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UNIVERSITY OF TORONTO
Faculty of Arts and Science

APRIL/MAY EXAMINATIONS 2009

ECO 100Y1 Y

Duration: 3 hours

Examination Aids allowed: Non-programmable calculators only


INSTRUCTIONS: Students are required to do Part I and ONE of Parts II, III, IV, or V.
Part I is the multiple choice section and is worth 50%. Record all your
answers for Part I on the SCANTRON sheet provided and in the
examination booklets (Note: in case of any disagreement, the answer to
be marked is the one on the SCANTRON sheet). For the Scantron
sheets please use a black pencil or a black or blue ball-point pen. There
is no penalty for guessing in the multiple choice so be sure to provide
an answer for every question. Answers for the other Part will be
written in examination booklets. The blank pages may be used for
rough work (which will not be marked).


PART I To be answered by all students.


PART II To be answered by students from Professor Pesandos section (L0101)


PART III To be answered by students from Professor Indarts section (L0201)


PART IV To be answered by students from Professor Carrs section (L0301)


PART V To be answered by students from Professor Wolfsons section (L5101)



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PART I [50%]
MULTIPLE CHOICE QUESTIONS
(To be answered by all students)
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 name of your instructor on the SCANTRON sheet (in the area where it says
DO NOT WRITE IN THIS SPACE).
Each question is worth 1 mark. No deductions will be made for incorrect answers.
Write your answers to the multiple choice questions ALSO on the first page of
the first examination booklet used for short answer questions. You may use this
question booklet for rough work, and then transfer your answers to each multiple
choice question 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.

Diagram 1


A
Price
B

C
Demand

Quantity

1. In Diagram 1, the price elasticity of demand

a) at point A is greater than at point C.
b) is equal at points A, B, and C.
c) at point A is less than at point C.
d) at point A is equal to that at point C.
e) none of the above.

2. If the net tax rate is 50 percent of income and the marginal propensity to consume (MPC)
out of disposable income is 0.8, what is the marginal propensity to consume out of GDP?

a) 0.1.
b) 0.2.
c) 0.4.
d) 0.8.
e) none of the above.


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3. Price elasticity of demand

a) is greater than one if the percentage increase in the commodity's price is greater than
the percentage decline in quantity demanded.
b) is higher for an entire group of related products than it is for a particular product in
that group.
c) is a positive number because price and quantity demanded move in the same direction.
d) is very small when good substitutes are readily available for the commodity.
e) usually increases over time.


4. A profit-maximizing monopoly, facing a positive marginal cost, will never produce at an
output level

a) at which it would make economic losses.
b) where marginal revenue is less than price.
c) at which average cost is greater than marginal cost.
d) in the inelastic range of its demand curve.
e) in the elastic range of its demand curve.


5. 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.


6. If there is only one chartered bank, the public holds no currency, and the banks desired
reserve ratio is 10 percent, a new bank deposit of $500,000 arising from an open market
operation results in the banks deposits eventually increasing by __________ and an
increase in the banks reserves of __________.

a) $500,000; $5,000,000.
b) $5,000,000; $500,000.
c) $9,500,000; $500,000.
d) $500,000; $50,000.
e) None of the above.









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7. 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.


8. Consumers will bear a larger burden of an excise tax if

a) demand is relatively elastic and supply is relatively inelastic.
b) the tax is collected by firms rather than remitted directly to the government by
consumers.
c) both demand and supply are relatively elastic.
d) demand is relatively inelastic and supply is relatively elastic.
e) both demand and supply are relatively inelastic.


9. Suppose a market is in equilibrium at price P
0
, and then an excise tax of t dollars per unit
of the good is imposed. At a price of (P
0
+ t) there will be excess ________ for the good
unless the demand curve is ________.

a) tax; unit elastic.
b) supply; vertical.
c) demand; vertical.
d) supply; horizontal.
e) demand; horizontal.


10. An 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.





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11. 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.


The following data show the total output for a firm when specified amounts of labour are
combined with a fixed amount of capital. When answering the questions, you are to
assume that the wage per unit of labour is $25 and the cost of the capital is $100.

TABLE 1

Labour per unit of time Total Output
0 0
1 25
2 75
3 175
4 250
5 305

12. Refer to Table 1. The marginal cost of producing the 250
th
unit is approximately

a) 33 cents.
b) 41 cents.
c) 45 cents.
d) 74 cents.
e) 82 cents.


13. Refer to Table 1. The average total cost for 250 units of output is approximately

a) 33 cents.
b) 40 cents.
c) 63 cents.
d) 80 cents.
e) $1.00.








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14. Suppose that the quantity demanded of a good rises from 90 units to 110 units when the
price falls from $1.20 to 80 cents per unit. The price elasticity of demand for this product
is:

a) 4.0.
b) 1.5.
c) 2.0.
d) 1.0.
e) 0.5.


15. If per capita income increases by 10 percent and household expenditures on fur coats
increase by 15 percent, one can conclude that the price elasticity of demand for fur coats
is:

a) positive.
b) not determinable from the information given.
c) elastic.
d) unity.
e) inelastic.


16. If Michelle used $1000 from her savings account, which was paying 6 percent interest
annually, to invest in her brother's new sporting-goods store, the opportunity cost of her
investment on an annual basis would be

a) her share of the store's profits.
b) $60.
c) $1,000.
d) $1,060.
e) None of the above.


17. 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.







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18. How much would the production of a canoe add to GDP if the shell costs $250, the paint
costs $20, the finisher costs $35, the manufacturer sold it to the dealer for $500, and the
dealer sold it to his customer for $700?

a) $1,605.
b) $1,300.
c) $700.
d) $500.
e) $300.


19. Suppose a firm's fixed costs are $100 and marginal cost is constant regardless of
output. Which of the following is then true?

a) Marginal cost will be less than average variable cost.
b) Average variable cost will be rising as output rises.
c) Average total cost will decrease when output is increased.
d) Marginal cost will equal average total cost.
e) None of the above.


20. If firms' marginal costs rise rapidly as output increases, the

a) demand curve will tend to be steep.
b) elasticity of demand will tend to be low.
c) price elasticity of supply will tend to be high.
d) price elasticity of supply will tend to be low.
e) supply curve will tend to be flat.


21. In the short run, an increase in fixed costs for a perfectly competitive firm should lead to

a) a decrease in output.
b) a decrease in the number of sellers.
c) a decrease in the units of fixed factor that the firm uses.
d) all of the above.
e) none of the above.


TABLE 2

Consider the following information about the production of two goods, X and Y, in two
countries, A and B:

In Country A it takes Xa units of resources to produce one unit of X and Ya units of
resources to produce one unit of Y.
In Country B it takes Xb units of resources to produce one unit of X and Yb units of
resources to produce one unit of Y.



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22. Refer to Table 2. Country A has an absolute advantage in producing good X if

a) Xa = Xb.
b) (Xa/Ya) is less than (Xb/Yb).
c) Xa is less than Ya.
d) (Xa/Xb) is less than (Ya/Yb).
e) Xa is less than Xb.


23. Refer to Table 2. Country A has a comparative advantage in producing good X if

a) (Xa/Xb) is greater than (Ya/Yb).
b) (Xa/Ya) is less than (Xb/Yb).
c) (Xa/Ya) is greater than (Xb/Yb).
d) Xa is less than Yb.
e) Xa = Xb.


24. Suppose a firm producing digital cameras is operating at a level of output where marginal
cost is higher than average total cost. If the firm produces one more camera, average total
cost will

a) fall.
b) remain constant.
c) be at a maximum.
d) rise.
e) None of the above.


25. 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 (used to produce bagels).
b) A fall in the price of milk (used to produce cream cheese).
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.


26. An appreciation of the domestic currency

a) lowers the domestic price of imported goods.
b) raises the domestic price of imported goods.
c) raises the world price of imported goods.
d) lowers the world price of domestic goods.
e) None of the above.



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27. One region is said to have an absolute advantage over another region in the production of
good X when

a) the first region has a more productive labour force than the second.
b) there is no demand for good X in the second region.
c) the first region has a larger supply of the raw materials required to produce good X.
d) the opportunity cost of one unit of X is lower in the first region than in the second
region.
e) None of the above.


28. At its present level of output of 100 units, a competitive firm discovers that: 1) its total
fixed costs are $200; 2) its marginal cost is $6; and 3) its average total cost is $7. The
price of the commodity being produced is $6. If the firm wishes to maximize profits,
which of the following statement is correct?

a) The firm is making economic losses of $100 and should shut down production.
b) The firm is making economic losses but should continue to operate as it is.
c) The firm is making economic losses greater than its total fixed cost and should shut
down production.
d) The firm should increase output to reduce its economic losses.
e) The firm should decrease output to reduce its economic losses.


29. Consider two countries that can produce rice and other products. If neither country has an
absolute advantage in the production of rice,

a) rice will still be traded as long as one of the countries has a comparative advantage in
its production.
b) the opportunity cost of producing rice must be identical in the two countries.
c) then rice should not be produced.
d) there is no possibility that either country will import rice from the other.
e) neither country can possibly have a comparative advantage in the production of rice.


30. If losses are being made by firms in a competitive industry, some firms will eventually
exit. This will shift the industry

a) demand curve leftward, causing market price to fall in the short run.
b) demand curve rightward, causing market price to rise in the short run.
c) short-run supply curve rightward, causing market price to rise in the short run.
d) short-run supply curve leftward, causing market price to fall in the short run.
e) None of the above is true.







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31. If Canada has an absolute advantage in the production of oil relative to the United States,
then

a) the opportunity cost of producing oil is higher in Canada than in the United States.
b) Canada also has a comparative advantage in producing some good other than oil.
c) Canada also has a comparative advantage in producing oil.
d) Canada may or may not have a comparative advantage in producing oil relative to the
United States.
e) the opportunity cost of producing oil is lower in Canada than in the United States.


32. A local ice cream parlour has the following data: market price is $3.50, output is 100 ice
cream cones, average total cost (ATC) is $4.00, and average variable cost (AVC) is $3.00.
Under these circumstances, the firm will

a) shut down in the short run since its making economic losses of $50.
b) continue to operate since economic losses would be $150 if it were to shut down in the
short run.
c) continue to operate since total fixed cost (TFC) is $100.
d) shut down in the short run since the price is less than the average total cost.
e) None of the above.


33. Assume that the following information applied to a firm in the short run at its current
output: the industry price was $10; marginal revenue was $5; average total cost was $11;
marginal cost was $5; average fixed costs were $3. 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.


34. In the short run, if average total cost is increasing as output rises, then

a) marginal cost must be below average total cost.
b) average fixed costs must be increasing.
c) average total cost is no longer equal to the sum of average variable cost and average
fixed cost.
d) total fixed costs must be increasing.
e) average variable cost must be increasing.








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35. For a competitive firm, marginal revenue is

a) equal to both price and average revenue.
b) equal to price but greater than average revenue.
c) greater than average revenue and less than price
d) less than price.
e) equal to price but less than average revenue.


36. Suppose that in a perfectly competitive industry, the market price of the product is $6.
Firm A is producing the output level at which average variable cost equals marginal cost,
both of which are $5. Average total cost is $7. To achieve its optimum output, firm A
should

a) reduce output.
b) increase its advertising.
c) change the price of the product.
d) expand output.
e) leave output unchanged.


37. The spaghetti sauce industry is a constant cost industry initially in long run equilibrium.
Suppose that the government imposes on producers a $1 tax per pound of spaghetti sauce.
What will happen to the spaghetti sauce industry in the long run?

a) Market price, industry output, firms output, and the number of firms will not change.
b) Market price will increase, industry output will decrease, firms output will decrease,
and the number of firms will decrease.
c) Market price will increase, industry output will fall, firms output will not change, and
the number of firms will decrease.
d) Market price will remain unchanged, industry output will fall, firms output will not
change, and the number of firms will decrease.
e) Market price will rise, industry output will remain unchanged, firms output will fall,
and the number of firms will increase.


38. When the price of flour used to produce bread falls, the consumer surplus associated with
the consumption of bread

a) will definitely increase.
b) will definitely decrease.
c) will increase if bread is a normal good.
d) will decrease if bread is an inferior good.
e) None of the above.







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39. Suppose that the incomes of buyers in a market for a normal good decline and there is a
reduction in input prices. What would you expect to occur in this market?

a) Equilibrium price would increase, but the impact on the equilibrium quantity would be
ambiguous.
b) Equilibrium price would decrease, but the impact on the equilibrium quantity would
be ambiguous.
c) Both equilibrium price and equilibrium quantity would increase.
d) Equilibrium quantity would increase, but the impact on the equilibrium price would be
ambiguous.
e) Equilibrium quantity would decrease, but the impact on the equilibrium price would
be ambiguous.


40. For Mohammad, X is a normal good and a substitute for good Y. All else equal, which of
the following will cause Mohammads demand for good X to shift to the right?

a) A decrease in the price of good X.
b) A decrease in his income.
c) An increase in the market demand for good X.
d) A decrease in the price of good Y.
e) A decrease in the supply of good Y.


41. Which one of the following would cause the demand curve in an industry to increase?

a) The price of a substitute decreased.
b) Disposable income increased and the good was an inferior good.
c) The price of a complement increased.
d) Disposable income decreased and the good was a normal good.
e) None of the above.


42. 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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43. Government bonds are as safe as money, but money is a better medium of exchange. The
opportunity cost of holding money

a) rises as the interest rate paid on government bonds rises, inducing people to hold less
money.
b) falls as the interest rate paid on government bonds rises, inducing people to hold less
money.
c) rises as the interest rate paid on government bonds falls, but this has no effect on
money holdings.
d) falls as the interest rate paid on government bonds rises, inducing people to hold more
money.
e) rises as the interest rate paid on government bonds rises, inducing people to hold more
money.


44. 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 equal
to

a) -$0.20.
b) $5.80.
c) $9.80.
d) $0.20.
e) uncertain, as not enough information is provided to compute marginal revenue.


45. 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) the price must be negative.
b) a profit-maximizing monopoly should increase output.
c) the elasticity of demand is greater than one at that output.
d) demand must be elastic at that output.
e) a profit-maximizing monopoly should decrease output.


46. In a cartel, the incentive to cheat is significant since

a) each individual member has the incentive to restrict its own output to maximize
profits.
b) the marginal cost is greater than the cartel price at the profit-maximizing output level.
c) each firm has the incentive to raise its price to reap monopoly rewards.
d) each firm has the incentive to expand output to increase its profits.
e) None of the above.







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47. Consider a simple economy, where the marginal propensity to consume out of income is
0.75, and the marginal propensity to import is 0.25. There is no government spending or
taxes. Suppose that investment spending rises by $100. Once a new equilibrium is
reached, investment spending and consumption of domestic goods will increase by

a) $100 and $200, respectively.
b) $100 and $100, respectively.
c) $50 and $150, respectively.
d) $100 and $150, respectively.
e) $0 and $200, respectively.


TABLE 3
Price Per Ticket

Quantity
Demanded
$1 4
$2 3
$10 2
$20 1

48. Refer to Table 3. The fan buys 2 tickets at $10 each. We can conclude that the fan values
the two tickets at

a) $10.
b) $20.
c) $30.
d) Less than $30, but more than $20.
e) $32.


49. Refer to Table 3. Suppose the game is sold out, and the fan cannot buy tickets except
from a scalper. The scalper offers to sell the fan one ticket at $20 and a second ticket at
$10. If the fan accepts this offer, what is the value of consumer surplus?

a) $10.
b) $20.
c) $30.
d) More than $30, but less than $32.
e) $0.


50. If the demand for a good fluctuates, but supply is constant, then which of the following
combinations would generally yield the greatest price fluctuations?

a) large demand fluctuations and inelastic supply.
b) large demand fluctuations and elastic supply.
c) small demand fluctuations and elastic supply.
d) small demand fluctuations and a unit elastic supply.
e) small demand fluctuations and inelastic supply.

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Professor Pesando
PART II [50%]

PART II To be answered by students from Professor Pesandos section (L0101)

Answer ALL questions.


I (12 points)

The market for mineral water is perfectly competitive and is in long run equilibrium. Each firm
has the identical cost schedules.

(a) In an appropriate diagram, show the equilibrium price and output for the market as a
whole and for a representative firm.

(b) To encourage the drinking of mineral water, the government gives $1,000 to each firm.
Explain what happens in the short-run, to:

(1) industry price and output
(2) the representative firms output and profit.

(c) Return to part (a). One firm, financed by a rich entrepreneur, buys up all of the other
firms. In an appropriate diagram, show what happens to industry price and output.
Explain why industry output changes.

(d) In part (c), is the level of output allocatively efficient? Explain your answer.


II (7 points)

Suppose that a monopolist can perfectly price discriminate (i.e. charge each customer the
maximum price that the customer is willing to pay).

(a) Would this monopolist produce a level of output less the perfectly competitive level of
output? Explain your answer.

(b) How would (1) consumer surplus and (2) output change if the marginal cost of producing
each unit of output falls by $10?


III (7 points)

The market for steel is perfectly competitive. The marginal cost of producing steel is constant, at
$2,000 per tonne. There are no fixed costs. The production of each tonne of steel releases
harmful smoke into the atmosphere. This environmental deterioration is estimated by economists
to equal $500 for each tonne of steel produced. The demand curve for steel is as follows:



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Professor Pesando

Price (per tonne) Quantity Demanded (tones)

1000 180
1500 160
2000 140
2500 120
3000 100

(a) In an appropriate diagram, show market price and output and social marginal cost.

(b) If the government sets a price floor of $3,000 per tonne, what would be the level of
output? Would this level of output be allocatively efficient? Explain your answer.


IV (18 points)

Explain whether the following statements are True, False, or Uncertain. All points are awarded
for the explanation.

(a) If the nominal interest rate is zero, the real interest rate is also zero.

(b) Workers and firms agree to a contract which increases wages by 3 percent, under the
assumption the inflation rate will be zero. If the actual inflation rate turns out to be 3
percent, workers lose and firms gain.

(c) Assume that the target reserve ratio for banks is 5 percent. If (1) the Bank of Canada sells
$1,000 worth of bonds to the public and (2) a rich individual deposits in a bank the $1,000
in cash that she had kept under the bed, the money supply will fall by $19,000.

(d) You purchased a bottle of wine for $50 three years ago. You paid $15 to a wine expert to
store your wine. Because of the recession, you can now buy (or sell) this wine for $30. If
you decide to drink the wine, the opportunity cost of doing so is $30.

(e) If the market demand curve is perfectly elastic, oligopolists who form a cartel will
produce a larger output than a monopolist would, but less than would be produced under
perfect competition.

(f) You see an advertisement that a shirt that normally costs $100 is on sale for $75. You
take a taxi to the store, which costs $15 for the round trip. When you arrive at the store,
you find that the sale is over, and you have to pay $100 to buy the shirt. Nonetheless, you
should buy the shirt.








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Professor Pesando
V (6 points)

Because of the recession, the unemployment rate in Canada rises to 9 percent and exceeds the
natural rate of unemployment (full-employment).

(a) What is the natural rate of unemployment? Is it zero? Explain.

(b) The central bank, to combat the recession, buys government bonds in the open market.
Explain what happens to:

(1) bank reserves
(2) the demand for money
(3) the level of imports





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Professor Indart

PART III To Be Answered by students in Professor Indarts Section L0201

Answer ALL questions. When required to provide a numerical answer, show ALL the work
that allows you to arrive to that answer.

1. (10 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 = 100 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 $90
thousand to write the book; and 2) the marginal cost of publishing the book is a constant $20
per book.
a) What is the expression for Pandos marginal revenue (MR) curve? (1 mark) What quantity
would it choose to print if it wishes to maximize profits? (1 mark) What price would it
charge? (1 mark) What profits would Pando make? (1 mark)
b) If the author were paid $60 thousand instead of $90 thousand to write the book, what price
would this profit-maximizing publisher charge? Explain. (1 mark) What profits would it
make? (1 mark)
c) Suppose Pando Publishers was not profit-maximizing but was instead concerned with
revenue maximization, what price would it charge? What quantity would it produce? (2
marks)
d) Suppose now that Pando Publishers is instead concerned in achieving allocative efficiency,
what price would it charge? What quantity would it produce? (2 marks)

2. (10 marks) Richards weekly demand for playing tennis is given by the following table:
Price per hour (for each
player) of court time
5 4 3 2 1 0
Hours of tennis
demanded per week
0 1 2 3 4 5
a) The only tennis courts available are at The Annex Tennis Club where each player is
charged $2 per hour (independently of whether the player uses the court for the whole hour
or not). How much tennis does Richard play per week? (1 mark) What is, in money terms,
his weekly consumer surplus from playing tennis? Explain. (2 marks)
b) The Annex Tennis Club is considering a pricing scheme whereby individuals still pay $2
per hour of court time, but in addition they must also pay a mandatory membership fee.
What is the largest fee The Annex Tennis Club could charge for a weekly membership
without losing Richard as a customer? Explain. (2 marks) If the club increases the price of
court time to $4 per hour, what will be the largest fee it could charge for a weekly
membership without losing Richard as a customer? Explain. (2 marks)
c) As an alternative pricing scheme, suppose that The Annex Tennis Club introduces a
membership fee but does not charge members for court time (i.e., members are entitled to
unlimited use of the facility). What is the maximum fee Richard is willing to pay for a
weekly membership under these circumstances? Explain. (3 marks)

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Professor Indart
3. (8 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? Show all your work. (1 mark)
What is the equation for the AE curve? Show all your work. (1 mark)
b) What is the equilibrium level of income? Show all your work. (1 mark) What is the value
of the expenditure multiplier (
AE
)? Show all your work. (1 mark)
c) What is the level of private saving when the economy is in equilibrium? Show all your
work. (1 mark) What is the level of public saving (i.e., the government budget surplus)
when the economy is in equilibrium? Show all your work. (1 mark)
d) If the government increases its expenditure on goods and services by 50, by how much will
equilibrium income increase? Show all your work. (1 mark) What will be the change in the
level of public savings? Show all your work. (1 mark)

4. (10 marks) The banking system of a hypothetical economy consists of only one commercial
bank, and this commercial bank does not hold any reserves above the desired level. The public
also holds the desired combination of currency and bank deposits. The balance sheets (T-
accounts) of the public and this commercial bank look as follows:

Public Commercial Bank
Currency
Deposits
Other assets
150
1,000
1,350

Loans
Equity
800
1,700
Currency
Deposit at B of C
Loans
Government bonds
50
150
800
200
Deposits
Equity
1,000
200
Note: Publics Deposits refers to demand (chequable) deposits only, and Deposit at B of C
represents the deposits that this commercial bank holds at the Bank of Canada.
Given the information in the above balance sheets and considering only the M1 definition of
money supply, answer the following questions:
a) What is the value of the banks target reserve ratio? Show all your work. (1 mark) What is
the publics desired currency-deposit ratio? Show all your work. (1 mark)
b) Assuming no cash drain on the banking system, what is the value of the money multiplier?
Show all your work. (2 marks)


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Professor Indart

c) Suppose that the banks deposits at the Bank of Canada increase by $100 million as a result
of the bank selling $100 worth of government bonds to the Bank of Canada. Neatly
reproduce the table below in your exam paper. Show in this table all the changes in the
balance sheets of the public and the commercial bank, i.e., show the new final values for all
items. (4 marks)

Public Commercial Bank
Currency
Deposits
Other assets

Loans
Equity
Currency
Deposit at B of C
Loans
Government bonds
Deposits
Equity
d) What is the final change in the banks reserves? Show all your work. (1 mark) What is the
final change in the money supply? Show all your work. (1 mark)

5. (12 marks) The table below shows a small country domestic demand schedule and domestic
supply schedule for widgets, where price is in dollars per unit and quantities are in thousands
of units. Suppose that the world price of widgets is $6 per unit.
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) In the absence of international trade, what is this countrys equilibrium price and
equilibrium quantity of widgets? Explain. (1 mark) In a neat and clearly labelled diagram,
draw this countrys domestic demand curve and domestic supply curve and indicate this
equilibrium (point A). (1 mark)
b) Suppose now that this country starts trading with the rest of the world. Given that the
international price of widgets is $6, will this country become an importer or an exporter of
widgets? Explain. (1 mark) How many widgets will this country import or export? (1
mark) In your diagram, draw the international supply or demand curve for widgets and
show the quantity demanded and the quantity domestically supplied after this country
starts trading in the international market. (2 marks)
c) The government of this country wants this industry to grow and, to that end, introduces a
subsidy to domestic producers of $4 per widget produced. In your diagram, show the
change caused by the introduction of this subsidy to the equilibrium of part b) above. (1
mark) How many widgets will domestic producers supply now? (1 mark) How many
widgets will this country import or export now? (1 mark)
d) The government is considering alternative methods to facilitate the growth of the domestic
widget industry and decides now to impose an import tariff of $2 per widget. In your
diagram, show the change caused by the introduction of this tariff to the equilibrium of
part b) above. (1 mark) How many widgets will domestic producers supply now? Explain.
(1 mark) How many widgets will this country import or export now? Explain. (1 mark)


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Professor Carr

PART IV To be answered by students in Professor Carrs section (L0301)
ANSWER ALL QUESTIONS.
Section I (25 Marks)

1. (15 Marks) Consider a closed economy with fixed prices and unemployed resources
defined by the following behavioral equations:
Consumption C= 100 + 2/3 (Y T)
Taxes T = 150 + 0.5 Y
Investment I = 200
Government Expenditures G = 400

a) (4 marks) What is the equilibrium level of GDP (Y)? Is the government running a
deficit or surplus?
b) (3 marks) Would a change in government expenditures which resulted in a balanced
budget, result in an increase in Y? Explain.
(c) (3 marks) If all taxes were lump sum (ie. T = 150) and if the economy were in
recession and the government desired to increase Y, would a $100 reduction in taxes have
a larger stimulative effect than a $100 increase in government expenditures financed by
bonds? Explain.
d) (2 marks) If all taxes were lump sum taxes (ie. T = 150), would an increase in
government expenditures of $100 financed by an increase in taxes of $100 result in an
increase in Y? Explain.
(e) (3 marks) If all taxes were lump sum taxes (ie. T = 150) and if all government
expenditures were on consumption goods and all government goods were a perfect
substitute for private consumption goods, would an increase in government expenditures
of $100 financed by an increase in taxes of $100, result in an increase in Y? Explain.

2. (10 Marks) In the housing market in the U.S., a number of homeowners have been
unable to make their mortgage payments and foreclosures (ie. the mortgage financier
taking possession of the house and selling it on the open market) have taken place.
a) (3 marks) Will an an increase in foreclosures result in a fall in housing prices?
Explain.

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Professor Carr
b) (3 marks) If the government subsidizes mortgage payments, will this government
action result in an increase in housing prices? Explain.
c) (4 marks) Will the imposition of binding rent control on the market for rental
accommodations result in an increase in housing prices? Explain.

Section II (25 Marks)
Answer the following questions TRUE, FALSE or UNCERTAIN. Give a brief explanation
of your answer. Marks are given entirely for the explanation. All questions are of equal
value.


1. In a perfectly competitive market with constant short-run and long-run marginal cost, the
consumer will bear all the burden of a unit sales tax.



2. An increase in the rate of growth of the money supply will always, in the long-run, cause a
decrease in market interest rates (e,g. interest rates on Government of Canada bonds).



3. If average costs increase as output increase, then it must be true that marginal costs will
also increase as output increases.


4. Currently the LCBO (Liquor Control Board of Ontario) has noted that wine sales (i.e. the
number of bottles of wine sold ) have decreased and total wine revenue has decreased
even more (on a percentage basis) From these facts alone, it can be concluded that the
demand for wine by Ontario consumers is inelastic.

5. An open border to fisherman from foreign countries makes the harvesting of fish more
efficient, just as a border open to imports of foreign goods makes production within a
country more efficient.







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Professor Wolfson

PART V: To be answered by students from Professor Wolfsons Section (L5101)

DO 2 QUESTIONS IN PART A AND 2 QUESTIONS IN PART B
(Each question is worth 12.5 marks, for a total of 50 marks)

PART A
DO 2 of 3 QUESTIONS

Question One

Consider a worker, Wally, who can freely vary the number of hours worked in a day. The wage
rate (after tax) is $10 per hour. Wally has a positively-sloped supply schedule of labour services.
Initially Wally chooses to work 8 hours a day. Wallys indifference curves are convex and do not
change.

1.1 With a fully labelled diagram, use indifference theory to demonstrate Wallys initial
equilibrium position. What is the value of the Marginal Rate of Substitution (MRS) at the
equilibrium point?

1.2 Wallys employer introduces an overtime policy: a worker can now earn $15 (after tax)
for every hour worked beyond 8 hours per day. Use the diagram from 1.1 to show his
new equilibrium. State whether Wally will work more than 8 hours per day. Also state
what happens to Wallys level of satisfaction as compared to the initial equilibrium.

1.3 Return to the original equilibrium (i.e., the same $10 wage rate for every hour worked). In
the recent federal budget, the rate of income tax was reduced. In a new diagram, analyze
in detail the impact of a lower tax rate on Wallys work decision. Use the Substitution
Effect and Income Effect in your answer.


Question Two [Note there are two major parts to Question 2]

2.1 The Clear Water Company (CWC) is the sole supplier of bottled water to the cottagers on
remote Clear Lake. It has no fixed costs and a constant marginal cost of $4 per bottle. The
demand schedule for water from Clear Lake is P = 104 0.1Q.

a) Calculate the equilibrium price, quantity and profits.

b) If the CWC is forced by government regulators to act as if perfect competition
prevailed, what would the price, quantity and profits be?

c)

Use a fully labelled (free-hand) diagram to show the equilibrium price and
quantity from part a) above (labelled Point A). Now show the equilibrium price
and quantity from part b) above (labelled Point B). Finally, show the profits and
the area of deadweight loss associated with part a).



10 of 27
Professor Wolfson

2.2 The Republic of Maple produces only two goods, syrup and corn, using labour only. It
takes 2 units of labour to produce 1 batch of syrup and 1 unit of labour to produce 1
bushel of corn (no matter how much of each is produced). Maple has 1,000 units of
labour.

a) Draw Maples Production Possibility Curve (PPC). If Maple is at full employment and is
producing 600 bushels of corn, how much syrup is it producing? Show this point on the
PPC (labelled as Point A). Put syrup on the X-axis in your diagram.

b) Maple opens its economy to trade. In the international market, 1 batch of syrup trades for
4 bushels of corn. What good will Maple export, if any? Explain your answer.

c) Now draw Maples Consumption Possibility Curve (CPC) that shows the maximum
possible combinations of syrup and corn that Maple can consume when trade opens up.
If Maple decides to consume 1,200 bushels of corn, how many batches of syrup can it
consume? Show this point on the diagram (labelled Point B).


Question Three

The widget industry is a perfectly competitive, constant cost industry. It is initially in long run
equilibrium. Each firm has the traditional U-shaped cost curves.

3.1 Show the initial equilibrium in two interrelated diagrams: one for a representative firm and
one for the industry as a whole. Use subscripts P
1
, Q
1
, q
1
, n
1
etc. What are the profits of each
firm?

3.2 It is known that the price elasticity of demand at the equilibrium does not have the same
value for both the industry and the firm. How do you explain this?

3.3 To support the industry, the government provides a subsidy of $10,000 to each firm.
Show the impact on the representative firm and the industry in the short run only. Use
subscripts P
2,
Q
2
etc. Show each firms profits, if any.

3.4 Provide a brief analysis of how you determined the short run equilibrium price and
quantity in 3.3 above. State whether there will there be any change in the number of firms
in the short run.

3.5 Now continue the analysis into the long run for the industry only. In a new diagram, for
the industry only, show the initial equilibrium (P
1
, Q
1
), the short run equilibrium (P
2,
Q
2
),
and the final long run equilibrium (P
3
, Q
3
). Compared to the short run, state whether there
will there be any change in the number of firms in the long run.

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Professor Wolfson

PART B
DO 2 of 3 QUESTIONS

Question Four

You are given the following information about the macro economy of the small country of
Kanadu:

Consumption C = 10 + 0.8Yd Exports X = 10
Personal Taxes T = 5 + 0.25Y Investment I = 20
Imports M = 25 + 0.1Y Govt Spending* G = 19
Disposable Income Symbol = Yd *on goods and services


Use the constant-price, simple model to answer the following:

4.1 What is the equation for Aggregate Expenditure (AE) in reduced form?

4.2 What is the level of equilibrium GDP?

4.3 At the equilibrium, what is the governments budget balance?
(Be sure to state whether it is a surplus or a deficit and give the amount).

Suppose the government of Kanadu increases its spending on domestically produced goods and
services by 5.

4.4 What is the value of the government spending multiplier?

4.5 By how much will equilibrium GDP change?

4.6 Using the traditional diagram (free-hand is OK), show the initial AE and equilibrium GDP
and the new AE and equilibrium GDP after government spending has changed.

Consider now adding a monetary sector to the model. Assume no change in the money supply.

4.7 How did the government finance its increased spending?

4.8 What impact does the increase in government spending have on the rate of interest? Use a
diagram in your answer.

4.9 What can you say about the value of the government spending multiplier you calculated in
4.4 above, now that there is a monetary sector in the model? Provide an explanation, using
a single diagram of the goods/output market.



12 of 27
Professor Wolfson

Question Five [Note there are two major parts to Question 5]

5.1 Below are data from the national accounts of a country. Assume that all relevant items
you need to answer the questions have been provided.

Personal Consumption Expenditure 920 Capital Consumption Allowances 60
Personal Taxes 250 Undistributed Corporate Profits 80
Corporate Profits before Taxes 300 Corporate Income Taxes 170
Imports 150 Exports 140
Rent 50 Transfer Payments to Households 70
Gross Investment Spending 200 Indirect Taxes minus Subsidies 40
Interest 150 Wages and salaries 800
Net Unincorporated Business Income 50

Use the above data to compute the following:
a) Gross Domestic Product (GDP) b) Govt Spending on Goods & Services (G)
c) Personal Income (PI) d) Personal Disposable Income (PDI)
e) Balance of Trade (BT) f) Net Investment (NI)


5.2 Consider a banking system in which banks act always to maintain the reserve ratio,
individuals and firms carry out money transactions through demand deposits at banks (i.e.,
there is no currency drain) and there are always willing borrowers to take up loans banks
might offer. The reserve ratio is 4%.

a) For each of the two events below, taken separately, calculate the final change in the reserves
and the demand deposits in the banking system and the final change in the money supply.
(You will just have three numeric answers for each event; do NOT show balance sheets.)

Event 1:

The central bank buys $40M worth (domestic value) of foreign exchange
from the public in order to stabilize the value of the dollar on the foreign
exchange market.

Event 2: Consumers decide to increase the number of dollars they carry in their
wallets, purses and backpacks by a total of $8M by withdrawing this amount
from their chequing accounts.

b) Using balance sheets (T-accounts) for the Public, All Banks (together), and the Central
Bank, show the effect of Event 1 above.
(Do NOT show the multiple deposit creation process in detail.)

c) Now consider the variable price model of the economy, with a positively sloped
Aggregate Supply Schedule. Using a fully-labelled diagram, show the impact on the price
level and real GDP arising from Event 1 above.

13 of 27
Professor Wolfson

Question Six

6. The economy in the country of Merika is faltering. The Central Bank intervenes with an
appropriate change in monetary policy designed to adjust the rate of interest.

a) In what direction does the Central Bank wish to move the rate of interest? Identify two
ways that the Central Bank could implement an appropriate change in policy.
(Do NOT describe these in detail; i.e., there is no need for balance sheets.)

b) In a set of interrelated diagrams, show the usual impact of the monetary policy pursued by
the Central Bank on the rate of interest and on the level of GDP. Use the constant-price
Keynesian model.

c) Now consider the impact of this monetary policy in the foreign exchange market. The
domestic currency is called the dollar and the exchange rate for the dollar is flexible and
fully determined in the foreign exchange market. What is likely to happen to the foreign
exchange rate of the Merikan dollar if the monetary policy in part b) is effective? Explain,
using a single diagram for the foreign exchange market.

d) Once again using the constant-price model, lets consider an unusual outcome of
monetary policy: it does not have any impact at all. Using a single diagram involving
investment demand, show how this result could occur. Explain why this situation might
happen in a faltering economy.



REMINDERS:

Be sure that your name and student number are on the front cover
of every answer booklet.

Indicate on the front cover of your booklet(s) that you are in the Wolfson Section.

Be sure you have your name and student number on the Scantron sheet
(and these have been bubbled in)
plus all MC answers are on the Scantron sheet.