University of Toronto February 15, ECO 100Y INTRODUCTION TO ECONOMICS Term Test # 3

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1 Department of Economics Prof. Gustavo Indart University of Toronto February 15, 2013 SOLUTIONS ECO 100Y INTRODUCTION TO ECONOMICS Term Test # 3 LAST NAME FIRST NAME STUDENT NUMBER INSTRUCTIONS: 1. The total time for this test is 1 hour and 40 minutes. 2. Aids allowed: a simple calculator. 3. Write with pen instead of pencil. 4. Please write legibly. If I can t read your handwriting, I can t award you any marks! DO NOT WRITE IN THIS SPACE Part I /30 Part II 1. /10 2. /10 3. /10 TOTAL /60 Page 1 of 10

2 PART I (30 marks) Instructions: Enter your answer to each question in the table below. Table cells left blank will receive a zero mark for that question. Each question is worth two (2) marks. No deductions will be made for incorrect answers C D B E C D C C D B B C C E B 1. Which of the following statements about single-price monopolists is not true? A) The average revenue curve coincides with the demand curve. B) MC = MR if the firm is at the profit-maximizing point. C) Price equals marginal cost at the profit-maximizing level of output. D) Price elasticity of demand will be greater than one if the firm is profit-maximizing. E) AR is greater than MR. 2. A single-price monopolist is currently producing an output level where P = $20, ATC = $15, and MC = $20. If the monopolist is a profit-maximizer, which of one of the following statements would be correct? A) The monopolist should shut down. B) The monopolist should not change her output level, because she is currently at the profit-maximizing output level. C) The monopolist should increase production and reduce price. D) The monopolist should decrease production and increase price. E) There is insufficient information to determine. 3. If a monopolist s marginal revenue is MR = 12 2Q and its marginal cost is MC = 3, then the profit-maximizing quantity is A) 4. B) 4.5. C) 6. D) 12. E) none of the above. Use this space for rough work. Page 2 of 10

3 4. What is the major difference between equilibrium in a competitive industry and equilibrium in an unregulated, single price monopoly? A) The monopolist produces where MR = MC, but the perfect competitor does not. B) Firms in perfect competition can make economic profits in the short run, but a monopolist cannot. C) The monopolist produces where P = MC, but the perfect competitor does not. D) The monopolist maximizes profits in the long run, but a perfectly competitive firm does not. E) Perfect competition achieves allocative efficiency but monopoly does not. 5. For a perfect price-discriminating monopoly, which one of the following statements is false? A) The firm sets prices. B) The firm captures the entire consumer surplus. C) Allocative efficiency is worse than with single-price monopoly. D) The firm can distinguish between buyers. E) Buyers cannot resell the product. 6. Suppose that a commodity s demand function is P = Q. What is marginal revenue when P = $140? A) $70. B) -$40. C) $40. D) $0. E) None of the above is correct. 7. Suppose a monopolist can sell 40 units of output per day for a price of $5 each, and 41 units of output per day for $4.90 each. The marginal revenue for the 41 st unit sold is equal to A) $4.90. B) $0.10. C) $0.90. D) -$0.10. E) none of the above. Use this space for rough work. Page 3 of 10

4 8. Which one of the following is not considered an investment item when calculating GDP? A) Melanie buys a new condominium on Queen Street. B) The TD Banks installs a new ATM in Robarts. C) Rachel buys 100 shares of Bell Canada. D) Pamela buys a 2013 pick-up truck. E) Both C) and D). 9. Which one of the following events would not be included in the calculation of GDP? A) The University of Toronto builds a new student residence. B) RIM exports BlackBerries Z10 to Japan. C) Some newly built condos remain unsold at the end of the year. D) The AGO purchases a Picasso for its permanent collection. E) The provincial government hires more teachers. 10. Suppose that a country imported 10 tractors at a cost of $25,000 each. Further suppose that 4 of these tractors were sold to farmers at $40,000 each and the remaining 6 tractors were left in inventory at their imported price at the end of the year. As a result of these transactions, the country s gross domestic product would increase by: A) $250,000. B) $60,000. C) $340,000. D) $240,000. E) $75, When unplanned inventory reduction occurs, which one of the following conclusions might be correct? A) The economy will contract. B) Desired investment is greater than actual investment. C) GDP is greater than its equilibrium level. D) Firms will lay off workers. E) None of the above is correct. Use this space for rough work. Page 4 of 10

5 12. Consider an economy without government sector and without international trade. At the equilibrium level of income/output, which one of the following statements is correct? A) Consumers purchases of goods and services equal total income. B) Firms hold no inventories. C) Aggregate expenditure equals total output. D) Changes in inventories are zero. E) Both C) and D) are correct. Use the following information to answer questions 13 to 15. Consider an economy without government sector and without international trade. Suppose that the functions for desired investment and desired consumption are: I = 75 and C = Y. All figures are in billions of dollars. 13. What is the level of equilibrium income (Y*) in this economy? A) $1,250. B) $1,750. C) $1,500. D) $2,000. E) None of the above. 14. What is the value of the expenditure multiplier (β AE ) in this economy? A) 2. B) 2.5. C) D) 5. E) None of the above. 15. If autonomous investment increases by $25 (billion), by how much will equilibrium income increase as a result? A) $25. B) $100. C) $50. D) $175. E) None of the above. Use this space for rough work. Page 5 of 10

6 PART II (30 marks) Instructions: Answer all questions in the space provided. Question 1 (10 marks) Consider the perfectly competitive market for widgets with the following market demand and supply functions: P = Q and P = Q. The widget market is in long-run equilibrium. All firms have identical cost schedules and the marginal cost function of each firm is MC = q. a) What is competitive equilibrium price and quantity in this market? Show all your work. (2 marks) Competitive equilibrium D = S Q = Q 0.005Q = 50 Q = 50/0.005 = 10,000 P = (10,000) = = $30 or P = (10,000) = = $30 b) What is the output of the individual firm in this market? How many firms are there in this market? Show how you obtained these figures. (2 marks) A perfectly competitive, profit-maximizing firm will produce where: P = MC 30 = q 0.2q = 20 q = 20/0.2 = 100 Since Q = n*q, Q = 10,000, and each firm produces q = 100, then the number of firms is: n = Q/q = 10,000/100 = 100. Page 6 of 10

7 c) Suppose now that the competitive firms decide to form a cartel. What price and output maximizes the profits of the cartel? Show how you obtained these figures. (2 marks) If the firms form a cartel, then the supply curve becomes the MC curve of the cartel. Since the cartel operates like a monopoly, the MR of the cartel is less than P and equal to: MR = Q The cartel will choose the level of output that allows the cartel to maximize profits, i.e., the level of output at which MR = MC: Q = Q 0.008Q = 50 Q = 50/0.008 = 6,250 And the cartel s price will be: P = (6,250) = = $ d) What output must each firm produce to maximize the cartel s profits? Show how you obtained this figure. (2 marks) Since there are 100 identical firms and the cartel s output is Q = 6,250, each firm will have to produce: q = Q/n = 6,250/100 = e) What output would an individual firm produce if it tried to maximize its own profits with no concern about the cartel? Show how you obtained this figure. (2 marks) If a firm tries to maximize its own profits independently of the cartel, it will produce where: P = MC = q 0.2q = q = 31.25/0.2 = Page 7 of 10

8 Question 2 (10 marks) Consider Net Musik, a firm in the music industry that makes its music available to the public through the Internet for a fee. Since a recorded piece of music is unique, Net Musik has a monopoly on its music and can charge a monopoly price to anyone who wants to have access to it. Suppose that the production and recording of a new CD by a popular band cost Net Musik a total of $175,000. Of course, the marginal cost of making this music available to one more member of the public (via the Internet) is zero. Suppose that the demand function for downloads is P = 40 Q, where P is dollars per download and Q is thousands of downloads. a) As an unregulated profit-maximizer monopoly, what price will Net Musik charge to anyone who wants to download the new CD? What will the quantity of downloads be? What profit will this new CD generate for the firm? Show all your work. (4 marks) As a monopolist, Net Musik will maximize profit by producing the level of output at which MR = MC. Given the expression for the demand curve, the expression for the MR curve is: MR = 40 2Q. Net Musik will maximize profits producing the level of output at which MR = MC and MC = 0. Therefore, the profit-maximizing level of output is: 40 2Q = 0 2Q = 40 Q = 20 (i.e., 20 thousand). At this level of output, Net Musik will charge a price equal to: P = 40 Q = = $20. And the total profits of the firm will be: p = TR TC = $400,000 $175,000 = $225,000. b) What will the efficient quantity of downloads be? Show all your work. (2 marks) The efficient quantity of downloads will be at the level where P = MC, i.e., 40 Q = 0 Q = 40. c) If the government regulates the music industry to protect consumers and allows Net Musik to make just normal profits on the new CD, what price ceiling should the government impose on the firm? What will the quantity of downloads be? Show all your work. (4 marks) The government should implement an average-cost-pricing policy and set a price ceiling where P = ATC, where ATC = TC/Q = $175/Q. That is, 40 Q = 175/Q 40Q Q 2 = 175 Q 2 40Q = 0. Therefore, Q = [ b ± (b 2 4ac) ½ ] / 2a = [40 ± ( ) ½ ] / 2 = 20 ± 15 = either 5 or 35. Since the government is regulating the monopoly to protect consumers and consumers will be better off (i.e., they will enjoy a larger consumer surplus) with Q = 35, we must conclude that Q will be 35,000 and thus the price ceiling will be P = $175/35 = $5. Page 8 of 10

9 Question 3 (10 marks) Consider the following information regarding the national accounts of a hypothetical country (all figures are in billions of dollars). Government Transfer Payments 10 Government Expenditures on Current Goods and Services 70 Indirect Taxes 25 Imports of Goods and Services 95 Interest Paid on the National Debt 5 Net Income of Unincorporated Businesses 30 Personal Savings 35 Dividends 30 Wages and Salaries 145 Depreciation (Capital Consumption Allowances) 35 Residents Investment Income from Abroad 12 Exports of Goods and Services 85 Consumption Expenditure 175 Interest and Rental Income 15 Corporate Profits before Taxes 50 Non-Residents Investment Income 20 Corporate Income Taxes 15 Personal Income Taxes 45 Gross Investment Expenditure 65 [Note: When answering the questions below, you must clearly show how you obtained each figure.] a) Calculate Gross Domestic Product (GDP) using the expenditure approach. Show all your work. (2 marks) GDP = C + G + I + X IM = = 300 b) Calculate Net Domestic Income (NDI) using the expenditure approach. Show all your work. (2 marks) NDI = GDP Depreciation Indirect Taxes = = 240 Page 9 of 10

10 c) Calculate Net Domestic Income (NDI) using the income approach. Show all your work. (2 marks) NDI = Wages & Salaries + Corporate Profits + Interest and Rental Income + Net Income of Unincorporated Businesses = = 240 d) Calculate Personal Disposable Income (PDI). Show all your work. (2 marks) PDI = Personal Income Personal Income Taxes Let s first calculate Personal Income: PI = NDI Corporate Profits + Dividends + Government Transfer payments + Interests on the National Debt = = 235 Therefore, PDI is: PDI = PI Personal Income Taxes = = 190 e) Calculate Gross National Product (GNP). Show all your work. (2 marks) GNP = GDP Non-Residents Investment Income + Residents Investment Income from Abroad = = 292 Page 10 of 10

SOLUTION ECO 209Y MACROECONOMIC THEORY. Midterm Test #1. University of Toronto October 21, 2005 LAST NAME FIRST NAME STUDENT NUMBER INSTRUCTIONS:

Department of Economics Prof. Gustavo Indart University of Toronto October 21, 2005 SOLUTION ECO 209Y MACROECONOMIC THEORY Midterm Test #1 LAST NAME FIRST NAME STUDENT NUMBER INSTRUCTIONS: 1. The total