1. Problems faced by all economic systems include

which of the following?

I. How to allocate scarce resources among unlimited

wants

II. How to decentralize markets

III. How to decide what to produce, how to

produce, and for whom to produce

IV. How to set government production quotas

(A) I only

(B) I and III only

(C) II and III only

(D) I, II, and III only

(E) I, II, III, and IV

(B) I and III only

Explanation: The basic problems of economics are related to scarcity and unlimited demand. Decentralized market does not deal with the issue of scarcity or unlimited demand. The government's production quotas can affect economic outcome positively or negatively, but not all quotas are intended to help with the scarcity issue. Therefore, I and III are the only correct answer. 

2. Which of the following would necessarily cause a fall

in the price of a product?

(A) An increase in population and a decrease in the

price of an input

(B) An increase in population and a decrease in the

number of firms producing the product

(C) An increase in average income and an

improvement in production technology

(D) A decrease in the price of a substitute product

and an improvement in production

technology

(E) A decrease in the price of a substitute product

and an increase in the price of an input

(D) A decrease in the price of a substitute product

and an improvement in production

technology

Explanation: The increases in population and income do not affect the price. The price only falls when the price of the substitute falls or when there is more advanced technology, making it cheaper to produce. Therefore, (D) is the correct answer.

4. suppose tnat a tamily buys all its clotning trom a

discount store and treats these items as inferior

goods. Under such circumstances, this family's

consumption of discount store clothing will

necessarily

(A) increase when a family member wins the state

lottery

(B) increase when a family member gets a raise in

pay at work

(C) remain unchanged when its income rises or fall

due to events beyond the family's control

(D) decrease when a family member becomes

unemployed

(E) decrease when a family member experiences an

increase in income

(E) decrease when a family member experiences an

increase in income

Explanation: An inferior good is a good that people consume less of when their income rises. Therefore, when the family gains a greater income, they will consume less of the inferior good.

5. Which of the following describes what will happen to

market price and quantity if firms in a perfectly

competitive market form a cartel and act as a profitmaximizing

monopoly?

Price Quantity

(A) Decrease Decrease

(B) Decrease Increase

(C) Increase Increase

(D) Increase Decrease

(E) Increase No change

Price Quantity

(D) Increase Decrease

Explanation: A cartel occurs when a group of firms agree on the same price in order to maximize their profits. When a cartel wants to maximize their profits, they will increase the price. If the price increases, then the quantity will decrease because of the law of demand. The law of demand states that if the price falls, the demand rises and vice versa. Therefore, (D) is the correct answer. 

6. Quantity Produced    Total Cost

0 $5

1 17

2 28

3 41

4   61

5 91

Barney's Bait Company can sell all the lures it

produces at the market price of $14. On the basis o

the cost information in the table above, how many

lures should the bait company make?

(A)l (B)2 (C)3 (D)4 (E)5

(C)3

Explanation: For Barney's Bait Company to make the most profit, the profit must be higher than the total cost. To find profit, multiply the quantity by the market price. The company should produce 3 for the number quantity because 3 x 14= 42 (profit), and 42 (profit)> 41 (total cost). Therefore, (C) is the correct answer. 

7. A natural monopoly occurs in an industry if

(A) economies of scale allow at most one firm of

efficient size to exist in that market

(B) a single firm has control over a scarce and

essential resource

(C) a single firm produces inputs for use by other

firms

(D) a single firm has the technology to produce the

product sold in that market

(E) above-normal profits persist in the industry

(A) economies of scale allow at most one firm of

efficient size to exist in that market

Explanation:A monopoly is when there is only one firm in that market. The advancement in technology allows only one firm to control the market in the economies of scale. No other firms can provide the same good at the same price or quantity. Therefore, (A) is the right answer. 

8. The typical firm in a monopolistically competitive

industry earns zero profit in long-run equilibrium

because

(A) advertising costs make monopolistic competition

a high-cost market structure rather than a

low-cost market structure

(B) the firms in the industry do not operate at the

minimum point on their long-run average

cost curves

(C) there are no restrictions on entering or exiting

from the industry

(D) the firms in the industry are unable to engage in

product differentiation

(E) there are close substitutes for each firm's product

(C) there are no restrictions on entering or exiting

from the industry

Explanation: In a monopolistically competitive industry, a firm earns zero in the long-run equilibrium, so there is no barrier or great cost to enter and exist the industry. Therefore, (C) is the correct answer. 

10. If hiring an additional worker would increase a

firm's total cost by less than it would increase its total

revenue, the firm should

(A) not hire the worker

(B) hire the worker

(C) hire the worker only if another worker leaves or is

fired

(D) hire the worker only if the worker can raise the

firm's productivity

(E) reduce the number of workers employed by the

firm

(B) hire the worker

Explanation: If hiring another worker does not raise the total cost by much and increases the total revenue, then it is wise to hire another worker. Therefore, (B) is the correct answer. 

14. An effective price floor introduced in the market for

rice will result in

(A) a decrease in the price of rice and an increase in

the quantity of rice sold

(B) a decrease in the price of rice and a decrease in the

quantity of rice sold

(C) a decrease in the price of rice and an excess

demand for rice

(D) an increase in the price of rice and an excess

supply of rice

(E) an increase in the price of rice and an excess

demand for rice

(D) an increase in the price of rice and an excess

supply of rice

Explanation: Price floor is put in place to increase the price, while price ceiling is intended to decrease the price. The increase in price is supposed to encourage the firm to increase the supply, so that they can gain more profit. Therefore, (D) is the correct answer. 

15. Marginal revenue is the change in revenue that results from a one-unit increase in the

(A) variable input

(B) variable input price

(C) output level

(D) output price

(E) fixed cost

(C) output level

Explanation: Marginal Revenue is the change in total revenue divided by the change in quantity. MR= change in TR/ change in Q. Therefore, (C) is the correct answer.

20. Assume that an electric power company owns two

plants and that, on a particular day, 10,000 kilowatts

of electricity are demanded by the public. In order to

minimize the total cost of providing the 10,000

kilowatts, the company should allocate production so

that

(A) marginal costs are the same for both plants

(B) average total costs are the same for both plants

(C) total variable costs are the same for both plants

(D) the sum of total variable cost and total fixed cost

is the same for both plants

(E) only the plant with the lower average cost is used

to produce the 10,000 kilowatts of electricity

(A) marginal costs are the same for both plants

Explanation: To minimize the total cost, use the Least Cost equation. 

Marginal Product a/ Marginal Resource Cost a = Marginal Product b/ Marginal Resource Cost b

MPa/MRCa=MPb/MRCb

21. Suppose that the consumption of a certain product

results in benefits to others besides the consumers of

the product. Which of the following statements is

most likely to be true?

(A) The demand for the product is price inelastic.

(B) A perfectly competitive industry will not produce

the optimal quantity of the product.

(C) A perfectly competitive industry will not produce

the product.

(D) Optimality requires that consumers of this

product be taxed.

(E) Producers of this product earn an economic profit.

(B) A perfectly competitive industry will not produce

the optimal quantity of the product.

Explanation: A perfectly competitive industry's price equals the marginal cost. For a good to have more marginal benefit than the marginal cost, a firm in a perfectly competitive industry will produce more than the optimal quantity of the product because they want to maximize their profit. Therefore, (B) is the answer. 

Questions 22-23 are based on the table below, which lists

the total output of workers in Greta's Jacket Shop.

Number of Workers Total Output

2 12

3 22

4 28

5 32

23. Greta already employs 3 workers. If the price of

jackets is $5 and the wage rate is $25, she should

(A) go out of business altogether

(B) lay off the third worker

(C) keep the third worker but not employ more

workers

(D) hire two more workers

(E) hire one more worker

(E) hire one more worker

Explanation: Find the revenue of the third worker: Price x Total Output

$5 x 22= $110 

Find the total cost: Wage x Number of workers

$25 x 3= $75

If the revenue is higher than the total cost, then hire one more worker.

Therefore, (E) is the correct answer. 

[PPF of Increasing Opportunity between Commodity 1 and Commodity 2]

26. Which of the following best explains the shape of the

production possibilities curve for the two commodity

economy shown above?

(A) The opportunity cost of producing an additional

unit of each commodity stays the same as production

of the commodity expands.

(B) The opportunity cost of producing an additional

unit of each commodity decreases as production of the

commodity expands.

(C) The opportunity cost of producing an additional

unit of each commodity increases as production of the

commodity expands.

(D) The quantity demanded of each commodity

decreases as consumption of the commodity increases.

(E) The quantity demanded of each commodity

increases as the production of the commodity expands.

(C) The opportunity cost of producing an additional

unit of each commodity increases as production of the

commodity expands.

Explanation: According to the Law of Increasing Opportunity Cost, the cost of producing increases when more product is produced. Therefore, (C) is the correct answer. 

27.1n the long run, compared with a perfectly competitive

firm, a monopolistically competitive firm with the same

costs will have

(A) a higher price and higher output

(B) a higher price and lower output

(C) a lower price and higher output

(D) a lower price and lower output

(E) tthhee ;s ame price and lower output

(B) a higher price and lower output

Explanation: In the long run, a monopolistically competitive firm will have higher price and lower output than a perfectly competitive firm because the monopolistically competitive firm has an efficient scale and excess capacity, so they will produce less and sell at a higher price. Therefore, (B) is the correct answer. 

29. Suppose that an effective minimum wage is imposed in

a certain labor market above the equilibrium wage. If labor

supply in that market subsequently increases, which of the

following will occur?

(A) Unemployment in that market will increase.

(B) Quantity of labor supplied will decrease.

(C) Quantity of labor demanded will increase.

(D) Market demand will increase.

(E) The market wage will increase.

(A) Unemployment in that market will increase.

Explanation: When a minimum wage is imposed above the equilibrium wage and labor supply increases, then more people will become unemployed because it would cost too much for the firm to keep its original number of workers. The marginal cost of labor would exceed the marginal product of firm. Therefore, (A) is the correct answer. 

Questions 31-33 are based on the table below, which

shows a firm's total cost for different levels of output.

Output

0

1

2

3

4

5

6

Total Cost

$24

33

41

48

54

61

69

31. Which of the following is the firm's marginal cost of

producing the fourth unit of output?

(A) $54.00

(B) $13.50

(C) $ 7.50

(D) $ 6.00

(E) $ 1.50

(D) $ 6.00

Explanation: The marginal cost is the additional cost it takes to get from one quantity to another. So, MC= 54-48= $6. (D) is the correct answer. 

Questions 31-33 are based on the table below, which

shows a firm's total cost for different levels of output.

Output

0

1

2

3

4

5

6

Total Cost

$24

33

41

48

54

61

69

33. Which of the following is the firm's average fixed cost

of producing 2 units of output?

(A) $24.00

(B) $20.50

(C) $12.00

(D) $ 8.00

(E) $ 7.50

(C) $12.00

Explanation: Total Fixed Cost= where Total Cost = O

TFC= 24 

Average fixed cost of producing two units= TC/Q

$24/2= $12.

35. Which of the following statements is true of

perfectly competitive firms in long-run

equilibrium'?

(A) Firm revenues will decrease if production is

increased.

(B) Total firm revenues are at a maximum.

(C) Average fixed cost equals marginal cost.

(D) Average total cost is at a minimum.

(E) Average variable cost is greater than marginal

cost.

(D) Average total cost is at a minimum.

Explanation: In the long run of a perfectly competitive market, the firm must have the minimum average total cost in order to gain some profit and stay in the market. Therefore, (D) is the correct answer. 

36. Assume that both input and product markets are

competitive. If the product price rises, in the short run

firms will increase production by increasing

(A) the stock of fixed capital until marginal revenue

equals the product price

(B) the stock of fixed capital until the average

product of capital equals the price of capital

(C) labor input until the marginal revenue product of

labor equals the wage rate

(D) labor input until the marginal product of labor

equals the wage rate

(E) labor input until the ratio of product price to the

marginal product of labor equals the wage

rate

(C) labor input until the marginal revenue product of

labor equals the wage rate

Explanation: In the short run, when both input and product markets are competitive, and the price rises, then the only way to increase production is by increasing labor input until the marginal product of labor equals the wage rage. This is because the price is greater than the marginal revenue, so the firm has to hire more labor up to the point where MRP= Wage rate.

39. A student who attends college would pay $10,000

annually for tuition, books, and fees. If the student's next

best alternative is to work and earn $15,000 a year, the

opportunity cost of a year in college would be equal to

(A) zero, since the lost opportunity to earn income is

offset by the opportunity to attend college

(B) $5,000, representing the difference between

forgone income and college costs

(C) $10,000, since opportunity costs include only

actual cash outlays

(D) $15,000, representing forgone income, since the

costs of tuition, books, and fees will be more

than offset by additional income earned after

graduation

(E) $25,000, representing the sum of tuition, books,

fees, and forgone income

(E) $25,000, representing the sum of tuition, books,

fees, and forgone income

Explanation: The opportunity cost of a year in college includes the cost of books, tuition, fees, and forgone income because opportunity cost accounts for the money that is going to be spent going to college and the money gone for not getting a job. Therefore, (E) is the correct answer.

42. A firm doubles all of its inputs and finds that it has

more than doubled its output. This situation is an

example of

(A) increasing marginal returns

(B) diminishing marginal returns

(C) constant returns to scale

(D) increasing returns to scale

(E) decreasing returns to scale

(D) increasing returns to scale

43. Reducing the tariff on Canadian beer sold in the

United States will most likely have which of the

following effects on the market for beer produced

and sold in the United States' ?

(A) The quantity of United States beer purchased

will increase.

(B) Total expenditure on United States beer will

increase.

(C) The Supply of United States beer will increase.

(D) The price of United States beer will decrease.

(E) More workers will be employed in the produc

tion of United States beer.

(D) The price of United States beer will decrease.

Explanation: If the tariff on Canadian beer is reduced, then Canadian beer will be cheaper. The U.S. beer, which is the Canadian beer's substitute product, will decrease the price because the U.S. beer is following the law of demand that the lower the cost, the higher the demand in order to compete with the Canadian beer. Therefore, (D) is the correct answer. 

44. Suppose that the license paid by each business to operate in a city

increases from $400 per year to $500 per year. What effect will this

increase have on a firm's short-run costs?

Marginal Cost Average Total Cost Average Variable Cost

(A) Increase increase  increase

(B) Increase increase No effect 

(C) No effect No effect No effect

(D) No effect Increase Increase

(E) No effect Increase No effect

(E) MC=No effect ATC=Increase AVC=No effect

Explanation: When the price of license for a business to operate increases, then in the short run the average total cost would increase. The increased price of license will increase the total fixed cost, not the average variable cost or marginal cost. Therefore, (E) is the correct answer. 

47. Which of the following is true if a perfectly competitive

industry is earning zero economic profits in the long run?

(A) The level of investment in long-run equilibrium is

greater than the efficient level.

(B) Relatively few firms are able to survive the

competitive pressures in the long run.

(C) Some firms will be forced to transfer their

resources to more lucrative uses.

(D) The resources invested in this industry are

earning at least as high a return as they

would in any alternative use.

(E) Firms will exit until economic profits become

positive.

(D) The resources invested in this industry are earning at least as high a return as they would in any alternative use.

Explanation: If a perfectly competitive industry is earning zero economic profit in the long run, then the resources are earning the least because the industry needs the marginal revenue equal the marginal cost in long run to gain zero economic profit in the long run. Therefore, (D) is the correct answer.

Lump-sum Subsidy

A chunk of money given to a firm. Lump-sum subsidy does not affect or change the profit-maximizing quantity.

Elasticity

= (Q2- Q1)/ [(Q2+Q1)/2]

(P2-P1)/[(P2+P1)/2]

Comparative Advantage

The ability to produce a good at a lower opportunity cost.

Law of Constant Opportunity Cost

Only applies when the tools of production are perfectly interchangeable.

Law of Increasing Opportunity Cost

Occurs when the tools of production are IMPERFECTLY interchangeable.

Substitution Effect

When the price of good A falls, people buys more of good B and less of good A.

Competitive Market

When there are many buyers and sellers.

Perfectly Competitive Market

When there are many firms offering the same product at market price. 

Price Takers

In perfectly competitive market, buyers and sellers have to accept the market price.

Law of Demand

The quantity of a good falls when the price rises.

Inferior Goods

When the income of people increases, the demand of the good decreases.

Normal Goods

When the income increases, the demand for the good increases.

Five reasons for a shift in Demand

Changes in income, price of related goods, expectations, number of buyers, and taste.

Law of Supply

The quantity of supply of a good rises when the price of the good rises.

Four reasons for a shift in Supply

Changes in input prices, expectations, technology, and number of sellers.

Law of Diminishing Marginal Utility [DMU]

The second unit of a good is not as useful or valuable as the first one.

Law of Diminishing Returns

The producers only want to produce an additional unit of goods if the price goes up.

Price floor

Government sets the legal minimum price.

Price ceiling

Legal maximum price.

Inelastic

When the elasticity < 1, the demanded quantity is not affected by the change in price.

Elastic

When the elasticity > 1, so the demand shifts according to price changes.

Unit Elastic

When the elasticity= 1

Cross-Price Elasticity

= % change in Q of Good A

% change in P of Good B

Total Revenue

= P x Q

if P decreases and the elasticity>1, then TR will rise.

if Q increases and the elasticity<1, then TR will fall.

if the elasticity is unit elastic, then TR will be at TR_max.

Three Constituencies

1) Consumer 2) Society 3) Producer

What is uncertain when the demand shifts right and supply shifts left?

The Quantity

The price is uncertain. 

The quantity is certain.

Tax Revenue

P_tax x Q

Economic Deadweight

The inefficiency that is created by taxes.

Laffer Curve

A semicircle in the first quadrant. 

Y-axis -> Tax Revenue

X-axis -> Tax Size 

Laffer states that tax revenue first increases and then decreases.

Supply-side Economics

Cut in tax rates was intended to encourage people to increase the quantity of labor they supplied. 

Pure Progressive Tax Rate

Each and every dollar is taxed at a higher rate than the first tax.

Externalities

Third-party intervention. 

Cost/benefit created by the a non-consumer.

Marginal Social Cost and Marginal Social Benefit

When MSC=MSB, it is the most efficient spot.

When MSC> MSB, we are overproducing, so we must produce less.

Coase Theorem

The proposition that if private parties can bargain without cost over the allocation of resources [cooperate], they can solve the problem of externality on their own. 

What happens to the price if the quantity is increased or decreased?

The price becomes uncertain.

Payroll Tax

Tax on wages that a firm pays its workers in order to pay social insurance taxes. 

Pure Proportional Tax

Flat tax.

Pure Regressive Tax

When each additional dollar is taxed at a lower rate than the first dollar. 

Economics and Accounting

Economics includes both implicit and explicit costs. 

Accounting only includes explicit costs. 

Explicit cost is the cost to third parties or cost of raw materials

Implicit cost is the cost to the owner.

Market Run, Short Run, and Long Run

Market Run/Immediate run- all costs are fixed

Short run- fixed costs= land/plant/machine

variable costs= labor/resources

Long run- no fixed cost because everything is variable.

Economic profit

TR-TC 

Average Cost [AC]

AC = TC/Q

Marginal Cost [MC]

MC= change in TC/ change in Q

Total Costs [TC]

TC= FC + VC

The relationship between Marginal Cost and Marginal Product

MC rises, MP falls

MC falls, MP rises.

The relationship between MC and AC

MC< AC; AC falls

MC>AC; AC rises

MC=AC; AC is at minimum

The relationship between Marginal Product and Average Product

MP> AP; AP rises

MP< AP; AP falls 

MP=AP; AP is at maximum.

Sunk Cost

Average Fixed Costs

What does change in MC lead to? 

Change in MC leads to change in AVC and change in AC

What does the change in AFC lead to? 

Change in AFC leads to change in AC, but AVC is constant.

What is Marginal Revenue in a competitive market?

MR= the price of the good in a competitive market

The relationship between MR and MC for a firm

MR>MC; firm should increase output

MR<MC; firm should decrease output

MR=MC; profit-maximizing level of output.

When does a firm shut down? 

 Shut down when TR<VC 

When does a firm exit the industry?

Exit if TR/TC < TC/Q or when P <AC 

When does a firm enter an industry?

Enter when P> AC

Profit 

How does a firm stay in the market? 

Must be making ZERO economic profit. 

What is Demand in imperfect competition equal to?

D=AR=P

What is Demand equal to in a perfect competition?

D=P=AR=MR

The demand is perfectly elastic.

The relationship of MR and MC in a competitive firm

P=MR=MC

The relationship between MR and MC in a monopoly firm

P > MR=MC

How do you find the socially optimal quantity?

The point where MC intersects the Demand Curve.

Synergies

Benefits from mergers

Oligopoly

When there are a few sellers with the same goods.

Monopolistic Competition

When there are firms that sell similar products, but not identical.

Duopoly

It is the smallest size of an oligopoly. [2]

Collusion

Agreement among the firms about price or quantity.

Cartel

When firms act in unison.

Nash Equilibrium

When the firms choose their best strategy according to the strategy another firm has chosen.

Dominant Strategy

In game theory, the dominant theory is when you choose your best option regardless to other people's choices.

How many workers should be hired?

A competitive, profit-maximizing firm hires the workers up to where MP_labor=Wage

Wage

Wage= P x MP_labor

Least Cost

MP_labor=MP_capital=MP_land

MRC_labor MRC_capital MRC_land

How do we get to equilibrium when MP_labor/W_labor> MP_capital/MRC_capital?

Law of diminishing demand-buy more labor to lower the MP or buy less capital

What is VMP?

VMP is Value of MP

VMP=P x MP

When is the resource being used most efficiently?

When  MRP_a/MRC_a=MRP_b/MRC_b=1

When MRP_a/MRC_b>1, it is the least cost and the profit-maximization point.