Economics 1
	1st Midterm - MAKEUP
Fall 1996
Instructions:
1.	Answer all sections of this test. This is a 60 minute exam; 50
minutes have been directly allocated to questions; you have 10 minutes for
review.  
2.	Illustrate your answers with carefully labeled diagrams, wherever
appropriate.
3.	Write all answers in the blue books provided. Show all work.
4.	Write your name and your instructor's name in every blue book that
you use.
5.	This exam is given under the rules of Penn's Honor System.
6.	All blue books, blank or filled, must be handed in at the end of
this exam. No blue books may be taken from this room.


Part I (32 minutes)
True/False.  State whether the statement is TRUE, FALSE or PARTLY TRUE. 
Be sure to EXPLAIN your answer.

1. If, at equilibrium, a consumer prefers coffee four times more than he
prefers tea (i.e. the marginal utility from coffee is 4 times more than
the marginal utility from tea), then he buys 4 times more coffee than tea.

2. Suppose an economy produces only guns and roses along a straight line
production possibilities frontier. The opportunity cost of a gun is 5
roses. If the gun technology improves so that the country can now produce
2 guns at the cost of 5 roses, then this country will produce more roses
and more guns.

3. The greater the price elasticity of supply, the greater is the cost of
a government program in which the government sets a price floor and buys
up all the market surplus at that price.

4. According to E. Banks' article, "Fare Rise Hit Buses Harder than
Subways, MTA Says" suggests that the demand for bus trips is more elastic
than the demand for subways.

5. Individuals buy more of a normal good when the price of the good rises.

6. The short run average cost curve can never decline over the entire
range of output if the Law of Diminishing Marginal Product operates over
the entire range of output.

7.  The elasticity of demand at the midpoint of a straight line demand
curve is exactly -1.

8. The Law of Diminishing Marginal utility implies that utility diminishes
when more of a good is consumed.

Part II (10 minutes)
Suppose the demand and supply equations for chocolates is given by:
		QD = 300 - 2P
		QS = 4P
where QD is the quantity of chocolates demanded and QS is the quantity of
chocolates supplied and P is the price of chocolates. 

(i) Find the market equilibrium price of chocolates and the quantity of
chocolates bought and sold.

Now, suppose the government has 2 goals:
A.	To reduce the number of chocolates consumed by the public.
B.	To get involved in the world trade of chocolates so as to
stimulate domestic production and employment. Answer the following
question keeping A and B in mind.

(ii) Suppose the world price is currently $25 per unit. The President has
suggested that this is the right time to jump into world trade.  If you
are a member of the congress how will you vote on this bill, keeping in
mind goals A and B, and why?

(iii) Now suppose that the world price rises to $75. Will participation in
the world market satisfy the two goals A and B:
Will consumption of chocolates decline? If so, by how much? If not, why
not?  Can domestic production and employment be stimulated? Explain



Part III (8 minutes) 

Suppose a utility maximizing consumer spends all her income on goods X and
Y.  Assume X and Y are normal goods.

(i) Using a carefully labeled diagram show the income and substitution
effects of a fall in the price of X on the consumption of Y. 

(ii) In your diagram, are X and Y substitutes, complements or unrelated?
Explain.