ECON130 ECONOMIC PRINCIPLES AND ISSUES 2014 2/3

Tutorials - introduction

Welcome to the ECON130 tutorials for trimester 2, 2014. Tutorials are a good chance foryou to practice what you have covered in class in small groups with your classmates, todiscuss problems and work through exercises.

What you get out of the tutorials depends on what you put in to your preparation andparticipation.

You are expected to prepare for tutorials by keeping up with the prescribed reading andby attempting the exercises in advance of your session. You should attempt, in writing,the tutorial questions and the corresponding set of multi-choice questions before attendingyour tutorial.

Tutorials will be held in weeks 2, 3, 4, 6, 7, 9, 11, 12 (starting week 2).

See the schedule in the Course Delivery section of the Course Outline to see what lecturesare covered in each tutorial.

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ECON130 Tutorial 01

Thinking like an economist

Multi Choice

1. When deciding whether or not to pursue a particular activity any further, individualsshould continue doing the activity:

(a) as long as they like it.

(b) as long as marginal benefits are positive.

(c) as long as marginal costs do not increase.

(d) as long as marginal costs are less than marginal benefits.

b) Suppose Frieda is offered a free voucher for one of the following: a movie, dinner ata restaurant, or a concert. Frieda values the movie at $15, dinner at $20 and theconcert at $40. Friedas opportunity cost of going to dinner is:

(a) $15.

(b) $20.

(c) $40.

(d) $55.

Q1 Education

A friend is deciding whether to go to university or whether to stick with their current job.They seek your advice, as a Commerce student. What would you tell them?

Q2 Models

What is a model? Why do economists use models?

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Q3 Economic logic

Explain the pitfalls in the following statements.

a Whenever John decides to wash his car, the next day it rains. Johns town is sufferingfrom a severe drought, so he decided to wash his car and, just as he expected, the nextday the thunderstorms rolled in. Obviously it rained because John washed his car.

b The principal of Hamilton High School found that requiring those students who werefailing algebra to attend an afternoon tutoring programme resulted in a 30 percentaverage increase in their algebra grade. Based on this success, the principal decidedto hire more tutors and require that all students must attend after-school tutoring, soeveryones algebra grades would improve.

c People who drive hybrid cars recycle their trash more than people who do not drivehybrids. Therefore, recycling trash causes people to drive hybrid cars.

Q4 The competitive model

What are the essential elements of the basic competitive model?

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ECON130 Tutorial 02

Consumer choice I

Multi Choice

MC1. Suppose consumption bundle A maximises Bens utility, subject to his budgetconstraint. Further, consumption bundle B gives Ben less utility than A. From this,we can infer that:

(a) The cost of B is greater than Bens income.

(b) The cost of B is less than Bens income.

(c) The cost of B is equal to Bens income.

(d) None of the above.

MC2. Suppose Ellen spends all her income on books and food. Following an increase inthe price of books (with income fixed), Ellen consumes fewer books and less food.From this, we can infer that:

(a) Books are normal goods, to Ellen.

(b) Books are inferior goods, to Ellen.

(c) Food is a normal good, to Ellen.

(d) Food is an inferior good, to Ellen.

MC3. Consider an individual farmer who consumes food and recreation goods. Thefarmers income comes from the sale of their endowment of food but is not related tothe price of recreation goods. For the particular individual, both goods are normal.An increase in the price of food will have a substitution effect, that causes thedemand for food to and an income effect that causes the demand for food to

.

(a) Decrease; decrease.

(b) Decrease; increase.

(c) Increase; decrease.

(d) Increase; increase.

MC4. Consider an individual who consumes only food and recreation goods. Supposethat when the individuals income is $100, the price of food is $2 and the price ofrecreation goods is also $2, the individual chooses to consume 30 units of food and20 units of recreation goods. Any consumption bundle that yields utilitythan the individuals chosen plan will .

(a) lower, be affordable.

(b) higher, be affordable.

(c) higher, not be affordable.

(d) lower, not be affordable.

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Q1 Utility

Why does marginal utility tend to diminish?

Q2 Hotdogs

The only foods Sammy consumes are hotdogs (for $2 each) and cups of coffee (for $4each). If she has a food budget of $100 per week:

a) What is maximum amount of each that she could choose to consume? Draw herbudget constraint, with hotdogs on the vertical axis and coffee on the horizontalaxis.

b) If she has a utility function such that she will always spend the same amount oneach of hotdogs and coffee, how will her consumption change if the price of a cup ofcoffee falls to $2.

Q3 Hotdogs II

Consider a consumer with a fixed income, who only consumes two goods (hotdogs andcoffee). How do they choose the consumption plan that will maximise their utility? Willthey ever spend less than their income? Will they ever consume only hotdogs?

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ECON130 Tutorial 03

Consumer choice II

Multi Choice

MC1. Consider an individual who spends all their income on beer and food. Followingan increase in the price of beer (with income fixed), the individual consumes morebeer. From this, we can infer that

(a) Both beer and food are normal goods to the individual.

(b) Beer is normal and food is inferior to the individual.

(c) Beer is inferior and food is normal to the individual.

(d) Both beer and food are inferior goods to the individual.

MC2. The figure below shows an individuals two-period budget constraint before andafter a change in the interest rate. If the individual chose E on the original budgetconstraint and E0 on the new budget constraint, this indicates that the

(a) income effect is non-existent.

(b) change in the interest rate decreased savings.

(c) substitution effect dominates the income effect.

(d) substitution effect exactly offsets the income effect.

BC 1

BC 0

Spending in period 2(future consumption)

Spending in period 1(current consumption)

B

B

C

E0

E

E1

b

b

b

b

b

b

b

MC3. Consider an individual whose only endowment is time and who derives utilityfrom leisure and consumption. For the individual, consumption and leisure areboth normal goods. If the income effect dominates the substitution effect, then anincrease in the wage rate will cause the individuals supply of labour to

(a) increase.

(b) decrease.

(c) remain unchanged.

(d) None of the above (as it will depend on the circumstances).

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Q1 Discussion

An increase in the price of a good will cause an individual to consume less of it. Discuss.

Q2 Leisure

Tommy works for an income which he then spends on consumption. His original choiceis 8 hours of leisure a day and $40 worth of consumption, which is shown in the figurebelow. A second budget line is also illustrated, corresponding to a wage increase. It turnsout that Tommy does not want to alter his hours worked as a result of this change.

a) Draw in an indifference curve consistent with Tommy not changing his desired num-ber of hours to work.

b) Now draw in a third budget line that represents an inheritance that results in thesame income as the wage increase (referred to in the preamble above).

c) Which of these two changes would lead to more time being taken for leisure?

BL2

BL1

leisure

0

$20

$40

$60

$80

$100

4 8 12 16 20 24

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Q3 Borrowing

Sophie consumes today (i.e. the present) and tomorrow (i.e. the future), and earns $100today and $100 tomorrow. The money prices of goods both today and tomorrow arefixed. Consumption today and consumption tomorrow are both normal goods.

a) If Sophie is currently a borrower, what does an increase in the interest rate do toher consumption (today and tomorrow)?

b) If Sophie is currently a lender (i.e. saver), what does an increase in the interest ratedo to her consumption (today and tomorrow)?

c) If Sophie currently chooses to spend $100 today, what does an increase in her incometomorrow (to $120) do to her saving behaviour (with the interest rate unchanged)?

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ECON130 Tutorial 04

Producer choice

Multi Choice

MC1. With only one input, the slope of the production function is the

(a) total product

(b) average product

(c) marginal cost

(d) marginal product

MC1. Consider a price-taking firm with one variable input and (positive) fixed costs. Ifthe marginal cost is a constant function of output, then the average cost curve willbe

(a) an increasing function of output.

(b) a decreasing function of output.

(c) a constant function of output.

(d) None of the above.

MC1. Consider a firm with a positive fixed cost and a constant marginal cost. As aconsequence, we know that:

(a) average cost is falling (as output increases).

(b) average cost is rising.

(c) average cost is constant.

(d) None of the above, as it depends on the circumstances.

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Q1 Costs

Imagine that labour is the only input of production for a firm, and the production functionis q = 3

L (plotted in the left pane below). Costs are w L, where w = 1 and L is

whatever is required for the desired level of output. Plot the cost function in the right-hand pane. If you are confident with maths, you might try to identify the cost functionmathematically. Otherwise just look at q = 0, q = 3, q = 6 and q = 9. Look at theproduction function to find out how much labour is needed, multiply by the wage rateand then plot in the right-hand pane.

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9

10

1 2 3 4 5 6 7 8 9 10

b

b

b

b

L

q

q = 3L

1

2

3

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5

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9

10

1 2 3 4 5 6 7 8 9 10q

c(q)

What can you conclude about the cost function?

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Q2 TC and AC

For each of the following four total cost functions, identify the shape of the marginal costfunction and the average cost function.

12345678910

1 2 3 4 5 6 7 8 9 10

c(q)

12345678910

1 2 3 4 5 6 7 8 9 10

c(q)

12345678910

1 2 3 4 5 6 7 8 9 10

c(q)

12345678910

1 2 3 4 5 6 7 8 9 10

c(q)

Q3 Price

Under what conditions will a firms output price equal its marginal revenue? What is thedifference between the concepts of marginal and average revenue, and when will they bethe same?

Q4 One unit

Consider a price-taking firm with a production function that yields output as a functionof labour (as the only input). If the firm makes a positive profit producing one unit ofoutput, then it will wish to produce more (than one unit of output). Discuss.

Q5 Short run profits

If a firm makes a positive profit in the short run (with capital fixed), then it will desireto increase its capital stock in the long run. Discuss.

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ECON130 Tutorial 05

Equilibrium

Multi Choice

The following information will be used for questions MC1-MC2.

Consider the market for a particular good in which all buyers and sellers are price takers.Further, the supply curve slopes up while the demand curve slopes down (with quantityon the horizontal axis and price on the vertical).

MC1. A shift to the right in the demand curve and a shift to the right in the supply curvewill cause in the equilibrium price and in the equilibrium quantity.

(a) An ambiguous change; an ambiguous change.

(b) An ambiguous change; an increase.

(c) An increase; an ambiguous change.

(d) An increase; an increase.

MC2. Which of the following would result in an increase in equilibrium price and anambiguous change in equilibrium quantity?

(a) A shift to the right in the supply and demand curves.

(b) A shift to the right in the supply curve and a shift to the left in the demandcurve.

(c) A shift to the left in the supply and demand curves.

(d) A shift to the left in the supply curve and a shift to the right in the demandcurve.

MC3. If the quantity of a product demanded increases at every price (shifting the de-mand curve rightward) and the supply of the product is perfectly price elastic (i.e.horizontal), equilibrium quantity will and equilibrium price will .

(a) increase; remain constant

(b) increase; increase

(c) decrease; remain constant

(d) remain constant; increase

MC4. Which of the following would result in an increase in equilibrium price and anambiguous change in equilibrium quantity?

(a) An increase in supply and demand.

(b) An increase in supply and a decrease in demand.

(c) A decrease in supply and demand.

(d) A decrease in supply and an increase in demand.

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Q1 Changes to demand

Use the following information to answer this question.

Consider the following demand schedule:

Price ($) 5 6 7 8 9 10 11

Quantity 450 400 350 300 250 200 150

Also, consider the following supply schedule:

Price ($) 6 7 8 9 10 11 12

Quantity 100 150 200 250 300 350 400

1. Draw a demand and supply diagram illustrating the information in the tables above.Clearly label your diagram. What is the equilibrium price and quantity?

2. Suppose that consumer incomes rise and demand increases by 100 units for everyprice. Illustrate this change in your diagram from part (1). Clearly label the changes.What is the new equilibrium price and quantity?

3. Discuss how the market adjusts from one equilibrium to another.

Q2 Supply shocks

Suppose that demand is given by the equation P = 14.5 2Qd, where P is price andQd is quantity demanded. Further, let supply be given by P = 0.5 + 1.5Qs, where Qsrepresents quantity supplied.

1. Draw a demand and supply diagram based on the equations for demand and supplyabove. Clearly label your diagram. What is the equilibrium price and quantity?

2. Suppose that a supply-side shock causes the supply equation to become P = 0.25+1Qs. What happens to the quantity supplied, for any price? Illustrate this change inyour diagram from part (1). Clearly label the changes. What is the new equilibriumprice and quantity?

3. Discuss the sorts of change to a factor of supply that would be consistent with theshock given above.

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ECON130 Tutorial 06

International Trade; the Government

Multi Choice

MC1. A country has a comparative advantage in the production of milk if:

(a) It can produce more milk than another country using the same amount ofresources.

(b) It also has an absolute advantage in the production of milk.

(c) It is relatively more efficient at producing milk than another country.

(d) It is richer and has more resources than another country.

MC2. Suppose New Zealand can produce either one tonne of wheat or 2,000 litres of milk,while Australia can produce either eight tonnes of wheat or X litres of milk. NewZealand will have a comparative advantage in the production of milk if, and only if,X is:

(a) Less than 4,000.

(b) More than 4,000.

(c) Less than 16,000.

(d) More than 16,000.

The information below will be used for the following two questions.

The governments (marginal) income tax rates are: 20% for income up to $50,000. 40% for income above $50,000.Further, individuals with one or more children receive a payment from the govern-ment of $10,000 upon the birth of their first child. This payment is clawed back bya surcharge of 20% (or 20 cents in the dollar) on income above $40,000, until thetransfer payment is recovered by the government. The tax bill of an individual willbe defined to be their income tax paid less the transfer payment they receive.

MC3. Consider an individual with one child. Their tax bill will be zero when their incomeis:

(a) $40,000.

(b) $45,000.

(c) $50,000.

(d) $55,000.

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MC4. Consider an individual with one child. Their maximum marginal tax rate (includingthe claw-back of the transfer payment) is 60%. This tax rate is reached for incomegreater than but less than :

(a) $40,000; $90,000.

(b) $40,000; $100,000.

(c) $50,000; $90,000.

(d) $50,000; $100,000.

Q1 Free trade deal

Suppose New Zealand and Australia consider a free trade deal, and that presently there isno trade between the two countries (and there are no other countries to trade with). Bothcountries currently produce and consume only two goods: wine and wool. The maximumamount of wine New Zealand can produce is 200, and the maximum amount of wool is400. The maximum amount of wine Australia can produce is 800, and the maximumamount of wool is 800. Both countries have linear production possibility curves, i.e. foreach country, the amount of wool that must be sacrificed to produce one extra unit ofwine is constant. The preferences of households in both countries are such that theyspend 50% of their income on wine and 50% on wool.

(a) What is the pre-free-trade equilibrium (the relative price of wine, production andconsumption) in New Zealand? In Australia?

(b) Suppose that the relative price of wine is 1 (i.e. 1 unit of wool trades for 1 unit ofwine). How much wine and wool will New Zealand produce? How much will NewZealand consume? How much wine and wool will Australia produce? How muchwill Australia consume?

(c) Will Australia be better off as a result of the free trade deal?

Q2 Laffer curve

On p.686 of the textbook, a Laffer curve is drawn, which shows the (income) tax revenuecollected by the government falling as the (income) tax rate rises (for high enough taxrates). Two reasons could explain this shape. First, people could work less as their post-tax wage rate falls. Second, people could evade tax more as the tax rate rises. Whicheffect do you think will be the largest?

Q3 Taxes and efficiency

If the government taxes households, the resulting equilibrium will not be Pareto efficient.Discuss.

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ECON130 Tutorial 07

Growth

Multi Choice

MC1. Consider two countries (call them A and B). Country A doubles its real GDP percapita every ten years. Country B doubles its real GDP per capita every 20 years.To begin with, assume Country B has four times the real GDP per capita as A.After 20 years, Country As real GDP per capita will be of Country Bs.

(a) 25%.

(b) 50%.

(c) 100%.

(d) 150%

MC2. Suppose Countries A and B both have the same real GDP at date 1. Considertwo different scenarios. In Scenario 1, Country As real GDP has a constant annualgrowth rate of 0%, while Bs has a constant annual growth rate of 2%. In Scenario2, Country As real GDP has a constant annual growth rate of 2%, while Bs hasa constant annual growth rate of 4%. At date 10, the ratio of As real GDP to Bsreal GDP is calculated. This ratio will be:

(a) Larger in Scenario 1 than Scenario 2.

(b) Larger in Scenario 2 than Scenario 1.

(c) The same in both Scenarios.

(d) None of the above (as it depends on the circumstances).

MC3. Suppose that in the year 2003, the average worker worked for 50 hours per weekand produced 1,000 units of output. By 2013, the average worker worked 40 hoursper week and produced 900 units of output. From 2003 till 2013, the average outputper worker , while the average output per hour worked :

(a) Fell; fell.

(b) Fell; rose.

(c) Rose; fell.

(d) Rose; rose.

MC4. The costs of economic growth include all of the following except the

(a) Loss of existing jobs.

(b) Increased demand for newly skilled workers.

(c) Need to relocate workers.

(d) Damage to the environment.

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Q1 Productivity

(a) What does productivity mean? How does productivity affect economic growth?Explain.(b) If technological change affects productivity, what type of economic policies couldbe used?

Q2 Growth

As a country becomes richer, workers will supply more labour. Discuss.

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ECON130 Tutorial 08

Exchange rates

Multi Choice

MC1. Suppose the NZ dollar appreciates against the US dollar. Therefore, the numberof NZ dollars that can be purchased with one US dollar will:

(a) Fall.

(b) Rise.

(c) Remain unchanged.

(d) None of the above.

MC2. Suppose the New Zealand dollar depreciates against the US dollar. As a conse-quence, we would expect the prices of imports expressed in NZ dollars to:

(a) Fall.

(b) Rise.

(c) Remain unchanged.

(d) None of the above.

MC3. In the foreign exchange market, suppose there is an increase in demand for NewZealand dollars. As a consequence, we would expect the New Zealand exchange rateto:

(a) Decrease.

(b) Remain unchanged.

(c) Increase.

(d) None of the above.

MC4. One reason that the demand curve for NZ$ in the forex market slopes downwardsis because when the price of the NZ$ (the exchange rate) falls:

(a) New Zealanders demand more foreign goods because these goods have becomeless expensive.

(b) foreigners demand fewer New Zealand goods because these goods have becomemore expensive.

(c) foreigners demand more New Zealander goods because these goods have be-come less expensive.

(d) New Zealanders demand fewer foreign goods because these goods have becomemore expensive.

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Q1 PPP

Purchasing power parity implies that if inflation in China increases, then the nominalexchange rate between Chinese and New Zealand (U/NZ$) will appreciate.

Q2 Arbitrage

With international trade, prices and exchange rates will adjust till all retail firms earnthe same rate of return on assets, no matter where they are located.

Revision

Past tests and exams, especially multi-choice questions done poorly. Refer to the TestAnalysis and Exam Analysis files on Blackboard. These give the correct answer and thedistribution of options chosen for each question.

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