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Economics Midterm Review: Sample Questions and Detailed Explanations

Sample Midterm Questions: ECO 20250 - Nagler

1. Inflation Rate and Real Price

  • Concept: Real price refers to the price of a good adjusted for inflation, reflecting its value in terms of a base year's purchasing power. The nominal price is the current price in monetary terms.

  • Objective: Determine the annual inflation rate that would keep the real price of gold unchanged.

  • Formula for Inflation Rate: Given initial price (P0) and final price (P1), the inflation rate (i) is calculated as the percentage change in the nominal price.
    i = \frac{P1 - P0}{P_0} \times 100\%

  • Scenario: The price of gold rose from P0 = \$120 to P1 = \$420.

  • Calculation:
    i = \frac{\$420 - \$120}{\$120} = \frac{\$300}{\$120} = 2.5
    Expressed as a percentage, i = 2.5 \times 100\% = 250\%.

  • Explanation: If the real price of gold is to remain unchanged, it implies that the entire increase in the nominal price of gold is due to inflation. Therefore, the inflation rate must be equal to the percentage increase in the nominal price of gold. A 250\% annual inflation rate would mean that the purchasing power of money decreased by 250\% relative to the base year, exactly offsetting the nominal price increase of gold, leaving its real value constant.

2. Supply and Demand Shifts: College Education

  • Concept: Changes in market equilibrium (price and quantity) are caused by shifts in the supply and/or demand curves.

  • Scenario: From 1970 to 1993, the real price of college education increased, and total enrollment (quantity) increased.

  • Analysis of Market Shifts: To achieve both an increase in price (P) and an increase in quantity (Q):

    • A rightward shift in the demand curve (e.d., due to increased value of education, population growth, higher incomes) leads to an increase in both P and Q.

    • A leftward shift in the supply curve (e.d., due to increased costs, fewer institutions) leads to an increase in P but a decrease in Q.

    • A rightward shift in the supply curve (e.d., due to efficiency gains, more institutions) leads to a decrease in P and an increase in Q.

    • A leftward shift in the demand curve leads to a decrease in both P and Q.

  • Conclusion: To get both an increased price and increased enrollment, a dominant force must be a rightward shift in the demand curve. If there is also a leftward shift in the supply curve, it would reinforce the price increase. The net effect on quantity would depend on the relative magnitudes of the shifts. If the rightward shift in demand is sufficiently large to offset the decrease in quantity from a leftward supply shift, then both price and quantity can increase.

    • Option A: A shift to the left in the supply curve for college education and a shift to the right in the demand curve for college education. This scenario could explain the observed outcome: the demand shift pushes both P and Q up, while the supply shift pushes P up and Q down. If the demand shift is stronger in magnitude for quantity, the net outcome is increased P and increased Q.

3. Price Elasticity of Demand for Q = a - bP with b = 0

  • Concept: Price elasticity of demand (E_d) measures the responsiveness of quantity demanded to a change in price.

  • Formula: The point price elasticity of demand is given by:
    E_d = \frac{dQ}{dP} \times \frac{P}{Q}

  • Given Demand Curve: Q = a - bP

  • Condition: If b = 0, the demand curve becomes Q = a

  • Explanation: When b=0, the quantity demanded (Q) is a constant value (a) regardless of the price (P). This means that a change in price has no effect on the quantity demanded.

  • Calculation: The derivative of Q with respect to P is:
    \frac{dQ}{dP} = \frac{d(a)}{dP} = 0
    Therefore, the price elasticity of demand is:
    E_d = 0 \times \frac{P}{Q} = 0

  • Conclusion: When E_d = 0, demand is completely inelastic. This means consumers will purchase the same quantity irrespective of price changes, often seen with essential goods with no substitutes (though this is a theoretical extreme).

4. Consumer Preferences: Transitivity

  • Concept: Consumer preferences are often modeled using a set of axioms or assumptions that describe rational behavior.

  • Scenario: A consumer prefers market basket A to market basket B (A \succ B), and prefers market basket B to market basket C (B \succ C). The conclusion is that A is preferred to C (A \succ C).

  • Explanation of Assumptions:

    • Transitivity: This axiom states that if a consumer prefers A to B, and B to C, then they must prefer A to C. It implies logical consistency in preferences and prevents circular preferences (e.g., A > B, B > C, but C > A).

    • Completeness: Assumes that a consumer can compare and rank all possible market baskets. For any two baskets A and B, a consumer can state whether they prefer A to B, B to A, or are indifferent between them.

    • **More is Better (or

Based on the provided notes for ECO 20250 - Nagler, here are the key formulas you would need for the exam:

1. Inflation Rate

  • Concept: Used to calculate the percentage change in the nominal price over a period.

  • Formula: i = \frac{P1 - P0}{P_0} \times 100\%

    • Where:

      • i = inflation rate

      • P_0 = initial price

      • P_1 = final price

2. Price Elasticity of Demand (E_d)

  • Concept: Measures the responsiveness of quantity demanded to a change in price.

  • Formula: E_d = \frac{dQ}{dP} \times \frac{P}{Q}

    • Where:

      • E_d = price elasticity of demand

      • \frac{dQ}{dP} = derivative of quantity with respect to price (representing the slope of the demand curve)

      • P = price

      • Q = quantity demanded

These formulas are directly derived from the concepts discussed in the provided midterm sample questions.