First Midterm, 30 September 1998

What follows is a discussion of the questions on the midterm that caused most trouble to students, i.e. questions that half or fewer of you got right. These represent failure on my part, mostly. However, one thing is common to several of them, which is slightly disturbing: arithmetic. Economics in general assumes you can do simple arithmetic; if you can't, there are always likely to be some questions you have trouble with. If you find arithmetic difficult, bring a calculator to exams.

Question: Suppose that, in dollar terms, nominal GDP increased by approximately 7 percent during a given year, but real GDP fell 4 percent. Which ....

Answer: Nominal or money + 7 percent; real - 4 percent. Explanation: prices + 11 percent.

We know real GDP = [(money GDP)/(price index)]x100; we have not explicitly talked about what that means when we go to growth rates (changes), but it is in the text and it is also common sense:

When we are talking growth rates, Change in real GDP as % = (Change in money GDP in %) minus (inflation rate in %); so (-4) = (+7) - (inflation rate), inflation rate is +11%. The distractors were just that -- nonsense distractors. This was the hardest question on the test: only 15% of you got it right.

Question: There are two markets for oranges, Florida and California. The price of oranges in Florida is 50 cents, in California 75 cents. If no barriers (or taxes) limit the movement of goods and the transportation cost is 10 cents per orange, then oranges would tend to ...

Answer: Move from Florida to California until the price is only 10 cents lower in Florida.

Buy low, sell high; it will be profitable to buy in Florida, take to California, and sell, until the price difference is the same as the transport cost, i.e. 10 cents. 49% of you got this right, but 41% probably did not read the whole question, because you said they would move until the price in Florida was 75 cents -- no for two reasons, (a) the 10 cent transport cost, and (b) because the increased supply in California would bring the California price down.

Question: A firm purchases $400,000 worth of raw materials and pays wages and salaries of $200,000, and dividends of $300,000. If it sells its output for $1 million, the firm's value added to GDP is

Answer: $600,000, i.e. value of output ($1 million) minus cost of intermediates, the raw materials ($400,000). The other numbers are all irrelevant to the question. Only a disappointing 41% got this right. Value added is always value of output minus the cost of intermediates (i.e. non-factor or 'resource' inputs).

Question: Last year, Mr Jones earned $50,000 in taxable income and paid $5,000 in taxes. This year his taxable income rose to $60,000 and his taxes to $8,000. If the tax structure didn't change, Mr Jones' marginal tax rate on his $10,000 of additional income was

Answer: It even tells you his additional income: $10,000. How much was his additional tax? $8,000 minus $5,000 equals $3,000. Marginal tax rate equals (change in tax)/(change in income) equals $3,000/$10,000 equals 30%. How come only 45% of you got this?

Question: Suppose apple juice and orange juice are substitutes. If an increase in the supply of apples reduces the price of apple juice and a cold spell damages orange groves in Florida, which of the following will necessarily follow in the market for orange juice?

Answer: This is a complicated question: two things are happening, you must figure out what each of them does in the orange juice market.

1) Apple juice price goes down; apple juice is a substitute; so at any given price, people want to buy less orange juice (because now apple juice is cheaper), so demand for OJ is reduced;

2) Damage to the orange groves presumably reduces the supply of OJ.

So both Demand and Supply for OJ is reduced; draw a little diagram: both D and S move to the left,

Answer: "The quantity of OJ sold goes down, while the price of OJ may go either up or down" -- the new intersection of D and S must be to the left of before, but could be either above or below before. 29% of you got it right, but 66% accepted the first alternative, which correctly said the quantity declined, but also said price goes up -- which it does not necessarily, because both supply and demand are reduced.

Question: Which of the following would be least likely to cause the production possibilities curve for material goods to shift outwards?

Answer: "A shift in preferences that causes expansion in the output of one product and a decline in the output of others." 46% of you got this; that response describes a movement from one point to another on a fixed PPC, not a shift in it. All the others described causes of outward shifts -- workers putting in more hours, technical progress making resources more productive, or investment in physical capital.

Question: (I) The height of the supply curve indicates the minimum price necessary to induce producers to supply the quantity specified;

(II) the height of the demand curve indicates the value consumers place on an additional unit of the commodity.

I'm not sure what the problem here was; maybe wording/language, maybe how you visualize or interpret graphs. If anyone can tell me what the problem was, I'd like to know. "Height" of the curve implies 'height above the X-axis, the quantity axis', i.e. price. These two statements are simply particular definitions or interpretations of the supply and demand curve, they are both true. But only 28% got it; 35% thought I was false, 23% both false, 13% II false. This is just definitions/understanding the wording, so I don't understand what went wrong. Let me know.

Question:

Year	1987		1997
	Q	P	Q	P
Video game cartridges	200	$50	200	$75
T-shirts	1000	$10	500	$30
Bubble gum	10000	$0.25	8,000	$0.50

Given the above information, the 1997 consumer price index (using a 1987 base year, i.e. index for 1987 is 100) is approximately

Answer: CPI means [(cost of fixed basket in 1997)/(cost of basket in base year)] times 100. I think a number of people went wrong because they were distracted by the quantities given for 1997 -- you don't need them because you use the fixed 1987 quantities, you are interested in price changes only (not changes in quantities).

So (200x$75 + 1000x$30 + 10000x$0.50)/(200x$50 + 1000x$10 + 10000x$0.25) equals

($15000 + $30000 + $5000)/($10000 + $10000 +$2500) equals

(50000)/(22500) equals about 2.22 times 100 equals 222.

Question: Which of the following would increase GDP?

Answers:

a. Ford begins to produce and sell cars in Japan -- NO, thats in Japan, not produced in USA

b. Mercede-Benz begins to produce and sell cars in Alabama -- YES, Alabama was part of the US last I heard;

c. An American investor buys 100 shares of Ford stock -- NO, that's a financial transaction, nothing was produced.

Only 41% of you got that.

Question: The number of persons wanting tickets to Super Bowl games is invariably greater than the number of tickets (and seats) available. This is evidence that the price of the tickets is

Answer: lower than the competitive equilibrium price. At the competitive equilibrium price, the number wanting to buy exactly equals the number for sale; as price goes down, the number wanting to buy will go up. So if more want to buy than are for sale, the price must be below the equilibrium price. Only 22% got this right; far more said the price was higher than the equilibrium price -- I don't get that, if the price was higher than the equilibrium price, that would mean sellers would be left with unsold goods, the opposite of the situation posited.

Question: Which of the following transactions would be included in GDP but not in GNP?

GDP is domestic, geographically in the US; GNP is national, belonging/accruing to nationals of the US.

Answer: "a citizen of Argentina is paid to work temporarily in a New York theater." The production is in New York, so part of GDP; but the worker is a foreign temporary resident, so the output is not part of US GNP (it would be part of Argentine GNP). 41% got this.

35% of you answered "a German lighting company purchases a computer from a California company." The computer is a US export; it is part of both US GDP and US GNP, it was produced in the US by a US company.

Question: If the amount of gasoline consumed per family is approximately the same at all income levels, then an excise tax on gasoline would

Answer: be a regressive tax. The definition of regressive is that the ratio (tax/income) goes down as income goes up. If all families use same amounts of gas, they pay the same amount of tax on gas; so (gas tax)/income goes down as income goes up because (gas tax) is fixed. Only 24% of you got this right; 67% said "proportional tax." Not proportional to income. The definitions of those jargon words, regressive, progressive, proportional are in terms of tax to income, not tax to tax base or price of the good.