The following 12 questions cover some of the material that is relevant for the first exam. While these exact questions will NOT be on the exam, questions that are similar to (at least) some of them will be. Therefore, seeing these questions will help you prepare for the exam.
Answers and explanations for all 12 questions are found at the bottom of this page. The link after each question takes you to the relevant answer. Please note that while checking the answer to question 3 (for example), you may also be able to see the answer to question 4. If you prefer not to see an answer before you've read the corresponding question, you may wish to look over all 12 questions before checking any answers.
Please note that studying for the first exam should entail more than merely reviewing these 12 questions. The exam itself will have 30 questions, and there are topics covered on the exam that do not appear in the sample questions. Also note that you do not receive any direct credit for accessing this page, nor is the page set up to report a score based on your answers.
The questions and answers on this page are also available (on paper) at the Reserve Desk of the main library.
| Unit | Willingness To Pay |
|---|---|
| 1 | 14 |
| 2 | 11 |
| 3 | 8 |
| 4 | 5 |
Question 1 answer is: c. greater than
Explanation: The opportunity cost of producing one additional unit of a Good X (or any good, for that matter) is found by measuring the number of units of some other good (in this case Good Y) that could have been made instead if the one unit of Good X hadn't been produced.
Here's a general example of how to measure opportunity cost. Suppose that 6 units of Good A and 10 units of Good B can be produced simultaneously. If production of Good A were increased to 7 units, however, some resources that had been used to produce Good B would have to shifted to producing Good A. As a result, let's suppose that only 8 units of Good B could then be produced. In this case, the opportunity cost of producing the 7th unit of Good A would be 2 units of Good B.
In the diagram of a Production Possibility Curve, the opportunity cost of producing a good is measured by the slope of the PPC. For example, think about the opportunity cost of producing Good X (which we'll assume is on the horizontal axis). If the PPC is (downward-sloping but) relatively flat, then increasing the production of good X would entail giving up only a small amount of Good Y. On the other hand, if the PPC was relatively steep, then producing more of Good X would entail giving up a considerable amount of Good Y.
In the question above, the PPC is "curved." which means that it starts out relatively flat and then gets steeper. Thus, when the first units of a good are produced, relatively few units of the other good have to given up. As production of the good increases, however, the PPC gets steeper, and each unit produced is more costly in terms of how many units of the other good must be surrendered. In other words, as production of the good increases, the opportunity cost of producing additional units of it rises.
For this particular question, therefore, we conclude that the opportunity cost of raising production from 3 to 4 exceeds the opportunity cost of raising production from 1 to 2.
Question 2 answer is: a. Spending the first $50 on advertising would increase your profit; spending the second $50 would decrease your profit.
Explanation: This questions relates to the principle of looking at marginal changes to determine the best amount of some activity to undertake. Specifically, if you are considering doing a "little more" of something, you should compare the resulting marginal benefit you will receive with the resulting marginal cost you will incur.
In this particular situation, the Marginal Cost of an advertisement is always $50.
The Marginal Benefit of advertising depends on the the profit you earn from each sale, and on the amount by which your sales increase. Here, each sale earns you a profit of $10 (you sell at a price of $20 something that costs you $10). The first ad produces 7 new sales, and thus its Marginal Benefit (the increase in your profit) is $70. For the first ad, therefore, MB ($70) is greater than MC ($50), which tells us that buying the first advertisement increases your profit.
For the second ad, the story is different. The Marginal Cost is still $50, but now the Marginal Benefit is only $20 (an increase of 2 sales at a $10 profit per sale). Since MB is less than MC, buying the second ad decreases your profit.
Note one important point. Looking at marginal effects can tell us only how changes in behavior will change your overall outcome. Marginal analysis can not tell us whether your overall outcome is good or bad; it tells us only whether that outcome is getting better or getting worse.
This is why statement (c) is not a correct answer.
We know for sure that buying the first ad will raise your firm's profit, while buying the second will reduce it. It is therefore possible that your total profit will be positive if you buy one ad and negative if you buy two. But, it is not true that this is the only possible outcome. Rather, it is also possible that your firm's overall profit might be positive in both situations (but bigger in the first than in the second). It is also possible that your profit might be negative in both situations (but less negative in the first than in the second). Statement (c) can be true, but is not definitely true.
The bottom line is to remember that looking at Marginal Benefit and Marginal Cost is a very important way to determine how changes in behavior will cause an outcome to change. Comparing MB and MC tells us whether an taking a certain action will make the outcome better or worse. However, even if an outcome is getting worse, it can still be an (overall) positive outcome -- it just won't be as positive as it could have been. [Correspondingly, even if an outcome is getting better, it can still be an (overall) negative outcome -- just not as bad as it could have been.]
Question 3 answer is: b. Both (i) and (ii) are true.
Explanation: (i) is correct since it is the definition of a budget constraint.
To distinguish between (ii) and (iii), remember that the budget constraint shows the quantities of goods that a person can buy. Therefore, a change that allows a person to afford more units of a good will move the budget constraint away from the origin. In contrast, a change that implies a person can afford fewer units of a good will move the budget constraint towards the origin.
An increase in income (as in (ii)), allows a person to buy more units of a good, and thus moves the budget constraint away from the origin.
An increase in the price of a good (as in (iii)), implies that a person can buy fewer units of the good, and thus moves the budget constraint towards the origin.
Question 4 answer is: d. Answers (b) and (c) are both correct -- which means that we know only that Jane likes Bundle C better than she likes either Bundle A or Bundle B.
Explanation: Since Jane likes both shakes and hamburgers, we know that she'll like a bundle that has more of both goods better than she'll like a bundle that has less of both goods. Thus she definitely prefers Bundle C to the other two bundles.
The remaining question is whether we can say anything about whether Jane likes Bundle A better than Bundle B or vice versa. In fact, we can't make any such statement. Bundle A has more hamburgers, while Bundle B has more shakes. If Jane really likes hamburgers (and only somewhat likes shakes), she would like Bundle A better than B. On the other hand, if Jane really likes shakes (and only somewhat likes hamburgers), she would like Bundle B better than A. Since we don't know enough about Jane's preferences to distinguish between these two possibilities, we can't say which of these two bundles she likes better.
In the same way, if we knew what Jane's indifference curves looked like, we could simply see whether Bundle A or Bundle B was on a higher indifference curve (since Jane would like a bundle on a higher indifference curve better than she would like a bundle on a lower indifference curve). Since we don't have information about the shapes of her indifference curves, however, we again can't tell whether Jane likes A or B better.
Note in particular that we can't simply add together the number of shakes and the number of hamburgers and decide that Jane likes Bundle B better than Bundle A because B has 8 items while A has only 7. Adding together in this way is correct only if Jane gets exactly as much satisfaction from a shake as she gets from a hamburger. If Jane is indifferent between a shake and a burger, then 8 "things" is preferable to 7 "things." Since we don't know how Jane values one shake compared to one hamburger, however, we don't know how she ranks Bundles A and B.
Question 5 answer is: b. 6 cakes.
Explanation: First, remember the demand curve described above does not tell us that when the price of cake is $8, Bob chooses to buy 16 cakes. Rather, it tells us that when the price of cake equals $8, Bob buys 0 cakes, and then his consumption of cake increases as the price falls, until he's buying 16 cakes when the price is $0.
To figure out consumption when the price is $5, start at $5 on the vertical axis, and draw a straight horizontal line until you hit the demand curve. Then go straight down from there until you hit the horizontal axis. The number where you hit the horizontal axis is the number of cakes that Bob buys.
This number can be found in two ways. Both use the fact that the (absolute value of the) slope of the demand curve is 1/2.
[By the way, we know that the (absolute value of the) slope of the demand curve equals 1/2 because the intercepts described above are 8 and 16. Moving down the demand curve from the vertical intercept to the horizontal intercept involves moving down 8 units and over 16 units. Since slope equals (vertical movement) divided by (horizontal movement) (or "rise" divided by "run"), the slope equals 8 divided by 16.]
We start our calculations at the vertical intercept of the demand curve (where price = $8 and quantity = 0). Since we are interested in a price of $5, we lower the price from $8 to $5, which entails moving down $3. Since you went down three units, you must go over 6 units. Why 6 units? Because the slope of the demand curve (which we computed above) tells us that when we slide along the demand curve, a one unit movement in the vertical direction always matches up with a 2 unit movement in the horizontal direction. Remembering that a price of $8 matched up with a quantity of zero units, moving down along the demand curve by $3 (from a price of $8 to a price of $5) entails moving out 6 units (from a quantity of 0 to a quantity of 6).
Alternatively, you can use the formula y=b+mx, or in this case P=(intercept)+(slope)Q. The intercept here is 8; the slope is - 1/2 (here you have to use the minus sign). Thus, P=8-(1/2)Q. Plugging P=5 into the equation and solving produces (1/2)Q=3, or Q=6.
Question 6 answer is: c. both I (an increase in income) and II (an increase in the price of a Y)
Explanation: Remember first that an inferior good (like good X) in one for which people buy less of the good as their income rises (possibly because they can now afford something they like better), and correspondingly buy more of the good as their income falls.
Also, remember that a leftward shift in a demand curve represents a reduction in the amount that people want to buy. Putting these together, an increase in income causes people to buy less of an inferior good, which is shown by shifting the demand curve for X to the left. Possibility I is thus correct.
Now, remember that when two goods are complements, people tend to use them together. If the price of Y rises, people will consume less Y. If X and Y are complements, people will then consume less X. Again this is represented by shifting the demand curve for X to the left (to lower levels of quantity). Possibility II is thus correct.
Finally, remember that when two goods are substitutes, people tend to consume one or the other. If the price of Z rises, people will consume less Z. If X and Z are substitutes, people will then consume more X to replace some of the Z they have given up. We would represent this by shifting the demand curve for X to the right (to higher levels of quantity). Thus, possibility III is incorrect.
Question 7 answer is: a. movement along; shift of
Explanation: When a person (or a group) buys more of a good only because the price of the good itself changes, the person's demand curve doesn't shift over. Instead the point of consumption moves from one point to another point along a stationary demand curve.
The fact that the person's demand curve doesn't shift tells us that his basic interest in buying the good hasn't changed -- he doesn't "like" the good any more (or any less) than he did previously. Rather he's buying more units of the good solely because the good is less expensive than it used to be.
When a person buys more of a good for some reason other than a change in its price (such a reason could be a change in income, a change in preferences, a change in the price of some other good, etc.), the person's entire demand curve shifts.
The significance of the whole demand curve shifting is that it tells us that the person wishes to buy more (or fewer) units of the good even if the good's price remains unchanged. In this particular question, a change in the consumer's income leads her to want to buy more units of the good than she did previously, not because the good got less expensive, but because her fundamental interest in buying the good increased.
Question 8 answer is: b. $5; better off
Explanation: Remember that consumer surplus (for a particular item of a certain good) is defined as the difference between the maximum amount you'd pay for that item (if you had to) -- which we call your Willingness To Pay -- and the amount you actually have to pay for it.
When more than one unit of the good is purchased, the (total) Consumer Surplus is found by adding up the CS for each unit. This can been done either by using numbers in a table (as in this question) or measuring areas on a graph.
Here, your Willingness To Pay for the first BB equals $14, but you only have to pay $10 to buy it. You thus decide to buy the first BB, and experience $4 worth ($14 minus $10) of Consumer Surplus as a result. In the same way, the second unit is worth $11 to you, but since you only have to pay $10, you buy the second BB and come out $1 ahead. Since your WTP for the third unit ($8) is less than the price you'd have to pay, you do not buy a third BB. Thus, your final CS from buying BBs is ($4 plus $1 equals) $5.
For the second part of the question, note that if you join the club and can therefore buy BBs for $7, you will choose to buy 3 of them (since your WTP for units 1, 2, and 3 exceed the per-unit price you must pay). Also, note that (total) CS in this case equals the sum of your CS (computed using the $7 price) for each BB purchased, minus the cost of joining the club.
In this case, your CS from the first BB is ($14 minus $7 equals) $7. Your CS from the second is ($11 minus $7) $4, and from the third is $1. These values ($7, $4, $1) add up to $12, but you have to subtract your other payment -- the $6.50 cost of joining the club. In total, therefore, joining the club leaves you with ($12 minus $6.50 equals) $5.50 worth of Consumer Surplus.
Remember that if you didn't join the club, your CS equaled $5 (we found this number in the first half of this question). Thus, joining the club leaves you better off (by $.50) than you would be otherwise.
Question 9 answer is: b. 1/2.
Explanation: The formula for elasticity is (percentage change in quantity demanded) /(percentage change in price).
Percentage change is equal to (actual change between starting and finishing values)/(average of starting and finishing values).
The elasticity at $2 is found by using a slightly higher price (like $2.10) and a slightly lower price ($1.90) and computing the elasticity using those two points.
Using the numbers in the question, quantity demanded was originally 4.1, and changed to 3.9. The actual change in quantity is thus .2, and the average value of quantity is 4. The percentage change in quantity demanded is thus (.2/4)=.05=5%.
Price was originally $1.90, and changed to $2.10. The actual change in price is thus .2, and the average value of price is 2. The percentage change in price is thus (.2/2)=.1=10%.
The elasticity thus equals (.05/.1)=(5%/10%)=1/2.
Question 10 answer is: e. 4%; fall
Explanation: The first blank is solved as follows.
According to the definition, elasticity = (percentage change in quantity demanded)/(percentage change in price). Here, elasticity = 2, and percentage change in price = 2%. Plugging these two values into the formula produces: 2 = (percentage change in quantity demanded)/2%.
Solving this equation shows that the top value in the fraction must equal 4%. You may be able to simply see that 4% is the correct answer, or you may prefer to get the answer by cross multiplying to produce 2 x 2% = (percentage change in quantity demanded) = 4%.
For the second blank, the key point is that an elasticity equal to 2 tells us that demand is elastic at the current market price. When demand is elastic, a price increase creates a decrease in quantity demanded that is larger in percentage terms. Price goes up some, but quantity bought goes down more (in percentage terms); as a result, the total amount spent on the good falls.
Question 11 answer is: c. A good that is an inferior good must have an income elasticity greater than 0.
Explanation: The correct statement is that a good is inferior if it has an income elasticity less than 0.
Inferior goods are ones for which a rise (positive change) in income produces a fall (negative change) in quantity demanded. Income elasticity equals (percentage change in quantity demanded)/ (percentage change in income). For an inferior good, this formula always has one positive number and one negative number, and thus always equals a negative number.
The other possible answers are all correct as written.
A good that has inelastic demand must indeed have a price elasticity less than 1. (A good with a price elasticity greater than 1 has elastic demand).
A good that is a luxury good must indeed have an income elasticity greater than 1. (A good is called a necessity if its income elasticity is greater than 0 but less than 1.)
Two goods that are substitutes must indeed have a cross elasticity greater than 0. A cross elasticity greater than 0 means that an increase in the price of good A leads to an increase in the quantity demanded of good B. Such goods are substitutes since a higher price for good A means that people buy less of good A and buy more of good B instead. (Two goods are complements if they have a cross elasticity less than 0).
Question 12 answer is: c. a positive number.
Explanation: Cross elasticity measures the extent to which a change in the price of one good alters the quantity demanded of some other good. Here, the two goods are in-state college attendance by Georgia residents (the question gives information about the change in the price of this good) and out-of-state college attendance by Georgia residents (the question gives information about the change in the quantity demanded for this good).
There are (at least) two ways to get the answer to this question. The first is to think about the described changes in price and quantity, and figure out what those changes imply about the value of the cross elasticity. In particular, a decrease in the price of in-state college has produced a decrease in the consumption of out-of-state college. We thus have a negative change in quantity demanded and a negative change in price. When we compute elasticity by putting this information in the form of a fraction, we get a negative number divided by a negative number, which equals a positive number.
Alternatively, one could recognize that in-state college and out-of-state college are substitutes for each other (a person will consume one or the other, but not both). Once you notice this, we know from class (and the book) that the cross elasticity for two goods that are substitutes is always a positive number.