Loading...

PPT – ECON 1001 PowerPoint presentation | free to download - id: 6e5aff-MzA3N

The Adobe Flash plugin is needed to view this content

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.

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

- 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

- 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

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

- 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

- 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.

- 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.

- 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

- 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

- 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

- 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

- 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

- 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

- 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

- 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

- 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)

- 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

- 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.

- 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

- 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

- (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.

- 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)

- 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

- 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

- 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

- 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

- Price Ceiling diagrammatic approach

Note that the price ceiling has impact on

quantity demanded AND quantity supplied.

Finding The New Qs

P

S

PC

Q

Qe

QS

Finding The New Qd

P

D

PC

Q

Qe

Qd

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).

- 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

- 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)

- 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.

- 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

- 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

- 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

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.

- 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

- 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.

- (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.

- (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.

- 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.

- 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.