1. E
Ø The first response describes a command economy. The other two choices describe how transactions take place in a market economy.
2. D
Ø A tax on the production of cars increases the cost of producing cars. Thus, the entire supply curve will shift to the left (supply decreases).
3. A
Ø A price floor sets a minimum price at which a producer can sell their product. In order for a price floor to be effective, it must be set above the market equilibrium price. Thus, the intention of a price floor is to help the producers of the good. The price floor will actually result in a surplus of the good since quantity supplied will be greater than quantity demanded.
4. E
Ø This is a simple supply and demand analysis question. Do the shifts to see which answer is correct. Remember, when there are both supply and demand shifts, sometimes the magnitude of the shifts will cause the effect to be unknown. By going through each answer, the only one that is true is if demand increases while supply decreases, the price of tomatoes will definitely increase.
5. A
Ø Consumer surplus is the area under the demand curve above the price. It is the difference between what you are willing to pay and what you actually pay. The thirsty athlete would have paid $1.50 for a drink when she only paid $0.85. This demonstrates the gain to the consumer since the market price was only $0.85.
6. C
Ø ATC (average total cost) = AFC (average fixed cost) + AVC (average variable cost). Thus, ATC of producing 2 units = $50 + $45 = $95.
7. D
Ø To maximize profits, a firm should produce where MR = MC. If it doesn’t work out exactly, you’ll want to produce where MR > MC. Since MR = $85, the firm will produce 5 units of output because the MC = $80 at 5 units, but MC = $90 at 6 units of output.
8. A
Ø Wages are a cost of production for a firm. Thus, if wages increase, the costs of production increase, and, therefore, the firm’s cost curves will shift upward.
9. D
Ø A profit-maximizing firm will always produce where MR = MC. For a perfectly competitive firm, Price (Demand) = MR. Thus, if price increases, the firm will increase output to where the new price crosses the MC curve. In the diagram, this occurs when output equals 18 units.
10. B
Ø A firm in a perfectly competitive market has a horizontal demand curve since it is a price taker. Thus, demand (price) = marginal revenue. If the firm charges a price lower than the market price, it will suffer losses and will eventually be forced out of the industry since there are so many producers. The firm will earn zero economic profits in the long run simply because if there are profits firms will enter, thereby squeezing out all of the profits. Or, if there are losses, firms will exit until the losses disappear.
11. D
Ø The main problem with monopolies are that they reduce output and charge a price higher than a competitive market price since P > MC.
12. A
Ø And increase in the demand for air travel would most likely cause the demand for aircraft mechanics to shift to the right (increase). This is simply a question of derived demand. An increase or decrease in the price of a license necessary for aircraft mechanics would cause the supply of aircraft mechanics to shift left or right respectively. If air travel decreases, there won’t be the need for as many aircraft mechanics (the demand for them decreases or shifts left). Likewise, a decrease in the marginal productivity of aircraft mechanics would decrease the demand for them since D = MRP = MP x P.
13. C
Ø MRP (marginal revenue product) = MP (marginal product) x P (product price). Thus, if MP increases, MRP will increase (shift to the right) and, therefore, the wage rate will rise.
14. E
Ø A positive externality exists when the production of a good results in additional benefits to a third party. Thus, a good that results in a positive externality is often under-produced. So, to increase the production of this good, the government could grant a subsidy to the private producers.
15. A
Ø Progressive income taxes are taxes that increase as income increases. This would not be a source of inequality in the distribution of income.
16. B
Ø In order for the PPC to expand, there must be a technological advancement or and increase in the supply or quality of resources.
17. B
Ø Opportunity cost represents what must be given up in order to have more of something else. Remember, there’s “no such thing as a free lunch.” Thus, to move from B to C, we must give up HG units of good Y. The result of giving up HG units of good Y is the gain of EF units of good X.
18. D
Ø By definition, a normal good is a good whose demand increases when income increases. An inferior good is a good whose demand decreases when income increases. A Giffen good is a good for which the demand curve slopes upward. A public good is a good that is non-exclusive and non-rival in consumption.
19. B
Ø If consumers are warned that eating beef has negative health effects, most likely they will alter their eating habits and demand less beef. Thus, the demand for beef will shift to the left (decrease) and, therefore, the price of beef will fall.
20. B
Ø In order to increase the supply of soldiers, there must be something to entice them to enroll. If wages paid to soldiers decrease, college tuition benefits paid to soldiers decrease, new restrictions are imposed on women in the military, or the required length of service increases, the supply of soldiers will decrease. The only answer that would entice more people to join the military is if the average wage rate of civilian employment declined.
21. E
Ø Complementary goods are goods that are used together. So, if the price of one good increases, the demand for the other good will decrease. Substitute goods are goods that are used in place of each other. So, an increase in the price of once good would actually increase the demand for the other good. Inferior, luxury, and normal goods all pertain to what is happening to their demand when income changes.
22. E
Ø ATC (average total cost) = AVC (average variable cost) + AFC (average fixed cost). Therefore, if AFC = $0, AVC = ATC. AVC will fall if marginal cost is less than average variable cost. Likewise, if marginal product decline, a firm’s average variable cost will rise since their workers aren’t as productive.
23. C
Ø Normal profits = 0 economic profits. If the market price is $6, the firm will produce 12 units of output and its average total costs will equal $6. Thus, the firm will be making 0 economic profits (or normal profits).
24. D
Ø A profit-maximizing firm will always produce where MR = MC. If the market price is $10, this means the firm will produce 16,000 widgets.
25. E
Ø If the costs of an input resource increase, the marginal costs of production will increase at each level of output since the resource is a variable input.
26. C
Ø If the firm increased output to q2, MC > MR (demand). Thus, the firm would experience a decline in profits.
27. A
Ø The first two choices are characteristics of a perfectly competitive industry. The third choice is incorrect since the industry’s demand curve is downward sloping. Remember, it’s the firm’s demand curve that is perfectly elastic (horizontal) since each firm is a price taker. And, the fourth choice is incorrect since the supply curve of an individual firm is its marginal cost curve above its average variable cost curve.
28. D
Ø Since a monopolist’s demand curve is greater than marginal revenue, the monopolist will always produce less than the socially optimum level because P > MC.
29. C
Ø The cost minimizing rule states that the marginal product of the last dollar spent on each resource should equal each other. Or, mathematically, MPx/Px = MPy/Py. The marginal product of the last worker hired is 100 units and the price of that worker is $10 per hour. This gives us 100 / 10 = 10. Whereas, the marginal product of an additional computer is 2000 units and the price of that computer is $100 per hour. This gives us 2000 / 100 = 20. Since an additional computer generates 10 more units than the additional worker, the firm should lay off some workers and rent more computers.
30. B
Ø The taxes are a method to decrease the negative externality that the firm is imposing on society. The firm will weigh the costs and benefits of reducing pollution, and hopefully choose the most efficient method to reduce pollution so that it doesn’t have to pay higher taxes.
31. C
Ø Opportunity cost is the value of the next best forgone alternative. Economic and accounting profits are what you gain from owning a business. The profits that you could be making if you were doing something else with those resources represent what you must give up to run your current business (or, in other words, your opportunity cost).
32. D
Ø So, the quantity of computers sold decreased, but the price remained the same. Since only quantity changed, we know that both the supply and demand curves shifted. If you draw a market in equilibrium and shift the demand curve to the left, you’ll see that quantity and price both fall. In order for price to remain unchanged, supply must also shift to the left. Don’t do these types of problems in your head! Draw the graphs!
33. C
Ø Minimum wage is an example of a price floor. If minimum wage increased, the quantity supplied (workers) will increase, but the quantity demanded (employers looking to hire workers) will decrease. Thus, the wage will be higher, yet employment will actually decrease since firms won’t want to pay that higher wage.
34. A
Ø This is an application of the total revenue test. If total revenue increases when prices increase, then demand is inelastic (arrows move in the same direction). The % decrease in quantity demanded is < the % increase in price. The consumers aren’t really responsive to the price level change.
35. B
Ø Oligopolies will often match price decreases since only a few firms dominate the market and if they didn’t match the price decreases they would go out of business.
36. E
Ø The farmer should continue to produce in the short run as long as the new price is covering his average variable costs. The farmer would incur his fixed costs regardless of whether or not he produced anything in the short run. Thus, if he can cover his variable costs, he should still produce in the short run.
37. C
Ø P = D = MR = MC = ATC for a perfectly competitive firm in long run equilibrium. There will be no incentive for other firms to enter the industry since economic profits are 0 in the long run.
38. A
Ø If you calculate the marginal product of capital from 1 to 2 units and 2 to 3 units of capital you’ll get MP = 40 and MP = 20 for one unit of labor, MP = 60 and MP = 40 for two units of labor, and, MP = 80 and MP = 60 for 3 units of labor. So, if you look at the change in MP when you go from 1 to 2 units of capital, you’ll see that it has increased by 20 (40 to 60 and 60 to 80) with each additional unit of labor. Likewise, if you look at the change in MP when you go from 2 to 3 units of capital, you’ll see that it has increased by 20 (20 to 40 and 40 to 60). Thus, in the long run (when capital can change), there are constant returns to scale. In the short run, the marginal product of capital decreases as you increase the number of labor units (40 to 20).
39. B
Ø The profit-maximizing firm will produce where MR = MC and charge the corresponding price on the demand curve. Since D > MR, the firm will charge a price higher than that necessary to maximize revenues. This firm wouldn’t produce where demand is inelastic since that occurs once MR < 0.
40. B
Ø For a monopolist who does not price discriminate, D > MR and, therefore, when the monopolist produces where MR = MC, he’ll charge the corresponding price on the demand curve which will be greater than marginal cost.
41. C
Ø This is an application of the hiring rule. You’ll always hire up to the point where MRP = MRC. If these figures never equal each other, you’ll never hire when MRP < MRC. In this example, the MRC is the wage rate of $20 per day. To calculate the MRP (marginal revenue product) you must multiply the change in number of sandwiches produced per day for each additional worker (marginal product) times the product price of $0.50. If you do the math, you obtain MRP (starting with 2 workers) of 35, 25, 20, 5, -10, and –15. Since 4 workers yield a MRP of $20, which equals the MRC of $20, 4 workers would be employed.
42. C
Ø With a negative externality, the private market price will be too low and too much will be produced since the producer is not bearing the full cost of production. There is an additional cost to society, which makes the marginal social cost curve higher than the marginal private cost curve.
43. C
Ø A firm always produces where MR = MC. This allows you to rule out answers a and b. The aspect that makes monopolistically competitive firms allocatively inefficient is simply the fact that they’ll charge a price that is greater than the marginal cost (because D > MR). In the long run, these firms will earn 0 economic profits since it is relatively easy for firms to enter and exit the industry.
44. D
Ø This question deals with the concept of resource or derived demand. The demand for a resource depends upon what’s going on in the product markets. In addition, firms will change their demand for a resource based on the prices of substitute resources. A change in the supply of the factor resource will not result in a shift of the demand for that resource, but rather a change in the quantity demanded (movement along the demand curve) of that resource.
45. A
Ø This is an example of a congested public good. As more and more people use the freeway, the cost imposed on others increase because traffic becomes congested and it takes longer to get to your final destination.
46. A
Ø A movement along the curve simply represents a change in society’s wants. A movement from a point on the curve to a point inside the curve means that some of our resources are being underemployed. Growth is shown by an actually shift outward of the production possibilities curve. This can happen if there is a technological advancement or and increase in the quantity or quality of resources.
47. A
Ø A one-of-a-kind product tells us that there is only one product. In other words the supply is fixed. This is illustrated with a perfectly inelastic supply curve.
48. D
Ø In order to get the monopolist to produce more, you could entice them through a subsidy. The subsidy would have to increase as output increases because when the monopolist sells more units, he must lower his price, which applies to all previous units as well.
49. E
Ø Policy I might require a subsidy to the firm simply because if the firm is required to produce where P = MC, it will incur a loss since P < ATC.
50. E
Ø If producers are consistently willing to sell more at the going price and consumers are willing to buy, this tells us that the price is above the market equilibrium price. Price floors (when effective) are set above the market equilibrium price and cause this same result.
51. C
Ø As you consume more and more of a good, your satisfaction from consuming that good eventually diminishes. This is known as the law of diminishing marginal utility. Thus, as additional units are consumed, your marginal utility decreases. Since the good is still bringing you some satisfaction, your total utility will continue to increase up until the point where additional consumption provides disutility (at which you would stop consuming the good even if it were completely free).
52. B
Ø Economies of scale exist when average total costs decrease when production increases. Thus, if a firm doubles its inputs and output triples, average total costs are actually decreasing with the additional output. Economies of scale often occur due to the specialization of labor, management, or capital that occurs when a firm expands.
53. A
Ø As long as marginal cost is less than average total cost, average total cost will be decreasing. Once marginal cost becomes greater than average total cost, average total cost will increase. Thus, average total cost will equal marginal cost when average total cost is a minimum. This of averages and marginal values in terms of grades. If you consistently get low scores, your average will fall. But, if you begin to receive higher marks, your average will begin to rise.
54. C
Ø A profit-maximizing firm will always produce where MR = MC (or at the closed point to that without MC > MR). Thus, this firm would decrease output and charge the corresponding price on the demand curve (which would be higher than the original price).
55. B
Ø The supply curve becomes more elastic in the long run simply because time permits firms to find additional buyers if price increases. Demand is also more elastic in the long run since time allows buyers to seek out substitutes that cost less. This is often referred to as the Second Law of Demand.
56. C
Ø Monopolistically competitive firms produce where MR = MC, and charge the corresponding price on the demand curve. Thus, since D > MR, they will be charging a price that is greater than marginal cost and, thus, they’ll be restricting their output level. These firms actually earn 0 economic profits in the long run because entry and exit is relatively easy.
57. E
Ø Since entry and exit is relatively easy, any economic profits or losses will be squeezed out in the long run (resulting in 0 economic profits).
58. D
Ø The demand for labor or MRP (marginal revenue product) equals MP (marginal product) times P (product price). If the price of a product decreases, the MRP of labor must decrease since MRP = MP x P.
59. B
Ø The hiring rule states that a firm should hire additional resources up until the point where MRP = MRC. Since MRP > MRC (the wage rate), the firm should employ more workers.
60. B
Ø Once a public good is provided, the cost of extending its use to one more person is absolutely nothing. Thus, the marginal cost of providing a pure public good to one more consumer is 0.