Section A: Multiple Choice Questions

1. Scarcity in economics implies that:

o a. Consumers have unlimited money to buy goods

o b. Society always has a surplus of goods and services

o c. There are limited resources but unlimited human wants

o d. Governments can always satisfy social needs with available resources

o e. Every good’s price will continuously fall

[3 marks]

2. Which of the following is studied by microeconomics rather than macroeconomics?

o a. Overall inflation rate in a country

o b. Market demand for electric vehicles

o c. National GDP growth rate

o d. Aggregate unemployment level

o e. A country’s balance of payments

[3 marks]

3. Economic models are useful because they:

o a. Exactly reproduce all details of the real world

o b. Exclude all assumptions about human behavior

o c. Include only the features needed for analysis of a specific issue

o d. Never make predictions about economic outcomes

o e. Assume all goods are free

[3 marks]

4. The ceteris paribus assumption in economics means:

o a. All variables change together over time

o b. One variable changes while others are held constant

o c. Government policy automatically adjusts markets

 o d. Prices always equal marginal cost

o e. Consumers’ tastes never change

[3 marks]

5. Which of the following best describes a perfectly competitive market?

o a. A market with many buyers and sellers trading identical products

o b. A market with a single seller of a unique product

o c. A market where only government-set prices are allowed

o d. A market dominated by a few large firms producing differentiated products

o e. A market with no entry of new firms

[3 marks]

6. Porter’s Five Forces framework is primarily used to analyze:

o a. Consumer demand elasticity

o b. The competitive structure and profitability of an industry

o c. Aggregate supply in the economy

o d. Fiscal policy tools

o e. Exchange rate fluctuations

[3 marks]

7. Which of the following is NOT one of Porter’s Five Forces?

o a. Threat of new entrants

o b. Bargaining power of suppliers

o c. Technological change

o d. Bargaining power of buyers

o e. Intensity of competitive rivalry

[3 marks]

8. Porter’s generic strategies for achieving competitive advantage include:

o a. Horizontal integration and vertical integration

 o b. Cost leadership and differentiation

o c. Market penetration and market development

o d. Collusion and price fixing

o e. Outsourcing and offshoring

[3 marks]

9. If the price of coffee increases and the quantity demanded of tea also increases,
then tea is:

o a. An inferior good

o b. A substitute for coffee

o c. A complement to coffee

o d. A public good

o e. A necessity good

[3 marks]

10. The Marginal Rate of Substitution (MRS) between two goods is:

o a. The ratio of their prices in the market

o b. The amount of one good a consumer will trade for another while keeping
the same utility

o c. The total utility gained from consuming one more unit of a good

o d. The slope of the supply curve

o e. Always equal to 1 for convex preferences

[3 marks]

11. Which statement about indifference curves is FALSE?

o a. They slope downward to the right.

o b. They are typically convex toward the origin.

o c. Higher indifference curves represent higher utility levels.

o d. Indifference curves of a single consumer cannot cross each other.

o e. They represent combinations of goods yielding the same total revenue.

[3 marks]

12. If a consumer’s income increases (and prices remain constant), the budget
constraint will:

o a. Shift outward in parallel

o b. Rotate around the current intercept

o c. Become steeper

o d. Become flatter

o e. Remain unchanged

[3 marks]

13. Which of the following would cause a movement along a normal good’s demand
curve (change in quantity demanded) rather than a shift of the demand curve?

o a. A rise in the good’s own price

o b. A change in consumer income

o c. A change in consumer tastes/preferences

o d. A change in the price of a related good

o e. A change in the number of buyers in the market

[3 marks]

14. The law of supply states that, ceteris paribus:

o a. As price rises, quantity supplied rises

o b. As price rises, quantity supplied falls

o c. Quantity supplied is independent of price

o d. Supply is always greater than demand

o e. Firms cannot alter supply in the short run

[3 marks]

15. Which of the following would shift the supply curve for a product to the right
(increase supply)?

o a. A new tax imposed on producers

 o b. A rise in the price of a key input

o c. Technological improvement in production

o d. Increase in the number of consumers

o e. Government-imposed price floor

[3 marks]

16. Market equilibrium price and quantity occur where:

o a. Quantity supplied exceeds quantity demanded

o b. Quantity demanded exceeds quantity supplied

o c. Quantity demanded equals quantity supplied

o d. Consumer surplus is maximized

o e. Total cost equals total revenue

[3 marks]

17. A binding price ceiling set below the equilibrium price generally leads to:

o a. A surplus of the good

o b. A shortage of the good

o c. An increase in equilibrium price

o d. No change in the market

o e. Producers bearing all of the price adjustments

[3 marks]

18. A binding price floor (e.g. a minimum wage above the market-clearing wage) will
typically cause:

o a. Excess supply (e.g. unemployment)

o b. Excess demand (e.g. labor shortage)

o c. No change if non-binding

o d. The market to clear at a lower price

o e. Marginal cost to drop

[3 marks]

19. A 5% increase in the price of a good leads to a 10% decrease in quantity demanded.
The demand is:

o a. Elastic

o b. Inelastic

o c. Unit elastic

o d. Perfectly inelastic

o e. Perfectly elastic

[3 marks]

20. If demand for a product is elastic (elasticity > 1), then a decrease in price will:

o a. Decrease total revenue

o b. Increase total revenue

o c. Leave total revenue unchanged

o d. Make demand inelastic

o e. None of the above

[3 marks]

21. If consumer income rises and the demand for good X increases, then X is:

o a. A normal good

o b. An inferior good

o c. A luxury good (provided elasticity > 1)

o d. A Giffen good

o e. None of the above

[3 marks]

22. An increase in the price of a Giffen good will:

o a. Increase the quantity demanded of that good

o b. Decrease the quantity demanded of that good

 o c. Not change the quantity demanded

o d. Increase demand for its complement

o e. Have an unpredictable effect on demand

[3 marks]

23. The law of diminishing marginal returns implies that as more of a variable input is
added to fixed inputs:

o a. Total output eventually decreases

o b. Marginal cost of production eventually increases

o c. Average cost remains constant

o d. Output increases indefinitely at the same rate

o e. Production will always be inefficient

[3 marks]

24. Marginal product of labor is defined as:

o a. Total output divided by total labor

o b. The change in total output from hiring an additional worker

o c. The total output when labor is doubled

o d. Output per dollar spent on labor

o e. Fixed output when labor is fixed

[3 marks]

25. If doubling all inputs leads to more than double the output, the production function
exhibits:

o a. Increasing returns to scale

o b. Decreasing returns to scale

o c. Constant returns to scale

o d. Diminishing marginal returns

o e. Negative returns

[3 marks]
 26. Which of the following is a fixed cost for a factory?

o a. Cost of raw materials per unit produced

o b. Monthly rent of the factory building

o c. Wages paid per hour of labor

o d. Electricity bill for running machines

o e. Commissions per unit sold

[3 marks]

27. The marginal cost curve is typically:

o a. Always upward sloping (rising)

o b. Always downward sloping

o c. U-shaped (first falling then rising)

o d. Horizontal

o e. Vertical

[3 marks]

28. Marginal cost intersects average total cost at:

o a. The maximum point of ATC

o b. The minimum point of ATC

o c. The maximum point of AVC

o d. A point where ATC is falling

o e. No intersection except at zero output

[3 marks]

29. Average variable cost (AVC) is calculated as:

o a. Total fixed cost / quantity

o b. Total variable cost / quantity

o c. Average total cost – average fixed cost

o d. Total cost / quantity

 o e. (Marginal cost + average fixed cost) / 2

[3 marks]

30. A perfectly competitive firm’s demand curve is:

o a. Downward sloping due to market power

o b. Horizontal at the market price

o c. Vertical at the optimal output

o d. U-shaped

o e. Part of its marginal cost curve

[3 marks]

31. In the short run, a perfectly competitive firm maximizes profit by producing where:

o a. Price equals marginal cost (P = MC)

o b. Price equals average total cost (P = ATC)

o c. Marginal revenue equals average variable cost (MR = AVC)

o d. Marginal cost equals average total cost (MC = ATC)

o e. Marginal revenue is zero (MR = 0)

[3 marks]

32. In long-run equilibrium of perfect competition:

o a. Firms earn positive economic profits

o b. Firms earn zero economic profit

o c. Firms make losses and go out of business

o d. Price is less than marginal cost

o e. Barriers to entry exist

[3 marks]

33. A monopoly firm maximizes profit by producing where:

o a. Price equals marginal cost (P = MC)

o b. Price equals average total cost

 o c. Marginal revenue equals marginal cost (MR = MC)

o d. Output is zero

o e. Demand is perfectly elastic

[3 marks]

34. Monopoly compared to perfect competition generally leads to:

o a. Higher output and lower prices

o b. Allocative and productive efficiency

o c. A deadweight loss to society

o d. Zero economic profit for the firm

o e. Equal consumer surplus

[3 marks]

35. Which is NOT an assumption of the monopoly market model?

o a. A single seller with no close substitutes for the product

o b. High barriers to entry prevent competition

o c. The monopolist is a price taker in setting its price

o d. The monopolist’s demand curve is the market demand

o e. Marginal revenue is below price for positive output

[3 marks]

36. Third-degree price discrimination means:

o a. Charging each customer their maximum willingness to pay

o b. Charging different prices in different market segments

o c. Charging the same price per unit for all quantity sold

o d. Charging more for higher quantities purchased

o e. Illegal in all markets

[3 marks]

37. A necessary condition for successful price discrimination is:

 o a. All consumers have identical demand curves

o b. The firm cannot identify different types of buyers

o c. Preventing resale between customer groups

o d. Demand is perfectly elastic

o e. The government subsidizes the product

[3 marks]

38. In long-run equilibrium of monopolistic competition:

o a. Firms earn positive economic profit due to branding

o b. Firms earn zero economic profit (normal profit)

o c. Firms produce at minimum average total cost

o d. There are significant barriers to entry

o e. Price equals marginal cost

[3 marks]

39. An oligopoly is characterized by:

o a. Many firms selling identical products

o b. A single firm with complete market power

o c. A few interdependent firms with barriers to entry

o d. Firms that cannot observe each other’s prices

o e. Perfectly elastic demand

[3 marks]

40. The Cournot model of oligopoly assumes that:

o a. Firms compete by setting prices simultaneously

o b. Firms collude to set output like a monopoly

o c. Each firm chooses output assuming rivals’ output is fixed

o d. Marginal cost is zero for all firms

o e. Entry into the market is unrestricted

[3 marks]

41. A Nash equilibrium is defined as a set of strategies where:

o a. Each player’s strategy is the best response to the other players’ strategies

o b. All players obtain the same payoff

o c. One player dominates the outcomes

o d. The outcome maximizes total social welfare

o e. There is no interaction between players

[3 marks]

42. In the classic Prisoner’s Dilemma game, the dominant strategy outcome is that:

o a. Both players cooperate

o b. Both players defect (betray)

o c. One defects and the other cooperates

o d. No strategy is dominant

o e. Payoffs are maximized

[3 marks]

43. Collusion among firms tends to be more sustainable when:

o a. There are many small firms in the market

o b. Products are highly differentiated

o c. Market demand is very unstable

o d. The number of firms is small and products are homogeneous

o e. Government regulation enforces open competition

[3 marks]

44. Which of the following is NOT a measure of market concentration?

o a. Four-firm concentration ratio (C4)

o b. Herfindahl-Hirschman Index (HHI)

o c. Gini coefficient
 o d. Five-firm concentration ratio (C5)

o e. All of the above measure concentration

[3 marks]

45. Gross Domestic Product (GDP) is best defined as:

o a. The total income earned by a country’s residents anywhere

o b. The total market value of final goods and services produced within a
country

o c. The total exports minus imports of a country

o d. The sum of consumer and government spending only

o e. The average income per person

[3 marks]

46. The expenditure approach to GDP calculation is given by:

o a. Y = C + S + T

o b. Y = C + I + G + (X – M)

o c. Y = I + T + M

o d. Y = C + M – G

o e. Y = (X – M) + T

[3 marks]

47. Inflation is defined as:

o a. A continuous decrease in the general price level

o b. A sustained increase in the average level of prices

o c. A government budget deficit

o d. The amount of money in circulation at any time

o e. The unemployment rate

[3 marks]

48. A current account surplus means that:

 o a. A country’s exports exceed its imports

o b. A country’s imports exceed its exports

o c. Fiscal deficit is greater than fiscal surplus

o d. Monetary policy is tightened

o e. Savings equal investment

[3 marks]

49. Which of the following is an example of a negative externality?

o a. A beekeeper’s bees pollinating nearby crops (benefit)

o b. A factory emitting pollution that harms local residents

o c. Reading in a library that helps others (positive spillover)

o d. Planting trees on private land (no external cost)

o e. Wearing a designer outfit to impress others

[3 marks]

50. Clean air, which anyone can breathe and one person breathing does not reduce
availability, is an example of:

o a. Private good

o b. Public good

o c. Common resource

o d. Club good

o e. Inferior good

[3 marks]

Section B: Short Answer Questions (5 marks each)

1. Ceteris Paribus: Define the term ceteris paribus and explain why economists use
this assumption in analyzing economic relationships. (5 marks)

2. Indifference Curves: Explain why indifference curves are typically drawn as convex
to the origin. Why cannot two indifference curves of the same consumer cross? (5
marks)
3. Price Elasticity of Demand: Define price elasticity of demand (PED) in words.
Discuss why knowing the PED of a product is useful for a firm when setting prices. (5
marks)

4. Elasticity Calculation: The price of a product increases from £10 to £12 and
quantity demanded falls from 100 units to 80 units. Calculate the price elasticity of
demand using the midpoint formula, and state whether demand is elastic, inelastic,
or unit elastic. (5 marks)

5. Demand vs. Shift: Explain the difference between a movement along a demand
curve and a shift of the demand curve. Give a real-world example of a factor that
would cause (a) a movement along the demand curve and (b) a shift of the demand
curve. (5 marks)

6. Supply Curve Shift: List three factors (other than the product’s own price) that
would shift the supply curve of a good, and explain the direction of each shift. (5
marks)

7. Diminishing Returns: State the law of diminishing marginal returns in production.

How does this principle affect a firm’s marginal cost as output increases? (5 marks)

8. Perfect Competition Assumptions: List three key assumptions of the perfect

competition model. For one of these assumptions, explain its implication for market
outcomes. (5 marks)

9. Barriers to Entry: Identify and briefly describe three types of barriers to entry that
can allow a monopoly to persist in a market. (5 marks)

10. Tax Incidence: Suppose the government imposes a £1 per-unit tax on cigarettes.
Using a supply and demand diagram, explain how this tax affects the market
equilibrium (price and quantity). Who ultimately bears the burden of the tax? (5
marks)

11. Deadweight Loss: Define deadweight loss in the context of monopoly. Using a
diagram, show the deadweight loss caused by a monopolist compared to a perfectly
competitive outcome. (5 marks)

12. Giffen Good: What is a Giffen good? Explain why its demand curve can slope
upward, using an example if possible. (5 marks)

13. Market Concentration: Define the Herfindahl-Hirschman Index (HHI) and explain
how it is calculated. What does a higher HHI indicate about a market’s structure? (5
marks)
 14. Inferior vs Normal Goods: Distinguish between inferior goods and normal goods.
Give an example of each and explain how demand for each responds to changes in
income. (5 marks)

15. Allocative Efficiency: What is allocative (Pareto) efficiency in a market? Under what
condition (in terms of price and marginal cost) is allocative efficiency achieved? (5
marks)

16. Short-Run vs Long-Run Costs: Explain why the short-run average total cost
(SRATC) curve is U-shaped. Why is the SRATC curve never below the long-run
average cost (LRAC) curve? (5 marks)

17. Monopoly vs Perfect Competition: Briefly compare a monopolist and a perfectly

competitive firm in terms of (a) market power, (b) long-run economic profits, and (c)
efficiency. (5 marks)

18. Game Theory: What is a dominant strategy in game theory? Explain its significance
with a brief example (you may describe the Prisoner’s Dilemma). (5 marks)

19. Collusion: Explain what collusion is in an oligopoly market. Why might firms in an
oligopoly attempt to collude, and what makes collusion difficult to sustain? (5
marks)

20. Price Discrimination: List two conditions necessary for successful price
discrimination. Provide an example of a third-degree price discrimination scenario.
(5 marks)

Section C: Essay Questions (15 marks each)

1. Industry Analysis (Five Forces): A large technology company is considering

entering the electric vehicle (EV) market. Using Porter’s Five Forces framework,
analyze the potential profitability and competitive dynamics of this industry. In your
answer, identify each of Porter’s forces and discuss how they are likely to affect a
new entrant in the EV market. (15 marks)

2. Collusion and Cartels: Define collusion and explain why firms in an oligopolistic
market might collude. Using a payoff matrix or qualitative explanation, discuss the
incentives for firms to collude or cheat on a collusive agreement. Illustrate your
answer with a real or hypothetical example (e.g., airline or pharmaceutical industry
collusion). (15 marks)

3. Market Structures – PC vs. Monopoly: Compare and contrast the perfectly

competitive market and the monopoly market in terms of firm characteristics
 (number of firms, product type, entry barriers), pricing, output decisions, and
welfare outcomes. Use supply-and-demand diagrams to show how price and output
are determined in each case. Discuss implications for consumer surplus, producer
surplus, and overall efficiency under each market structure. (15 marks)

4. Natural Monopoly: Explain the concept of a natural monopoly and why such
markets often occur in industries with large economies of scale (e.g., public
utilities). Discuss how a natural monopoly can be considered inefficient in terms of
competition but potentially desirable in terms of economies of scale. Use the
example of a local water supply company (like a city’s water utility) to illustrate your
points, including any welfare implications. (15 marks)

5. Macroeconomic Environment: In recent times, many economies have faced high

inflation and slow growth. Discuss how a high-inflation, low-growth environment
(stagflation) might impact firms’ pricing strategies, cost structures, and investment
decisions. Consider effects on both businesses and consumers, and provide
examples of sectors that might be particularly affected (e.g., retail, banking,
manufacturing). (15 marks)

6. Taxes and Market Outcome: Consider the imposition of a per-unit tax on

cigarettes. Explain how this tax affects the equilibrium price and quantity in the
market, the tax incidence (who bears the burden), and social welfare (including
deadweight loss). Use supply and demand diagrams to illustrate your analysis.
Extend your discussion by comparing the effects of the tax on the tobacco market
versus on a highly elastic market like consumer electronics. (15 marks)

Answer Key

Section A Answers

1. c) Scarcity means resources are limited while human wants are unlimited.
Economics studies how to allocate these scarce resources (L10-L12) (Introduction
and models - [Link]).

2. b) Market demand for electric vehicles is a microeconomic issue (individual

markets), whereas the others are macroeconomic.

3. c) Economic models include only relevant features needed for analysis and
prediction. They simplify reality with assumptions (Introduction and models -
[Link]).

4. b) Ceteris paribus means “all else equal”: one variable changes while others are
held constant (Introduction and models - [Link]).
5. a) Many buyers and sellers of identical products is the hallmark of perfect
competition.

6. b) Porter’s Five Forces analyzes industry structure and profitability (Strategy and Five
Forces - [Link]) (Strategy and Five Forces - [Link]).

7. c) Technological change is not one of Porter’s original five forces (the others are
entry, suppliers, buyers, substitutes, rivalry).

8. b) Porter identified cost leadership and differentiation as the two generic strategies
(Strategy and Five Forces - [Link]).

9. b) If coffee price rises and tea demand rises, tea is a substitute for coffee.

10. b) MRS is the rate at which a consumer will trade one good for another while keeping
utility constant (slope of indifference curve) (UG Class sheet [Link]).

11. e) Indifference curves show equal utility (not revenue), slope down due to trade-
offs, cannot cross (revealed by convexity) (UG Class sheet [Link]) (UG Class sheet
[Link]).

12. a) An increase in income shifts the budget line outward in parallel (more income
means afford more of both goods).

13. a) Only a change in the good’s own price causes a movement along its demand
curve; the other factors shift the curve.

14. a) Law of supply: higher price → higher quantity supplied (upward-sloping supply
curve) (4 - Supply and equilibrium - [Link]).

15. c) Technological improvement lowers production costs and increases supply

(rightward shift).

16. c) Equilibrium is where quantity demanded equals quantity supplied.

17. b) A binding price ceiling (below equilibrium) causes shortages (excess demand).

18. a) A binding price floor (above equilibrium) causes excess supply (unemployment, if
labor market).

19. a) Elastic: |%ΔQ| > |%ΔP| (10%/5% = 2 > 1), so elastic demand.

20. b) If demand is elastic, price cuts increase total revenue (more proportionate
increase in Q).
21. a) If demand increases with income, X is a normal good (demand falls if income
falls) (UG Class sheet [Link]).

22. a) A Giffen good’s demand rises when price increases (upward-sloping demand due
to strong income effect).

23. b) Diminishing returns imply marginal product eventually falls, so marginal cost
eventually rises (U-shaped MC).

24. b) Marginal product is the extra output from one additional unit of input (ΔQ/ΔL).

25. a) If output more than doubles when inputs double, increasing returns to scale.

26. b) Factory rent is fixed cost (does not vary with output).

27. c) MC is usually U-shaped (falls then rises) due to diminishing returns.

28. b) MC intersects ATC at ATC’s minimum point.

29. b) AVC = TVC/Q (by definition), which is also ATC – AFC.

30. b) A competitive firm’s demand curve is horizontal at the market price (perfectly
elastic).

31. a) Profit maximization in PC occurs where P (which equals MR) = MC.

32. b) In the long run, PC firms earn zero economic profit (normal profit) due to free
entry.

33. c) A monopolist maximizes profit by setting MR = MC (then uses demand to find

price).

34. c) Monopoly causes deadweight loss (inefficiency), lower output and higher price
than PC.

35. c) Monopolist is not a price taker (d is correct statement for PC, not monopoly).

36. b) Third-degree discrimination = different prices to different market segments (e.g.

student vs normal pricing).

37. c) Successful discrimination requires market segmentation and no resale (must

prevent arbitrage).

38. b) Long-run monopolistic competitors earn zero economic profit (free entry erodes
profit).

39. c) Oligopoly: few interdependent firms with barriers (e.g. airlines).

 40. c) Cournot: firms choose output assuming competitors’ output is fixed.

41. a) Nash eq: each player’s strategy is optimal given the others’ strategies.

42. b) In Prisoner’s Dilemma, both players’ dominant strategy is to defect (betray).

43. d) Collusion is easiest when few firms and similar products (homogeneous) – less
incentive to cheat.

44. c) Gini coefficient measures income inequality, not market concentration.

45. b) GDP = value of all final goods/services produced domestically in a period.

46. b) Expenditure GDP: Y = C + I + G + (X – M).

47. b) Inflation = sustained rise in the general price level.

48. a) Current account surplus: exports > imports.

49. b) Factory pollution harming others is a negative externality.

50. c) Clean air is a common resource (non-excludable but rivalrous when scarce).

Section B Answers

1. Ceteris Paribus: Ceteris paribus means “other things being equal.” Economists use
it to isolate the effect of one variable by holding all other relevant factors constant
(Introduction and models - [Link]). This simplifies analysis and helps study
cause-and-effect relationships (e.g. how price changes affect demand while
assuming income and preferences don’t change).

2. Indifference Curves: Indifference curves are typically convex to the origin because
of diminishing marginal rate of substitution – as a consumer has more of good X and
less of Y, they are willing to give up fewer units of Y for additional X. Convexity
reflects the preference for diversified bundles over extremes. Two indifference
curves cannot cross for the same consumer, because that would violate the
assumption that higher curves represent higher utility. Crossing curves would imply
inconsistent preferences.

3. Price Elasticity of Demand (PED): PED measures the responsiveness of quantity

demanded to a change in price. Formally, PED = (% change in Qd) / (% change in
P). It is useful because it tells a firm how total revenue will change with price: if
demand is elastic, a price cut raises revenue, whereas if it is inelastic, a price cut
lowers revenue. Firms use PED to set prices strategically (e.g. luxury goods often
face elastic demand, necessitating careful pricing).
4. Elasticity Calculation: Initial price P₁ = £10, P₂ = £12; Q₁ = 100, Q₂ = 80. Midpoint
%ΔP = ((12–10)/11)×100% ≈ +18.18%. %ΔQ = ((80–100)/90)×100% ≈ –22.22%. PED ≈
|–22.22/18.18| = 1.22. Since PED > 1, demand is elastic.

5. Demand Movement vs Shift: A movement along the demand curve occurs when
the good’s own price changes (quantity demanded changes in response). For
example, if the price of coffee rises, we move up along the coffee demand curve. A
shift of the demand curve happens due to non-price factors (income, tastes, prices
of related goods). For instance, if consumer income increases, the demand for
normal goods shifts out (right).

6. Supply Curve Shifters: (i) Input prices: If the price of a key input falls (e.g. cheaper
labor), supply increases (shift right). (ii) Technology: An advance (e.g. automation)
increases supply (shift right). (iii) Number of sellers: More firms entering boosts
market supply (shift right). Conversely, a tax on production or a rise in input costs
would shift supply left.

7. Diminishing Returns: The law of diminishing marginal returns states that as more
units of a variable input (e.g. labor) are added to fixed inputs, eventually the
additional output (marginal product) from each new unit declines. This increases a
firm’s marginal cost as output rises, because more and more input is required for
each extra unit of output.

8. Perfect Competition Assumptions: (a) Many small firms and buyers exist (no
single agent can influence price). (b) Products are homogenous (identical). (c) Free
entry and exit (no long-run economic profit). One implication: no single firm can set
price above market level; each is a price-taker and produces where P = MC in
equilibrium.

9. Barriers to Entry: (1) Legal barriers: Patents or licenses restrict entry (e.g.
pharmaceutical patents). (2) Economies of scale: Incumbents have cost
advantages making entry unprofitable (e.g. utility networks). (3) Ownership of
resources: Control of a critical input (e.g. De Beers controlling diamond mines).
These prevent new firms from entering, sustaining monopoly power.

10. Tax Incidence: Imposing a per-unit tax shifts the supply curve up by the tax amount
(to S+tax). Equilibrium price rises and quantity falls. The incidence (burden)
depends on elasticities: if demand is relatively inelastic (as with cigarettes),
consumers bear most of the tax (higher price paid by consumers) (Strategy and Five
Forces - [Link]). The remaining tax is absorbed by producers (lower net price
received). The tax creates a deadweight loss, reducing welfare.
11. Deadweight Loss: Deadweight loss (DWL) is the loss of total surplus when a market
is not at the efficient (competitive) outcome. In monopoly, price is above marginal
cost, so the monopolist produces less than the competitive output. The area
between the demand and supply curves (MC) over the lost output units is the DWL.
On a diagram, DWL is the triangle between the competitive equilibrium and
monopoly outcome. Consumers buy less, and some mutually beneficial trades do
not occur.

12. Giffen Good: A Giffen good is an inferior good for which the income effect of a price
rise outweighs the substitution effect, causing the quantity demanded to rise when
its price rises (upward-sloping demand). For example, if bread is a staple for a low-
income consumer, a price increase might make them effectively poorer, so they
can’t afford more expensive substitutes (meat) and paradoxically buy more bread
despite the higher price. This contravenes the normal law of demand.

13. Herfindahl-Hirschman Index: HHI = Σ (market share of firm i)² (expressed as

percentages). For example, if four firms have 50%, 30%, 15%, 5% shares, HHI =
50²+30²+15²+5² = 3650. A higher HHI indicates a more concentrated market (less
competition). Regulatory agencies use HHI to assess market concentration: higher
values (close to 10,000) signal monopoly or tight oligopoly, whereas low values
indicate competitive markets.

14. Inferior vs Normal Goods: An inferior good is one where demand falls as consumer
income rises (e.g. generic brands, bus travel). A normal good is one where demand
rises with income (e.g. restaurant meals, electronics). For example, as incomes
increase, people buy more dining-out (normal good) and less instant noodles
(inferior good).

15. Allocative Efficiency: Allocative (Pareto) efficiency occurs when the price of the
good equals its marginal cost (P = MC). This condition ensures that resources are
allocated to produce exactly what consumers value, maximizing total surplus. In
perfect competition, P = MC at equilibrium, so allocative efficiency is achieved. In
monopoly, P > MC, indicating allocative inefficiency (welfare loss).

16. Short-Run vs Long-Run Costs: The SRATC curve is U-shaped because it reflects
first increasing then diminishing returns: at low output, fixed cost is spread out
(falling ATC), then increasing marginal costs eventually dominate (rising ATC). The
SRATC is never below LRAC because the LRAC represents the lowest possible cost
curve when the firm can adjust all inputs. LRAC envelopes the SR curves, and in the
 short run the firm cannot achieve the minimum efficient scale unless it is at the
bottom of LRAC.

17. Monopoly vs Perfect Competition:

o (a) Market Power: PC firms have no market power (price-takers). A

monopolist has significant market power (price-maker).

o (b) Long-run Profits: In PC, free entry leads to zero economic profit in the long
run. A monopolist can sustain positive economic profit indefinitely due to
entry barriers.

o (c) Efficiency: PC is efficient (P = MC, producers at min ATC), maximizing total

welfare. Monopoly produces lower output at higher price (P > MC), causing
deadweight loss and allocative inefficiency.

18. Dominant Strategy: A dominant strategy is one that yields a player the highest
payoff regardless of the other players’ actions. In game theory, if a player has a
dominant strategy, they will choose it no matter what the rival does. For example, in
the Prisoner’s Dilemma, each prisoner’s dominant strategy is to confess (defect),
even though both would be better off if they both remained silent (cooperated). The
result (both defecting) is a Nash equilibrium but not a cooperative outcome.

19. Collusion: Collusion occurs when firms in an oligopoly agree (explicitly or tacitly) to
restrict competition, typically by setting high prices or output quotas (like a cartel).
Firms collude to increase joint profits (acting like a monopolist). However, collusion
is hard to sustain because each firm has an incentive to cheat by secretly
undercutting price or increasing output to capture more market share, which can
lead to breakdown of the agreement (prisoner’s dilemma scenario). External
enforcement or strong trust is often required to maintain a cartel.

20. Price Discrimination Conditions: Two conditions are: (1) The firm can segment the
market into groups with different price elasticities (e.g. students vs non-students).
(2) No arbitrage between segments (consumers cannot resell to each other at a
profit). For example, airlines often use third-degree discrimination by charging
different fares in different markets (business vs leisure travellers) based on differing
demand elasticities.

Section C Answers

1. Industry Analysis (Five Forces): To assess the EV market, we apply Porter’s Five
Forces:
 o Threat of New Entrants: Barriers include high R&D costs, established
brands, and charging infrastructure requirements. Tesla’s strong brand and
patents raise entry barriers, which could benefit incumbents.

o Bargaining Power of Suppliers: Key inputs (batteries, rare minerals) may be

concentrated. If few battery suppliers exist, they can demand high prices,
squeezing auto firms’ margins. However, large EV firms may integrate supply
(vertical integration) to reduce this power.

o Bargaining Power of Buyers: Buyers today have more options (Tesla, VW,
GM, etc.) but brand loyalty and technical complexity (range anxiety,
performance) give firms some pricing power. As more competitors enter,
buyer power increases (firms compete on price/features).

o Threat of Substitutes: Traditional gasoline cars and public transport are

substitutes. If fuel prices fall, consumers might switch away from EVs. High
performance hydrogen or emerging tech (e.g. advanced public transit) could
also substitute. A higher substitute threat limits profitability.

o Industry Rivalry: Rivalry is intense with several big automakers and tech
entrants (e.g. new startups). Rapid innovation cycles, heavy marketing, and
price competition (tax credits affecting net prices) intensify rivalry, typically
reducing margins.
In summary, the EV industry has high capital and technology barriers
(moderate threat of new entrants), some supplier power (materials),
increasing buyer options, significant threat from traditional cars as
substitutes, and fierce rivalry. Overall profitability will depend on managing
costs (e.g. battery tech) and innovation to mitigate rivalry, while taking
advantage of rising demand for green vehicles.

2. Collusion and Cartels: Collusion is when oligopoly firms cooperate (often secretly)
to act like a monopoly, setting higher prices or controlling output. They do so to
increase joint profits. For instance, if two airlines collude on seat prices, they split a
higher monopoly output and share profits. However, each firm has an incentive to
cheat by slightly undercutting price or expanding output to gain extra profit (the
Prisoner’s Dilemma).
A simple payoff matrix can illustrate: suppose two firms agree to produce 100 units
each (monopoly output), earning $500 each. If one cheats by producing 120, it might
earn $550 while the other earns $450. The equilibrium (non-cooperative) is both
produce 120 (Cournot equilibrium) and earn less ($400 each) than under collusion.
 The dominant strategy for each is to cheat, leading to the stable (but less profitable)
Nash outcome where neither colludes.
In practice, cartels (like OPEC in oil or past truck manufacturers) try to enforce
agreements by setting quotas or penalties. Collusion is easier when there are few
firms, demand is stable, and products are similar. For example, if three major truck
makers secretly agreed on prices, they maximize combined profits. But if one maker
secretly sells more at a slightly lower price, it gains market share. Governments also
often crack down on cartels, making collusion risky.

3. Market Structures – PC vs Monopoly:

o Number of Firms: PC has many small firms; monopoly has one.

o Product: PC firms sell identical products; monopoly sells a unique product

with no close substitutes.

o Entry Barriers: PC has free entry/exit; monopoly has high barriers (patents,
resources).

o Pricing: PC firms are price-takers (P fixed by market, P=MC); monopoly is a

price-maker (sets P > MC to maximize profit).

o Output: PC equilibrium output maximizes efficiency (many trades occur).

Monopoly restricts output to raise price (output < competitive level).

o Diagram: In PC, supply and demand intersect at P* = MC, with

consumer+producer surplus maximized. In monopoly, MR=MC determines
output Qm, price Pm from demand. Pm > MC → deadweight loss (triangle
between demand and MC from Qm to Qc) (Strategy and Five Forces -
[Link]).

o Efficiency: PC is allocatively efficient (P=MC) and productively efficient

(firms produce at min ATC). Monopoly is allocatively inefficient (P > MC)
causing DWL, and often productively inefficient (produces on a higher-cost
portion of average cost).

o Consumer Surplus: Higher in PC (lower P, higher Q). Monopoly raises price,

transfers surplus to producer, and creates DWL.
In summary, perfect competition yields maximum total surplus (efficient
outcome). Monopoly yields higher profits for the firm but lower consumer
surplus and inefficiency.
4. Natural Monopoly: A natural monopoly arises when one firm can supply the entire
market at a lower cost than multiple firms, due to large economies of scale (LRAC
declining over market range). Utility industries (water, electricity) often have huge
fixed infrastructure costs but low additional cost per customer.

o Inefficiency (Competition): In theory, competition is ideal, but in a natural

monopoly, duplicating infrastructure is wasteful. If this market were perfectly
competitive, many small providers would each have high costs, raising
prices.

o Desirability (Scale): Allowing one firm (under regulation) can be efficient.

The single large firm achieves the lowest average cost, benefiting from
spreading fixed costs. It can charge a regulated price closer to MC without
losing money.

o Example – Water Supply: If Bath Water Co. is the only provider, it builds one
network of pipes. If competition were forced, two companies would
duplicate pipes (inefficient). The water company might charge a monopoly
price above MC, causing inefficiency. But society accepts this because it’s
cheaper than multiple overlapping networks. Regulation (e.g. price caps) is
often used to protect consumers.
Thus, a natural monopoly can be considered inefficient from an allocative
standpoint (since P > MC implies welfare loss) but desirable from a cost
standpoint (lower costs than any competitive outcome). The trade-off is
managed by regulation to balance price/cost.

5. Macroeconomic Environment: In a high-inflation, low-growth scenario

(stagflation):

o Pricing Strategies: Firms face rising input costs (wages, materials) and may
have to raise prices frequently. If demand is weak (slow growth), raising
prices can reduce quantity sold. Firms might invest in cost-saving
technologies. They may also be cautious with price increases, absorbing
some cost to retain customers. For example, grocery retailers might keep
staple food prices relatively stable to maintain demand.

o Consumer Behavior: Consumers’ real income is squeezed, so demand for

non-essential (luxury) items declines (these have high income elasticity).
Demand shifts inward for normal goods; inferior goods (like budget brands)
may see stable or higher demand. Firms selling luxury cars might see a
demand drop, while discount retailers may do relatively better.
 o Investment Decisions: High inflation typically leads central banks to raise
interest rates to control prices. Higher rates increase firms’ cost of
borrowing, so capital investments (new factories, R&D) become more
expensive. Uncertainty about future prices also makes long-term planning
harder. For instance, a manufacturing firm might delay expanding production
until economic signals stabilize.

o Sector Examples:

▪ Retail: Price-sensitive; sales promotions may increase.

▪ Banking: Lends at higher interest (higher profits per loan) but loan
demand may fall.

▪ Manufacturing: Input costs (energy, raw materials) rise; margins shrink

unless passed to customers.

o Outcomes: Some firms may hedge by indexing prices to inflation (e.g.

leasing contracts with inflation clauses). Others focus on efficiency to
maintain margins. In summary, stagflation forces businesses to balance
raising prices (to cover costs) against losing market share, and to be prudent
with investments due to economic uncertainty.

6. Taxes and Market Outcome: Imposing a £1 tax per pack of cigarettes shifts the
supply curve left (upward) by £1. The new equilibrium has a higher price for
consumers (Pc) and lower quantity (Qc) (UG Class sheet [Link]). The tax incidence
depends on elasticity: because cigarette demand is relatively inelastic, consumers
pay most of the tax (Pc rises by most of £1), while producers receive a lower net
price.

o Equilibrium Effects: Quantity sold decreases (less smoking). Consumer

price rises and producer price falls (by the remainder). The area of tax
revenue is the rectangle (Qc × £1), part paid by buyers (higher Pc) and sellers
(lower Ps). A deadweight loss (DWL) triangle forms representing lost welfare
from trades that no longer occur.

o Comparison: If instead we tax a good with elastic demand (e.g. flat-screen

TVs), the price consumers pay would rise very little (consumers are sensitive
and buy much less with higher price), so producers would bear more of the
tax. The quantity drop would be large, creating a larger DWL. Thus, the same
tax has different outcomes: inelastic markets transfer more burden to
consumers, elastic markets shrink heavily in quantity (larger DWL).
These comprehensive questions and answers cover the key concepts, formulas, diagrams,
and applications needed for MN12011, aligned with past exam style and difficulty. The
answer explanations include all necessary details, ensuring this document stands alone as
a complete study resource.