Economics 53
Introductory Microeconomics
Midterm 1
NAME:___ANSWER KEY_______________
Answer all the questions. Allocate your time according to the points that each question is worth.
There are 100 points in the exam. You should plan on spending 100 minutes to complete the
exam.
Part I Multiple Choice (44 Points, 2 Points each question)
Write the letter corresponding to the correct answer in the space next to the question
1. The statement, ʺThe minimum wage is harmful to teenagers and should be reduced
or eliminated to increase employment among teenagersʺ is an example of
A) a descriptive economic statement
B) a normative economic statement
C) a positive economic statement
D) an economic theory
1._______
2. Which of the following WILL NOT shift a country’s production possibilities frontier
outward (to the right)?
A) An increase in the amount of capital in the economy
B) A technological advance
C) A reduction in the number of unemployed
D) An increase in the amount of labor in the economy
2._______
3. As more of a good, such as television sets, is produced, the opportunity costs of
3._______
producing it increases. This most likely occurs because
A) as more of a good is produced the inputs used to produce that good will increase in price.
B) consumers would be willing to pay higher prices for the good as more of the good is produced.
C) resources are not equally well suited to producing all goods and as more of a good is
produced it is necessary to use resources less well suited to the production of that good.
D) as more of a good is produced the quality of that good declines and therefore the
costs of production increase.
4. Consider two countries, Ghana and Mali. Mali devotes a smaller portion of its
4._______
income to capital goods. All other things equal which of the following statements
is most likely true?
A) Ghana is a poorer country than Mali.
B) Mali will move up its production possibility curve faster than Ghana.
C) Mali is producing inside its production possibility frontier, whereas Ghana is
producing at a point on its production possibility frontier.
D) Ghanaʹs production possibility frontier will shift up and out farther and faster than Maliʹs.
5. During an economic downturn when household income falls, the demand for
tacos increases and the demand for sushi decreases. This implies that
A) tacos and sushi are complements
B) tacos are a normal good and sushi is an inferior good
C) tacos are an inferior good and sushi is a normal good
D) None of the above statements are true
5._______
6. Papayas and grapefruit are substitute goods. A drought in California destroyed
a good portion of the grapefruit crop. Holding all else constant (ceteris paribus),
A) the price of both papayas and grapefruit will increase.
B) the price of both papayas and grapefruit will fall.
C) the price of grapefruit will increase and the price of papayas will fall.
D) the price of grapefruit will fall and the price of papayas will increase.
6._______
7. Recent forest fires in the western states are expected to cause the price of lumber
to rise in the next 6 months. As a result we can expect the supply of lumber to
A) fall in 6 months, but not now.
B) increase in 6 months when the price goes up.
C) fall now.
D) increase now.
7._______
8 . Suppose that demand decreases AND supply decreases. What would you expect
to occur in the market for the good?
A) Equilibrium price would increase, but the impact on equilibrium quantity
would be ambiguous.
B) Equilibrium price would decrease, but the impact on equilibrium quantity
would be ambiguous.
C) Equilibrium quantity would decrease, but the impact on equilibrium price
would be ambiguous.
D) Both equilibrium price and equilibrium quantity would increase.
8._______
9. The price system
A) determines which households are allocated scarce goods
B) is inefficient.
C) requires government help to allocate goods.
D) is the only way to allocate goods.
9._______
10. If the government imposes a price ceiling that is above the equilibrium price,
A) the price ceiling will have no economic impact.
B) quantity demanded will be less than quantity supplied.
C) demand will be greater than supply.
D) the available supply will have to be rationed with a non-price rationing mechanism.
10.______
11. A patient that needs to take heart medication to stay alive most likely has a demand
for that drug that is
A) perfectly inelastic.
B) unit elastic.
C) perfectly elastic.
D) elastic
11.______
12. Your younger sister needs $50 to buy a new bike. She has opened a lemonade stand 12.______
to make the money she needs. She currently is charging 25 cents per cup, but she wants to
adjust her price to earn the $50 faster. If you know that the price elasticity of demand for
lemonade is elastic, what is your advice to her?
A) Leave the price at 25 cents and be patient.
B) Raise the price to 50 cents to increase total revenue.
C) Lower the price to 15 cents to increase total revenue.
D) There isnʹt enough information given to answer this question.
13. A bakery would be willing to supply 500 bagels per day at a price of $0.50 each.
At a price of $0.80, the bakery would be willing to supply 1,100 bagels. Using the
midpoint method, the elasticity of supply for bagels is about
A) 0.62.
B) 0.77.
C) 1.24.
D) None of the above
13.______
14. The cross-price elasticity of demand between good X and good Y is -3. Given this
information, which of the following statements is TRUE?
A) Goods X and Y are luxuries.
B) Goods X and Y are substitutes.
C) Goods X and Y are complements.
D) Goods X and Y are inferior.
14.______
15. A consumer that doesnʹt spend all of her income
A) would be at a point outside of her budget constraint.
B) would be at a point inside her budget constraint.
C) must not be consuming one or more goods.
D) must be consuming at a point where her budget constraint touches one of the axes.
15.______
16. The substitution effect of a wage decrease implies a ________ demand for
leisure and a ________ labor supply.
A) lower; higher
B) higher; lower
C) higher; higher
D) lower; lower
16.______
17. Jonathan is planning ahead for retirement and must decide how much to spend
and how much to save while heʹs working in order to have money to spend when
he retires. When the substitution effect dominates the income effect, an increase in
the interest rate on savings is likely to
A) increase saving.
B) decrease saving.
C) have no effect on saving.
D) All of the above are possible
17.______
Table 1
18. Refer to Table 1. If the hourly price of labor is $10 and the hourly price of
capital is $1, which production technology should be selected?
A) A
C) C
B) B
D) D
Table 2
Labor
0
1
2
3
4
5
6
18.______
Output (Number
of Oil Changes)
0
5
11
18
24
29
33
19. Refer to Table 2. Diminishing marginal returns begin when the
________ worker is hired.
A) first
C) fourth
B) second
D) sixth
19.______
20. Refer to Table 2. The average product of the third worker is
A) -6
B) 6
C) 7
D) None of the above
20.______
21. If marginal product is greater than average product, then
A) average product must be decreasing.
B) marginal product must be decreasing.
C) marginal product must be increasing.
D) marginal product could either be increasing or decreasing.
21.______
22. You own a business that answers telephone calls for physicians after their
offices close. You have an incentive to substitute capital for labor if the
A) price of capital increases.
B) price of labor decreases.
C) price of capital decreases.
D) marginal product of labor increases.
22.______
Part II Short-Answer Section (56 Points Total)
You must show your work to receive full or partial credit.
Question 1: Opportunity Costs and the Production Possibility Frontier (10 Points)
Kyle and Antoine are rival bakers. The table below show how many brownies and toffee bars each can
bake in 1 hour.
Brownies
Toffee Bars
Kyle
15
5
Antoine
4
4
(A) If each baker works a typical 40 hour workweek, draw the production possibility frontier for each
baker. Put “Brownies” on the horizontal (x-axis) and “Toffee bars” on the vertical (y-axis). Be sure to
identify the intercept values on your graphs. (3 points)
Kyle's PPF
250
Toffee Bars
200
150
100
PPF
50
0
0
100
200
300
400
Brownies
500
600
700
Kyle in 1 week can at
most produce 200
toffee bars (5 toffee
bars/hour x 40
hours). He can
produce at most 600
brownies in 1 week
(15 brownies/hour x
40 hours).
Toffee Bars
Antoine PPF
180
160
140
120
100
80
60
40
20
0
PPF
0
20
40
60
80
100
120
140
160
Antoine can at most
bake 160 toffee bars
in 1 week (4 toffee
bars per hour x 40
hours) while he can
bake at most 160
brownies (4 brownies
x 40 hours).
180
Brownies
(B) Suppose each baker decides to split their workweek evenly between baking brownies and baking
toffee bars. That is each worker will spend 20 hours baking brownies and 20 hours baking toffee bars.
Complete the table below to show each baker’s output of the two products and the total output between
them (3 Points)
Production and Consumption with No Trade (1 Week)
Brownies
Toffee Bars
Kyle
300
10
Antoine
80
80
Total Output
380
180
(C) Suppose the two bakers decide to specialize (by spending every hour of the work week baking either
brownies or toffee bars). Who should bake only brownies and who should bake only toffee bars? To
receive credit, you must show your work justifying your answer. (4 Points)
For Kyle in 1 hour he can bake either 5 toffee bars or 15 brownies. In ratio 5 toffee bars: 15 brownies.
To find the opportunity cost of producing 1 brownie, we divide both sides of the ratio by 15 to get:
1/3 toffee bar: 1 brownie.
Thus Kyle must sacrifice 1/3 toffee bar to produce 1 brownie.
For Antoine in 1 hour he can bake either 4 toffee bars or 4 brownies (4 toffee bars: 4 brownies)
The opportunity cost of producing 1 brownie is found by dividing the ratio by 4 on both sides.
1 toffee bar: 1 brownie
Antoine must sacrifice 1 toffee bar to produce 1 brownie.
Since Kyle has a lower opportunity cost (comparative advantage) in producing brownies he should
specialize in brownie production.
A similar calculation would have shown that Antoine’s opportunity cost of producing 1 toffee bar is 1
brownie, while Kyle must sacrifice 3 brownies to produce 1 toffee bar. Antoine has a lower opportunity
cost in producing toffee bars, thus he should specialize in toffee bar production.
Question #2: Demand and Supply (14 Points)
The market demand and supply curves for Duff Beer are given by the following equations:
Qd = 60 – 3P
Qs = 3P
(market demand curve)
(market supply curve)
(a) Graph the demand and supply curves together in one graph. In your graph be sure to label the
axes and the curves. Clearly indicate where the demand curve crosses the axes (find the X and Y
intercepts). (4 Points)
25
Demand
Supply
40
Quantity
60
Price ($)
20
15
10
5
0
0
20
80
The X-intercept for the demand curve is found by plugging P = 0 into the demand equation. We see
when P = 0, Qd = 60 – 3(0) = 60. Thus the x-intercept for the demand curve is (60,0) shown by Point B on
the graph. The y-intercept for the demand curve is found by plugging Q=0 into the demand equation.
Thus we have Q = 0 = 60 -3P or 3P = 60 → P = 20. The y-intercept for the demand curve is (0,30) which is
Point A on the graph. The x and y-intercept for the supply curve will be at the origin (0,0) which is Point
C on the graph.
(b) Calculate the equilibrium price and quantity algebraically. (2 Points)
At market equilibrium it must be the case that Qd=Qs. Set the market demand curve equal to the market
supply curve. 60 – 3P = 3P → 60 = 6P→ P = 10.
Thus the equilibrium price is P = 10.
To find equilibrium quantity just plug P = 10 to either the market supply or market demand curve. The
quantity will be the same.
Qd = 60 – 3(10) = 30 or Qs = 3(10) = 30
Thus the equilibrium quantity is 30.
(c) Calculate the consumer surplus, producer surplus and total surplus for Duff Beer. (3 Points)
Consumer surplus is the area below the demand curve but above the price paid by consumers. Since the
price paid by consumer is 10, it is the area of the triangle above $10 but below the demand curve.
Consumer Surplus = (½)(30)(10) = 150
Where 30 is the base of the triangle and 10 is the height of the triangle.
Producer surplus is the area above the supply curve but below the price received by firms. Producer
surplus in this case is the area of the triangle below $10 but above the supply curve.
Producer Surplus = (1/2)(30)(10) = 150.
Total Surplus is just consumer plus producer surplus = 150 + 150 = 300
(d) Suppose the equation for the supply curve changes to Qs = 3P -30. Does this new supply curve
indicate an increase or decrease in the supply curve? Suggest two possible explanations for the
indicated change in the supply curve. (3 Points)
The equation of the new supply curve shifts the supply curve upward to the left. You can also see this
by trying to graph the new supply curve.
25
20
A
Price
15
Qd
10
Qs
Qs (New)
5
0
C
0
B
20
40
60
80
Quantity (bottles of beer)
There are many reasons which could explain the upward shift in the supply curve, these are mainly due
to some type of increase in costs. Acceptable answers might include
1. Increase in cost of inputs
5. Increase in price of a related good
2. Increase in taxes
6. Expected increase in future price
3. Decrease of subsidies
7. A decrease in the number of suppliers.
4. Negative technological shock
(e) Calculate the new equilibrium price and quantity using the market supply curve equation in Part
(d). (2 Points)
Set the market demand curve equal to the market supply curve. 60 – 3P = 3P - 30 → 90 = 6P→ P =
15.
Thus the equilibrium price is P = 15.
To find equilibrium quantity just plug P = 15 to either the market supply or market demand curve.
Qd = 60 – 3(15) = 15 or Qs = 3(15)- 30 = 15
Thus the equilibrium quantity is Q = 15
Question #3: Applications of Demand and Supply (10 Points)
Refer back to the original market demand and supply curves for Duff Beer that was given in Question #2.
Qd = 60 – 3P
Qs = 3P
(market demand curve)
(market supply curve)
Suppose the town of Springfield imposes a price ceiling of $6 per bottle of Duff Beer.
(a) At the price ceiling of $6 calculate the shortage (excess demand) of bottles of Duff Beer. (2
Points)
At P = $6, the quantity demanded is equal to Qd = 60 – 3($6) = 42 bottles of beer
Likewise at P = $, the quantity supplied will be equal to Qs = 3($6) = 18 bottles of beer
Since quantity demanded exceeds quantity supplied we have a shortage of 42-18 = 24 bottles of beer.
(b) Propose one rationing mechanism that will determine which households of Springfield will get
the scarce bottles of Duff Beer. (2 Points)
Because the town of Springfield imposes a price ceiling, prices can no longer be used as a rationing
mechanism. In order to determine who gets the bottles of beer, non-price rationing mechanisms must be
used. Three examples are (1) standing in line (queing), (2) favored customers or (3) ration coupons.
(c) Calculate the deadweight loss that will result from the imposition of the price ceiling. (6 Points)
We know that the existence of a price ceiling will lead to underproduction. The optimal production is at
30, but the firms are only producing 18 bottles. The deadweight loss is the loss to society that arises from
the bottles that should be produced but are not. This is captured by the area of the shaded triangle.
Area of triangle = ½ (30-18)(14-6) = $48
Alternatively you could have calculated PS and CS and compared the total surplus to the total surplus
that existed before the price ceiling
The producer surplus is equal to the area below the new price of $6 and above the supply curve
PS = 1/2 (6)(18) = $54
Consumer surplus is a bit more tricky to calculate. It’s still the area below the demand curve and above
the price of $6. There is one additional caveat. Suppliers will only supply 18 units, thus consumers gain
surplus only up until the 18th unit. Thus the consumer surplus is the trapezoidal area labeled “CS”.
CS = ½(20)(18) + (8)(18) = $198
Total surplus under the price ceiling is $54+$198 = $252, which is $48 less than the original total surplus.
Thus the deadweight loss is $48.
Question 4: Elasticity (6 Points; 2 Points each)
For each pair of goods listed below, which good would you expect to have the more elastic demand? In
one or two sentences explain your answer.
(a) A bottle of pepper or a new house
A new house will have a more elastic demand. Housing costs represents a much greater share of a
household budget as opposed to pepper. Thus households will be more responsive if housing price
changes.
(b) A vacation to Tahiti or drinking water
A vacation to Tahiti will be more elastic. It is a luxury good, while drinking water is a necessity.
(c) Gasoline today or Gasoline 5 years in the future
Gasoline 5 years in the future will be more elastic. Consumers have a longer time to adjust their behavior
to any anticipated changes in price of gasoline (i.e. they can start using public transportation or buy a
hybrid car).
Question 5: Budget Constraint (9 Points)
Assume that Darth Vader buy only two goods: inhalers for his breathing problem and black capes. Lord
Vader gets an income of 1000 Imperial Credits from the Emperor. The price of an inhaler is 5 Imperial
Credits, and the price of a black cape is 10 Imperial Credits.
(a) Draw Lord Vader’s budget constraint. Plot inhalers on the vertical (y-axis) and black capes on
the horizontal (x-axis). Clearly show the intercepts. In your graph be sure to indicate the
opportunity set (choice set) for Darth Vader. (3 points)
To find Darth
Vader’s budget constraint, you
need to find the two intercepts.
To find the y-intercept it’s a
matter of asking how many
inhalers could Darth Vader
purchase if he spent his entire
income of 1000 credits on
inhalers. In this case its 1000/5 =
200. To find the x-intercept,
what is the total amount of black
capes he could purchase with
his income. It will be 1000/10 =
100. Thus with your two
intercepts found you can just
draw a line between them to
form your budget constraint.
The opportunity set is all the
affordable bundles that Lord
Vader could purchase. It’s the
area below the budget constraint.
(b) Calculate the slope of the Lord Vader’s budget constraint. (2 Points)
The slope of the budget line is
− PX
10
= − = −2
PY
5
(c) Suppose that the price of an inhaler increases to 10 Imperial Credits while the price of a black
cape remains at 10 Imperial Credits. Given the new price for an inhaler draw Lord Vader’s new
budget constraint. Clearly show the intercepts. What has happened to Lord Vader’s opportunity
set relative to the situation in (a) above? Is Lord Vader better off or worse off after the change in
price? Explain. (4 Points)
With an increase in the price of
inhalers, Lord Vader can now
purchase less inhalers than before
if he were to spend his income on
inhalers. (1000/10= 100). The
budget constraint shifts inward.
Notice that the opportunity set
is now smaller which implies that
Darth Vader can afford less
bundles than he could before. He
will definitely be worse off than
before. Somebody might get
choked for this.
Question 6: Deriving the Optimal Consumption Bundle (7 Points)
Pat is a very immoral person and is currently dating two individuals Sam and Jaime. Pat likes to take
both Sam and Jaime on dates (obviously not at the same time!). Pat’s marginal utility for taking Sam on a
date is equal to MUS = S, while Pat’s marginal utility for taking Jaime on a date is equal to MUJ=J.
Let S = Number of romantic dates with Sam
Let J = Number of romantic dates with Jaime
Jaime is a high maintenance person and it costs $30 to take Jaime on a date (PJ = $30), while Sam is a cheap
date (PS = $15). Assume that Pat’s income is $300. What is the optimal level of romantic dates Pat will go
on with each person?
You had to use the utility maximizing condition that the slope of the indifference curve = slope of the
budget constraint.
−
MU S
P
=− S
MU J
PJ
Plugging in the variables that were given to you the utility maximizing condition becomes:
S 15
=
→ 30 S = 15 J
J 30
Or 2S = J
We can then plug this into our budget equation which is
PS S + PJ J = I
Or
$15(S) + $30(2S) = $300
$75S = $300
S=4
Since S = 4, it must be that J = 2(4) = 8
Thus for Pat his optimal bundle is 4 dates with Sam and 8 dates with Jaime.