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Department of Economics Prof. Gustavo Indart

University of Toronto July 24, 2009



ECO 100Y
INTRODUCTION TO ECONOMICS
Midterm Test # 3



LAST NAME


FIRST NAME


STUDENT NUMBER



Check your section of the course: L0201 (T/R from 2:00 to 4:00 PM)
L5101 (T/R from 6:00 to 8:00 PM)


INSTRUCTIONS: 1. The total time for this test is 1 hour and 50 minutes.
2. Aids allowed: a simple calculator.
3. Write with pen instead of pencil.



DO NOT WRITE IN THIS SPACE


Part I /25
Part II 1. /12
2. /7
3. /8
4. /8
5. /12
6. /8

TOTAL /80
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PART I (25 marks)

Instructions:
Multiple choice questions are to be answered using a black pencil or a black or blue ball-
point pen on the separate SCANTRON sheet being supplied.
Be sure to fill in your name and student number on the SCANTRON sheet!
Write you class section on the SCANTRON sheet either L0201 or L5101 where it says
DO NOT WRITE IN THIS SPACE.
Each question is worth 2.5 marks. No deductions will be made for incorrect answers.
Write your answers to the multiple choice questions ALSO in the table below. You may
use this question booklet for rough work, and then transfer your answers to each multiple
choice question to the table AND onto the separate SCANTRON sheet. Your answers
must be on the SCANTRON sheet. In case of a disagreement, the answer to be marked is
the one on the SCANTRON sheet.



1 2 3 4 5 6 7 8 9 10 11


1. Oil sands projects require two to six barrels of water to produce one barrel of oil and all this
water is ultimately disposed as waste material containing highly toxic chemicals. Economic
efficiency requires that in oil sands projects the
A) marginal private cost of producing oil must equal its marginal benefit.
B) firms operating the projects must reduce the quantity of water they use to produce a
barrel of oil.
C) marginal private cost plus the marginal external cost of producing oil must equal its
marginal benefit.
D) marginal social cost of pollution be at a minimum.
E) None of the above.


2. Assume that the following information applied to a firm in the short run at its current output:
the industry price was $7; average fixed cost was $3; marginal revenue was $5; average
total cost was $11; marginal cost was $5. On the basis of this information, which one of the
following statements is correct in the short run?
A) The firm is not in perfect competition and is at a profit maximizing output.
B) The firm is in perfect competition and should produce a greater output.
C) The firm is not in perfect competition and should shut down.
D) The firm is in perfect competition and is at a profit maximizing output.
E) None of the above.

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3. When a negative externality occurs in the production of a good, which of the following
statements is true?
A) Market price will be too high relative to the socially efficient price.
B) The market supply schedule would be higher if all costs were included.
C) The market supply curve overstates the total costs of production.
D) Market equilibrium output will be too low relative to the socially efficient level of
output.
E) None of the above is true.


4. Suppose that a monopolist can sell 20 units of output per day for a price of $10 each and 21
units of output per day for $9.80 each. The marginal revenue for the 21
st
unit is
A) -$0.20.
B) $5.80.
C) $9.80.
D) $0.20.
E) uncertain, as not enough information is provided to compute marginal revenue.


5. If marginal revenue is negative at the current level of output and the marginal cost is positive
at the current level of output, then
A) a profit-maximizing monopoly is at a profit-maximizing output.
B) a profit-maximizing monopoly should increase output.
C) the elasticity of demand is greater than one at that output.
D) demand must be inelastic at that output.
E) a profit-maximizing monopoly should shut down.


6. At the level of the industry, the condition for productive efficiency is that
A) there are no idle resources in the industry.
B) MC is equal for all firms in the industry.
C) MC = P for all goods.
D) MR = P for all inputs.
E) goods are allocated equitably.


7. A private art collector recently sold a piece of pottery for $300. He had purchased it for $200
only two years earlier. How will the most recent sale affect current GDP?
A) GDP will increase by $300.
B) GDP will increase by $200.
C) GDP will decrease by $100.
D) GDP will not change.
E) GDP 2 years ago must be adjusted downwards by $200, and current GDP will rise
by $300.


8. Which one of the following would be considered an expansionary monetary policy?
A) An increase in the exchange rate.
B) A decrease in personal income taxes.
C) The Bank of Canada sells government bonds.
D) The Bank of Canada buys government bonds.
E) None of the above.

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9. Suppose that between year 1 and year 2 the nominal GDP of an economy increased from
$1 billion to $3 billion and that the appropriate index of prices increased from 100 in year 1
to 200 in year 2. GDP for year 2 in terms of year 1 prices would be
A) $6 billion.
B) $3 billion.
C) $1.5 billion.
D) $2 billion.
E) None of the above.


10. Suppose that, in current dollar terms, GDP increased by approximately 7 percent between
one period and the next, but real GDP fell by 2 percent. Which of the following explanations
is most likely?
A) Prices fell by 9 percent.
B) Prices fell by 2 percent.
C) Output rose by 2 percent.
D) Prices increased by 7 percent.
E) None of the above.



Bonus question (an additional 2.5 marks):
11. Suppose the technology of an industry is such that the typical firms minimum efficient
scale is 8000 units per month at an average long-run cost of $5 per unit. If the total quantity
demanded at a price of $5 per unit is 8500 units per month, the likely result would be
A) a concentrated oligopoly.
B) a cartel.
C) a natural monopoly.
D) price discrimination.
E) perfectly competitive firms.

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PART II (55 marks)

Instructions: Answer all six questions in the space provided.

Question 1 (12 marks)
Pando Publishers is preparing the publication of a new first-year economics textbook. Pando will
have the exclusive rights to publish this textbook. The demand curve for this textbook is given
by the expression P = 150 0.01 Q, where P is the price in dollars and Q is the quantity of
books. Pando only faces the following costs: 1) the author is paid $60 thousand to write the
book; and 2) the marginal cost of publishing the book is a constant $30 per book.





























a) What is the expression for Pandos marginal revenue (MR) curve? (2 mark)





b) Draw Pandos demand (D), marginal revenue (MR), average variable cost (AVC), and
marginal cost (MC) curves in the diagram above. (2 marks)
P
r
i
c
e

(
d
o
l
l
a
r
s
)

Quantity of books (thousands)
10 20
150
50
100
5 15
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c) What quantity would Pando choose to print if it wishes to maximize profits? What price
would it charge? Briefly show how you obtained all these figures. Show Pandos
equilibrium price and quantity in the diagram above. (2 marks)


d) What is the average total cost (AC) of producing the equilibrium output of part c) above?
What profits would Pando make? Briefly show how you obtained all these figures. Show
Pandos profits in the diagram above. (2 marks)


e) If the author were paid $90 thousand instead of $60 thousand to write the book, what
quantity would this profit-maximizing publisher print? What price would it charge? What
profits would it make? Briefly show how you obtained these figures. (2 marks)



f) Suppose Pando Publishers was not profit-maximizing but was instead concerned with
revenue maximization, what price would it charge? What quantity would it produce?
Briefly show how you obtained these figures. (2 marks)
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Question 2 (7 marks)
well as a representative firms equilibrium output (q
1
). Assume that all firms are making zero
economic profits. (2 marks)

b) Suppose now that all firms in the flower market form a cartel. In the above diagram, clearly
show the new market price (P
2
) and output (Q
2
) as well as a representative firms new output
(q
2
) and level of economic profits. Briefly explain. (3 marks)


c) Complying with the agreement of the cartel, is the representative firm maximizing its profits?
Why or why not? Briefly explain. (2 marks)

$
$
S
q
Q
D
Industry
Representative Firm
Q
2
P
2
q
2
P
1
P
1
Q
1
P
2
q
3
MR
MC
Economic
Profits
q
1
AC
Assume that the market for flowers is perfectly competitive and that its market supply and
market demand curves are as shown below. Further assume that all firms have identical cost
schedules and that their average total cost (AC) curves have the usual U-shape.




















a) In the above diagram, show the short-run market equilibrium price (P
1
) and output (Q
1
) as
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Question 3 (8 marks)
Suppose that an unregulated monopolist is in short-run equilibrium and making positive
economic profits. Further suppose that the minimum of the monopolists total average cost
curve lies below the market demand curve. The government now attempts to regulate the
monopolist by implementing an average-cost pricing policy.
Statement: Jessica believes that, as a result of this policy, the monopolist will achieve allocative
efficiency and its economic profits will be eliminated.
Position: Do you agree with Jessicas belief? Use a proper diagram to analyze this situation
and indicate, with reasons, whether you agree or disagree with Jessicas belief.
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Question 4 (8 marks)
Suppose that the government is considering two policy options: 1) to increase government
expenditure on goods and services by $1,000,000; or 2) to increase transfer payments to
households by $1,000,000. Further assume that the marginal propensity to consume out of
disposable income is 0.8 and that the value of the expenditure multiplier is 4.
Statement: Shirin concludes that a $1,000,000 increase in government expenditure and a
$1,000,000 increase in transfer payments will have an identical effect on the countrys level of
national income but a different effect on the government budget deficit.
Position: Do you agree with both of Shirins conclusions? Analyze this situation and indicate,
with reasons, whether you agree or disagree with Shirins conclusions.
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Question 5 (12 marks)
Consider the following model of the economy:
Aggregate expenditure AE = C + I + G + NX
Consumption expenditure C = 200 + 0.8 YD
Investment expenditure I = 240
Government expenditure on goods and services G = 300
Taxes TA = 0.25 Y
Government transfer payments to households TR = 100
Net exports NX = 80 0.1 Y
Disposable income YD = Y TA + TR


a) What is the equation for the C curve as a function of Y? What is the equation for the AE
curve? Show all your work. (3 marks)
b) What is the equilibrium level of income? What is the value of the expenditure multiplier
(
AE
)? Show all your work. (3 marks)
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c) What is the level of private saving when the economy is in equilibrium? What is the level of
public saving (i.e., the government budget surplus) when the economy is in equilibrium?
Show all your work. (3 marks
d) If the government increases its expenditure on goods and services by 50, by how much will
equilibrium income increase? What will be the change in the level of public savings? Show
all your work. (3 marks)
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Question 6 (8 marks)
Suppose that the desired reserve ratio in the Canadian banking system is 10 percent and that
Nicole deposits $100 in Bank of Canada bills in her Canadian bank account. Further assume
that there is no cash drain on the banking system.
Statement: Joanne takes the position that the reserves of the Canadian banking system will
increase by $1,000 and the M1 money supply will also increase by $1,000.
Position: Do you agree with Joannes position? Analyze this situation and indicate, with
reasons, whether you agree or disagree with Joannes position.