MICROECONOMICS PRACTICE EXAM #1

Section 1—Multiple Choice

Directions: You will have 70 minutes to answer the following 60 multiple choice questions.
Each of the questions or incomplete statements below is followed by five suggested answers or
completions. Select the one that is best in each case by choosing the oval next to that answer.

1. The concept of scarcity can be best summed up as:

(A) the fact that there is always a surplus of goods when price is high
(B) the reality that individuals have unlimited wants and limited resources
(C) what an individual gives up when faced with making a decision
(D) the increased amount of product one must give up when choosing to produce more of
another product
(E) the process in which society must determine the optimal price to set in a given market

Scarcity is prevalent in any type of economy as only a finite amount of resources exists that
can be used in the production process of various products. Businesses must make decisions
every day that affect the allocation of resources and how they are used to make final
products. Although it may seem on the surface that individuals can buy anything they
want as long as they have the money to do so, all societies will constantly be faced with the
issue of coordinating unlimited wants in the constraints of limited resources.

2. A command economy is most likely to have which of the following characteristics?

(A) the protection of private property rights

(B) the ability for society to choose what will be produced
(C) an economic system that is primarily controlled by a central government
(D) a free market enterprise system that encourages the start-up of new businesses
(E) the enforcement and encouragement of competition in the marketplace

A command economy usually offers little choice to businesses and consumers in the
marketplace and is usually controlled by a central government or an individual that
determines who, what, and how goods/services will be produced. All other answer choices
besides “C” are more closely aligned to that of a market economy.

3. Assume that the price elasticity of demand for a product is equal to 2. If the price of this
product increases, which of the following statements is true for the firm that produces this
product?

(A) total revenue will decrease since the percent change in quantity demanded will be more
significant than the percent change in price
(B) total revenue will decrease since the percent change in price will be more significant than the
percent change in quantity demanded
(C) total revenue will increase since there will be an increase in quantity demanded for this
product
(D) total revenue will increase since there will be a decrease in quantity demanded for this
product
(E) there will be no change in total revenue as elasticity and the calculation of total revenue have
no relation with one another

If the demand for a product is elastic (Ed > 1), an increase in price will lead to a decrease in
total revenue. Total revenue can be calculated by multiplying the price of the product with
the quantity that is demanded at that price. When demand is elastic, an increase in price
will lead to an even greater decrease in the quantity that is demanded for a product, thus
leading to a decrease in total revenue.

Question 4 refers to the graph below.

If a price floor “Pf” is implemented in the market for grapes as shown above, which of the
following will occur in the market for grapes?

(A) The equilibrium price will increase since there will be a surplus for grapes
(B) The equilibrium price will increase since there will be an increase in the quantity demanded
of grapes
(C) The equilibrium price will decrease since there will be a surplus of grapes
(D) The equilibrium price will decrease since there will be a decrease in the quantity demanded
of grapes
(E) The equilibrium price will remain unchanged as the price floor as shown will have no effect
on the market for grapes
In order for a price floor to be effective, it must be implemented above the equilibrium
price of a given product; a price floor will establish a minimum price that must be charged
in the market for a given product. A price floor that is implemented below the equilibrium
price of a product serves no purpose as it is rendered ineffective. The correct answer is
“E.”

5. Suppose that the market for bicycles is currently in equilibrium. A change in which of the
following will lead to an increase in the quantity supplied of bicycles?

(A) An increase in the market price of bicycles

(B) A decrease in the cost of inputs that are used in the production of bicycles
(C) An increase in the productivity of workers who produce bicycles
(D) A decrease in the price of scooters, which is a substitute for bicycles
(E) An increase in the price of bicycle helmets, which is a complement to bicycles

An increase in the quantity supplied of bicycles infers a movement along the supply curve
of bicycles itself; an increase in the supply of bicycles would infer a shift of the entire
supply curve. The only factor that can cause a movement along a given supply curve is a
change in price of the market good itself (in this case, bicycles). Answers “B” through “E”
all describe shift factors of supply (“B” and “C”) or demand (“D” and “E”).

6. Debbie likes to consume brownies and fudge. At her current consumption, the marginal utility
received from consuming another unit of brownies is 15, and the price of a brownie is $3. If the
price of fudge is currently $5, which of the following statements is true?

(A) Debbie should choose to consume an additional unit of fudge if her marginal utility of fudge
is equal to 20.
(B) Debbie should choose to consume an additional unit of fudge if her marginal utility of fudge
is greater than 25.
(C) Debbie should choose to consume more brownies, regardless of her marginal utility of fudge.
(D) Debbie should choose to consume more brownies if her marginal utility of fudge is equal to
30.
(E) Debbie should choose to consume more brownies if her marginal utility of fudge is equal to
40.

According to the utility maximization rule, an individual should consume an additional

unit of a good if it will provide them with a greater marginal utility per dollar (MU/$) when
compared to another good. In this case, the MU/$ of brownies is equal to 5 (15/$3). In
order for the MU/$ of fudge to be greater than the MU/$ of brownies, the marginal utility
of fudge must be greater than 25. If this is the case, Debbie should choose to consume
additional units of fudge since the MU/$ of fudge will be greater than the MU/$ of
brownies.

7. The point at which all inputs to production become variable in the production process is
known as the:
(A) law of diminishing returns
(B) short run
(C) shut-down point
(D) long run
(E) profit-maximization rule

In economics, the long run can be defined as the point where all inputs to production
become variable. In the short run, all inputs to production remain fixed with the exception
of one (which is usually labor). The short and long run are not defined by specific time
periods (such as one week, one month, one year, etc.), but rather by the constraints
mentioned above.

8. A given monopolist will maximize profit when marginal revenue is $10, average revenue is
$15, and marginal cost is $10. If the monopolist is currently operating at an output where price
is equal to $8, what should this monopolist do to the price and quantity produced of its product in
order to maximize profits?

Price of Product Quantity Produced of Product

(A) Increase Increase

(B) Increase Decrease
(C) Decrease Increase
(D) Decrease Decrease
(E) No change Decrease

Since average revenue is also equal to price for a monopolist, we can conclude that the
profit-maximizing price for this product must also be $15. Therefore, the monopolist
should increase their current price in order to maximize profit. Since a monopolist must
continually lower its price as it produces more and more, we can also conclude that in
order to increase its price (from $8 to $15) that it must decrease its current
output/production. As a result, the correct answer is “B.”

9. Which of the following is true regarding the demand curve for labor in the factor market?

(A) it is perfectly elastic

(B) it is perfectly inelastic
(C) it reflects the inverse relationship between wages paid to laborers and the quantity demanded
of labor by business
(D) it reflects the direct relationship between wages paid to laborers and the quantity demanded
of labor by business
(E) it is upward sloping and has a positive slope

In the labor market, businesses represent the demand curve as they are the ones who are
demanding/hiring labor. Businesses will be more willing hire greater quantities of labor at
lower wage rates, thus reflecting the inverse relationship between wages and quantity of
labor hired. The demand curve for labor is downward sloping and to the right, thus
eliminating answers “A,” “B,” and “E.”

Questions 10-11 refer to the graph below, where MC = Marginal Cost, ATC = Average
Total Cost, AVC = Average Variable Cost, P = Price, and MR = Marginal Revenue.

10. At which quantity will this firm maximize profit?

(A) Q1
(B) Q2
(C) Q3
(D) Q4
(E) Q5

The graph above depicts a perfectly competitive firm, since price/marginal revenue of the
firm is constant. A perfectly competitive firm always maximizes profit where MC = MR,
thus leading to a quantity of Q3.

11. Below which price would this firm be advised to shut down in the long run?

(A) P1
(B) P2
(C) P3
(D) P4
(E) P5
The shut-down rule for a firm is when P < AVC. If a firm cannot cover their AVC in the
long run, it is better for them to shut down and not produce anything at all than it would
be for them to continue to produce (they will lose more money if they continue to produce
than they would if they decided to shut down completely). As a result, the correct answer is
“B.”

12. The difference between the average total cost curve and average variable cost curve can be
best described as the:

(A) sum of the average fixed cost and marginal cost curves
(B) marginal cost curve
(C) long run average total cost curve
(D) difference of the average variable cost and average fixed cost curves
(E) average fixed cost curve

Total costs are calculated by adding fixed costs to variable costs. Consequently, the sum of
the AFC and AVC curves must equal the ATC curve. As a result, the difference between
the ATC and AVC curves is simply the AFC curve.

13. Firm XYZ’s marginal revenue and average revenue are always equal to each other,
regardless of the quantity that XYZ produces. The type of industry that Firm XYZ operates in
must be:

(A) perfect competition

(B) monopoly
(C) monopolistic competition
(D) oligopoly
(E) imperfect competition

Since the price that a firm receives for the sale of an additional unit is constant in a
perfectly competitive industry, marginal revenue and average revenue will always equal
each other. Answers “B” through “E” are all imperfectly competitive industries, and the
price of the product will decrease as more and more units are sold. Because of this, MR
and AR will rarely equal each other.

14. Assume that the pursuit of a college education creates a positive externality. Which of the
following statements is necessarily true?

(A) The socially optimal quantity is less than the private market quantity of college education.
(B) Government should tax the market for college education to arrive at the socially optimal
quantity.
(C) The socially optimal price is less than the private market price of college education.
(D) The free-rider problem will have considerable effects on the market for college education.
(E) Government should subsidize the market for college education in order to arrive at the
socially optimal quantity.
For any externality (positive or negative), the socially optimal quantity and price will occur
where MSB = MSC. With a positive externality, this intersection occurs and a price and
quantity that is greater than the private market price and quantity. As a result, if
government would like to encourage more individuals to enroll in college at a higher price,
they will have to provide a subsidy to consumers. The free-rider problem is typically
associated with public goods, not private goods (college education being a private good).

15. Suppose that peanut butter and jelly are complements. If the price of peanut butter increases,
what will happen to the price of jelly and the demand for jelly in the jelly market?

Price of Jelly Demand for Jelly

(A) Decrease Decrease

(B) Decrease Increase
(C) Increase Indeterminate
(D) Increase Increase
(E) Increase Decrease

If peanut butter and jelly are complements, an increase in the price of peanut butter will
lead to a decrease in the demand for jelly, since there will be fewer purchases of peanut
butter at higher prices (which results in fewer purchases of jelly). A decrease in demand
for jelly will shift the demand curve for jelly to the left, leading to a lower equilibrium
quantity and price in the market for jelly.

16. If average total costs increase as a firm increases its production in the long run, this firm must
be experiencing:

(A) economies of scale

(B) economies of scope
(C) constant returns to scale
(D) diseconomies of scale
(E) productive efficiency

The portion of the LRATC where ATC increases as output increases is known as
diseconomies of scale, or decreasing returns to scale. Economies of scale occur when ATC
decreases as quantity increases, and constant returns to scale infers that ATC remains
unchanged as quantity increases.

17. A monopolistically competitive firm is currently in long-run equilibrium. If the output of the
firm is 20 units and the price the firm receives for each product is $5 at this equilibrium, what is
the average total cost for this firm?

(A) $0
(B) $5
(C) $20
(D) $100
(E) There is not enough information given to determine average total cost.

A monopolistically competitive firm will earn zero economic profit in the long-run. Zero
economic profit occurs when the price the firm receives for each product is equal to the
average total cost of producing the product. Since price is $5 in the question above, ATC
must also equal $5.

Question 18 refers to the graph below.

Which of the following could lead to a movement from point “B” to point “D” on the graph
above?

(A) An increase in the unemployment rate

(B) A decrease in the productivity of apple workers
(C) A decrease in orange production and an increase in apple production
(D) An increase in the availability of resources used to produce apples and oranges
(E) A decrease in apple production and an increase in orange production

A shift in the production possibilities curve reflects long-run economic growth for an
economy. There are typically only two shift factors associated with economic growth; an
increase in the availability of resources, or an increase in technology or productivity. An
economy could also potentially get from point “B” to point “D” by trading with another
economy, but this would not lead to an entire shift of the PPC as shown.

19. The cross-price elasticity of demand for Good X and Good Y is equal to 2.5. What does this
infer about the relationship between Good X and Good Y?

(A) Good X and Good Y are both inferior goods

(B) Good X and Good Y are both elastic in demand
(C) Good X and Good Y are substitutes
(D) Good X and Good Y are complements
(E) Good X and Good Y are both luxury goods
Goods that have a positive cross-price elasticity coefficient are substitutes; if the price of
one good increases, the demand for the other good will also increase (and vice versa).
Complements have negative cross-price elasticity coefficients. There is not enough
information to conclude whether answers “A,” “B,” or “E” are true.

20. Which of the following is true for a perfectly competitive firm that maximizes profit in the
long run?

(A) Price will be greater than average total cost

(B) Price will equal marginal cost
(C) Marginal revenue will be less than average variable cost
(D) Average fixed cost will be greater than average variable cost
(E) Average revenue will be less than average total cost

A perfectly competitive firm earns zero economic profit in the long run. All of the
following conditions are true in the long run for a PC firm: P = MR = AR = MC = ATC.
All other answer choices are false.

21. If marginal productivity increases as the quantity of labor increases, then:

(A) total productivity must be increasing at a decreasing rate

(B) total productivity must be increasing at an increasing rate
(C) total productivity must be decreasing at a constant rate
(D) average productivity must be decreasing at an increasing rate
(E) average productivity must be decreasing at a decreasing rate

Marginal productivity is a change in total productivity given a change in quantity. If

marginal productivity is increasing, this means that total productivity must also be
increasing at an increasing rate. For example, if marginal productivity is 4, 6, 8, etc…then
total productivity is increasing at a rate of 4, 6, 8, etc. Average productivity would also be
increasing if marginal productivity was increasing.

22. A monopolist has a marginal cost of $20 and an average variable cost of $25 at a quantity of
10 units of output. If marginal cost is equal to $19 at a quantity of 11 units of output, then:

(A) average total cost must be increasing

(B) average fixed cost must be increasing
(C) average variable cost must be increasing
(D) average variable cost must be decreasing
(E) marginal productivity must be decreasing

Average variable cost is just what is sounds like—it represents an average of the variable
costs of production at different quantities. If marginal cost (a change it total cost given a
change in quantity) is decreasing, this must mean that average costs as a whole (both AVC
and ATC) must be decreasing as well. Since productivity and costs are inversely related, a
decrease in MC would infer an increase in MP, eliminating answer “E.” Average fixed
costs always decrease when there is an increase in quantity, thus eliminating answer “B.”

23. A firm that operates in an oligopolistic industry:

(A) will always produce where MC = MR

(B) faces no barriers to entry
(C) is productively efficient in the long run
(D) is allocatively efficient in the long run
(E) will make pricing decisions based on the actions of other firms

A key characteristic of an oligopoly is that pricing decisions are dependent on the pricing
decisions of other firms. Because of this, oligopolies will not necessarily produce at a
quantity where MC = MR. Oligopolies do face barriers to entry, and there is no long run
equilibrium output/quantity for an oligopoly.

24. Which of the following is true for both a perfect competitor and a monopolistic competitor in
the long run?

Perfect Competitor Monopolistic Competitor

(A) Price = Marginal Revenue Price > Marginal Revenue

(B) Price < Marginal Cost Price > Marginal Cost
(C) Price = Average Revenue Price < Average Revenue
(D) Demand > Marginal Revenue Demand < Marginal Cost
(E) Demand = Average Revenue Demand < Marginal Revenue

Answer “A” is the only answer with two correct answer choices. In the long run, Price =
MC and Demand = MR for a perfect competitor, thus eliminating “B” and “D.” For a
monopolistic competitor, Price = AR and Demand > MR in the long run, thus eliminating
answers “C” and “E.”

Question 25 refers to the graph below.

A per-unit tax is implemented the market above, leading to a new equilibrium quantity and price
of Q2 and P2. Which of the following statements is true?

(A) The demand for this product is relatively elastic.

(B) The supply for this product is perfectly inelastic.
(C) Consumers will bear a greater portion of the tax than producers.
(D) Producers will bear a greater portion of the tax than consumers.
(E) Consumers and producers will share the burden of tax equally.

An individual will bear a greater burden of a tax (pay a greater portion of it) if it has a
more inelastic demand (or supply) for it. In this case, consumers have an inelastic demand
curve while suppliers have a relatively elastic supply curve; as a result, consumers will bear
a greater portion of this tax.

26. Assume that the consumption of cigarettes creates additional costs to society. If the
government taxes firms that produce cigarettes, which of the following should occur in the
market for cigarettes?

Quantity Produced Deadweight Loss

(A) Decrease No change

(B) Decrease Increase
(C) Decrease Decrease
(D) Increase No change
(E) Increase Increase

The market above creates a negative externality since additional costs to society are
imposed. A tax on cigarettes will encourage firms to decrease the production of cigarettes,
thus moving the market closer to the socially optimal quantity and price (where MSB =
MSC). A movement towards the socially optimal quantity infers that deadweight loss is
decreasing since no deadweight loss will exist at the socially optimal level of output.

Questions 27-28 are based on the information below, which shows the marginal physical
product and selling price of t-shirts at various quantities of labor. Assume that marginal
physical product represents the amount of t-shirts that can be produced by a given worker
in one day.
27. What is the marginal revenue product of the 6th worker?

(A) $5
(B) $8
(C) $20
(D) $30
(E) $40

Marginal revenue product can be calculated by multiplying the marginal physical product
with the price of the product being sold. The 6th worker has an MPP of 8, meaning that the
MRP of the 6th worker is $40 (8 x $5). Marginal revenue product represents the “value” of
the worker to the firm.

28. If this firm can hire as many laborers as it would like at a daily wage of $65, what is the
profit-maximizing number of laborers this firm should hire?

(A) three
(B) four
(C) five
(D) six
(E) seven

The profit-maximizing rule for a firm hiring labor in the labor market is to hire the
quantity of laborers where MRP = MRC. Since the firm always receives $5 for each t-shirt
regardless of quantity produced, we know this firm is operating in a perfectly competitive
labor market. In a perfectly competitive labor market, MRC is also equal to the wage paid.
At a quantity of three laborers, MRP = $75 (15 x $5) and MRC = $65. At a quantity of four
laborers, MRP = $60 and MRC = $65. Since the firm would lose $5 if it hired four
workers, the profit-maximizing quantity of laborers to hire is equal to three (if MRP and
MRC are not exactly equal to each other, always select the quantity of workers where MRP
> MRC).

29. Which of the following is true if a monopolist can successfully use price discrimination to
earn short-run economic profits?

(A) The monopolist will produce at a quantity that is less than the quantity where marginal cost
equals marginal revenue
(B) The monopolist will produce at a quantity that is greater than the quantity where marginal
cost equals marginal revenue
(C) Consumer surplus will increase as profits increase for the monopolist
(D) Marginal revenue will be negative at the profit-maximizing quantity
(E) There will be no deadweight loss at the profit-maximizing quantity

A price-discriminating monopolist can charge consumers the maximum amount that they
are willing to pay for a given product, thus eliminating consumer surplus. A price-
discriminating monopolist will typically produce up to a quantity where price is equal to
ATC; any quantity greater than this would incur loss for the monopolist. If a monopolist is
earning short-run economic profits as stated above, the intersection where price equals
ATC must occur at a quantity greater than where MC = MR. Answers “D” and “E” are
indeterminate as they may or may not be true depending on where the ATC curve falls for
the monopolist.

30. Suppose that the current equilibrium price of grapes is equal to $2.50 per pound. If
producers of grapes charge a price of $3.50 per pound, which of the following will occur in the
market for grapes?

(A) The demand for grapes will increase

(B) The quantity supplied of grapes will decrease
(C) There will be a shortage of grapes
(D) There will be a surplus of grapes
(E) The new equilibrium price of grapes will equal $3.50 per pound

If the equilibrium price of grapes is currently $2.50 per pound and producers try to sell
grapes for $3.50 per pound, a surplus will develop in the market for grapes. A surplus
occurs when the quantity supplied exceeds the quantity demanded in the market for a
particular good, and this is what a price of $3.50 per pound would lead to in the market for
grapes.

31. A perfectly competitive firm perceives the demand curve for its product to be:

(A) perfectly elastic

(B) relatively elastic
(C) unit elastic
(D) relatively inelastic
(E) perfectly inelastic

A perfectly competitive firm can sell as much of a quantity as it would like and it will
always receive the same price for its product. As a result, the demand curve for its product
is horizontal, or perfectly elastic.

32. Consumer and producer surplus in the market for a particular good can be maximized when:

(A) markets are allocatively efficient

(B) excise taxes are imposed
(C) price floors are implemented
(D) deadweight loss increases
(E) monopolists are allowed to operate freely

Consumer and producer surplus are typically maximized when markets are efficient and
there is no government intervention. Allocative efficiency infers that markets are
allocating resources effectively and to the best uses of society; as a result, total surplus will
be maximized. When markets are allocatively efficient, no deadweight loss will exist in the
market for the product. Answer “E” is incorrect since monopolists create deadweight loss.

Questions 33-34 are based on the information in the payoff matrix below. The first entry in
each cell illustrates the profits to Joe, and the second entry in each cell illustrates the
profits to Nancy.

33. What is the predicted Nash equilibrium given the information above?

(A) Joe will price high and Nancy will price high
(B) Joe will price high and Nancy will price low
(C) Joe will price low and Nancy will price high
(D) Joe will price low and Nancy will price low
(E) There is not enough information to determine a Nash equilibrium

Payoff matrices can be solved by creating hypothetical scenarios that involve each
“player.” For example, if Nancy believes that Joe will price high, Nancy can respond by
also pricing high ($125 profit) or by pricing low ($175 profit). Since Nancy would earn a
greater profit by pricing low, she will choose to price low. If Nancy believes that Joe will
price low, Nancy can price high ($50 profit) or price low ($75 profit). Again, Nancy will
choose to price low. If this analysis is also completed for Joe, we will find that the predicted
outcome (Nash equilibrium) will be for both Joe and Nancy to price low.

34. According to the information above, which of the following is true?

(A) Joe has a dominant strategy to price high while Nancy does not have a dominant strategy
(B) Nancy has a dominant strategy to price low while Joe does not have a dominant strategy
(C) Both Joe and Nancy have a dominant strategy to price low
(D) If Joe prices high, Nancy will be better off if she prices high
(E) If Nancy prices low, Joe will be better off if he prices high
A dominant strategy exists if a “player” will always choose the same pricing strategy
regardless of what they think their opponent will do. In the explanation above for question
#33, you can see that Nancy will always price low, regardless of whether Joe chooses to
price high or low. As a result, Nancy has a dominant strategy of pricing low. The same is
true for Joe as well, as he also has a dominant strategy to price low.

35. Firm X operates in a perfectly competitive industry and is currently in a long-run

equilibrium. Which of the following statements concerning Firm X’s profit is true?

(A) Firm X has a positive accounting profit.

(B) Firm X has a negative accounting profit.
(C) Firm X has a positive economic profit.
(D) Firm X has a negative economic profit.
(E) Firm X has a negative normal profit.

Perfectly competitive firms earn zero economic profit in the long run. “Economic” profits
take both explicit and implicit costs/revenues into consideration, while “accounting” profits
only take explicit costs/revenues into consideration. The following equation/identity can be
used when differentiating between economic and accounting profits: Economic profit =
Accounting profit – Opportunity cost. If a firm earns zero economic profit, this implies
that their accounting must be positive since all firms have an opportunity cost (the amount
of money they could make by doing something else) to doing business.

36. Which of the following is the best example of a private good?

(A) Missiles that are produced to support the national defense of an economy
(B) Elementary schools that are built in new communities
(C) The construction of a bridge to connect two highway systems
(D) The addition of a traffic light at a busy intersection
(E) A lighthouse that is converted into hotel rooms for vacationers

Private goods are excludable and rivalrous in nature, meaning that an individual can
prevent other consumers from enjoying the benefits and/or consumption of a particular
good. Answers “A” through “D” are all examples of public goods, as consumption by one
individual does not preclude consumption by another individual. Vacationers who reserve
a hotel room can prevent others from enjoying the benefits of the hotel room (for the
duration of the rental period) and is the best example of a private good.

37. Assume that Hayden’s Blueberry Farm operates in a perfectly competitive industry. If the
demand for blueberries increases in the market for blueberries, what is true for Hayden’s
Blueberry Farm?

(A) Average revenue will decrease

(B) Marginal cost will decrease
(C) Average total cost will increase
(D) Hayden’s Farm should increase its output in order to maximize profits
(E) Hayden’s Farm should decrease its output in order to maximize profits

If demand for blueberries increases, this will lead to a higher equilibrium price in the
market for blueberries. This increase in price will carry over to Hayden’s Farm and will
increase marginal revenue, average revenue, and the price Hayden’s Farm can receive for
the blueberries it produces. An increase in marginal revenue will lead to a new profit-
maximizing output that is greater than the previous profit-maximizing output, so Hayden’s
Farm should increase its output in order to maximize profits. The cost curves of Hayden’s
Farm will be unaffected by the increase in demand for blueberries.

38. A simultaneous decrease in the supply and demand for a good will cause the equilibrium
price and quantity of that good to change in which of the following ways?

Equilibrium Price Equilibrium Quantity

(A) Indeterminate Increase

(B) Indeterminate Decrease
(C) Decrease Increase
(D) Decrease Decrease
(E) Increase Indeterminate

A decrease in supply and demand will cause each curve to shift to the left, thus leading to a
lower equilibrium quantity will each shift that takes place. The final equilibrium price will
be indeterminate, however, since we are not able to tell the magnitude of each curve that
shifts. A decrease in supply will lead to a higher equilibrium price, but a decrease in
demand will lead to a lower equilibrium price. Without further information, we cannot
conclusively determine how the final equilibrium price will compare with the original
equilibrium price.

39. Suppose that Tori only consumes two goods, Good A and Good B. If the price of Good A
increases while the price of Good B remains unchanged, which of the following is true?

(A) The income effect will predict an increase in demand of Good A.

(B) The substitution effect will predict a decrease in demand of Good A.
(C) The marginal utility per dollar of Good A will increase.
(D) The marginal utility per dollar of Good B will increase.
(E) The marginal utility per dollar of Good A and B will remain unchanged.

The substitution effect states that if the price of one good increases that consumers will
likely switch their consumption to another good that is comparatively cheaper. In the
example above, Tori will likely decrease her demand for Good A and increase her demand
for Good B. An increase in the price of Good A will decrease the marginal utility per
dollar of Good A for Tori, and would not have an immediate effect on the marginal utility
per dollar of Good B.
40. The following question is based on the table below.

Assume that the disposal of chemicals in a community has created toxic waste. If the first
column represents the quantity of toxic cleanup that can be undertaken, what is the socially
optimal quantity of cleanup for this community?

(A) one
(B) two
(C) three
(D) four
(E) five

Although a quantity of five might look like a tempting answer, it is incorrect. The socially
optimal quantity will occur where the social marginal benefit is equal to the social marginal
cost. This occurs at a quantity of 3, since the marginal social benefit and marginal social
cost both equal 400 (a change from 1,600 to 2,000 and from 350 to 750). Moving from a
quantity of 4 to 5 should not be undertaken since the marginal benefit of doing so (100)
would be less than the marginal cost (900).

41. A decrease in tariffs on foreign automobiles will have which of the following effects in the
market for domestic automobiles in the United States?

(A) The demand for domestic automobiles will decrease since the cost of foreign automobiles
will become less expensive
(B) The demand for domestic automobiles will remain unchanged as tariffs will have no effect
on the demand for domestic automobiles
(C) The supply for domestic automobiles will increase since there will be a decrease in the cost
of inputs to production for domestic automobiles
(D) Domestic automobiles will tend to become inferior goods while foreign automobiles will
tend to become luxury goods
(E) Domestic automobiles will tend to become luxury goods while foreign automobiles will tend
to become inferior goods

A decrease in tariffs on foreign automobiles will make foreign automobiles less expensive
and thus become more of an attractive option for U.S. consumers. Since domestic and
foreign automobiles can be classified as substitute goods, a decrease in the price of one good
(foreign imports) will decrease the demand for the other good (in this case, domestic
automobiles). Answers “D” and “E” are distractors and “C” is incorrect since a decrease
in tariffs would cause a shift factor in demand, not supply.

42. A monopolistic competitor is currently maximizing profits at a quantity of 500 units. At this
quantity, marginal cost is $30, average total cost is $35, and the price of each unit sold is $40.
What is this firm’s overall profit at a quantity of 500 units?

(A) $500
(B) $2,500
(C) $5,000
(D) $15,000
(E) $20,000

Profit can be calculated in a few different ways; profit is equal to total revenue minus total
cost, or you can calculate profit by taking the profit per unit sold and multiplying that
number by quantity of units sold. In this case, it might be easiest to take a look at the
profit per unit and then multiply by quantity. If P = $40 and ATC = $35, then the profit
per unit sold is $5. If Q = $500, this means that total profit is equal to $2,500 (500 X $5).

43. A nation has a comparative advantage in the production of a particular good if:

(A) the opportunity cost of producing the good is less than that of another country
(B) it can produce more units of the good than another country can given the same amount of
resources
(C) it can operate at an output that is on its production possibilities curve
(D) it can operate at an output that is inside its production possibilities curve
(E) its resources can specialize in the production of the good

Comparative advantage can be found by finding the country/economy that has the lowest
opportunity cost in the production of a particular good. Answer “B” describes the
definition of absolute advantage, while answers “C” and “D” do not speak to the definition
of comparative advantage. All economies can use specialization in their production
processes, whether or not they have a comparative advantage in the production of a good.

44. A monopolist:

(A) minimizes average total cost when it produces at the profit-maximizing quantity
(B) minimizes deadweight loss when it produces at the profit-maximizing quantity
(C) produces at a profit-maximizing output that is comparatively less than that of a perfectly
competitive firm
(D) charges a lower price at the profit-maximizing output than that of a perfectly competitive
firm
(E) breaks even in the long run
When compared to the profit-maximizing output of a perfect competitor, a monopolist
maximizes profit at a lower quantity. Perfectly competitive firms maximize profit at a
quantity where P = MC, but the profit-maximizing output of a monopolist occurs at a
quantity that is less than where P = MC for a monopolist. All other answer choices are
false.

45. A lump-sum tax that is imposed on firms engaged in monopolistic competition will:

(A) decrease the profit-maximizing quantity of firms in the industry

(B) increase the profit-maximizing quantity of firms in the industry
(C) increase the average variable cost curves of firms in the industry
(D) increase the marginal cost curves of firms in the industry
(E) increase the average fixed cost curves of firms in the industry

Lump-sum taxes act as an additional fixed cost to a firm, thus increasing the average fixed
cost curves of firms that are levied with such a tax. AVC and MC do not change, since a
change in AFC will only cause a change in ATC (no other cost curves will change or be
affected). Since MC does not change (and MR will also remain unaffected), a lump-sum
tax will not change the profit-maximizing quantity of a firm.

46. Which of the following is the best example of a negative externality?

(A) The construction of a new road that will reduce traffic during morning and afternoon hours
(B) An increase in the availability of flu vaccines
(C) Loud music that is played by a resident in an apartment building
(D) Excise taxes that are levied on the purchase of cigars
(E) The proliferation of an insect that feeds on termites, which can damage wood that is used in
the construction of homes

A negative externality is an event or agreement between two entities that impose costs onto
a third party. The best example of a negative externality is answer “C,” since loud music
would create and cause a disturbance to other residents of the apartment complex. All
other answers either help to reduce an existing negative externality or are examples of a
positive externality.

Question 47 refers to the graph below, which shows the labor market for a monopsony.
47. If a minimum wage of $12 is implemented by the government in the monopsony above, what
will be the profit-maximizing quantity of labor that will be hired and the wage that will be paid
to laborers?

Quantity of Labor Wage Rate

(A) 25 $18
(B) 25 $10
(C) 40 $16
(D) 40 $12
(E) 60 $14

When a minimum wage of $12 is implemented by government, that minimum wage

becomes the MRC for this monopsony from a quantity of 0 to 40 workers (since this
minimum wage is higher than what the monopsony would normally pay its workers in this
range of 0 to 40 laborers). At a quantity of 40 workers, MRP = $16 and MRC = $12.
However, at a quantity of 41 workers, the minimum wage no longer holds (since the supply
curve of labor will be at a higher wage than $12), and MRC would now be calculated by
looking at the MRC curve on the graph, which is greater than $18 at a quantity of 41
laborers. Since MRP > MRC at a Q of 40 but MRP < MRC at a Q of 41, this monopsony
would maximize profits by hiring 40 workers at a wage rate of $12 (the government
implemented minimum wage).

48. The law of diminishing marginal productivity states that:

(A) all inputs to production will become variable once productivity begins to decrease
(B) the amount of satisfaction received from the consumption of a good will decrease as more
and more of the good is consumed
(C) productivity will at some point begin to decrease as more and more of a variable input is
added to a set amount of fixed inputs
(D) productivity will decrease during the early stages of production but will increase as more
labor is added to a set amount of fixed inputs
(E) total productivity must be decreasing if marginal productivity is decreasing

Answer “C” describes the law of diminishing marginal productivity; answers “A,” “D,”
and “E” are all false and answer “B” describes the law of diminishing marginal utility.

49. It is easiest for oligopolies to collude with one another when:

(A) the number of firms in the industry is small

(B) pricing information is not available to all firms
(C) supply quotas are not enforced
(D) firms in the industry act as perfect competitors
(E) the products that each firm produces are unique
Oligopolies collude with one another when they agree to set artificially high prices in the
marketplace. The more firms that exist in the industry, the harder it will be to collude with
one another (since there is a greater chance that one firm will want to break the collusive
agreement). Therefore, collusion is most successful when there are only a few firms in the
industry. Pricing information must be known in order to collude, while the non-
enforcement of supply quotas (or limits) would break down any type of existing collusive
agreement. Since firms that collude with one another set high prices, they would not want
to act as perfect competitors (who typically have competitive or low prices for their
products), and collusion is easier to accomplish when products are similar in nature.

Questions 50-51 are based on the information below, which shows the distribution of
income for the countries of Lumingston and Ambronia.

50. The second quintile of households in Ambronia earn approximately:

(A) 3.4% of total income in Ambronia

(B) 8.4% of total income in Ambronia
(C) 11.8% of total income in Ambronia
(D) 15.4% of total income in Ambronia
(E) 27.2% of total income in Ambronia

The second quintile is defined as the percentage of households that exist within the 20-40%
range of households. Since the first quintile (bottom 20%) of households earn 3.4% of the
income and the first and second quintile (bottom 40%) of households earn 11.8% of the
income, the second quintile makes 8.4% of total income, which is the difference between
the bottom 20% and bottom 40% of households.

51. Which of the following statements is true according to the tables above?

(A) Income is distributed more equally in Ambronia than it is in Lumingston.

(B) Average income in Lumingston is greater than the average income in Ambronia.
(C) Average income in Ambronia is greater than the average income in Lumingston.
(D) The gini coefficient of Ambronia is greater than the gini coefficient of Lumingston.
(E) The gini coefficient of Lumingston is greater than the gini coefficient of Ambronia.

The country of Ambronia shows a greater income inequality than that of the country of
Lumingston, since all quintiles (besides the top 20%) earn a percentage of income that is
comparatively less than the income earners in Lumingston. A gini coefficient ranges from
a value of zero to one and attempts to illustrate the breadth of income inequality in a given
nation. The more unequal the distribution of income, the higher the gini coefficient will be.
Lorenz curves and/or gini coefficients do not provide any information regarding the
average income levels of a particular country.

52. A monopolist is currently producing at an unregulated profit-maximizing output. If the

government decides to regulate this monopoly and requires it to produce at the allocatively
efficient level of output, which of the following statements is necessarily true?

(A) The area of total consumer surplus will increase.

(B) Total revenue for the monopoly will decrease.
(C) Price will equal average total cost.
(D) Marginal revenue will equal zero.
(E) A per-unit tax will be required in order for the monopolist to earn short-run economic profits.

An unregulated monopoly will produce at the quantity where MC = MR. If the monopoly
is now required to produce at the allocatively efficient level of output (which is where P =
MC), the monopoly will have to increase the quantity it produces and decrease the price
that it charges. As a result, the area of consumer surplus will increase as this policy will
benefit consumers. It is likely that total revenue will increase as the monopolist becomes
allocatively efficient, and it is only possible for answers “C” and “D” to be true; it is not a
certainty that this will always happen. It is not likely that the government would tax this
monopolist as a result of the policy it created.

53. George has a total of 10 hours to study for two final exams, Geology and Physics. If he uses
all 10 hours to study for Geology, he estimates that he can earn a 100% in Geology and a 65% in
Physics. If he uses all 10 hours to study for Physics, he estimates that he can earn a 95% in
Physics and an 80% in Geology. Assuming constant opportunity costs, what exam scores should
George expect to receive if he studies for 7 hours in Physics and for 3 hours in Geology?

Physics Grade Geology Grade

(A) 94 percent 86 percent

(B) 94 percent 91 percent
(C) 86 percent 94 percent
(D) 86 percent 86 percent
(E) 91 percent 94 percent

Given the numbers above, George will lose 3% for every hour he does not study for Physics
(95% - 65% divided by 10 hours) and will lose 2% for every hour he does not study for
Geology (100% - 80% divided by 10 hours). Therefore, if George studies for 7 hours in
Physics and for 3 hours in Geology, he will lose 9% on his Physics grade (95% - 9% =
86%), and he will lose 14% on his Geology grade (100% - 14% = 86%). As a result, the
expected score on both exams would be an 86%.
Question 54 refers to the graph below.

54. Which of the following could cause a decrease in supply as shown in the graph above?

(A) A decrease in consumer income

(B) An increase in the price of a substitute good
(C) An increase in technology that is used to produce this product
(D) A negative change in consumer tastes relating to this product
(E) An increase in the cost of inputs that is used to produce this product

An increase in costs of production of a good will cause the supply curve in the market for
this good to shift to the left. Answers “A” and “D” would shift the demand curve for this
good to the left, while answer “B” would shift the demand curve for this good to the right.
Answer “C” would shift the supply curve to the right, as an increase in technology will lead
to a greater supply of products.

55. Which of the following is true if a firm is experiencing constant returns to scale in the long
run?

(A) The firm should increase its output in order to maximize profits.
(B) The firm should decrease its output in order to decrease costs.
(C) Average fixed costs for the firm are constant.
(D) The short-run average total cost curve will be less than the long-run average total cost curve.
(E) The firm is minimizing average total costs.

In the range where constant returns to scale exist in the long-run average total cost curve,
average total costs remain constant. This particular range of the LRATC curve also
happens to be where ATC is minimized. The LRATC curve only provides information
about costs; it does not say anything about profit. The AFC curve is not constant (rather it
is downward sloping), and the LRATC curve will always be less than the SRATC curve,
since all inputs to production are variable in the long run and can be changed.
56. If marginal revenue for a monopolist is equal to zero, then:

(A) demand for the good must be elastic

(B) total revenue must be maximized
(C) marginal cost must be minimized
(D) price must be less than marginal revenue
(E) average revenue must equal marginal revenue

Marginal revenue is equal to a change in total revenue given a change in quantity. If MR is

positive for a monopolist (or for any other firm for that matter), this means that total
revenue is increasing; if MR is negative, this would infer that total revenue is decreasing.
TR is always maximized when MR = 0. For a monopolist, answers “A,” “D,” and “E” are
all false at the quantity where MR = 0, and “C” is indeterminate.

57. The free rider problem is most often associated with:

(A) negative externalities

(B) positive externalities
(C) rivalrous goods
(D) public goods
(E) private goods

The free rider problem is associated with individuals’ unwillingness to reveal the true value
that they have for a public good. Since public goods are financed by tax dollars and are
provided by the government, individuals have an incentive to hide the true value that they
have towards the good and/or the amount of money (in the form of tax dollars) they would
be willing to contribute to such a good. Instead, they would rather take a “free ride” and
receive the benefits of the good without having to pay for it.

58. The short-run supply curve for a perfect competitor is equal to:

(A) the section of the marginal cost curve where price is greater than average variable cost.
(B) the entire marginal revenue curve.
(C) the section of the average variable cost curve where price is less than average total cost.
(D) the entire average total cost curve.
(E) the long run supply curve for a monopolist.

A perfectly competitive firm will always maximize profits where MC = MR, and should
always produce as long as price is greater than AVC. As a result, the short-run supply
curve for a PC firm effectively becomes the section of the MC curve that is above the point
where MC = AVC. A perfectly competitive firm will produce at any point on the MC curve
that intersects with MR as long as MR (which is also equal to price for a PC firm) is above
AVC.
59. If Stacey’s income increases by 50 percent, her demand for designer purses will increase by
100 percent. As a result, Stacey would consider designer purses to be a:

(A) necessity
(B) luxury good
(C) inferior good
(D) Giffen good
(E) Veblen good

Income elasticity of demand is equal to the percent change in demand for a good divided by
a given percent change in income; therefore, Stacey’s income elasticity of demand for
designer purses is equal to 2 (100%/50%). An income elasticity coefficient that is greater
than one indicates that the good is a luxury good. A necessity good would have a coefficient
in between zero and one and an inferior good would have a negative coefficient (as income
goes up, demand goes down, and vice versa). Answers “D” and “E,” although not often
discussed in introductory economics texts, both relate to goods whose demand increases as
the price of the item itself increases.

60. Assume that computers are produced in a perfectly competitive labor market. If the demand
for computers increases, what will happen to the wages of workers who produce computers and
the marginal revenue product of those same workers?

Wages of Workers Marginal Revenue Product

Producing Computers of Computer Workers

(A) No change Increase

(B) Decrease Increase
(C) Decrease Decrease
(D) Increase Decrease
(E) Increase Increase

An increase in the demand for computers will lead to an increase in demand for workers
who produce computers (known as “derived demand”), thus increasing the wages of
computer laborers. Because the price of computers itself will also increase, this means that
the MRP of workers producing computers will also increase, since the price of the product
being produced is a component of MRP (MRP = Marginal Physical Product x Price of
Product).
 MICROECONOMICS PRACTICE EXAM #1 ANSWER KEY

Multiple Choice

1. B
2. C
3. A
4. E
5. A
6. B
7. D
8. B
9. C
10. C
11. B
12. E
13. A
14. E
15. A
16. D
17. B
18. D
19. C
20. B
21. B
22. D
23. E
24. A
25. C
26. C
27. E
28. A
29. B
30. D
31. A
32. A
33. D
34. C
35. A
36. E
37. D
38. B
39. B
40. C
41. A
42. B
43. A
44. C
45. E
46. C
47. D
48. C
49. A
50. B
51. D
52. A
53. D
54. E
55. E
56. B
57. D
58. A
59. B
60. E