Department of Business Studies

Bachelor of Business Year 1

PRINCIPLES OF MICROECONOMICS
ECO101
TUTORIAL QUESTIONS

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Chapter 1 :Ten Principles of Economics)

1. The overriding reason as to why households and societies face many decisions is
that
a. resources are scarce.
b. goods and services are not scarce.
c. incomes fluctuate with business cycles.
d. people, by nature, tend to disagree.

2. A tradeoff exists between a clean environment and a higher level of income in that
a. studies show that individuals with higher levels of income actually pollute less
than low-income individuals.
b. efforts to reduce pollution typically are not completely successful.
c. laws that reduce pollution raise costs of production and reduce incomes.
d. by employing individuals to clean up pollution, employment and income both rise.

3. Which of the following is true?

a. Efficiency refers to the size of the economic pie; equity refers to how the pie is
divided.
b. Government policies usually improve upon both equity and efficiency.
c. As long as the economic pie continually gets larger, no one will have to go hungry.
d. Efficiency and equity can both be achieved if the economic pie is cut into equal
pieces.

4. Economists use the phrase "There is no such thing as a free lunch," to illustrate the
principle that
a. inflation almost always results in higher prices over time.
b. nothing is free in a market economy.
c. making decisions requires trading off one goal against another.
d. if something looks too good to be true, it probably is not worth pursuing.

5. Efficiency means that

a. society is conserving resources in order to save them for the future.
b. society's goods and services are distributed equally among society's members.
c. society's goods and services are distributed fairly, though not necessarily equally,
among society's members.
d. society is getting the maximum benefits from its scarce resources.

6. Zeti decides to spend three hours working overtime rather than watching a video
with her friends. She earns $8 an hour. Her opportunity cost of working is
a. the $24 she earns working.
b. the $24 minus the enjoyment she would have received from watching the
video.

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c. the enjoyment she would have received had she watched the video.
d. nothing, since she would have received less than $24 of enjoyment from the video.

7. Making rational decisions "at the margin" means that people

a. make those decisions that do not impose a marginal cost.
b. evaluate how easily a decision can be reversed if problems arise.
c. compare the marginal costs and marginal benefits of each decision.
d. always calculate the marginal dollar costs for each decision.

8. An example of an externality is the impact of

a. bad weather on the income of farmers.
b. the personal income tax on a person's ability to purchase goods and services.
c. pollution from a factory on the health of people in the vicinity of the factory.
d. increases in health care costs on the health of individuals in society.

9. The primary determinant of a country's standard of living is

a. the country’s ability to prevail over foreign competition.
b. the country’s ability to produce goods and services.
c. the total supply of money in the economy.
d. the average age of the country's labor force.

10. A person’s willingness to pay for a good is based on

a. the availability of the good.
b. the marginal benefit that an extra unit of the good would provide for that person.
c. the marginal cost of producing an extra unit of the good.
d. esoteric factors, the study of which lies beyond the boundaries of economics.

11. Which of the following topics would be studied in a microeconomics course?

a. How a trade agreement between the United States and Mexico affects both nations’
unemployment rates.
b. Comparing inflation rates across countries.
c. How rent ceilings impact the supply of apartments.
d. How a tax rate increase will impact total production.
12. On Saturday morning, you rank your choices for activities in the following order:
go to the library, work out at the gym, have breakfast with friends, and sleep late.
Suppose you decide to go to the library. Your opportunity cost is
a. working out at the gym, having breakfast with friends, and sleeping late.
b. working out at the gym.
c. zero because you do not have to pay money to use the library.
d. not clear because not enough information is given.
13. Corporate scandals, such as Enron and MCI,
a. prove that self interest cannot promote social interest

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b. are examples of a conflict between self interest and social interest in a market
economy
c. clearly show that a market economy cannot be efficient and should be replaced
with a government central planning agency.
d. are examples of the new economy.

14. John has two hours of free time this evening. He ranked his alternatives, first go to
a concert, second go to a movie, third study for an economics exam, and fourth
answer his e-mail. What is the opportunity cost of attending the concert for John?
a. Attending a movie
b. Studying for an economics exam
c. Answering his e-mail
d. Attending a movie, studying for an economics exam, and answering his email

15. Your employer has asked you to start working overtime and has offered to pay $18
per hour for every hour you work beyond forty hours a week. The wage rate for
each of the first forty hours will continue to be the usual $15 per hour. In terms of
dollars, what is the marginal benefit of working each hour of overtime?
a. zero.
b. $3.00.
c. $15.00.
d. $18.00.

16. Which of the following will create an incentive to increase the amount of an
activity?
a. An increase in the marginal cost of the activity and a decrease in the marginal
benefit of the activity.
b. A decrease in the marginal cost of the activity and an increase in the marginal
benefit of the activity.
c. Constant marginal cost and constant marginal benefit of the activity.
d. None of the above will create an incentive to increase the amount of an activity.
Section B Question 1
What is scarcity? Why is scarcity central to the study of economics?
Question 2
Use a suitable economic model to explain the management of scarce resources that have
alternative uses. Question 3

Evaluate the following statement: "A society can always produce more computers if it chooses to
do so; therefore there can never be any real scarcity."

Chapter 2 :( Thinking Like An Economist) Section A

1. The goal of an economist who formulates new theories is to

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a. provide an interesting framework of analysis, whether or not the framework turns
out to be of much use in understanding how the world works.
b. provoke stimulating debate in scientific journals.
c. demonstrate that economists, like other scientists, can formulate testable theories.
d. contribute to an understanding of how the world works.

2. In the circular-flow diagram,

a. firms are buyers in the markets for goods and services.
b. households are sellers in the markets for the factors of production.
c. firms are sellers in the markets for factors of production and in the markets for
goods and services.
d. dollars that are spent on goods and services flow directly from firms to households.

3. When constructing a production possibilities frontier, which of the following

assumptions is not made?
a. The economy produces only two goods or two types of goods.
b. Firms produce goods using factors of production.
c. The technology available to firms is given.
d. The quantities of the factors of production that are available are increasing over the
relevant time period.

4. Unemployment would cause an economy to

a. produce inside its production possibilities frontier.
b. produce on its production possibilities frontier.
c. produce outside its production possibilities frontier.
d. experience an inward shift of its production possibilities frontier.
5. The circular-flow diagram is a
a. visual model of how the economy is organized.
b. visual model of the relationships among money, prices, and businesses.
c. model that shows the effects of government on the economy.
d. mathematical model of how the economy works.
6. Production is efficient if the economy is producing at a point
a. on the production possibilities frontier.
b. outside the production possibilities frontier.
c. on or inside the production possibilities frontier.
d. inside the production possibilities frontier.

7. Here are some production possibilities for an imaginary economy for a given year.

Cars Newspapers
10 400
12 360

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 14 ?

If the production possibilities frontier is bowed outward, then in place of "?" we

might have
a. 340.
b. 330.
c. 320.
d. 310.

8. A production possibilities frontier can shift outward if

a. government increases the amount of money in the economy.
b. there is a technological improvement.
c. resources are shifted from the production of one good to the production of the
other good.
d. the economy abandons inefficient production methods in favor of efficient
production methods.
9. Jane produces only corn and cloth. Taking account of her preferences for corn and
cloth
a. makes her production possibilities frontier straighter.
b. makes her production possibilities frontier steeper.
c. makes her production possibilities frontier flatter.
d. does not affect her production possibilities frontier.

10. When resources are assigned to inappropriate tasks, that is, tasks for which they
are not the best match, the result will be producing at a point
a. where the slope of the PPF is positive.
b. where the slope of the PPF is zero.
c. inside the PPF.
d. outside the PPF.

11. Production Productio

Point of soda n
of pizza
A 40 0
B 28 3
C 20 5
D 12 7
E 0 10
Suppose that, for given resources and production technology, the above table is an
accurate description of the production relationship between soda and pizza. For the
sake of simplicity we assume the relationship is linear. Which of the following
production possibilities is not attainable?

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a. 15 sodas, 5 pizzas
b. 40 sodas, 0 pizzas
c. 5 sodas, 10 pizzas
d. All of the above possibilities are attainable.

12. Increasing opportunity cost is due to

a. firms’ needs to earn more and more profits.
b. ever increasing taxes.
c. the fact that it is more difficult to use resources efficiently the more society
produces.
d. the fact that resources are not equally suited for different types of production.

Section B Question 1

Why do economists use models in order to help explain how the economy works? Use a suitable
model to explain the interaction between the household and the business sectors.

Question 2

Explain the concept of opportunity cost and discuss how it relates to the problem of choice
between scarce alternatives. Illustrate your answer using a suitable model.

Question 3

What generates economic growth? How does economic growth influence the production
possibilities frontier?

Question 4
The data in Table 1 below is for the small country of Murreyville.

Table 1

Combination Consumer goods Capital goods

A 200 0
B 180 90
C 150 170
D 110 240
E 60 300
F 0 350

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 i) Draw the production possibilities curve for Murreyville, with consumer goods on the
xaxis and capital goods on the y-axis. Label the production possibilities curve PPF.

ii) Can this economy produce 200 capital goods and 60 consumer goods and why?

iii) Given PPF, what can you say about the economy of Murreyville if 120 capital goods and
150 consumer goods are being produced?

iv) A technological change occurs that enables Murreyville to produce 30% more capital
goods. Develop Table 2, with the new quantities of capital and consumer goods at
combinations A to F, as in Table 1, that Murreyville may produce given the technological
change.

v) Given PPF, and assuming that the economy is producing at combination C, what is the
opportunity cost of producing 91 more units of capital goods?

Answer:

i) Draw the production possibilities curve for Murreyville, with consumer goods on the x-axis and capital
goods on the y-axis.

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 Murreyville's PPF
400

350

300

250

200

150

100

50

0
0 50 100 150 200 250

ii) Can this economy produce 200 capital goods and 60 consumer goods and why? No, because at
combination A (200 consumer goods, 0 capital good) is on PPF, so the combination (200, 60)
lies outside PPF

iii) Given PPF, what can you say about the economy of Murreyville if 120 capital goods and 150
consumer goods are being produced?

Take a look to combination C (150, 170) on PPF, it is easily seen that combination (150, 120)
lies inside the PPF

iiii) A technological change occurs that enables Murreyville to produce 30% more capital goods.
Develop Table 2, with the new quantities of capital and consumer goods at combinations A to F,
as in Table 1, that Murreyville may produce given the technological change.

Combination Consumer goods Capital goods

A 200 0
B 180 117
C 150 221
D 110 312
E 60 390
F 0 455

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 Murreyville's new PPF
500
450
400
350
300
250
200
150
100
50
0
0 50 100 150 200 250

v) Given PPF, and assuming that the economy is producing at combination C, what is the
opportunity cost of producing 91 more units of capital goods?
Take a look to new table, at C (150, 221), an increase of 91 capital goods means this economy
has capital goods of (221 +91) = 312. Also, take a look to the combination D (110, 312), we can
easily compute the opportunity cost of producing 91 more capital goods = 150 – 110 = 40
(consumer goods)

Chapter 3: (Interdependence and Gains from Trade) Section A

1. For two individuals who engage in the same two productive activities, it is
impossible for one of the two individuals to
a. have a comparative advantage in both activities.
b. have an absolute advantage in both activities.
c. be more productive per unit of time in both activities.
d. All of the above are correct.

Refer to the table below to answer Question 2 and 3.

Devarani and Saras run a business that involves setting up and testing computers. The following
table applies.

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 Number of Computers Set Up or Tested in a
Minutes Needed to 40-Hour Week
Set Up Test Computers Computers
a a Computer Set Up Tested
Computer
Devaran 30 40 80 60
i
Saras 48 ? 50 40

2. The number of minutes needed by Saras to test a computer is

a. 36.
b. 48.
c. 60.
d. 64.
(explanation: in a 40-Hour Week the computers tested by Saras is 40, so the time needed to test a
computer is 1 hour or 60 minutes)
3. For Devarani, the opportunity cost of testing a computer is
a. setting up 2/3 of a computer.
b. setting up 3/4 of a computer.
c. setting up 1 1/3 computers. (explanation: to test a computer Devarani needs 40
minutes, with this time Devarani has to give up 40/30 setting-up computers)
d. setting up 1 1/2 computers.

4. Without trade,
a. a country is better off because it will have to learn to be self-sufficient without
trade.
b. a country's production possibilities frontier is also its consumption possibilities
frontier.
c. a country can still benefit from international specialization.
d. interdependence is more extensive than it would be with trade.

(explanation: Without trade, the country can only consume on its PPF)

5. Which of the following statements is not correct?

a. Trade allows for specialization.
b. Trade has the potential to benefit all nations.
c. Trade allows nations to consume outside of their production possibilities curves.

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d. Absolute advantage is the driving force of specialization. (explanation: comparative

Labour Hours Needed to

Make 1 Pound of: Pounds produced in 40 hours:
Meat Potatoes Meat Potatoes
Farmer 8 2 5 20
Rancher 4 5 10 8
advantage is the driving force of specialization) 6.

Refer to the above table. The opportunity cost of 1 pound of meat for the farmer is
a. 1/4 hour of labour.
b. 4 hours of labour.
c. 4 pounds of potatoes.
d. 1/4 pound of potatoes.

7. Country A Country B
Good X Good Y Good X Good Y
(units of (units of (units of (units of
X) Y) X) Y)
0 16 0 12
2 12 2 9
4 8 4 6
6 4 6 3
8 0 8 0
In the table above, country A is
producing 4 units of X and 8 units of Y and country B is producing 4 units of X and
6 units of Y. The opportunity cost of producing more of
a. good X is the same for both countries.
b. good Y is the same for both countries.
c. good X is lower in country A.
d. good Y is lower in country A. (hint: observe two rows in the above table)

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8.
In the figure above, suppose that Mac and Izzie trade and reach point c. Then
a. Mac produces outside his production possibilities frontier.
b. Izzie produces outside her production possibilities frontier.
c. Mac and Izzie both produce outside their production possibilities frontiers.
d. neither Mac nor Izzie produce outside their production possibilities frontiers.
(note: trading point and producing point are different, producing outside PPF is impossible)
9. Homer and Teddy are stranded on a desert island. To feed themselves each day
they can either catch fish or pick fruit. In a day, Teddy could pick 60 pieces of fruit
or catch 20 fish. Homer could pick 100 pieces of fruit or catch 150 fish. Which of
the following statements is correct?
a. Homer has an absolute advantage in catching fish and Teddy has an absolute
advantage in picking fruit.
b. Homer has an absolute advantage in picking fruit and Teddy has an absolute
advantage in catching fish.
c. Homer has an absolute advantage in both catching fish and picking fruit.
d. Teddy has an absolute advantage in both catching fish and picking fruit.

10. Assume an economy with two products: food and shelter. There are two
individuals in the economy: Bill and Mary. Mary’s opportunity cost of producing 1
unit of shelter is 2 units of food. Bill’s opportunity cost of producing shelter is 4
units of food.
a. Bill has a comparative advantage over Mary in the production of shelter.
b. Mary has a comparative advantage over Bill in the production of food.
c. Mary has a comparative advantage over Bill in the production of shelter.
d. Bill has an absolute advantage over Mary in the production of shelter.

11. Tom takes 20 minutes to burn a CD and 5 minutes to make a sandwich. Jerry
takes 15 minutes to burn a CD and 3 minutes to make a sandwich. If Tom and
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 Jerry trade
a. Tom will benefit and Jerry will not.
b. Jerry will benefit and Tom will not.
c. both will benefit.
d. none of them will benefit.

Section B Question 1

Explain the difference between absolute advantage and comparative advantage.

Question 2
Suppose that a typical German factory can produce 20 cameras or 1 computer in an hour, and that
a typical American factory can produce 10 cameras or one computer in an hour.
I) Determine the opportunity cost of 20 cameras in terms of computers in Germany and in
the U.S.
II) If Germany produces one less computer and switches resources to cameras, and the US
produces one more computer and takes resources out of cameras. What is the net change in
camera production in both countries taken together?
III) Germany wishes to purchase computers from the US in exchange for cameras. What is the
maximum number of cameras per computer that Germany would be willing to pay the US?
IV) Determine the market exchange rate which will benefit both the nations.

Answer:

I) Determine the opportunity cost of 20 cameras in terms of computers in Germany and

in the U.S.
- the opportunity cost of 20 cameras in Germany is one (1) computer - the
opportunity cost of 20 cameras in US is two (2) computers

II) If Germany produces one less computer and switches resources to cameras, and the
US produces one more computer and takes resources out of cameras. What is the net
change in camera production in both countries taken together?
- the net change in camera production in both countries taken together: (+ 20)
+ (-10) = 10 (increases by 10)

III) Germany wishes to purchase computers from the US in exchange for cameras. What
is the maximum number of cameras per computer that Germany would be willing
to pay the US?
20 cameras (equal to the opportunity cost of producing 1 computer in Germany)
IV) Determine the market exchange rate which will benefit both the nations.
exchange rate: the rate at which computer and camera are traded between two countries,
this exchange rate should be between two opportunity costs.

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 In Germany, the opp. Cost of 1 computer is 20 cameras

In US, the opp. Cost of 1 computer is 10 cameras

So, US specializes in computer production, and Germany specializes in camera

production, the exchange rate is the price of computer in terms of camara (e): 10 < e < 20
cameras

Section C

Question 1

With the use of an appropriate economic model and examples, explain how trade makes
everyone better off.

Chapter 4 : (Market Forces of Supply and Demand) Section A

1. If buyers and sellers in a certain market are price takers, then individually
a. they have no influence on market price.
b. they have some influence on market price, but that influence is limited.
c. buyers will be able to find prices lower than those determined in the market.
d. sellers will find it difficult to sell all they want to sell at the market price.

2. Two goods are substitutes if a decrease in the price of one good

a. decreases the demand for the other good.
b. decreases the quantity demanded of the other good.
c. increases the demand for the other good.
d. increases the quantity demanded of the other good.

3. The law of demand says that

a. an increase in quantity demanded causes price to decrease.
b. an increase in price causes quantity demanded to increase.
c. an increase in price causes quantity demanded to decrease.
d. an increase in quantity demanded causes price to increase.

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4. Which of the following events would cause a movement upward and to the right
along the supply curve for tomatoes?
a. The number of sellers of tomatoes increases.
b. There is an advance in technology that reduces the cost of producing tomatoes.
c. The price of fertilizer decreases, and fertilizer is an input in the production of
tomatoes.
d. The price of tomatoes rises.

5. Which of the following events could cause an increase in the supply of ceiling
fans?
a. The number of sellers of ceiling fans increases.
b. There is an increase in the price of air conditioners, and consumers regard air
conditioners and ceiling fans as substitutes.
c. There is an increase in the price of the motor that powers ceiling fans.
d. All of the above are correct.

6. If, at the current price, there is a shortage of a good,

a. sellers are producing more than buyers wish to buy.
b. the market must be in equilibrium.
c. the price is below the equilibrium price.
d. quantity demanded equals quantity supplied.

7. A decrease in input costs to firms in a market will result in

a. a decrease in equilibrium price and a decrease in equilibrium quantity.
b. an increase in equilibrium price and no change in equilibrium quantity.
c. an increase in equilibrium price and an increase in equilibrium quantity.
d. a decrease in equilibrium price and an increase in equilibrium quantity.

8. Suppose that demand decreases and supply decreases. What would you expect to
occur in the market for the good?
a. Equilibrium price would increase, but the impact on equilibrium quantity would be
ambiguous.
b. Equilibrium price would decrease, but the impact on equilibrium quantity would be
ambiguous.
c. Equilibrium quantity would decrease, but the impact on equilibrium price would be
ambiguous.
d. Both equilibrium price and equilibrium quantity would increase.

9. Which of the following would not be a determinant of the demand for a particular
good?
a. prices of related goods
b. income
c. tastes
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d. the prices of the inputs used to produce the good

10. Two goods are complements if a decrease in the price of one good
a. decreases the quantity demanded of the other good.
b. decreases the demand for the other good.
c. increases the quantity demanded of the other good.
d. increases the demand for the other good.

11. Two goods are substitutes if a decrease in the price of one good
a. decreases the demand for the other good.
b. decreases the quantity demanded of the other good.
c. increases the demand for the other good.
d. increases the quantity demanded of the other good.

12. Proton Berhad announces that it will offer RM3,000 rebates on new Waja starting
next month. As a result of this information, today’s demand curve for Waja
a. shifts to the right.
b. shifts to the left.
c. shifts either to the right or to the left, but we cannot determine the direction of the
shift from the given information.
d. will not shift; rather, the demand curve for Mustangs will shift to the right next
month.

13. Which of the following is consistent with the law of demand?

a. An increase in the price of a tape causes an increase in the quantity of tapes
demanded.
b. An increase in the price of a soda causes a decrease in the quantity of soda
demanded.
c. A decrease in the price of a gallon of milk causes a decrease in the quantity of milk
demanded.
d. A decrease in the price of juice causes no change in the quantity of juice
demanded.

14. A drop in the price of a compact disc shifts the demand curve for prerecorded tapes
leftward. From that you know compact discs and prerecorded tapes are
a. complements.
b. substitutes.
c. inferior goods.
d. normal goods.

15. A reduction in the price of a good

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a. shifts the good’s demand curve leftward and also decreases the quantity demanded.
b. shifts the good’s demand curve leftward but does not decrease the quantity
demanded.
c. does not shift the good’s demand curve leftward but does decrease the quantity
demanded.
d. neither shifts the good’s demand curve leftward nor decreases the quantity
demanded.

16.
The figure above represents the market for candy. People become more concerned
that eating candy causes them to gain weight, which they do not like. As a result,
the
a. demand curve shifts from D2 to D1 and the supply curve will not shift.
b. demand curve shifts from D1 to D2 and the supply curve shifts from S1 to S2.
c. demand curve shifts from D2 to D1 and the supply curve shifts from S2 to S1.
d. demand curve will not shift, and the supply curve shifts from S1 to S2.

17. Which of the following correctly describes how price adjustments eliminate a
shortage?
a. As the price rises, the quantity demanded decreases while the quantity supplied
increases.
b. As the price rises, the quantity demanded increases while the quantity supplied
decreases.
c. As the price falls, the quantity demanded decreases while the quantity supplied
increases.
d. As the price falls, the quantity demanded increases while the quantity supplied
decreases.

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18. Goods A and B are complementary goods (in consumption). The cost of a resource
used in the production of A decreases. As a result,
a. the equilibrium price of B will fall and the equilibrium price of A will rise.
b. the equilibrium price of B will rise and the equilibrium price of A will fall.
c. the equilibrium prices of both A and B will rise.
d. the equilibrium prices of both A and B will fall.
Explanation: there are two goods A and B, in the market of good A, supply of good A increases
(due to the fall in cost), and the supply shifts right which leads to a decrcease in price of good A.
Since A and B are complements, a decrcease in price of good A leads to an increase in the
demand for good B which shifts demand curve of good B right and hence leads to an increase in
price of good B.
19. The demand for hot dogs is given by QD = 8000 – 7000P, where QD is the quantity
demanded and P is the price in dollars. The supply for hot dogs is given by QS =
4000 + 1000P, where QS is the quantity supplied and P is the price in dollars. Given
these supply and demand relationships,
a. At the equilibrium, the price = $0.50 and the quantity = 4500 hot dogs.
b. At a price of $1, there is a shortage of 4000 hot dogs.
c. At a price of $1, there is a surplus of 4000 hot dogs.
d. Both answers A and C are correct.

Let QD = QS .→ 8000 – 7000P = 4000 + 1000P 0.5, replace this 0.5 into QD or QS equations
→ Q = 4500
Also, replace P = 1 into QD and QS equations → QD = 1000, and QS = 5,000 → surplus =
4000

Section B Question 1
Outline the main determinants of quantity demanded and quantity supplied, and explain how
these interact to determine the market price.

Question 2
Given the following demand and supply functions of product X (units/day).
Demand : Qd = 20 – 2P
Supply : Qs = 2 + 4P

a) Currently, price = 2, is the market in equilibrium? if not, is there a shortage and surplus and
how many units?
20 – 2P = 2 +4P → P = 3, Q = 14
b) Graph the demand and supply. Label the equilibrium price and equilibrium quantity.

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Question 3
Suppose that the demand and supply for standard microwaves is described by the following
equations: QD = 20,000 – 100P and QS = –1,000 + 50P where P is the price in dollars; QD is
the quantity demanded in units per month; QS is the quantity supplied in units per month.
a) Solve for the equilibrium price and quantity.
20,000 – 100P = –1,000 + 50P → P = 140, and Q = 6000
b) Determine the price the buyers pay and the price the sellers receive if a $30 unit tax is
imposed on the sellers.
If $30 unit tax is imposed on seller, the new supply function will be: QS = –1,000 + 50(P – 30)
Combine with the initial demand function: 20,000 – 100P = –1,000 + 50(P – 30)
→ P = 150 (this is also the price buyers pay)
The price sellers receive = 150 – 30 = 120
Question 4
Below you find a demand schedule for ice cream cones for June, July and August. A, B and C are
three different consumers.
Price A B C
$2 40 30 10
$3 30 22 8
$4 20 18 2
a) Draw a market demand schedule for ice cream cones.
b) The current market price is $3. What is market demand at this price?
c) Show on your diagram what happens to the market demand curve when market
demand declines by 20 percent owing to cold, rainy weather.
Answer:
a)
Market
Price A B C
Qd
$2 40 30 10 80
$3 30 22 8 60
$4 20 18 2 40

B) 60
C) explanation 64 = 80*0.8
New
Price Market
Qd
$2 64
$3 48
$4 32

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Question 5
The following is a supply table for trading cards. Price is stated in terms of price per package of
10. Quantity is package per week.

a. Determine the market supply for trading cards using the table.

b. What is the relationship between price and market quantity supplied? What two things
accounts for this relationship?
Section C Question 1
Using supply and demand analysis, explain the effect on the equilibrium price and quantity traded
of houses in a country of each of the following events. (Consider each event separately.) (a) A
rise in real incomes.
(b) A fall in the rate of interest on loans for house purchases for an extended period of time.
(c) A rise in the level of taxes to be paid on the sale of a house.
(d) The relaxation of planning controls allowing more land to be used for building new houses.

Question 2
Using supply and demand analysis, consider the effect on the market price and quantity traded of
beef traded in a country following:
a. An outbreak of a disease which affects the beef stock in the country.
b. The introduction of new regulation for beef production which raises the cost of
supplying beef.
c. An effective advertising campaign promoting the consumption of beef.

21
Chapter 21: Theory of Consumer Choice

Section A
1. The theory of consumer choice examine
a. the determination of output in competitive markets.
b. the tradeoffs inherent in decisions made by consumers.
c. how consumers select inputs into manufacturing production processes.
d. the determination of prices in competitive markets.

2. The theory of consumer choice examines how

a. firms make profit-maximizing decisions.
b. consumers make utility-maximizing decisions.
c. wages are determined in competitive labor markets.
d. prices are determined in competitive goods markets.
3. The following diagram shows a budget constraint for a particular consumer.
y

40

30

20

10

10 20 30 40 50 60 70 80 90 x

If the price of X is $10, what is the price of Y?

a. $15
b. $25
c. $35
d. $70

4. A budget constraint illustrates the

a. prices that a consumer chooses to pay for products he consumes.
b. purchases made by consumers.
c. consumption bundles that a consumer can afford.
d. consumption bundles that give a consumer equal satisfaction.

5. Karen, Tara, and Chelsea each buy ice cream and paperback novels to enjoy on hot
summer days. Ice cream costs $5 per gallon, and paperback novels cost $8 each.
Karen has a budget of $80, Tara has a budget of $60, and Chelsea has a budget of

22
 $40 to spend on ice cream and paperback novels. Who can afford to purchase 8
gallons of ice cream and 5 paperback novels?

a. Karen, Tara, and Chelsea

b. Karen only
c. Tara and Chelsea but not Karen
d. none of the women

6. A consumer who doesn't spend all of her income

a. would be at a point outside of her budget constraint.
b. would be at a point inside her budget constraint.
c. must not be consuming positive quantities of all goods.
d. must be consuming at a point where her budget constraint touches one of the axes.

7. An increase in income will cause a consumer's budget constraint to

a. shift outward, parallel to its initial position.
b. shift inward, parallel to its initial position.
c. pivot along the horizontal axis.
d. pivot along the vertical axis.

8. The slope of the budget constraint is determined by the

a. relative price of the goods measured on the axes.
b. relative price of the goods measured on the axes and the consumer’s income.
c. endowment of productive resources.
d. preferences of the consumer.

9. Suppose a consumer spends her income on two goods: iTunes music downloads
and books. The consumer has $100 to allocate to these two goods, the price of a
downloaded song is $1, and the price of a book is $20. What is the maximum
number of books the consumer can purchase?
a. 100
b. 20
c. 10
d. 5

10. A decrease in a consumer's income

a. increases the slope of the consumer's budget constraint.
b. has no effect on the consumer's budget constraint.
c. decreases the slope of the consumer's budget constraint.
d. has no effect on the slope of the consumer's budget constraint.

23
Section B Question 1
Answer the following questions based on the table. A consumer is able to consume the following
bundles of rice and beans when the price of rice is $2 and the price of beans is $3.
RICE BEANS
12 0
6 4
0 8
a. How much is this consumer's income?
b. Draw a budget constraint given this information. Label it B.
c. Construct a new budget constraint showing the change if the price of rice falls $1.
Label this C.
d. Given the original prices for rice ($2) and beans ($3), construct a new budget
constraint if this consumer's income increased to $48. Label this D.
Question 2
Quantity Marginal utility(Bananas) Marginal utility(Apples)
1 30 40
2 24 34
3 18 24
4 12 16
5 6 8
6 0 0

The table above gives Sam's marginal utility schedule for bananas and apples. Sam's fruit budget
is $10.
a) If bananas cost $1 per pound and apples cost $2 per bag, what is Sam's marginal utility per
dollar for all quantities of both goods?
b) What is the utility maximizing combination of bananas and apples for Sam?
c) If the price of bananas increases to $2 per pound, how does Sam's marginal utility per dollar
for bananas change?
d) At the banana price of $2 per pound, what is the new utility maximizing combination of
bananas and apples for Sam?
e) List two points on Sam's demand curve for bananas.

24
We do not learn the theory of utility, so you don’t need to solve this question Section
C
Question 1
Use the consumer choice model to explain the inverse relationship between the price and
quantity demanded for a normal good.

Chapter 5 :(Elasticity and Its Application)

Section A
1. Which of the following is not a determinant of the price elasticity of demand for a
good?
a. The time horizon.
b. The steepness or flatness of the supply curve for the good.
c. The definition of the market for the good.
d. The availability of substitutes for the good.

2. If the price elasticity of demand for a good is 4.0, then a 10 percent increase in
price results in a
a. 0.4 percent decrease in the quantity demanded.
b. 2.5 percent decrease in the quantity demanded.
c. 4 percent decrease in the quantity demanded.
d. 40 percent decrease in the quantity demanded.

3. Consider airfares on flights between Kuala Lumpur and Singapore. When the
airfare is $250, the quantity demanded of tickets are 2,000 per week. When the
airfare is $280, the quantity demanded of tickets are 1,700 per week. Using the
midpoint method,
a. the price elasticity of demand is about 1.43 and an increase in the airfare will cause
airlines' total revenue to decrease.
b. the price elasticity of demand is about 1.43 and an increase in the airfare will cause
airlines' total revenue to increase.
c. the price elasticity of demand is about 0.70 and an increase in the airfare will cause
airlines' total revenue to decrease.
d. the price elasticity of demand is about 0.70 and an increase in the airfare will cause
airlines' total revenue to increase.

25
4. The case of perfectly elastic demand is illustrated by a demand curve that is
a. vertical.
b. horizontal.
c. downward-sloping but relatively steep.
d. downward-sloping but relatively flat.

5. Suppose demand is perfectly inelastic and the supply of the good in question
decreases. As a result,
a. the equilibrium quantity decreases and the equilibrium price is unchanged.
b. the equilibrium price increases and the equilibrium quantity is unchanged.
c. the equilibrium quantity and the equilibrium price both are unchanged.
d. buyers’ total expenditure on the good is unchanged.

6. On a downward-sloping linear demand curve, total revenue reaches its maximum

value at the
a. lower end of the demand curve.
b. upper end of the demand curve.
c. midpoint of the demand curve.
d. It is impossible to tell without knowing prices and quantities demanded.

7. If a 6 percent increase in income results in a 10 percent increase in the quantity

demanded of pizza, then the income elasticity of demand for pizza is
a. negative and therefore pizza is an normal good.
b. negative and therefore pizza is a inferior good.
c. positive and therefore pizza is an inferior good.
d. positive and therefore pizza is a normal good.

8. Last month, sellers of good Y took in $100 in total revenue on sales of 50 units of
good Y. This month sellers of good Y raised their price and took in $120 in total
revenue on sales of 40 units of good Y. At the same time, the price of good X
stayed the same, but sales of good X increased from 20 units to 40 units. We can
conclude that goods X and Y are
a. substitutes, and have a cross-price elasticity of 0.60.
b. complements, and have a cross-price elasticity of 0.60.
c. substitutes, and have a cross-price elasticity of 1.67.
d. complements, and have a cross-price elasticity of 1.67.
TR = 100, Q = 50 →P = 2
TR = 120, Q = 40 →P = 3 (the price of good Y increases), percentage
change in price of good Y = (3-2)/2.5
Demand of good x increases, percentage change in demand of good X =
(40-20)/30
26
 Exy = [(40-20)/30]/[ (3-2)/2.5] = 1.67

9. A key determinant of the price elasticity of supply is

a. the ability of sellers to change the price of the good they produce.
b. the ability of sellers to change the amount of the good they produce.
c. how responsive buyers are to changes in sellers' prices.
d. the slope of the demand curve.

10. Other things equal, the demand for a good tends to be more inelastic, the
a. fewer the available substitutes.
b. longer the time period considered.
c. more the good is considered a luxury good.
d. more narrowly defined is the market for the good.

11. Suppose demand is perfectly elastic and the supply of the good in question
decreases. As a result,
a. the equilibrium quantity decreases and the equilibrium price is unchanged.
b. the equilibrium price increases and the equilibrium quantity is unchanged.
c. the equilibrium quantity and the equilibrium price both are unchanged.
d. buyers’ total expenditure on the good is unchanged.

12. An increase in price causes an increase in total revenue when

a. demand is elastic.
b. demand is inelastic.
c. demand is unit elastic.
d. All of the above are possible

13. A person who takes a prescription drug to control high cholesterol most likely has
a demand for that drug that is
a. inelastic.
b. elastic.
c. unit elastic.
d. highly responsive to changes in income.

14. Which of the following is not a determinant of the price elasticity of demand for a
good?
a. the steepness or flatness of the supply curve for the good
b. the time horizon
c. the definition of the market for the good

27
d. the availability of substitutes for the good

15. How does total revenue change as one moves downward and to the right along a
linear demand curve?
a. It always increases
b. It always decreases.
c. It first increases, then decreases.
d. It is unaffected by a movement along the demand curve.

16.
The figure above illustrates a linear demand curve. In the price range from $8 to $6,
demand is ____ and in the price range $4 to $2, demand is ____.
a. elastic; elastic
b. elastic; inelastic
c. inelastic; elastic
d. inelastic; inelastic
Hint: Use midpoint method

Section B Question 1
What are the main influences of the elasticity of supply that make the supply of some goods
elastic and the supply of other goods inelastic?

Question 2

28
The above figure shows the demand curve for movie rentals from Blockbuster.

a) Determine the price elasticity of demand if Blockbuster raised its price from $2.50 to
$3.00.
b) At which of the following prices is the demand unit elastic?
c) At which of the following prices does Blockbuster have the maximum total revenue and
how much is the maximum total revenue?
d) What will happen if Blockbuster lowered its price from $4.00 to $3.50?

Section C Question
1
a) The price elasticity of demand for a monopolist’s product is –0.7. Advise the firm on its
pricing strategy.
b) A firm sells two products: A and B. Product A has an income elasticity of demand of +1.3
and product B has an income elasticity of –1.4. Advise this firm on how it might plan its
production in the coming year if real consumer incomes are set to rise by 12%.
c) A firm sells two products: C and D. C has a cross elasticity of demand with another firm’s
product (product E) of +0.8 whilst D has a cross elasticity of demand with another firm’s
product (product F) of –1.9. Advise the firm on how its sales would be affected by a fall
in the price of the other firms’ products of 25%.

Question 2
a) Distinguish between price elasticity of demand, income elasticity of demand and cross
elasticity of demand.
b) Explain the relationship between price elasticity of demand and total revenue or total
expenditure.

29
Chapter 6 (Supply, Demand, and Government Policies ) Section A

1. Which of the following statements is correct?

a. A price ceiling is not binding when the price ceiling is set above the equilibrium
price.
b. A price floor is not binding when the price floor is set below the equilibrium price.
c. A binding price ceiling causes a shortage and a binding price floor causes a
surplus.
d. All of the above are correct.
30
2. An outcome that can result from either a price ceiling or a price floor is
a. an enhancement of efficiency.
b. undesirable rationing mechanisms.
c. excess supply.
d. excess demand.

3. Which of the following is the most correct statement about tax burdens?
a. A tax burden falls most heavily on the side of the market that is more elastic.
b. A tax burden falls most heavily on the side of the market that is less elastic.
c. A tax burden falls most heavily on the side of the market that is closer to unit
elastic.
d. A tax burden is distributed independently of relative elasticity of supply and
demand.

4. The presence of price controls in a market usually is an indication that

a. an insufficient quantity of a good or service was being produced in that market to
meet the public’s need.
b. the usual forces of supply and demand were not able to establish an equilibrium
price in that market.
c. policymakers believed that the price that prevailed in that market in the absence of
price controls was unfair to buyers or sellers.
d. policymakers correctly believed that, in that market, price controls would generate
no inequities of their own.

5. A price ceiling will be binding only if it is set

a. equal to equilibrium price.
b. above equilibrium price.
c. below equilibrium price.
d. none of the above; a price ceiling is never binding.

6. A minimum wage that is set above a competitive market's equilibrium wage will
result in
a. an excess demand for labour, that is, unemployment.
b. an excess demand for labour, that is, a shortage of workers.
c. an excess supply of labour, that is, unemployment.
d. an excess supply of labor, that is, a shortage of workers.

7. If a tax is imposed on a market with elastic demand and inelastic supply,

a. buyers will bear most of the burden of the tax.
b. sellers will bear most of the burden of the tax.

31
c. the burden of the tax will be shared equally between buyers and sellers.
d. it is impossible to determine how the burden of the tax will be shared.

8. The term tax incidence refers to

a. the matter of whether buyers or sellers of a good are required to send tax payments
to the government.
b. the matter of whether the demand curve or the supply curve shifts when the tax is
imposed
c. the distribution of the tax burden between buyers and sellers.
d. All of the above are correct.

9. In a market economy, government intervention

a. will always improve market outcomes.
b. reduces efficiency in the presence of externalities.
c. may improve market outcomes in the presence of externalities.
d. is necessary to control individual greed.

Section B Question 1
Using the graph shown, answer the following questions.
a. What was the equilibrium price in this market before the tax?
b. What is the amount of the tax?
c. How much of the tax will the buyers pay?
d. How much of the tax will the sellers pay?
e. How much will the buyer pay for the product after the tax is imposed?
f. How much will the seller receive after the tax is imposed?
g. As a result of the tax, what has happened to the level of market activity?
32
ANSWER

a. What was the equilibrium price in this market before the tax?
P = 10
b. What is the amount of the tax?
t = 11 – 8 = 3 (per unit)
c. How much of the tax will the buyers pay?
buyers pay= 11 – 10 = 1 (per unit)
d. How much of the tax will the sellers pay?
buyers pay= 10 – 8 = 2 (per unit)
e. How much will the buyer pay for the product after the tax is imposed?
buyers pay = 11*90 =
f. How much will the seller receive after the tax is imposed?
Sellers receive = 8*90 =
g. As a result of the tax, what has happened to the level of market activity? level of
market activity decreases (Q falls from 100 to 90)

Question 2
Using the graph shown, answer the following questions.

33
a) What was the equilibrium price in this market before the tax?
b) What is the amount of the tax?
c) How much of the tax will the buyers pay?
d) How much of the tax will the sellers pay?
e) How much will the buyer pay for the product after the tax is imposed?
f) How much will the seller receive after the tax is imposed?
g) As a result of the tax, what has happened to the level of market activity?

Price
Swith tax

$12.5

$10.0
$7.50

Quantity
80 100

34
Question 3

a. Using the graph shown, analyze the effect a RM 300 price ceiling would have on the
market for ten-speed bicycles. Would this be a binding price ceiling?
b. Using the graph shown, analyze the effect a RM 700 price floor would have on this
market. Would this be a binding price floor?
c. Why would policymakers choose to impose a price ceiling or price floor?
Price (RM/unit))

700

500

300

D
Quantity

300 500 700

35
 Chapter 7 (Consumers, Producers, and the Efficiency of Markets ) Section A

1. Consumer surplus in a market can be represented by the

a. area below the demand curve and above the price.
b. distance from the demand curve to the horizontal axis.
c. distance from the demand curve to the vertical axis.
d. area below the demand curve and above the horizontal axis.

2. Consumer surplus is
a. the amount a buyer is willing to pay for a good minus the amount the buyer
actually pays for it.
b. the amount a buyer is willing to pay for a good minus the cost of producing the
good.
c. the amount by which the quantity supplied of a good exceeds the quantity
demanded of the good.
d. a buyer's willingness to pay for a good plus the price of the good.

3. We can say that the allocation of resources is efficient if

a. producer surplus is maximized.
b. consumer surplus is maximized.
c. total surplus is maximized.
d. sellers’ costs are minimized.

4. It is efficient to produce an additional shirt if

a. the marginal benefit of producing the shirt is greater than zero.
b. the marginal benefit of producing the shirt is zero.
c. the marginal benefit of producing the shirt is greater than the marginal cost of
producing it.
d. total benefits from producing shirts are maximized.

5.

36
 In the above figure, what is the marginal benefit of the four-hundredth pretzel?
a. $0
b. $2.00
c. $3.00
d. $4.00

6. Nick can purchase each milkshake for $2. For the first milkshake purchased Nick is
willing to pay $4, for the second milkshake $3, for the third milkshake $2 and for
the fourth milkshake $1. What is the value of Nick’s consumer surplus?
a. $2
b. $9
c. $3
d. $10

37
7.

In the above figure, the producer surplus would be zero if the price per ton of wheat
was
a. $25.
b. $50.
c. $75.
d. $100.

8. When the competitive market is using its resources efficiently, the

a. total amount of consumer surplus is maximized.
b. total amount of producer surplus is maximized.
c. sum of the total amount of consumer surplus plus the total amount of producer
surplus are maximized.
d. sum of the total amount of consumer surplus plus the total amount of producer
surplus equals zero.

9. Suppose Larry, Moe and Curly are bidding in an auction for a mint-condition
video of Charlie Chaplin's first movie. Each has in mind a maximum amount that
he will bid. This maximum is called
a. a resistance price.
b. willingness to pay.
c. consumer surplus.
d. producer surplus.

38
10. Denise values a stainless steel dishwasher for her new house at $500. The actual
price of the dishwasher is $650. Denise
a. buys the dishwasher and on her purchase she experiences a consumer surplus of
$150.
b. buys the dishwasher and on her purchase she experiences a consumer surplus of $-
150.
c. does not buy the dishwasher and on her purchase she experiences a consumer
surplus of $150 on her non-purchase.
d. does not buy the dishwasher and on her purchase she experiences a consumer
surplus of $0 on her non-purchase.

11. Which of the following is not true when the price of a good or service falls?
a. Buyers who were already buying the good or service are better off.
b. Some new buyers, who are now willing to buy, enter the market.
c. The total consumer surplus in the market increases.
d. The total value of purchases before and after the price change is the same.

12. Which of the following events would increase producer surplus?

a. Sellers' costs stay the same and the price of the good increases.
b. Sellers' costs increase and the price of the good stay the same.
c. Sellers' costs increase and the price of the good decreases.
d. All of the above are correct.

13.

39
 Refer to the graph above. When the market is in equilibrium, consumer surplus is
equal to:
a. 500.
b. 1000.
c. 1500.
d. 2000.
14.

Refer to the graph above. An effective price ceiling at Pc causes producer surplus
to:
a. change from areas C + D + F to areas B + C + D.
b. change from areas A + B + E to areas A + B + C.
c. fall from areas C + D + F to area D.
d. fall from areas A + B + E to area A.

Section B Question 1
Ali loves donuts. The table shown reflects the value Ali places on each donut s he
eats:

VALUE OF FIRST DONUT $0.60

VALUE OF SECOND DONUT $0.50
VALUE OF THIRD DONUT $0.40
VALUE OF FOURTH DONUT $0.30
VALUE OF FIFTH DONUT $0.20
VALUE OF SIXTH DONUT $0.10

a. Use this information to construct Ali's demand curve for donuts.

40
b. If the price of donuts is $0.20, how many donuts will Ali buy?
c. Show Ali's consumer surplus on your graph. How much consumer surplus would he have
at a price of $0.20?
d. If the price of donuts rose to $0.40, how many donuts would he purchase now? What
would happen to Ali's consumer surplus? Show this change on your graph.

ANSWER a. Willingness to pay = P

P in vertical and Q in horizontal

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0
0 1 2 3 4 5 6 7

b. at price of $0.25 Ali buys 5 donuts

c. Draw demand curve, choose the area below D curve and above the price of $0.2
CS = (½)*5*(0.6 – 0.2)
d. P = 0.4, Ali buys 3 donuts, CS = (½)*3*(0.6 – 0.4)

Question 2
The table gives the demand and supply schedules for spring water.
Price(dollars per bottle) Quantity demanded Quantity supplied (bottles
(bottles per day) per day)
0 80 0
0.50 70 10
1.00 60 20
1.50 50 30
2.00 40 40
2.50 30 50
3.00 20 60
3.50 10 70
4.00 0 80

41
 a. What is the maximum price that consumers are willing to pay for the 50th bottle?
b. What is the minimum price that producers are willing to accept for the 50th bottle?
c. Are 50 bottles a day less than or greater than the efficient quantity?
d. What is the consumer surplus if the efficient quantity of spring water is produced?
e. What is the producer surplus if the efficient quantity of spring water is produced?
f. Calculate the deadweight loss if 50 bottles were to be produced per day.

ANSWER
a. What is the maximum price that consumers are willing to pay for the 50th bottle?
P = 1.5
b. What is the minimum price that producers are willing to accept for the 50th bottle?
P = 2.5
c. Are 50 bottles a day less than or greater than the efficient quantity?
efficient quantity = 40 (Qd = Qs), answer: greater
d. What is the consumer surplus if the efficient quantity of spring water is produced?
CS =1/2. 40. (4 - 2) =40
e. What is the producer surplus if the efficient quantity of spring water is produced?
PS =1/2. 40. (2 - 0) =40
f. Calculate the deadweight loss if 50 bottles were to be produced per day. if 50
bottles were to be produced, the mrket price is 1.5 (see demand schedule).
New CS = 1/2. 50. (4 – 1.5) =62.5
New PS = ½ .(50 -30). (2.5 -1.5)= 10
New TS = 72.5
From results of d and e, initial TS = 40 +40 = 80 →TS decreases by (80 - 72.5) = 7.5 (this is
the deadweight loss or ∆TS = - 7.5)

42
Chapter 10 (Externality) Section A

1. When externalities are present in a market, the well-being of market participants

a. and market bystanders are both directly affected.
b. and market bystanders are both indirectly affected.
c. is directly affected, and market bystanders are indirectly affected.
d. is indirectly affected, and market bystanders are directly affected.

2. In a market economy, government intervention

a. will always improve market outcomes.
b. reduces efficiency in the presence of externalities.
c. may improve market outcomes in the presence of externalities.
d. is necessary to control individual greed.

3. Private solutions may not be possible due to the costs of negotiating and enforcing
these solutions. Such costs are called
a. transaction costs.
b. opportunity costs.
c. deadweight loss.
d. corrective taxes

4. Markets are often inefficient when negative externalities are present because
a. private costs exceed social costs at the private market solution.
b. externalities cannot be corrected without government regulation.
c. social costs exceed private costs at the private market solution.
d. production externalities lead to consumption externalities.

5. An externality is the impact of

a. society's decisions on the well-being of society.
b. a person's actions on that person's well-being.
c. one person's actions on the well-being of a bystander.
d. society's decisions on the poorest person in the society.

43
6. Which of the following statements is correct?
a. Internalizing a negative externality will cause an industry to decrease the quantity
it supplies to the market and decrease the price of the good produced.
b. Internalizing a negative externality will cause an industry to decrease the quantity
it supplies to the market and increase the price of the good produced.
c. Internalizing a negative externality will cause an industry to increase the quantity it
supplies to the market and decrease the price of the good produced.
d. Internalizing a negative externality will cause an industry to increase the quantity it
supplies to the market and increase the price of the good produced.

Section B Question 1
Using a supply and demand diagram, demonstrate how a negative externality leads to market
inefficiency.

Question 2
Using a supply and demand diagram, demonstrate how a positive externality leads to market
inefficiency.
Question 3
Consider the following example of a market described by the following marginal cost and benefit
equations:

MSC = -200 + 10Q

MPC = -200 + 5Q
MPB = 1000 – 10Q

a) Calculate the equilibrium quantity and price in the market.

b) Calculate the socially efficient quantity and price.
c) Is the equilibrium quantity greater than or less than the socially efficient quantity? Do
widgets create a positive or a negative externality in society?
d) Calculate the deadweight loss at the equilibrium quantity in the market.

Section C Question 1
Using appropriate diagrams:
(a) Explain what is meant by a negative production externality.

(b) Explain (and indicate on the diagram in (a) what is meant by the social cost of a negative
production externality.

44
 (c) Explain how a government may use taxation to deal with the problem caused by a negative
production externality.

Chapter 13 (Production and Cost Theory)

Section A

1. Ah Cheong wants to start his own business. The business he wants to start will
require that he purchase a factory that costs $400,000. Ah Cheong currently has
$500,000 in the bank earning 3 percent interest per year.

If Ah Cheong purchases the factory with his own money, what is the annual
implicit opportunity cost of purchasing the factory?
a. $0
b. $3,000
c. $12,000
d. $15,000

2. When a profit-maximizing firm in a competitive market has a zero economic

profit, accounting profit
a. is negative (accounting losses).
b. is positive.
c. is also zero.
d. could be positive, negative or zero.

3. Siva Kamesh used to work as a telemarketer, earning $25,000 per year. She gave
up that job to start a catering business. In calculating the economic profit of her
catering business, the $25,000 income that she gave up is counted as part of the
catering firm's
a. total revenue.
b. implicit costs.
c. explicit costs.
d. marginal costs.

4. For a firm, the production function represents the relationship between

a. implicit costs and explicit costs.
b. quantity of inputs and total cost.
c. quantity of inputs and quantity of output.
d. quantity of output and total cost.

5.
45
 Number of workers Output
0 0
1 50
2 110
3 180
4 260
5 330

What is the marginal product of the fourth worker?

a. 65
b. 70
c. 75
d. 80

6. The short run total cost curve gets steeper as output increases due to
a. diseconomies of scale.
b. economies of scale.
c. diminishing marginal product.
d. increasing returns to scale.

7. A certain firm produces and sells staplers. Last year, it produced 7,000 staplers and
sold each stapler for $6. In producing the 7,000 staplers, it incurred variable costs
of $ 28,000 and a total cost of $ 45,000.

The firm's accounting profit for the year was

a. -$ 3,000.
b. -$ 5,000
c. $ 7,000.
d. $ 17,000

8. Opportunity cost differs from the costs measured by an accountant because

opportunity cost includes all
a. profits.
b. implicit costs.
c. conventional depreciation.
d. economic profit.

9. Greg, a landscaper, is planning on opening his own landscaping company. He

currently earns $40,000 per year working for his uncle. He plans to use $10,000 in
savings to pay for the equipment he needs, though even after use he could sell the

46
 equipment for what he paid, $10,000. The current interest rate on savings is 5
percent. What is the total implicit cost incurred by Greg when he opens his own
business?
a. $40,500
b. $40,000
c. $10,000
d. $50,000

10. "The short run" is defined as a period of time in which

a. all factors (inputs) are variable.
b. all factors (inputs) are fixed.
c. inputs classified as capital are fixed, but other inputs, including labour and
materials, are variable.
d. inputs classified as capital are variable, but other inputs, including labour and
materials, are fixed.

11. When marginal cost (MC) is greater than the average total cost (ATC)
a. MC is falling
b. MC is less than average variable cost
c. ATC is falling
d. ATC is rising

12. Which of the following never rises as output increases?

a. Short run average total cost.
b. Long run average total cost.
c. Short run average variable cost.
d. Short run average fixed cost.

13. Economies of scale

a. deal with what happens if all of the inputs are increased by some proportion.
b. can be shown using a total product curve.
c. imply falling average total costs in the long run.
d. require that at least one factor be fixed.

14. Sunk or "historical" costs are

47
a. costs associated with current operational decisions.
b. costs that have already been incurred as a result of past decisions.
c. costs that add to the firm's marginal costs.
d. costs that are the major component of a firm's average variable cost.

15. Which of the following is an implicit cost?

(i) the owner of a firm forgoing an opportunity to earn a large salary working for
a Wall Street brokerage firm
(ii) interest paid on the firm's debt
(iii) rent paid by the firm to lease office space
a. (ii) and (iii)
b. (i) and (iii)
c. (i) only
d. (iii) only

16. Which of the following expressions is correct?

a. accounting profit = economic profit + implicit costs
b. accounting profit = total revenue - implicit costs
c. economic profit = accounting profit + explicit costs
d. economic profit = total revenue - implicit costs

17.

48
 As the number of workers increases,
a. total output increases, but at a decreasing rate.
b. marginal product increases, but at a decreasing rate.
c. marginal product increases at an increasing rate.
d. total output decreases.

18. Suppose that for a particular business, there are no implicit opportunity costs. Then
a. accounting profit will be greater than economic profit.
b. accounting profit will be the same as economic profit.
c. accounting profit will be less than economic profit.
d. the relationship between accounting profit and economic profit cannot be
determined since the amount of explicit opportunity costs is not given.

19. A firm’s average total cost is $60, its average variable cost is $30, and its total
fixed cost is $600. Its output is
a. 20 units.
b. 30 units.
c. 40 units.
d. 50 units.

Section B Question 1
What are diseconomies of scale? How do they arise?

Question 2
What are implicit costs? How are they different from explicit costs?

Question 3
Consider the table below which shows the total fixed costs (TFC) and variable costs (TVC) for
producing dog kennels in a small factory with a fixed amount of capital.
Output per Total Fixed Total Variable Cost
year Cost(TFC) ($000’s (TVC) ($000’s
(000’s of
kennels)
0 200 0
1 200 40
2 200 70
3 200 90
4 200 100
5 200 110

49
 6 200 130
7 200 160
8 200 200
9 200 250
10 200 310
11 200 380

a) Compute the average fixed cost (AFC), average variable cost (AVC), marginal cost (MC)
and average total cost (ATC) for each level of output.

b) Explain the relationship between the between marginal cost and average variable cost.

Section C Question 1
What are economies of scale and diseconomies of scale? How do they arise?

50
Chapter 14 (Perfect Competition) Section A

1. The short-run supply curve for a firm in a perfectly competitive market is

a. horizontal.
b. likely to slope downward.
c. determined by forces external to the firm.
d. the portion of its marginal cost curve that lies above its average variable cost.

2. If a firm in a perfectly competitive market triples the number of units of output

sold, then total revenue will
a. more than triple.
b. less than triple.
c. exactly triple.
d. Any of the above may be true depending on the firm’s labor productivity.

3. In a competitive market, no single producer can influence the market price because
a. many other sellers are offering a product that is essentially identical.
b. consumers have more influence over the market price than producers do.
c. government intervention prevents firms from influencing price.
d. producers agree not to change the price.

4. Suppose a firm in a competitive market produces and sells 8 units of output and
has a marginal revenue of $ 8.00. What would be the firm's total revenue if it
instead produced and sold 4 units of output?
a. $ 4.00
b. $ 8.00
c. $ 32.00
d. $64.00

5. Which of the following is NOT a characteristic of perfect competition?

51
 a. There are many firms, each selling an identical product.
b. There are many buyers.
c. Firms in the industry have an advantage over potential new entrants.
d. Firms and buyers are well informed about the prices of the products of each firm in
the industry.

6. A perfectly competitive firm’s marginal revenue

a. increases as the firm produces more output.
b. decreases as the firm produces more output.
c. is less than the market price of its product.
d. equals the market price of its product.

7.
Total Total
The figure above depicts the marginal
Quantity fixed variable
revenue and costs of a perfectly competitive
cost, TFC cost, TVC
firm. The firm’s profit is maximized
(dollars) (dollars)
when the firm produces
a. 90 units of output. 0 500 0
b. 130 units of output. 1 500 100
c. 170 units of output. 2 500 180
d. 210 units of output. 3 500 220
4 500 300
8. 5 500 390
6 500 500
7 50052 640
8 500 800
9 500 1000
10 500 1250
 The table above shows some of the costs for a perfectly competitive firm. The firm
will produce 9 units of output if the price per unit is
a. $1750.
b. $200.
c. $300.
d. $500.

9. At the present level of production, a perfect competitive firm observes that

MR=$50, MC=$50, and AVC=$75. Based on these figures:
a. the firm is maximizing profit.
b. the firm should shut down.
c. The firm should continue to produce, but should reduce its rate of output.
d. the firm should expand production

10. For a firm in a perfectly competitive market, the price of a good is always
a. equal to marginal revenue.
b. equal to total revenue.
c. greater than average revenue.
d. equal to the firm’s efficient scale of output.

11. Which of the following is NOT a characteristic of a perfectly competitive market?

a. Firms are price takers.
b. Firms have difficulty entering the market.
c. There are many sellers in the market.
d. Goods offered for sale are largely the same.
12. Which of the following statements best reflects a price-taking firm?
a. If the firm were to charge more than the going price, it would sell none of its
goods.
b. The firm has an incentive to charge less than the market price to earn higher
revenue.
c. The firm can sell only a limited amount of output at the market price before the
market price will fall.
d. Price-taking firms maximize profits by charging a price above marginal cost.

13. Suppose a firm in a competitive market received $1,000 in total revenue and had a
marginal revenue of $10 for the last unit produced and sold. What is the average
revenue per unit, and how many units were sold?
a. $5 and 50

53
b. $5 and 100
c. $10 and 50
d. $10 and 100

14.

Refer to the graph above. When the industry is in long-run competitive equilibrium
a. the price of the product will be $6.
b. the firm will produce 100 units of output.
c. the firm will earn economic profits of $300 per day.
d. the marginal cost of production will be $3. Section B

Question 1
Explain how a firm in a competitive market identifies the profit-maximizing level of production.
When should the firm raise production, and when should the firm lower production?

Question 2
What is the relationship between a perfect competition firm’s supply curve, its marginal cost
curve, and its average variable cost curve?

Question 3
Use the following graph to answer the questions below.

54
a) Assuming that the industry is in an equilibrium characterized by D1 and S1, calculate the
profit of the firm?
b) Consider a decrease in the demand from the original equilibrium described in a) above,
what is the profit of the firm now?
c) As a result in the decrease in demand some firms are not able to operate and have to scale
down or exit the industry. Given the new supply curve, what should this firm do in the long run?
d) Based on the industry graph, what type of industry is it?

Section C Question 1
Use a graph to demonstrate the circumstances that would prevail in a competitive market where
firms are earning economic profits. Can this scenario be maintained in the long run? Carefully
explain your answer.

Question 2
Describe the course of events in a competitive industry following a permanent increase in
demand. What happens to output, price, and economic profit in the short-run and in the long-run?
Question 3
Describe the course of events in a competitive market following the adoption of a new
technology. What happens to output, price, and economic profit in the short run and in the long
run?

Chapter 15 (Monopoly) Section A

1. Suppose most people regard emeralds, rubies, and sapphires as close substitutes for
diamonds. Then DeBeers, a large diamond company, has

55
a. less incentive to advertise than it would otherwise have.
b. less market power than it would otherwise have.
c. more control over the price of diamonds than it would otherwise have.
d. higher profits than it would otherwise have.

2. The figure below illustrates the cost and revenue structure for a monopoly firm.

MC

ATC

AR

MR
A profit-maximizing monopoly's profit is equal to
a. P3 × Q2.
b. P2 × Q4.
c. (P3 – P0) × Q2.
d. (P3 – P0) × Q4.

3. Which of the following statements is (are) true of a monopoly?

(i) A monopoly has the ability to set the price of its product at whatever level it
desires.
(ii) A monopoly's total revenue will always increase when it increases the price of
its product.
(iii) A monopoly can earn unlimited profits.
a. (i) only
b. (ii) only
c. (i) and (ii)
d. (ii) and (iii)

4. A natural monopoly occurs when

a. the product is sold in its natural state (such as water or diamonds).
b. there are economies of scale over the relevant range of output.
c. the firm is characterized by a rising marginal cost curve.
d. production requires the use of free natural resources, such as water or air.

5. When a firm operates under conditions of monopoly, its price is

a. not constrained.

56
b. constrained by marginal cost.
c. constrained by demand
d. constrained only by its social agenda

6. If a profit-maximizing monopolist faces a downward-sloping market demand

curve, its
a. average revenue is less than the price of the product
b. average revenue is less than marginal revenue.
c. marginal revenue is less than the price of the product.
d. marginal revenue is greater than the price of the product.

7. If a monopolist was operating in a price range where marginal revenue was

negative, it would be
a. in the inelastic range of the demand for its product.
b. in the unit elastic range of the demand for its product.
c. in the elastic range of the demand for its product.
d. maximizing revenue but not profits.

8. Which of the following is true of a monopoly?

a. It can always increase its revenue by increasing the price to its customers.
b. It will always operate somewhere along the inelastic portion of the demand curve.
c. Its marginal cost curve is always downward sloping.
d. None of the above is correct.

9. A profit-maximizing monopolist must cut the price of his product if

a. marginal revenue is greater than marginal costs.
b. marginal revenue is equal to variable costs.
c. marginal revenue is less than marginal costs.
d. average total costs fall.

10. Suppose we know that a monopolist is maximizing its profits. Which of the
following is a correct inference? The monopolist has
a. maximised its total revenue.
b. set price equal to its average cost.
c. maximised the difference between marginal revenue and marginal cost.
d. equated marginal revenue and marginal cost.
11.

57
 The shape of the average total cost curve reveals information about the nature of
the barrier to entry that might exist in a monopoly market. Which of the following
monopoly types best coincides with the figure?
a. Ownership of a key resource by a single firm
b. Natural monopoly
c. Government-created monopoly
d. A patent or copyright monopoly

12. Monopoly firms have

a. downward-sloping demand curves and they can sell as much output as they desire
at the market price.
b. downward-sloping demand curves and they can sell only a limited quantity of
output at each price.
c. horizontal demand curves and they can sell as much output as they desire at the
market price.
d. horizontal demand curves and they can sell only a limited quantity of output at
each price.

13. If a firm has a monopoly over the sale of photographic paper and seeks to
maximize profits, then:
a. it adjusts the price of the product until demand becomes perfectly inelastic.
b. it will set the price of the product equal to the marginal cost of production.
c. it will set the price of the product equal to the average total cost of production.
d. it will set the price of the product so that its marginal revenue equals its marginal
cost.

14.

Refer to the graph above. Which rectangle represents monopolists' profit?

a. A
b. A+B+C
c. C+D
d. None of the above

15.

58
 Refer to the graph above. If this firm were forced to set price equal to marginal
cost, it would likely:
a. charge a price of $1.
b. charge a price of $2.
c. charge a price of $9.00.
d. eventually stop producing.

Section B Question 1
Explain why a profit-maximizing monopolist will be selling on an elastic portion of its demand
curve.
Question 2
How does a single-price monopoly determine the price it will charge its customers?

Question 3

What is the objective of price discrimination? What conditions must be present for a firm to be
able to price discriminate?

Section C Question
1
i) Distinguish between a price-discriminating monopoly and a single price monopoly.
ii) Explain how consumer surplus, economic profit, and output change when a monopoly
perfectly price discriminates.

Question 2
Suppose that a perfectly competitive industry becomes a monopoly. Describe the effects of this
change on consumer surplus, producer surplus, and deadweight loss.

Question 3
Compare the consumer surplus, producer surplus, and deadweight loss that arise from average
cost pricing with those that arise from profit-maximization pricing and marginal cost pricing.

59
Chapter 16 (Oligopoly) Section A

1. The following table shows the total output produced by the top six firms as well as
the total industry output for four industries.

Firm Industry A Industry B Industry C Industry D

1 13,250 8,750 1,750 15,000
2 10,975 7,500 1,725 14,000
3 8,175 6,400 1,700 13,000
4 4,275 5,000 1,675 12,000
5 1,250 4,250 1,650 11,000
6 875 4,000 1,625 10,000
Total 45,350 70,900 30,125 120,000

Which industry has the highest concentration ratio?

a. Industry A
b. Industry B
c. Industry C

60
d. Industry D

2. When firms are faced with making strategic choices in order to maximize profit,
economists typically use
a. the theory of monopoly to model their behavior.
b. the theory of aggressive competition to model their behavior.
c. game theory to model their behavior.
d. cartel theory to model their behavior.

3. The prisoners' dilemma is an important game to study because

a. most games present zero-sum alternatives.
b. it identifies the fundamental difficulty in maintaining cooperative agreements.
c. strategic decisions faced by prisoners are identical to those faced by firms engaged
in competitive agreements.
d. all interactions among firms are represented by this game.

4. ACME is an oligopoly that believes it has a kinked demand curve. ACME is

assuming that if it
I) increases its price, its competitors will not increase their prices.
II) decreases its price, its competitors will decrease their prices.
III) increases output, its competitors will not increase their output.
a. I and II.
b. I and III.
c. II and III.
d. I, II and III.

5. In a prisoners’ dilemma game, in the Nash equilibrium

a. both players have another outcome that does not occur but is more favorable.
b. neither player has another outcome that does not occur and is more favorable.
c. one player has another outcome that does not occur and is more favorable.
d. collusion would not alter the outcome.

6. Which of the following is not a characteristic associated with oligopoly?

a. few firms
b. standardised or differentiated goods
c. lack of concern regarding a rival's behavior
d. barriers to entry

7. Cartel agreements tend to be unstable because:

a. cartel agreements tend to lower profits.
b. a firm can increase its profits by cheating on the agreement.
c. agreements become unnecessary as the number of firms in the cartel increases.
d. cutting output and raising prices will benefit each firm in the cartel.

61
8. The prisoners' dilemma helps to explain:
a. why cooperation occurs in strategic situations.
b. why cooperation is difficult to maintain in strategic situations
c. why cooperation is mutually beneficial in strategic situations.
d. why cooperation never oocurs in strategic situations.

9. Which of the following is a characteristic of oligopoly, but NOT perfect

competition?
a. Advertising and sales promotion
b. Profit maximization according to the MR = MC rule
c. Firms are price takers rather than price makers
d. Horizontal demand and marginal revenue curves

10. As a group, oligopolists would always earn the highest profit if they would
a. produce the perfectly competitive quantity of output.
b. produce more than the perfectly competitive quantity of output.
c. charge the same price that a monopolist would charge if the market were a
monopoly.
d. operate according to their own individual self-interests.

11. The equilibrium quantity in markets characterized by oligopoly is

a. higher than in monopoly markets and higher than in perfectly competitive markets.
b. higher than in monopoly markets and lower than in perfectly competitive markets.
c. lower than in monopoly markets and higher than in perfectly competitive markets.
d. lower than in monopoly markets and lower than in perfectly competitive markets.

12. The model that assumes that oligopolies act jointly as if they were monopolists is
the:
a. cartel model.
b. contestable market model.
c. monopolistically competitive model.
d. prisoner's dilemma.

13. According to the kinked demand curve theory of oligopoly, each firm believes that
if it raises its price,
a. the government will impose price controls.
b. other firms will not raise their prices.
c. the overall price level will rise by the same percentage.
d. its profits will rise by the same percentage.

62
14.

In the figure above, if the firm’s marginal cost is MC0, then the firm will produce
a. less than 30 units per day.
b. 30 units per day.
c. more than 30 but less than 40 units per day.
d. 40 units per day

15. In the dominant firm model of oligopoly, the smaller firms act as if they were

a. perfect competitors.
b. monopolistic competitors.
c. oligopolists.
d. monopolists.

63
Section B Question 1
Describe the source of tension between cooperation and self-interest in a market characterized by
oligopoly. Use an example of an actual cartel arrangement to demonstrate why this tension
creates instability in cartels.

Question 2
Describe the prisoners’ dilemma game and explain why the Nash equilibrium delivers a bad
outcome for both players?

Chapter 17 (Monopolistic Competition) Section A

1. When an industry has many firms, the industry is

a. an oligopoly if the firms sell differentiated products, but it is monopolistically
competitive if the firms sell identical products.
b. an oligopoly if the firms sell differentiated products, but it is perfectly competitive
if the firms sell identical products.
c. monopolistically competitive if the firms sell differentiated products, but it is
perfectly competitive if the firms sell identical products.
d. perfectly competitive if the firms sell differentiated products, but it is
monopolistically competitive if the firms sell identical products.

2. Monopolistic competition differs from perfect competition because in

monopolistically competitive markets
a. there are barriers to entry.
b. all firms can eventually earn economic profits.
c. each of the sellers offers a somewhat different product.
d. strategic interactions between firms is vitally important.

3. The profit-maximizing rule for a firm in a monopolistically competitive market is

to always select the quantity at which
a. marginal revenue is equal to marginal cost.
b. average total cost is equal to marginal revenue.
c. average total cost is equal to price.
d. average revenue exceeds average total cost.

4. Which of the following is NOT true of firms in monopolistic competition?

64
a. They are price takers.
b. They practice product differentiation.
c. They have excess capacity in the long run.
d. They earn a normal profit in the long run.

5. In the long run, a firm in monopolistic competition produces an output at which

a. price equals marginal cost but exceeds average total cost.
b. price equals both marginal cost and average total cost.
c. price equals average total cost but exceeds marginal cost.
d. price equals average total cost but is less than marginal cost.

6. Compared to perfect competition, monopolistic competition:

a. provides greater product differentiation at the cost of some excess capacity.

b. offers less product differentiation but attains equal productive efficiency.
c. provides greater product differentiation and achieves greater productive efficiency.
d. offers less product differentiation and lower productive efficiency.

7. In long-run equilibrium, the monopolistically competitive firm:

a. produces at its minimum long-run average cost
b. experiences excess capacity.
c. can earn economic profits if it is efficient.
d. earns a price that exceeds the average total cost of production.

8. At the present level of production, a monopolistically competitive firm observes

that P=$100, MR=$50, MC=$50, and AVC=$75. Based on these figures:
a. the firm is maximizing profit.
b. the firm should shut down.
c. the firm should continue to produce but should reduce its rate of output.
d. the firm should expand production

9. A market structure in which there are many firms selling products that are similar
but not identical is known as
a. oligopoly.
b. monopoly.
c. monopolistic competition.
d. perfect competition.
65
10. A similarity between monopoly and monopolistic competition is that, in both
market structures,
a. strategic interactions among sellers are important.
b. there are a small number of sellers.
c. sellers are price makers rather than price takers.
d. product differentiation is important.

11.

Which of the graphs depicts the situation for a profit-maximizing firm in a

monopolistically competitive market?
a. Panel a
b. Panel b
c. Panel c
d. Panel d

66
12. If a monopolistically competitive firm is earning economic profits in the short-run,
then:
a. these profits will persist in the long-run because of the firm's limited monopoly
power.
b. these profits will be eliminated in the long-run as new firms enter the industry.
c. its output will increase in the long-run.
d. price will be driven down to minimum average total cost in the long-run.

13. Under monopolistic competition a firm's ability to influence the price of the
product it sells arises because:
a. sellers in the market have large market shares.
b. sellers in the market have small market shares.
c. the product of each seller is differentiated from that of others.
d. each seller sells a standardized product.

14. Monopolistic competition and monopoly are ____ market types in that firms
in____.
a. similar; both market types have products that are identical to those of their
competitors.
b. similar; both market types have many competitors.
c. different; monopoly are protected by barriers to entry.
d. different; monopolistic competition have only a few competitors.
15. In monopolistically competitive industries,
a. non-price competition through product differentiation is vigorous.
b. the amount of variety in products is the same as in perfectly competitive industries.
c. firms are not sensitive to changes in consumer demand.
d. firms produce where marginal cost exceeds the marginal benefit to consumers.

16. In monopolistic competition, in the long run customers pay a price that is
a. less than the minimum ATC.
b. more than the minimum ATC.
c. equal to both the minimum ATC and the minimum AVC.
d. equal to the minimum ATC, but not equal to the minimum AVC.

17. Which of the following is NOT a characteristic of monopolistic competition?

a. There are a large number of competing firms.
b. There are significant barriers to entry.
c. Each firm produces a differentiated product.
d. Collusion is impossible

18. Within a monopolistically competitive industry,

67
a. firms can freely enter and exit and economic profits are zero in the long run.
b. firms can freely enter and exit and economic profits are greater than zero in the
long run.
c. there are some barriers to entry and exit but economic profits are zero in the long
run.
d. there are some barriers to entry and exit and economic profits are greater than zero
in the long run.

Section B Question 1
Use a graph to demonstrate why a profit-maximizing monopolistically competitive firm must
operate at excess capacity.

Section C Question 1
a) What are the chief characteristics of a monopolistic competitive market?
b) Is a monopolistic competitive firm an efficient firm?

Question 2
Draw the relevant curves to show a monopolistic competitor earning an economic profit in the
short run. Graphically show and explain what this firm can expect to happen to this economic
profit in the long run.

68
69