Chapter 4
Markets in Action
1. A decrease in demand with the supply held constant leads to a(an)
a. increased equilibrium price and an increased equilibrium quantity.
b. decreased equilibrium price and a decreased equilibrium quantity.
c. decreased equilibrium price and an increased equilibrium quantity.
d. increased equilibrium price and a decreased equilibrium quantity.
ANS
a. Incorrect. This is the result of an increase in demand.
b. Correct. This is the result of a decrease in demand.
c. Incorrect. This is the result of an increase in supply.
d. Incorrect. This is the result of a decrease in supply.
2. An increased equilibrium price and a decreased equilibrium quantity results from a(an)
a. a decrease in demand.
b. an increase in supply.
c. a decrease in supply.
d. an increase in demand.
ANS
a. Incorrect. This would cause a decreased equilibrium price and a decreased equilibrium quantity.
b. Incorrect. This would cause a decreased equilibrium price and an increased equilibrium quantity.
c. Correct. This causes an increased equilibrium price and a decreased equilibrium quantity.
d. Incorrect. This would cause an increased equilibrium price and an increased equilibrium quantity.
3. Assume no price ceiling exists in a market. Then a price ceiling is established below the market equilibrium. What would result?
a. Shortage
b. Equilibrium
c. Surplus
d. The exchange price
ANS
a. Correct. A shortage would result from a price ceiling set below equilibrium price.
b. Incorrect. At the price ceiling below equilibrium, the quantity supplied would be less than the quantity demanded. A shortage would result.
c. Incorrect. At the price ceiling below equilibrium, the quantity supplied would be less than the quantity demanded. A shortage would result.
d. Incorrect. This is meaningless. Any price is an exchange price.
4. Which of the following is not an example of market failure?
a. Lack of competition
b. Externalities
c. Efficient equilibrium
d. Extreme income inequality
ANS
a. Incorrect. Lack of competition is an example of market failure.
b. Incorrect. Externalities are an example of market failure.
c. Correct. Efficient equilibrium results in the efficient amount of resources being used in the production of a good or service.
d. Incorrect. Extreme income inequality is an example of market failure.
5. A cost imposed on people other than the consumers of a good or service is a
a. price floor.
b. negative externality.
c. positive externality.
d. price ceiling.
ANS
a. Incorrect. A price floor is a legally established minimum price a seller can be paid.
b. Correct. This is the definition of a negative externality.
c. Incorrect. A positive externality is a benefit, not a cost, enjoyed by people other than the producers of a good or service.
d. Incorrect. A price ceiling is a maximum price set by government.
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6. Suppose that X and Y are substitutes. If the price of Y increases, how will this change the market equilibrium for X?
a. Both equilibrium price and quantity both decline.
b. Both equilibrium price and quantity both rise.
c. Equilibrium price declines, and equilibrium quantity rises.
d. Equilibrium price rises, and equilibrium quantity falls.
ANS
a. Incorrect. If the price of a substitute rises, demand increases, leading to a new equilibrium with a higher price and higher quantity.
b. Correct. Demand for X increases.
c. Incorrect. If the price of a substitute rises, demand increases, leading to a new equilibrium with a higher price and higher quantity.
d. Incorrect. If the price of a substitute rises, demand increases, leading to a new equilibrium with a higher price and higher quantity.
7. If the cost of producing a good rises for sellers, how will this affect the market equilibrium for that good?
a. Price will rise and quantity will fall.
b. Price will fall and quantity will rise.
c. Both price and quantity will both rise.
d. Both price and quantity will both fall.
ANS
a. Correct. Higher production costs will reduce supply (shift the supply curve inwards), resulting in a new equilibrium with a higher price and a lower quantity.
b. Incorrect. This would require an increase in supply.
c. Incorrect. This would require an increase in demand.
d. Incorrect. This would require a decrease in demand.
8. If goods A and B are complements, and if the price of good B rises, how will this affect the market equilibrium for good A?
a. Price will rise and quantity will fall.
b. Price will fall and quantity will rise.
c. Both price and quantity will both rise.
d. Both price and quantity will both fall.
ANS
a. Incorrect. This would require a decrease in supply.
b. Incorrect. This would require an increase in supply.
c. Incorrect. This would require an increase in demand.
d. Correct. If the price of a substitute good "B" rises, the demand for good "A" decreases causing both the equilibrium price and quantity to fall.
9. Suppose that Big-Cat and Fat-Cat are rival cat food brands, and the price of Fat-Cat is reduced. Following this price drop, is there a shortage or a surplus of Big-Cat at the old price of Big-Cat?
a. Shortage.
b. Surplus.
c. Neither, equilibrium exists.
d. Neither,because a price drop can not cause a shortage or surplus.
ANS
a. Incorrect. A decline in the price of Fat-Cat will draw some customers away from Big-Cat, reducing the quantity demanded for Big-Cat, and so at the old Big-Cat price, there is a surplus.
b. Correct. A decline in the price of Fat-Cat will draw some customers away from Big-Cat, reducing the quantity demanded for Big-Cat, and so at the old Big-Cat price, there is a surplus.
c. Incorrect. The quantity demanded must equal the quantity supplied for equilibrium to exist.
d. Incorrect. A price drop can cause a surplus.
10. Suppose that the average equilibrium monthly rental price of apartments and rooms in a college town has been steady at $600, but then the college expanded enrollment from 10,000 to 12,000.Suddenly there is a shortage of rental housing at the prevailing price of $600. Which of the following is most likely to be true?
a. The shortage occurred because demand increased, and a new market equilibrium will feature higher rental prices and more rental units available on the market.
b. The shortage occurred because supply increased, and a new market equilibrium will feature lower rental prices and fewer rental units available on the market.
c. The shortage occurred because demand decreased, and a new market equilibrium will feature lower rental prices and fewer rental units available on the market.
d. The shortage occurred because demand increased, and a new market equilibrium will feature higher rental prices and fewer rental units available on the market.
ANS
a. Correct. More students means more buyers in the market for rental housing, which increases demand and results in a higher equilibrium market price and quantity.
b. Incorrect. An increase in students will increase demand, not supply, and moreover supply will not cause a shortage at the old price.
c. Incorrect. More students means more buyers of rental housing, and thus demand will increase rather than decrease.
d. Incorrect. This is correct until the very end, where more rather than fewer rental units will be available on the market.
11. If a price ceiling is set at $10, and the equilibrium market price is $8, then which of the prices below is the price that consumers actually pay?
a. $10.
b. $8.
c. $18.
d. $2.
ANS
a. Incorrect. A price ceiling is a maximum price, and since the equilibrium market price is less than the maximum price, consumers pay $8.
b. Correct. A price ceiling is a maximum price, and since the equilibrium market price is less than the maximum price, consumers pay $8.
c. Incorrect. A price ceiling is a maximum price, and since $18 is above the maximum price, consumers pay the equilibrium price of $8.
d. Incorrect. A price ceiling is a maximum price, and since $2 is less than the maximum price, consumers pay the equilibrium price of $8.
12. Suppose that the state of California imposes a minimum wage of $10 per hour. In the entry-level labor market in California fast-food restaurants, the quantity of labor demanded at $10 per hour is 800,000, and the quantity of labor supplied is 1.2 million. Which of the following is true?
a. There is a shortage of 800,000 workers in the labor market.
b. There is a surplus of 400,000 workers in the labor market.
c. There is a shortage of 400,000 workers in the labor market.
d. There is a surplus of 1.2 million workers in the labor market.
ANS
a. Incorrect. When quantity supplied is greater than quantity demanded, there is a surplus, not a shortage.
b. Correct. The surplus is (quantity supplied - quantity demanded).
c. Incorrect. When quantity supplied is greater than quantity demanded, there is a surplus, not a shortage.
d. Incorrect. While there is indeed a surplus, it is (quantity supplied - quantity demanded), not the number for quantity supplied.
13. Suppose the federal government imposes a price floor (support price) in the milk market at a price of $6 per gallon. If market quantity demanded at $6 is 1 billion gallons, and market quantity supplied is 1.5 billion gallons, which of the following is true?
a. There is a shortage of 500 million gallons of milk, and the federal government will buy 1 billion gallons to maintain the $6 price.
b. There is a surplus of 500 million gallons of milk, and the federal government will buy this 500 million gallons to maintain the $6 price.
c. There is a shortage of 500 million gallons of milk, and the federal government will buy an additional 500 million gallons to maintain the $6 price.
d. There is a surplus of 1 billion gallons of milk, and the federal government will buy 1.5 billion gallons to maintain the $6 price.
ANS
a. Incorrect. At the $6 price there is a surplus of 500 million gallons, not a shortage.
b. Correct. The federal government must buy up all the surplus milk to support the $6price.
c. Incorrect. At the $6 price there is a surplus of 500 million gallons, not a shortage.
d. Incorrect. At the $6 price there is a surplus of 500 million gallons, not 1 billion gallons.
14. Suppose the city of Arcata, California, imposes rent control so that rents cannot exceed $1,000 per month on one bedroom rental units. Suppose that $1,000 had also been the equilibrium rental price in Arcata before a huge new apartment complex was built in the nearby town of McKinleyville, where rents are $800 per month. Which of the following is most likely true?
a. There will be a shortage of rental housing in Arcata at the rentcontrol price of $1,000.
b. There will be a lasting surplus of rental housing in Arcata after the new apartment complex is built in McKinleyville.
c. The equilibrium rental price in Arcata will fall below $1,000, and thus rent control will not affect the rental market in Arcata.
d. The equilibrium price of $1,000 per month in Arcata will not change.
ANS
a. Incorrect. Demand for rental housing in Arcata will decline with the construction of cheaper substitute rental housing, so the new Arcata equilibrium price will fall below the maximum rent-control price.
b. Incorrect. The rent control price is a maximum price, and thus allows the market rental price to fall below the rent control price. Consequently there will be no lasting surplus of rental housing in Arcata.
c. Correct. A price ceiling does not affect an equilibrium that makes price decline.
d. Incorrect. Demand for rental housing in Arcata will decline with the construction of cheaper substitute rental housing, so the new Arcata equilibrium price will fall below the maximum rent-control price.
15. Suppose the federal government provides wheat farmers with a price floor above the market equilibrium price of wheat, creating a surplus. Which of the following causes a reduction in the surplus of wheat?
a. Elimination of the price floor.
b. An increase in the price of wheat.
c. A decreases in the demand for wheat.
d. An increase in the supply of wheat.
ANS
a. Correct. Lower prices increase quantity demanded a decrease quantity supplied, thus reducing the surplus.
b. Incorrect. This will tend to make the surplus larger.
c. Incorrect. This will tend to make the surplus larger.
d. Incorrect. This will tend to make the surplus larger.
16. If society allows firms to freely pollute the environment, then which of the following is true?
a. Market equilibrium output will be too high relative to the efficient output level.
b. Market equilibrium output will be too low relative to the efficient output level.
c. Market equilibrium output will be equivalent to the efficient output level.
d. The efficient output level can be achieved by giving firms a subsidy for the pollution they generate.
ANS
a. Correct. Firms operate on an artificially low supply curve that reflects only the firms' private costs of production, and so does not include external costs.
b. Incorrect. The market supply curve with negative externalities is larger than the socially efficient supply curve.
c. Incorrect. Firms operate on an artificially low supply curve that reflects only the firms' private costs of production, and so does not include external costs. Thus the output level with negative externalities is higher than the efficient level.
d. Incorrect. The efficient output level can be achieved by taxing firms based on external costs, not subsidizing them.
17. If there are external benefits for good X , which of the following is true?
a. The socially efficient amount of good X can be achieved if society taxes consumers of good X.
b. The socially efficient amount of good X can be achieved if society subsidizes consumers of good X.
c. The socially efficient amount of good X will be equivalent to the free market equilibrium quantity.
d. The socially efficient amount of good X does not exist.
ANS
a. Incorrect. This would decrease demand and move equilibrium further from efficiency.
b. Correct. This would increase demand and move equilibrium toward efficiency.
c. Incorrect. The existence of external benefits means the free market equilibrium quantity does not equal to the efficient quantity.
d. Incorrect. The socially efficient quantity of good X occurs where the supply of good X is equal to the social demand for good X (which includes both the private and the external benefits of good X).
18. Suppose the federal government imposes a new pollution tax of $0.01 per kilowatt-hour of electricity is imposed on coal-fired power producers . Which of the following correctly describes how this tax will affect the market for electricity served by these power plants?
a. Demand for electricity will decrease.
b. Demand for electricity will increase.
c. The supply of electricity will decrease.
d. The supply of electricity will increase.
ANS
a. Incorrect. The tax will decrease supply.
b. Incorrect. The tax will decrease supply.
c. Correct. The tax will decrease supply.
d. Incorrect. The tax will decrease supply.
19. Why don't competitive markets do a good job providing public goods?
a. Because people do not receive benefits from public goods.
b. Because firms cannot produce enough goods to satisfy market demand.
c. Because public goods generate negative externalities, and pollution taxes reduce the incentive for firms to supply public goods.
d. Because it is difficult to exclude people from gaining benefits from public goods without paying for them, and so market demand does not reflect the benefits to society from the public good.
ANS
a. Incorrect. Public goods such as parks, uncongested roads, and public radio create benefits for many people.
b. Incorrect. Market demand is too low because potential buyers can free ride.
c. Incorrect. Public goods do not generate negative externalities to any greater extent than other types of goods that are freely traded in markets.
d. Correct. This is an accurate description of the special characteristics of public goods.
20. Which of the following is not an example of market failure?
a. Lack of competition.
b. Externalities.
c. Efficient equilibrium.
d. Extreme income inequality.
ANS
a. Incorrect. Firms agreeing to restrict supply in order to increase profits are an example of market failure.
b. Incorrect. Externalities are an example of market failure.
c. Correct. Efficient equilibrium results in the efficient amount of resources being used in the production of a good or service.
d. Incorrect. Extreme income inequality is an example of market failure.
Exhibit 11 Supply and Demand Curves
21. In Exhibit 11, which of the following might cause a shift from S1 to S2?
a.A decrease in input prices.
b.An improvement in technology.
c.An increase in input prices.
d.An increase in consumer income.
ANS
a. Incorrect. This would shift the supply curve rightward.
b. Incorrect. This would shift the supply curve rightward.
c. Correct. This would shift the supply curve leftward
d. Incorrect. This would shift the demand curve rightward.
22. The market shown in Exhibit 11 is initially in equilibrium at point E1. Union negotiations for workers producing good X result in a wage increase. Other things being equal, which of the following is the new equilibrium after this wage increase is in effect?
a.E1.
b.E2.
c.E3.
d.E4.
ANS
a. Incorrect. An increase in labor cost shifts the supply curve leftward.
b. Correct. An increase in labor cost shifts the supply curve leftward.
c. Incorrect. An increase in labor cost shifts the supply curve leftward.
d. Incorrect. An increase in labor cost shifts the supply curve leftward.
23. The market shown in Exhibit 11 is initially in equilibrium at E1. Changes in market conditions result in a new equilibrium at E2. This change is stated as a (an)
a.increase in supply and an increase in quantity demanded.
b.increase in supply and a decrease in demand.
c.decrease in supply and a decrease in quantity demanded.
d.increase in demand and an increase in supply.
ANS
a. Incorrect. A decrease in supply causes a movement upward along the demand curve.
b. Incorrect. A decrease in supply causes a movement upward along the demand curve.
c.Correct. A decrease in supply causes a movement upward along the demand curve.
d. Incorrect. A decrease in supply causes a movement upward along the demand curve.
24. The market shown in Exhibit 11 is initially in equilibrium at E3. Changes in market conditions result in a new equilibrium at E4. This change is stated as a (an)