Comments on questions that were hard on the first midterm, 30 September.

General comment: A fair number of students had problems that concerned questions about

• Supply and Demand and either asked you to distinguish between quantity supplied/demanded and supply/demand; or asked you to distinguish between things that shift supply and those that shift demand.

On the other hand, quantity supplied means the amount actually sold at a particular price for a particular state of the world [i.e. supply curve], and quantity demanded the amount actually bought at a particular price for a particular state of the world [i.e. demand curve]. The only thing that changes quantity supplied or quantity demanded [i.e. moves you up or down a particular supply or demand curve] is a change in the own-price of the good. The 'state of the world' determines the supply curve [shifters PEST] and the demand curve [shifters PYNTE].

- some people had evidently not yet absorbed the national income accounting definitions of chapter 6.

Notes on particular questions:

Q: Increasing opportunity cost occurs along a production possibility frontier because

1. resources are not equally productive in all activities. That is the right answer; resources are not equally productive in all uses, and therefore it makes sense if starting from zero to use first the resources that are most productive in that activity. That gives you an increasing opportunity cost, because as you increase output of that good, you have to use progressively less and less productive resources in that activity, i.e. things that were relatively better and better suited to the activity you are giving up. Only about 14% of you saw this; over 80% said


"in order to produce more of one good decreasing amounts of another good must be sacrificed" -- this is WRONG, it would be right if it said "increasing amounts …"
 
 

Q: The price of the steel used to produce engines increases. How does this price hike affect the demand for cars?

Oh dear, this is a very common kind of question, and it caught over half of you. The cost of making cars has gone up, that affects the supply of cars, i.e. the amount producers are willing to sell at each price. There is no reason whatsoever why it should affect the demand for cars, i.e. how many buyers want to buy at each price. So the right response was

2. It does not change the demand, that is, the demand curve does not shift. However, only 17% of you saw that. 55% said it decreased demand, 24% said there was not enough information to tell.

 

 
 

Q: Suppose that coffee and sugar are complements. If poor weather causes the supply curve for coffee to shift leftward, the most likely result will be

Nothing has happened to change the demand for coffee. So when the supply curve for coffee shifts left, the price of coffee must go up, the equilibrium quantity purchased decrease. Sugar is a complement, i.e. sugar is consumed with coffee. Less coffee is being bought, so at any price for sugar, less sugar is bought. Nothing has changed the supply of sugar, but the demand has decreased, i.e. the demand curve has shifted left. So the price of sugar will go down, i.e. the right response was

3. a decrease in the price of sugar. Only 27% of you got this right; 40% said the supply curve of sugar would shift left -- but why, what has happened to change the willingness of sellers to sell sugar? Nothing in the question. The easiest way to be sure of understanding this kind of question is to draw a little supply and demand diagram -- in this case two, one for coffee and one for sugar, move the curve(s) in the diagram and figure out what happens.

 

 
 

Q: Assume the inflation rate falls from 4 percent to 2 percent. This means that

B) the average price level is increasing more slowly. This is almost a definition. The inflation rate is the rate of change of the average price level; so if the inflation rate falls from 4% to 2%, the average price level is growing (increasing) more slowly. 29% of you got this, but slightly more said the average price level had fallen [that would require a negative inflation rate, also known as deflation), and a full third of you said the economy was experiencing deflation (no, for that prices must be actually falling, i.e. the inflation rate would be negative).
 
 

Q: Which of the following expenditures would not be included directly in GDP?

We had only just done this and not done much practice. Expenditures included directly in GDP are those on final goods, i.e. consumption, investment, government, or net exports. Not included directly are, among other things, expenditures on intermediates, i.e. those goods or services used (up) to produce other goods or services. So the right answer was

4. General Motors buys new tires to put on the cars that it's building -- because they are intermediates, their value will be included in the value of the cars. 34% of you got it; government buying tires, tires sold to Canada [exports], and you buying new tires (consumpiton) for your car, whether used or not, are all final goods so included directly.

Q: An example of "investment" in computing real GDP using the expenditure approach is the purchase of

1. a new set of tools by an auto mechanic, for use in repairing cars. This is investment because this is the purchase of something durable that will be used to produce something else, i.e. the tools are going to be used to produce something, and they won't be fully used up doing so in the time period. Again only 34% got it. The other options were shares [financial, not investment in GDP sense]; an old house [not produced in the period, therefore not part of GDP, an exchange of an existing used good]; and computer chips bought by IBM to put in a PC [intermediates -- fully used up making the PC].

Q: Auto workers negotiate a wage increase; how does this affect the supply of cars?

The wages of autoworkers are the price of an input [resource] used to produce cars; so when they go up, the cost of making cars goes up, and sellers will want to sell fewer at any given price, i.e. the supply curve shifts in to the left,

1. it decreases the supply is the right answer; 37% of you got it. For reasons I don't understand, 40% of you said there was not enough information to tell. I think there is.

 

 
 

Q: Which of the following best reflects an increase in quantity supplied rather than an increase in supply?

"change in quantity supplied" means a movement along an unchanged supply curve, i.e. it can only be caused by a change in the own-price of the thing itself. So the right response was

2. the government stops controlling the price of a product, allowing the price to increase. 37% of you got that, but nearly as many thought the things that would change costs or the number of sellers [and therefore shift the supply curve, an increase in supply] were correct answers -- NO!