Tes OSN 2008
Ujian Mikroekonomi
By : Mr Muhammad Putra Aprullah
Your Results:
The correct answer for each question is indicated by a .
1 General equilibrium analysis seeks to
A) make sure that all beneficial trades among all consumers are made.
B) make sure that the marginal rate of technical substitution of labor for capital is the same in all production processes.
C) make sure that the rate at which society would like to exchange one good for the other is the same as the rate at which society is able to exchange one good for the other.
D) achieve all of the above at once.
Feedback: If all of the above conditions are met, society is producing the perfect mix of goods with the best input combinations and the production is going to its highest final use. That is sometimes called society's bliss point.
8 If the marginal cost of clothing divided by the marginal cost of food is greater than the price of clothing divided by the price of food, then we know that
A) the economy is producing too much clothing and not enough food.
B) the economy is producing too much food and not enough clothing.
C) the economy is off its production possibility curve.
D) firms are producing where the marginal cost of food equals the price of food.
Feedback: The ratio of marginal costs is reduced by producing less clothing and producing more food. When the ratios are equal the right balance of goods has been reached.
9 Which statement is false?
A) Income taxes distort labor supply decisions.
B) A tax on goods produced in competitive markets will offset the underproduction inefficiency of monopoly priced goods.
C) A tax on goods whose production pollutes the air will reduce the overproduction tendency of such goods.
D) Pure public goods will usually be over produced if their provision is left to the private sector.
Feedback: Public goods are underproduced by the private sector because producers are unable to exclude those who won't pay from the benefits of the output.
10 Being on a production contract curve implies that
A) the ratio of the marginal products of the inputs is equal to the ratio of their respective prices.
B) all inputs in the production space are employed.
C) no more production of one commodity can be obtained without giving up some of the alternative commodity.
D) all of the above are true.
E) none of the above are true.
Feedback: Pareto optimality has been reached on the contract curve.
16 INCORRECT In order for the right mix of goods to be produced efficiently in an economy, all of the following except which one must be true for a two person, two-commodity economy.
A) The marginal rate of transformation that exists in the production of two goods must equal the marginal rate of substitution that consumers have between those goods.
B) The ratio of the marginal products of both inputs in the production of each good must equal the ratio of the input prices.
C) The marginal rates of substitution between the two goods must be the same for both consumers
D) The marginal rate of substitution between the two goods for each consumer must be the same as the ratio of the marginal products of the inputs of production.
Feedback: The ratio of the marginal products of inputs relates to their input prices rather than to consumer preferences.
19 Which of the following is not true?
A) Monopolies introduce inefficiencies into a Pareto optimal world because they price above the efficient price giving off the wrong signals for efficient allocation.
B) Negative externalities mess up resource flows because they cause some costs to be significantly overcounted.
C) Taxes improve efficiency if they offset the effects of negative externalities.
D) Public goods tend to be underprovided by the markets.
Feedback: Negative externalities are costs that are not counted at all so an undercounting of costs occurs which leads to too much provision in the effected output.
1 Monopoly differs from perfect competition in that
A) the industry demand curve in perfect competition is horizontal while the demand curve facing a monopolist is downward sloping.
B) The cost structure of a monopolist is higher than the cost structure of a perfectly competitive firm producing the same product.
C) The total revenue function of a perfectly competitive firm is linear and a monopolist's total revenue function increases and then decreases with respect to quantity sold.
D) A monopolist has a specific supply curve and a perfectly competitive firm has no specific supply curve.
Feedback: Only c is a true statement since revenue rises as price falls to the midpoint of the demand curve after which revenue falls for further price reductions. Letter a is wrong because the market demand for a competitive industry is downward sloping. Letter c is wrong because market structure does not impact technological cost conditions. Finally, monopoly has no specific supply curve while competitive firms have a supply curve equal to their marginal cost curve above the shut down point.
2 If the demand curve for the monopolist is P = 100 -20Q, then the marginal revenue of that firm is
A) P = 200 - 20Q
B) P = 50 - 40Q
C) P = 100 - 20Q
D) P = 100 - 40Q
E) Something other than the four options above.
Feedback: the MR is the demand curve with twice the slope.
3 It the demand facing a monopolist is P = 100 - 10Q and marginal cost is constant at 20, then the profit maximizing price and quantity for this monopolist is
A) P = 4 and Q = 60
B) P = 20 and Q = 8
C) P = 90 and Q = 10
D) P = 60 and Q = 4
Feedback: MC = MR or 100 - 20Q = 20 which solves for Q = 4.
4 If the firm described in question three above has fixed cost of 200, what is the profit or loss situation of the firm and what should its strategy be?
A) profit = 40: firm should continue as is in short-run and long-run.
B) Loss = 40; firm should shut down now.
C) Loss = 40: firm should continue operating in the short-run but reassess its long run strategy.
D) None of the above can be certain without more information.
Feedback: TR = 240 and TC = 280, but the loss of 40 is less than the 200 that would be lost if the firm shut down now.
5 A profit maximizing monopoly firm with a demand curve P = 50 - Q is a perfect price discriminator. If it has marginal costs of 10 and fixed cost of 30, it will produce _____ units of output and will make______ profit.
A) 40: 400
B) 40: 800
C) 40: 770
D) 20: 300
E) 20: 600
Feedback: Since marginal cost equals the demand function the quantity is 40. Profit is everything under the demand curve minus the 400 variable cost and 30 fixed cost or 1200 - 430 = 770.
6 From the point of view of consumers as a group, a single price monopolist is preferred to a price discriminating monopolist. A price discriminating monopolist will always make more profit or lose less than if it were a single price monopolist.
A) Both statements are true.
B) The first statement is true and the second is false.
C) The first statement is false and the second is true.
D) Both statements are false.
Feedback: Because the price discriminating monopolist leaves no consumer surplus, the consumers are not as well off as with a single price monopolist. Because the price discriminator takes all the consumer surplus they have more profit.
7 For airlines to effectively price discriminate they must
A) be selling tickets in more than one market and the elasticities in the markets must be different for any given market price.
B) Be sure that the two markets can sell to each other.
C) Have a horizontal marginal cost function.
D) Be sure that all of the above are true.
E) Have both a and b present.
Feedback: Only a is relevant to the issue. Letter b is something that must not be true.
8 Which is an example of the hurdle model of price discrimination?
A) stores that use coupons and mail-in rebates
B) stores that have sale prices that end tomorrow
C) water companies that lower price as larger quantities of water are used.
D) bookstores that give faculty 20% off of the student price
E) All of the above are examples of hurdle price discrimination.
9 The social welfare loss that makes single price monopoly suspect to economists exists because
A) monopolies transfer value to the producer that would normally go to the consumer in perfect competition.
B) the monopolist does not equate marginal cost and marginal revenue.
C) the monopolist stops producing where price is greater than marginal cost so some output that is valued above cost never gets produced.
D) the threat of monopoly power, even if not used, makes people feel helpless.
E) all of the above are true.
Feedback: Letter a is a distribution problem, but it is not a welfare loss problem.
10 Natural monopolies exist because
A) of patent laws.
B) one company controls key inputs into production.
C) of government regulations which privilege one company.
D) economies of scale.
E) of all of the above.
Feedback: Letters a through c create monopolies, but not natural monopolies.
11 Public transportation systems are often regulated monopolies that receive subsidies. The subsidies exist because
A) the regulated price is below ATC.
B) the regulated price allows only normal profit so the subsidy partially offsets the loss of monopoly profit for the firm.
C) the lower fares and the subsidy system is an efficient way to help poor people who need transportation.
D) they result in campaign contributions back to the politicians that provide the subsidies.
E) of all of the above.
Feedback: Without the subsidy no firm would provide the service because they would lose money. Letters b and d are politically not feasible and letter c is certainly not efficient since high income people benefit from the low fares also.
12 The strongest case against the notion that monopoly suppresses innovation is
A) that government regulatory penalties are severe if suppression is discovered.
B) that innovation usually is profitable for monopolists.
C) that it is impossible to keep original research secret in an era of electronic information and corporate espionage.
D) that humans are creative beings who innovate for its own sake and they would not permit their creativity to be stifled in the interest of monopoly profit.
Feedback: Innovation usually lowers costs and increases productivity and profit.
13 Networking in the economy can lead to monopoly market structures because
A) to network effectively a firm must have government regulation protecting the heavy initial investments.
B) the more people using the product, the more valuable the product is to everyone. This means the first firm in the market may dominate the market.
C) networks are another name for backward vertical integrating which leads to control of key inputs.
D) networking arises due to patent rights that a firm secures. These rights become the basis for monopoly control in a market.
Feedback: Classic examples of the networking effect are fax machines that become worth more to everyone when everyone has one. The other answers do lead to monopolies, but are not the basis of the networking story.
14 Of all the factors that lead to monopoly power, according to your text one is by far the most enduring. Which one?
A) controlling supply sources.
B) economies of scale
C) patents
D) government licenses
Feedback: The firm has more control over its technology and cost of production processes than over the other factors and beating the competition with lower costs guarantees market penetration.
15 Which of the following is not true?
A) Perfectly competitive firms have a linear positive sloped total revenue function while monopolies have an increasing and then decreasing total revenue function.
B) Perfectly competitive firms face a horizontal demand curve and monopolies face a downward sloping demand curve.
C) Perfectly competitive firms and monopoly firms both generally have U shaped ATC curves.
D) Both perfectly competitive firms and monopolies control prices by altering their output.
Feedback: Perfectly competitive firms are price takers and can not change the market price of their commodity if they want to stay in business.
16 A monopoly demand curve is P = 500 - 5Q. Without knowing anything about costs, which of the following prices would definitely not be a profit maximizing option for the firm?
A) 400
B) 300
C) 200
D) It is impossible to make a judgment about the prices listed unless something is known about the cost structure.
Feedback: This option is on the inelastic portion of the demand curve so the firm could make more profit by increasing price no matter what the cost structure.
17 If demand is P = 1000 - .5Q, the marginal revenue function for the monopoly firm will be
A) MR = 500 - Q
B) MR = 1000 - 2Q
C) MR = 1000 - Q
D) MR = 1000
Feedback: The intercept will be the same as demand and the slope will be twice that of demand.
19 A monopoly should definitely shut down if its
A) marginal revenue is below its average total cost at all output levels.
B) marginal revenue is below its marginal cost at all output levels.
C) demand curve is below its average variable cost at all output levels.
D) marginal revenue is below its average variable cost at all output levels.
Feedback: This is the same principle that applies to perfect competition since to not cover the variable costs is to be worse of operating than to shut down.
20 A perfectly price discriminating monopolist faces the demand curve P = 50 - 10Q and has a marginal cost which is constant at 10. If it maximizes profit and has fixed costs of 20, how much profit will it make?
A) 30
B) 60
C) 70
D) 17.5
E) 47.5
Feedback: In this case demand = marginal revenue so 10 = 50 - 10Q and Q = 4. The area under the demand curve at a quantity of 4 is 120. From that revenue 40 variable costs are subtracted and 20 fixed costs leaving a profit of 60.
21 Given the demand curve P = 500 - 5Q and a constant marginal cost of 10, if the firm is a single price profit maximizing monopolist, how much deadweight loss to society will result from the monopolists behavior?
A) 2,250
B) 4,500
C) 18,000
D) 9,000
E) None of the above are the correct answer.
Feedback: The output will be 30 and the price 350 for the firm. That leaves the deadweight triangle with a quantity of 30 wide and 150 high. This 4,500 divided by 2 = 2,250.
22 If a firm has significant economies of scale with constantly falling ATC so that producing at lowest costs are possible only if one firm produces in the industry, then
A) the firm can not price at marginal cost and make a profit.
B) a profit maximizing strategy will create substantial deadweight loss to society.
C) social efficiency can only be attained if the firm is subsidized by the public.
D) all of the above are true.
E) none of the above are true because falling costs are good for everyone no matter what the goals of the firm may be.
Feedback: Since marginal cost is everywhere below average total cost it is impossible to produce at a profit and price at marginal cost where social efficiency would be. Only a subsidy can make this industry efficient.
1 A self-employed shoe repairman's business is analyzed by the perfect competition model. His revenue is exactly equal to his average total costs as measured by the economists so he has not made any economic profit, yet he seems to be living on adequate income. How do we account for this set of circumstances?
A) We assume he is living off of past savings or transfer income.
B) We include the opportunity cost of his work as part of the AFC of doing business.
C) We include the opportunity cost of his work as part of the AVC of doing business.
D) We include the opportunity cost of his work as part of the MC of doing business, but we do not count that in the ATC.
Feedback: Since the owner's opportunity cost is part of the ATC of the enterprise, it is appropriate to count it as a variable cost even though it is not labeled as accounting profit by accountants.
2 Which two of the four conditions for perfect competition, are best illustrated by the Iowa corn farmers?
A) standardized product : price taker
B) standardized product: perfect information
C) mobile factors of production: price taker
D) perfect information: mobile factors of production
E) price taker: perfect information
Feedback: One farmer's corn is indistinguishable from another farmer's corn and all farmer take what the market price offers them when they take the corn to the market. While some factors are very mobile and information is relatively low cost, these factors are not as clearly a match as the other two.
3 The market demand for duct tape is P = 100 - 9Q. ten firms supply the tape and each has a marginal cost function MC = 10Q. What is the going price for duct tape that each producer must take as given and what is the total market quantity produced?
A) Q = 5.26 and P = 52.7
B) Q = 10 and P = 10
C) Q = 1 and P = 91
D) None of the above is the correct answer.
Feedback: By summing the ten firms supply horizontally the market supply is MC = Q or P = Q since the profit maximizing position is P = MC. By setting the market supply equal to market demand the answer is letter b.
4 Each firm in problem 3 above will have _________ producer surplus if the demand shifts making equilibrium output equal to 8. Nothing changes on the cost side of the market.
A) 80
B) 28
C) 64
D) 32
Feedback: From the supply curve we find that output of 8 brings a price of 8. Thus producer surplus is 8 times 8 divided by 2.
5 I If the price in a perfectly competitive market is 10, ATC is 11 and there are no fixed costs, then the
A) firm should shut down in the short-run.
B) firm should stay open in the short run but look to change or close in the long-run.
C) Firm should raise its price to at least 11.
D) Firm must seek more information before it can answer questions.
Feedback: Since this firm has no fixed cost its variable costs are above the price so it could save the loss by shutting down which would make costs and revenue zero.
6 Which is false if, in a perfect competition model, a firm is making economic profit?
A) more resources will flow into the industry in the long-run.
B) The firm's marginal cost is higher than its ATC.
C) The firm's ATC will rise until ATC = P.
D) The firm's price will fall in the long run.
Feedback: There is nothing in the scenario that leads to a cost increase, but the economic profits will attract new entrants which will increase supply and bring down price in the long-run.
7 In a perfectly competitive industry at long-run equilibrium
A) all consumer surplus is bid away.
B) All producer surplus is bid away.
C) All economic profit is bid away.
D) All of the above are bid away as efficiency is reached.
Feedback: The best thing of the market story is that the sum of consumer and producer surplus is maximized in the competitive model. Only economic profits are bid away as resources reach their best use.
8 If economic profit becomes significantly positive for a competitive firm because that firm has a uniquely gifted laborer, then
A) that economic profit can last indefinitely.
B) Government regulation rather than competition is needed to curb the excessive profit.
C) The profit will disappear as other firms bid up the price of the gifted laborer.
D) The laborer will feel exploited and will leave the industry after which the economic profit disappears.
Feedback: Economic profits generated by a gifted laborer soon lead to high wages for that laborer. Witness Michael Jordan and other sports and entertainment celebrities.
9 The industry supply curve is P = .5Q. What is the price elasticity of supply in this industry if the quantity of output is 10? (Use absolute values.)
A) elastic
B) inelastic
C) unitary elasticity
D) The elasticity can not be calculated without more information on price.
Feedback: (P/Q)(1/slope) = (5/10)(1/.5) = 1.
10 In a constant cost industry where the long-run supply curve is horizontal and the LAC curve is U-shaped, an increase in demand will, in the long run,
A) increase the size of each firm and decrease the number of firms in the industry.
B) increase the number of firms in the industry but not the size of existing firms.
C) lead to a lower price, larger firms, and more of them.
D) lead to any one of the above because the outcome is indeterminate.
11 The market demand for wedding reception meals is P = 100 - Q. Ten restaurants in town supply the meals and each has a marginal cost function MC = Q. The meals are perfect substitutes for each other. What is the going price for these meals that each restaurant will take as given and what is the total market quantity produced?
A) Q = 50 and P = 50
B) Q = 500 and P = 50
C) Q = 91 and P = 9
D) None of the above is the correct answer.
Feedback: By summing the ten firms supply horizontally the market supply is MC = .1Q. Demand summed horizontally is P = 100 - .1Q. Equating the two gives the answer b.
12 Given a market demand curve P = 480 - 10Q and a market supply curve MC = 2Q, how much producer surplus is generated in the entire market?
A) 1,600
B) 3,200
C) 8,400
D) 11,600
Feedback: Since equilibrium quantity is 40 and price is 80, the producer surplus will be 80 times 40 divided by 2 to get the area above the MC curve and the price.
13 Economic and accounting profit usually differ primarily because
A) the opportunity cost of the owners time is not included as a cost in economic profit.
B) employee labor costs are not counted in the former but are counted in the latter.
C) rental costs of land are valued much higher in accounting profit than they are in economic profit.
D) accounting overestimates capital costs and economic accounting tends to underestimate capital costs.
Feedback: Answers b,c, and d are simply not true while a is definitely true. Thus economic profit is generally smaller than accounting profit.
17 Market supply is the horizontal summation of
A) the average variable cost function of the firms in the market.
B) the average total cost function of the firms in the market.
C) the marginal cost function of the firms in the market.
D) none of the above since it is derived from total market data rather than data from individual firms.
Feedback: Since all firms respond along their MC function the summation of these outputs will be the total market supply.
19 A pecuniary diseconomy refers to
A) inefficiencies that result from constantly changing firm size to keep up with the market pressures.
B) inefficiencies that result from firms being off their profit maximizing output levels because output maximizing is the goal.
C) cost increases that result from supplier price increases as an industry expands.
D) inefficiencies that result because the realities in the real world do not match the assumptions of the ideal perfectly competitive economy.
Feedback: This raises the cost curves of the firm and leads to an upward sloping long run supply curve.
20 Which statement is false of perfectly competitive markets?
A) Innovations do not occur frequently because economic profits cannot be reaped from the effort.
B) If firms have U shaped long-run ATC curves and input prices stay constant, then firms will pass along to the consumer an entire per unit tax that might be levied on the firm.
C) Agricultural price supports tend to bid up the price of land in the long run.
D) The elasticity of supply is infinite in an industry that has a horizontal long-run supply curve.
Feedback: In the short-run profits can be obtained as others try to catch up with the innovation.
1 Present-aim rationality
A) insists that one's aims fit the prevailing social norms.
B) ignores possible motives like altruism, desire for justice and fidelity to principle.
C) takes aims as given exogenously and therefore these aims are not subject to critique.
D) eliminates unusual or bizarre behavior from economic consideration.
Feedback: This means any behavior is logical on its own terms so the theory explains everything and predicts little.
2 If Franny's utility function is U = f(Franny's income and Zooey's income), then
A) the rational self-interest assumption of behavior will not predict Franny's behavior in many cases.
B) altruistic behavior can be explained and predicted.
C) present-aim rationality is the only feasible way to model her behavior.
D) all of the above are true.
E) none of the above are true.
Feedback: With altruism built into the model it is possible to predict how much income Franny will wish to redistribute to Zooey and how much she wishes to keep. The rational self-interest model would predict that Franny will keep it all.
3 Biologists have helped economists see that
A) self preservation, narrowly defined, is the only motive that preserves a species.
B) organism's tastes are arbitrarily given rather than formed in a contest of adaptation.
C) preferences depend on historical and developmental circumstances.
D) all organisms have the same basic strategic preferences.
Feedback: Although biologists show us that tastes are not purely exogenously determined, economists have been slow to expand beyond the narrow rational choice framework. This chapter and the next are exceptions to this generalization.
7 INCORRECT The moral of the story presented in the three questions above is that
A) players who pretend to be team players but are really individualists will get further ahead in the long run.
B) outcomes are the same no matter what the basic nature of people.
C) self centered individualists will always be better off than team players.
D) there is a viable niche for groups with significantly different but sincerely held preferences.
Feedback: People who are known as genuinely team players will reap the gains that come from activities where joint production brings significant benefits.
8 CORRECT The prisoners dilemma problem would result in the prisoners going free if
A) the prisoners were allowed to discuss their situation before being separately questioned.
B) the prisoners would simply tell the truth.
C) the prisoners could develop an effective foolproof commitment device.
D) each prisoner would follow their self-interest assuming their partner would confess.
Feedback: If they could be certain their partner would not confess they would not confess and go free. To be sure of this requires a foolproof commitment device.
9 Irrational behavior or the credible threat of it
A) is bound to detract from an optimal outcome for an individual.
B) increases the possibility of credible commitments among people.
C) can reduce the need to continue the practice of such irrational behavior.
D) is what makes the prisoners dilemma outcome plausible.
Feedback: If someone is know to react irrationally when offended, a possible offender will think twice before running the risk of a disproportionate retaliation. Thus the credible threat of irrational behavior makes that behavior less necessary.
10 The commitment model's functional view of preferences
A) suggests that the economists repertoire of tastes be expanded beyond the simple egoistic tastes.
B) views tastes as means rather than ends.
C) helps constrain the open ended nature of present aim rationality.
D) does all of the above.
Feedback: These three qualities of the commitment model are summarized in the text
11 The text case of Zooey and Franny illustrates that
A) preferences are interdependent in that someone may gain utility by seeing another's welfare increase.
B) present aim rationality and the standard rational choice analysis are incompatible.
C) altruism is irrational.
D) all of the above are true.
E) none of the above are true.
Feedback: Franny's welfare was enhanced when Zooey's income was increased toward a more equal distribution of income. This was shown using the standard optimizing tools of rational choice.
12 In the parable of the hawks and the doves, which statement is true?
A) The hawk's share of the population grows more rapidly when they are few in number.
B) Doves learn over time to be more aggressive so they survive by beating the hawks at their own game.
C) The entire society would be worse off if the hawks all adopted dovish behavior.
D) From the hawks point of view all doves be eliminated and from the doves point of view, all hawks should be eliminated.
E) None of the above is true.
Feedback: The smaller the hawk population in percentage terms, the more likely it is that they will be pared with a dove and get the maximum calories. This will enhance their growth rates due to the high caloric intake.
13 In most cases where cooperation would result in higher payoffs than competing behavior, cooperation fails as a social coordinating principle because
A) competing behavior pays off if only a few engage in it while everyone else is cooperating.
B) the trust required to have everyone cooperate is difficult to generate.
C) there are very few commitment devices that are foolproof.
D) all of the above help explain why competing behavior dominates economic behavior.
E) none of the above explain why cooperation fails as a social coordinating mechanism.
Feedback: This assumes that people are inherently bent to be self-interested rather than cooperative.
Feedback: Being sincere and finding others who genuinely are nonegoistic can help both parties generate the rewards that can be reaped from such behavior.
18 INCORRECT This chapter challenges the prevailing wisdom in NeoClassical economics that
A) people's preferences do not change since only income and prices change.
B) survival depends on one's ability to effectively pursue self-interests.
C) emotions, commitments, and values do not significantly effect behavior.
D) all of the above are true.
Feedback: While few would deny that a,b, and c are integral to life's experiences, economic methodology generally ignores them in formal analysis. Challenging this orthodoxy is one of the attractive features of your text.
1 In 1997-98 hog prices reached almost 50 cents a pound to the farmer. This was very high by normal standards and a farmer in Michigan decided to increase his hog production from 6,000 to 30,000. However, to his dismay, hog prices in 1999 plunged to a low of almost 15 cents a pound. Economists would explain this drop in hog prices by saying that the
A) quantity of hogs supplied increased so the price of hogs fell.
B) supply of hogs increased so the price fell and the quantity demanded of hogs increased.
C) The demand for hogs increased so the quantity supplied of hogs increased.
D) The quantity of hogs demanded increased because the quantity of hogs increased.
Feedback: Since the supply curve of hogs shifted to the right, the price fell as people moved down the market demand curve.
2 If the market demand for Dutch Delftware plates in the United States is P = 140 - 4Q and the Supply of the plates is 3Q the market equilibrium price and quantity respectively will be
A) 60, 20
B) 105, 35
C) 136, 1
D) none of the above is correct.
Feedback: 3Q = 140 - 4Q so 7Q = 140 so Q = 20
3 In question 2 if an import duty of 7 is put on the Dutch plates and is paid by the importer, how much will the plates cost to the consumer what is the quantity of plates now imported?
A) 64, 19
B) 56, 21
C) 0, 0
D) 3, 147
E) none of the above is correct.
Feedback: If 7 is added as an intercept to the supply curve and supply is set equal to demand the quantity of 19 will result.
4 In question 3, How much net welfare is lost to society because of the import duty?
A) $7
B) $3.5
C) 0
D) This question can not be answered from the information given.
Feedback: The triangle under the demand curve and above the supply curve from quantity 20 to quantity 19 is the lost net benefit. That would be (1 x 7)/2.
5 If the price support for tobacco has created excess supply of tobacco, and now a new report about the dangerous health risks of tobacco is published and a drought has hurt tobacco farmers, we can be sure that
A) the amount of excess supply has increased.
B) the amount of excess supply has been reduced.
C) the changed circumstances do not effect the excess supply of a price support.
D) we can not answer the question until we get more specific data.
Feedback: Since both the demand and supply shift left we can not know the change in excess supply until we know the magnitudes of the shifts.
6 A minimum wage law and a rent control price have a similar effect on a market in that they both
A) create excess supply.
B) create excess demand.
C) lead to a below equilibrium prices (wages).
D) Result in less than equilibrium quantities in their respective markets.
Feedback: Minimum wage laws create higher than equilibrium wage and lower quantities while a rent control law creates lower than equilibrium prices and lower output of rental units.
7 When government intervenes into a market situation to make adjustments in price and quantity it would be fair to assume that
A) everyone is made worse off since there is a loss in net welfare.
B) Some are made better off and some are made worse off, but the gainer's gains outweigh the loser's loses.
C) Some are made better off and some are made worse off, but the loser's loses outweigh the gainers gains.
D) Everyone is made better off if the government's decision is a democratic one.
Feedback: If there is a net welfare loss from a disequilibrium price, Then the losers must be losing more than the gainer's are gaining.
8 If hotdogs are inferior goods, community incomes are rising, hamburger prices are falling, and hot dog casings (the synthetic skin around the hotdog) must now undergo a careful sterilization process not required before, we can conclude that
A) the quantity of hotdogs consumed will go down and the price change is indeterminate.
B) The quantity of hotdogs consumed will go down and the price of hotdogs will rise.
C) The price of hotdogs will rise and the quantity consumed will rise also.
D) Both the price of hot dogs and the quantity of hotdogs consumed will decrease.
E) The price of hotdogs will go up and the quantity consumed is indeterminate.
Feedback: The first three variables shift demand left and the last one shifts supply left. Since the magnitude of the shifts is not known the price change can not be known.
9 Which statement is always true according to correct economic terminology assuming all else stays constant but the stated change?
A) a shift to the right of the demand curve increases the supply of a good.
B) A shift to the left of the supply curve decreases demand for a good.
C) A shift to the right of the supply curve increases the quantity supplied of the good.
D) A shift to the left of the demand curve decreases the quantity supplied of a good.
Feedback: A shift in one curve moves the market along the other curve. Movements along a curve are called changes in quantity supplied or demanded. Thus a shift in demand involves a change in quantity supplied of the good.
10 If the demand curve is P = 20 - Q and the supply curve is P = 5 + 2Q, then a $1 per unit tax imposed on the buyer at the point of sale would do which of the following?
A) Change the demand curve to P = 19 - Q.
B) Change the supply curve to P = 6 + 2Q.
C) Change the demand curve to P = 21 - Q.
D) Change the supply curve to P = 7 + Q.
E) Change the supply curve to P = 5 + 3Q.
Feedback: A per unit tax on the buyer shifts the effective demand curve to the left in a parallel fashion.
11 In a first-come-first-serve system of allocation system with prices held artificially low, supply and demand pressures are not negated because
A) people still pay the dollar value of market equilibrium price.
B) people still buy the same amount of goods as a price system provides.
C) people still pay full price according to their demand schedule by spending in money and in waiting time.
D) all of the above are true.
Feedback: Since time spent in waiting lines helps to determine what people really give up to get the goods, both the time value and the money spent will be the price paid for the limited supply of the good. The pressures of supply and demand can not be avoided.
12 The law of demand refers to the idea that people
A) buy more of a good as their income increases.
B) buy more of a good as the price of the good falls.
C) will spend all of their money on something.
D) want more of everything even if they have no money to buy anything.
Feedback: The law of demand relates specifically to the fact that the demand curve slopes downward because people buy more of a good as its price falls. While the other answers may be true statements they do not relate to the law of demand.
13 The law of supply implies that
A) the supply curve slopes upwar
B) firms are enticed to supply more output if the price is higher
C) costs of providing goods and services rise as more output is generated.
D) all of the above are true.
Feedback: Each of the above answers reinforces the others to define the law of supply.
14 Which statement is true of a typical market supply and demand situation?
A) At equilibrium supply equals demand and the quantity supplied equals the quantity demanded.
B) At a price lower than the equilibrium price, demand has increased from where it was at equilibrium.
C) At a price higher than equilibrium more goods are sold because firms find it profitable to produce more.
D) All of the above statements are true for a market situation.
Feedback: Only (a) is true because in (b) only the quantity demand has increased and in (c) the firm cannot sell more goods than the quantity demanded even though it would produce more creating a surplus.
15 If a Big Mac sells for $3.95 and that price is a market equilibrium price, which of the following statements will be true if the mad cow disease now hits the beef market?
A) The demand for Big Macs will decrease and the quantity supplied of Big Macs will decrease.
B) The quantity demanded of Big Macs will decrease and the supply of Big Macs will decrease.
C) The supply of Big Macs will increase lowering the price and causing the quantity demanded of Big Macs to rise.
D) The supply of Big Macs will shift left and the price of Big Macs will rise significantly.
Feedback: Since the first effect is to reduce consumer demand by shifting the demand left, it follows that price will fall so that the quantity supplied along the supply curve will be reduced.
16 If pizza prices fall and Big Macs and pizza are substitutes, then
A) the quantity demanded of Big Macs will fall and the supply of Big Macs will shift left.
B) the demand for Big Macs will shift left and the quantity supplied will fall.
C) the demand for Big Macs will shift right and the quantity supplied will increase.
D) the quantity demanded of Big Macs will fall and the supply of Big Macs will shift right.
E) none of the above are correct because economists assume that there is no interdependence among goods as relative prices change.
Feedback: Since the products are substitutes, the demand curve for Big Macs will shift left, but the supply curve is unaffected. Therefore the quantity supplied moves down the supply curve to a new equilibrium at a lower price with less bought in the market.
17 In the early 1970s oil prices quadrupled in one year. In an article in the US News, Milton Friedman predicted that the prices would crash in the not too distant future. He based his prediction on the fact that
A) the demand curve had been artificially shifted right and would have to shift left again.
B) the supply curve had been artificially shifted left so that it overestimated the cost of supplying oil.
C) the OPEC cartel that supplied most of the oil would have compassion on the consumers and soon lower the price.
D) political pressure would force oil producers to lower prices soon.
Feedback: Friedman assumed that producers would exercise their self-interest, which would be to increase output first hoping to make big profits before the prices fell. When all act in this manner the supply shifts back right to its true level.
18 If the market demand for bikes in the United States is P = 200 - 2Q and the Supply of the bikes is 2Q the market equilibrium quantity and price respectively will be
A) 50, 100
B) 192, 4
C) 100, 50
D) none of the above is correct.
Feedback: 2Q = 200 - 2Q so 4Q = 200 so Q = 50 and P will then be 200 - 100 = 100.
19 In question 18, if the bikes are imported and an import duty of 20 is put on the bikes, what is the quantity of bikes now imported and how much will the bikes cost to the consumer?
A) 50, 110
B) 45, 100
C) 50, 120
D) 45, 110
Feedback: The supply equation now becomes P = 20 + 2Q which is set equal to the demand curve and then solved for Q and P.
20 When a price support is set on agricultural goods to help the farmers, which of the following is bound to happen?
A) A shortage develops because the government action is a signal that farmers should leave the industry.
B) The supply curve shifts right as farmers produce more because of the higher price.
C) The demand curve shifts left as consumers respond to the higher price.
D) A surplus develops as consumers consume less and producers producer more.
E) All but a above are correct.
F) Since the change in the market is price related there are no shifts of the curves. Rather the consumers and producers move along their curves to the new price level.
21 Which of the following shifts the supply curve in the opposite direction from the other three?
A) technological improvements
B) lower interest rates
C) an increase in the number of firms producing
D) an expectation of higher prices
E) All of the above shift the supply curve in the same direction.
1 If Fred plays tennis every day, but tells his wife he would rather be working longer hours at his job, economists would say which of the following about his behavior, assuming that his work hours are totally up to him.
A) Fred has a preference for tennis over work at the times he plays tennis.
B) Fred prefers to work rather than to play more tennis since that is what he tells his wife. Economists are not about to question a person's motives.
C) Fred is irrational because he is not doing what he says he wants to do.
D) There is no way to model the behavior of someone who claims one thing and does another.
Feedback: Correct! Economists are inclined to observe behavior rather than statements about behavior. Future behavior is more easily predicted by past behavior than by good intentions and pleasing statements.
2 A fairy offers you and you alone a million free wishes that will all come true. Being a good student of economic methods you know that you
A) are no longer living in a world of scarcity and economic principles will not apply to you any more.
B) are faced with a serious economic problem of scarcity because you don't have time to absorb the benefits of a million wishes.
C) feel unfulfilled since humans can not be fulfilled unless they strive and compete for pleasure.
D) feel quilty because your happiness will fall if you have advantages that others do not have
Feedback: Correct! Economists generally model behavior assuming that peoples preferences are not interdependent and that more is preferred to less. But if time is limited, than a critical resource is scarce and a distinct feeling of shortage will exist.
4 INCORRECT Economists believe that human behavior follows economic principles to some extent because
A) people are intelligent and study the principles until it becomes natural for them to act according to the principles.
B) the principles are merely a reflection of what people are naturally inclined to do.
C) People muddle through life learning from their mistakes and finally end up doing what economic theory predicts they will do.
D) Emotions, social norms, and values are all based on rational choice concepts.
Feedback: Incorrect: According to the text, Milton Friedman believes that "by trial and error we eventually absorb theses rules just as pool players absorb the laws of physics." Answer b may seem correct to some, but it is natural to forget implicit costs and be influenced by sunk cost even though this behavior is bad economics.
5 Phil is considering whether to buy a townhouse or rent one. If he puts 20% down his monthly payment on the 80% loan will be $500. The rental charge is $600 for a similar place. He decides he should buy because $500 is less than $600. Which of the following is true? Assume no tax complications are involved.
A) He definitely made a wise choice since his reasoning is sound..
B) He definitely made a bad choice because the 20% down payment amount must be added to the $500 as a cost.
C) He may have made a wrong decision because he must add to the $500 the lost interest he experiences by taking his down payment out of the bank.
D) None of the above statements are true.
Feedback: Incorrect: The lost interest is a clear opportunity cost which is called an implicit cost of buying the house even though it is not a cost for which Phil must write a check.
6 On a recent golfing outing our foursome paid for the 18 hole greens fees. On the fifth hole it started to rain, but we still managed to enjoy the game. By the twelfth hole it was pouring and we were sloshing around complaining how nice it would be to be dry in the clubhouse. Unfortunately the golf management would not refund us for unplayed holes so we kept beating the ball through the mud to "get our money's worth." An observant economist would say we were
A) inaccurately measuring our benefits.
B) inaccurately measuring our costs.
C) ignoring all costs and benefits.
D) exercising good economic judgement since no refunds were available.
Feedback: Incorrect: Since we would have rather been in the clubhouse and the greens fees were a sunk cost, we were lowering our pleasure level by continuing the game.
7 Which kind of behavior would best represent rational behavior only under the present aim standards of rationality?
A) Doing a half-hour of exercise a day instead of working for pay that half-hour.
B) Working overtime every day for double pay.
C) Committing suicide if life becomes oppressive.
D) Quitting work to go on welfare when welfare benefits exceed after tax earnings potential.
Feedback: Incorrect: The other answers describe things that fulfill objectives common to most people faced with similar situations. However, while suicides do happen, they are not the strategy common to most who are having hard times in life.
8 If external costs are significant in a production process it is likely that
A) The output of the production process will be greater than it should be for efficiency.
B) The output of the production process will be less than it should be for efficiency.
C) The output of the production process will not deviate from the efficient output even if the external costs persist.
D) The costs will be automatically eliminated by the market forces that push toward efficiency.
Feedback: Correct! Since these costs should be included in the supply curve of production and are not, the supply is too far to the right and output is too large for efficiency.
9 Which is true of homo economicus?
A) He is inclined to ignore any social cost of his behavior that he is not required to consider.
B) He is not driven by social norms, emotions, or values other than self-interest.
C) He tends to avoid being actively involved in community volunteer projects.
D) All of the above are true of homo economicus.
E) None of the above are true or homo economicus.
Feedback: Incorrect: The descriptions listed would take away from his search to fulfill himself .
10 Which statement is a normative statement?
A) Manual transmissions have four speeds and automatic transmissions have five speeds.
B) Paper towels should be used in all restrooms instead of hot air dryers.
C) Airline food is worse than restaurant food.
D) All computers now have at least 64 Megabytes of RAM.
E) None of the above are normative. They all are positive statements.
Feedback: Incorrect: Whenever the word should is used a value judgement rather than a declarative statement is being made.
11 You should definitely attend class today. This statement
A) is true if the professor takes points off your grade if you are not there.
B) is true if you will get a lower score on the next exam if you miss the class.
C) is true if your being in class will contribute to the discussion and help many other students.
D) is true for all of the above statements.
E) cannot be answered without more information.
Feedback: Incorrect: While each of the other answers is a valid reason why one may want to attend class, the decision can only be made with full information regarding the cost to you of getting to the class compared with the benefits that are listed in options a-c.
12 Economic theory claims to
A) describe human actions in as realistic a manner as possible.
B) have tools which predict normal and abnormal behavior.
C) be as accurate as the physical sciences in its predictions.
D) arrive at the best available predictions by assuming that people merely act as if they constantly calculated costs and benefits of all actions.
E) do all of the above.
Feedback: Correct! Economics is very pragmatic in its modeling. If a model works, it doesn't matter how realistic the assumptions are. If people end up doing what is in their interest even if their motives were very altruistic, then a self-interest model will work despite the fact that self interest was not actually pursued.
13 Our choir is recording a CD on the day I was offered $500 for doing a simple task that would have been as much fun as recording. If I fulfill my obligation to the choir it is correct to say that
A) the $500 is an implicit cost of singing that day.
B) the $500 is a sunk cost since I will never see it if I sing that day.
C) the $500 is no cost at all since I do not have to pay anything to sing.
D) I should definitely not sing because I get no money for singing.
Feedback: Incorrect: The $500 is certainly an opportunity cost of singing, but since I do not have to pay it from my cash flow it is an implicit cost.
14 Which statement is always true?
A) Implicit costs are always sunk costs.
B) Sunk costs are always implicit costs.
C) Sunk costs do not enter into the cost-benefit analysis of a given decision.
D) All of the above are correct statements.
Feedback: Incorrect: Implicit costs are usually not sunk since they often can be avoided at the decision point. Sunk costs are usually explicit and, since they can not be recovered, they are absorbed no matter what decision is made. Thus they do not enter into the cost-benefit analysis.
15 When I go golfing I sometimes complain that it is an expensive sport. If I am deciding if I can afford to go tomorrow, which of the following costs should I consider?
A) a portion of the club's annual membership fee.
B) the greens fee, the value of the balls I hit in the water, and the wear and tear on my shoes and equipment.
C) the average cost per mile of the car trip to the golf course.
D) All of the above.
Feedback: Incorrect: The first answer is a sunk cost which is paid whether I golf or not. The third answer includes some sunk costs of car ownership. I should include in addition to the items listed in b) the opportunity cost of my time for spending the morning away from other pursuits.
16 Which activity has little, if any, external cost?
A) Driving to work in rush hour traffic.
B) Taking a nap in your bed.
C) Cheering for the Phillies in the Cubs ballpark.
D) All of the above have external costs.
E) None of the above are a good answer.
Feedback: Incorrect: The first and third activities impact others around you while b) effects no one but yourself unless you snore loudly and there are others nearby.
17 Homo Economicus, as a model of behavior
A) would be a good guide for people to follow in their relationships with others.
B) focuses on personal material costs and benefits rather than other more social values.
C) is built on trust of others which is why it works in a free society where trust is important.
D) Includes many motives for behavior that are not usually part of economic thinking.
Feedback: This answer is correct because it involves the most narrowly defined self-interest concept which is what the Homo Economicus model relates to.
18 Which of the following is least likely to interest a pure rational choice economists?
A) Why do men's public rest rooms have urinals, but almost no one has them at home?
B) Why is there a perpetual traffic jam around the south edge of Lake Michigan when traveling on Route 80.
C) Should governments allow charities to avoid property taxes when the state is running large budget defiicits?
D) Is the high tax rate a detriment to capital investment?
Feedback: This answer is the only one that uses the value judgement statement "should" which makes the issue one of normative content rather than one of positive import.
19 Your text claims that
A) microeconomists are better at predicting behavior than macroeconomists are at predicting economy wide variables.
B) macroeconomics has increasingly related to microeconomic foundations in its analysis.
C) the distinction between macro and micro economics has become less clear in recent years.
D) all of the above are true.
1. The interstate toll roads are collective goods rather than public goods because
A) they are subsidized by general tax revenue.
B) They are limited access excluding those who won't pay.
C) Many people can use the same road repeatedly
D) Not everyone in the population drives.
Feedback: Non diminishability generally applies to roads (although we all wonder sometimes) but people can be excluded so the non-excludability principle of public goods does not apply.
2. The demand curve for a public good
A) is the horizontal summation of the demand curves of all citizens.
B) Shows how much people desire a public good whether or not they are willing to pay for it.
C) Is the vertical summation of each citizen's willingness to pay for the good or service.
D) Can be empirically determined by observing voting patterns.
Feedback: Since joint consumption applies the effective demand must be summed vertically
3. Two citizens, the only citizens in the community, have identical willingness to pay curves for a public good. That demand is P = 20 - 2Q. If the marginal cost of providing the public good is 20, how much of the good should the public provide?
A) 0
B) 5
C) 10
D) 20
Feedback: The vertical summation is P = 40 - 4Q and when set equal to 20 results in a Q of 5.
4 . In a suburban town the city council contracted with the local paper to have the police throw out the morning papers while they do their routine patrol. The patrolman get paid some more, but the city budget keeps the transportation portion of the paper delivery. This reduced the cost of providing the police protection. It is an example of
A) Using club theory to provide the public good of police protection.
B) Relying on charity to provide a public good.
C) Taxing the paper readers.
D) Selling a by-product of a public good.
Feedback: The by-product of police protection is the police car roaming the streets in the early morning hours. To use that as a method for funding a public service is creative finance.
5 . Your student government has three possible projects to emphasize. One third of the students want 1) more movies 2) longer library hours and 3) more parking in that order. Another third of the student body want 1) more parking 2) more movies and 3) longer library hours in that order. Finally the last third of the student body want 1) longer library hours 2) more parking and 3) more movies in that order. You want longer library hours and you will set up the vote. First two issues will be voted on and then the winner will be pitted against the third issue. How will you structure the vote?
A) First movies and parking will be voted on and then the winner of that will face the library issue.
B) First movies and library will be voted on and then the winner of that will face the parking issue.
C) First library and parking will be voted on and then the winner of that will face the movie issue.
D) It doesn't matter because library will lose no matter what.
Feedback: All other possibilities will have library losing. This illustrates the way in which agenda can be manipulated toward desirable ends.
6 . Majority voting would be more efficient if
A) voters could buy and sell their votes on an open market..
B) Voters would honestly vote on an intensity scale of -5 to +5.
C) Both a and b were possible.
D) Neither a or b were possible because majority voting is efficient already.
Feedback: Both a and b would deal with the problem that majority voting does not get at the intensity of feeling. Therefore majority voting falls short of the standards of cost-benefit analysis which look at intensity like a demand curve does in a product market.
7. The Tiebout model of public goods
A) works best for people already located in a town rather than at the time when they are exploring a move.
B) is problematic empirically because there is very little variation in public goods provided by communities in a given region.
C) relates more to migration between countries than it does to intra-country location decisions.
D) is described or critiqued effectively by none of the above.
Feedback: In fact the model works best before roots are established in a community. It works because there is considerable variation among communities and the model is not designed for inter country migrations.
8. Two firms are seeking a special exporting license that will give them a $1 million economic profit. Only one will get the license. It is likely that
A) they will dissipate the expected profit by competing with each other in a lobbying frenzy for the license.
B) they will collude to share the profits of these favors over time.
C) the government will redo the license agreement if they suspect that economic profits are being made.
D) the firms will recognize the futility of rent seeking and simply hope that they will be awarded the license on the merits of their operation.
Feedback: The risks of collusion and the theory of public choice would lead to letter a even though we might wish for c.
9. Students are told to pick their grade out of a hat that has a grade distribution of 5 A, 10 B, 15 C, 10 D, and 5 F. They can change the distribution if they like but they can not change the overall class grade point average. Following John Rawls' "veil of ignorance" predictions, they invariably
A) choose to leave the distribution as it is.
B) choose to eliminate the F and A grades and sometimes even the B and D grades so everyone gets a C.
C) choose to increase the A grades and the F grades hoping to increase their chances of an A.
D) toss a coin to decide what to do because they are indifferent between any of the above listed options.
Feedback: Rawls theory of income distribution, rather than grade distribution, states that people choose to eliminate the extremes because they are risk averse and prefer an egalitarian social order to one where they might be on the bottom of a widely dispersed income distribution pattern. If they do this behind a "veil of ignorance" this thinking should be what determines justice in the system.
10 The "veil of ignorance" referred to in question 18-8 leads to qualifications of marginal productivity theory. The main policy conclusion of this Rawlsian thinking is that
A) society should socialize its citizens in ways that will teach them to work for non-material rewards.
B) public goods should be provided in greater quantity to all citizens.
C) additional inequality will only be justified if it has the effect of raising everyone's income.
D) there should be an upper limit on income beyond which a 100% tax rate would apply.
Feedback: If everyone is getting more income the distribution dispersion is not as offensive.
11 Which of the following is the least likely to be provided by the government?
A) mosquito control
B) anti terrorist intelligence
C) baseball stadiums
D) July 4th parades down Main Street.
Feedback: Both (a) and (b) clearly have non-exclusion and non-rivalry properties. On option (d) those properties apply at least partially. Except for some tourist type externalities, stadiums exclude non-payers and when they are full rivalry applies.
14 CORRECT If both Karen and Pete are taxed 0w for each unit of Q and a unanimous vote is required to pass a public provision bill, how much will be provided?
A) 0
B) 0a
C) 0c
D) 0
Feedback: After 0a Karen votes no since her benefit is below 0w at quantities higher than 0a.
17 In any majority voting system,
A) extremists have the vote go their way.
B) Efficient outcomes are the rule.
C) The outcome is guaranteed to be close.
D) The median voter always determines the outcome.
Feedback: If half the voters are with the median voter and half are not, the median voter casts the deciding vote that puts his preference over 50%.
18 If I prefer three dips of ice cream, would take two dips as my second choice, or finally settle for one dip if all else fails, it is true that I have
A) double peaked preferences.
B) Single peaked preferences.
C) zero peaked preferences
D) Median voter tendencies.
Feedback: My preferences are all in a descending order of ice cream dips.
19 If I want the sun to shine today for golfing, would be most upset if a steady drizzle happened, and would prefer heavy rains to the drizzle, it is true that I have
A) double peaked preferences.
B) single peaked preferences.
C) zero peaked preferences
D) Median voter tendencies.
Feedback: I prefer the extremes to the middle position. This can lead to voting outcomes that are dependent on how the issues are posed in the voting process.
20 Which is a practical reason for favoring redistribution of income from the rich to the poor by the government?
A) Rich people benefit more from public goods like defense because they have more to protect.
B) Low incomes lead to discouragement, frustration and sometimes violence.
C) People will accept lower social positions in society if they get more income than those lowly positions might pay. When upper class people transfer income to the lower class, social stability is more likely and the rich can retain their social standing.
D) Rich people value their last dollar much less than poor people do so a shift of one dollar from the rich to the poor brings more gain than loss and therefore enhances overall welfare in the system.
E) All of the above make sense as reason for some form of income redistribution in a society.
Feedback: The four items given are somewhat self evident and they form the basic logic for public transfers designed to redistribute income. Perhaps compassion, a desire for fairness, and recognition of human value would be better reasons for redistribution but such virtues are scarce and hard to coordinate.
1. A firm will employ real capital to the point where
A) the return on the capital is equal to the rental rate at which the firm could rent the capital.
B) the return on the capital is equal to the interest rate at which the firm can borrow money.
C) the marginal revenue product equals the purchase price of the capital.
D) the rental rate equals the market interest rate.
Feedback: The rental rate includes all the opportunity costs of employing the capital and so becomes the standard against which the return should be compared.
2 If the price of a machine is $100, annual maintenance on the machine is $15, the machine's useful life is five years, there is no technological change in this area, and the market interest rate is 10%, how much will it cost to rent this machine?
A) $10/year
B) $15/year
C) $30/year
D) $45/year
Feedback: The costs that must be covered are 15 maintenance + 20 depreciation + 10 to cover the opportunity cost of lost interest. This adds up to 45.
3 If the scrap value of a $1000 machine you intend to buy will be $100 in two years, what will you do with that information as you decide whether or not to buy today?
A) subtract $100 form the present cost.
B) Add approximately $91 to the cost of the machine.
C) Subtract approximately $91 from the cost of the machine.
D) Subtract approximately $82.6 from the cost.
Feedback: The $100 discounted over two years means that the present value of that scrap value is $82.6.
4 A firm buys a $1000 machine that earns $600/year in profit for two years after which it collapses in a worthless heap. No maintenance costs or technology change exists for this machine. If the interest rate is 12% the firm made
A) good decision to buy.
B) Bad decision to buy.
C) Neither a good nor a bad decision to buy since it breaks even in the deal.
D) Decision that we can not judge without more information.
5 The decision to buy earns a present value of $1014 in revenue and costs only $1000.
A) The decision to buy earns a present value of $1014 in revenue and costs only $1000.
B) The decision to buy earns a present value of $1014 in revenue and costs only $1000.
C) The decision to buy earns a present value of $1014 in revenue and costs only $1000.
6 Which statement is false?
A) If a firm has 5 machines but wishes it had 6, then the value of one machine would be the firm's demand for loanable funds.
B) Consumer's desire to borrow for a house is part of the demand for loanable funds.
C) Government borrowing does not constitute a demand for loanable funds since loanable funds markets include only private money flows.
D) Corporate retained earnings, consumer savings and foreign money seeking US safety and high rates of return are all part of the supply of loanable funds.
Feedback: Government borrowing is a demand for the limited amount of loanable funds.
7 Which of the following questions is the least worthwhile question to ask of your broker?
A) Given my tax circumstance, should I consider municipal bonds or stock for my new investments?
B) Which blue chip stocks would be the best buy for me now?
C) I am taking my retirement money in a lump some and want to have income as well as growth of my assets. Which mutual funds offer the balance that I need?
D) I need to reduce the risk in my investment portfolio, How should I do that?
Feedback: Choosing from among a class of stocks can be done by throwing darts at the daily stock quotations if the financial markets are highly efficient. The other questions deal with matching your investing preferences with the various kinds of instruments available.
8 A municipal tax-free bon
A) is less attractive to a poor person than to a rich person.
B) complicates the simple theory of efficient market allocation of investments because everyone has a different tax situation.
C) falls in value when the interest rate falls.
D) has a higher rate of interest than a treasury bill.
10 Economic rent is the same as what concept we have used many times earlier in the course?
A) producer surplus
B) consumer surplus
C) economic profit
D) value of the marginal product.
Feedback: The amount of payment above what is needed for a factor owner to supply the good or service.
11 The rental rate of capital includes
A) a charge for maintenance of real capital.
B) the opportunity cost of money needed to buy real capital.
C) a charge for technological obsolescence.
D) all of the above.
E) a and b but not c.
Feedback: The text uses the formula r = I + m + ( for a, b, and c respectively.
12 In the discounting of future dollars to arrive at the present value of a machine the present value will go down if
A) the interest rate falls.
B) the revenue stream is realized earlier than expected.
C) maintenance costs in the earlier periods are reduced and they are increased by the same amount in a later period.
D) the scrap value is decreased.
Feedback: Since scrap value is not moved over time the discounting variables do not apply. A future value is simply reduced so the present value of the machine declines.
13 If you are holding a bond it is to your advantage if
A) the market interest rate rises.
B) the market interest rate falls.
C) inflation increases.
D) the demand for stocks goes up and the demand for bonds goes down.
Feedback: If the interest rate falls people will be willing to pay more for your bond because it has a higher income stream that any newly issued bond at a lower interest rate.
14 The theory for capital markets and labor markets is similar except that
A) capital by its nature is long run in character while labor can be easily varied in the short run.
B) the time dimension and discounting is important for capital and not for labor.
C) capital depreciates but labor improves with experience.
D) capital expenditures are sunk costs and labor costs are not sunk costs.
E) all of the above are differences in the character of the two inputs.
Feedback: While each is employed to the point where marginal cost equals marginal benefit, capital is different from labor in the areas mentioned above.
15 Consumers supply savings to the loanable funds market if
A) the interest rate rises and the substitution effect that encourages savings outweighs an income effect that sometimes works in the opposite direction.
B) the interest rate rises and the substitution effect that discourages saving is offset by the income effect which encourages savings.
C) the interest rate falls and the substitution effect that encourages savings is not offset by an income effect that discourages savings.
D) both a and c occur.
Feedback: In b and c the substitution effect is going in the opposite direction from reality.
16 Because it seems that capital markets are highly efficient,
A) any stock purchased will have the same expected rate of return.
B) one company that is twice as productive as another company will have a stock price only half as high as the less productive company.
C) investment newsletters are necessary for any novice tying to invest.
D) better managed companies have much higher rates of return to the investor.
Feedback: Assuming good accessible information, the markets will equalize returns on alternative investments and any newsletter will be outdated before it reaches its readers.
17 Which statement is true about tax policy and the capital market?
A) Returns from municipal bonds are taxed more heavily than corporate bonds making it more difficult for local governments to raise funds.
B) Depreciation allowances lower taxes because they reduce the stated profits of firms.
C) Capital gains are taxed at higher rates than wage income. This lowers the effective rate of return on capital.
D) All of the above are true.
E) None of the above are true.
Feedback: The opposites of a and c are true.
18 Suppose that the market for machines is defined by the demand curve P = 10 - Q and the supply curve is P = 2 + Q. How much economic rent is being transferred in the market?
A) 24
B) 16
C) 50
D) 18
E) 8
Feedback: The market equilibrium is Q = 4 and P = 6. Since the supply intercept is at two, the economic rent is 4 times 4 divided by 2 or 8.
19 If the supply curve in question 16 above were vertical at a quantity of 4, how much economic rent would exist in the market?
A) 24
B) 16
C) 50
D) 18
E) 32
Feedback: The price would be 6 and the quantity 4 and the machines would have been provided even if they received no return. Therefore the entire 4 times 6 revenue is economic rent.
1. If the total product of labor per day is as shown in the chart below and the price of the product is $10/unit, how many employees will be hired if the wage rate is $99/day?Labor 1 2 3 4 5
Total output 10 25 35 40 41
A) 1
B) 2
C) 3
D) 4
E) 5
Feedback: The marginal product of 10 times the $10 price of the product means the 3rd worker brings in $100 for the employer and cost him only $99. The 4th worker would bring in less than $99.
2 Given the information in question 1, what is the value of the marginal product (VMPL) of the 5th worker?
A) 5
B) 10
C) 50
D) 100
E) 150
Feedback: The marginal product is one and the price is $10 for a VMPL of 10.
3 If the going wage in a small community falls and a firm in that community is selling its product in the national market, that firm moves down its VMPL curve and hires more workers. If the wages fall across the entire country for all firms, then the VMPL curve for labor
A) does not shift either
B) shifts right as workers work overtime to make up for lost wages.
C) Shifts left as more labor and increased output cause product prices to fall.
D) Shifts right because employees seek more labor at the lower wage rate.
Feedback: If all firms hire more and product supply shifts right, then product price falls and the VMPL is less at all employment levels.
6 The marginal factor cost of the third laborer is _____ if the labor supply curve has the following wage-quantity coordinates.Quantity of Labor Supplied: 1 2 3 4
Reservation Wage Rate 5 10 15 20
A) 15
B) 20
C) 25
D) 30
8 Which statement is true?
A) If Ingrid has a target level of income she seeks to maintain, she will have a backward bending labor supply curve.
B) If leisure is an inferior good to Ingrid she will not have a backward bending labor supply curve.
C) It is more likely that Ingrid would have a backward bending supply of labor curve than it is likely that the entire labor market would have a backward bending labor supply curve.
D) All of the above are true.
E) None of the above are true.
Feedback: Letter a is correct because a rising wage will increase income unless one works less. Letter b is correct because if leisure is an inferior good the income effect of a wage increase will decrease the desire for leisure and make the Ingrid offer more labor at the higher wage. Letter c is correct because at the market level new entrants into the labor force make it harder for the market labor supply to have a backward bend.
9 A minimum wage set above market equilibrium could lead to more workers being hired at the higher wage if
A) the product produced is sold in a perfectly competitive market.
B) The employer is a monopsonist.
C) The supply of labor curve is backward bending at high wage levels.
D) The supply of labor curve is horizontal.
Feedback: A minimum wage makes the labor supply curve horizontal at the minimum wage level up to the point where the supply curve rises above the minimum wage. Consequently the marginal factor cost is not above the wage in this range and therefore more labor will be hired. The only labor market circumstance where the marginal factor cost exceeds the wage is in the monopsony market form.
10 In the VMPL measurement the MPL and the price of the output are key determinants of the wage rate. Frank suggests that the puzzling "winner take all" phenomenon may still fit marginal productivity theory if
A) one realizes that MPL measurements are vastly underestimated for a few stars.
B) the public's fascination with being first dramatically raises the price of what the winner is selling.
C) the unseen earnings of less heralded second place performers are fully known.
D) perfect competition was present in the labor markets where superstars perform.
Feedback: When Michael Jordan was playing, perhaps ten times more people watched TV and what Jordan was selling was a captive audience to advertisers. Therefore the advertisers paid more for time and the VMPL of Jordan went sky high. In other words, marginal productivity theory still works if the product price is understood properly.
11 The demand for labor in a competitive market for labor is W = 101 - QL. If the price of the product is 2, what is the marginal product of the first worker employed?
A) 50
B) 100
C) 50.50
D) The answer can not be determined with the information given.
Feedback: At QL = 1 the value of the marginal product must be 100 since that is what the employer is willing to pay according to the demand for labor curve. If the value of the workers production is 2 each, then the worker is producing 50 which adds 100 to the employers revenue.
12 The demand for labor in a competitive market for labor is W = 101 - QL. If the marginal product of the 5th worker is 32, what is the unit price of the product if the product sells in a competitive market?
A) 2
B) 3
C) 69
D) 64
E) The answer cannot be determined form the information given.
Feedback: Since the employer is willing to pay 96 to the 5th employee and the worker produces 32 units of output, each unit must be worth 3 bringing the revenue up to 96 for the firm.
13 The value of the marginal product of labor and the marginal revenue product of labor differ. The difference between the two comes from the fact that the VMPL assumes that
A) labor is not subject to diminishing marginal productivity.
B) the product market is perfectly competitive while the MRPL assumes that the product market is imperfect.
C) employers are profit maximizers while the MRPL assumes that employers are sales maximizers.
D) the short run and the MRPL assumes the long run.
Feedback: The VMPL keeps the product price constant as sales go up while the MRPL reduces price to sell the additional output.
14 The market demand curve for labor is more elastic than the individual firm's demand curve for labor. This is
A) always true because when wages fall in the entire labor market the economy as a whole demands far more labor than any individual firm would demand.
B) true only when product prices fall as industry output expands.
C) never true because labor expansion across an industry will always involve greater industry output and falling product prices. Thus the demand for labor curve becomes more inelastic.
D) true only if diminishing returns to labor do not exist.
Feedback: Since the MRPL is the marginal product times the marginal revenue from that product, if prices fall due to industry wide expanded production, the quantity demanded of labor will not increase as much as it would if only one firm lowers its wages and product price stayed at its previous level. Thus the industry demand for labor is more inelastic than the individual firm's demand for labor.
15 If one laborer produces 15 and two laborers together produce 32, and if the product is sold in a imperfectly competitive market where demand for the product is P = 50 - Q, what is the marginal revenue product of the second worker?
A) 18
B) 17
C) 51
D) 576
Feedback: The total revenue from the one worker is 15 times the price of 35 or 525. The added revenue from the second worker is 32 times the price of 18 or 576. Thus the second worker adds only 51 additional revenue units to the firm. If one uses calculus to find the marginal product of labor it will be negative because the calculation will find the value at a point rather than over the range between worker one and two.
16 You employ 10 workers for $10 each You then add another worker for which you must move up the supply curve of labor to $12 in order to attract that worker. You can not wage discriminate since you are in a perfect labor market environment. Your marginal factor cost of the 11th worker is
A) 12.
B) 2.
C) 112.
D) 122.
E) 32.
Feedback: Since your total wage bill for the 10 workers was 100 and your new wage bill is 12 times 11 or 132, you now are paying 32 more for 11 workers than you paid for 10 workers before.
17 A backward bending supply of labor curve
A) is theoretically impossible given normal indifference curves in the leisure-income tradeoff model.
B) is less likely to occur for the individual than for the market as a whole.
C) can happen if the income effect of a wage increase discourages work more than the substitution effect of the wage increase encourages work.
D) generally happens at low wage levels rather than at high wage levels.
Feedback: Though not often empirically observable, it can happen at high wage levels for individuals who prefer to cut back work effort and enjoy more leisure.
20 Of the various types of discrimination in the labor market, the one that the market has the hardest time discouraging is
A) customer discrimination
B) coworker discrimination
C) employer discrimination
D) none of the above because the market makes all of these types very expensive to foster.
Feedback: Customer discrimination makes it hard for employers to treat people fairly and still make a profit. Thus collective action forcing all employers to not discriminate may be the only way to solve the problem. Thus the Civil Rights legislation.
4 The Bertrand model assumes that the opponent's _______ will not change. The outcome of the model results in an equilibrium output that is the same as the __________.
A) quantity: single price monopoly
B) price: perfect competition
C) quantity: perfect competition
D) price: single price monopoly
E) reaction curve: Cournot
Feedback: Perpetual price reductions lead the Bertrand oligopolists down the demand curve until marginal cost is reached.
5 In the Stackelberg model the Stackelberg leader assumes it knows
A) the opponents reaction curve.
B) Its own marginal cost curve.
C) The demand curve it faces.
D) All of the above.
Feedback: With all this information the Stackelberg leader puts the opponents reaction curve into its demand function and maximizes its profit by setting its MR = MC and solving for its quantity.
8 In baseball games if a pitcher appears to have thrown at an opposing batter it is generally understood that someone on that pitcher's team will be thrown at later in the game. Sometimes bench clearing brawls result, but these incidents happen relatively infrequently over a season. Once each team has made its point the incident is usually forgetten. All of this seems to fit with the oligopoly strategy calle
A) Cournot duopoly strategy
B) Prisoner dilemma dominant strategy
C) Tit for tat strategy
D) Contestable market strategy
9 Strategic entry deterrence.
A) Retaliate if attack, but don't attack first can bring stability if it is followed carefully. When one side does attack it is quickly punished and then both recognize the costs exceed the benefits of further hostilities.
B) Retaliate if attack, but don't attack first can bring stability if it is followed carefully. When one side does attack it is quickly punished and then both recognize the costs exceed the benefits of further hostilities.
C) Retaliate if attack, but don't attack first can bring stability if it is followed carefully. When one side does attack it is quickly punished and then both recognize the costs exceed the benefits of further hostilities.
D) Retaliate if attack, but don't attack first can bring stability if it is followed carefully. When one side does attack it is quickly punished and then both recognize the costs exceed the benefits of further hostilities.
E) Retaliate if attack, but don't attack first can bring stability if it is followed carefully. When one side does attack it is quickly punished and then both recognize the costs exceed the benefits of further hostilities.
11 Monopolistic competitive firms must decide how much to differentiate their product from similar products. Suppose your college is trying to decide how many academic majors it should offer its constituency. The two costs it must consider are shown in the graph below.
To find the optimal number of majors, given these cost functions, school administrators shoul
A) horizontally sum the costs and minimize the result.
B) Offer the number of majors represented by the point where the 2 costs intersect.
C) Vertically sum the costs and minimize the resulting total costs.
D) Find the point where the rate of decline of one cost equals the rate of increase of the other cost. (i.e. where the slopes of the two functions are equal.
12. Do either c or d since they both amount to the same thing.
A) The minimum cost of both vertically summed functions will be at the place where the marginal cost decline of the inconvenience function is equal to the marginal cost increase of the other cost function.
B) The minimum cost of both vertically summed functions will be at the place where the marginal cost decline of the inconvenience function is equal to the marginal cost increase of the other cost function.
C) The minimum cost of both vertically summed functions will be at the place where the marginal cost decline of the inconvenience function is equal to the marginal cost increase of the other cost function.
D) The minimum cost of both vertically summed functions will be at the place where the marginal cost decline of the inconvenience function is equal to the marginal cost increase of the other cost function.
E) The minimum cost of both vertically summed functions will be at the place where the marginal cost decline of the inconvenience function is equal to the marginal cost increase of the other cost function.
13 The Frank text developed a model for determining the optimal number of restaurants that should be built around a lake. To work with the model one needs to know the average distance traveled by each citizen. If the lake is 10 miles in circumference and the people are evenly distributed around the lake, what is the average distance traveled to and from a restaurant if there are 4 restaurants?
A) 1.25 miles
B) 2.5 miles
C) .625 miles
D) 5 miles
Feedback: The furthest anyone will live from a restaurant is 1.25 miles. Their round trip is 2.5 miles. The closest person lives at the restaurant so their distance is 0 miles. The average of the 2 people is 1.25 miles which is the overall average since the people are located equal distance from each other. The formula that solves this is 1/2N.
14 Author Frank argues that the consumer preference driven market sequence is a more accurate description of the way markets work than the producer advertiser led market sequence of John K. Galbraith because
A) advertising is usually ignored by an increasingly well educated public.
B) producers use advertising to unload items already produced that failed to sell on their merits.
C) advertising efforts cancel each other and as such help neither consumer nor producer.
D) producers advertise most heavily the products that consumers already have expressed a preference for or what producers believe consumers want so the advertising does not revise the sequence of the market signals.
Feedback: Advertising is a sunk cost so they spend there advertising dollars on the items they think will bring the biggest payback and that means the items most desired by the public will get advertised the most.
The following three questions relate to the table below. The issue for Boeing and Airbus is whether or not to build a new super jumbo jet that can transport 500 people. The numbers in the boxes represent profits that the firms earn under the four different scenarios proposed.
Airbus vs. Boeing& super jets Boeing builds the plane Boeing doesn't build the plane
Airbus builds the plane Boeing = 50: Airbus = 50 Boeing = 40: Airbus = 75
Airbus doesn't build the plane Boeing = 75: Airbus = 40 Boeing = 55: Airbus = 55
15 Given the data shown above, which of the following is true?
A) Boeing and Airbus both have a dominant strategy to build the plane
B) Airbus has a dominant strategy to build the plane, but Boeing doesn't have a dominant strategy.
C) Boeing and Airbus both have a dominant strategy not to build the plane.
D) Neither firm has a dominant strategy and must decide what to do on some other grounds.
Feedback: If Boeing builds, Airbus is better off building and if Boeing doesn't build, Airbus is also better off building. Since the payoff matrix is symmetrical Boeing has the same incentive that Airbus has.
16 If the Airbus profit in the lower middle cell is changed from 40 to 51, then
A) Boeing no longer has a dominant strategy.
B) Airbus has a dominant strategy not to build.
C) Airbus has a dominant strategy to build.
D) the final outcome has Boeing building and Airbus not building.
Feedback: Boeings dominant strategy is to build and Airbus optimizes subsequently by not building.
17 Which of the following statements is true about the plane building industry described in the two problems above?
A) Both firms would likely support a governmental regulation forbidding super planes if the original numbers prevail in the industry.
B) There is a Nash equilibrium in the outcomes of both cases presented above.
C) If the starting point is the present situation of not building, then the firms would prefer the status quo rather than the building strategy.
D) The status quo of not building is not a Nash Equilibrium.
E) All of the above are true statements about this industry.
Feedback: If the government outlawed big planes the firms could each make 55 which is better than 50. Thus the status quo is preferred but not likely because it is not a Nash equilibrium. Each firm would have incentive to build hoping that the other would not.
18 In the text the question is asked: Why would firms make investments they hope they will never use? The answer given is that
A) firms make bad decisions in the heat of an intense struggle for market share.
B) the firms intend to sell the investments to competitors when they find a technology that is superior.
C) some investments are designed as signals to competitors to back off from intense competition lest the investment be unleashed as a counter weapon.
D) firms assume that technology moves rapidly and firms that adopt new technology early will need to discard some investments before they are used.
Feedback: The story in the book of the Sears tower design as a deterrent to other attempts to build higher is an example of this answer.
21 The contestable market theory is based on the assumption that
A) sunk costs are high in imperfectly competitive markets.
B) competitors make no assumptions about opponents behavior.
C) repeat business is always the reality.
D) entry and exit into imperfectly competitive markets is basically free.
Feedback: Because sunk costs are avoided by leasing and rental of capital, sunk cost do not act as a deterrent to market entry. Thus oligopolies can not rely on fear of lost sunk costs as a protector of market share.
22 Even identical commodities are not perfect substitutes because
A) different people evaluate the same item differently.
B) they are differentiated by time and space.
C) they can not be used simultaneously.
D) of all of the above reasons.
Feedback: Plane rides to the same destinations at different times are not the same and identical gas stations at opposite ends of the town are not the same product to residents.
23 The optimal number of flights from Chicago to Philadelphia will be reduced if
A) the time costs of people go up.
B) the number of people traveling goes up.
C) the price of an airplane goes up.
D) all of the above occur.
Feedback: The other items will increase the optimal number of flights.
24 The central tendency theory described in Hotelling's paper helps to explain why
A) gas stations tend to cluster around the same intersections.
B) politicians seem so similar in elections.
C) traffic jams occur.
D) all of the above are applications of Hotelling's theories.
E) both a and b are correct.
Feedback: In order to capture the largest possible share of a market it is important to minimize the distance to the customer spatially and ideologically.
1 A production schedule is given showing the output that is generated in a factory as labor is increased from 1 to 10 units. The wage rate is given. From this information we could construct
A) a total variable cost function.
B) a Total fixed cost function.
C) a Marginal cost function.
D) two of the above functions.
Feedback: Since labor is the variable input and its wage is given we will have a total variable cost for the various quantities produced. Incremental cost of output is not given and neither is data on any fixed inputs.
2 If average total cost is 50, quantity produced is 10 and total fixed cost is 100, what is the total variable cost for the output of 10?
A) 500
B) 100
C) 400
D) 1000
Feedback: Since total cost will be 500 and total fixed cost is 100, the total variable cost must be 400.
6 When choosing which plant to use for the production of increased output one must know which of the following information?
A) The ATC function of each plant.
B) The AFC function of each plant.
C) The MC function of each plant.
D) More than one of the above.
Feedback: Since fixed costs need to be paid anyway, only the marginal cost is relevant and the plant with the lowest marginal cost should produce the output even if it has high ATC because its fixed costs are high.
9 Long run cost curves for a firm
A) can be derived from the expansion path of a firm.
B) imply an optimal input combination for each output.
C) show the lowest possible cost for each possible output quantity.
D) are described in part by each one of the above answers.
E) are described in part by none of the above answers.
Feedback: Each of the first three answers implies that the other two are correct.
10 Which statement is not true about costs.
A) Economies of scale give rise to natural monopolies.
B) A small firm producing at the lowest point on its short-run ATC curve may have higher ATC costs than a larger firm producing at outputs less than the lowest point on its short-run ATC.
C) If the long run marginal cost is below the long run average total cost over the entire market output, then diseconomies of scale exist in the cost structure of that industry.
D) It is not possible for a firm to be operating efficiently if its short-run ATC curve is not tangent to the long-run ATC in the industry.
Feedback: As long as MC is below ATC the ATC is falling and economies of scale are present. Diseconomies require that MC be above ATC. Sketch a long-run envelop ATC curve with a couple short-run firms to illustrate this question.
11 Given an output of 20, if average total cost is 80 and total fixed cost is 600, what is the average variable cost?
A) 50
B) 80
C) 1600
D) 1000
E) None of the above is correct.
Feedback: Total cost will be 20 times 80 or 1600 and 1000 of that is variable so 1000 divided by 20 is equal to 50. Also, one could take 600/20 to get average fixed cost and then subtract that from average total cost to get 50.
12 Which statement is true?
A) Fixed costs do not apply to the long-run.
B) Average fixed costs are constant over the relevant range of output.
C) Marginal costs are unrelated to variable costs.
D) Total costs constantly rise over any relevant range of output.
Feedback: In the long run all costs are variable. Average fixed costs always fall as output rises. Variable costs are the marginal costs and since output can not be produced at less than zero costs the total cost function must keep rising.
13 Which of the following is not true about a set of average and marginal cost curves?
A) The marginal cost curve intersects the average variable cost curve at its lowest point.
B) The marginal cost curve intersects the average total cost curve at its minimum point.
C) The average variable cost curve reaches a minimum at a lower output than does the average total cost curve.
D) The marginal cost curve never declines in a typical graph of typical cost curves.
Feedback: If there are increasing returns to production initially the marginal cost curve will fall.
14 If the marginal cost curve of one factory is MC = 10Q and a second factory producing the same product has a MC = 15Q, then if you want to produce 25 units of output you should produce ___ in factory 1 and ____ in factory 2.
A) 25, 0
B) 15, 10
C) 0, 25
D) It is impossible to tell without average cost information how much should be produced where.
Feedback: This combination will equate the marginal costs in both factories which results in least cost production. The average costs are irrelevant since they are sunk.
15 Your textbook uses the following equation to describe an isocost line. (C = rK + wL) In this equation the
A) r is the unit cost of capital.
B) w is the number of labor units employed.
C) C is the per unit cost of output.
D) L is the wage rate of labor.
E) Answers above are all correct.
Feedback: The w is the wage rate, the C is total cost of the possible combinations of inputs and L is the number of units of labor.
19 INCORRECT Labor unions generally
A) oppose minimum wage legislation because it brings more labor into the labor markets and ultimately increases the supply of labor.
B) support minimum wage legislation because many union members have low wages that are effected by the laws.
C) oppose minimum wage legislation because they think it creates unemployment in the long run.
D) support minimum wage legislation because it raises the wages of unskilled workers who are substitutes for union labor. This wage increase means employers substitute union labor for unskilled minimum wage labor.
Feedback: This chapter shows that when one factor of production has a relative price increase, the other factor benefits by being more attractive for employment.
20 A natural monopoly
A) typically has marginal costs rising over the relevant range of output.
B) has lower long-run average total costs than it would have if it shared the market with another firm.
C) has a minimum efficient point of production at an output level that serves a small share of the market.
D) is describe by none of the options above.
Feedback: Because of the economies of scale involved in production, the average total cost continues to fall until most of the market is served. Cutting production to accommodate two firms will push both firms back up the ATC curve.
21 Which is true of the long run cost function?
A) Each point on the LATC function would be produced by a different size short- run plant.
B) On the downward sloping portion of the LATC function the plants doing the producing are producing at the bottom of their short-run ATC.
C) At the bottom of the LATC function short-run marginal cost is greater than long run marginal cost.
D) All of the above are true.
Feedback: Every increment in production is produced by a slightly larger plant for perfect efficiency.
1 Production, as economists deal with it,
A) involves the process of motivating labor inputs.
B) involves the process of getting the right mix of inputs together to generate utility for people.
C) counts intermediate goods as part of the output of any production process.
D) Distinguishes between goods and services and focuses on the former as the key to economic success.
Feedback: The value added output of anything that generates utility is the focus of production and getting the right recipe to produce that output efficiently is the task of economic analysis.
2 An intermediate good
A) is counted as part of value added at all stages of production.
B) never enters into the price of the final good.
C) would be the coffee making machine in a Starbucks enterprise.
D) exists in the production of goods but not in the production of services.
Feedback: The machine is bought by Starbucks rather than produced by them. Even though its value must be imputed into the final cost of coffee, it is not part of the value added by Starbucks.
3 In a typical short-run production function
A) the maximum average product occurs at lower levels of labor than does the maximum marginal product.
B) the marginal product of labor increases until total product peaks.
C) an employer is likely to increase employment until average product of labor is zero.
D) the marginal product of labor equals the average product of labor where the average product is at its peak.
E) none of the above is true.
Feedback: If the average product is rising the marginal product is higher pulling the average up and if the average is falling, then the marginal must be below it pulling the average down. Consequently the marginal must be at the peak of the average product of labor.
4 The shape of the typical short-run production function of a factory has first a range of employment where increasing returns exist and then a range of employment where decreasing returns exist because
A) the earlier workers hired are the best workers and later hires are of lower quality.
B) the factory is highly productive when it is new, but it becomes less productive as it ages. The diminishing returns notion picks up the aging problem of capital.
C) the factory has too few workers for its size at low output levels so as the number of workers increase the mix of capital and labor inputs is more desirable and increasing returns result. However, as labor increases the factory has too many laborers to be efficient.
D) of all of the above.
E) of none of the above.
Feedback: Diminishing returns relates solely to effects of applying labor to a fixed amount of capital. The quality of worker is assumed to be uniform, and the age of the factory is not part of the concept.
5 If the owner of a service station told a mechanic looking for work that he would not hire another mechanic if the mechanic offered to work for nothing, we can assume that
A) the average product of mechanics is 0.
B) the average product of mechanics is rising.
C) the average product of mechanics is negative.
D) the average product of mechanics is falling.
Feedback: The marginal product must be zero or below, but the average product will be positive and falling.
6 Plant 1 has a total product of 100 produced by 10 workers. Plant 2 has a total product of 100 produced by 8 workers. From this information we can say that any additional production should be
A) produced by plant 1
B) produced by plant 2
C) divided equally between plant 1 and plant 2.
D) allocated after more information is acquired.
Feedback: The information given provides average product information, but it does not provide the marginal product information needed to make the decision.
7 Referring to question 6 above, if we know that an 11th worker in plant 1 would add 4 units of ouput and a 9th worker in plant 2 would add 3 units it is then clear that added output should be produced by
A) plant 1
B) plant 2
C) either plant since both have the same average cost.
D) neither plant until more information is given.
Feedback: The marginal information needed is now presented and the first plant has the higher marginal product of labor even though it has a lower average product. You should sketch several production functions to show how this can make sense.
8 Isoquants are negatively sloped because
A) of diminishing returns to production.
B) labor and capital are substitutes in production.
C) the price of each input rises as more of it is employed.
D) of all of the above.
Feedback: If labor replaces capital the isoquant will be negatively sloped. Diminishing returns makes the isoquant concave from above. The input price is unrelated to the shape of the isoquants.
9 Decreasing returns to scale
A) are the same as diminishing returns to production.
B) means that as inputs expand proportionately the average cost of production falls.
C) is present when isoquants numbered 10, 20, 30, 40, etc. get closer together as the output expands.
D) is described by none of the above.
Feedback: Letter a refers to short run returns when the variable factor is increased. Letters b and c describe increasing returns to scale.
10 The marginal rate of technical substitution of labor for capital
A) falls as more labor is hired.
B) can be measured by the slope of the isoquant.
C) can be meaningfully measured only by holding the level of output constant.
D) All of the above are true.
E) None of the above are true.
Feedback: Options a, b, and c all describe certain aspects of the MRTS.
14 In a typical short-run production function with labor on the horizontal axis and total output on the vertical axis, technological change can be shown by
A) a movement upward along the production curve.
B) a shift of the production function downward.
C) a shift of the production function upward.
D) none of the above because technology must be assumed constant in this model and can not be shown on the graph.
Feedback: With improved technology the output of any given labor force will go up.
15 Diminishing returns of labor in a typical production function is
A) a short-run concept only.
B) due to increases in the labor input while capital is kept constant.
C) usually preceded by increasing returns to labor.
D) described, in part, by all of the above.
E) described, in part, by none of the above since they describe economies of scale.
Feedback: Changes in labor while capital is constant is the definition of the short run and when labor is scarce in a production process there is a period of increasing returns before congestion sets in.
16 If your object was to produce as much output as possible with a given short-run production function you would produce where the
A) average product is the greatest.
B) marginal product is the greatest.
C) marginal product is zero.
D) average product is zero.
E) marginal product equals the average product.
Feedback: The total product peaks where the marginal product is zero because there is no increment being added to the total product at that point.
17 You own two factories and in factory 1 the average product of labor is 12 bicycles a day and in factory 2 the average product of labor is 18 bicycles a day. This information tells you that you should
A) move labor from factory 1 to factory 2 to capitalize on the higher average product..
B) move labor from factory 2 to factory 1 to help it increase its average product.
C) close down factory 1 and produce all the bicycles in factory 2.
D) make no changes until you get more information that would be relevant to the situation.
Feedback: The movement of labor would be determined by the marginal product of labor alone.
18 It is possible to have three types of long-run production isoquants. One would be the typical negatively sloped function with a decreasing slope, a second would be an L shaped function and a third would be a negatively sloped straight line. These three would represent respectively which type of products?
A) perfect complements, perfect substitutes, imperfect substitutes
B) imperfect substitutes, perfect substitutes, perfect complements
C) imperfect complements, perfect complements, perfect substitutes
D) imperfect substitutes, perfect complements, imperfect complements
E) None of the above is correct.
Feedback: The correct sequence is imperfect substitutes, perfect complements, perfect substitutes.
19 If the isoquants of a production surface are sequenced from the origin outward with the numbers, 100, 300, 600, 800, 1000, 1200, 1300, we
A) know that there are increasing returns to scale, then constant returns to scale, and finally decreasing returns to scale.
B) know that There are constant returns to scale, then increasing returns to scale, and finally decreasing returns to scale.
C) know that There are increasing returns to scale over the entire specified range of output.
D) know that There are decreasing returns to scale over the entire specified range of output.
E) can not know anything about the returns to scale without information about the inputs.
Feedback: It the inputs were doubled between isoquants, then (a) would be correct, but no information is given about inputs.
20 Which statement is true?
A) The marginal rate of technical substitution of labor for capital (MRTS) at a given point on an isoquant is the slope of the isoquant at that point.
B) The MRTS is constant at any given level of production for perfect substitutes in production.
C) The MRTS is equal to the ratio of the marginal product of labor divided by the marginal product of capital at a given point on an isoquant.
D) All of the above statements are true.
E) None of the above statements are true.
Feedback: Each of these answers is shown in the text in the section on MRTS.
1 Which comment best describes the purpose of chapter 8 on cognitive limitations that effect behavior. Few other texts treat this material directly.
A) The integration of psychology into economics presents us with an entirely new way of doing economics. The old methods of rational choice are essentially obsolete.
B) Understanding our cognitive limitations will help us understand an area of our behavior that rational choice can not deal with effectively.
C) The power of rational choice analysis is especially evident in these areas of cognitive limitations because it predicts well even when people clearly behave in irrational ways.
D) Other social sciences like psychology study human behavior in order to describe and explain behavior. Only economists build models that are designed to predict what people will do.
Feedback: The other three answers are simply false.
2 Which of the following best explains why people who budget carefully tend to spend less money?
A) Bounded rationality
B) The asymmetric value function
C) Hedonic framing
D) Out of pocket costs versus opportunity costs
Feedback: Because of bounded rationality, people are hesitant to dip into another budgeted area when one area is depleted.
3 Which case best shows how marketing people use the asymmetric value function to their advantage.
A) They take full page adds on interior pages instead of half page adds on the front pages of sections.
B) They make a deal that is good only for one day rather than an indefinite period of time.
C) They bundle items together so the consumer must buy several things to get one item.
D) They give cash rebates rather than reduce the price of the item.
Feedback: The pain of paying the last $1000 for the new car that costs $20,000 doesn't feel as bad as the pleasure received from the $1000 rebate check in the mail.
4 If economists tend to be left-brained people, then
A) if you find a left-brained person and assume you have an economist, you are falling into the representative bias.
B) if you find an economist and assume you have a left-brained person, you are falling into the anchoring bias.
C) if a person is right-brained and an economist, he must have an asymmetric value function.
D) if a person is a right-brained economist, she will be more susceptible to the psychophysics of perception.
Feedback: There are far more left-handed non economists than there are left handed economists.
5 Karl is a senior faculty member who bought his house 20 years ago. His neighbor, Carlos, just joined the faculty and for a similar house has mortgage payments that are three times what Karl pays. Recently Carlos commented that life would be so much easier if he had housing costs as low as Karl. This comment illustrates the problem of
A) considering out-of-pocket costs as full opportunity costs.
B) an asymmetric value function.
C) judgemental heuristics and biases.
D) the psychophysics of perception.
Feedback: If both homeowners have a house of similar value they both are paying a similar housing cost. Karl is paying the opportunity cost of tying up large amounts of money in a house and Carlos is paying out of pocket mortgage payments. Carlos may feel the hurt more than Karl but they both are paying the about the same for housing.
6 Credit cards have reduced the pain of shopping, not only because they are convenient, but because
A) of the initially steep slope of the utility function for losses.
B) of the fact that credit card payments are not out of pocket loses.
C) people are risk averse.
D) the psychophysics of perception makes a $1000 bill seem small.
Feedback: Credit cards bundle losses which makes the total cost seem less painful than it would seem if each purchase had to be paid separately.
7 Most sports writers seem to think that Sammy Sosa and Mark McGuire will never again engage in a home run race like they did in 1998. Yet the die-hard fans seem to expect another effort to top the record in 1999. Which of the following concepts would tend to back the sports writer's view?
A) psychophysics of perception.
B) Regression to the mean
C) Bias of representativeness
D) Sports writers are risk lovers
Feedback: The 1998 performance was exceptional even by Sosa and McGuire standards so it represents the infrequent upper tail of the annual home run distribution. The mean is probably 40 - 50 home runs.
8 In my intermediate micro class the exams seem to get progressively more difficult for the students as the semester goes along. The material builds and the concepts become more complicated. Although I do not try to make the exams harder, I welcome this trend because students tend to be pleasantly surprised by their final course grade. What from this chapter would explain why they are surprised at how high a final grade they receive?
A) the concept of an asymmetric value function
B) the fact that earlier grades are sunk costs.
C) the idea of availability in memory as it relates to more recent events.
D) the fact that students are risk averse.
Feedback: The poor recent grades stand out in the student's mind more than the higher earlier grades so they underestimate their expected grade.
9 The story of the tennis court decision at Cornell University illustrates that people are psychologically inclined to
A) take sunk costs into account when making decisions.
B) expect the worst.
C) overestimate losses and underestimate gains.
D) prefer rebates to price reductions.
Feedback: The money paid for the indoor court was a sunk cost, yet the players were inclined to consider it when they decided where to play.
10 An asymmetric value function underlies which of the following behavior?
A) Buying most purchases with a credit card.
B) Wrapping three Christmas presents in one large box.
C) Mowing one's own lawn instead of paying the neighbor boy $8 to mow it, but at the same time refusing to mow the other neighbor's similar lawn for $20.
D) All of these examples illustrate asymmetrical value functions.
E) None of the above illustrate asymmetrical value functions.
Feedback: This bundling of loses makes the hurt less apparent.
11 People often feel a sense of relief when they pay off their mortgage and have a debt free house. Which of the following is an accurate assessment of that feeling?
A) It is a false sense of relief because housing costs have not diminished at all.
B) It is a false sense of relief because the cash flow situation of the household budget has not improved at all.
C) It is a valid sense of relief because housing costs have fallen and the family is richer.
D) It is a valid sense of relief because it is always true that the less debt the better.
Feedback: The out of pocket costs have stopped but the full opportunity cost of living in the house has not changed. The family will have an improved cash flow position and perhaps feel richer, but that is not because debt is bad.
12 My daughter recently purchased a new car. There was the sticker price and the dealer discount. There also was a $1000 manufacturers discount and a student $400 discount, plus a zero percent finance charge for a 36-month loan. All the options were already included on the sticker as standard equipment. This practice takes advantage of the psychology of
A) sunk costs.
B) hedonic framing because of an asymmetric value system.
C) judgmental heuristics
D) anchoring and adjusting.
Feedback: Bundling costs (car options) and segregating gains (rebates, discounts, etc.) makes the customer feel like he got a real deal.
13 The psychophysics of perception would be a reason why most people
A) get upset only when bills come but not when the receipts come later.
B) overestimate loses and underestimate gains.
C) fail to ignore sunk cost in a decision.
D) get upset when the toll on the highway doubles to 50 cents but ignore the price increase of a round of golf which goes form $25 to $26.
Feedback: This concept deals with proportions in perception. We notice the percent increase or decrease more than we do the absolute value of the change.
14 Politicians might notice that 70% of those who enter a primary, including those unopposed, win the party nomination. Yet, in a two-person race, one can win only 50% of the time. If politicians keep surfacing because they first see the 70% figure, they are likely being influenced by
A) the psychophysics of perception.
B) the Anchoring and adjustment factor.
C) the choice under uncertainty factor.
D) an asymmetric value function.
Feedback: The first figure they see has a heavy influence over their perception of the probabilities.
15 One of the sad aspects of the terrorist attacks was the way many people of Middle East decent were treated after the tragedy. Since probably 100% of the terrorists were from the Middle East many people mistrusted thousands of other folks who came from that region originally. This mistake is most likely due to biases in judgement related to
A) availability.
B) anchoring and adjustment.
C) the psychophysics of perception.
D) representativeness
Feedback: While all the terrorists of September 11 may have been from the Middle East, the probability that any randomly picked Middle Eastern person would be a terrorist is extremely small.
16 After playing 4 holes of golf without success I mysteriously rolled in a par. On the way to the next tee I calculated what my score would be if I pared the rest of the holes. I had fallen prey to the bias of
A) availability
B) representativeness
C) anchoring and adjustment
D) the psychophysics of perception.
Feedback: Availability weighs the recent events more than the averages and thus biases the judgment. It was not long until I was counting how bad my score might become because of the same bias.
1 In general, we would expect that heavily advertised items
A) will be of lower quality than items that are not advertised.
B) will be of higher quality than items that are not advertised.
C) will have no tendency to be of different quality from items that are not advertised.
D) will be of lower quality than unadvertised products if the item is a service and of higher quality if the item is a product.
Feedback: Since advertising is a sunk cost, the vendor has a high stake in making the venture work so the product will likely be a good one.
2 The full-disclosure principle assumes that sellers disclose to buyers even things they are not supposed to tell because
A) the buyer will view the seller as a liar if all is not told.
B) people are inherently conscientious and cannot live with themselves if they do not tell all.
C) the buyer will believe the worst about anything not disclosed.
D) sellers are usually outwitted by buyers into telling everything even though it is not in the seller's interest to tell all.
Feedback: The full disclosure principle assumes that people believe the worst if something is not disclosed.
3 Why do local newspapers often have dating information services while small college newspapers do not?
A) College students have more time for search than do people in the working world.
B) The high level of student interaction and socializing typical on a college campus lowers the cost of individual information gathering.
C) College newspapers are more politicized and less reliable than local newspapers so students do not trust them.
D) College students are more outgoing and uninhibited than non college people so they do not need a dating service.
Feedback: While it is possible that a, c, and d could be answers, the best answer relates to the lower information costs experienced by students.
4 Lee, a 45 year old marathon runner in excellent health with no family history of heart disease, pays more for life insurance than Pete, age 37, who is 40 pounds overweight, is a couch potato, and has lost his older brother to a heart attack. This apparent insurance premium mistake occurs due to
A) the lemons principle.
B) adverse selection.
C) a breakdown in the full disclosure principle.
D) statistical discrimination.
E) conspicuous consumption.
Feedback: Lee is discriminated against because of his age even though he is a far better risk than Pete.
5 Many desirable people avoid dating services because they view the process as subject to
A) the lemons principle.
B) adverse selection.
C) the full disclosure principle.
D) statistical discrimination.
E) conspicuous consumption.
Feedback: Only those least able to arrange dates on their own enter the information pool.
6 Some people of moderate income make a public display of their lifestyle even though they can not match the Mercedes jet set standard of living. This behavior is likely due to the following combination of explanations.
A) statistical discrimination and conspicuous consumption.
B) the lemons principle and the full disclosure principle.
C) conspicuous consumption and the full disclosure principle.
D) adverse selection and the lemons principle.
Feedback: They want to make sure people do not think they are poorer than they are, they want to flaunt what they have to impress their peers with their success.
Use the following information for the next three questions. My watch is worth $100. There is a 25% chance that it will be stolen from the locker room when I play racquetball. My utility function for money is U = (money)2.
7 I On the basis of this information the expected value of my watch is ______ and the expected utility from my watch, given these circumstances, is ________.
A) 100: 10,000
B) 75: 7,500
C) 75: 10,000
D) 25: 2,500
Feedback: 75%(100) + 25%(0) = 75 and 75%(10,000) + 25%(0) = 7,500.
8 I am able to buy an insurance policy to cover my watch against theft. How much would I be willing to pay for the insurance?
A) 13.40
B) 25
C) 15.80
D) 9.90
Feedback: 75%(10,000) + .25%(0) would be my expected utility if I took my chances. The same utility would come from 86.60 of sure money so I would be willing to pay $13.40 of the $100 sure money to guarantee that the $100 was secure.
9 The insurance company that insures my watch will not insure it unless I pay a premium of
A) $75.
B) $15.80
C) $25
D) $13.40
E) none of the above.
Feedback: There expected loss is $25 so they can not insure for less than that premium.
10 If I were risk averse
A) I would be willing to pay the insurance company the same amount, but no more than the amount that the risk lover would pay.
B) I would be willing to pay the insurance company more than the amount that the risk lover would pay.
C) I would not be willing to pay the insurance company as much as the risk lover would pay.
D) I could not answer this question without knowing what my specific risk averse utility function for money is.
Feedback: A risk averse person will always be willing to pay more to insure a $100 item than a risk lover.
13 Which statement is false about information?
A) Heavily advertised items are generally of lower quality because they do not sell on their own merits.
B) Advertising is a sunk cost for firms engaging in it.
C) The full disclosure principle assumes that people are prone to believe the worst about something if it is not disclosed.
D) The pitch of a frog's voice is reliable information of the size of the frog because it is hard to mimic another frog's voice.
E) None of the above are false.
Feedback: Because advertising is a sunk cost it is important to spend the money only on a product that is likely to succeed.
14 Which of the following does not relate to the full disclosure concept?
A) Product warranties
B) Used car valuations
C) Regulations about what can be asked in an employment interview.
D) Adverse selection
Feedback: Adverse selection occurs when less desirable potential trading partners volunteer to exchange.
19 If your marginal utility of money is increasing at an increasing rate you will
A) get more pleasure from a dollar gained than displeasure from a dollar lost.
B) be likely to accept some unfair gambles.
C) not buy extended warrantees for most household appliances.
D) be classified as a risk lover.
E) fit all of the above options since they are consistent with each other.
20 Someone who is risk neutral
A) will buy insurance only if the insurance company sells it at cost.
B) sees the expected utility from the expected value of a gamble as greater than the actual utility that would be gained from the money if it were a sure thing.
C) has a decreasing marginal utility of income.
D) will avoid a gambling game where the odds favor the house.
Feedback: Since risk is not a plus or a minus for a risk neutral person those who are risk neutral are indifferent to a fair gamble, avoid unfair gambles, and always accept gambles that are in their favor.
4 An income consumption curve shows what happens to the consumer's consumption of good X as nominal income increases and
A) the price of X falls.
B) the prices of X and Y stay constant.
C) the price of Y falls.
D) real income stays constant.
Feedback: Prices do not change for an income consumption curve.
5 If you were selling a product in a setting where incomes were rapidly rising, which of the 4 Engel curve slopes listed below would you prefer for your product?
A) -2
B) -10
C) +2
D) +10
Feedback: Since a +2 would give the most added demand for a given income increase you would wish for that number. A negative number would mean that less of your product is sold as income rises.
8 Price changes have less effect on consumption
A) the larger the budget share involved.
B) The further from the Y intercept the consumer's optimal market basket lies.
C) The easier it is to substitute toward an alternate product.
D) The larger the arc of the indifference curve.
E) When the opposite of all the above is true.
Feedback: The smaller the budget share, the closer to the Y intercept, the more difficult it is to substitute, and the smaller the indifference curve arc, the less price changes effect consumption.
9 What is the market demand curve for the two consumers who have the following demand functions? 1) P = 60 - 1.2QQ 2) P = 60 - 2Q.
A) P = 60 - 3.2Q
B) P = 120 - 3.2Q
C) P = 60 - .75Q
D) P = 60 - .8Q
Feedback: Horizontally summing both equations gives the right answer.
10 If the slope of a demand curve is constant, then as the price of X moves upward from zero, the price elasticity of X
A) increases.
B) decreases.
C) doesn't change since the slope is constant.
D) increases up to the midpoint of demand and then decreases.
Feedback: Since the slope is constant the P/Q portion of the elasticity equation is the only part effected and that is increasing as price increases and quantity decreases.
11 What is the point elasticity for the demand curve P = 100 - 4Q at the price of 20?
A) - .25
B) - 1.2
C) - 1
D) - .2
E) None of the above is correct.
Feedback: P/Q is 20/20 and 1/slope is 1/-4. Thus 1 times -1/4 = -.25.
12 If you were in business and had the demand curve P = 100 - 4Q and your price was 30. Which of the following would definitely be a good strategy?
A) You should raise your price because your revenues would increase and you would be producing less.
B) You should lower your price to gain more revenue.
C) You should hold price where it is because you are profit maximizing now.
D) You do not have enough information to make any of the statements listed above.
Feedback: Since you are below the midpoint of the demand curve, a will be true.
20 What is the market demand curve for the two consumers who have identical demand functions as shown here? ( P = 60 - 2Q.)
A) P = 60 - 4Q
B) P = 120 - 4Q
C) P = 60 - Q
D) P = 60 - 15Q
E) None of the above is correct.
Feedback: Horizontally summing the two identical equations gives the right answer.
21 If the slope of a demand curve for good X is constant, then the price elasticity of the goo
A) increases as the price falls.
B) decreases as the price falls.
C) has a constant elasticity.
D) increases up to the midpoint of the demand curve and then begins to decrease.
Feedback: Since the slope is constant, the P/Q portion of the elasticity equation is the only part effected and that is decreasing as price increases and quantity decreases.
22. Which of the following is not true about the determinants of elasticity?
A) If there are many substitutes for a good, the elasticity of that good will be higher than would otherwise be true.
B) Cars would tend to have more elastic demand curves than would toothpaste.
C) The longer the time period the more elastic the demand curve.
D) A normal good will tend to have a lower price elasticity than an inferior good.
Feedback: Since, for a normal good, the income effect of a price reduction reinforces the movement toward more quantity purchased, the final change in quantity purchased is increased and therefore the demand curve is more elastic rather than less elastic.
23 If you were in business and had the demand curve P = 100 - 4Q and your price was 70. Which of the following would definitely be a good strategy?
A) You should raise your price because your revenues would increase and you would be producing less.
B) You should lower your price to gain more revenue.
C) You should hold price where it is because you are profit maximizing now.
D) You do not have enough information to make any of the statements listed above.
Feedback: Since you are above the midpoint of the demand curve you will need to know what your cost function is before you can give a definitive answer to where you should produce.
24 The demand curve is P = 10 - Q. If the price is 4, what is the price elasticity at that point?
A) - .67
B) - 1.5
C) - 1.67
D) - 10
Feedback: The P/Q is 4/6 and the slope is - 1 so the elasticity is - 0.67.
1 If the government put a tax on shelter and then lowered the income tax, how would that be shown using a budget line model?
A) The budget line would shift parallel to the right because of the tax on X and then rotate counterclockwise because of the income tax reduction.
B) The budget line would shift parallel to the left because of the tax on X and then rotate clockwise because of the income tax reduction.
C) The budget line would rotate counterclockwise because of the tax on X and then shift parallel to the right because of the income tax reduction.
D) The budget line will rotate clockwise because of the tax on X and then shift parallel to the right because of the income tax reduction.
Feedback: The tax on X acts as an increase in the price of X and the income tax acts as a subsidy increasing the consumer's income.
2 If Scott's demand curve for theater tickets is P = 100 - 5Q and the price of the ticket is 40, how much consumer surplus does Scott receive from buying theater tickets?
A) 360
B) 480
C) 40
D) 1000
E) None of the above.
Feedback: At price 40 Scott buys 12 tickets. The area under the demand curve above 40 is equal to 60 times 12/2 or 720/2 = 360.
3 In question 2 above, If the theater was giving away tickets on a first come first serve basis instead of charging admission, and if Scott's time was worth 100 units of consumer surplus pleasure per hour, how many hours would Scott be willing to wait in line for free tickets if he was assured of getting the number he wanted from the wait.. Assume there is no limit on the amount of tickets he can have when he gets to the ticket window.
A) 3.6 hours
B) 4 hours
C) 10 hours
D) no hours
Feedback: Because the entire amount of consumer surplus at zero price is 1000, Scott would still be gaining something if he waiting anything less than 10 hours.
4 The upward bias of the consumer price index would not exist if
A) people consumed the same market basket no matter what the relative prices of the goods.
B) All consumers made market choices as rational choice optimizers.
C) The second year market basket rather than the first year market basket was used as the base.
D) All goods were used in the market basket instead of just a limited selection of consumer items.
Feedback: The bias comes because consumers constantly substitute away from the goods that have the highest inflation rate. Therefore keeping the same market basket over time makes it impossible to eliminate the part of inflation that consumers fight off by substituting cheaper goods for higher priced ones.
5 On May 13, 1999 the US government accused American Airlines of cutthroat competition. On May 14 the Chicago Tribune listed rates and passenger numbers for three cities. Before the low-cost carriers entered the Dallas-Colorado Springs route, American charged $156 and had 3,700 thousand passengers. When the competition came in the market fare was $88 and 19,900 thousand passengers traveled the route on all carriers. After the small carriers went bankrupt the rates went back to $133 and 9,200 thousand people bought tickets. Given this information we can say that the elasticity of demand for air travel between Dallas and Colorado Springs is very nearly a straight line with a vertical intercept of approximately _____ and a slope of approximately ______.
A) 156, 3.7
B) 200, .016
C) 140, .25
D) 171, .004
Feedback: For every $22 drop in price the quantity of passengers rises by about 5,500 over the range given. Thus the slope is .004. In other words, for each dollar drop the number of passengers rises by 250. By projecting the slope toward the vertical axis that intercept will be close to 171.
10 Which statement is true?
A) The desire for growth and improvement tends to bias people toward a negative time preference.
B) Wars andfeelings of an uncertain future tend to bias people toward a positive time preference.
C) Positional concerns tend to bias people toward a positive time preference.
D) Weak commitment devices related to one's financial planning tend to bias people toward exhibiting a positive time preference.
E) None of the above is true.
Feedback: All of the answers say the opposite of what is right.
11 In the case of an gasoline tax with a equal rebate, the graphical analysis proceeds by
A) rotating the budget line counterclockwise and then shifting that entire budget line parallel to the right.
B) rotating the budget line clockwise and then shifting that entire budget line parallel to the left.
C) rotating the budget line counterclockwise and then shifting that entire budget line to the left.
D) rotating the budget line clockwise and then shifting that entire budget line parallel to the right.
Feedback: The clockwise rotation increases the price of gasoline and the rightward shift of the budget line gives the consumer more income via the rebate.
14 The consumer price index is biased
A) upward because it does not allow consumers to fight off inflation by substituting goods in their market basket.
B) upward because people claim to be worse off even when they are really better off.
C) downward because it uses the market basket in the second year for comparison of price levels.
D) downward because it over-adjusts for quality improvements.
Feedback: By requiring consumers to keep the same market basket from year to year the normal substitutions that people make to avoid inflation are not counted in the calculations.
15 In the case of the Cornell faculty educational benefit described in the text, the administration did not take into account the fact that
A) faculty children see the Cornell education as an normal good.
B) faculty children have an inelastic demand for an education at other colleges.
C) faculty children have an elastic demand for an education at other colleges.
D) there is no consumer surplus generated for faculty children if they pay the full tuition at a college different from Cornell.
Feedback: If the tuition at another college is partially subsidized the children have a price reduction at the other college and if they have an elastic demand curve they will more readily leave Cornell which creates a space for another full paying student at Cornell.
16 If a person earns M1 this year and M2 next year and the interest rate is denoted by the letter i, what is the formula for the present value of both incomes?
A) M1(1 + i)/M2
B) (M1 + M2)/i
C) M1(i) + M2(i)
D) M1 + M2/(1 + i)
E) None of the above
Feedback: The money available now does not need to be discounted , but next year's money must be discounted by the interest rate.
17 A person willing to forego 100 dollars today in order to receive 100 next year is said to have a
A) negative time preference.
B) positive time preference.
C) neutral time preference
D) irrational time preference
Feedback: A negative interest rate is implied when I am willing to pay something to avoid consuming in the present.
18 Which statement is true?
A) The September 11 tragedy would most likely decrease the time preference of Americans.
B) If I seek to keep up with my neighbors, the Jones', I will likely have a lower time preference than would otherwise be the case.
C) A preacher who preaches against materialism regularly will likely lower the time preference of his congregation.
D) None of the above statements is true.
Feedback: A lowering of time preference means present consumption is becoming less important. If tomorrow is uncertain people spend today and if they are in a consumption arms race with their neighbors they have an elevated time preference. On the other hand , the person who cuts back consumption for religious reasons is displaying a lower time preference.
19 A graph has current income on the horizontal axis and future income on the vertical axis. Which statement is true from the graphical perspective?
A) If the budget line is relatively steep and the indifference curve of the consumer is relatively flat, then the consumer is patient and the interest rate is relatively high.
B) If the budget line is relatively flat and the indifference curve of the consumer is relatively steep, then the consumer is patient and the interest rate is relatively high.
C) A steep indifference curve will tend to lead to less current consumption.
D) If both the indifference curve and the budget line of the graph are relatively flat, then less money will be saved for the future than would otherwise be the case.
Feedback: A steep budget line means that much future income must be given up to get more present income which means that the interest rate is high. A flat indifference curve means that the consumer is willing to give up much present income to get a small amount of return in the future.
20 Milton Friedman's concept of permanent income refers to
A) the future value of all present income.
B) the economic position of a person in the community.
C) the present value of all future income.
D) the amount of one's present income that is transferredto the future via savings.
Feedback: Friedman believes this is what determines present consumption more than anything else.
21. Which of the following is false about the rational choice model of consumer behavior?
A) Consumers experience reduced pleasure from each successive unit consumed of a given product therefore they prefer a balance of goods in their basket rather than a market basket dominated by one item. This leads to indifference curves that are convex to the origin.
B) Consumers are never satiated. They always want more rather than less so indifference curves located further to the northeast on a graph are preferred over those closer to the origin.
C) If you prefer an apple to an orange and an orange to a banana, then we do not have enough information to infer that you would choose an apple over a banana.
D) Consumers are able to differentiate between minutely small differences in market baskets in order to rank all possibilities as preferred or not preferred to each other.
Feedback: Because of transitivity we do have enough information to say that an apple is preferred to a banana.
22 If a budget line with good Y on the vertical axis and good X on the horizontal axis is linear with a negative slope we know that
A) the price of good X declines as more of the good is purchased.
B) the price of good X and the price of good Y are constant no matter what the consumer' market basket mix between the two goods is.
C) the price of good Y increases as more of it is purchased.
D) Both a and c are correct.
Feedback: A straight line implies a constant amount of Y that must be given up if more X is obtained. This tradeoff rate stays constant over the entire range of consumption of good X.
6 The marginal rate of substitution is the rate at which a person is willing to exchange good Y for good X. The slope of the budget line is the rate at which a person is able to exchange good X for good Y.
A) Both statements are true.
B) Only the first statement is true.
C) Only the second statement is true.
D) Both statements are false.
Feedback: The first statement is simply the definition of the MRS term. The second is the ratio of the price of X to the price of Y which is the exchange rate of the two goods.
10 An indifference curve is linear and has a steeper slope than the budget line. This means that
A) the optimal solution will include a market basket of all one good.
B) there is no diminishing marginal utility in the consumption of either good.
C) the marginal rate of substitution of X for Y is everywhere greater than the ratio of the price of X to the price of Y.
D) all of the above are true.
E) none of the above are true.
Feedback: A corner solution on the horizontal axis means that a through c are all correct.
11 To draw a budget line for two goods one must know at least
A) the relative prices of the goods and the money income of the consumer.
B) the money income of the consumer and the absolute price of one good.
C) the absolute price of both goods.
D) the relative price of one good and the absolute price of the other good.
E) the money income of the consumer and the absolute price of both goods.
Feedback: The relative price of the goods gives you the slope of the line but can not fix the intercept. The absolute price of a good and the income will give the intercept of that good but not the slope of the line. The absolute price of both fixes the relative prices and the income sets the final location.
16 The fact that indifference curves tend to be convex to the origin shows us that
A) people exhibit diminishing marginal utility characteristics.
B) people prefer more rather than less.
C) consumer's preference ordering is transitive.
D) consumers can rank all possible combinations of goods and services.
Feedback: Since a convex indifference curve has a flatter slope as more of a good is consumed, that good is worth less and less to the consumer as more is consumed.
17 The marginal rate of substitution
A) shows how intensely the consumer values one good in comparison to another.
B) shows the rate at which the consumer can exchange one good for another in the market.
C) Is sufficient to determine the absolute price of each of two goods in the model.
D) can easily be obtained empirically
E) relates accurately to none of the above statements.
Feedback: The MRS is specifically related to the consumer's preferences and they show relative intensities rather than any empirically explicit values of pleasure.
18 Peter would give anything to obtain more of good X and he considers good Y to be worthless. In other words, Peter's ____________________ if X is on the horizontal axis.
A) budget line is a straight line.
B) indifference curve is horizontal
C) optimal point is on the vertical axis
D) indifference curve is vertical
Feedback: This questions relates to the indifference curve only and it means that Peter will reach a solution when he is on the horizontal intercept as far out as the budget line allows him to go. In other words, this question requires a corner solution on the horizontal axis.
19 Which one of the following three statements is false?
A) A cash grant always allows the consumer more choices than a subsidy of equal value applied to only one product.
B) It is possible that a consumer will pick the same market basket when faced with a choice of a cash grant or a single product subsidy of equal value.
C) Cash grants shift part of the budget line to the right but cash subsidies shift the entire budget line to the right.
D) None of the above three statements are false.
Feedback: The cash grant allows the consumer more choice because it moves the budget line to the right. The subsidy moves only part of the budget line rightward.
20 For perfect substitutes
A) the indifference curve is a straight line.
B) there is no diminishing marginal utility.
C) the consumer will either pick a corner solution or be totally indifferent between all possible market baskets.
D) all of the above statements are correct.
Feedback: All are correct including c in which a consumer might have the budget line and the indifference curve perfectly coincide
1 If the rules allow Loud Mouth to do as he pleases and Mr. Mouth and Mr. Fan can negotiate without cost, how many drinks will Loud consume.
A) DR
B) DU
C) DN
D) DK
Feedback: Ardent Fan will pay DEN for a monitor and NEK to bribe Loud not to drink the last NK amount of beer.
2 If the rules prohibit disturbing behavior and are enforced only upon request of an offended party and Loud and Ardent can negotiate freely, how much will Loud drink?
A) DR
B) DU
C) DN
D) DK
Feedback: Now Loud will hire a monitor for DEN because that is less costly than giving up DN beer. However, since his benefit from additional beer is less than the monitor's extra cost he stops drinking at DN.
3 The moral of the story of questions 1 and 2 is
A) Always make the perpetrator of the problem responsible for the solution.
B) There is no efficient outcome of an externality problem.
C) If negotiation cost are zero, it makes no difference who is responsible because efficiency will be reached.
D) If negotiation cost are zero, efficiency is best served if the person held responsible for the problem is the one with the highest cost of solving the problem.
Feedback: The efficient output of DN (where marginal benefit = the lowest marginal cost) is reached no matter who is held responsible.
4 If Ardent and Loud are so upset with each other that no deals can be made and there are no rules against disturbance, then ______ beer will be consumed.
A) DR
B) DU
C) DN
D) DK
Feedback: With no constraint or cost to drinking Loud drinks until he gets the entire DAK amount of benefit.
5 What will be the disturbance cost of Loud's action in question 4 above?
A) DFK
B) DGK
C) DHK
D) DEK
Feedback: Ardent has no alternative left but to move away or absorb the disturbance. Since moving is the least costly he moves and Loud drinks DK which makes his costs DGK.
6 If Ardent and Loud are so upset with each other that no deals can be made and disturbances are stopped upon complaint, how much beer will Loud drink?
A) DR
B) DU
C) DN
D) DK
Feedback: Loud will have no choice but to control his drinking by hiring a behavior monitor or quitting his drinking. Since the cost of the monitor is less than the benefit of drinking, he hires the monitor, drinks to DN and then quits because the benefit of more drinks is less than the cost of the monitor.
7 The moral of the story in questions 4 to 6 is that
A) when negotiation costs are prohibitive the best alternative is to make the person responsible who has the highest cost of solving the problem.
B) when negotiation costs are prohibitive the best alternative is to make the person responsible who has the lowest cost of solving the problem.
C) A law outlawing beer at games would serve society best.
D) No rules or regulations are necessary. Let the parties battle to some solution or live in conflict. The medicine of rules is worse than the externality disease.
Feedback: Loud's costs of solving the problem are lower than Ardent's costs so Loud is forced to solve the problem since he is made responsible.
8 If ball park owners held an auction between Loud and Ardent, how high would Loud bid and who would win the bid for the right to make the beer drinking rules?
A) DEK, Ardent would win the bid.
B) DEK, Loud would win the bid.
C) DEHK, Loud would win the bid.
D) EHK, Ardent would win.
Feedback: Since no one will bid more than their cost of correcting the problem, Loud will bid only DEK since by hiring a monitor and cutting beer back to DN he will absorb that much cost. Since Ardent has higher costs than that he is willing to bid more, but since Loud stops bidding at DEK, Ardent need only bid one penny more to get the rule making rights.
9 In the case of Loud and Ardent, the ball park owners could achieve the efficient result if they added a tax to the cost of beer. The correct amount of tax would be
A) OA per beer.
B) BR per beer.
C) CU per beer.
D) EN per beer.
Feedback: By adding that tax, Loud would have zero extra benefits at DN beers so he would stop drinking at that point. Since that is the efficient point according to the information presented in the problem, the tax would be efficient.
10 In recent months increasing numbers of people in business have begun seeking a career change into academia. The reason often given is that they are tired of working 80 hours a week away from home and would rather have a different lifestyle. Given this information, which of the following statements is clearly false?
A) These people would probably favor a requirement that would make long workweeks an exception rather than the rule.
B) There are positional externalities to long workweeks in a firm.
C) The cost of career climbing is starting to exceed the benefits for these workers.
D) These workers are not willing to give up good ratings and promotions in business for family time, so they seek an environment where family time and work esteem are not mutually exclusive.
E) None of the above are clearly false.
Feedback: The problem of positional externalities frequently makes it hard to optimize lifestyle.
11 Chapter 10 As Ronald Coase pointed out in a famous paper, externalities are reciprocal. This means that
A) everyone absorbs and causes externalities so they cancel for the most part.
B) what is an externality one person is a blessing to another.
C) people pay taxes to alleviate externalities and then receive the benefits of the tax dollars when the externality is eliminated.
D) if an externality is prohibited or fined, some people are helped but those creating the externality are hurt.
Feedback: Injury cannot be avoided when an externality is dealt with. Someone gains and someone loses.
12 Coase suggested that the efficient way to deal with externalities is to
A) hold the perpetrator responsible.
B) develop social rules and rights that force the person with the least cost solution to solve the problem.
C) tax everyone and have the government solve the problem as efficiently as possible.
D) create rules that forbid externalities from being created in the first place.
Feedback: Least cost solutions are always the most efficient if not always the most fair.
13 Economics and law have combined to find the most efficient legal outcomes. As in the safe harbor case, Judges are inclined to find outcomes that
A) will penalize those who take risks.
B) will favor those who have property rights well established.
C) will prevent the problem from happening again.
D) would have been found privately if transactions costs had been zero.
Feedback: This method assesses costs and benefits more accurately and leads to efficient outcomes.
14 The tragedy of the commons would not exist if
A) people would properly assess the average cost of their behavior in public forums.
B) private property was eliminated in cases where the public interest is involved.
C) there was a way to discern and charge for the effects people have on others in public places.
D) everyone was honest and trustworthy.
Feedback: If this was accomplished people would know the true marginal cost of their actions and appropriate charges could be made for what is now held in common. The problem would not be solved by simply higher morals because discerning the real costs is the hard part.
15 The terrorist attacks of September, 2001 illustrate how impossible it is to negotiate on a case by case basis what would be an efficient set of laws to prevent future attacks. Yet the degree of security expense we must absorb should, as much as possible, still be based on the principle that
A) the average cost of security should not be more than the average benefit received from the security.
B) the total cost of security should not exceed the total benefit of the security.
C) the marginal cost of the security should not exceed the marginal benefit of the security.
D) all three of these propose since they are saying, in effect, the same thing.
Feedback: The others would not bring the most efficient amount of security.
16 No law exist which prohibit smoking in apartment buildings even though the externalities of smoking are great. The most likely reason for this is that
A) few people are bothered enough by smoke to make a law against smoking necessary.
B) such a law would be unenforceable .
C) it is relatively easy to protect oneself from secondary smoke in a building.
D) the transactions cost of roommates negotiating an agreement on air rights in an apartment are fairly low.
Feedback: Since costs of negotiation are low, negotiation between roommates and spouses is more efficient than passing a law making everyone in a building adopt the same solution.
17 Which of the following is an example of a positive externality?
A) Your neighbor's fireworks party on July 4.
B) Your neighbor's rock music at midnight when you are trying to sleep.
C) Your favorite ice cream that your neighbor just brought you for desert.
D) Both a and c are positive externalities.
Feedback: Assuming that you like fireworks on July 4 and that he doesn't charge you for the show, this would be a positive externality. The ice cream is free to you but it is paid for by someone and you alone get the benefit.
18 You buy a new car and that makes your neighbor feel poorer until he gets a new car. This is an example of
A) positive externality.
B) tragedy of the commons
C) positional externality
D) violation of home as a safe harbor
19 Your neighbor absorbs a cost because of something you did that affects him. His position is lowered because of the new car.
A) Your neighbor absorbs a cost because of something you did that affects him. His position is lowered because of the new car.
B) Your neighbor absorbs a cost because of something you did that affects him. His position is lowered because of the new car.
C) Your neighbor absorbs a cost because of something you did that affects him. His position is lowered because of the new car.
20 Some argue that private charities should be the ones who provide for the poor in our society. An easily defensible counter argument to this appeal is that
A) private charities can not be sufficiently trained to meet the needs of the poor.
B) there are positive externalities to helping the poor and thus it will be impossible for charities to sufficiently fund these benefits.
C) the poor do not want help from charities.
D) Negotiation costs between the poor and their neighbors are low and so individual solutions can be made to poverty than do not involve charitable organizations.
Feedback: While some of the other answers might have some merit answer b is certainly true and stands as a primary obstacle in shifting the burden of helping the poor from the government to private charities.
21 If the government made a law prohibiting elaborate jewelry for any occasion
A) society as a whole would be worse off because all those with jewels would be worse off and no one would be better off.
B) Society would be worse off because all those who admired the elaborate jewelry would be denied that positive externality.
C) Society would be better off because jewelry has positional externalities that create jewelry expenditure races making no one better off and everyone poorer.
D) People would secretly wear it so the law would be unenforceable.
Feedback: Jewelry, like other nonfunctional consumer items, is a positional good that people pay huge sums for simply to keep up with other people in their social class. If it was outlawed people would still be equal to each other without the expense of jewelry. If there is intrinsic pleasure in wearing jewelry even when one is home alone, or if admiring it on other people in public is a true pleasure than answers a and b could have merit.
22 If the main impact of the Coase theorem is to be summarized it might be as follows.
A) The government should be more active in solving externalities.
B) The informal interactions of private individuals and groups can solve many externality problems.
C) The tragedy of the commons and other negative externality problems are far greater than the positive and positional externality problems
D) People are not inclined to register their preferences where externalities are the issue.
Feedback: Although some may take the views expressed in the other answers, Coase focused on the possibilities of private negotiation as a way to solve the reciprocal nature of externalities.
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