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UNIVERSITY OF TORONTO
DEPARTMENT OF ECONOMICS

ECO100Y L5101
Midterm Test #2; June 22, 2011



Time Allowed: 60 Minutes



This total marks in this test are 50. The test is divided into two parts:

Part I - problem format - is worth 40 marks (80% of the total marks of 50)

Part II: A) 5 explanation questions worth one mark each (10% of the total mark of 50)
B) 5 multiple choice questions worth one mark each (10% of the total mark of 50)


Show your work where applicable.


YOU MUST USE PEN INSTEAD OF PENCIL




Print your name and student number clearly on the front of the exam and on any loose pages.



Name: _______________________________________
(Family Name) (Given Name)


Student #: ______________________





There are 7 pages to the exam.


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ECO100Y L5101; Midterm Test #1: June 22, 2011
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Part I: Place your answers (and work where necessary) in the space provided.
Clearly label all axes, curves, and points.

1. Consumer Choice (5 marks)

In the space below, draw a diagram to derive consumer equilibrium under the following
conditions. Be sure to label your diagram specifically.
a) Draw a budget line for an individual with an income of $900/year to spend on Books and
DVDs if Books are $12.50 each and DVDs are $15 each. Put DVDs on the vertical axis.
Books are an inferior good and DVDs are a normal good. (1 mark)
b) Derive a possible consumer equilibrium if the individual has a strong preference for DVDs.
Indicate this as (B*, D*). (1 mark).
c) Suppose that the individual initially has a marginal rate of substitution of 1.5 Books for 1
DVD. Indicate this on your diagram as (Bo, Do). (1 mark)
d) What is the exchange rate of DVDs for Books at consumer equilibrium? (1 mark)
1 mark: = 0.83 dvds for a book from 12.5/15

e) Now show a possible equilibrium (B
1
, D
1
) if the individuals income falls. (1 mark)

a) linear with intercepts dvd = 300 and books =360
b) (B*, D*) tangency of relatively flat indifference
curve (no positive slope) and budget line
c) (Bo, Do) to the right of equilibrium on Ind Curve
d) see above
e) parallel shift down of budget line with tangency to
new indifference curve (must not intersect the
first) at more books (i.e., to the right of original)

2. Short-run Supply function. (5 marks)

Use diagrams and an explanation to show why the Short-run Supply curve of the firm is
positively sloped. (5 marks)
1 mark: short-run => Capital is fixed
1 mark: K fixed => MP (eventually falls) (simple diagram to show this)
1 mark: MC = w/MP
1 mark: MC falls then rises (simple diagram to show this)
1 mark: Supply is positively sloped (simple diagram to show this in some fashion) because supply
is MC

MP
MC
S

DVDs
Books
360
300
(B*,D*)
(Bo, Do)
(B
1
,D
1
)

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ECO100Y L5101; Midterm Test #1: June 22, 2011
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2. Derivation of Demand and Substitution and Income Effects: Diagram (10 marks)

In the space below, draw a diagram to demonstrate the Substitution and Income effects and
the derivation of two points of a unit elastic demand curve for a good X from indifference
curve and budget line analysis given an increase in the price of X. The subsections below
help you through this exercise. Clearly label your diagram.
a) Draw a diagram of a budget line reflecting the initial prices of X (Pxo) and Y (Py) and the
individual's income. Label your axes and intercepts (1 mark)
b) Show the quantity of X (Xo) at initial consumer equilibrium. (2 marks)
c) Indicate a quantity of X
1
at equilibrium for the increase in the price of X to Px
1
. (2 marks)
d) Indicate the Substitution Effect of the increase in the price of X to Px
1
. (2 marks)
e) Indicate the Income Effect of the increase in the price of X to Px
1
. (1 mark)
f) Draw a unit elastic Demand diagram reflecting the information from your indifference curve
and budget line diagram. (1 mark)
g) Draw the Income Compensated Demand curve for the increase in price of X. (1 mark)
Px
Qy (all other goods)
Qx
Qx
D
I/Py
I/Px
1
I/Px
0
X
0
X
1
Px
0
X
0
Px
1
X
1
Pri ce Increase: Uni t El asti c
Xs
SE IE
D
Income Compensated


a) 1 mark: linear budget line with intercepts m/Py and m/Pxo (or some such indication) with
correct axis Qy (all other goods) and Qx
b) 1 mark: Convex indifference curve (no positive slope)
1 mark: Xo at tangency of indifference curve and budget line
c) 1 mark: inward rotation of budget line around fixed y-intercept
1 mark: tangency of indifference curve with new budget line at X
1
< Xo (no intersection of
indifference curves
d) 1 mark: Draw a budget line parallel to new budget line and tangent to original Indif. Curve
No mark if they have tangent to new IC but give subsequent marks if consistent with mistake
1 mark: Indicate SE from Xo to Xs as output at tangency
e) 1 mark: Indicate Income Effect from Xs to X
1
(must be in same direction to SE)
f) 1 mark: unit elastic Demand (%Q = %P; must be obvious) through (Xo, P
Xo
) or (X
1
,P
X1

> Pxo) and X must be consistent with the IC/BL diagram
g) 1 mark: negatively sloped Demand through (Xo, P
Xo
) and (Xs,P
X1
)
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ECO100Y L5101; Midterm Test #1: June 22, 2011
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3. Competitive Short-Run and Long-run Equilibrium: Diagrammatic (10 marks)

Assume that the Gasoline industry in Toronto is perfectly competitive with typical demand
and supply functions. It is initially in long-run firm and industry equilibrium with price
equal to $1.30/litre.
In the grid graphs below, draw a firm and an industry diagram to depict the initial long-run
equilibrium. Then draw the short-run equilibrium that results from a decrease in variable
costs of $0.50/litre due to a decrease in the price of crude oil.
Label the relevant curves and points with the subscript 'o' for the original equilibrium and 's'
for the short-run equilibrium. In particular
a) Draw the firm and industry diagram showing price (Po), industry output (Qo), and firm
output (qo) at the initial long-run equilibrium. (1 mark)
b) Label ('s') the curve(s) that change due to the decrease in per unit costs. (3 marks)
c) Label the short-run equilibrium Price (Ps), industry output (Qs), and firm output (qs). (2
marks)
d) Clearly identify the firm's economic profit or loss at short run equilibrium. (2 marks)
e) Clearly identify the long-run equilibrium P
1
, Q
1
, and q
1
, including the curves that change. (2
marks)
Firm Industry
Cost/unit
P
Q q
qo Qo
Po($1.30)
MCo
ACo
Do
So
Po-$0.50
MCs
ACs
Ss
qs Qs
Ps
ACs
Ec. Profit
Q
1
P
1
q
1
S
1

1 mark: S intersect Demand at Po = min ACo
1 mark: shift down of AC (where not important yet)
1 mark: MC shifts down and must go through min ACs
1 mark: Ss shifts down to pass through min ACs and Qo
1 mark: Ps < Po but > min AC and Qs > Qo from intersection of Ss and D
1 mark: qs > qo from MCs at Ps
1 mark: ACs > min AC (must be obvious) from ACs at Ps
1 mark: Economic Profit between an AC (doesnt have to be correct) and Ps but must have
qs as the horizontal dimension
1 mark: P
1
and q
1
= qo (must be shown) from minimum AC
1 mark: Q
1
> Qs from intersection of a new S curve through Demand at min AC
If they shift MC and AC up instead of down, mark wrong marks 2 to 5 (shifts in AC, MC, and S
and equilibrium Ps and Qs) but then give marks for consitency with their mistake.

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ECO100Y L5101; Midterm Test #1: June 22, 2011
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4. Per Unit Taxes: Linear Equation Example (10 marks)

The demand and supply equations for Gas Lawnmowers in Toronto are

P = 850 0.16Q and P = 160 + 0.24Q

Prices are $'s/Lawnmower and quantities are in Lawnmowers

a) What is the equilibrium price and quantity of Lawnmowers? (2 marks)

1 mark: Q = 1,725 from solution of something like 850 0.016Q = 160 + 0.24Q
1 mark: P = $574 either from 850 0.16*1725 = 160 + 0.24*1725



b) What is the new equilibrium price and quantity of Lawnmowers given a per unit tax of $90?
(3 marks)


1 mark: Q = 1,500 from solution of something like 850 0.016Q = 160 + 90 + 0.24Q
1 mark: P = $610 either from 850 0.16*1500 = 160 + 90 + 0.24*1500


e) What is the Sellers Price (i..e, after payment of the tax) of the per unit tax of $90 (1 mark)
1 mark: = P = $520 from 610 90 or 574 0.24/0.4 *90


5. Short-run Cost functions: Equations (5 marks)

The firm (publisher) Variable Cost (VC), Fixed Cost (FC), and Marginal Cost (MC)
functions for textbooks per day in the perfectly competitive textbook industry are
VC = 0.03q
2
+ 5q + 108 FC = 3,999 MC = 0.06q + 5
(Costs are measured in $s/textbook and quantities in textbooks).

a) What is the the shut-down price and output for this industry? (2 marks)

1 mark: 0.03q + 5 + 108/q = 0.06q + 5 => q = 60
1 mark: P = $8.60 from something like 0.03*60 + 5 + 108/60 or 0.06*60 + 5


b) What is the equilibrium output of the firm if the market price is $36.20? (1 mark)
1 mark: 520 from 36.20 = 0.06q + 5


c) What is the total cost for the firm at a price of $36.20? (2 marks)

1 mark: 14,819 from something like 0.03*520
2
+ 5*520 + (108 + 3999)

d) What is the economic profit(+)/loss(-) for a firm at a price of $36.20? (1 mark)
1 mark = 4,005 from 36.20*520-14,819
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ECO100Y L5101; Midterm Test #1: June 22, 2011
- 6/7 -
Part II A: Explanations.
Give a brief explanation for each of the following questions

1. What is Minimum Efficient Scale? (1 mark)





2. Why cant Indifference Curves intersect? (1 mark)







3. Why do we derive the Income-compensated Demand function? (1 mark)






4. What is a variable input into production? (1 mark)






5. Why does long-run average cost decrease given increasing returns to scale? (1 mark)





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ECO100Y L5101; Midterm Test #1: June 22, 2011
- 7/7 -
Part II B: Multiple Choice: Circle the best answer for each question.
Each question is worth 1 mark. No marks deducted for wrong answers.

1. Suppose that a fall in Price causes a fall in Quantity due to the Income Effect and an
increase in quantity due to the Substitution Effect but that the Substitution Effect is greater
than the Income Effect. Which of the following is most likely for this commodity?
a) demand is positively sloped b) demand is inelastic c) demand is perfectly inelastic
d) demand is unit elastic e) demand is elastic f) none of the above

2. Which of the following is false?
a) Average Product falls when Marginal Product falls
b) Average Product rises when Marginal Product rises
c) A firm would not hire any workers at a real wage above maximum Average Product
d) Marginal Product eventually falls because capital is fixed
e) None of the above

3. What is the effect of an increase in Demand on the long-run on equilibrium Price (P) and
firm output (q) of an industry if all firms are the same size?
a) no change in P and no change in q b) no change in P and increase in q
c) increase in P and no change in q d) increase in P and increase in q
e) none of the above

4. What is the effect of an increase in Demand on the long-run on equilibrium Industry output
(Q) and economic profit (profit) of a firm in an industry if all firms are the same size?
a) no change in Q and no change in profit b) no change in Q and increase in profit
c) increase in Q and no change in profit d) increase in Q and increase in profit
e) none of the above

5. Which of the following is true if the Buyers Share is greater than the Sellers Share of a per
unit tax?
a) Demand is relatively more elastic than Supply
b) Supply is relatively more inelastic than Demand
c) the magnitude of the slope of Demand is greater than that of the slope of Supply
d) the magnitude of the slope of Supply is less than that of the slope of Demand
e) none of the above




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