Student number: ______________
ECO1104B INTRODUCTION TO MICROECONOMICS
Professor: David Gray Fall 2010
a) The allotted time is one hour and twenty minutes. There are a total of 80 points, or one point per
b) Turn off all cellular telephones.
c) You may notconsult with anywritten materials whatsoever, including other students' papers, and
no conversation is permitted while the examination is in progress. You may not use palm pilots.
The only electronic devices that are permittnon-programmable calculatorsand dictionaries for
students whose native tongue is not English. Any ravention of these ruleswill be treated as an
infraction to the honour code of the university.
d) Good luck. I anticipate that some of you will be pressed for time. Please pace yourself
accordingly, and respond carefully. DO NOT SPEND TOO MUCH TIME ON ANY ONE
e) All of the questions which follow are verstraightforward, and can be answered in a few
sentences. The responses that I hope to elicit have been repeated by me several times in class.
Please take a minute to concentrate on the que stion being asked, as opposed to writing down
everything which comes to your mind about a certain topic. I have tried to pose the questions in
such a way that you focus correctly.
1 PART I – SHORT ANSWER, CONCEPTUAL QUESTIONS
1) (4 points; 2-3 sentences) Identify and give thesignificance of the price elasticity of demand. In
other words, what is its purpose? In still other words, why do we bother studying it? Do not give
details concerning the price elasticity of demand, such as the formula that we use to calculate it.
What I am looking for here is a brief discussion of how it fits in with supply and analysis.
IT INDICATES THE RESPONSIVENESS OF QUANTITY DEMANDED TO CHANGES IN
PRICE. THE LAW OF DEMAND SAYS TH AT THERE IS ALWAYS A NEGATIVE,
INVERSE RELATIONSHIP BETWEEN PR ICE AND QUANTITY DEMANDED. THE
PRICE ELASTICITY OF DEMAND IS A T OOL THAT MEASURES THE DEGREE OF
RESPONSIVENESS BY GIVING IT A PRECISE MAGNITUDE.
2) (4 points; 2 sentences) How does the model of supply and demand relate to the first central
coordination task that faces any economy - snd services should be produced, and in what
quantities? Do not draw the graph, as this is strictly a verbal question.
THE EQUILIBRIUM QUANTITY THAT ISGENERATED ON THE QUANTITY AXIS BY
THE FORCES OF SUPPLY AND DEMAND S HOWS HOW MUCH OF A GOOD WILL BE
PRODUCED IN A FREE MARKET ECONOMY.
3) (8 points)
a) Explain why governments regulate thend quantities of certain commodities, particularly
in the agricultural sector.
FOR CERTAIN MARKETS, SOCIETY DECIDES (OR THE GOVERNMENT
DECIDES) THAT THE MARKET PRICE (THAT IS GENERATED BY THE FORCES
OF SUPPLY AND DEMAND) IS NOT SOCIALLY FAIR AND/OR EQUITABLE.
SOCIETY DEEMS THAT EITHER THE DEMANDERS OR THE SUPPLIERS (BUT
NEVER BOTH IN THE SAME MARKET) WOULD SUFFER GREAT HARDSHIP IF
THE MARKET PRICE WERE TO PREVAIL. IN THE CASE OF AGRICULTURAL
PRIOCE SUPPORTS, IT IS THE PRODUCERS WHO ARE DEEMED NEEDY.
b) Explain why most economists tend to be very critical of interventions such as price floors and
price ceilings. You do not need to give any graph. What I am looking for is an explanation of
the economic behaviour the follows the imposition of these policies, and a description of the
TAMPERING WITH PRICES DISTORTS THE CHOICES OF BOTH SUPPLIERS AND
DEMANDERS. BOTH SIDES OF THE MARKET REACT TO PRICE CHANGES BY
ALTERING THEIR BEHAVIOUR, AND THEY DO SO IN A WAY THAT WORKS
AGAINST THE INITIAL OBJECTIVE OF MAKING ONE PARTY BETTER OFF.
MARKET IMBALANCES IN THE FORM OF SURPLUSES OR SHORTAGES ALWAYS
2 ARISE. TRYING TO DEFY THE NATURAL FORCES OF SUPPLY AND DEMAND
ALWAYS HAS UNINTENDED – BUT PREDICTABLE - CONSEQUENCES.
c) What type of alternative policy instrument do economists recommend if the objective is to
make a certain group of economic agents better off?
THE NEEDY, DESERVING GROUP, WHETHER IT IS EITHER SUPPLIERS OR
DEMANDERS, SHOULD BE GIVEN A SUM OF MONEY THAT SUFFICES TO MAKE
THEM BETTER OFF. THIS SO-CALLED LUMP-SUM PAYMENT SHOULD BE
INDEPENDENT OF THE PRICE RECEIVED OR THE QUANTITY BOUGHT OR THE
QUANTITY PRODUCED. IT IS BETTER TO JUST GIVE THEM THE MONEY WITH
NO STRINGS ATTACHED, WHICH MEANS THAT THEY CAN SPEND IT AS THEY
PLEASE. THE KEY IS THAT THE LUMP-SUM PAYMENT SHOULD NOT AFFECT
EITHER THE QUANTITY DEMANDED OR THE QUANTITY SUPPLIE
4. (3 points, 2-3 sentences) Explain briefly the nature of the difference between microeconomics
THE PRIMARY DIFFERENCE LIES IN THE SCOPE. WHILE BOTH DISCIPOLINES
DEAL WITH EQUILIBRIUM PRICES AND QUNATITIES, IN MICRO WE ANALYZE
PRICES AND QUANTITIES AT THE LEVEL OF INDIVIDUAL FIRMS, CONSUMERS,
WORJKERS, OR MARKET. IN MACRO, BY CONTRAST, WE ANALYZE PRICES AND
QUANTITIES AT THE GLOBAL OR AGGREGATE LEVEL, CONCERNING OURSELVES
WITH VARIABLES SUCH AS UNEMP LOYMENT, INFLKATION, AND GROSS DOMESTIC
5. (3 points, 2 sentences) What is generally the role of models in economic analysis? In other
words, what is their function?
THEY ARE AN ANALYTICAL TOOL THAT IS USED TO EXPLAIN HOW THE
ECONOMY FUNCTIONS. TYPICALLY THE CHANGES IN ONE ECONOMIC
VARIABLE ARE RELATED TO CHANGES IN ONE OR SEVERAL OTHER ECONOMIC
VARIABLES. THEY ARE OFTEN STATED IN HYPOTHESIS FORM – IF THERE IS A
CHANGE IN ONE VARIABLE, ALL OTHER FACTORS HELP CONSTANT, WHAT IS
THE CHANGE IN ANOTHER ECONOMIC VARIABLE? SEE PAGE 24 IN THE TEXT.
6. (7 points) These questions are easy.
a) Explain why the production possibilities frontier has a concave shape.
IT REFLECTS THE LAW OF INCREASING OPPORTUNITY COSTS. AS MORE AND
MORE RESOURCES ARE ALLOCATED AWAY FROM THE PRODUCTION OF ONE
GOOD TOWARD THE ALLOCATION OF THE OTHER GOOD, THE TRADEOFF
BECOMES LESS AND LESS FAVOURABLE. THIS MEANS THAT IN ORDER TO
PRODUCE ONE MORE UNIT OF GOOD A, WE HAVE TO GIVE UP MORE AND
MORE UNITS OF PRODUCTION OF GOOD B. THE LAW OF INCREASING
3 OPPORTUNITY COSTS IN TURN IS DUE TO THE FACT THAT THE ECONOM’S
RESOURCES ARE NOT EQUALLY WELL-SUITED TO TE PRODUCTION OF BOTH
b) What would be implied if the frontier has the form of a straight line?
THERE WOULD BE CONSTANT OPPORT UNITY COSTS, SO THE TRADEOFF
BETWEEN THE TWO GOODS IS EVEN. THISDOES NOT MEAN THAT THE TRADE
OFF IS ONE-TO-ONE. THIS WOULDIMPLYS THAT THE ECONOMY’S RESOURCES
ARE EQUALLY WELL SUITED FOR THE PRODUCTION OF BOTH GOODS. IT
CERTAINLY DOES NOT MEAN THAT THE FRONTIER HAS A POSITIVE SLOPE.
c) Explain why the production possibilities frontier has a negative slope.
IT IS DUE TO SCARCITY. IF WE W ANT TO INCREASE PRODUCTION OF ONE
GOOD, WE MUST SACRIFICE SOME OF THE OTHER GOOD. IN OTHER WORDS,
THERE IS A TRADEOFF ONCE WE ARE ONTHE FRONTIER. IT HAS NOTHING TO
DO WITH THE LAW OF INCREASING OPPORT UNITY COSTS. ITDOES MEAN THAT
OPPORTUNITY COSTS EXIST.
7. (4 points) Explain the relationship between comaprative advantage, specialization, and the pattern
of international trade (this means which country imports and/or exports which good).
A COUNTRY SHOULD SPECIALIZE IN TH E PRODUCTION OF THE GOOD IN WHICH
IT HAS A COMPARATIVE ADVANTAGE. IT SHOULD DEVOTE EITHER ALL OR
MOST OF ITS RESOURCES TO THE PR ODUCTION OF THAT GOOD, AND LITTLE OR
NONE OF ITS RESOURCES TO THE PR ODUCTION OF THE OTHER GOOD. IT
SHOULD CONSUME SOME OF ITS PRODUCTION OF THE GOOD IN WHICH IT
SPECIALIZES, AND IT SHOULD THEN EXPORT THE REST. IT CAN USE THE
PROCEEDS FROM ITS EXPORT SALES TO PURCHASE IMPORTS FROM ITS
TRADING PARTNER. IT IMPORTS THEGOOD IN WHICH IT HAS A COMPARATIVE
DISADVANTAGE. SEE PAGES 57-58 OF THE TEXTBOOK.
8. (6 points) This question is drawn from th e assigned readings – the one-page document that I
authored and posted on the website.
a) Explain why most economists believe that free trade is beneficial from an economic point of
SEE THE DOCUMENTS THAT I HAVE POSTED WITH THE LECTURE SLIDES FOR
CHAPTER 3. IT LEADS TO A GR EATER VARIETY OF GOODS AVAILABLE TO
CONSUMERS. IT LEADS TO LOWER PRIC ES FOR CONSUMERS. MOST OF THE
POPULATION CAN EXPECT HIGHER LIVING STANDARDS STEMMING FROM THE
LOWER PRICES. IT GIVES AN INCE NTIVE FOR DOMESTIC PRODUCERS TO
BECOME MORE COST EFFICIENT, AND THE LEAST EFFICIENT FIRMS ARE
4 DRIVEN OUT OF BUSINESS. IT CAN ALSO OPEN UP NEW MARKETS FOR
CANADIAN GOODS THROUGH EXPORTATION.
b) Explain why anti-globalization types, such as those who were demonstrating in Toronto at the
G20 summit this past summer, firmly believe the opposite. In other words, they HATE fee trade.
IN THE RICHER COUNTRY, CERATIN PRO DUCERS ARE DRIVEN OUT OF BUSINESS,
WHICH CAUSES THEIR WORKERS TO BE DISP LACED. IN THERICHER COUNTRY,
THERE IS INCREASED PRESSURE TOLOWER TAXES AND REDUCE REGULATION,
WHICH COULD PUT STRAIN ON SOCI AL PROGRAMS AND SEVERELY DAMAGE
THE SOCIAL AND ECONOMIC FABRIC OF THE RICHER COUNTRY. THE