Part I Multiple Choice Questions

Final Exam

Please write your name in the upper right hand corner of this exam, so it can be returned to you later. Turn in this copy with your answers. Please also put your name on the back of each sheet of your essay answers, as I would like to grade the essays "blind."

Part I Multiple Choice Questions

Answer the questions below on the answer sheet provided, using a #2 pencil. You should take a maximum of 80 minutes for this section. Each question is worth 3 points; the entire section is worth 75 points.

1) If profits in industry X are above normal and free entry prevails, in the long run one would expect

a) a lower price.

b) falling profits.

c) the entry of new firms.

d) All of the above are true.

2) If a firm has some degree of market power, then output price

a) is guaranteed to be above a firm's average cost.

b) is determined by the actions of other firms in the industry.

c) no longer influences the amount demanded of the firm's product.

d) becomes a decision variable for the firm.

3) In the diagram above, the firm’s profit-maximizing output level is

a) 400 units

b) 600 units

c) 900 units

d) 1000 units

4) Economies of scale are sometimes a barrier to entry because

a) it is expensive to advertise enough to gain visibility in the market.

b) one must have the right technology to produce some products competitively.

c) it can cost a lot to build a plant large enough to achieve low production costs.

d) government may decide that the public is best off if those economies are protected by law.

5) From the 1981 introduction of the IBM PC to the fall of 2003, the price elasticity of demand for IBM PCs has

a) fallen due to the growth of substitutes, e.g., Dell and Gateway.

b) increased due to the lower price of IBM computers.

c) increased due to the growth of substitutes, e.g., Dell and Gateway.

d) fallen because consumers started to switch from PCs to handhelds.

e) increased due to a reduction in demand for PCs.

6) Which of the following circumstances does not involve game theory?

a) a gas station owner wondering how his competition will react to his decision to lower prices

b) buying a can of beef stew at the grocery store

c) negotiating a salary when two firms have made offers

d) deciding whether to have an extramarital affair

e) playing poker

7) The marginal cost curve for information is upward sloping because

a) most information is false.

b) consumers start with the least expensive sources and progress to more expensive sources.

c) there is only so much to learn about a product.

d) some information is useless.

e) most information is misleading.

8) Imagine a world in which landlords always fix problems quickly, tenants never damage property, and always pay their rent in a timely fashion. In such a world,

a) lease agreements would still exist to solve the commitment problem.

b) lease agreements would be unnecessary.

c) lease agreements would only serve the interests of landlords.

d) lease agreements would only serve the interests of tenants.

9) Jason has a plot of land that has three alternative uses: R, S, and T. The revenue from each use is $5, $6, and $8, respectively. The accounting cost of each use is zero. The opportunity cost of using the land for Use S is

a) $5, the value in Use R.

b) $8, the value in Use T.

c) $1, the difference in value between Use R and Use S.

d) $2, the difference in value between Use T and Use S.

10) The demand curve of an oligopolistic firm

a) depends partly on its marginal costs of production.

b) lies above the demand curve of a perfectly competitive firm.

c) depends upon the actions of rival firms.

d) is the same as its marginal revenue curve.

11) In the short run, which of the following is possible?

a) The average fixed cost may be greater than the average total cost.

b) The marginal cost may intersect average total cost when average total cost is decreasing.

c) The average fixed cost may be greater than the average variable cost.

d) The total fixed cost falls as output rises.

Answer question 12) based on the diagram above. Assume the diagram displays the costs for a profit-maximizing firm in a perfectly competitive industry.

12) Given a market price of P4, this firm should

a) close down in the short run.

a) produce 10 units and earn zero economic profit.

b) produce 24 units and earn an economic profit.

c) produce 30 units and earn economic losses.

d) produce 30 units and earn zero economic profit.

e) None of the above is true.

13) In a perfectly competitive market, producing up to the point where price equals marginal cost yields the socially efficient level of output if there are

a) external costs, but not external benefits.

b) external benefits, but not external costs.

c) neither external benefits nor external costs.

d) both external benefits and external costs.

14) A local public bus system recently raised fares and was surprised when the accounting department reported declining revenues. Which of the following seems like the most reasonable conclusion to draw?

a) The demand curve for bus transportation slopes upward from left to right.

b) The income elasticity of demand for bus transportation is greater than 1.

c) The demand for bus transportation is price elastic.

d) The accounting department has made an error.

15) When firms leave a purely competitive market, ceteris paribus,

a) market demand will increase and market price will rise.

b) market demand will decrease and market price will fall.

c) market supply will decrease and market price will rise.

d) market supply will decrease and market price will fall.

e) both market demand and market supply will decrease, with an unpredictable impact on market price.

16) The best explanation for the difference in real earnings between popular singers at the turn of the century and today is that

a) singers today are more talented.

b) singers today can reach a much larger audience.

c) singers of yesteryear did not have aggressive agents.

d) labor unions for singers were formed.

e) the elasticity of demand for singers is much smaller today.

17) Between 1980 and 2000, the 20% of families with the lowest incomes in the US saw their real incomes

a) fall by about 3% per year.

b) rise by about .5% per year.

c) rise by about 4% per year.

d) rise by about 8% per year.

18) Antitrust laws are based on the proposition that

a) regulation is the best way to achieve efficiency.

b) public ownership is the best way to achieve efficiency.

c) increasing market power is the best way to achieve efficiency.

d) competition is the best way to achieve efficiency.

19) [Hint: draw the supply and demand diagram before answering this one.] Consider a product produced and sold in a perfectly competitive market. For the product in question, a modest rise in supply results in a dramatic drop in the market price. This suggests that the quantity of the product demanded is relatively ______to changes in price.

a) sensitive

b) insensitive

20) The model of perfect competition would be most appropriate to analyze a situation in which

a) firms engage in price wars in order to secure a position in the market.

b) firms perceive themselves as unable to influence their product's price.

c) firms engage in advertising and other forms of non-price competition.

21) Imagine an economy with only one kind of worker and competitive product markets. Suppose the labor market is competitive (many firms hiring workers and no unions) and the wage is equal to the equilibrium wage. Which of the following statements about that market would be true?

a) Every individual who desires a job is employed.

b) The marginal revenue product of labor is maximized.

c) Workers who demand wages above the equilibrium wage rate are not employed.

d) The marginal physical product of labor is zero.

22) For the Coase theorem to apply, which of the following conditions must be satisfied?

a) The basic rights of the individuals must be clearly understood.

b) There must be no impediments to bargaining.

c) Only a few people can be involved.

d) All of the above.

23) Which of the following is least likely to cause a shift in a market demand curve?

a) a change in the price of the good

b) a change in the income of consumers

c) a change in the number of consumers

d) a change in the price of a substitute

e) a change in the income distribution of consumers

24) Adverse selection is present in medical insurance because as fewer families choose to purchase insurance, the costs of premiums will _____, ensuring that _____ families buy insurance.

a) fall; even fewer

b) fall; even more

c) remain unchanged; even more

d) rise; even fewer

e) rise; even more

25) The concern that HMOs provide less than the efficient level of medical care is because

a) of the higher costs for HMOs.

b) doctors in HMOs are less sensitive to the4 needs of the patients.

c) of government regulation.

d) of the incentive to order fewer medical procedures and enjoy greater profits.

e) lack of peer review.

Please continue on the opposite side!

Part II Short Answer and Essay Questions

Think about the state of a professor’s brain and motivation at this point in the semester. Use some of the time available to think and outline before you write. Write concise answers to each question on lined paper. Please use complete sentences and write your answer to each question on a separate sheet of paper, using only the front side. If a question asks for a numerical answer, please show your work. You should take a maximum of 35 minutes for the whole section. The entire section is worth 42 points.

The following question is mandatory:

1) [14 pts.] You are a perfect monopolist producing zeps. Suppose the figures below describe the demand curve you face and your total production costs:

a) What is the marginal revenue per unit for the last 100 zeps sold when you cut your price from $8 to $7? What is the marginal cost per unit for those same zeps?

b) Will your profits rise or fall if you cut your price from $8 to $7? Explain your answer in plain English, using the concepts of marginal revenue and marginal cost.

2) [14 pts.] Flood control dams are dams built to store water at a time of year a river would normally flood; they prevent flooding downstream from the dam. Is a flood control dam a public good, pure or otherwise? Please explain your answer.

3) [14 points]

a) Microeconomists love to point out the social benefits which result from marginal cost pricing. Explain, in the simplest terms possible, why it might be a good thing for society to have the price of a product be equal to the marginal cost of producing it.

b) For the maximum social benefit to occur, should the price be equal to the marginal social cost or the marginal private cost? Explain.

Correct Answers to Part I

Fabulous Answers to Part II

1)

a) The marginal revenue per unit when I cut my price from $8 to $7 is $1.00 per zep. The marginal cost per unit for producing those zeps is $1.25 per zep.

b) My profits will fall if I cut my price from $8 to $7. Although I average $1 of additional revenue on the 100 additional units I sell, they each cost me $1.25 additional to produce. As a result, each additional zep sold reduces my profit by 25 cents.

2) Yes, the dam is a public good, a pure public good. A pure public good is non-excludable and non-rival. The dam is non-excludable because if it is built, it will necessarily benefit everyone near the river and downstream from the dam. Suppose a private firm built the dam. If a beneficiary refused to help pay for it, the firm would not be able to deny them the benefit. What about non-rivalry? The dam is non-rival because the benefit enjoyed by one person living downstream, the flood protection resulting from the dam’s construction, would not affect the benefit enjoyed by anyone else living downstream.

3) a) If price is equal to marginal cost, a consumer automatically takes into account the cost of producing the product when she makes a purchasing decision. As a result, she won’t buy products for which her marginal benefit is less than the marginal cost of production. This means that consumption is efficient! Nothing produced will have benefits smaller than its costs!

b) For the maximum social benefit to occur, the price should be equal to the marginal social cost. The consumer should take all costs of producing the product into account when she decides whether to buy or not. Think about a kilowatt of electricity generated by a coal-fired power plant. The cost of the damage from acid rain is just as much a cost of producing the kilowatt as the cost of the coal burned to turn the generator.