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ECON 1001

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ECON 1001 Midterm #1 Revision Q1) After paying the movie distributor and meeting all other non-interest expenses, the owner expects to net $2.00 per ticket sold. – PowerPoint PPT presentation

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Title: ECON 1001


1
ECON 1001
  • Midterm 1 Revision

2
  • Q1) After paying the movie distributor and
    meeting all other non-interest expenses, the
    owner expects to net 2.00 per ticket sold.
    Construction costs are 1,000,000 per screen. How
    many screens should be built if the real interest
    rate is 7 ?
  • A) 1
  • B) 2
  • C) 3
  • D) 4
  • E) 5
  • Ans B

3
  • We should use a cost-benefit analysis
  • In particular, Marginal Benefit vs Marginal
    Cost of installing ONE MORE screen.
  • MB of installing ONE MORE screen
  • (increase in patrons)2

Installing the ? in patrons ? in revenue (MB)
1st 50000 100000
2nd 40000 80000
3rd 30000 60000
4th 20000 40000
5th 10000 20000
4
  • How about the MC of installing ONE MORE screen?
  • Cost of constructing ONE screen 1,000,000
  • If you save the money in a bank instead of
    investing it in the cinema, how much do you get?
    (r7 per annum)
  • So MC of installing ONE MORE screen 1m0.07

Installing the n-th screen Interest income forgone (MC)
1 70000
2 70000
3 70000
4 70000
5 70000
5
Should you install the first screen? ? YES!
Because MBgtMCHow about the second one? The
third one?How many screens would you install in
total?
Installing the ? in revenue (MB) Interest income forgone (MC)
1st 100000 70000
2nd 80000 70000
3rd 60000 70000
4th 40000 70000
5th 20000 70000
6
  • Q2) Mike gives a non-refundable 100 to ACE
    adventure to reserve a raft for a group rafting
    trip in the New River. The raft has room for 5
    people. He can only sell 3 tickets at 25 each
    for a total of 75. Should Mike cancel the trip?
  • Yes, because he will lost 100.
  • No, because he is making 75.
  • Yes if Mike values going on the trip at less than
    25.
  • No, because losing 25 is better than losing
    100.
  • Yes, because he will lost 25 on the venture.
  • Ans D

7
  • This is a question about opportunity cost.
  • If Mike cancels the trip, he loses 100 and gets
    nothing. Hence, the net loss is 100.
  • If the trip goes as planned, Mike loses 100, and
    gets 75 back. The net loss is 25.
  • In other words, if he cancels, he loses 100 if
    he goes, he loses 25 only.

8
  • As a rational economic agent, what would Mike
    choose?
  • NOT to cancel the trip!
  • Because losing 25 is better than losing 100
    (D).
  • The key word in the question is non-refundable.
    That means the 100 is already sunk. Mike would
    endeavour to recover as much money as possible
    from the venture.

9
  • Q3) How many hours should IBM employ Pam to
    maximise its benefit from her employment?
  • 1 hour.
  • 2 hours.
  • 3 hours.
  • 4 hours.
  • 5 hours.
  • Ans D

10
  • This is a slightly tricky question. However, all
    we have to do is to apply the usual p-max
    principle MRMC.
  • To summarise the information provided
  • Cost of all hardware needed to assemble a
    computer is 600

No. of Hours No. of Computers
1 1
2 4
3 8
4 10
5 11
11
  • To apply the MRMC principle, first, we need to
    find out that Marginal Increment in No. of
    Computers in each hour.

No. of Hours No. of Computers Additional Computers from the n-th hour
1 1 1
2 4 3
3 8 4
4 10 2
5 11 1
12
  • Then, we can find out the extra Revenue brought
    along by the computers in each hour. (MR of hour)
  • To calculate the MRhour, multiply the price
    (620) by Additional computers Computers.

No. of Hours No. of Computers Additional Computers from the n-th hour MRhour ()
1 1 1 620
2 4 3 1860
3 8 4 2480
4 10 2 1240
5 11 1 620
13
  • We then compute the MC of each working hour.
    (MChour)
  • MChour is the sum of Pams wage and all hardware
    costs (600 each computer).

No. of Hours No. of Computers Additional Computers from the n-th hour MChour ()
1 1 1 640
2 4 3 1840
3 8 4 2440
4 10 2 1240
5 11 1 640
14
  • To find the No. of hours that maximises IBMs
    profit, find where MRhour MChour.
  • So the answer is 4 hours (D).

No. of Hours MChour () MRhour ()
1 640 620
2 1840 1860
3 2440 2480
4 1240 1240
5 640 620
15
  • Just to show that profit has been maximised...
  • At 4th hour, Marginal Profit 0 (feature of
    p-max)

No. of Hours MChour () MRhour () Mphour ()
1 640 620 -20
2 1840 1860 20
3 2440 2480 40
4 1240 1240 0
5 640 620 -20
16
  • Q4) How many hours should IBM employ Pam to
    maximise its benefit from her employment if
    output price is 640?
  • 1 hour.
  • 2 hours.
  • 3 hours.
  • 4 hours.
  • 5 hours.
  • Ans E

17
  • We use the same technique as in Q3.
  • However, the selling price of computers has
    changed to 640.
  • This may affect Pams number of working hours.
  • Is MC affected by the price change? How about
    MR?
  • MC no change. MR different now. (recalculate)

18
  • To calculate the new MRhour schedule, multiply
    640 by ?Computers for each hour.

No. of Hours No. of Computers Additional Computers from the n-th hour MRhour ()
1 1 1 640
2 4 3 1920
3 8 4 2560
4 10 2 1280
5 11 1 640
19
  • To find the No. of hours that maximises IBMs
    profit, find where MRhour MChour.
  • So the answer is 5 hours (E).

No. of Hours MChour () MRhour ()
1 640 640
2 1840 1920
3 2440 2560
4 1240 1280
5 640 640
Note When there is an increase in output price,
the suppliers are likely to increase their
output, and hence employment.
20
  • Just to show that profit has been maximised...
  • At 5th hour, Marginal Profit 0 (feature of
    p-max)

No. of Hours MChour () MRhour () Mphour ()
1 640 640 0
2 1840 1920 80
3 2440 2560 120
4 1240 1280 40
5 640 640 0
21
  • Q5) Chris has been charging 1 for a pound of
    potatoes. Suppose Chris faces a linear demand
    curve. When P? to 0.90, TR drops. When P? to
    1.10, TR also drops. Why?
  • 1 is the equilibrium price for potatoes.
  • AT 0.90, there is excess demand for potatoes.
  • 1.10 is more than Chriss customers reservation
    prices.
  • Price elasticity of demand is unitary at 1.00.
  • Both A and D must be true.
  • Ans D

22
  • (A) claims that 1 is the equilibrium price.
  • There is no basis for that.
  • To determine the equilibrium price, we need to
    have BOTH the demand and supply schedules.
    Without this information, we cannot tell what
    equilibrium price is.
  • Therefore, both (A) and (E) are wrong.
  • Note that (B) and (C) also require additional
    supply and demand information. Therefore, they
    cannot be correct.

23
  • e must be unitary at 1 according to what
    happened.
  • When demand is price inelastic, reducing the
    price would lead to a drop in TR. That is
    because ?Qd lt ?P.
  • When demand is price elastic, raising the price
    would mean losing many customers, since they are
    all very sensitive to price changes (?Qd gt ?P)

24
  • Since TR decreases whenever there is a deviation
    from P 1.00, 1.00 must be the separation
    point between the price elastic part of the
    demand curve, and the price inelastic part of the
    demand curve.
  • Therefore, (D) is the correct answer.

P
Elastic
Unitarily Elastic
1
Inelastic
Q
25
  • Q6) Pat earns 25,000 per year. Her partner,
    Chris, earns 35,000 per year. They have 2
    children. Childcare for their children is
    12,000 per year. Pat has decided to be a
    stay-home mum. Pat must
  • Be irrational.
  • Value spending time with the children by more
    than 25,000.
  • Value spending time with the children by more
    than 12,000.
  • Value spending time with the children by more
    than 13,000.
  • Value spending time with the children more than
    Chris does.
  • Ans D

26
  • Pat has to choose between two alternatives.
  • Net gain from alternative go work and pay for
    childcare
  • 25000-12000 0 (value of quality time with her
    children)
  • 13000
  • Net gain from alternative Take care of children
    herself
  • 0 0 value of quality time with her
    children
  • value of quality time with her children
  • Pat chose Choice II (stay-home mum), it must be
    the case that
  • value of quality time with her children gt 13000

27
  • Q7) Suppose at the market eq. price of natural
    gas, price elasticity of demand is -1.2, and
    price elasticity of supply is 0.6. What will
    result from a price ceiling that is 10 below the
    mkt eq. price?
  • A shortage equal to 1.8 of the market eq.
    quantity.
  • A shortage equal to 0.6 of the market eq.
    quantity.
  • A shortage equal to 18 of the market eq.
    quantity.
  • A shortage equal to 6 of the market eq.
    quantity.
  • Ans C

28
  • Price Ceiling diagrammatic approach

Note that the price ceiling has impact on
quantity demanded AND quantity supplied.
29
Finding The New Qs

P
S
PC
Q
Qe
QS
30
Finding The New Qd

P
D
PC
Q
Qe
Qd
31
Calculating the Shortage
  • To calculate the shortage, simply find the
    difference between Quantity Demanded and Quantity
    Supplied.
  • Both Qd and Qs have been expressed in terms of
    Qe.
  • Qd-Qs 0.18Qe
  • Therefore, the shortage is 18 of the original
    eq. quantity. Hence, (C).

32
  • Q8) Suppose the demand for gourmet coffee can be
    represented by a linear demand curve. At the
    prevailing market price, the INCOME ELASTICITY of
    demand for gourmet coffee is 2. When income
    rises, the demand for gourmet coffee
  • Becomes less elastic at every price.
  • Becomes less elastic at the price that prevailed
    before the change in income.
  • Becomes more elastic at every price.
  • Becomes more elastic at price that prevailed
    before the change in income.
  • Both A and B are both correct.
  • Ans C

33
  • The first elasticity mentioned in the question is
    INCOME ELASTICITY.
  • Income elasticity measures the responsiveness of
    quantity demanded to changes in income.
  • A positive figure means the product is a normal
    good. A negative figure denotes inferior good.
  • The second elasticity, the elasticity mentioned
    in the 5 options, refers to price elasticity of
    demand for gourmet coffee.
  • What affects the price elasticity of demand?
  • Many factors, among which, the proportion of
    expenditure on the item. (???e)

34
  • The INCOME ELASTICITY is 2.
  • Suppose income now rises by 10 and price does
    not change.
  • Quantity demanded will rise by 20.
  • Consumers are now spending a HIGHER PROPORTION of
    their income on gourmet coffee.
  • Therefore, the PRICE ELASTICITY of demand should
    now be MORE ELASTIC at all prices than in the
    past (before income increases).
  • Hence C.

35
  • Q9) Other things being equal, the increase in
    rents that occur AFTER abolishing rent control is
    smaller when
  • The own price elasticity of demand is inelastic.
  • The own price elasticity of demand is elastic.
  • The own price elasticity of demand is unitarily
    elastic.
  • Rented homes and owned homes are substitutes.
  • Rented homes and owned homes are complements.
  • Ans B

36
  • Rent control is a form of PRICE CEILING.
  • Price Ceiling is set at a price LOWER than the
    market equilibrium price.

P
D
S
Trading Loci
Pe
Price Ceiling
Q
37
  • When Rent Control is imposed, Qd gt Qs.
  • Equilibrium is not reached.
  • And when the Price Ceiling is lifted, the market
    equilibrium quantity and price should be restored
    eventually.
  • Price (rent) should increase.
  • Because supply is upward sloping,
  • ?P ? ? TR

38
Relative inelastic
P
D
S
Pe
Price Ceiling
Relative elastic
Q
Hence, the increase in rents that occur AFTER
abolishing rent control is smaller when (B) The
own price elasticity of demand is elastic.
39
  • Q10) What might cause a supply function to shift
    to the LEFT?
  • An increase in the products own price.
  • An expectation that the products own price will
    fall in the future.
  • Endorsement of the product by a popular
    celebrity.
  • An expectation that the products own price will
    rise in the future.
  • A decrease in the price of one of the inputs to
    making the product.
  • Ans D

40
  • When Supply shifts to the LEFT, is Supply
    increasing or decreasing?
  • Decreasing.
  • When Supply shifts to the left, quantity supplied
    at all prices drops.
  • The shifting of the Supply schedule can be caused
    by anything but a change in the current own
    price.
  • A change in the current own price of the product
    leads to a change in Qs only. Hence (A) is wrong.

41
  • (C) is also obviously wrong.
  • When a product is publicly embraced by
    celebrities, DEMAND is affected (demand will
    shift to the right).
  • The celebrity factor does not affect the Supply
    side.
  • Hence, (C) can be eliminated.

42
  • (E) is a sound reason for changes in Supply.
  • A drop in the cost of production, esp. variable
    costs, can shift the Supply curve.
  • However, the Supply should shift to the right
    instead of shifting to the left.
  • Therefore, (E) is not the correct answer.

43
  • That leaves us with options (B) and (D).
  • Both are related to expectations of the future
    price.
  • Expectations on the future price can shift the
    supply curve.
  • Note not talking about current price.

44
  • If a supplier expects price will be higher in the
    future
  • Current stock should be held back as any unit
    sold in the future earns more revenue than that
    at present.
  • As a result, (D) is the correct answer.
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