on economics as a positive science? (5 points)
(Mark all statements that are false) ABC
A. Economists should never make normative statements.
B. Economists should not make unrealistic assumptions as they undermine the empirical
conclusions drawn from them.
C. One should judge economic models only by whether they accurately describe the world.
D. Some economic models that rely on obviously false assumptions are widely successful for the
purposes they are designed for.
Note: For Q1 and Q2, you must mark all statements that are false to get marks. No partial
credits for incomplete choices or wrong choices.
Question 3 ( 10 points):
True or False?
For a linear Demand curve, the own price elasticity of Demand necessarily increases (in
magnitude) as the price increases.
True. ϵ =
ΔQ
P
⋅ . For a linear demand curve, say Q = a − bP , here b is positive
ΔP
Q
because demand curve is sloping downwards.
ΔQ
is the absolute value of slope, which is
ΔP
constant and equal to b . While
P
is increasing as price increases because demand curve is
Q
sloping downwards, when price goes up, quantity demanded decrease, thus
P
increases.
Q
Note: you get full marks if you indicate it’s true, otherwise no points. No justification
needed.
Question 4 (5 points):
True or False?
For a linear Supply curve, the own price elasticity of Supply necessarily increases as the price
increases.
False. ϵ =
ΔQ P
⋅
. For a linear supply curve, say Q = a + bP, here b is positive because
ΔP Q
supply curve is sloping upwards.
ΔQ
is the slope of supply curve, which is constant and
ΔP
equal to b. Since supply curve is sloping upwards, when price goes up, quantity supplied also
increase but the magnitude is determined by parameters a and b , thus
P
could be
Q
increasing, decreasing or even constant as price increases.
Note: you get full marks if you indicate it’s false, otherwise no points. No justification
needed.
Question 5 (10 points)
Assume that the own price elasticity of Demand for a good is -1 and the income elasticity of
Demand for this good is 2 . Assume that the price of the good increases by 2% and income
increases by 3%. How much does the quantity demanded change?
ΔQ
= 2% ⋅ (−1) + 3% ⋅ 2 = 4%. Quantity demanded will increase by 4%.
Q
Note: you get full marks only if you got the correct number and interpretation. Otherwise,
you might get zero or partial credits of one or two depending on your math work and
explanation.
Question 6 (10 points)
Assume that the Demand for a good is perfectly inelastic. Write down the Demand function for
this good using as parameters the letters of the alphabet.
ϵ=
ΔQ P
ΔQ
⋅
= 0 for all prices implies that
= 0, the slope of demand curve is zero.
ΔP Q
ΔP
Hence the demand function for this good is Q
= a + 0P = a, a > 0, a is a constant.
Note: you get full marks only if you got equation Q=a (you can use other symbols to
represent constant). Otherwise, you might get zero or only partial credits of one or two
depending on your math work and explanation.
Question 7 (5 points)
What sign is the cross-price elasticity of the Demand for Coffee with respect to changes in the
price of Tea?
Coffee and tea are substitutes. Hence, when price of tea increases, demand of coffee will also
increase, that means
ΔQcoff
ΔPtea
> 0 hence ϵc =
ΔQcoff
ΔPtea
⋅
P
> 0.
Q
Note: you get full marks if you indicate sign is positive or (+), otherwise zero. No explanation
needed.
Question 8 Aggregate Demand ( 20 points total)
Assume the Demand for a Good is given by Q=50-10* P and the supply the Good is perfectly
elastic when the price of the good is P=3.
In equilibrium:
A. What is the quantity exchanged in this market? (5 points)
In equilibrium, P=3 and Q = 50-10*3 = 20
B. What is the marginal willingness-to-pay in this market? (5 points)
marginal willingness-to-pay=equilibrium price=3
C. What is the marginal willingness-to-accept in this market? (5 points)
marginal willingness-to-accept=equilibrium price =3
Assume that the Demand for the Good shifts out by some amount. In this new equilibrium, what is
the marginal willingness to pay? What is the marginal willingness to accept? (2.5+2.5 points)
Since supply is perfectly elastic, equilibrium price is determined by supply curve only, i.e.,
P*=3 no matter how demand shifts. Marginal willingness to pay is 3 and marginal
willingness to accept is 3.
Note: you get full marks only if you got the correct number. No marks if you give a
range that includes the correct answer(e.g., 0<=MWTP<=3).