Microeconomics Harder Questions to Review

Which of the following statements explains why it is so difficult for private markets to provide the optimal quantity of a public good?

The efficient price of a public good is zero (free).

Differences in income inequality between countries of similar income levels can primarily be attributed to:

income redistribution by governments.

In South Africa, landowners are eligible for government __________ if they keep and protect endangered species.

tax breaks

______ costs are costs that require a firm to spend money, whereas ______ costs do not require a firm to spend money or take on obligations.

explicit; implicit

Johnston Forest in Rhode Island has a cave that houses thousands of fruit bats. Bat droppings are highly acidic and have ruined the paint on many Rhode Island cars. The flying radius of the Johnston Forest bats encompasses two towns, Johnston and Foster. The residents of Johnston collectively value bat removal at $400,000. Foster residents collectively value bat removal at $500,000. Pest control experts estimate that the cost of bat removal would be $450,000. Which of the following scenarios would lead to removal of the bats? Check all that apply.

ALL: Foster pays Johnston $50,000 to contribute to bat removal; Foster and Johnston evenly split the cost of bat removal; Johnston contributes nothing toward bat removal.

Other things equal, the short-run market supply curve is upward sloping because each firm supplies:

more as the price rises.

t's Friday night. You already have a ticket to a concert, which cost you $30. A friend invites you to go out for a game of paintball instead. Admission would cost you $25, and you think you'd get $25 worth of enjoyment out of it. Your concert ticket is nonrefundable.Your opportunity cost (in dollars) of playing paintball is:

the enjoyment of the concert (since the $30 cannot be recovered).

One challenge in government provision of public goods is determining how they should be paid for. Public goods are best funded by user fees when:

the goods can be made excludable.

Think about the definition of scarcity that you learned in this chapter. Identify three examples of scarcity people face every day.

Limited resources for travel; Limited income for family cars; Not enough time to do everything they want

Many people are concerned about the rising price of gasoline. Suppose that government officials are thinking of capping the price of gasoline below its current price. Which of the following outcomes do you predict will result from this policy? Long lines will develop at gas stations Quantity demanded for gasoline will rise Oil companies will work to increase their pumping capacity Drivers will purchase more gasoline

Long lines will develop at gas stations Quantity demanded for gasoline will rise Explanation Quantity demanded for gasoline will increase at a price below the equilibrium price. Drivers will not purchase more gasoline, however, because quantity supplied will be below the equilibrium quantity. As a result, there will be a shortage of gasoline and long lines will develop at gas stations. With a ceiling on price, oil companies will not have an incentive to increase supply.

Which of the following is a way that profit-maximizing and loss-minimizing are different?

Loss-minimizing involves the shut down condition that price must equal or exceed AVC.

A firm's short-run supply curve is the same as its:

MC curve at quantities after it intersects the AVC curve Explanation The firm's short-run supply curve is equal to the marginal cost curve above the minimum of the AVC. If the price is greater than the minimum of the AVC but less than the minimum of the ATC, the firm will produce in the short run but earn losses. If the price is greater than the minimum of the ATC, the firm will produce and earn profits. If the price is less than the minimum of the AVC, the firm will not produce.

Consider a market in which the government imposes a price ceiling. Assume that neither supply nor demand is perfectly elastic nor perfectly inelastic. Which of the following groups will always gain from a price ceiling?

No group will always gain from a price ceiling Explanation Individual consumers who are able to purchase the good at the ceiling price will be better off. However, whether total consumer surplus will increase or decrease depends on the shape of the supply and demand curves. Thus while consumers as a group may gain, this is unclear.

From the list below, which of the following do you expect to suffer from a free-rider problem? Check all that apply.

Pay-what-you-can yoga classes; Fund-raiser for public television; Neighborhood park cleanup day; Suggested museum-admission donation

The key assumptions of the Coase theorem that must hold are:

People can make enforceable agreements to pay one another; There are low transaction costs

Problems with Pigovian tax:

Pigovian taxes are not a perfect solution to externalities. There are two problems. The first is setting the tax at the right level. It is not always easy to put a dollar-and-cents value on external costs. Second, while taxes are effective at transferring surplus away from consumers and producers and toward the government, there is no guarantee that the government can or will then do anything to help the people who are bearing the external cost.

If education has private benefits to an individual as well as external benefits to society, which of the following explains why a less-than-optimal amount of education occurs?

The decision makers usually only consider private benefits and private costs.

Which of the following statements explains why it is so difficult for governments to provide the optimal quantity of a public good?

The marginal benefit of each individual user must be known, and it is often overstated by individuals.

Free riders are a problem because:

they lead to underprovision of goods.

Examples of public policy that can use subsidies to solve an externality problem include:

education; vaccination; anti-virus software Explanation A subsidy can help consumers or producers capture the benefits of positive externalities. Of the examples listed, education, vaccinations, and anti-virus software all generate positive externalities so subsidies can help attain the socially efficient outcome. Pollution and automobiles generate negative externalities so a tax should be used to help attain the socially efficient outcome.

Free entry into a market can:

help drive innovation, cost-cutting, and quality improvements.

Social norms can solve the tragedy of the commons by:

increasing cost or reducing benefits of consumption.

Because skills and abilities are influenced by the environment people grew up in, evidence indicates that one who grows up in poverty is more likely to have:

less human capital

The city of Seattle limits each household to one can of free garbage collection per week. There are fees for any extra garbage collected from the curb. This type of quota policy is a _____ efficient way of reducing waste than charging a set price per can because:

less; the marginal benefit of having a can of garbage collected varies among households.

Means-testing can also create perverse incentives because recipients have an incentive to:

limit their means in order to receive benefits.

An effective price ceiling will cause consumers to: lose surplus from paying a lower price lose surplus from trades that no longer take place gain surplus from paying a lower price gain surplus from additional trades

lose surplus from trades that no longer take place gain surplus from paying a lower price Explanation The price ceiling causes the total quantity traded to fall relative to equilibrium. This price ceiling has two effects on consumers: it causes surplus to be transferred from producers to consumers because of a lower price and it causes surplus to be lost due to fewer trades.

The international poverty line is based on:

purchasing power parity

As compared to poorer countries, income distribution in the United States is __________

relatively equitable

As compared to countries with approximately the same income level, income distribution is ____________

relatively inequitable

_______ transfer programs are, by design, more restrictive than ________ transfer programs.

in-kind; cash Explanation A conditional cash transfer is a program in which financial support is given only to people who engage in certain actions. An in-kind transfer is a program that provides specific goods or services, rather than cash, directly to needy recipients. In-kind transfer programs are, by design, more restrictive than cash-transfer programs because there is not flexibility to choose what goods or services will be purchased.

Common resource problems can be resolved or reduced using quotas, but tradeable permits are likely to result in more efficient outcomes because:

sources are allocated to the highest value users.

In a perfectly competitive market, MR =

Price; Average revenue; Δ in total revenue/ Δ in quantity

The monthly average variable costs, average total costs, and marginal costs for Alpacky, a typical alpaca wool-manufacturing firm in Peru, are shown in the table below. All firms in the industry share the same costs as Alpacky, and the industry is in long-run equilibrium. Given that the market is in long-run equilibrium, the market price is:

$19.50 Explanation If the firms all share the same cost structure and the industry is in long-run equilibrium, the market price must be $19.50. That amount is equal to the minimum ATC, which corresponds with zero economic profit for the firms and no incentive for entry or exit by other firms.

The U.S. government is concerned about the huge numbers of people converging on Yellowstone National Park every year. Government officials are worried that the park might be getting overused and the natural beauty will be ruined as a result. Suppose someone suggests dividing the park into private lots and selling them to individuals. Which of the following statements correctly describes how this solution might address the tragedy of the commons that is occurring?

Each land owner would have to bear all of the costs and benefits of their choices about how many people to allow on the land each year.

Consider the following government-provided goods. Which of these goods necessarily require funding via general taxation (as opposed to direct user fees)?

Each of the following require general taxation instead of user fees because they are nonexcludable: street lights, a fireworks display, and a public radio. Parks and libraries are excludable and could include user fees.

Which of the following is is not an example of a barrier to entry that would lead to monopoly power?

Firms cannot enter industries in the short run, so there may be a single firm in the industry.

The U.S. Postal Service maintains a monopoly on mail delivery in part through its exclusive right to access customer mailboxes. Which barrier to entry best describes this situation?

Government intervention

Joan loves turning up her electric guitar amp all the way, but her next-door neighbor hates listening to her. Which of the following private solution to their problem is most likely to be sustainable in the long run?

Joan's neighbor pays Joan at the end of each month as long as Joan has kept the noise down all month. Explanation One way Joan and her neighbor could work out a private solution is if the neighbor offers to pay Joan to keep the noise down. Note that this solution would be much more difficult to enforce if Joan is paid ahead of time since the neighbor has no way of enforcing the solution. However, if Joan is paid after the fact, her neighbor could simply withhold payment if there was noise and Joan could start making noise if no payment was made. Note that the suggestion of giving Joan five occasions to be loud is very likely to cause future problems as the neighbor has no control of when those occasions are. Note also that while it is true that the police might fine Joan if they find that she is disturbing the peace, this would not be an example of a private solution between Joan and her neighbors.

Which of the following groups will always lose from a price ceiling?

Society as a whole because total surplus will decrease Producers Explanation Producers clearly lose from the price ceiling because they sell less and receive a lower price. Society as a whole loses due to the deadweight loss created by the price ceiling.

Which of the following is not a social insurance program?

TANF Explanation Medicare, Social Security, and unemployment insurance are examples of social insurance programs. The TANF program is a conditional cash transfer program. Families must perform certain actions to be eligible.

Suppose a city has a chain of fitness centers (gyms) all owned by the same company, Fit Fun. Then a new company considers opening a gym in the city. Which of the following is an example of an aggressive tactic Fit Fun might take to maintain its monopoly?

Temporarily make its membership dues so low that it operates at a loss

Your professor has decided that, from now on, students who receive less than a 60 percent grade on any exam will be eligible to go to a review session. If they attend the session, they will receive an extra 10 percent on their grade. A fellow student sees a problem with this policy and instead proposes to your professor that people who go to the review session should receive 50 percent of the difference between their grade and 60 percent. Which of the following is correct in regards to the equity and efficiency of the two proposed policies?

The student's policy is more equitable than the professor's original policy, but not more efficient. Explanation The professor's original policy is more efficient than the one proposed by the student: by simply adding 10 percent to the grades of people who went to the review session, the professor avoids the hassle of having to recalculate all of the grades in the way that the student proposed. This means lower administrative costs. On the other hand, the original policy is less equitable. People who received a 65 percent on the test, for instance, would have a lower grade relative to people who received a 59 percent and could go to the review session.

Which of the following is a way that profit-maximizing and loss-minimizing are the same?

They both mean increasing production until marginal revenue equals marginal cost.

The city of Seattle limits each household to one can of free garbage collection per week. There are fees for any extra garbage collected from the curb. Suppose that a neighborhood group in Seattle organizes a group of families so that those who plan to go over their one-can garbage quota can find households that are under their quota and pay them to put out the extra trash.

This policy will increase efficiency.

Changes in income inequality within countries like the United States in recent years can be attributed to all of the following except:

changes in the poverty line. Explanation Changes in income inequality in countries like the U.S. are also related to changes in government redistributions, and it is also related to skill-based technical change and international trade.

Suppose that legally, people own the right to clean air. That is, it is illegal for factories to emit toxic gases into the atmosphere. (Or, in other words, the right to clean air has been assigned to citizens rather than factories.) Thus, legally, factories would need to either abate pollution or pay people for the damage to the air. Either case would be expected to internalize the cost of pollution and reach an optimal level of output. Which of the following is the most likely reason that private markets may not reach this optimal solution?

Transaction costs may be too high. Explanation If contracts are enforceable and there are no transactions costs, and if there is a negative externality (or a positive externality), it would be expected that a socially optimal price and quantity could be achieved through private negotiation. However, even if contracts are enforceable and property rights are clearly assigned, high transactions costs may prevent a private solution. In this case, there are many, many people, so transactions costs of negotiation are very high, particularly relative to individual benefits, and thus the optimal output may not be achieved.

Last year, you estimated you would earn $5 million in sales revenues from developing a new product. So far, you have spent $3 million developing the product, but it is not yet complete. Meanwhile, this year you have new sales projections that show expected revenues from the new product will actually be only $4 million.How much should you be willing to spend to complete the product development?

Up to $4 million Explanation You should spend up to $4 million. The $3 million you have spent already is a sunk cost and cannot be recovered. Therefore, the $3 million you have spent is irrelevant to the decision of how much to spend going forward. This year, the relevant decision is: How much are you willing to spend to have $4 million in revenue? If you had known that product development may cost you more than you will gain in revenues, you should not have started this project. But at this point, by thinking on the margin, you can see that you should be willing to move forward as long as the costs of going forward are not greater than the benefits of going forward ($4 million).

Whichever method a government chooses to supply a public good, these common issues arise:

When a government chooses to supply a public good, two common issues arise: 1. What is the right amount of the public good to supply? If the government is supplying a public good, such as road maintenance, the efficient quantity is the one at which the marginal social benefit equals the cost. 2. Who will pay for it? Sometimes it is easy to enforce payments among those who use the good (e.g., toll roads) but other times the good is paid for through tax revenue.

Last year, Jarod left a job that pays $80,000 to run his own bike repair shop. Jarod's shop charges $65 for a repair, and last year the shop performed 4,000 repairs. Jarod's production costs for the year included rent, wages, and equipment. Jarod spent $60,000 on rent and $120,000 on wages for his employees. Jarod keeps whatever profit the shop earns but does not pay himself an official wage. Jarod used $25,000 of his savings to buy a machine for the business. His savings were earning an annual interest rate of 6 percent. a. What is Jarod's annual accounting profit? b. What is Jarod's annual economic profit?

a. $80,000 Explanation Accounting profit = Total revenue - Explicit costs Accounting profit = ($65 × 4,000) - ($60,000 + $120,000) Accounting profit = $260,000 - $180,000 Accounting profit = $80,000 b. -$1,500 Explanation Economic profit = Total revenue - (Explicit costs + Implicit costs) Economic profit = ($65 × 4,000) - ($60,000 + $120,000 + Forgone interest on savings + Forgone wages) Economic profit = ($65 × 4,000) - [$60,000 + $120,000 + (0.06 × $25,000) + $80,000] Economic profit = $260,000 - $261,500 Economic profit (loss) = −$1,500

In season three of the TV show The West Wing, the federal government considers redefining the national poverty measure in a way that would classify an additional 4 million people as poor. The fictional president worries that his administration will be criticized for leading the country into greater poverty. a. This change would have reflected a change in which of the following types of poverty measurements? b. Which of the following statements would be correct about this fictional president being responsible for causing greater poverty?

a. Either a relative or an absolute measure of poverty b. People's circumstances are exactly the same as they were before the measurement change.

The firm in the graph above represents the cost structure for all firms in the industry. a. What change will lead to long-run equilibrium in this market? b. The change in the graph above will be caused by:

a. MR will decrease. b. the market supply curve shifting to the right. Explanation If the firm represented in the figure is representative of all firms, firms in this market are all making positive economic profits. We can see this because price is above ATC. In the long run, other firms will enter this industry to chase these profits. As other firms enter and the supply curve shifts to the right, the price in the market will fall. This process will continue until price falls to the point where there is no further incentive for firms to enter. This happens when economic profit is zero and price is equal to the minimum of ATC.

Madeline quit her job, at which she was earning $20,000 per year. She took $50,000 out of savings, for which she was earning 10 percent interest, and used it to buy supplies for her new business. She paid $10,000 in rent on the building and $15,000 in additional labor costs. In her first year of operations, Madeline received $150,000 in revenue from sales. a. What is Madeline's accounting cost? b. What is Madeline's economic cost? c. What is Madeline's accounting profit? d. What is Madeline's economic profit?

a. Madeline's accounting costs are the sum of all the explicit costs: $50,000 + $10,000 + $15,000 = $75,000. b. Madeline's economic costs include her explicit costs, calculated above, plus her implicit costs, foregone interest and salary: $50,000 + $10,000 + $15,000 + $20,000 + $5,000 = $100,000. c. Her accounting profit is $150,000 - $75,000 = $75,000. d. Her economic profit is $150,000 - $100,000 = $50,000.

Suppose you are evaluating the profit earned by a pharmaceutical company that produces three different medicines. a. What values below will help you determine the company's revenue? b. What values below will help you determine the company's total cost?

a. Price; Quantity b. Fixed cost; variable cost; quantity

Consider the market for cars. Which determinant of supply is affected by each of the following events? a. A steel tariff increases the price of steel. b. Improvements in robotics increase efficiency and reduce costs. c. Factories close because of an economic downturn. d. The government announces a plan to offer tax rebates for the purchase of commuter rail tickets. e. The price of trucks falls, so factories produce more cars. f. The government announces that it will dramatically rewrite efficiency standards, making it much harder for automakers to produce their cars.

a. Prices of inputs b. Technology c. Number of sellers d. Expectations e. Prices of related goods f. Technology

There is a road between the suburbs and downtown. The road becomes congested at rush hour. As long as fewer than 100 people use the road at rush hour, the trip takes 30 minutes. When the 101st person enters the road, everyone has to slow down and the trip now takes 31 minutes. People value their time at $6 per hour (i.e., $0.10 per minute) and so a 30 minute trip costs $3.

a. The private cost of one of the 100 individuals using the road is $ 3.00. The total private cost of 100 people using the road is $ 300.00. The total social cost of 100 people using the road is $ 300.00. b. The total social cost of 101 people using the road is $ 313.10. The private cost of using the road for the 101st individual is $ 3.10. The external social cost of the 101st person using the road is $ 10.00.

a. As compared to countries with similar incomes, intergenerational income mobility in the United States is relatively ______ b. This means that it takes ________ generations before your ancestors' place in the income distribution to cease to have any predictive power for what your own will be.

a. low b. relatively many

Madeline quits her job, at which she was earning $20,000 per year, and takes $50,000 out of savings and uses it to buy inventory for her business. She also pays $10,000 in rent on the building and $15,000 in additional labor costs. Madeline's explicit costs are: Madeline's implicit costs are:

a. the cost of additional labor; the cost of the building; the cost of the inventory b. the salary that Madeline could have earned; the interest that could have been earned on Madeline's savings

A monopolist can set prices and quantities without fear of being undercut by competitors because of:

barriers to entry

Assignment of property rights can solve common resource problems because:

owners have an incentive to use resources optimally.