Sample Exam Questions
Economics 503
Microeconomics
1. Assume that the newspaper market in Hong Kong is characterized by
monopolistic competition. The marginal cost of producing South China Morning
Post and Ming Pao are approximately equal. SCMP sells at a price of HK$8 per
copy while Ming Pao sells at a price of $6 per copy. In the long run, would we
expect that SCMP was earning higher profits or lower profits than Ming Pao?
Explain why or why not?
Each of these newspapers are being produced in markets with differentiated goods
and free entry. If SCMP were indeed earning higher profits, new English language
newspapers would enter the market pushing down the demand for SCMP until the
price was equal to average cost. This must mean that the average cost of producing
the SCMP is greater than the average cost of producing Ming Pao. This could be
because the fixed costs are spread over many customers.
2. As an experiment, McDonalds raises the price of two of its sandwiches. The
following chart shows the sales per restaurant per week
Big Mac
Filet o’ Fish
Before
P
$12
$20
After
P
$15
$24
Q
1200
500
Q
800
450
Calculate the elasticity of demand for these two sandwiches
Calculate the marginal cost of producing each sandwich is HK$10. What is the
profit maximizing price for each sandwich?
Q2  Q1
.The elasticity of demand is
Q2  Q1
2
P2  P1
. In the case of the Big Mac, the price
P2  P1
2
elasticity of demand
% Change in Price
% Change in Quantity
Elasticity
Big Mac
0.222222
-0.4
-1.8
Filet o
Fish
0.181818
-0.10526
-0.57895
In the case of the Big Mac, the rule of thumb suggests
P
1
1.8


 2.25 With a marginal cost of 10, the profit maximizing
MC 1  ( 1
) .8
elasticity
price is 22.50.
In the case of the Filet o’ Fish, demand is inelastic. Raising the price increases revenues.
McDonalds should raise the price at least to 24 and beyond until the elasticity becomes
less than 1.
3. A person has $100 to spend on either apples or oranges. The price of apples is $5
and the price of oranges is $10 dollars. What is the ratio of the marginal utility of
apples relative to the marginal utility of oranges when the consumer is choosing
the optimal amount of apples and oranges? Draw the budget constraint, clearly
marking the intercepts. Draw the indifference curve at the optimal combo of
MU APPLES
P
5
 APPLES 
 .5
apples and oranges.
MU ORANGES PORANGES 10
Oranges
10
[ORANGES*,APPlES*]
Apples
20
4. The following table shows information on the Long run average total cost curve
and the demand curve. Plot the following data on a graph. Show the areas of
economies and diseconomies of scale and constant returns to scale. What is the
minimum efficient scale? What is the scale of production in this economy?
Quantity
LR ATC
1
33
2
27
3
25
4
25
5
30
6
38
7
50
Price
Quantity
50
43
36
29
22
15
8
1
2
3
4
5
6
7
Scale
Economies
LR
ATC
Scale
Diseconomies
Constant
Returns to
Scles
Q
3
4
5. Consider two industries: gravel and gourmet restaurants. The first produces an
undifferentiated product while there are a large number of potential types of
cuisine, each with its own particular qualities. There are not large barriers to entry
into either industry. Explain in which industry firms will be operating at a scale
closest to an efficient level. Why?
The gravel industry is likely to be perfectly competitive. Firms will be operating at a
scale where price equals marginal cost. In the long run, firms will change scale until
the average cost equals price. Marginal cost equals the average cost where average
cost is at a minimum. Firms operate at a scale that minimizes average cost at any
level of demand. The gourmet industry is monopolistically competitive. Firms will
charge a price higher than average cost. In the long run, firms will enter or exit until
price equals average cost. But marginal cost will be below price which is below
average cost. When marginal cost is below average cost, average cost has not
reached its minimum. Firms will produce at a scale below the scale the minimizes
average cost.
Macroeconomics
6. What are the three types of policy lags? Is the combined lag likely to be longer for
fiscal or montetary policy?
The lags are
a. Recognition Lag
b. Administrative Lag
c. Impact Lag
Administrative lags for fiscal policy are likely to be so long, that the lag for fiscal policy
is longer.
7. Which will cause a larger short-run increase in prices, an anticipated or
unanticipated increase in aggregate demand? Why? Will they cause the same
increase in prices in the long run?
A shift out in the aggregate demand represents consumers willingness to pay a higher price for
any level of output. If this comes as a surprise, there will be some long-term contracts signed that
will not take higher price levels into account. If firms with fixed input prices can sell their
production at higher prices, the profit maximizing scale of production will increase. But with
more goods produced, the higher demand will not translate 100% into higher prices.
P
SRAS
3
P****=PE***
2. Unanticpated
Demand Shift
P**
2
3. Anticipated
Demand Shift
P*=PE
1
´
YLR
AD
AD
GDP
8. Suppose that the central bank increases the money supply. Assume that the output
level is below the potential GDP before the increase of money supply.) In order to
increase money, the central bank uses the open market operation. Explain what the
10
central bank should do in the open market operation. How does the central bank
increase the monetary base and money supply?
The central bank will need to conduct an open market purchase of government bonds. They will
pay money for the bonds which will increase the money holdings of the banks who will lend this
money. The money will circulate through the banking system creating multiple bank deposits
which are part of the money supply.
9. Suppose that the change of money supply is not expected by the public and that the
increase of money supply is not enough to achieve the potential GDP in the short run.
Describe the short-run equilibrium, and the transition to the new long run equilibrium by
using AD/AS diagram and money market diagram. What happens to the output, the price
levels, and the resource prices?
P
*
P =P
P**
SRAS
YLR
E
SRAS´
1. Output below
potential
2. Open Market
Purchase
3. Self-correction
Mechanism
2
1
3
´
AD
AD
GDP
An unexepected increase in the money supply will push interest rates in money markets
down. Households will attempt to push the extra money into the loanable funds market
until the interest rate is low enough that people are willing to hold the extra money.
Lower interest rates will increase demand for output. This will push up price level and
increase production. But not enough to get output back to potential or prices back up to
expectations. Input prices are still high. Overtime, contracts will be renegotiated to
reduce input costs. As costs come down, prices will drop and consumer will be able to
increase production.
i
LD
´
LS
1
2
MD
Loanable Funds
10. Suppose that the central bank increases the money supply and that this change is
expected. The output level is at the potential GDP before the increase of money
supply. Describe the short-run equilibrium, and the transition to the new long run
equilibrium by using AD/AS diagram. What happens to the output, the price
levels, and the resource prices?
The money supply increases as expected. This would push up the willingness to pay
money for any level of goods. But input firms expect high prices so they demand high
prices for their own goods. In the short run, households are willing to pay higher
prices for goods but producers demand higher prices to produce the same amount.
The economy smoothly moves to higher price levels in the short run and long run.
P
SRAS
2
P****=PE***
2. Anticipated
Demand Shift
P**
P*=PE
1
´
YLR
AD
AD
GDP