UNIVERSITY OF TORONTO
Faculty of Arts and Science
AUGUST EXAMINATIONS, 2003
ECO105Y1 Y
Duration: 3 Hours
Non-programmable calculators only
Answer all questions on this test paper
INSTRUCTIONS:
This examination consists of THREE PARTS for a total of 100 marks
Part I
Ten microeconomic questions of which you are expected to answer any eight
(5 marks each for a total of 40%)
Part II
Ten macroeconomic questions of which you are expected to answer any eight
(5 marks each for a total of 40%)
Part III
10 multiple choice questions worth 2 marks each for a total of 20%. Wrong
answers will not be deducted from right in grading Part III.
All questions are to be answered in the spaces provided in this question paper booklet
Do not remove any pages or add any pages. No additional paper will be supplied.
The blank backs of pages may be used for rough work. Show your work where applicable.
Print your name and student number clearly on the front of the exam and on any loose
pages.
Student Name: _______________________________________________________
(Family Name)
(Given Name)
Student Number: ___________________________________
There are 24 pages to the exam.
- 1/24 -
ECO105YI Y: Final Exam; August, 2003
PART I: MICROECONOMICS
Place your answers (and work where necessary) in the space provided.
1.
Production Possibilities Curves (5 marks)
A country has 5,000 units of a single homogeneous resource with which it can produce
each the following output combinations in any year.
Consumer Goods
Capital Goods
a)
3000
0
2600
400
2000
800
1200
1200
0
1600
Sketch this country's production possibility curve (PPCo) with Capital Goods on
the vertical axis. (1 mark)
1 mark: Linear with Capital Goods intercept = 1600 and Consumer Goods intercept = 3000
b) What is the opportunity cost of increasing capital goods from 400 to 1200 units? (1
mark)
1 mark: 1400 Consumer goods: must mention Consumer goods
c) Which is the best of the above options for society? Briefly explain. (1 mark)
1 mark: either all since all give equal production efficiency (or something similar)
or none since they all give equal production efficiency and there is no choice function
(or something similar)
d) Suppose that the capital stock depreciates by 500 units per year. What is the change in
the capital stock if the country produces 2,600 units of consumer goods? (1 mark)
1 mark: -100 (400 - 500)
e) Suppose that technological change increases the output of consumer goods by 20%.
Draw the production possibility curve (PPC1) that would result from this change. (1
mark)
1 mark: Linear with no change in K goods intercept and Consumer goods intercept
becomes 3600
- 2/24 -
ECO105YI Y: Final Exam; August, 2003
2.
Demand and Supply (5 marks)
The diagrams below represent the original equilibrium position in the market for
highrise rental apartments, a perfectly competitive industry. Rental apartments are an
inferior good. Appliances are complements in consumption and residential houses are
a substitute in consumption for rental apartments. Factory buildings are a substitute
in production for rental apartments. Concrete is a variable (per unit) input and the
property tax on land is a fixed input into the production process.
Evaluate the statement given in each part to show the shift in the demand curve
and/or the supply curve or movement along either curve in the short-run ceteris
paribus. Mark the new equilibrium price P1 and the new equilibrium quantity Q1.
Designate Qs and Qd if there is no market equilibrium. Analyze each question
independently of the other questions. No explanations are required.
a) Technological change allows the production of
apartments with fewer resources. (1 mark)
1 mark: Supply increases (shifts to the right)
S o
P o
D o
Q o
b) The market price for factory buildings rises. (1 mark)
S o
1 mark: Supply falls (shifts to the left)
P o
D o
c)
The government imposes a tax per apartment unit and
the price of appliances increases. (1 mark)
1 mark: Supply falls (shifts up due to tax) and Demand falls
Q o
S o
P o
D o
Q o
d) The price of concrete increases and the price of
residential housing decreases. (1 mark)
1 mark: Supply falls (shifts up) and Demand falls
S o
P o
D o
Q o
e)
The government imposes a tax on the highrise land
(not the individual apartments) and the economy goes
into a recesssion. (1 mark)
S o
P o
1 mark: Demand increases (inferior good). [no change due
to property tax since fixed cost in short-run]
D o
Q o
- 3/24 -
ECO105YI Y: Final Exam; August, 2003
3.
Demand and Supply: Government Price Regulation (5 marks)
a) In the space below, sketch a diagram to illustrate the equilibrium market price and
quantity for peanuts if the demand for peanuts is relatively elastic (not perfectly) and
the supply of a peanuts is relatively inelastic (not perfectly). (1 mark)
P
So
Pmin
Po
D
Qd
Qo Qs
Surplus
Q
1 mark: D noticeably less steep than supply
1 mark: P > Po
1 mark: identify Surplus (or identify Qs and Qd such that Qs > Qd)
1 mark: identify the area below Pmin and between Qs and Qd (Pmin*(Qs-Qd))
1 mark: identify the area between Pmin and Po and below D to P axis (shaded area above)
b) Suppose that the U.S. government legislates a price floor (minimum price) for peanuts
to help southern U.S. peanut farmers. Identify diagrammatically the surplus or
shortage that results from such a minimum price ‘Pg’. (2 marks)
c) Clearly identify in your diagram the cost to the government of this price floor. (1
mark)
d) Now identify in your diagram the cost to consumers of this price floor. (1 mark)
- 4/24 -
ECO105YI Y: Final Exam; August, 2003
4.
Indifference Curves/Budget Lines (5 marks)
In the space below, draw a diagram to demonstrate the derivation of two points of an
inelastic (not perfectly) demand curve for a good X from indifference curve and budget
line analysis of an increase in the price of X. The subsections below are intended to
help you through this exercise. Clearly label your diagram.
a) Draw a diagram of a budget line (Bo) reflecting the initial prices of X (Pxo) and Y (Py)
and the individual's income. Be sure to label the X and Y intercepts. (1 mark)
b) Show the quantity of X (Xo) at an initial consumer equilibrium. (1 mark)
c) Draw a budget line representing an increase in the price of X to Px1. (1 mark)
d) Indicate the quantity of X (X1) at consumer equilibrium for the new budget line. (1
mark)
e) Draw a demand diagram incorporating the information from your indifference curve
and budget line diagram. (1 mark)
Qy (all other goods)
Inc/Py
Px
X1
Inc/P1
Xo
Inc/Po Qx
P1
Po
D
X1 Xo
Qx
1 mark: A budget line with identification of axes (i.e., Inc/Pxo, etc.)
1 mark: Xo (or whatever) at tangency of budget line and an indifference curve
1 mark: inward rotation of budget line around fixed Qy axis
1 mark: X1 (or whatever) at tangency of new budget line and an indifference curve
1 mark: Po and Xo and P1 and X1 in Demand Diagram below such that Xo and X1 accord
with the indifference diagram and D is relative steep (i.e., inelastic)
- 5/24 -
ECO105YI Y: Final Exam; August, 2003
5.
Competitive Long-Run Equilibrium: Decrease in Fixed Costs (5 marks)
The Toronto hotel industry is a perfectly competitive and constant-cost industry in
long-run equilibrium (subscript 'o') with downward sloping Demand and upward
sloping Supply. Use firm and industry diagrams to analyze the long-run (subscript '1')
impact on the firm and the industry of a decrease in fixed costs due to an decrease in
property tax as a means of alleviating the SARS crisis. You do not need to show the
short-run equilibrium.
In particular
a) Draw the firm and industry diagram showing price (P1), industry output (Q1), and
firm output (q1) at the initial long-run equilibrium (1 mark)
b) Label ('1') the curves that change due to the decrease in fixed costs. (1 mark)
c) Label the long-run equilibrium Price (Ps), industry output (Qs), and firm output (qs).
(2 marks)
d) Clearly identify the firm's economic profit or loss (1 mark)
Cost/unit
P
MC
So
ACo
S1
AC1
Po
P1
D
q1
qo
q
Qo
Q1
Q
1 mark: initial setup: Po at S intersects Demand at MC intersect min AC
1 mark: shift down of AC (non-parallel)
1 mark: q1 < qo and P1< Po from MC intersect minimum AC1
1 mark: Q1 from S1 intersecting D at P1
1 mark: there is no economic profit or loss, i.e., economic profit = 0 (P1 = AC1)
- 6/24 -
ECO105YI Y: Final Exam; August, 2003
6.
Competitive Short-Run Equilibrium: Increase in Variable Costs (5 marks)
Suppose that gasoline is a perfectly competitive and constant-cost industry initially in
long-run equilibrium (subscript 'o'). Use firm and industry diagrams to analyze the
short-run (subscript ‘o') impact on the firm and the industry of an increase in the cost
of gasoline of $0.10 per litre.
In particular, draw the firm and industry diagram showing price (Po), industry
output (Qo), and firm output (qo) at the initial long-run equilibrium
a) Label (‘s’) the firm curves that change in the short-run due to the increase in the cost
of gas of $0.10 per litre. (1 mark)
b) Label (‘s’) the industry curves that change in the short-run due to the increase in the
cost of gas of $0.10 per litre. (1 mark)
c) Label the new short-run equilibrium Price (Ps) and industry output (Qs). (1 mark)
d) Label the new short-run firm output (qs). (1 mark)
e) Clearly identify the economic profit or loss. (1 mark)
Cost/unit
P
MC
MC1
ACo
So
Ss
AC1
Po
Ps
Po-0.10
D
qo qs
q
QoQs
1 mark: parallel shift down of MC and AC with MC though min AC (don't worry about
min AC still at qo)
1 mark: Supply shifts down (don't worry about where yet)
1 mark: Ps < Po but greater than Po - 0.10
1 mark: qs > qo from MC1 at Ps
1 mark: Economic Profit = (Ps - ACs)*qs but Acs must not equal min AC
- 7/24 -
Q
ECO105YI Y: Final Exam; August, 2003
7.
Monopoly (5 marks)
The graph below represents the Demand curve for Rydalin (a drug for hyperactive
children) in Canada and the Average Cost curve for an optimally sized producer.
a) In the graph, draw a diagram depicting the equilibrium price (Pm) and quantity (Qm)
if Rydalin was patented and produced by a private monopoly. (2 marks)
b) Clearly indicate on your graph the economic profit or loss of the monopoly at
monopoly equilibrium. (1 mark)
c) Indicate the P (Pc) and output (Qc) that would result in the short-run if the firm
produced at competitive pricing . (1 mark)
d) Now indicate the efficiency loss for society that results if the firm is allowed to operate
as a monopoly. (1 mark)
P
MC
Pm
Pc
AC
Economic
Profit
Eff. Loss
ACm
D
MR
Qm
Q
Qc
1 mark: upward sloping MC through minimum AC and downward sloping MR about
halfway between D and P axis
1 mark: Qm from MR intersect MC and Pm from D at Qm
1 mark: Economic Profit = (Pm - Acm)*Qm (Acm should not equal min AC unless it is
unclear because of the graph
1 mark: Pc and Qc at MC intersect D
1 mark: area below D and above MC between Qm and Qc
- 8/24 -
ECO105YI Y: Final Exam; August, 2003
8.
Monopoly: Cartel (5 marks)
a) Draw a firm and industry diagram showing the effect on equilibrium price, firm and
industry output, and firm profit in oil production due to the OPEC cartel. Assume
that the OPEC countries are perfectly competitive firms. Show both the competitive
equilibrium without the cartel and the cartel price and firm and industry output at
profit maximization on the same graph. (4 marks)
Cost/unit
P
MCo
So
ACo
Pm
ACm
Po
Do
Qm/#firms qo
q
Qm Qo
1 mark:
MR below Do in basic S and D diagram with equilibrium Po and Do
1 mark:
Qm at MC (Supply) intersect MR
1 mark:
Pm from D at Qm
1 mark:
Output for each firm is Industry Output divided by # firms < qo
(Do not have to show Acm or firm profit)
Q
b) Briefly explain why cartels do not have a stable equilibrium at the profit maximizing
price, i.e, why the cartel tends to produce more than the profit maximizing quota. (1
mark)
1 mark:
An explanation that notes that a single firm would optimize profit at P = MC so
that there is a tendency for individual firms to exceed their quotas.
- 9/24 -
ECO105YI Y: Final Exam; August, 2003
9.
Efficiency and Externalities (5 marks)
Given internet access to pirated music, the musicians union argues that the market
price and output of CDs results in ‘free riders’ and does not fairly compensate
musicians and composers for their work.
Demonstrate their argument by first drawing a diagram indicating market equilibrium
price (Po) and quantity (Qo) for CDs.
P
S
S-Sub
Ps
Eff. Loss
Po
Ds
Do
Q
Qo Qs
1 mark: show a higher demand than the original and an equilibrium (Ps and Qs) at the
intersection of this Demand and original Supply
1 mark: Efficiency loss below D and above S between Qo and Qs (> Qo)
a) Now indicate on your diagram the equilibrium that would result if pirated software
was eliminated and all listeners obtained music by buying CDs. (1 mark)
b) Clearly indicate on your diagram the efficiency loss to society of ‘free riding’, i.e.,
consumption of music without paying for the music. (1 mark)
c) The musicians have suggested a $1 fee per CD to compensate musicians for lost
revenue. Explain briefly whether this will eliminate the efficiency loss due to free
riding. (2 marks)
1 mark: this would shift up Supply (Supply would fall)
1 mark: this would decrease Q < Qo but we want to increase it
d) What government policy do you suggest to induce market equilibrium at the socially
optimal allocation of resources for CDs? Briefly explain. (1 mark)
1 mark: government could give a subsidy which would shift down supply to Qs
- 10/24 -
ECO105YI Y: Final Exam; August, 2003
10. Comparative Advantage (5 marks)
The following table gives the resource (R) input needed per unit of output. Assume
that these are the only countries and commodities in the world and that there are no
economies of scale and no transportation costs.
Output
Beef
Wheat
Argentina
1R
2R
Brazil
2R
8R
a) In the space below, determine the country with the comparative advantage in beef
production and the country with the comparative advantage in wheat production.
Show your calculations. (2 marks)
1 mark: Argentina's OC: 1 Beef cost 1R/2R = 1/2W or 1 Wheat cost 2Beef
1 mark: Brazil's OC: 1 Beef cost 2R/8R = 1/4W or 1 Wheat cost 4 Beef
b) Suppose that Argentina has 2,000 units of the resource and that Brazil has 6,000 units
of the resource. In the space below, draw each country's production possibility curve
in separate diagrams with wheat on the vertical axis. (1 mark)
1 mark: Argenina's linear PPC with Beef intercept = 2000 and wheat intercept = 1000
and Brazil's PPC with beef intercept = 3,000 and wheat intercept = 750
1 mark: Argentina's CPC with Beef intercept = 3,000 and wheat intercept = 1000
and Brazil's CPC with Beef intercept = 3,000 and wheat intercept = 1000
c) Suppose that these countries agree to exchange 1 unit of wheat for 3 units of beef.
i) In your diagram, draw each country's consumption possibility curve with trade.
(1 mark)
ii) If Argentina consumes 400 units of wheat, what is the maximum units of beef that
Brazil can consume given trade? Show your work. (1 mark )
1 mark: Argentina trades 600 (1000 - 400) wheat for 1800 beef leaving Brazil with 1200 beef
(3000 - 1800)
- 11/24 -
ECO105YI Y: Final Exam; August, 2003
PART II: MACROECONOMICS:
1.
Prices Indices (5 marks)
1998
Cheese (kilo)
Chicken (kilo)
Price/unit
$2.40
$1.80
2003
Quantity
25
20
Price/unit
$2.80
$1.50
Quantity
15
30
The above table gives data for the price/unit and quantity of Cheese and Chicken
consumed by the average student in 1998 and 2003. Assuming that 1998 is the base
year, calculate the following values.
a) nominal student consumption in 2003 (1 mark)
1 mark: = 2.80*15 + 1.50*30 = 87
b) the consumer price index for 2003 (1 mark)
1 mark: (2.8 * 25 + 1.5 * 20)/(2.4 * 25 + 1.8 * 20) = 104 [.17]
c) real consumption in 2003 relative to 1998 according to the consumer price index
(1 mark)
1 mark: 100*87/104.16 = 83.5
e) real consumption in 2003 according to the GDP deflator measure (1 mark)
1 mark: 2.4 * 15 + 1.8 * 30 = 90
f) the GDP deflator for 2003 given 1998 as the base year (1 mark)
1 mark: = (2.80*15 + 1.50*30)/(2.4*15 + 1.8*30) = 96.6
- 12/24 -
ECO105YI Y: Final Exam; August, 2003
2.
National Accounts (5 marks)
The following data are from the National Accounts of Canada for 2001 ($Billions)
Corporate Profits (before Taxes)
Interest and Miscellaneous Investment Income
Net Investment Income of Non-Residents
Government Spending
Wages and Salaries and Supplementary Labour Income
Government Transfer Payments
Depreciation (Capital Consumption Allowances)
Investment (Gross)
Consumption
Net Income of Unincorporated Businesses (Farm and non-Farm) and Rent
Imports
Personal Taxes
Indirect Taxes Less Subsidies
Corporate Taxes
Undistributed Corporate Profits (Retained Earnings)
Savings
Calculate (Show your work)
a) Net Domestic Income (1 mark)
1 mark: correct answer = 570 + 130 + 70 + 50 = 820,000 [no mark without work]
b) Gross Domestic Product (1 mark)
1 mark: : 1,092,000 or answer to a) + 127 + 145
c) Exports (1 mark)
1 mark: 473 with work or consistent with 620 + 230 + 185 – 416 [=619] from GDP
d) Personal Income (1 mark)
1 mark: 620 + 55 + 25 = 700
e) Gross National Product (1 mark)
1 mark: 1 mark: GDP – 25 = 1067,000 (or consistent with answer from b))
- 13/24 -
130,000
50,000
25,000
230,000
570,000
60,000
145,000
185,000
620,000
70,000
416,000
25,000
127,000
35,000
70,000
55,000
ECO105YI Y: Final Exam; August, 2003
3.
MacroModel: Equations (5 marks)
An economy has the following set of macroeconomic equations. There are no taxes or
transfer payments in this economy
Consumption:
C = 650 + .8Yd
Investment:
I = 125
Exports
X = 350
Government Spending: G = 275
Imports
M = 250 + 0.05Y
a) Calculate the equation for Aggregate Expenditure. (1 mark)
1 mark: AE = 1150 + 0.75Y (with some work)
b) Calculate the value of equilibrium Income (1 mark)
1 mark: = 1150/0.75 = 4600
c) Graph the Aggregate Expenditure function to show autonomous spending, the slope of
the aggregate spending function, and equilibrium income. (1 mark)
1 mark: equilibrium Y = 4600 (or consistent with b) from intersection of 45 degree line and
upward sloping AE with AE intercept = 1150 (or consistent with a)
d) What is the change in inventories when GDP is 5,000? (1 mark)
1 mark: AE = 1150 + 0.75(5000) = 4900 => change in inv = 5000 - 4900 = +100
e) What is the change in equilibrium income due to an increase in government spending
of +30? (1 mark)
1 mark: = 30*(1/1-0.75) = +120
- 14/24 -
ECO105YI Y: Final Exam; August, 2003
4.
MacroModel: Equations (5 marks)
An economy has the following set of macroeconomic equations.
Consumption:
C = 240 + 0.8Yd
Investment:
I = 60
Government Spending G = 220
Exports:
X = 180
Imports:
IM = 40 + 0.12Y
Net Taxes (Taxes – Transfers) T = 0.1Y
a) Calculate the equation for Aggregate Spending (1 mark)
1 mark: = 660 + 0.6Y with some work,
e.g. = 240 + 0.8(Y-0.1Y) + 60 + 220 + 180 -(40 + 0.12Y)
b) Calculate the value of equilibrium income. (1 mark)
1 mark: = 660/(1- 0.6) = 1650
c) What is the change in equilibrium income if Government Spending increases by 50?
(1 mark)
1 mark: = +50 * 1/(1-0.6) = +125
d) What is the change in equilibrium income if Fixed Taxes increase by 50? (1 mark)
1 mark: +50 *(-0.8)*(1/(1-0.6) = +100
e) Suppose that expenditure is described by the original equations with the equilibrium
found in part b). What is the change in govennment spending necessary to eliminate
the recessionary gap if potential GDP is 1800? (1 mark)
1 mark: Recessionary gap = 1800 - 1650 = 150 => change in G = 150/2.5 = +60
- 15/24 -
ECO105YI Y: Final Exam; August, 2003
5.
Money Supply (5 marks)
Assume that the following conditions hold in Canada's banking system: deposits are all
demand deposits, the required reserve ratio for deposits is 12.5% [0.125]and there is
neither excess reserves nor excess circulation.
Suppose that the Bank of Canada has an outstanding note issue of $34 billion; the
chartered banks have $3 billion worth of deposits at the bank of Canada; and the
currency in circulation (i.e., in the hands of the public) is $28 billion.
a) What is the money supply at equilibrium given the above information? (1 mark)
1 mark: = 28 + (34 - 28 + 3)/0.125 = $100b
Now calculate the change in the money supply for each of the following circumstances
given the above information.
b) The Bank of Canada sells $40 million worth of Federal bonds to the general public?
i) the change in the money supply is? (1 mark)
1 mark: = -40/0.125 = -320b
c) The Bank of Canada switches $30 million in Federal government deposits from the
Bank of Montreal to the Bank of Canada.
i) the change in money supply is? (1 mark)
1 mark: +30/0.125 = + 240b
d) The Bank of Canada sells $50 million Canadian to buy Japanese Yen in the foreign
exchange market.
i) the change in money supply is? (1 mark)
1 mark: = +50/0.125 = +400b
e) The general public increases the currency in circulation by $15 million to avoid sales
taxes.
i) the change in money supply is? (1 mark)
1 mark: = +15 + (-15)/0.125 = +105b
- 16/24 -
ECO105YI Y: Final Exam; August, 2003
6.
Spending and Monetary Equilibrium: Fiscal Policy (5 marks)
Suppose that the demand for money is elastic and the marginal efficiency of investment
is inelastic. Canada is presently at full employment and the government decides to
slow down the economy by decreasing government spending. The opposition parties
claim that the policy will be ineffective since the decrease in government spending will
cause a large increase in investment. Show the effect of the decrease in government
spending by using the appropriate diagrams to demonstrate the impact on aggregate
expenditure, GDP, the interest rate, and investment. Be sure to demonstrate whether
the opposition is correct or not. Ignore price level and exchange rate effects.
Label your axes carefully and use different subscripts to distinguish between the
original equilibrium and subsequent changes.
AE
Y1
Yo
Y (GDP)
r
r
ro
r1
M
Io I1
I
1 mark: AE/Y diagram with shift down of AE to give Y1 < Yo
1 mark: initial equilibrium of Money diagram: ro at intersection of negatively sloped D for
money and vertical (could be positive I suppose) Money supply
1 mark: fall in Demand for money to give r1 < ro
1 mark: MEI diagram showing increase in I due to fall in r (amount irrelevant here)
1 mark: a statement or obvious from diagram that fall in Investment is relatively small.
i.e., opposition are incorrect (Don't need to show this effect in AE diagram)
- 17/24 -
ECO105YI Y: Final Exam; August, 2003
7.
Money and Spending Equilibrium: Monetary Policy (5 marks)
The recent increase in unemployment has convinced the Bank of Canada to stimulate
the economy through purchases of government bonds from the public.
Demonstrate the impact of this policy on the equilibrium interest rate, equilibrium
investment, and equilibrium income through a set of diagrams and a brief explanation.
Ignore exchange rate and price level effects as well as crowding out.
Label your axes carefully and use different subscripts to distinguish between the
original equilibrium and subsequent changes. (4 marks)
Below your diagram, briefly explain the parameters within this model that might limit
the effectiveness of this policy. (1 mark)
Y1
So
r
S1
r
ro
r1
MEI
Do
Io I1
M
AE
I1
I
Yo
Y1
Y (GDP)
1 mark: initial equilibrium r from intersection of money demand and money supply
1 mark: decrease in r due to increase in money supply
1 mark: increase in I from downward sloping MEI (doesn't have to be labeled) from fall in
interest rate
1 mark: initial setup of AE/Y diagram with Yo from intersection of positively sloped AE
and 45 degree line
1 mark: increase in Y to Y1 (say) due to shift up of AE
- 18/24 -
ECO105YI Y: Final Exam; August, 2003
8.
Aggregate Demand and Aggregate Supply (5 marks)
Suppose that the Canadian economy is presently at short-run Price and real GDP
equilibrium with an unemployment rate of 9% and an inflation rate of 1%/year. Using
only an Aggregate Expenditure/Income and Aggregate Demand/Supply diagram,
demonstrate the effect on equilibrium Price and real GDP of an increase in government
spending that would exactly eliminate the recessionary gap if there were no change in
prices. The following subsections will help you through this.
a) Diagram an initial equilibium for Aggregate Expenditure and Income and for short run
and long run Aggregate Demand and Aggregate Supply. Label your axes properly. (2
marks)
b) Indicate the effect of an increase in government spending on the Expenditure/Income
diagram and show the short-run effect of this change on price and output in your
Aggregate Demand/Aggregate Supply diagram. (3 marks)
AE
AE1
AEo
Y (GDP)
Yo
LRAS
SRAS
P1
Po
ADo
AD1
Yo Y1
1 mark: Yo in AD/AS diagram from intersection of positively sloped SRAS (doesn't have to be
upward sloping) and negatively sloped Do
1 mark: vertical LRAS to the right of Yo
1 mark: shift up of AE in AE/Y diagram
1 mark: shift to right of AD in AD/AS diagram (doesn't have to be in right place yet)
1 mark: new short-run equilibrium P and Y with P1 > Po and Y1 > Yo but < LRAS (this
latter is important)
- 19/24 -
ECO105YI Y: Final Exam; August, 2003
9.
Aggregate Demand and Aggregate Supply (5 marks)
a) Assume that an economy is initially in short-run Price (Po) and GDP (Yo) equilibrium
with considerable unemployment due to a recessionary gap. Draw an Aggregate
Demand/Aggregate Supply diagram to show the short-run (Ps, Ys) and long-run (P1,
Y1) effects of an increase in government spending. (3 marks)
LRAS
SRASo
SRAS1
Ps
Po
ADo
AD1
Yo YsY1
1 mark: Aggregate Demand shifts to the right in a AD/AS diagram (don't worry about
placement of LRAS or where AD shifts to or where Ps and Ys are)
1 mark: shift to the right of SRAS (don't worry about where)
1 mark: long-run equilibrium at intersection of vertical LRAS and AD1 (don't worry about
where SRAS is)
b) Suppose that an economy is initially in short-run and long-run Price (Po) and GDP
(Yo) equilibrium. Draw an Aggregate Demand/Aggregate Supply diagram to show the
short-run (Ps, Ys) effects of an increase in the price of oil. (2 mark)
LRAS
SRAS1
SRASo
Ps
Po
ADo
Ys Yo
1 mark: SRAS shifts up (or to left). Don't worry about where LRAS is, etc.
1 mark: new equilibrium Ps > Po and Ys < Yo at intersection of SRAS1 and ADo
- 20/24 -
ECO105YI Y: Final Exam; August, 2003
10.
Fixed Exchange Rates and Monetary Policy (5 marks)
The following diagrams represent the original equilibrium position in the market for the
Canadian dollar. Show the shift in the demand and/or supply of Canadian dollars and the
new equilibrium exchange rate under the following circumstances each considered
separately. Assume that the exchange rate is flexible unless otherwise advised..
a) A decrease in U.S. tariffs on Canadian products. (1
mark)
Ec/us
1 mark: Increase in Demand
Eo
So
Do
Q
b) An increase in Canadian prices relative to U.S.
prices (1 mark)
1 mark: decrease in Demand and increase (shift right) in
Supply (Give the mark if one of these is correct)
Ec/us
So
Eo
Do
Q
Ec/us
So
c)
Expansion in the Canadian economy and recession
in the U.S. economy (1 mark)
1 mark: increase in Supply (shift right) and decrease in
Demand
Ec/us
Eo
So
Do
Eo
Q
Do
Q
d) Now assume a fixed exchange rate for the Canadian
dollar. Show the effect of an increase in U.S interest
rates in the adjacent diagram. (1 mark)
Ec/us
Ec/us
So
So
Eo
Eo
Do
1 mark: decrease in Demand and increase (shift right) of
Supply (Don't worry about fixed exchange rate
Do
Q
Q
Ec/us
e)
What effect will the increase in U.S. interest rates have on the interest rate in Canada
given the fixed exchange rate? Draw a Money Demand/Supply diagram in the space
below to demonstrate your position. (1 mark)
So
Eo
Do
1 mark: Money demand and supply diagram with decrease in money supply
Q
- 21/24 -
ECO105YI Y: Final Exam; August, 2003
PART III: MULTIPLE CHOICE
Circle the best answer for each question.
Each question is worth 2 marks. No marks deducted for wrong answers.
1.
Which of the following could explain the coincidence of an increase in the price of
gasoline and a decrease in the quantity sold of gasoline?
a) an increase in car usage due to summer holidays
b) a decrease in the oil quota set by OPEC
c) a decrease in the price of oil due to a decrease in demand for oil
d) a decrease in car usage during the winter months
e) none of the above
2.
Which of the following is false for free markets ?
a) competitive markets do not optimally allocate resources if there are free riders
b) natural monopolies can produce cheaper than competitive firms in the same
industry
c) efficiency loss is zero if marginal social cost equals marginal social benefit (price)
d) economic profit is zero in long-run competitive equilibrium
e) competitive markets do not optimally allocate resources if there are cost externalities
f) monopolies do not optimally allocate resources because MR = MC
g) none of the above (i.e., all of the above are true for free markets)
3.
Which of the following would definitely represent monopoly behaviour by the
operators of the 407 highway?
a) an increase in price coincident with an increase in the number of cars using the road
b) an increase in price coincident with a government tax per car using the road
c) an increase in price in the long-run coincident with government tax on 407 property
d) an increase in price coincident with a decrease in the number of cars on the road
e) none of the above
4.
Suppose that a perfectly competitive industry with downward sloping demand and
upward sloping supply is initially in long run equilibrium. An increase in fixed cost
causes which of the following changes in short-run equilibrium?
a) no change in price, firm output, industry output, or profit
b) no change in price, firm output or industry output but a decrease in profit
c) increase in price and firm output but decrease in industry output and profit
d) increase in price but decrease in firm output, industry output, and profit
e) increase in price and industry output but decrease in firm output and profit
f) none of the above
5.
An increase in transfer payments financed by a similar decrease in government
spending will cause which of the following changes in equilibrium?
a) no change in GDP and no change in the interest rate
b) a decrease in GDP and a decrease in the interest rate
c) a decrease in GDP and an increase in the interest rate
d) an increase in GDP and a decrease in the the interest rate
e) an increase in GDP and an increase in the interest rate
f) none of the above
- 22/24 -
ECO105YI Y: Final Exam; August, 2003
6.
How does an increase in the tax rate effect Aggregate Expenditure ceteris paribus?
a) Autonomous Spending decreases and Marginal Propensity to Spend decreases
b) Autonomous Spending decreases and Marginal Propensity to Spend increases
c) Autonomous Spending increases and Marginal Propensity to Spend decreases
d) Autonomous Spending increases and Marginal Propensity to Spend increases
e) Autonomous Spending doesn’t change and Marginal Propensity to Spend decreases
f) Autonomous Spending doesn’t change and Marginal Propensity to Spend increases
g) Autonomous Spending decreases and Marginal Propensity to Spend doesn’t change
h) Autonomous Spending increases and Marginal Propensity to Spend does not change
i) none of the above
7.
What is the effect on equilibrium GDP and on the interest rate of a simultaneous
increase in government spending and Bank of Canada sales of government bonds?
a) a decrease in GDP and decrease in the interest rate
b) a decrease in GDP and increase in the interest rate
c) an increase in GDP and decrease in the interest rate
d) an increase in GDP and increase in the interest rate
e) a decrease in GDP but the interest rate may increase or decrease
f) an increase in GDP but the interest rate may increase or decrease
g) GDP may increase or decrease but the interest rate decreases
h) GDP may increase or decrease but the interest rate increases
e) none of the above
8.
Which of the following best describes the U.S. economic experience during the summer
of 2003?
a) low inflation, decreasing government deficits, and falling unemployment
b) low inflation, decreasing government deficits, and increasing unemployment
c) low inflation, increasing government deficits, and increasing unemployment
d) high inflation, decreasing government deficits, and decreasing unemployment
e) high inflation, decreasing government deficits, and increasing unemployment
f) high inflation, increasing government deficits, and increasing unemployment
g) none of the above
9.
Which of the following is most likely to cause an appreciation of the Canadian dollar
and a decrease in Canadian prices?
a) a decrease in government spending
b) an increase in government spending
c) Bank of Canada purchases of bonds
d) Bank of Canada sales of bonds
e) none of the above
Brad: give them a mark for this one: it's too hard for this level.
- 23/24 -
ECO105YI Y: Final Exam; August, 2003
10. Suppose that a country has the following balance of payments data (not including the
change in official reserves)
Merchandise Exports
$540b
Merchandise Imports
$525b
Capital Exports
$ 65b
Capital Imports
$ 75b
Service Exports
$ 30b
Service Imports
$ 40b
Interest and Dividend Payments $ 25b
Interest and Dividend Receipts
$ 15b
What is the current account balance?
a) –20b
b) – 15b
c) –10b
d) -5b
e) 0
f) +5b
g) +10b
h) +15b
i) +20b
j) none of the above
- 24/24 -