Test01_fin.docFoundations of Economic AnalysisStratton

Fall 2005 Test 01Name ______

Description: This test is divided into four (4) sections: definitions, short answer, problems and applications. Your ability to demonstrate understanding, insight and/or the ability to use the material is the primary purpose of the assessment. Thus full credit will only be earned if you follow the directions carefully and provide the explanation, description, thought process as directed. Note the slight difference in the weight of the questions in each section and allocate your time accordingly.

Instructions: All answers are to be in the booklet provided. While you may want to use the test page as scratch paper, only the responses in the booklet will be graded. Please be sure to write legibly, identify the question being answered, and clearly mark any information you want ignored.

Definitions(Q1 – 5) (10 points total – 1 point each for definition, 1 point each for significance):For each term, write a short definition in your own words and explain the significance of the term.The significance should indicate why this term is important in the study of economics.

  1. Relative scarcity
  2. Opportunity cost
  3. Market Supply
  4. Transaction costs
  5. External cost

Short Answer Questions(Q6 – 14) (27 points total – 1 point each for the answer, 2 points each for explanation or reasoning):Answer each question in the booklet provided. Please indicate any assumptions you make, explain your thinking and show all work to receive full credit.

  1. If consumers’ income increases by 10% would you expect the demand for coffee to increase by less than 10%, just 10%, or more than 10%? Why?
  2. If the cross-price elasticity between two goods equals – 0.65, what is the relationship between these goods?Why?
  3. If the income elasticity of a good equals 2.4, what kind of good is it?Why?
  4. Because of declining revenues, the US Postal Service is planning to increase the cost of a first class stamp. What must the US Postal Service believe the own-price elasticity of demand for first class mail to be? Why?
  5. If demand decreases and supply increases, what will happen to the equilibrium price and quantity? Why?

The next few questions pertain to the circular flow diagram below. This diagram shows some of the most important sectors, markets and money flows in an economy. Some of the sectors, markets and flows are not identified, but are numbered. Identify and provide a short description in your own words of each of the missing parts of the circular flow diagram requested. Be sure to indicate if it is a sector, market or flows!

  1. #1 - Identify & describe:
  2. #3 - Identify & describe:
  3. #5 - Identify & describe:
  4. #8 - Identify & describe:

Problems(Q15 – 27)(52 points total – 2 points each for the answer, 2 points each for explanation or reasoning):Answer each question in the booklet provided. Please indicate any assumptions you make, explain your thinking and show all work to receive full credit.

The table below represents the production possibilities of two hypothetical subsistence farmers (Ms. Quincy and Mr. Holly). Milk is measured in gallons per week; Eggs are measured in dozens per week. Use this information to answer the following questions.

Ms. Quincy / Mr. Holly
Milk / Eggs
5 / 0
4 / 2
3 / 4
2 / 6
1 / 8
0 / 10
/ Milk / Eggs
15 / 0
14 / 2
12 / 4
9 / 6
5 / 8
0 / 10
  1. What is Ms. Quincy’s opportunity cost of increasing milk production from 3 to 4 gallons per week? Explain.
  2. Does Mr. Holly face increasing opportunity costs in egg production? Explain.
  3. If Ms. Quincy currently produces and consumes 4 gallons of milk and 2 dozen eggs per week and Mr. Holly currently produces and consumes 5 gallons of milk and 8 dozen eggs per week does Ms. Quincy have an absolute advantage in the production of milk? Explain.
  4. If Ms. Quincy currently produces and consumes 4 gallons of milk and 2 dozen eggs per week and Mr. Holly currently produces and consumes 5 gallons of milk and 8 dozen eggs per week would these farmers find exchange mutually beneficial at a price of 1 dozen eggs per gallon of milk? Explain.

Assume you are the owner/manager of a local, single location video rental store. For each situation below, indicate theimpact on demand, supply, equilibrium price (rental rate), and equilibrium quantity (volume) for your business.Be sure to explain your reasoning. Thus, if the situation described will shift demand indicate the direction (and magnitude if possible) demand will shift and how both equilibrium price and quantity will change. Consider only the comments made in the specific question. These are independent situations, not part of a continuous scenario. Also, assume you have no reason to believe other things will change.

  1. The population within a five mile radius of your location increases by 20%.
  2. Ohio increases the legal minimum wage from $4.25 to $5.15 per hour.
  3. Several major film distributors announce plans to release DVDs on the same day as new movies open in theatres.
  4. A very popular fast food restaurant opens in the space adjacent to your store.
  5. Time Warner Cable begins cable television service to your neighborhood.

The next four (4) questions pertain to the market for 1-qt. plastic containers. A marketing firm estimates that the demand in this market is: Q = 20 - 10 P; and the current supply is: Q = 20P –4. Answer each question in the booklet provided. Remember each answer is worth 2 points and each explanation is worth 2 points.

  1. Calculate the equilibrium price and quantity. Explain your reasoning.
  2. Is total revenue maximized at the equilibrium price?Explain your reasoning.

Consider a new demand such that Q = 26 - 10 P.

  1. Is this an increase or decrease in demand?Explain your reasoning.
  2. Is this demand more or less elastic than the old demand? [Hint: To be more (less) elastic the absolute value of the elasticity coefficient must be greater (smaller) for the new demand curve.]

Applications (Q28 – 30)(15 points total – 2 points each for the answer, 3 points each for explanation or reasoning):Answer each question in the booklet provided. Please indicate any assumptions you make, explain your thinking and show all work to receive full credit.

“Taking tuition fees as the relevant price, enrollments in US higher education tend to show significant but small price elasticities, around -0.3 (McPherson, 1978, pp. 180-1; Leslie and Brinkman, 1987). … estimates of the income elasticity tend to be higher, usually more than 0.5, and frequently 1.0 (Campbell and Siegel, 1967; Jackson and Weatherby, 1975; Corman, 1983).”[1]

Use the estimates quoted for the market for higher education in the United States, to answer the following questions. Be as precise as possible and remember to explain your reasoning. Assume these are separate, independent situations and that the answers to one are not dependent on a preceding question.

  1. The U.S. average increase in undergraduate tuition for the fall 2005 term is about 7% [WSJ 7/09/2005; p. D1]. Holding all else constant, what change would you predict in undergraduate college enrollment for the fall 2005 term?
  2. From BEA data on the National Income and Product Accounts [ U.S. personal income may be about 1% higher this fall than last fall. Holding all else constant, what change would you predict in undergraduate college enrollment for the fall 2005 term from this increased income?
  3. For the fall 2005 term, the University of Akron and most of its competitors increased undergraduate tuition by 6%. Assume income in northeast Ohio follows the national trend, an income elasticity of 0.75 and fall 2004 undergraduate enrollment of 17,500 students. What change would you predict in UA’s undergraduate college enrollment for the fall 2005 term?

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[1]Paul Ryan. “UNBALANCED GROWTH AND FISCAL RESTRICTION: PUBLIC SPENDING ON HIGHER EDUCATION IN ADVANCED ECONOMIES SINCE 1970.” Structural Change and Economic Dynamics, 1992, 3(2), p. 9.