Practice Questions for the First Exam

Econ 200
There are full answers for some of the
questions and hints for others in the
question file below (answers and hints are
in pages 6-11). We do not provide complete
answers to every question for a good
reason:
learning the economic way of
thinking for you involves the process of
thinking
and
reasoning
through
the
questions and writing complete answers. If
we provide the full answers to every
question, your learning process will be cut
short! Your TAs will be happy to check your
answers on individual questions.
The questions below pertain to the material
of Chapters 1-4, the material for your first
exam.
1. Seungs MV for pizza and salad per month are given below:
Q
1
2
3
4
5
6

MV of Pizza
25
21
17
13
9
5

MV of salad
6
5
4
3
2
1

Rissos pizza chain charges $17 for a pizza and $2 for salad.
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Dinnos pizza charges $13 for pizza and $4 for a salad.

a. Which restaurant does Seung purchase his pizza and salad assuming he buys
them at one place and how much of each good will he consume?
b. Now suppose that Rissos adopts a new pricing policy: Pizza and salad are to
be purchased in 1:1 ratio (one pizza to be purchased with 1 salad or 2 pizzas
with 2 salads and so on). How much is Seung willing to tip the waitperson
(per month) at Rissos to be able to buy pizza and salad separately?
2. The Bureau of labor statistics has reported the following data on gas prices
and the Consumer Price Index (CPI) for 1983, 2005, and 2010 as follows:
CPI
100
198.8
219.18
238.64

1983
2005
2010
2015

Oil price ($ per barrel)

29
56
80
56

Would you expect the consumption of oil to be higher or lower in 2005 as

compared to 1983? Explain your answer. How about the consumption of oil in i)
2010 and ii) 2015 as compared with 1983?
3. a) The U.S. Postal Service is planning to increase the price of stamps by 5%.
Would you expect its revenues to increase or decline? Explain. b) A small shoe
repair store in the Shoe Repair district of Mumbay, India is planning on
increasing the price of shoe repair in order to increase its revenues. Do you
think this is a realistic strategy for the shop owner? Explain.
4. Define the concept of transactions costs. What role do transaction costs play
in realization of gains from trade? Explain if the presence of middlemen (e.g.,
distributors of goods such as fresh produce) lowers or increases transaction
costs of doing business in those goods. Briefly explain your answer.
5. Spirit spends her time working in a telemarketing job at home for which she
earns $12 an hour. She buys meat at the Haunted Shop. Her MV for meat
consumption per week is given below:
Q (lb.)
1
2
3
4
5
6

MV($)
15
12
9
6
3
0

a. The Haunted Shop charges $6 per lb. of meat. Spirit can research a spell that
she can cast for a whole week on the Haunted Shop to buy meat at $3 per lb.
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How many hours does it pay for her to research and perfect her spell? Show
your work and explain your answer.
b. Now consider again the MV above and suppose the price of meat is at $6 per
lb. Ignore Spirits spell strategy. Suppose the government taxes Spirit by $3
for every lb of meat she purchases. Write down her new MV schedule and
calculate how many lbs of meat does she purchase? Draw a graph of Spirits
demand before and after the tax policy.
6. From the point of view of economic analysis, which of the following explanation
are relevant to the
observation that the number of children per family has
declined in the last 100 years:
a. The dollar cost of raising children has risen
b. Modern couples do not like large families
c. The cost of raising a child has risen relative to prices of other goods and
services.
Choose all that apply and explain your answer(s). For the category (or categories)
that you did not choose, explain why you did not choose them as economic
explanation of the observation mentioned.
7. An economys exports lumber increased by 5% last year, as the price of lumber
decreased by 2%. i) Calculate the price elasticity of demand for lumber by foreign
importers. ii) Did this countrys export revenues rise or fall? calculate the
percentage change in export revenues.
8. In which season are you likely to see grapefruits sold by weight rather than by
piece? (Grapefruits are more plentiful in winter and measuring the weight is
costly). Consider the lump sum cost of weighing to explain your answer.

9. Kia and Maria have the following MVs for chairs. Maria has an endowment of 7
chairs.
Quantity of chairs
1
2
3
4
5
6
7

MV -- Kia
$300
$250
$200
$150
$100
$50
$0

MV -- Maria ($)
$600
$500
$400
$300
$200
$100
$0

a. How many units of chairs are exchanged between Kia and Maria? (Consider
the last unit where MVs are equal to not be traded). Briefly explain how you
came to choose the number of chairs traded.

b. What are the total gains from trade? Show your work.
10. Consider the following table of MVs for consumption of comic books for Aaron.
He has 6 comic books.
Q
MV($)

1
12

2
10

3
8

4
6

5
4

6
2

a. Derive Aarons supply schedule for comic books. And write down your
reasoning.
b. Now suppose that the market price of a comic book is $8. How many books
will Aaron supply (offer for sale)? What is the reasoning by which he provides
this number of books (why does he not offer one more book--than what you
find as your answer here--for sale)? What is Aarons producer surplus (rents)
at this price? Show your work.
c. Now consider the supply curve for books from part b. above. Suppose the
government provides a subsidy to the seller of $2 per book. How does the
subsidy affect the behavior of the seller? Use a graph to show this effect and
briefly explain.

11. Hermione has the following demand curve for pizzas per month:
P
$35 30
25
15
10
5
Q
1
2
3
4
5
6
The pizzeria down the block sells pizzas for $15 apiece. Hermione does
telemarketing from her home whenever she feels like it and earns $10 per hour. In
addition, Hermione can, after a certain amount of research, cast a one-month long
spell on the pizzeria owner to sell pizzas to her at $5 apiece. How many hours
would it be worth to her to research and perfect this spell?
12. Last year, the United States imported approximately $100 billion worth of oil.
Many people believe we should simply stop importing all oil (about half of our
domestic consumption). One argument in favor of this is that this oil is only about
1% of our $10 trillion economy. Thus, it is argued, it would therefore be a small
sacrifice to eliminate entirely our dependence on foreign oil, since the economy
grows by over $100 billion each year, and therefore eliminating foreign oil would
reduce our standard of living only to what it was a year or two ago. No big deal!
Evaluate this argument.
13.
a. Would you expect the price elasticity of demand for gasoline to be -0.5 or -2.0 in
the short run? Justify your answer.
b. Assume the price of gasoline is currently $3.50 per gallon. Suppose the U.S.
eliminated all gasoline imports implying that quantity of gasoline sold in the U.S.
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drops by 20%. Using your estimate in part a., what will the new price of gasoline
be? Show your work.

14. Chris and Pat are identical twins, but Chris is clean and neat while Pat is a slob.
They have the same tastes, being identical twins, and their Marginal Values of
hamburgers, in terms of hamburgers consumed per month are as follows:
Q
1
2
3
4
5
6
7
MV
$12 $10 $8
$5
$3
$1
$0
Because Pat is a slob, the only hamburger proprietor in town charges Pat $8 for
hamburgers instead of $3, which the proprietor charges everyone else. How much
would it benefit Pat per month to clean up?
15. Many young people regard the older generation as rigid and uncompromising,
seemingly unable to assimilate new ideas, learn new technology, etc. Certainly, the
development and use of new computer programming languages has been done
almost exclusively by relatively young people, and many seniors dont even own a
computer, no less learn computer languages or tools. Provide an economic
explanation for these observations, i.e., an explanation that does not depend on
progressive brain rot with aging.
16. One of the very old paradoxes in economics is the observation that diamonds,
though a frivolity, are everywhere expensive, whereas water, which is essential to
life, is generally inexpensive.
a. The classical economists, including Adam Smith and Karl Marx explained this
paradox by stating simply that diamonds had high exchange value but low use
value, whereas for water, it was the other way around. Why is this explanation
unsatisfactory, just from the standpoint of scientific methodology?
b. Resolve the paradox using marginal analysis.
17. (Historically, women have tended to participate in religious activities to a
greater extent than men. Provide an economic explanation of this phenomenon,
and include a discussion about how this might change based on the more recent
greater participation of women in professional and managerial jobs.
18. Some industries are considered to be highly competitive, meaning they
consist of many firms selling the same or a similar product, whereas others are
largely monopolistic, meaning one or two firms are protected from competition by
state and local governments, such as the local telephone company and gas and
electric utilities. Economists studying patterns of racial discrimination in labor
markets have found that such discrimination varied with the degree of competition
among firms.

Provide an economic explanation of how the degree of competition in an industry

would affect the incidence of racial or other discrimination on the basis of
something other than merit.
19. Although lung cancer is almost always fatal, great progress has been made in
other areas of medicine leading to a significant increase in the number of years we
can expect to live. How do these facts relate to the decrease in rates of smoking in
the past few decades? How would your analysis change, if at all, if a cure for lung
cancer is discovered?
20. Last year, Americans spent more on pet food than on milk for their children.
Does this mean that Americans care more about their pets than about their
children?
21. When the economics department recruits new professors, the department
wants the current faculty to go to dinner with the visitors. It subsidizes this activity
by reimbursing current faculty up to $10 per dinner with visitors. What effect does
this have on the quantity of dinners current faculty will have with visitors, and on
the quality of those dinners (i.e., is this subsidy likely to induce the faculty to go to
more expensive or to less expensive restaurants)?
22. Read article no. 06 (Reading 06 under Readings on the course website) and
answer the following questions: a. What types of transactions costs do you find
when shopping in another country (for example, the market in Shanghai)? Explain
if gains from trade in a market --where haggling for small items is common (and
transaction costs exist)-- are as high as the gains in a U.S. market where prices for
these items are posted and are non-negotiable.
b. Related to the question above, why do foreign tourists tend to pay more than
locals in Shanghai markets? Explain.

Answer Key/hints to Practice Questions

above:
1. a. His CS for his purchases at Rissos is $22. His CS for purchases at Dinos is
$27. So he chooses Dinos.
b. Here we need to compare his CS of the new policy with his old CS at Rissos. If
he buys them together, he is willing to buy up to where the combined MV is $19 (it
may exceed $19 but is not lower than $19, the combined price of pizza and salad).
His choice would be 3 pizzas and 3 salads.
TV of 3 pizzas = 25 + 21 + 17 = 63. TE on 3 pizzas = $17* 3 = $51. CS = 63-51 =
$12. From purchase of 3 salads, TV = 6+5+4 = $15. TE is 3*$2 = $6, so CS for
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salad = 15 6 = $9. Total CS here is $12 + $9 = $21. The difference between the
two policies is $22-$21 = 1. So he will be willing to tip $1.
2. The real price of oil (inflation adjusted price) is $28.16 so oil was relatively
cheaper in 2005. {(56/198.8)*100} = $28.16. The real price of oil in 2010: $36.49
which is higher than the price of oil in 1983. Therefore in the consumption basket
of consumers, there should be relatively less oil consumed in 2010 than in 1983
(and relatively more of other goods in 2010 compared to 1983). The real price of
oil (in terms of 1983 prices) in 2015 is {(56/238.64)*100} = $23.47, so oil is
cheaper in 2015 than in 1983 and hence more of it will be consumed.
3. a) increase in revenues, b) decrease in revenues. You want to use the scenarios
to decide whether demand for each service is elastic or inelastic and address the
question accordingly.
4. Transactions costs are attributes and/or circumstances that prevent mutually
beneficial trade, or transaction, from taking place. These costs of transacting
essentially make trade difficult! They include the cost of establishing and enforcing
property rights over the goods or services traded, cost of establishing the salient
features/properties of goods traded, cost of Information about where the
buyer/seller is (where the goods are!), etc. Since transactions costs can potentially
prohibit mutually beneficial trade, they clearly are undesirable! They prevent
mutually beneficial trade form occurring and hence reduce economic efficiency.
Middlemen who perform the service of say, distributing goods, reduce transaction
costs and increase economic efficiency. (Read Section 4.6 in Ch. 4 of the
textbook.)

5. a. At price of $6 per lb., her CS is $18. At price of $3 per lb., her CS is $30. The
difference is $12. It pays her up to an hour of forgoing her salary at the
telemarketing companywhere she earns $12 an hour to research her spell.
b. Consider now she has to pay $3 more for each lb. So her choice of meat would
be: Buy Q such that $P+$3 = $MV or $MV-$3 = $P [her New MV is her old MV- $3]
Q (lb.)
1
2
3
4
5
6

MV($)
15
12
9
6
3
0

New MV
12
9
6
3
0
-3

At the price of $6 per lb, she now purchases only 3 lb per period instead of 4 lb of
meat.

P
D (original MV)

Market P = $6

D (new MV) inclusive of the tax

6. Number a) does not explain why couples have less kids. The dollar cost of just
about everything has risen over years and yet we do not observe people buying
less of many goods and services. The relevant explanation is in the relative cost
of rearing children (relative to other goods and services).
7. i) price elasticity is -2.5%. Export revenues increase 3% (approximately-- by the
following relationship: %change in export revenues = %change in P + %change in
quantity exported).
8. Grapefruits will be weighted and sold when they are relatively scarce (around
later Spring and Summer when they are out of season). This is because the cost of
weighting (relative to the price of fruit) is relatively less out of season. It is good
idea to make up a table of relative price of weighing in and out of season. You can
consider the price of grapefruit higher out of season than in season. The cost of
weighing in each case would be the same but the relative costs would differ.
9. a. For the first unit Kia wants she values it at 300 and Maria has 7 so her 7th is
valued at $0, Maria would be happy to receive anything form Kia in exchange for
her 7th chair. So this chair is definitely traded.
For the next chair, Kia values it at $250 and Marias is $100, so this chair is also
traded since for any price in between 100 and 250, they both gain from exchange.
For the 3rd one, they both value it at 200. We consider this last item not to be
traded. Therefore the quantity traded is just 2.
b.
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The total gains from trade are: $300 + $150 = $450

10.
a. The MV schedule for Aaron as a buyer is:
Q
MV($)

1
12

2
10

3
8

4
6

5
4

6
2

And he owns 6 books.

At a market price of $12 per book, using his MV schedule, we know that Aaron
will demand (i.e., keep) one book. He will offer the rest for sale (why??). At P =
$12, he will offer 5 books for sale. And so on at other prices
At P = $12, Qdemanded = 1, QSupplied = 5
At P = $10, Qdemanded = 2, QSupplied = 4
At P = $8, Qdemanded = 3, QSupplied = 3
At P = $6, Qdemanded = 4, QSupplied = 2
At P = $4, Qdemanded = 5, QSupplied = 1
At P = $2, Qdemanded = 6, QSupplied = 0
Therefore Aarons supply schedule is:
Marker P
$
Q offered
for sale

10

12

b.
At P = $8 per book, he offers 3 books for sale.
We can use the supply schedule to decipher how much Aarn values his successive
books as a seller!
From the table, it is clear that Aaron requires to be paid $4 to give up his first book
and sell it. He will not sell any if price is below that amount. For his second book he
requires to be paid at least $6. For his 3rd book, as a seller, he requires to be paid
at least $8, and for his 4th book, he requires to be paid at least $10.
Therefore at a price of $8 per book, he will NOT give up his 4th or 5th book. As a
seller, Aaron values the 4th book higher than the market price so he will not offer it
for sale. He only supplies 3 books for sale.

In fact, we consider the Marginal Cost (MC) of the first book he gives up for sale to
be $4 (as a seller he values his first book to be given up for sale at $4). As a seller,
the MC of his second book is $6 and so on.
Q offered
for sale
MC $

1st

2nd

3rd

4th

5th

10

12

To calculate his revenues, costs, and rents: At P = $8 per book

Revenues = $8 x 3 = $24
Costs = $4+ $6 + $8 = $18
Therefore rent (in discrete number calculation) is 24-18 = $6
c. Now we consider the effect of government subsidy on the behavior of the seller.
For this we note her MC schedule below. With the subsidy included, the rule is:
offer Q for sale where at that Q: P +$2 = MC or, P = MC -$2
Q offered
for sale
Old MC $
New MC $

1st

2nd

3rd

4th

5th

2
0

4
2

6
4

8
6

10
8

12
10

Therefore at P = $8 per book, the seller now offers 4 units! We draw a graph of
supply (MC with market prices included) and draw the new supply inclusive of the
subsidy there and show the quantities offered for sale at P = $8 in each case.

$P

S-including the subsidy

P = $8 per book

10

11.
You need to calculate her CS at price of $15 a piece. Also calculate her
CS at the price of $5 each piece. The difference between the two CS should
be $45. Now decide how much time (away from her job) is it worth for
Hermione to research the spell.
12.
Use the graphical analysis of Total Value (and Consumer Surplus) to
argue whether we lose just $100 billion, or more, or, less. if we stop our
imports of oil.
13.
In the short run, demand for oil is inelastic! Therefore the price
elasticity of demand in the short run would be -0.5. For calculating the new
price, use the relationship for/definition of price elasticity of demand. The
only unknown in the equation is the new price. The new price = $4.90.
14.
Use the calculation of the CS for each person to decide how much it
would pay for Pat to clean up.
15.
You need to compare the opportunity cost of gaining computer skills for
young with that of the old! Where the opp. Cost is higher, less quantity of the
activity is observed
16.
This is the original water-diamond paradox! Think of how the
explanation by Smith and Marx just restates the paradox, but does not solve
it!
17.
Just saying that some groups (women) are more religious than another
(men) is an ad-hoc statement. Instead, think of the opportunity cost of
attending religious activities. According to law of demand where the
opportunity cost is less, there is more of the activity
18.
Use the concept of the opportunity cost of discrimination and law of
demand to address this question.
19.
Consider the opportunity cost of smoking and use the law of demand
to address this question.
20.

This is an application of the Water-Diamond paradox.

21.
Use the law of demand, and, an application of this law, shipping out
the good apples to discuss this question.

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22.
a. We can identify two (or possibly more) types of transaction costs
when consumers from one country purchase items in a different country
where asymmetric information about the quality of goods exists and haggling
is common. The two types of transaction costs that are readily present in
these types of transactions are:
i.

Costs of establishing the salient features/properties of goods traded. This

means that for example, the seller may claim a piece of jewelry is gold
and therefore price the good accordingly, while the buyer has no certainty
about whether the item is actually gold or some other non-precious metal.
This type of trade has a high transaction cost

ii.

Cost of reaching an agreement over the price of the good or service to be

traded (haggling).

Where transactions costs of exchange exist, the gains form trade are reduced. For
one thing, spending valuable time to haggle over price of an item reduces the
gains from trade.
b. Tourists may pay more due to i. Asymmetric informationtourists who are
unfamiliar with the local market of a country they visit may not know the range of
possible prices for a good. The locals usually have a better idea and as buyers their
information about the prices is close to the sellers in that market.
And ii. Tourists may decide it is not worth their time to haggle over a good. They
usually have a limited time to visit the various sites of a new country and therefore
may be unwilling to haggle for many minutes to bring down the price of a good
(this means they face a higher opportunity cost of haggling as compared to some
locals). Tourists may therefore pay higher prices for goods than locals.

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