MICROECONOMICS ANSWERS FOR EXAM 1

MICROECONOMICS CHAPTER 1-4 ANSWER KEYS FOR EXAM 1

Assignment # 1 (Module 1)

  1. What is true about decision making in economics?
  • You go ahead with a decision if the benefits outweigh the accounting costs
  • You consider the “opportunity cost” of a decision while estimating the costs
  • You consume as long as marginal costs are greater than marginal benefits
  • If economic costs are greater than the benefits for a certain option, all options are equal

Answer: Part b). In economics you pursue a decision if benefits>economic costs. Economic costs include both accounting costs and opportunity costs.

  1. What are opportunity costs?
  • The cost in terms of the money you need to spend for a decision
  • The cost in terms of the foregone opportunity when making a decision
  • The opportunities that arise after a decision has been made
  • The interest paid on a loan

Answer: Part b) Opportunity cost is the “cost” to you of letting go of the benefits that you have gained if you had pursued the alternative (or the other opportunity).

  1. What is true about how much an individual decides to consume?
  • This is a decision made at the margin
  • If the marginal cost of a unit is higher than the marginal benefit, the individual will not consume it
  • Both a) and b) are true
  • Neither a) nor b) is true

Answer: Part c). To decide how much to consume an individual compares the cost of the additional unit (marginal cost) to the benefit of the additional unit (marginal benefit). As long as the marginal benefit is higher than the marginal cost, you continue consumption/production. When marginal benefit is equal to the marginal cost, this is the last unit if consumption/production. When marginal benefit is less than marginal cost, you do not consume/produce.

  1. What are information asymmetries?
  • When there are side effects of individual actions that markets can’t account for
  • When buyers and sellers don’t have equal access to information
  • Both a) and b) are true
  • Neither a) nor b) is true

Answer: Part b)- when buyers and sellers don’t have equal access to the information about the quality of the product.  Part a) refers to externalities.

  1. An industry pollutes a nearby water stream because of its production activity. What is this an example of?
  • This is an example of a positive externality
  • This is an example of a negative externality
  • This is an example of information asymmetry
  • This is an example of specialization

Answer: Part b). Externality refers to a side effect of an activity that is not accounted for by the market. Here the activity is production and the side effect is pollution which negatively impacts the environment.

  1. What is the impact on the market of information asymmetries or externalities?
  • They create conditions where government intervention will cause markets to fail
  • They create conditions for market failure
  • Both a) and b) are true
  • Neither a) nor b) is true

Answer: Part b) When information asymmetries exist, they create a lack of trust and potential for fraud which weakens market signals (such as prices- they no longer communicate the actual quality of the product) and creates conditions for market failure. Similarly, with externalities, the market overproduces a negative side effect (example: pollution) or underproduces a positive side effect (example: immunization), also creating conditions for market failure. In both these cases, the government intervention is desirable to fix problems created by markets.

7. Why are there gains from trade from the market?

  • Markets allow for overvaluation of products so producers can gain
  • Markets allow for undervaluation of products so consumers can gain
  • Markets allow for specialization
  • None of the above

Answer: Part c). Markets allow for exchange of goods and services, which means we can focus on (or specialize in) the activity we have an advantage in. This allows each individual to contribute more to society- more can be produced which means more is available for consumption and exchange. This specialization gives rise to gains from trade.

8. What are some desirable qualities of markets?

  • Markets are efficient when there is competition amongst buyers and sellers
  • Markets can guarantee equity
  • Both a) and b) are true
  • Neither a) nor b) is true

Answer: Part a) Competition amongst buyers and sellers ensure that the most cost-effective sellers survive whereas those buyers that value the product the most (and are thus, willing to pay a higher price) get access to the product. In this way, the market ensures that there is efficiency, or no wastage of resources. Markets however, cannot guarantee a fair distribution of resources (or incomes) across consumers.

9. How can governments try to reduce to the consumption of a product in the economy?

  • They can increase taxes on the margin
  • They can decrease taxes on the margin
  • They can provide subsidies for the product
  • None of the above

Answer: Part a). Given what we know about how individuals decide how much to consume (that they consume on the margin), governments can increase the cost on the margin by increasing taxes on the margin to reduce consumption.

10. Why do individual agents have to make decisions?

  • Resources are scarce
  • There are many options to choose from when deciding how to use resources
  • Both a) and b) are true
  • Neither a) nor b) is true

Answer: Part c). Individuals are constrained in terms of resources (time/money/natural resources) and have many options/desires to fulfil. This means they need to decide on the best possible option for the use of these scarce resources.

Chapter 2: Trade-offs and Trade (Module 2)

  1. The Production Possibility Frontier of Canada is given by: 400=2F+4C where F represents units of food, and C represents units of clothing. You can use this information for all the questions in this assignment. What is the maximum amount of food that Canada can produce?
  • 100 units
  • 50 units
  • 200 units
  • 400 units

Answer: Part c). In the equation 400=2F+4C, substitute C=0. We obtain 400=2F, thus F=400/2, or F=200

2. If Canada produces 80 units of Food and 50 units of Clothing, is this bundle of food and clothing efficient, inefficient, or not attainable? (Hint- plug F=80, and C=50 in the right hand side of the equation, i.e. 2*80+4*50: if this is less than 400, the bundle lies inside the PPF, if it is greater than 400 it lies outside the PPF, if it is equal to 400 it lies on this line)

  • The bundle is efficient
  • The bundle is inefficient
  • The bundle is not attainable
  • None of the above

Answer: Part b) In the equation 400=2F+4C, we only consider the right-hand side. Plug the values F=80 and C=50, we obtain 2*80+4*50=160+200=360. 360 is less than 400, thus, the point lies inside the PPF and is inefficient

3. What is the opportunity cost of one unit of food produced by Canada?

  • One unit of clothing
  • Half a unit (or 0.5 units) of clothing
  • Two units of clothing
  • Four units of clothing

Answer: Part b) We have the equation 400=2F+4C. When C=0, 400=2F, or F=200. When F=0, 400=4C, or C=100. In terms of resource utilization: 200 units of food are equivalent to 100 units of clothing; thus, one unit of F is equivalent to 0.5 units of clothing (200F=100C, or F=0.5C).  Thus, the opportunity cost of one unit of food is half a unit of clothing.

4. What is the opportunity cost of one unit of clothing produced by Canada?

  • One unit of food
  • Half a unit (or 0.5 units) of food
  • Two units of food
  • Four units of food

Answer: Part c) We have the equation 400=2F+4C. When C=0, 400=2F, or F=200. When F=0, 400=4C, or C=100. In terms of resource utilization: 100 units of clothing are equivalent to 200 units of clothing; thus, one unit of c is equivalent to 2 units of clothing (100C=200F, or C=0.5F).  Thus, the opportunity cost of one unit of clothing is two units of food.

5. In this example, the Production Possibility Frontier (PPF) of Canada is a straight line. What would a more realistic PPF look like? Why?

  • It will be curved, bowed out, because of increasing opportunity costs
  • It will be curved, bowed out, because of decreasing opportunity costs
  • It will be curved, bowed in, because of increasing opportunity costs
  • It will be curved, bowed in, because of decreasing opportunity costs

Answer: Part a) As we produce more of any product, the opportunity cost of the producing that product (or pursuing that activity) goes on increasing (one explanation is that resources are specialized). In the PPF, the slope represents the opportunity costs, thus, the slope increases as we produce more of any product, giving the PPF its curved, bowed out shape.

6. If Canada were to experience an improvement in technology or an increase in resources (land or labour), what would happen to its Production Possibility Frontier?

  • It would curve inwards
  • It wouldn’t change
  • It would shift out
  • It would shift in

Answer: Part c). As technology improves or resources increase, more production is possible, shifting the PPF outwards or to the right.

7. Assume that Vietnam can produce a maximum of 300 units of clothing or a maximum of 100 units of food. The opportunity cost of one unit of clothing is 0.333 (or 1/3rd) units of food, and the opportunity cost of one unit of food is 3 units of clothing. Vietnam would like to trade with Canada. Use this additional information to answer this question and the following questions. What does Vietnam have an absolute advantage in?

  • Food
  • Clothing
  • Both Food and Clothing
  • Neither Food nor Clothing

Answer: Part b). In order to determine absolute advantage, we only need to compare the maximum amount of each product each country can produce if they devote all their resources towards producing that product. In this case, Vietnam produces 300 units of clothing, whereas U.S. produces 100 units of clothing, if each country devotes all its resources towards clothing. If we consider food production, Vietnam produces 100 units of food, whereas U.S. produces 300 units of food, if each country devotes all its resources towards producing food. Thus, the only product Vietnam can produce more than U.S. (if each country devotes all their resources towards producing that product) is clothing.

8. What does Vietnam have a comparative advantage in?

  • Food
  • Clothing
  • Both Food and Clothing
  • Neither Food nor Clothing

Answer: Part b). To determine comparative advantage, we compare opportunity costs. The country which has a lower opportunity cost in producing a product, also has the comparative advantage in that product. In this example, Vietnam has the lower opportunity cost in producing Clothing than the U.S., so it has a comparative advantage in producing clothing.

9. Which product should Vietnam specialize in and export?

  • Food
  • Clothing
  • Both Food and Clothing
  • Neither Food nor Clothing

Answer: Part b) The theory of comparative advantage states that each country should specialize in and export the product of their comparative advantage. Vietnam has a comparative advantage in producing clothing, and thus, should specialize in and export clothing.

10. After trade, how can we show that Vietnam and Canada are better off?

  • They can both consume on the Production Possibility Frontier
  • They can both consume outside the Production Possibility Frontier
  • They can both consume inside the Production Possibility Frontier
  • None of the above

Answer: Part b) While both countries still produce on their PPF, they can trade and consumer outside their respective PPFs, showing that trade allows them to consume beyond their respective production capabilities.

ECO 202: Module 3: Assignment 3

11. Why is the individual demand curve downward sloping?

  • The market caters first to individuals who are willing to pay a higher price than other consumers
  • As individuals consumer more of a product the utility derived on the margin diminishes
  • Consumers like to pay more for higher quantities
  • There is a higher potential to make profits, so consumers buy more when the price rises

Answer: Part b). This question specifically asks about the individual demand curve and not the demand curve in general (or market demand). What drives the relationship between price and quantity demanded is the law of diminishing marginal utility- as an individual consumes more of a product, the utility (or value) they derive from every additional unit diminishes. Thus, they are willing to pay a lower price for additional units of the same product.

12. A shoe company has two markets- in New Jersey and New York. In New York, consumers demand 10,000 pairs at $40, and 15,000 pairs at $35. In New Jersey, consumers demand 5,000 pairs at $40, and 10,000 pairs at $35. What is true about the total market demand across the two states for this company?

  • They can sell a total of 15,000 pairs at $80
  • They can sell a total of 5,000 pairs at $80
  • They can sell a total of 20,000 pairs at $35
  • They can sell a total of 15,000 pairs at $40

Answer: Part d). In order to calculate the market demand curve we horizontally sum up demand curves, which means we keep the price constant and sum up the quantity demanded across all consumers. In this case, at $40, a total of 15,000 pairs (10,000 from NY and 5,000 from NJ) are demanded, whereas at $35, a total of 25,000 (15,000 from NY and 10,000 from NJ) are demanded.

13. If Calvin Klein offers a 15% discount on their jeans, which of the following can we expect?

  • There will be a movement along the demand curve for Calvin Klein jeans
  • The demand curve for Calvin Klein will shift to the right
  • The demand curve for Calvin Klein will shift to the left
  • The supply curve for Calvin Klein will shift to the right

Answer: Part a) Since this is a change in the price of the product itself, we will observe a movement along the demand curve.

14. What will happen in the market for denim jeans if khaki pants are more in fashion?

  • The demand curve for denim jeans will shift to the right
  • The demand curve for denim jeans will shift to the left
  • The supply curve for khaki pants will shift to the right
  • The supply curve for khaki pants will shift to the left

Answer: Part b). There is a change in tastes and preferences such that consumers prefer khaki pants, so consumers will shift from wearing denim to khaki, and there will be a leftward shift of the demand curve for denim jeans.

15. If Calvin Klein offers a 15% discount on their jeans what will happen in the market for Levi’s jeans?

  • The demand curve for Levi’s jeans will shift to the right
  • The demand curve for Levi’s jeans will shift to the left
  • The supply curve for Levi’s jeans will shift to the right
  • The supply curve for Levi’s jeans will shift to the left

Answer: Part b) Calvin Klein jeans and Levi’s jeans are substitutes. If the price of Calvin Klein’s jeans falls, the demand curve for Levi’s jeans will shift to the left.

16. What will happen in the market for cars that run on gasoline if the price of gasoline increases?

  1. The demand curve for cars that run on gasoline will shift to the right
  2. The supply curve for cars that run on gasoline will shift to the right
  3. The demand curve for cars that run on gasoline will shift to the left
  4. The supply curve for cars that run on gasoline will shift to the left

Answer: Part c). Gasoline and cars that run on gasoline are complements. Thus, if the price of gasoline increases, the demand for cars that run on gasoline will shift to the left.

17. What would happen in the market for denim jeans if the cost of denim fell?

  1. The demand curve for denim jeans will shift to the right
  2. There will be a movement along the supply curve for denim jeans
  3. The supply curve for denim jeans will shift to the right
  4. The supply curve for denim jeans will shift to the left

Answer: Part c). Denim is an input for producing denim jeans. Thus, if the cost of producing denim jeans falls, the supply curve for denim will shift to the right.

18. A book seller uses their shop to sell fiction and non-fiction books. The price that non-fiction books fetch in the market increases over time, what would happen to the supply to fiction books in this book seller’s shop?

  • The supply of fiction books will not be affected
  • There will be a movement along the supply curve of fiction books
  • The supply of fiction books will decrease
  • The supply of non-fiction books will decrease

Answer: Part c) Fiction and non-fiction books in this case are substitutes in supply- they compete for space in the book seller’s shop. If the price of non-fiction books rises, the book seller will start supplying more of those leading to a decline (or a leftward shift)  in the supply of non-fiction books.

19. A natural by-product of coconut is the fiber of the fruit called coir. If the price of coconuts increases over time (causing coconut producers to sell more coconuts), what can we expect to happen to the supply of coir?

  • There will be a movement along the curve for coir
  • There will be a rightward shift in the supply of coir
  • There will be a leftward shift in the supply of coir
  • The supply of coir will not be affected

Answer: Part b). Coconuts and coir are complements in supply. If the price of coconuts increases, suppliers would increase the quantity supplied of coconuts, and as a result, the supply curve for coir will shift to the right.

20. If in the month of February, Apple announces a back to school sale on laptops for August, what is likely to happen?

  1. There is a movement along the demand curve for laptops in February
  2. The demand curve for Apple’s laptops will shift to left in February
  3. The demand curve for Apple’s laptops will shift to the right in February
  4. The supply curve for Apple’s laptops will shift to the right in February

Answer: Part b) Expecting a sale in August, some consumers will decide not to buy in February and buy in August instead, shifting the demand curve for Apple’s laptops to shift to the left in February.

Assignment # 4 ( Chapter 4- Module 4)

1. If the price of a product is set above its equilibrium price as determined by the market, then:

  1. There will be a surplus*
  2. The price of the product will increase to adjust back to the equilibrium
  3. Both a) and b) are true
  4. Neither a) nor b) is true

Answer: Part a). When the price is set higher than the equilibrium price, suppliers increase the quantity supplied whereas consumers reduce the quantity demanded. Quantity supplied thus exceeds quantity demanded, and there is a surplus (or excess supply) of the product on the market. The price will decrease back to the equilibrium level as suppliers reduce the price of the product to sell the excess inventory

2. If the price of a product is set below its equilibrium price as determined by the market, then:

  • There will be a shortage
  • The price of the product will increase to adjust back to the equilibrium
  • Both a) and b) are true*
  • Neither a) nor b) is true

Answer: Part c) When the price is set lower than the equilibrium price, suppliers are less willing to supply and reduce the quantity supplies, whereas consumers increase the quantity demanded. Quantity demanded thus exceeds the quantity supplied, and there is a shortage (or excess demand) in the market. The price will increase back to the equilibrium level as consumers bid up the equilibrium price in order to ensure access to the product (or producers increase the price to be able to supply more of the product).

3. In the market for glass bottles, if the price of glass used in the bottles falls, then what will happen?

  • The price of glass bottles will increase, and the quantity sold will increase
  • The price of glass bottles will decrease, and the quantity sold will increase*
  • The price of glass bottles will increase, and the quantity sold will decrease
  • The price of glass bottles will decrease, and the quantity sold will decrease

Answer: Part b) Glass is an input used in the production of glass bottles, thus if the cost of production falls, we should expect an increase or a rightward shift of the supply curve. This will reduce the equilibrium price of glass bottles and increase the equilibrium quantity.

4. If because of the pandemic, availability of inputs for health equipment falls because of a disruption in supply chains across the world, what should we expect?

  1. The price of health equipment will increase, and the quantity sold will increase
  2. The price of health equipment will increase, and the quantity sold will decrease*
  3. The price of health equipment will decrease, and the quantity sold will increase
  4. The price of health equipment will decrease, and the quantity sold will decrease

Answer: Part (b). If inputs are not easily available, the supply curve will shift to the left, causing the price of the health equipment to increase and the quantity sold to decrease.

5. In the current climate, due to fears of community spread of the virus travel has been restricted and hotel owners have experienced a decline in demand. Which of the following is likely?

  1. Hotel room prices will increase, and fewer rooms will be booked
  2. Hotel room prices will decrease, and fewer rooms will be booked*
  3. Hotel room prices will increase, and more rooms will be booked
  4. Hotel room prices will decrease, and more rooms will be booked

Answer : Part a) Because of a change in tastes and preferences as well as expectations, the demand curve for hotel rooms has shifted to the left. This causes the price of the hotel rooms to decrease, and fewer hotel rooms will be booked.

6. The pandemic has caused an increased need for online technologies such as Zoom. What is likely to happen to the price of such services and the quantity sold?

  1. Both price and quantity sold will increase*
  2. Both price and quantity will decrease
  3. Price will increase but quantity will increase
  4. Price will decrease but quantity will decrease

Answer: Part (a) An increased need and preference for online technologies will shift the demand curve to the right, causing the price of such services to increase, as well as an increase in their sales (or quantity sold).

7. If there is a growing awareness about the health benefits of running, and the tariffs on running shoes fall, which of the following will happen in the market for running shoes?

  • Equilibrium price will increase, equilibrium quantity cannot be determined
  • Equilibrium price will decrease, equilibrium quantity cannot be determined
  • Equilibrium quantity will increase but equilibrium price cannot be determined*
  • Equilibrium quantity will decrease but equilibrium price cannot be determined

Answer: Part c). A change in tastes and preferences such that people like to run more will lead to a rightward shift of the demand curve for running shoes. This will cause the equilibrium price to increase and the equilibrium quantity to increase. However, a reduction in tariffs will reduce the cost of production and shift the supply curve to the right. This will cause equilibrium price to decrease and equilibrium quantity to increase. Both effects together reinforce the effect of increased quantity, but they cause equilibrium price to move in opposite directions. Thus, while equilibrium quantity increases, the impact on equilibrium price cannot be determined.

8. If the price of gasoline increases, and there is an improvement in the technology for producing cars that run on gasoline, which of the following will happen in the market for cars that run on gasoline?

  • Equilibrium price will increase, equilibrium quantity cannot be determined
  • Equilibrium price will decrease, equilibrium quantity cannot be determined*
  • Equilibrium quantity will increase, equilibrium price cannot be determined
  • Equilibrium quantity will decrease, equilibrium price cannot be determined

Answer: Part b) An increase in the price for gasoline (which is a complement for cars that run on gasoline) will shift the demand curve for the abovementioned cars to the left. This will decrease the equilibrium price and quantity of these cars. An improvement in the technology of production will shift the supply curve to the right, which will cause a reduction in the equilibrium price, but will increase the equilibrium quantity. Both effects are causing the equilibrium price to fall but have opposing effects on equilibrium quantity. Thus, together they cause a decrease in equilibrium price, however, the impact on equilibrium quantity cannot be determined.

9. If the price of Andriod phones falls, and Apple finds a cheaper supplier for some of its inputs in Vietnam, what will happen in the market for iPhones?

  1. Equilibrium price will increase, equilibrium quantity cannot be determined
  2. Equilibrium price will decrease, equilibrium quantity cannot be determined*
  3. Equilibrium quantity will increase, equilibrium price cannot be determined
  4. Equilibrium quantity will decrease, equilibrium price cannot be determined

Answer: Part b) If the price of Android phones falls (Android phones are substitutes for iPhones) the demand for iPhones will shift to the left, causing a reduction in both the equilibrium price and quantity of iPhones. However, finding a cheaper supplier in Vietnam allows for a reduction in the cost of production for iPhones which shifts their supply curve to the right. This will cause a reduction in the equilibrium price of the iPhones, but an increase in the equilibrium quantity. Together, the two effects will reduce the price of iPhones, but the impact on equilibrium quantity cannot be determined.

10. In the market for N-95 masks, the demand surged suddenly, while the cost of production also went up. The result was an increase in the market price and the quantity sold. Which of the following must have happened?

  1. The demand shifted more to the right than supply shifted to the left*
  2. The supply shifted more to the left than demand to the right
  3. The demand and supply curves shifted equally
  4. The demand shifted more to the left than supply to the right

Answer: Part a). A rightward shift of the demand curve causes the equilibrium price and quantity of masks to increase. However, an increase in the cost of production causes the supply to shift to the left. This causes an increase in equilibrium price and a reduction in equilibrium quantity. Both effects cause equilibrium price to increase, but the impact on equilibrium quantity cannot be determined. If however, the final result in the market was an increase in the quantity sold, we can conclude that the impact of an increase (or a rightward shift) in demand was greater than the impact of the decrease (or the leftward shift) in supply.

MICROECONOMICS ANSWERS FOR EXAM 1

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