ECON practice Exams 2
23. Trucking and commercial airlines are examples of industries that a. were substantially deregulated in the 1970s and 1980s. b. are natural monopolies. c. are perfectly competitive. d. were transformed when a huge firm was broken up, as a result of an antitrust action. e. all of the above.
a.
15. What is the average total cost when Q=5? a. $ 5 b. $ 4 c. $ 3 d. $ 2 e. $ 1
a. Average total cost (or total cost per unit of output) is calculated by dividing total cost by the number of units of output: ATC = TC/Q. Here, we are asked to find ATC when Q=5, so we already have the denominator. To find the numerator, TC, we need to recall that total cost is the sum of total fixed cost and total variable cost: TC = TFC + TVC. When Q=5, TFC=$5 and TVC=$20. This means that total cost is equal to $(5+20) = $25. If we insert this value for total cost into the equation for average total cost, we have ATC = $25/5 = $5. When Q=5, the average total cost is $5 per unit
34. Which of the following statements is supported by the Prisoner's Dilemma model? a. The firms in a cartel may have difficulty in sustaining collusion for very long, because the firms have an incentive to cheat on the cartel. b. A monopoly firm is protected by barriers to entry. c. The tendency in a perfectly competitive industry is toward zero economic profit. d. Firms in a monopolistically competitive industry have market power, because they produce differentiated products. e. Sirius Black suffered very bad treatment at the hands of the Dement
a. The Prisoner's Dilemma model shows that, under certain conditions, the firms that are part of a cartel agreement will try to cheat on the agreement by secretly offering price discounts to customers, in an attempt to increase market share. If enough firms do this, then the cartel will break down
17. What is the firm's profit-maximizing quantity of output? a. 5 b. 4 c. 3 d. 2 e. 1
a. The profit-maximizing quantity is the quantity at which marginal revenue is equal to marginal cost: MR = MC. We can find MR by following the procedure developed for #16, above, and we can find MC by following the procedure developed for #15. On this basis, we find that the marginal revenue of the fifth unit is $6, and the marginal cost of the fifth unit is also $6. Thus the profit-maximizing quantity is 5
16. What is the marginal revenue of the fourth unit (the marginal revenue associated with going from Q=3 to Q=4)? a. $ 10 b. $ 8 c. $ 6 d. $ 4 e. $ 0
b. Marginal revenue is the additional revenue that the firm receives when it sells one more unit of output: MR = ΔTR/ΔQ. For this question, we are asked for the marginal revenue associated with increasing output from 3 to 4. Thus ΔQ = (4-3) = 1, so that all that we really need to do is to find the change in total revenue. Total revenue is equal to price multiplied by quantity: TR = (P)(Q). When Q=3, P=$12, so that total revenue is ($12)(3) = $36. When Q=4, P=$11, so that total revenue is ($11)(4) = $44. Subtracting the total revenue when Q=3 from the total revenue when Q=4, we find that the marginal revenue of the fourth unit is $(44 - 36) = $8
13. What kind of curve could this be? a. An average-fixed-cost curve. b. A marginal-revenue curve for a monopolist. c. A marginal-revenue curve for a perfectly competitive firm. d. A total-fixed-cost curve. e. An average-total-cost curve for a firm that is not a natural monopolist
b. Of the various curves that are offered as choices in this question, the only one that crosses the horizontal axis into negative territory is the marginal-revenue curve for a monopolist. The marginal-revenue curve for a perfectly competitive firm is a horizontal line, but the marginal-revenue curve for a monopolist is downward-sloping. In the inelastic portion of the demand curve for a monopolist, marginal revenue is negative
2. If there is a decrease in the price of DVD players, the consumers of DVD players will benefit. What is our best measure of the dollar value of the benefit to consumers? a. The decrease in marginal utility. b. The increase in quantity. c. The increase in consumer surplus. d. The change in the total amount of money spent on DVD players. e. The decrease in price.
c. Consumer surplus is the difference between the maximum amount that consumers are willing to pay (represented by the demand curve) and the amount they actually have to pay (represented by the price line). If the price of DVD players were to decrease, there would be an increase in consumer surplus, for two reasons. Consumer surplus would increase because the quantity demanded would increase, and it would also increase because the consumers would receive more surplus from every unit that is consumed
14. What is the marginal cost of the third unit (the marginal cost of going from Q=2 to Q=3)? a. $ 2 b. $ 3 c. $ 4 d. $ 5 e. $ 6
c. Marginal cost is the additional cost necessary to produce one additional unit of output. In other words, marginal cost is the change in total cost, divided by the change in the number of units: MC = ΔTC/ΔQ. However, the change in total cost is exactly the same as the change in total variable cost, because total fixed cost does not change when quantity changes. Thus MC = ΔTVC/ΔQ. For this question, we are given TVC. When Q increases from 2 to 3, TVC increases from $5 to $9. Thus the marginal cost of the third unit is $(9-5) = $4
6. Profit per unit of output is equal to a. (price minus average total cost) multiplied by quantity. b. average total cost. c. price minus average total cost. d. price. e. price times quantity.
c. Profit is equal to total revenue minus total cost: Profit = TR -TC. If we divide both sides of this equation by Q, to get per-unit values, we have Profit/Q = Profit Per Unit = TR/Q - TC/Q. TC/Q is called average total cost. TR is equal to price multiplied by quantity. Thus, TR/Q = P. Therefore, profit per unit is equal to price minus average total cost
35. Which of the following describes a monopoly? a. The monopolist faces a downward-sloping demand curve. b. The monopolist is protected by barriers to entry. c. There are no close substitutes for the monopolist's output. d. All of the above. e. (a) and (c) only
d. A monopoly firm is the only firm in the market. Thus the demand curve facing the monopoly firm is exactly the same as the market demand curve, so that choice (a) is correct. Choices (b) and (c) are also parts of our definition of a monopoly. Without barriers to entry, monopolies would not be able to maintain themselves for any substantial period of time. Also, if there are close substitutes for a firm's output, we would say that the firm is not truly a monopoly, but one of a group of sellers in a market characterized by product differentiation
12. Which of the following statements is/are true regarding average total cost (ATC)? a. ATC = AVC + AFC. b. ATC is minimized at the quantity at which MC = ATC. c. ATC is total cost divided by the quantity of output. d. All of the above. e. (a) and (c) only.
d. Total cost is equal to total variable cost plus total fixed cost: TC = TVC + TFC. If we divide both sides of this equation by the quantity to get average values, we find that ATC = AVC + AFC. In the case of our standard short-run cost curves, the ATC curve begins with a downward- sloping portion, in which MC<ATC. Then, the ATC curve reaches its minimum, at a quantity at which MC=ATC. Finally, the ATC curve slopes upward, with MC>ATC
25. In 1911, the Standard Oil and American Tobacco cases tested whether these companies had violated the antitrust laws. What happened in these cases? a. Both firms were found guilty, and both were broken into smaller pieces. b. American Tobacco was broken into smaller pieces, but Standard Oil was found not guilty. c. Standard Oil was broken into smaller pieces, but American Tobacco was found not guilty. d. Both firms were found not guilty. e. All of the above
a.
3. Which of the following is restricted by the antitrust laws? a. Price fixing. b. Interlocking directorates. c. Tie-in sales. d. Attempting to monopolize. e. All of the above.
e.
33. The Jensen farm is a perfectly competitive firm. The market price of Jensen's output is $9 per unit. At its current level of output, the firm's marginal cost is $7 per unit and its average total cost is $6 per unit. On the basis of this information, what should the firm do? a. The firm should increase its output. b. The firm should not change its output. c. The firm should decrease its output, but still produce a positive amount. d. The firm should shut down. e. All of the above.
a. A firm will only consider shutting down if it is suffering losses. Since profit per unit is equal to price minus average total cost, a firm will only consider shutting down if its price is less than average total cost. In this question, P = $9 and ATC = $6. Thus the firm is earning positive economic profits of $(9-6) = $3 per unit, and it will not want to shut down; this means that choice (d) is incorrect. The condition for profit maximization for any firm is that the firm should produce and sell the quantity at which marginal revenue is equal to marginal cost. In the special case of a perfectly competitive firm, another way to state the condition is that firm should produce and sell the quantity at which price is equal to marginal cost. Here, P = $9 and MC = $7. This means that the firm is not at its profit-maximizing level of output, so that choice (b) is incorrect. Instead, this firm is in a position where, if it were to produce and sell one more unit, its profits would increase by $(9-7) = $2. Thus the firm should increase its output
18. Flimflam Corporation has an upward-sloping long-run average-total-cost curve. This means that Flimflam Corporation has a. decreasing returns to scale. b. constant returns to scale. c. increasing returns to scale. d. all of the above. e. none of the above
a. If, when all of a firm's inputs increase by the same percentage, the firm's output increases by less than that percentage, we say that the firm is experiencing decreasing returns to scale. If all of the firm's inputs increase by some percentage, then the firm's costs will increase by that same percentage. However, if output increases by a smaller percentage, then cost per unit (i.e., average total cost) will be larger at the higher level of output. This means that the long-run average-total-cost curve will slope upward as we go from left to right across the diagram, from a smaller quantity to a larger quantity
28. The marginal revenue for good A is greater than zero. This means that a. demand for good A is elastic. b. demand for good A is unit elastic. c. for good A, the percentage change in quantity demanded is equal to the percentage change in price. d. an increase in the price of good A will lead to an increase in total revenue for the sellers of good A. e. (b) and (c).
a. Marginal revenue is the additional revenue that the firm receives when it sells one additional unit: MR = ΔTR/ΔQ. If marginal revenue is to be greater than zero, then it must be true that the numerator and denominator of this expression have to be of the same sign. When the firm sells an additional unit of output, ΔQ is positive. Thus for MR to be greater than zero, ΔTR must be greater than zero. When Q increases, if we are on a demand curve that obeys the Law of Demand, P must decrease. By itself, the increase in Q will tend to increase TR, but by itself the decrease in P will tend to decrease TR. Thus the net effect on TR will depend on the relative sizes of the change in Q and the change in P. If TR is to increase, it must be true that the increase in Q is relatively larger than the decrease in P. This will be true if demand is elastic. When demand is elastic, the percentage change in quantity demanded is greater than the percentage change in p
29. Rank the four market structures in terms of market power, from most market power to least market power. (In other words, the first in the list will be the market structure in which the firm(s) have the most market power, and the last in the list will be the market structure in which the firm(s) have the smallest amount of market power.) a. monopoly, oligopoly, monopolistic competition, perfect competition b. perfect competition, monopolistic competition, oligopoly, monopoly c. monopoly, monopolistic competition, perfect competition, oligopoly d. monopolistic competition, oligopoly, monopoly, perfect competition e. oligopoly, monopoly, perfect competition, monopolistic competition
a. Monopolies have the greatest possible amount of market power, because they face the entire market demand curve. Oligopolies have at least the potential to have a substantial amount of market power, especially if they do not compete aggressively against each other. Monopolistically competitive firms have some market power because they sell differentiated products. However, the amount of market power for a monopolistically competitive firm is likely to be small, because the firm is only one of a large number of firms in the market. A perfectly competitive firm has zero market power, which is the smallest possible amount of market power
4. In our discussion of consumer demand, we assumed that the individual consumer is unable to have an effect on the market price. We also assumed that the individual consumer has diminishing marginal utility, and that marginal utility is measured in dollars of willingness to pay. Under these circumstances, if the consumer wants to do the best he/she can, a. the individual consumer's demand curve will be a horizontal line. b. the individual consumer's demand curve will be the downward-sloping marginal-utility curve. c. the individual consumer does not have a unique, well-defined demand curve. d. the individual consumer's demand curve will be a downward-sloping straight line, and its slope will be exactly twice as great as the slope of the marginal-utility curve. e. we have no way of knowing what the individual consumer will do, since we assume that consumers are irrational.
b. At any given price, the consumer will do his/her best by consuming the quantity at which marginal utility is equal to price. When price changes, the consumer will continue to choose a quantity at which MU=P. Thus, each time we announce a different price, we can find the consumer's quantity demanded by using the marginal-utility curve. Therefore, the marginal-utility curve is the consumer's demand curve. Since the marginal-utility curve slopes downward, it follows that the individual consumer's demand curve also slopes downward
20. Monopolistically competitive industries have a tendency to move toward zero economic profits. Perfectly competitive industries also have a tendency to move toward zero economic profits. Which of the characteristics of these industries is responsible for this tendency? a. The industry has many firms. b. The industry is characterized by free entry and exit. c. The firms produce differentiated products. d. Each firm in the industry is small relative to the market. e. (a) and (d).
b. Choices (a) and (d) are characteristics of both perfectly competitive and monopolistically competitive industries. However, these are not the reasons why these industries have a tendency to move toward zero economic profits. The zero-profit condition comes from free entry and exit. If there is free entry and if the existing firms are making positive economic profits, new firms will enter, and this will push down the price until the industry has returned to zero economic profits. If there is free exit and if the existing firms are suffering economic losses, then some firms will eventually exit the industry, and this will push the price upward until the industry has returned to zero economic profit
21. Which of the following statements about a cartel is true? a. Cartels are the little boxes from which schoolchildren drink their chocolate milk. b. A cartel occurs when a group of oligopolistic firms colludes, for the purpose of increasing profits. c. Cartels are encouraged by the antitrust laws in the United States. d. Cartels are usually very stable, because there is no incentive for any of the cartel members to cheat on the cartel. e. Jimmy Cartel was the 39 the President of the United States
b. Choices (a) and (e) are attempts to inject a little bit of lighthearted mirth into the exam, and it is hoped that everyone can see that neither of these would be the correct answer. Choice (c) is the exact opposite of the truth—in fact, the antitrust laws discourage cartel formation, by making cartels illegal. Choice (d) is also incorrect. Fortunately, cartels often break down because firms have an incentive to cheat on the cartel agreement. Choice (b) fits with the definition of a cartel
24. Consumer surplus is represented graphically by a. the vertical distance between price and average total cost. b. the area between the demand curve and the price line. c. the area between the supply curve and the demand curve. d. the area of the deadweight-loss triangle. e. an abstract painting by Piet Mondrian
b. Consumer surplus is the difference between (a) the maximum amount that the consumer is willing to pay, which is represented graphically by the area under the demand curve, and (b) the amount that the consumer actually pays, which is represented graphically by the area under the price line. Thus consumer surplus is represented graphically by the area that is under the demand curve, but above the price line
10. Grippotz Corporation is a perfect competitor. The market price for a unit of Grippotz's output is $10. The firm's marginal cost is $10, its average total cost is $12, and its average variable cost is $8. This suggests that a. the firm should shut down. b. the firm is suffering losses, but it should continue to produce in the short run. c. the firm could increase its profits by expanding output. d. the firm is making zero profits. e. the firm is making positive profits.
b. For a perfectly competitive firm, profit is maximized at the quantity at which price is equal to marginal cost. In this question, the perfectly competitive firm's price is indeed equal to its marginal cost. Thus, if the firm is to be in business at all, it is producing the profit-maximizing quantity. However, the price is less than average total cost, which means that the firm is suffering losses. This raises the question of whether the firm should shut down. However, the firm should only shut down in the short run if price is also less than average variable cost. In this case, price is greater than average variable cost, so that the firm should continue to produce in the short run
31. In a perfectly competitive industry, positive economic profits are being earned. This can be expected to lead to a sequence of events. Which of the following is the best description of this sequence? a. Firms exit the industry; price rises; firms continue to earn positive economic profits indefinitely. b. New firms enter the industry; price falls; zero economic profits are restored. c. Firms exit the industry; price rises; zero economic profits are restored. d. New firms enter the industry; price falls; economic profits become negative; firms continue to earn negative economic profits indefinitely. e. Economic profits occur on even-numbered days and economic losses happen on odd- numbered days, except that zero economic profits occur on the 17th of each month
b. If the existing firms in a perfectly competitive industry are making positive economic profits, potential entrants will want to enter the industry. One of the characteristics of a perfectly competitive industry is free entry and exit, so that these potential entrants will indeed be able to enter the industry. As a result of the entry of new firms into the industry, the market supply curve will shift to the right. This will lead to a decrease in the equilibrium price. The price will fall until the firms are making zero economic profits. At that point, new firms will no longer have an incentive to enter the industry.
9 . Which of the following is represented by a horizontal line? a. An average-fixed-cost curve. b. A marginal-revenue curve for a monopolist. c. A marginal-revenue curve for a perfectly competitive firm. d. A total-revenue curve. e. An average-total-cost curve for a natural monopolist.
c. Choices (a), (b), and (e) all refer to curves that are downward-sloping. Choice (d) refers to a total-revenue curve, which is upward-sloping. However, the marginal-revenue curve for a perfectly competitive firm is a horizontal line, given by the price. Since a perfectly competitive firm takes the price as given, the price is a constant from the perspective of the firm. This means that every unit sold by the firm will bring in the same amount of additional revenue. Therefore, marginal revenue is constant
26. For Clarence Gideon, marginal utility can be measured in dollars of willingness to pay. Clarence's marginal-utility schedule for trips to the movie theater this month is given: the current market price of a movie ticket is $8. How many movie tickets will Clarence buy this month? a. 1 b. 2 c. 3 d. 4 e. 5
c. The consumer's optimal purchase rule is to produce and sell the quantity at which marginal utility is equal to price. In this question, P = $8 (at any quantity) and MU = $8 at a quantity of three. Thus the consumer in this question will choose to buy and consume a quantity of three.
22. In Industry X, there are many firms, and each of the firms is small relative to the market. The industry is characterized by product differentiation. In addition, the industry is characterized by free entry and exit. What kind of industry is Industry X? a. A monopoly. b. An oligopoly. c. A monopolistically competitive industry. d. A perfectly competitive industry. e. All of the above, except on alternate Mondays, when none of the above would be the correct answer
c. When an industry has many firms, each of which is small relative to the market, and when the industry is characterized by free entry and exit, it could be either perfectly competitive or monopolistically competitive. The key difference between perfect competition and monopolistic competition is whether the industry is characterized by product differentiation. If the industry has differentiated products, in addition to the other characteristics described above, then it is monopolistically competitive
8. Marginal cost is currently equal to average variable cost (AVC) but less than average total cost (ATC). This means that a. AVC and ATC are both increasing. b. AVC and ATC are both decreasing. c. AVC is at its minimum value, but ATC is increasing. d. AVC is at its minimum value, but ATC is decreasing. e. AVC has a rare glandular condition that causes obesity.
d. For any set of marginal and average values, we have the following relationships: If marginal is greater than average, average is rising; if marginal is equal to average, average is constant; if marginal is less than average, average is falling. Thus, if marginal cost is equal to average variable cost, average variable cost must be constant (i.e., at its minimum value). If marginal cost is less than average total cost, then average total cost must be decreasing
1. Which of the following statements is/are true, regarding a firm that is maximizing profits? a. Marginal revenue is equal to marginal cost. b. The total-revenue curve is parallel to the total-cost curve. c. The vertical distance between the total-revenue curve and the total-cost curve is maximized. d. All of the above. e. None of the above.
d. Our favorite way of describing the firm's profit-maximizing quantity is that the firm chooses the quantity at which marginal revenue is equal to marginal cost. Thus, choice (a) is true.However, choices (b) and (c) are also true, because they are merely different ways of saying the same thing. Marginal revenue is the slope of the total-revenue curve, and marginal cost is the slope of the total-cost curve. Thus, when marginal revenue is equal to marginal cost, the slope of the total-revenue curve is equal to the slope of the total-cost curve, which means that those two curves are parallel to each other. The vertical distance between the total-revenue curve and the total-cost curve is maximized at the quantity at which the two curves are parallel
19. The demand curve facing Colossal Corporation is a downward-sloping straight line. On the basis of this information, we can say that a. the firm is not a perfectly competitive firm. 4 b. the MR curve is also downward sloping, and it is twice as steep as the demand curve. c. Colossal Corporation will charge a price that is greater than marginal cost. d. all of the above are true. e. (a) and (b) only
d. Perfectly competitive firms are the only firms that take the market price as given. Thus perfectly competitive firms are the only firms for which the demand curve is a horizontal line. Firms in every other market structure will have at least some market power, which means that they will face a downward-sloping demand curve. Thus choice (a) is correct. If the demand curve is a downward-sloping straight line, the marginal-revenue curve will also be downward sloping, and the slope of the MR curve will be exactly twice as great as the slope of the D curve. Thus choice (b) is also correct. Finally, choice (c) is also correct. A perfectly competitive firm is the only type of firm for which P=MC at the profit-maximizing quantity of output. A firm in any other type of market structure will charge a price that is greater than marginal cost
30. Which of the following is necessary for a firm to increase its profits by engaging in price discrimination? a. The firm must be a monopoly. b. The firm must have some way of distinguishing among its customers, to tell which ones have demand that is more elastic and which ones have demand that is less elastic. c. It must be difficult or impossible for customers to re-sell to other customers. d. All of the above. e. (b) and (c) only.
e. Both (b) and (c) are conditions for a firm to engage successfully in price discrimination. However, choice (a) is incorrect. If conditions (b) and (c) are met, a monopoly firm would indeed want to engage in price discrimination. However, if (b) and (c) are met, then price discrimination would also be attractive to firms that are monopolistically competitive or oligopolistic
11. Which of the following statements is/are true regarding profit? a. Profit = total revenue - total cost b. Profit = (P - ATC)*Q c. Profit is maximized at the quantity at which total revenue is equal to total cost. d. All of the above. e. (a) and (b) only.
e. Choice (a) is correct, by the definition of profit. Choice (b) is also correct: Profit per unit is equal to P - ATC, and if we multiply profit per unit by Q, the number of units, we get back to profit. However, choice (c) is incorrect. Profit is maximized at the quantity at which marginal revenue is equal to marginal cost.
32. We say that a perfectly competitive firm is a "price taker". In other words, a perfectly competitive firm takes the market price as given. Which of the following characteristics is/are necessary for a firm to be a price taker? a. The firm is one of many firms in the industry, each of which is small relative to the market. b. The industry is characterized by free entry and exit. c. The firms produce standardized products. d. All of the above. e. (a) and (c) only.
e. Free entry and exit are indeed characteristics of perfectly competitive industries. However, free entry and exit are not the reason why the perfectly competitive firm is a price taker. For a firm to be a price taker, two things have to be true. First, the firms all have to be small relative to the market, so they do not have any market power as a result of size. Second, the firms have to produce homogeneous output, so they do not have any market power as a result of product differentiation.
7. The change in total cost from producing one additional unit of output is equal to a. the change in total variable cost from producing one additional unit of output. b. the change in total fixed cost from producing one additional unit of output. c. marginal cost. d. all of the above. e. (a) and (c) only.
e. Marginal cost is defined as the change in total cost from producing one additional unit of output. Total cost is equal to total fixed cost plus total variable cost: TC = TFC + TVC. Therefore, the change in total cost is equal to the change in total fixed cost plus the change in total variable cost: ΔTC = ΔTFC + ΔTVC. However, by definition, the ΔTFC = 0, since total fixed cost does not change. This means that ΔTC = ΔTVC. Thus, if marginal cost is equal to the change in total cost from producing one additional unit of output, marginal cost must also be equal to the change in total variable cost from producing one additional unit of output
5. The short-run supply curve for a monopoly firm is a. the marginal-cost curve. b. the average-variable-cost curve. c. the marginal-cost curve for prices equal to or greater than average total cost. If price is less than average total cost, the quantity supplied is zero. d. the marginal-cost curve for prices equal to or greater than average variable cost. If price is less than average variable cost, the quantity supplied is zero. e. none of the above. The monopoly firm does not have a unique, well-defined supply curve.
e. The extent to which a monopoly will mark up the price above marginal cost will depend on the elasticity of demand. Thus, it is possible to identify two firms with the same marginal-cost curves, which produce the same profit-maximizing quantity, but for which the prices will be different. Also, it is possible to identify two firms which charge the same price, but for which the profit-maximizing quantity will be different. Thus, the monopoly does not have a unique, well-defined supply curve
27. The deadweight loss of monopoly is a measure of a. the difference between the amount consumers are willing to pay, and the amount they actually pay. b. the difference between the price charged by a monopoly and the price charged by a perfectly competitive industry. c. the difference between aardvarks and zebras. d. the difference between quantity demanded and quantity supplied. e. the difference between the consumers' loss from monopoly and the producers' gain from monopoly
e. if a competitive industry is monopolized, the industry's profits will increase, but consumer surplus will decrease. The loss to consumers is larger than the gain to producers. The difference between the consumers' loss and the producers' gain is the deadweight loss of monopoly.