Principles of Economics (Econ 100) 26th March 2019

Lahore University of Management Sciences

School of Humanities, Social Sciences and Law

Roll number: Total Pages: 11

Semester:
Section: Academic Year:

Course Title: Principles of Economics Date:

Instructors: Time Allowed: 90 minutes

Exam: Midterm Total Marks: 65

The instructions below must be followed strictly. Failure to do so can result in serious grade loss.
 DO NOT OPEN THIS EXAM UNTIL  Keep your eyes on your own paper.
TOLD TO DO SO.
 You may not
 Read all questions very carefully before answering  talk to anyone once the exam begins.
them.  leave the examination room and then return.

 Check the number of papers in the question sheet

and make sure the paper is complete.

 Specific instructions: Answer all questions.

 For MCQs, please mark your choice clearly by circling it.
 For structured questions, please write clearly and concisely. Your grader needs to understand
what you’ve written. You will be penalized for overly verbose answers.

Open book/notes, help sheet: Closed book / Closed notes

Calculator usage: Yes
Write in pen/pencil: Pen
Any other instruction(s): Be clear and concise

Section 1: Multiple Choice Questions (40-points)

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Principles of Economics (Econ 100) 26th March 2019

Note: Each question in this section is worth 2-points.

Question-1
Suppose that in the long run, if a firm increases its output from 50 to 80 units, this causes its
total cost to increase from $1200 to $1500. Given this information and holding everything
else constant, this firm exhibits:
a. Decreasing returns to scale
b. Increasing returns to scale
c. Constant returns to scale
d. Decreasing marginal product of labor

Question-2
Suppose the marginal cost curve is increasing. If at a quantity q* the marginal cost curve is
above the average total cost curve, we can conclude that:
a. q* is larger than the quantity at which the average total cost curve achieves its minimum.
b. q* is smaller than the quantity at which the average total cost curve achieves its minimum.
c. At q* the average total cost curve has a negative slope.
d. At q* the marginal cost curve has a negative slope.

Question-3
An effective (binding) price floor would cause:
a. A price lower than equilibrium
b. A surplus
c. A shortage

Question-4
Consider the market for music file downloads and consider the effect of increased lawsuits against
illegal downloaders. This would cause:
a. An increase in illegal downloading
b. An increase in demand for legal downloads
c. A decrease in demand for legal downloads
d. A decrease in the price of legal downloads

Question-5
The price of tea increases. At the same time, robots are developed which prove to lower the cost of
production of coffee. In the market for coffee, we should expect to see curves shift. The supply curve
will --- and the demand curve will ---.
a. shift up – shift to the left
b. shift up – shift to the right
c. shift down – shift to the left
d. shift down – shift to the right

Question-6
As a result of a simultaneous increase in the price of tea and of the drop in the cost of production of
coffee, we would expect that price of coffee will -- and the quantity of coffee will --- in the new
equilibrium.
a. increase – be uncertain
b. decrease – be uncertain
c. be uncertain -- increase
d. be uncertain – decrease

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Principles of Economics (Econ 100) 26th March 2019

Question-7
Which of the following statements about cost functions is TRUE?
a. If there is an increase in total fixed costs (TFC), average variable costs (AVC) will increase.
b. A firm that has increasing average costs as output expands experiences increasing returns to scale.
c. Marginal cost is not affected by changes in fixed costs.
d. As the level of output increases, the difference between average total cost (ATC) and average
variable cost (AVC) widens.

Question-8 NOT INCLUDED

A regulated natural monopolist practicing average cost pricing
a. makes zero economic profit.
b. produces an allocatively inefficient level of output.
c. produces the largest quantity possible while still enabling the firm to cover its total costs.
d. all of the above.

Question-9 NOT INCLUDED

Which of the following statements is NOT a characteristic of a perfectly competitive market?
a. The equilibrium output is both allocatively and productively efficient.
b. While firms in a perfectly competitive market can make positive, zero, or negative economic profits
in the short-run, they have to make zero economic profits in the long-run.
c. Marginal revenue for a perfectly competitive firm is equal to the market price because firms in a
perfectly competitive market are price takers.
d. None of the above

Question-10 NOT INCLUDED

The figure above shows the cost structure of a representative firm in a perfectly competitive market.
Suppose the current market equilibrium price is $12. Which of the following statements is FALSE?
A. The marginal revenue curve for the firm is P = $12.
b. The long-run equilibrium price is $16.
c. In the short run, this firm will shut down the business and leave the market.
d. In the long run, if there are 100 firms staying in this market, the equilibrium quantity will be
1,000 units.

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Principles of Economics (Econ 100) 26th March 2019

Questions 11 to 16
2
Use the following graphs to answer the next 6 questions. You may answer D , D
1
, D 3, D4, S1, S 2

Question-11
_D1__ is the demand curve for a good which takes up a large portion of a consumer's budget, while
D2___is the demand curve for a good which takes up a small portion of a consumer's budget.

Question-12
___D1_ is the demand curve where, as price increases, total revenue decreases, while _D2__is the
demand curve where, as price increases, total revenue also increases.

Question-13
__D4_indicates the demand curve for a lifesaving drug, which patients need a fixed amount of (over a
limited range of prices), while _D3__indicates the demand curve for an individual farmer's apples at a
farmers' market.

Question-14
_S2___ is the supply curve for when suppliers have a long time to adjust to a price change, while
_S1__ is the supply curve for when suppliers have only a short time to react to a price change.

Question-15
_D2__ is the demand curve for gasoline, while __D1_is the demand curve for Froot Loops cereal.

Question-16
_D1__is the demand curve for bread, while _D2__is the demand curve for food in general.

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Principles of Economics (Econ 100) 26th March 2019

Section 2: Structured Questions (15-points)

Question-1
The questions below pertain to a firm in a competitive market.

a. Please complete the table below. Assume that the cost of a unit of labor is $2 and that the factory
cost $5. [3]

Total Total Total

Output
Labor Input Variable Cost Fixed Cost Cost
0 0 0 5 5
1 1 2 5 7
2 1.9 4 5 9
3 2.7 6 5 11
4 3.4 8 5 13
5 4 10 5 15
6 4.5 12 5 17
7 4.9 14 5 19
8 5.2 16 5 21
9 5.4 18 5 23
10 5.5 20 5 25

b. Does this production function exhibit diminishing marginal productivity? Justify your answer. [1]

Answer (start)

Yes, as L increases from 0 to 1, additional output, i.e., the MPL is 1, but it then falls to 0.9, 0.8,0.7,0.6
for L=2,3,4, and 5 respectively. This shows that there is diminishing marginal productivity of labour.

Answer (end)

c. Assuming that same cost information supplied above, complete the table below. [4]

Total Total Average Average Average

Fixed Variable Fixed Variable Total Margina
Output Input Cost Cost Cost Cost Cost l Cost

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Principles of Economics (Econ 100) 26th March 2019

0.00 0.00 5 0 N/A 0 N/A

1.00 1.00 5 2 5 2 7 2
2.00 2.12 5 4.24 2.5 2.12 4.62 2.24
3.01 3.42 5 6.84 1.66 2.27 3.93 2.57
4.00 5.00 5 10 1.25 2.5 3.75 3.19
5.00 7.30 5 14.6 1 2.92 3.92 4.6

d. What is the efficient scale for this firm? Why? Please explain. Any numbers you quote can be a
range. [2]

Answer (start)

The efficient scale, where the firm experiences the lowest average costs is for the quantities in the
range 3.01 to 5, as this corresponds to the lowest portion of the U-shaped AC, where costs are below
$3.93.

Answer (end)

Question-2
Here is some data on price and demand.

Good-1 Good-2
Price Demand Price Demand
Point A 5 20 7 20
Point B 10 10 11 34

a. Please calculate the price elasticity of demand for Good-1 and Good-2. Which good has a higher
price elasticity of demand. Please clearly show your calculation and explain any assumptions. [5]

Answer (start)

Use the midpoint method

Good 1: FROM A to B -1
Good 2: A to B: 1.17
Good 2 is more price elastic

Answer (end)

b. Define cross-price elasticity. [1]

Answer (start)

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Principles of Economics (Econ 100) 26th March 2019

The percentage change in the quantity demanded of Good 2 when the price of Good 1 changes.

Answer (end)

c. What is the cross-price elasticity of good-1, in relation to good-2? Are these goods substitutes or
complements? Why? Please explain and ensure your calculations are clear. State any assumptions. [4]

Answer (start)

Using midpoint method, % change in qty demanded of Good 1 (20 to 10) when price of Good 2
changes from 7 to 11. This comes out to be -1.5. The quantity demanded of Good 1 has fallen when
the price of Good 2 has risen. This means they are complements.

Answer (end)

Question-3
You are the manager at a bagel shop and must decide whether to open on Sunday. Your lease of the
space costs you $6,000 a month. (Assume there are 30 days in the month.) If you open on Sunday,
you would sell 1,000 bagels at a price of $.75 per bagel and 500 cups of coffee at a price of $1 per
cup. The material (flour, onions, raisins, etc.) for each bagel costs you $.20 and the material for the
coffee costs you $.30 per cup. To stay open on Sunday, you require 5 workers. Each worker costs you
$100 per day. Assume the utilities used on a Sunday costs you $50. Should you open on Sunday?
Show your calculations. [5]
Answer (start)

The additional revenue (benefit) obtained from opening on Sunday is

1000(0.75)+500(1)= $1250.
The additional cost is
1000(0.2)+500(0.3) +5(100)+50=900.
Because the additional revenue is greater than the additional cost, you should open on Sunday.
Important: the cost of the lease does not impact your decision because you have to pay the lease
whether or not you open on Sunday, it is a sunk cost unless the firms goes out of business

Answer (end)

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