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Department of Economics Prof. Gustavo Indart

University of Toronto October 22, 2010




ECO 100Y
INTRODUCTION TO ECONOMICS
Midterm Test # 1



LAST NAME
FIRST NAME
STUDENT NUMBER



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 1. /10


2. /8


3. /12


4. /10


5. /12


6. /12



Part II /36




TOTAL /100

Page 2 of 16
PART I (64 marks)


Instructions: Answer all questions in the space provided.


1. (10 marks) Determine the amount of consumer or producer surplus generated in each of the
following situations. Briefly explain how you get to this amount.
a) Aneseh goes to the CD store to buy Lady Gagas latest CD. She is willing to pay up to $15
for the CD and finds that its price tag is exactly $15. At the cash register she is told that
Lady Gagas CD is on sale today for $12. (2 marks)
Anesehs consumer surplus is the difference between the value she assigns to the CD
i.e., the maximum price she is willing to pay for it and the price she actually pays for the
CD. Aneseh was willing to pay up to $15 for the CD but she got it for only $12, and thus her
consumer surplus is $3.









b) Galina is willing to pay up to $20 for a used copy of the last of Harry Potters books. She
goes to the bookstore and finds one copy selling for $20. (2 marks)
Galinas consumer surplus is the difference between the value she assigns to the Harry
Potters book i.e., the maximum price she is willing to pay for it and the price she
actually pays for the book. Galina was willing to pay up to $20 for the book and this is
exactly what she paid for it, and thus her consumer surplus is $0.

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c) Bowen has just finished a soccer practice at the Athletic Centre. She wants to purchase a
bottle of mineral water for up to $2. The Centres vending machine sells mineral water for
$2.50. (2 marks)
Bowens consumer surplus is the difference between the value she assigns to a bottle of
mineral water i.e., the maximum price she is willing to pay for it and the price she
actually pays for it. However, since Bowen is willing to pay a maximum of $2 for a bottle of
mineral water and the price is $2.50, she will not buy any bottle (and thus there will not be
any consumer surplus to calculate).












d) Fatima advertises her car for sale in the Varsity for $2,000. She is, however, willing to sell
her car for any price above $1,800. A classmate buys her car for $2,000. (2 marks)
Fatimas producer surplus is the difference between the minimum price she is willing to
accept for her car and the price she actually gets for it. Fatima was willing to accept a
minimum price of $1,800 for her car but she got $2,000 for it, and thus her producer surplus
is $200.












e) Lady Gagas concert is sold out. Allison got a ticket for the concert for $50. She lists her
ticket on eBay thinking of selling it for at least $75. To her surprise, after two days of bidding
she sells the ticket for $150. (2 marks)
Allisons producer surplus is the difference between the minimum price she is willing to
accept for her ticket to Lady Gagas concert and the price she actually gets for it. Allison
was willing to accept a minimum price of $75 for her ticket but she got $150 for it, and thus
her producer surplus is $75.
Note as well that the minimum price of $75 she is willing to accept for the ticket represents
the value she assigns to it, and thus her consumer surplus when she bought the ticket for
$50 was $25.

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2. (8 marks) What can you conclude about the price elasticity of demand in each of the following
statements? Briefly explain with the help of an appropriate demand curve diagram.
a) My economics professor has chosen to use the Ragan/Lipsey textbook. I have no choice
but to buy this book. (2 marks)

Recall that = % Q / % P and that we can
also express this relationship as:
= (Q / Q) (P / P).
Since I must buy a textbook and the
Ragan/Lipsey is the only textbook I can use for
my course, I have no choice but to buy it. This
means that I must get a copy of the textbook
independently of its price. In other words, my
price elasticity of demand for Ragan/Lipsey
textbook is zero ( = 0) and thus my demand
curve for this textbook is vertical at Q = 1.








b) The photocopy business is very competitive. I would lose half of my sales when I raised the
price by as little as 10 percent. (2 marks)

Recall that = % Q / % P.
Since when price increases by 10 percent
the quantity demanded for my photocopies
decreases by 50 percent, Im operating in
the elastic segment of my demand curve,
i.e., in the segment where demand elasticity
is greater than one. More precisely, the
price (arc) elasticity of demand is:
= % Q / % P = 50% / 10% = 5 (or 5
in absolute value).







1
D
P
> 1

Q
P
D
Q

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c) I dont get it! Im spending more on coffee even though the price of coffee fell from $8 to $5
a pound. (2 marks)
Recall that = % Q / % P.
If my total expenditure on coffee increases
when the price of coffee decreases, then Im
operating in the elastic segment of my demand
curve. Indeed, if elasticity is greater than one
then the percentage increase in the quantity
demanded is greater than the percentage
decrease in price and thus my total
expenditure increases. This can be observed
in the diagram on the right.
We are operating in the segment where > 1,
i.e., in the segment of the demand curve
between the vertical intercept and the mid-
point. As the price falls from $8 to $5, total
expenditure (i.e., price times quantity)
increases by the difference between areas (B)
and (A).





d) The price of coffee has oscillated between $0.75 and $1.50 a cup during the last two years.
However, I always spend exactly $15 a week on coffee. (2 marks)

Recall that = % Q / % P.

We are told that I always spends the same
amount of money ($15) on coffee although the
price of coffee changes. That is, P might
increase and thus Q decrease, but my total
expenditure (TE) doesnt change TE = P*Q
is constant.
A constant TE means that Q changes in the
same proportion as P but in the opposite
direction. In other words, in absolute value,
% Q = % P
and thus = 1.






(A)
(B)
Q
0
/2
$5
Q
2
$8
Q
1
P
0
/2
P
0
> 1
Q
0
Q
P
Q
1
Q
2
P
2
P
P
1
P
1
* Q
1
= P
2
* Q
2
D
Q

Page 6 of 16
100 150 50
Y
X
50
200 250 300
150
100
PPC
1

PPC
2

PPC
3

3. (12 marks) Consider a hypothetical country that has 250 units of resources and produces only
two goods, good X and good Y. The table below shows different allocations of resources
between these two industries and the corresponding maximum levels of output that can be
produced of each of these two goods.












a) In the diagram below, draw this countrys production possibilities curve (PPC
1
). (2 marks)






b) What is the opportunity cost of producing 30 additional units of X if the economy is initially
producing 60 units of X and 60 units of Y? And, what is the opportunity cost of producing 30
additional units of X if the economy is initially producing 90 units of X and 45 units of Y? (2
marks)

When X = 60 and Y = 60, increasing the production of X by 30 units requires a transfer of
resources from the Y industry which reduces de quantity produced of Y by 15 units (from 60
units to 45 units). Therefore, the opportunity cost of producing these 30 additional units of X
is 15 units of Y.

When X = 90 and Y = 45, increasing the production of X by 30 units requires a transfer of
resources from the Y industry which reduces de quantity produced of Y by 25 units (from 45
units to 20 units). Therefore, the opportunity cost of producing these 30 additional units of X
is 25 units of Y.
Quantity of
resources used
in the Y
industry
Annual
production of Y
Quantity of
resources used
in the X
industry
Annual
production of X
0 0 250 130
50 20 200 120
100 45 150 90
150 60 100 60
200 70 50 35
250 75 0 0


















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c) Given your answer in b), what can you conclude regarding the opportunity cost of X? What
is the economic explanation of your conclusion? (2 marks)

The answers to part b) show that the opportunity cost of producing X increases as more of
X is produced.
The reason for this is that although additional resources allocated to the production of X
increase the output of X, they do so at a decreasing rate. This means that the production of
each additional unit of X requires the use of more resources than the previous one (and
thus it becomes necessary to transfer more and more resources from the Y industry to
produce additional units of X).



d) Suppose now that only the technology associated with producing good Y improves, so that
the maximum level of Y that can be produced with any given quantity of resources
increases by 100 percent. Fill in the table below with the annual production of Y and X
corresponding to each resource allocation. Draw this countrys new production possibilities
curve (PPC
2
) in your diagram above. (3 marks)








e) Go back to the situation of part a) above. Suppose now that the technology associated with
producing both good X and good Y improves, so that the maximum level of X and the
maximum level of Y that can be produced with any given quantity of resources increases by
100 percent. Fill in the table below with the annual production of Y and X corresponding to
each resource allocation. Draw this countrys new production possibilities curve (PPC
3
) in
your diagram above. (3 marks)







Quantity of
resources used
in the Y
industry
Annual
production of Y
Quantity of
resources used
in the X
industry
Annual
production of X
0 0 250 130
50 40 200 120
100 90 150 90
150 120 100 60
200 140 50 35
250 150 0 0
Quantity of
resources used
in the Y
industry
Annual
production of Y
Quantity of
resources used
in the X
industry
Annual
production of X
0 0 250 260
50 40 200 240
100 90 150 180
150 120 100 120
200 140 50 70
250 150 0 0

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4. (10 marks) Consider the market for milk in the small country of Las Piedras. This market
demand and supply schedules are shown in the table below, where the price of milk is
expressed in pesos per litre and the quantity of milk in millions of litres per month:
Price 10 9 8 7 6 5 4 3
Quantity demanded 2 4 6 8 10 12 14 16
Quantity supplied 11 10 9 8 7 6 5 4
a) Assuming there is no government intervention in this market, what are the equilibrium price
and the equilibrium quantity? Briefly explain. (2 marks)
Equilibrium is established at the price level at which the quantity demanded is equal to the
quantity supplied. Therefore, equilibrium is reached at P = $7 since at that price the quantity
demanded and the quantity supplied are both equal to 8 millions of litres per month.







b) Now suppose the government of Las Piedras guarantees milk producers a price of 9 pesos
per litre and promises to buy any amount of milk that the producers cannot sell. What are
the quantities demanded and supplied at this guaranteed price? Briefly explain. (1 mark)
How much milk would the government be buying (per month) with this price support
program? Briefly explain. (1 mark)
If P = $9, the above schedule shows that the quantity demanded is 4 million while the
quantity supplied is 10 million litres per month i.e., there will be an excess supply equal
to 6 million litres per month. Therefore, the government will have to buy 6 million litres per
month with this price support system.


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c) What is, in pesos, the cost of this price support system (to the government)? Briefly explain.
(1 mark) Who pays for the milk that the government buys? Who is helped and who is
harmed by this policy? Briefly explain. (2 mark)
The cost of this price support system to the government is the cost of purchasing 6 million
litres of milk per month, i.e., $9 X 6 (million) = $54 million per month.
The government will pay for this price support system from its general revenues, and thus it
is taxpayers who end up paying for the milk that the government buys.
Milk producers are the clear and direct beneficiaries of this price support system (i.e. now
they receive a higher price and produce a larger output, which means an increase in
producer surplus), while milk consumers are those harmed by this policy (i.e., now they pay
a higher price and purchase a lower output, which means a decrease in consumer surplus).





d) Suppose that the price of milk in Ontario is equal to the equilibrium price you determined for
Las Piedras in part a) above, i.e., equal to the equilibrium price in Las Piedras before the
intervention of the government. Further suppose that the government of Las Piedras
exports to Ontarioat a price of 6 pesos per litrethe milk it purchased through the pricing
system of part c) above. What is now, in pesos, the cost of this price support system (to the
government of Las Piedras)? Briefly explain. (1 mark) Who is helped and who is harmed by
this policy in Ontario? Briefly explain. (2 mark)
Since the government of Las Piedras now sells to Ontario the milk it purchases under the
price support program, the cost per litre to the government of Las Piedras is the difference
between the price it pays to producers ($9) and the price it receives from Ontarian
importers ($6). Therefore, the total cost of this program to the government of Las Piedras is
($9 $6) X 6 (million) = $18 million per month.
The milk imports from Las Piedras increases the supply of milk in Ontario (i.e., the supply
curve shifts down to the right), and thus the price of milk falls in Ontario. Therefore,
Ontarian milk consumers are the beneficiaries of this policy since they end up paying a
lower price per litre of milk, while Ontarian milk producers are those harmed by this policy
because now they end up receiving a lower price for their milk.

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5. (12 marks) Suppose that the hockey arena of a small town has a seating capacity of 6000.
Hockey is the main sports activity in this town and every Saturday the local hockey team plays
in this arena. The demand schedule for regular hockey games tickets is as follows:
a) What price would fill the arena without creating a shortage of seats at a regular Saturday
hockey game? Briefly explain. (1 mark) At this price, what is the revenue generated at each
hockey game? Show your work. (1 mark)

Since the arena has a maximum seating capacity of 6000, a price of $8 per ticket would
ensure a full house without creating any excess demand. At P = $8, the total revenue
generated at each hockey game is TR = P*Q = $8 x 6000 = $48 thousand.














b) If the hockey team sets a price of $10 per ticket, will there be an excess demand or supply
of tickets for a regular hockey game? Briefly explain. (1 mark) At this price, what is the
revenue generated at each hockey game? Show your work. (1 mark) Considering the
range of the demand curve for hockey games between P = $8 and P = $10, without doing
any additional calculation what can you conclude about the price elasticity of demand? Is it
elastic or inelastic? (2 marks)

When P = $10, the quantity demanded is 5000. Therefore, 1000 tickets will be left unsold
i.e., there will be an excess supply equal to 1000 tickets.
At P = $10, the total revenue generated at each hockey game is TR = P*Q = $10 x 5000 =
$50 thousand.
Since TR rises as P increases from $8 to $10, we can conclude that demand is inelastic in
this segment of the demand curve for hockey games. That is, < 1 in this segment of the
demand curve which means that % Q < % P and thus TR > 0.








Price $4 $6 $8 $10 $12 $14
Quantity demanded 8000 7000 6000 5000 4000 3000

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c) If the hockey team sets a price of $12 per ticket, what is the revenue generated at each
hockey game? Show your work. (1 mark) Considering the range of the demand curve for
hockey games between P = $10 and P = $12, without doing any additional calculation what
can you conclude about the price elasticity of demand? Is it elastic or inelastic? (1 mark)

When P = $12, the quantity demanded is 4000. Therefore, the total revenue generated at
each hockey game is TR = P*Q = $12 x 4000 = $48 thousand.
Since TR falls as P increases from $10 to $12, we can conclude that demand is elastic in
this segment of the demand curve for hockey games. That is, > 1 in this segment of the
demand curve which means that % Q > % P and thus TR < 0.





d) Once a year, the Maple Leafs come to town to play a friendly game against the local team.
If at each price the quantity demanded of tickets doubles when the Leafs play, what is the
equilibrium price for a Leafs game? Briefly explain. (2 marks)
The demand for Maple Leaf games is as shown in the following schedule:



Since the arena has a maximum seating capacity of 6000, a price of $14 per ticket will
ensure a full house without creating any excess demand. Therefore, the equilibrium price is
$14.




e) Go back to the situation of part a) above. Suppose now that, in order to promote hockey
among children, the team decides to give local schools 1000 free tickets to every game. If
the team also decides to charge a price to paying fans that will ensure every hockey game
to be sold out without creating a shortage, what price will the team set? Briefly explain. (2
marks)

If the hockey team sets aside 1000 tickets for the local schools, then only 5000 tickets will
be left available for regular hockey fans. Therefore, according to the demand schedule
provided, for Q = 5000 the corresponding price is $10.
Price $4 $6 $8 $10 $12 $14
Quantity demanded 16000 14000 12000 10000 8000 6000

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6. (12 marks) Suppose that government regulation does not allow Canadian salmon to be
exported to other countries. Further suppose that the yearly supply and domestic demand
schedules of Canadian salmon are as follows:
Price (per pound) $15 $12 $9 $6 $3
Quantity demanded (thousands of pounds) 200
400
600 800 1000
Quantity supplied (thousands of pounds) 800 700 600 500 400

a) Draw the supply (S) and domestic demand (D) curves in the diagram below and clearly
show the market equilibrium (point A). (1 mark)





























b) Now suppose that Canadian salmon can also be sold in the U.S. and that the American yearly
demand schedule for Canadian salmon is as follows:
Price (per pound) $15 $12 $9 $6 $3
Quantity demanded (thousands of pounds) 200 300 400 500 600
Fill in the blanks in the box below to express the yearly demand schedule for Canadian Salmon
now that Americans are also buying it. (1 mark)
Price (per pound) $15 $12 $9 $6 $3
Quantity demanded (thousands of pounds) 400 700 1000 1300 1600

4
0
0

2000 1500
5
15
10
Q
D
1000
12
3
500
6
0
0

7
0
0

P
D
S
A
B
9
S

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c) In the diagram above, draw the new demand curve (D) for Canadian salmon now that
American consumers can also buy it. (1 mark) What is the new equilibrium price and
equilibrium quantity of Canadian salmon sold in the market? Clearly show the new market
equilibrium (point B) in your diagram. (1 mark) What happens to the quantity purchased by
Canadian consumers? Briefly explain. (2 marks)
To get the new market demand curve (D) we must add the quantities demanded at each price
level by both Canadian and American consumers. The corresponding increase in demand for
Canadian salmon results into an increase in the equilibrium price from $9 to $12 and an
increase in the quantity demanded from 600 to 700 thousand pounds. Therefore, Canadian
consumers are now paying $3 more per unit than before and, as a result, they are buying a
smaller quantity400 instead of 600 thousand pounds.


d) Suppose that as a result of overfishing after the increase in demand of part c), the stock of
Canadian salmon is seriously depleted. In order to allow salmon stock to recover, the
government introduces a quota limiting the quantity of Canadian salmon caught to 400
thousand pounds per year. What happens to the price paid by consumers? What happens to
the quantity purchased by Canadian consumers? What happens to the quantity purchased by
American consumers? Briefly explain. (3 marks)
The introduction of a quota of 400 thousand pounds per year creates a situation of excess
demand at the initial equilibrium price of $12. Therefore, price increases to $15 (i.e., consumers
demand a quantity of 400 thousand pounds per year when the price is $15). At this price,
Canadian consumers buy only 200 thousand pounds as indicated by the Canadian demand
curve. The Americans, therefore, buy the restanother 200 thousand poundsas indicated by
the American demand schedule.



e) The government finds that the quota is difficult to administer and decides to impose instead a
unit-tax on producers to reduce the quantity of Canadian salmon caught to 400 thousand
pounds per year. In the diagram above, draw the new supply curve (S) of Canadian salmon.
What is the amount of the tax per pound? Briefly explain. What price do consumers pay? What
price do producers receive net of the tax? Briefly explain. (3 marks)
The imposition of the unit-tax on producers increases the cost of production of the fishing
industry. Therefore, the industry supply curve shifts up by exactly the size of the unit-tax. Note
that this is a parallel shift, i.e., the minimum price that producers are willing to accept for each
additional unit of output increases by the size of the unit-tax. The supply curve thus shifts up to
S, i.e., just enough to intersect the market demand curve (D) at the price level of $15. As
shown in the diagram, the unit-tax is thus equal to $12the difference between the price
consumers pay ($15) and the minimum price producers are willing to accept in order to
produce the 400 thousandth pound ($3).





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PART II (36 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 the version of your paper either A A or B B on the SCANTRON sheet where it says DO
NOT WRITE IN THIS SPACE.
Each question is worth 3 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 12
C E E B E B C D C B C B


1. Which one of the following will cause the demand for bacon to decrease?
A) The price of ham (a substitute) increases.
B) Disposable income decreases and bacon is an inferior good.
C) The price of eggs (a complement) increases.
D) The price of bacon decreases.
E) A storm in Southern Ontario kills 30 percent of the provinces pigs.

2. Which one of the following circumstances would cause the supply curve of goat cheese to shift
down?
A) The price of labour increases in the goat cheese industry.
B) The government imposes a quota on the goat cheese industrys output.
C) The government introduces a specific unit-tax on the goat cheese industry.
D) Energy prices increase for each firm in the goat cheese industry.
E) The price of goat milk decreases.

3. At a garage sale, Heba purchases a used bicycle for $60 when she was willing to pay $100.
Before paying for the bicycle she realizes that it needs repair at a cost of $15 but she buys it
anyway. If the bicycle costs $200 new, Hebas consumer surplus is
A) $140.
B) $115.
C) $100.
D) $40.
E) $25.

4. When the price of milk used to produce cheese rises, the consumer surplus associated with
the consumption of cheese
A) will definitely increase.
B) will definitely decrease.
C) will increase if cheese is a normal good.
D) will decrease if cheese is an inferior good.
E) None of the above is true.

Page 15 of 16
Diagram 1: Production Possibility Curve




Quantity
of good Y


PPC
1
PPC
2


Quantity of good X

5. In Diagram 1, the shift of the production possibility curve from PPC
1
to PPC
2
might be the
result of
A) an increase in the quantity of resources available for production combined with
technological improvement throughout the economy.
B) a decrease in the quantity of resources used by the Y industry and an increase in
quantity of resources used by the X industry.
C) an increase in the quantity of resources used by the X industry.
D) technological improvement throughout the economy with no change in the quantity of
resources.
E) a decrease in the quantity of resources throughout the economy and technological
improvement in the X industry.


6. Because hamburgers and French fries are often eaten together, they are complements. We
observe that both the equilibrium price of hamburgers and the equilibrium quantity of French
fries have risen. What could be responsible for this pattern?
A) An increase in the price of potatoes.
B) A fall in the price of potatoes.
C) A fall in the price of beef.
D) An increase in the price of beef.
E) A decrease in the price of hot dogs, a close substitute for hamburgers.


7. Consider a country that produces only two goodsgood X and good Y. If the production of one
unit of good X requires 10 units of resources and the production of one unit of good Y requires
20 units of resources, what is the opportunity cost of producing one unit of X in this country?
A) 2.5.
B) 2.0.
C) 0.5.
D) 0.4.
E) 20.


8. Because bagels and cream cheese are often eaten together, they are complements. We
observe that both the equilibrium price of cream cheese and the equilibrium quantity of bagels
have risen. What could be responsible for this pattern?
A) An increase in the price of flour.
B) A fall in the price of milk.
C) An increase in the price of milk.
D) A fall in the price of flour.
E) A decrease in the price of muffins, a close substitute for bagels.


Page 16 of 16
Diagram 2: Price Elasticity of Demand



B A

Price

D
1


D
2


Quantity

9. In Diagram 2, the demand curves D
1
and D
2
are parallel. Therefore, we can conclude that the
price elasticity of demand
A) at point A is greater than at point B.
B) is equal at points A and B.
C) at point A is less than at point B.
D) at point A cannot be compared to that at point B.
E) is not determinable from the information given.


10. Sandys demand schedule for soccer games is given in the following table:
Price Per Ticket $1 $5 $10 $15
Quantity Demanded 4 3 2 1
The price of a ticket is $5 and Sandy is planning to buy three tickets. However, the game is
sold out and now Sandy cannot buy tickets except from a scalper. The scalper sells tickets
only in packages of three. The scalper offers her a package of three tickets at $25. If Sandy
accepts this offer, what is the value of her consumer surplus?
A) $0.
B) $5.
C) $10.
D) $15.
E) None of the above is correct.


11. If per capita income increases by 10 percent and household expenditures on fur coats
decrease by 15 percent, one can conclude that the income elasticity of demand for fur coats is
A) unity.
B) elastic.
C) negative.
D) inelastic.
E) not determinable from the information given.


12. Suppose that the demand for CDs is very elastic and the supply is very inelastic. A sales tax on
CDs would be paid:
A) equally by buyers and sellers.
B) more heavily by sellers.
C) more heavily by buyers.
D) by neither buyers nor sellers.
E) cannot be determined without more information.