2005 Subject Test—Economics



2006 Economics Subject Test

Part I. Multiple Choice (30 questions, 60 points total)

Choose the letter of ONE best answer (each question is worth 2 points).

1. If the cross elasticity of demand between two goods is –0.56, then a fall in the price of one good leads to a ____ shift in the ____ of the other good.

A) rightward; demand

B) rightward; supply

C) leftward; demand

D) leftward; supply

2. Nick can purchase each milkshake for $2. For the first milkshake purchased Nick is willing to pay $4, for the second milkshake $3, for the third milkshake $2 and for the fourth milkshake $1. What is the value of Nick’s consumer surplus?

A) $2

B) $9

C) $3

D) $10

3. Suppose, a firm has $1500 in variable costs and $500 in fixed costs when it produces 500 units of output and sells it for $50 per unit. If the price of the product drops to $4 each, should this firm continue operation during the short run?

A) No, because P < ATC

B) Yes, because P > ATC

C) No, because P < AVC

D) Yes, because P > AVC

4. Suppose there is an announcement that peanut butter is good for you. What is the most likely result?

A) An increase in the price of grilled cheese sandwiches, a substitute.

B) An increase in the price of jelly, a complement.

C) A reduction in the consumption of peanut butter.

D) An increase in the cost of making peanut butter.

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5. The water and diamonds paradox of value results from

A) the concept of deadweight loss.

B) the “law of demand.”

C) diminishing marginal utility.

D) the elasticity of demand.

6. A price taker confronts a demand curve that is

A) vertical at the market price.

B) upward sloping.

C) downward sloping.

D) horizontal at the market price.

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7. For the monopoly shown in the figure above, when it maximizes its profit the marginal cost is ____ per unit and the price is ____ per unit.

A) $10; $30

B) $20; $20

C) $10; $20

D) $30; $20.

8. If demand is inelastic, an increase in the price will

A) decrease total revenue.

B) increase total revenue.

C) not change total revenue.

D) increase the quantity demanded.

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[pic]

9. In the figure above, suppose that Mac and Izzie trade and reach point c. Then

A) Mac and Izzie should both produce at point a.

B) Mac should produce at point b and Izzie should produce at point d.

C) Mac should produce at point d and Izzie should produce at point b.

D) Mac and Izzie should both produce at point c.

[pic]

10. Ricky's work-leisure choices are given in the above figure. As the wage rate increases from $5 to $10 per hour so that Ricky’s income-time budget line shifts from BL0 to BL1, Ricky’s ____ effect is stronger. As the wage rate increases from $10 to $15 per hour, so that his budget line shifts from BL1 to BL2, Ricky’s ____ effect is stronger.

A) income; substitution

B) income; income

C) substitution; income

D) substitution; substitution

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11. Assume a person’s consumption of just the right amounts of pork and chicken is in equilibrium. We can conclude that the

A) marginal utility of pork must equal the marginal utility of chicken

B) price of pork must equal the price of chicken

C) ratio of marginal cost to price must be the same in both the pork and the chicken markets

D) ratio of marginal utility to price must be the same for pork and chicken

12. A minimum wage imposed above a market’s equilibrium wage will result in the quantity

A) supplied of labor being greater than the quantity demanded of labor and unemployment will occur.

B) demanded of labor being greater than the quantity supplied of labor and unemployment will occur.

C) supplied of labor being greater than the quantity demanded of labor and a shortage of workers will occur.

D) demanded of labor being greater than the quantity supplied of labor and a shortage of workers will occur.

13. A monopolistically competitive firm has the following cost structure:

|Output |1 |2 |3 |4 |5 |6 |7 |

|Total Cost($) |30 |32 |36 |42 |50 |63 |77 |

The firm faces the following demand curve:

|Price ($) |20 |18 |15 |12 |9 |7 |4 |

|Quantity |1 |2 |3 |4 |5 |6 |7 |

If the government forces this firm to produce at its efficient scale, it will

A) produce 3 units and make $9.

B) produce 4 units and make $6

C) produce 5 units and lose $5.

D) produce 7 units and lose $49.

14. If supply is perfectly elastic, the supply curve is

A) vertical

B) horizontal

C) any straight-line supply curve

D) any supply curve intersecting a perfectly elastic demand curve

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15. When a market is in equilibrium,

A) producers earn profits

B) the minimum possible price is achieved

C) there is no incentive for consumers or producers to change their current behavior

D) excess demand is less than excess supply

16. Nominal GDP is measured in

A) current-year prices

B) base-year prices

C) real dollars

D) quantity of goods produced

17. Real GDP does not show the state of economic welfare in a country in part because GDP omits

I. household production.

II. leisure time available.

III. the quality of the environment.

A) I only.

B) I and III.

C) II and III.

D) I, II and III.

18. The term “stagflation” refers to the situation when

A) the aggregate supply curve shifts leftward, prices increase and real GDP decreases.

B) real GDP and the price level both rise because of an increase in aggregate demand.

C) prices become stagnant and do not increase or decrease.

D) the aggregate supply and demand curves shift in opposite directions.

19. Which of the following does NOT shift the short-run aggregate supply curve?

A) a change in the wage rate.

B) technological progress.

C) a reduction in the price of a raw material.

D) a change in the price level.

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20. Which of the following changes produces an upward shift in the consumption function?

A) An increase in consumer wealth

B) A decrease in consumer wealth

C) A decrease in autonomous consumption

D) Both B) and C)

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21. Which of the above figures best shows the start of a demand-pull inflation?

A) Figure A.

B) Figure B.

C) Figure C.

D) Figure D.

22. Which of the following makes the multiplier larger?

A) An increase in the marginal propensity to import.

B) An increase in the tax rate.

C) An increase in the marginal propensity to consume.

D) An increase in the marginal propensity to save.

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23. Which of the following changes causes reported GDP to increase when, in fact, total production is unchanged?

A) A shift from household production to market production.

B) The legalization of previously illegal activities.

C) Neither of the above will cause reported GDP to increase when total production does not change

D) Both answers A) and B) are correct.

24. The natural rate of unemployment

A) occurs when the unemployment rate is 0 percent.

B) is the unemployment rate when there is no structural unemployment.

C) is the unemployment rate at full employment.

D) is the unemployment rate when there is only cyclical unemployment.

25. If the CPI is 120, this means that

A) prices are 120 percent higher than in the reference base period.

B) prices are 0.12 times higher than in the reference base period.

C) prices are 20 percent higher than in the reference base period.

D) nominal GDP will be less than real GDP.

26. Despite some problems with equating GDP with economic well-being, real GDP per person does imply greater economic well-being because it tends to be positively associated with:

A) crime, pollution, and economic inequality.

B) better education, health and life expectancy.

C) poverty, depletion of nonrenewable resources, and congestion.

D) unemployment, availability of goods and services, and better education.

27. If planned aggregate expenditure (PAE) in an economy equals 2,000 + .8Y and potential output (Y*) equals 9,000, then this economy has:

A) an expansionary gap.

B) a recessionary gap.

C) no output gap.

D) no autonomous expenditure.

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[pic]

28. In the above figure, a recession begins at point ____ and an expansion begins at point ____.

A) a; b

B) b; c

C) b; a

D) d; c

| | |Not working and |Want to work but no longer |

|Total |Currently |looking for work|looking for work |

|population |employed |(millions) |(millions) |

|(millions) |(millions) | | |

|80 |40 |2 |4 |

29. In the table above, the size of the labor force is

A) 80 million.

B) 46 million.

C) 42 million.

D) 40 million.

30. Suppose that some people are counted as unemployed when, to maintain unemployment compensation, they search for work only at places where they are unlikely to be hired. If these individuals were counted as out of the labor force instead of as unemployed,

A) both the unemployment rate and labor-force participation rate would be higher.

B) both the unemployment rate and labor-force participation rate would be lower.

C) the unemployment rate would be lower and the labor-force participation rate would be higher.

D) the unemployment rate would be higher and the participation rate would be lower.

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Part II. Problems (2 questions, 40 points total)

Write your answer in the paper provided. Show your calculations and justifications to your answer (points are in brackets after the question).

1. Daniel allocates his budget of $24 per week among three goods. Use the following table of the marginal utilities for Good A, Good B, and Good C to answer the questions below:

|Q(A) |MU(A) |Q(B) |MU(B) |Q(C) |MU(C) |

|1 |50 |1 |75 |1 |25 |

|2 |40 |2 |60 |2 |20 |

|3 |30 |3 |40 |3 |15 |

|4 |20 |4 |30 |4 |10 |

|5 |15 |5 |20 |5 |7.5 |

a) If the price of A is $2, the price of B is $3, and the price of C is $1, how much of each will Daniel purchase in equilibrium? [6 points]

b) If the price of A rises to $4 while the other prices and Daniel's budget remain unchanged, how much of each will he purchase in equilibrium? [6 points]

c) Using the information from parts (a) and (b), draw the demand curve for good A. Be sure to indicate the price and quantity for each point on the curve labeled. [8 points]

ANS

a) Four units each of goods A, B, and C. The per dollar marginal utility is 10 for each good, and total spending equals $24 ($8 on A, $12 on B, and $4 on C).

b) Two units of A with four units each of goods B and C. The per dollar marginal utility is 10 for each good, and total spending equals $24 ($8 on A, $12 on B, and $4 on C).

c)

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2. You are given the following information about the economy of Formosa: Autonomous consumption expenditure is $100 billion, and the marginal propensity to consume is 0.75.

Investment is $50 billion, government purchases of goods and services are $30 billion, net exports are –$100 billion, and net taxes are a constant $100 billion—they do not vary with income.

a) What is the consumption function? [4 points]

b) What is the equation that describes the aggregate expenditure curve? [4 points]

c) What is the real GDP demanded (i.e., the equilibrium expenditure)? [4 points]

d) What is the size of the multiplier? [4 points]

e) What would happen to real GDP demanded if government purchases increased to $40 billion? [4 points]

ANS

a) The consumption function is C = 100 + 0.75(Y - T ) where 100 is $100 billion, and T is net taxes of $100 billion.

The consumption function is the relationship between consumption expenditure and disposable income, other things remaining the same. The constant in the consumption function is autonomous consumption, $100 billion. The slope parameter of the consumption function is the MPC, 0.75 in the case at hand.

b) The equation of the AE curve is AE = 5 + 0.75Y, where Y is real GDP.

Aggregate planned expenditure is the sum of consumption expenditure, investment, government purchases, and net exports. Then, using the symbol AE for aggregate planned expenditure, aggregate planned expenditure is:

AE = 100 + 0.75(Y - 100) + 50 + 30 - 100

AE = 100 + 0.75Y - 75 + 50 + 30 - 100

AE = 5 + 0.75Y

c) Equilibrium expenditure is $20 billion.

Equilibrium expenditure is the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP. That is,

AE = 5 + 0.75Y and AE = Y

Solving these two equations for Y gives equilibrium expenditure of $20 billion.

d) The size of the multiplier is 4.

The simple spending multiplier equals 1/MPS or 1/(1-MPC). In this problem, the MPS (MPC) is 0.25 (0.75) and the multiplier is 4.

e) GDP demanded will increase by $40 billion.

If government spending increases to 40, this increase of 10 will increase GDP demanded by the multiplier, which is 4, multiplied by 10. Thus, GDP demanded will increase by 40 to a level of 60 billion.

[ End of Exam ]

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Questions are printed on both sides of the paper.

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