Description

 

INSTANT DOWNLOAD COMPLETE TEST BANK WITH ANSWERS
 
Microeconomics An Intuitive Approach With Calculus 2nd Edition by Thomas Nechyba – Test Bank
 
Sample  Questions

 

True / False

 

1. A decrease in a wage taxes causes the opportunity cost of leisure to increase.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The opportunity cost of leisure is how much a worker gives up by taking leisure. If the wage tax falls, the worker gives up more when he does not work.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

2. In the typical leisure/consumption model, an increase in the wage is equivalent to a decrease in the price of the composite consumption good.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The two scenarios both increase the slope of the worker budget constraint without changing the horizontal intercept (assuming leisure is modeled on the horizontal axis.)
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

3. Changes in interest rates cause the same rotations of intertemporal budget lines regardless of whether you are a borrower or a saver.

a. True
b. False

 

ANSWER:   False
RATIONALE:   While it is true that the slopes of the intertemporal budgets will be the same for borrowers and savers (if they face the same interest rates), a change in the interest rate causes a rotation through the endowment on the horizontal axis for a saver and through the endowment on the vertical axis for the borrower.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

4. An increase in the interest rate is an increase in the opportunity cost of consuming in the future.

a. True
b. False

 

ANSWER:   False
RATIONALE:   No, it is an increase in the opportunity cost of current consumption — because you now give up more in future consumption for every dollar you consume now.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

5. The opportunity cost of current consumption differs for borrowers and savers only if the interest rate for savers differs from the interest rate for borrowers.

a. True
b. False

 

ANSWER:   True
RATIONALE:   If borrowers and savers faced the same interest rates, they would be giving up the same in future consumption for every dollar consumed now.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

6. In the worker’s leisure/consumption model, the wage is the same as the price of consumption.

a. True
b. False

 

ANSWER:   False
RATIONALE:   The price of the composite consumption good is by definition equal to 1 — the wage is the price of taking leisure because it is how much a worker gives up when taking leisure.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

7. A bond that promises to pay $X in 10 years must be worth less than $X now.

a. True
b. False

 

ANSWER:   True
RATIONALE:   An asset that can fund consumption in the future must be worth less now — else no one would buy the asset but would instead simply save money in some other way.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

8. Progressive wage taxes cause worker leisure/consumption budgets (with leisure on the horizontal axis) to become steeper as leisure increases.

a. True
b. False

 

ANSWER:   False
RATIONALE:   Regressive wage taxes levy high rates on initial hours worked and lower rates on later hours — which implies that, beginning at the leisure endowment point, the budget starts shallow and becomes steeper as we move to the left. Thus, as we move in the other direction (of leisure increasing), the budget becomes shallower.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

9. Since interest rates for borrowing are usually higher than interest rates for savings, the intertemporal budget constraint has an inward kink for individuals that earn income now and in the future.

a. True
b. False

 

ANSWER:   False
RATIONALE:   Individuals who earn income both now and in the future have an endowment bundle that lies in the interior of our current consumption/future consumption graph. Anywhere to the left of this, they save — and anywhere to the right of it they borrow. If interest rates on saving are lower than on borrowing, this implies that the budget will be shallow initially and then gets steep when borrowing commences. The kink therefore points out, not in.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

10. In choice sets, intertemporal budget constraints illustrate consumption trade-offs over time.

a. True
b. False

 

ANSWER:   True
RATIONALE:   Intertemporal budget constraints illustrate consumption trade-offs over time.
POINTS:   1
DIFFICULTY:   A section material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   10/7/2015 11:52 AM
DATE MODIFIED:   10/7/2015 12:13 PM

 

11. An “endowment” is something whose value is unknown.

a. True
b. False

 

ANSWER:   False
RATIONALE:   An “endowment is something whose value is determined by prices in the economy. Examples are savings, mutual funds, real estate investments and other assets.
POINTS:   1
DIFFICULTY:   A section material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   10/7/2015 11:53 AM
DATE MODIFIED:   10/7/2015 12:17 PM

 

Multiple Choice

 

12. Suppose you earn annually compounding interest of 10% (per year) on an initial investment of $1,000. Rounded to the nearest 100, what will your balance in 10 years be?

a. $11,000
b. $5,200
c. $2,600
d. $2,000
e. $1,600
f. None of the above

 

ANSWER:   c
RATIONALE:  
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

13. A bond will pay $10,000 to its owner in 5 years. If the relevant annual interest rate is 5%, what is the bond worth today (rounded to the nearest 100)?

a. $9,500
b. $7,800
c. $6,600
d. $1,900
e. None of the above.

 

ANSWER:   b
RATIONALE:  
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

Subjective Short Answer

 

14. Write down the budget constraint equation as well as the choice set for a worker who has 100 possible hours of leisure per week and can earn a wage of $25 per hour.

ANSWER:   Equation:
Choice Set:
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

15. Suppose a worker gets a weekly check equal to $1,000 from a risk-free investment, has 60 hours of weekly leisure that can be devoted to work and can earn a wage of $40 per hour.

a. Illustrate this worker’s budget constraint, with weekly leisure hours on the horizontal and weekly consumption (in dollars) on the vertical.

b Illustrate what happens to this worker’s budget constraint when the weekly investment check increases to $1,500.

c. Illustrate what happens to this worker’s budget constraint when instead the wage increases to $50 per hour.

d. Suppose the worker can hire help at $20 per hour, and each hour of help adds a half an hour to his available leisure. Will the budget constraint described in (a) change?

ANSWER:   a. This budget constraint has a vertical intercept of $3,400 and a slope of -40 up to 60 hours of leisure (at which point the consumption level is $1,000). It then becomes a vertical line down to the horizontal axis (because the worker cannot buy leisure with the investment income.)

b. When the investment check increases by $500, the vertical intercept increases by $500, the slope does not change and the budget constraint still becomes vertical at 60 hours of leisure.

c. The vertical intercept now goes to $4,000, and the slope up to 60 hours of leisure increases (in absolute value) to -50. At 60 hours of leisure, consumption has fallen to $1,000, with the budget constraint become perfectly vertical at that point.

d. Yes — the budget constraint would now have a slope of -40 throughout, all the way down to the horizontal axis. This is because the worker can now not only sell leisure for $40 her hour but also buy it for $40 per hour, which implies that he can get as much as 25 additional hours of leisure by spending the $1,000 of investment income.

POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

True / False

 

1. Homothetic tastes are always tastes over essential goods.

a. True
b. False

 

ANSWER:   False
RATIONALE:   Tastes for perfect substitutes are homothetic — but neither good is essential in that case.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

2. Tastes for perfect substitutes are both homothetic and quasilinear.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The MRS for such tastes is the same everywhere — which implies it is the same along any ray from the origin (required for homotheticity) and along any vertical or horizontal ray (implying quasilinearity in both goods).
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

3. Tastes for perfect complements are both homothetic and quasilinear.

a. True
b. False

 

ANSWER:   False
RATIONALE:   They are not quasilinear.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

4. There are no quasilinear tastes that have elasticity of substitution equal to 1 everywhere.

a. True
b. False

 

ANSWER:   True
RATIONALE:   In order for tastes to have constant elasticity of substitution, they must be representable by a constant elasticity of substitution (CES) utility function. The CES utility function that has elasticity of substitution equal to 1 is the Cobb-Douglas function — which is homothetic and not quasilinear.
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

5. There are no quasilinear tastes that have constant elasticity of substitution.

a. True
b. False

 

ANSWER:   False
RATIONALE:   This is false — perfect substitutes are quasilinear (in both goods) and have constant elasticity of substitution equal to .
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

6. There is no elasticity of substitution that is inconsistent with tastes being homothetic.

a. True
b. False

 

ANSWER:   True
RATIONALE:   All CES utility functions represent homothetic tastes — and their elasticity of substitution can vary from 0 to .
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

7. Consider the utility function . If , the elasticity of substitution is equal to 1.
The elasticity of substitution for CES utility functions is .

a. True
b. False

 

ANSWER:   True
RATIONALE:   The elasticity of substitution for CES utility functions is .
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

8. Consider the utility function . If , the elasticity of substitution is equal to .

a. True
b. False

 

ANSWER:   False
RATIONALE:   The elasticity of substitution for CES utility functions is — thus the elasticity of substitution in this case is .
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

9. All homogeneous functions (of any degree) are homothetic but not all homothetic functions are homogeneous (of some degree).

a. True
b. False

 

ANSWER:   False
RATIONALE:   All homothetic functions are homogeneous but not all homogeneous functions are homothetic.
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

10. If tastes are Cobb-Douglas, they can be represented by a utility function that is homogeneous of degree k where k can take on any positive value.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The Cobb-Douglas utility function is homogeneous of degree . Since we can take a utility function to any power an retain the same underlying indifference curves, we can represent Cobb-Douglas indifference curves with a function that is homogeneous of any degree.
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

11. When two goods are perfect substitutes, averages are better than extremes, resulting a diminishing marginal rate of substitution.

a. True
b. False

 

ANSWER:   False
RATIONALE:   When two goods are perfect substitutes, averages are valued the same as extremes, resulting in a constant indifference curve, giving us constant rather than diminishing marginal rates of substitution.
POINTS:   1
DIFFICULTY:   A section material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   10/7/2015 1:00 PM
DATE MODIFIED:   10/7/2015 2:04 PM

 

12. In the case of perfect complements, more is not necessarily better.

a. True
b. False

 

ANSWER:   True
RATIONALE:   Perfect complements represent an extreme case in that more of one component is not better if the other is missing; only more of both goods is better.
POINTS:   1
DIFFICULTY:   A section material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   10/7/2015 1:00 PM
DATE MODIFIED:   10/7/2015 2:08 PM

 

Multiple Choice

 

13. Suppose  consumer cannot taste the difference between Miller Lite and Bud Light, but Miller Lite is sold in 12 ounce cans while Bud Light is sold in 8 ounce cans. In a graph with cans of Miller Lite on the horizontal and cans of Bud Light on the vertical axis, which of the following is the correct slope for this consumer’s indifference curves:

a.
b. -1
c.
d. There is not enough information to tell.

 

ANSWER:   c
RATIONALE:   It takes 1.5 Bud Light cans to get to 12 ounces of beer — which is what one can of Miller Lite contains. Thus, 1.5 cans of Bud Light are just as good as (and no better than) 1 can of Miller Lite, giving us the slope of -1.5.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

14. Consider the utility function . Which of the following are true statements about the indifference maps represented by this function.

a. MRS=-1 along the 45 degree line if and only if .
b. MRS=-1 along a ray steeper than the 45 degree line if and only if .
c. MRS=-1 along a ray shallower than the 45 degree line if and only if .
d. All of the above.
e. None of the above.

 

ANSWER:   a
RATIONALE:   When the exponents are equal to one another, the Cobb-Douglas function gives rise to indifference curves that are symmetric around the 45 degree line — thus (a) is true. Options (b) and (c) would be true if the inequalities were reversed.
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

Subjective Short Answer

 

15. Suppose our tastes are homothetic. It is often observed that people become more rigid — more set in their ways — as they get older. Can you translate this observation into “economics-speak” by discussing which feature of our tastes is likely the be changing as we get older?

ANSWER:   The feature of our tastes that is indicative of “flexibility” is the degree of substitutability in our indifference map. The more substitutable we think of goods, the more flexible we are in terms, whereas we become more inflexible as our tastes treat goods as relatively more complementary.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

16. Suppose our tastes can be represented by the function . It is often observed that people become more rigid — more set in their ways — as they get older. What parameter is changing as we get older — and how is it changing? (Explain.)

ANSWER:   The parameter is increasing from a value as low as -1 to a value as high as — causing our elasticity of substitution to fall from a value as high as to one as low as 0 as we grow older.
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

17. Suppose the only characteristic of beer that a consumer cares about is alcohol content. Currently, Bud Light and Miller Lite both have the same alcohol content.

a. Illustrate the consumer’s indifference curves in a graph with ounces of Miller Lite on the horizontal and ounces of Bud Light on the vertical axis.

b. Suppose that the producers of Bud Light lower the price of Bud Light. How will your answer to (a) change?

c. Suppose that the producers of Bud Light lower the alcohol content of their beer by 50%. How will your answer to (a) change?

d. Since we identify tastes with indifference maps, would you say that the consumer’s tastes have changed in (b) or (c)?

e. How could we change the units we use to measure Miller Lite in order to get the indifference map in (c) to again look like the one in (a)?

ANSWER:   a. The indifference curves are straight lines with slope of -1.

b. The answer will not change — prices affect budgets, not tastes.

c. The indifference curves will again be straight lines, but this time with slope of -2.

d. While the indifference map has changed in (c), the consumer’s tastes have not. Rather, the nature of the underlying product has changed — and the same tastes that care only about alcohol content therefore give rise to an indifference map that looks different.

e. If we changed the units of Miller Lite to “half-ounces”, we would again have indifference curves that are straight lines with slope of -1.

POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

18. Suppose the only characteristic of beer that a consumer cares about is alcohol content. Currently, Bud Light and Miller Lite have the same alcohol content.

a. Using to denote ounces of Miller Lite and to denote ounces of Bud Light, what’s the simplest possible utility function that can describe this consumer’s tastes over the two products.

b. Suppose Bud Light lowers its alcohol content by 50%. How would you change the utility function to account for this?

c. Derive the MRS for the functions in (a) and (b) — and interpret your answer.

ANSWER:   a.
b. or
c. In (a), MRS = -1 — i.e. no matter what bundle the consumer consumers, she is always willing to trade one Bud Light for one more Miller Lite.In (b), MRS = -2 — i.e. no matter what bundle the consumer consumes, she is always willing to trade 2 Bud Lights (that now have half the alcohol content) for 1 more Miller Lite.
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

19. Suppose you are very picky about your outdoor BBQ experiences — and you need exactly 1 cup of lighter fluid for each bag of charcoal you use. If you have either leftover charcoal or leftover lighter fluid, you simply discard it.

a. With cups of lighter fluid on the horizontal and bags of charcoal on the vertical axis, illustrate some of your indifference curves.

b. Suppose that your favorite charcoal has just gotten better because the producer has infused the charcoal with half a cup of lighter fluid per bag. How does your answer to (a) change?

c. How could you change the units in which lighter fluid is measured on the horizontal axis to get your graph from (b) to look the same as you original graph in (a)?

ANSWER:   a. The indifference curves would have an L-shape, with the corner of each indifference curve lying on the 45 degree line.

b. The indifference curves would still be L-shaped, but the corners of the curves would now lie on the 60-degree line; i.e. 1 charcoal bag is paired with half a cup of lighter fluid, 2 bags with 1 cup, etc.

c. If we measure lighter fluid in half cups, we get back the original graph.

POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM

 

20. Suppose you are very picky about your outdoor BBQ experiences — and you need exactly 1 cup of lighter fluid for each bag of charcoal you use. If you have either leftover charcoal or leftover lighter fluid, you simply discard it.

a. Letting cups of lighter fluid be denoted as and bags of charcoal as , give the simplest possible utility function that captures your tastes.

b. Suppose that your favorite charcoal has just gotten better because the producer has infused the charcoal with half a cup of lighter fluid per bag. How does your answer to (a) change?

ANSWER:   a.

b. or

POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:52 PM
DATE MODIFIED:   2/11/2015 10:52 PM
True / False

 

1. Conditional input demand curves always slope down, but unconditional input demand curves can slope up.

a. True
b. False

 

ANSWER:   False
RATIONALE:   All input demand curves slope down.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

2. Short run economic costs must be lower than long run economic costs because long run economic costs include the cost of inputs that are fixed in the short run (and thus are not part of short run cost).

a. True
b. False

 

ANSWER:   False
RATIONALE:   Most of the statement is true — except for the first part. It is true that the expense on capital is not a cost in the short run. But suppose that capital was fixed at a relatively low level in the short run, and suppose that we considered the cost of producing a high level of output. It may be that the cost associated with all the labor that is needed (given the low level of capital) is higher than the long run cost of both labor and capital when capital can be adjusted to its optimal level (given the high level of output).
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

3. The fixed expense on a fixed level of capital in the short run becomes a fixed cost for the firm in the long run.

a. True
b. False

 

ANSWER:   False
RATIONALE:   It becomes a variable cost in the long run.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

4. Except for the output level for which short-run fixed capital is long run cost-minimizing, short-run average expenses incurred by the firm are higher than long run average costs.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The long run average cost curve is the lower envelope of short run average expenditure curves (corresponding to different levels of short run fixed capital).
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

5. Long run average cost curves are downward sloping for increasing returns to scale production technologies.

a. True
b. False

 

ANSWER:   True
RATIONALE:   It gets easier and easier to produce — thus costing less and less on average.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

6. Long run marginal cost curves are increasing for decreasing returns to scale production technologies.

a. True
b. False

 

ANSWER:   True
RATIONALE:   Decreasing returns to scale means it is getting harder and harder to produce more — implying that each additional unit is costing more and more to produce.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

7. If the production technology has increasing returns to scale, short run marginal cost curves must be downward sloping.

a. True
b. False

 

ANSWER:   False
RATIONALE:   Increasing returns to scale is consistent with either increasing or diminishing marginal product of capital — which in turn determines whether the short run marginal costs slope up or down.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

8. Short run average expenditure curves are tangent at their lowest point to the long run average cost curve.

a. True
b. False

 

ANSWER:   False
RATIONALE:   They are tangent, but not usually at their lowest point.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

9. (Long run) average cost curves are U-shaped when the production technology has decreasing returns to scale and the firm faces recurring fixed costs.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The recurring fixed costs are high on average for low levels of output but become small on average as output increases. The AC without the fixed costs is upward sloping when the technology has increasing returns to scale. Combined, these two facts give us the U-shape.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

10. (Long run) average cost curves are U-shaped when the production technology has increasing returns to scale and the firm faces recurring fixed costs.

a. True
b. False

 

ANSWER:   False
RATIONALE:   Both the increasing returns to scale and the recurring fixed costs give rise to downward sloping AC curves — with nothing causing the upward slope in a U-shape.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

11. Suppose the AC curve is U-shaped. Then an increase in a recurring fixed cost will cause the AC curve to shift up, with its lowest point shifting to the right.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The new AC curve will converge to the original one (as the increase in the FC becomes smaller and smaller on average) — and this implies that the original AC curve shifts up, with the lowest point shifting to the right.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

12. If labor and capital are perfect complements in production, short run supply curves are vertical.

a. True
b. False

 

ANSWER:   True
RATIONALE:   If capital cannot be varied, there is no way to increase production when output price rises.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

13. When output price rises, the long run increase in labor input will be larger than the short run increase in labor input.

a. True
b. False

 

ANSWER:   False
RATIONALE:   The long run increase might be larger or smaller than the short run increase depending on the degree of substitutability between capital and labor.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

14. The greater the degree of substitutability between capital and labor, the greater will be the downward shift in the cost curve when wage falls.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The more substitutable labor and capital are, the more the firm can respond to the decrease in wages by shifting away from capital and into labor.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

15. If the wage falls, we know for sure that the firm will produce more in the long run but we cannot be sure whether it will use more or less capital.

a. True
b. False

 

ANSWER:   True
RATIONALE:   See Graph 13.8 in the text.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

16. If the rental rate increases, we know for sure that the firm will produce less and will (in the long run) use less capital.

a. True
b. False

 

ANSWER:   True
RATIONALE:   See Graph 13.8 in the text.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

17. If the rental rate increases, we know that output and labor input will fall in the long run.

a. True
b. False

 

ANSWER:   False
RATIONALE:   We know for sure that output will fall — but labor input might fall or rise. (See Graph 13.8 in the text.)
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

18. The cross-price demand for capital (relative to the wage) may slope up or down.

a. True
b. False

 

ANSWER:   True
RATIONALE:   See Graph 13.9.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

19. The more substitutable capital and labor are in production, the more likely it is that the cross-price demand curve for capital (relative to the wage) is upward sloping.

a. True
b. False

 

ANSWER:   True
RATIONALE:   See Graph 13.9 in the text.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

20. If the cross-price demand curve for capital (relative to the wage) is vertical, the short run response by a firm to an increase in the wage is the same as its long run response.

a. True
b. False

 

ANSWER:   True
RATIONALE:   See Graph 13.9 in the text.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

21. If a firm’s labor input response to a decrease in the wage differs between the short and the long run, we know that more workers will be hired after the initial short run adjustment.

a. True
b. False

 

ANSWER:   True
RATIONALE:   See Graph 13.9 in the text — short run labor demand curves are always steeper than long run labor demand curves (unless they are the same).
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

22. The production function can have increasing returns to scale or decreasing returns to scale — but it cannot have initially increasing and eventually decreasing returns to scale.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The returns to scale is determined solely by the parameter .
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

23. The parameter A re-scales the production function — allowing us to transform a decreasing returns to scale production function to an increasing returns to scale production function.

a. True
b. False

 

ANSWER:   False
RATIONALE:   The returns to scale are determined solely by the parameter .
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

24. Output supply is more responsive to price in the short run than in the long run. ​

a. True
b. False

 

ANSWER:   False
RATIONALE:   Output supply is more responsive to price in the long run than in the short run, since the producer will hire more, causing an increase in output in the long run, beyond that of the short run.
POINTS:   1
DIFFICULTY:   A section material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   10/12/2015 2:14 PM
DATE MODIFIED:   10/12/2015 2:53 PM

 

25. Output price changes cause substitution effects and scale effects. ​

a. True
b. False

 

ANSWER:   False
RATIONALE:   Output price changes cause no substitution effects, only scale effects.
POINTS:   1
DIFFICULTY:   A section material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   10/12/2015 2:14 PM
DATE MODIFIED:   10/12/2015 2:47 PM

 

Multiple Choice

 

26. Which of the following are true in a graph of isoquants (with capital on the vertical and labor on the horizontal) assuming a given wage and rental rate.

a. All long-run cost minimizing input bundles lie on a ray from the origin.
b. (a) is true only if the production technology is homothetic.
c. All short-run cost minimizing input bundles lie on a horizontal line.
d. (c) is true only if the production technology is homothetic.
e. (a) and (c) are true.
f. (b) and (c) are true.
g. (a) and (d) are true.
h. None of the above.

 

ANSWER:   f
RATIONALE:   If production is homothetic, the tangencies between isocosts (whose slope is always the same) and isoquants (whose slope is the same along a ray from the origin) lie on a ray from the origin. But if production is not homothetic, that’s not the case. Thus (b) is true. In the short run, capital is fixed — which means that the short run production frontier is a slice with fixed capital. Such a slice lies on a horizontal line in the isoquant graph — thus (c) is true.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

27. After a firm makes short-run adjustments in its production plan following a wage increase,

a. the marginal product of labor will be higher.
b. the marginal product of labor will be lower.
c. the marginal product of capital will be higher.
d. the marginal product of capital will be lower.
e. (a) and (c)
f. (a) and (d)
g. (b) and (c)
h. (b) and (d)

 

ANSWER:   a
RATIONALE:   The increase in the wage will cause a short run reduction in the labor force until the marginal revenue product of labor is equal to the new wage. Since the new wage is higher and the output price is unchanged, that must mean the marginal product of labor will be higher. But the marginal product of capital may be higher or lower depending on the degree of substitutability between capital and labor (see Graph 13.10 in the text).
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

28. After a firm makes both short and long run adjustments in its production plan following a reduction in the wage,

a. the marginal product of labor will be higher.
b. the marginal product of labor will be lower.
c. the marginal product of capital will be unchanged.
d. the marginal product of capital may be higher or lower depending on the degree of substitutability between capital and labor.
e. (a) and (c)
f. (a) and (d)
g. (b) and (c)
h. (b) and (d)

 

ANSWER:   g
RATIONALE:   At the new production plan, the marginal revenue product of labor is equal to the wage — and since the wage has fallen (and output price has remained constant), this implies that the marginal product of labor must be lower. Similarly, the marginal revenue product of capital will be equal to the rental rate — and since neither the rental rate nor the output price have changed, the marginal revenue product of capital must not have changed.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

29. After a firm makes both short and long run adjustments to its production plan following an increase in the output price,

a. the marginal product of capital will be higher.
b. the marginal product of labor will be lower.
c. the technical rate of substitution will be unchanged.
d. (a) and (c)
e. (b) and (c)
f. (a) and (b)
g. All of the above.
h. We cannot tell for sure — so none of the above.

 

ANSWER:   g
RATIONALE:   Output will increase, requiring both more capital and more labor — and thus causing a decrease in the marginal product of each. The new production plan is cost-minimizing — and the isocost slopes have not changed. Thus, the TRS must be unchanged.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

Subjective Short Answer

 

30. Suppose there are different ways of producing computer chips. If you hire one worker (for the day) for each machine that you rent (for the day), you can produce 10 chips per day with each worker/machine pair for the first 60 machine/worker pairs. For the next 60 worker/machine pairs (assuming still that you hire them as pairs for the day), you are able to produce 20 chips per day with each of the additional pairs. Once you have 120 worker/machine pairs, you can only get 5 additional chips per day for each additional pair.

But hiring 1 worker for each machine is not the only way to produce computer chips. Suppose you are starting from a production plan where you are using exactly as many workers as machines to produce a given level of chips. The technology is such that, starting at the production plan where you are using the same number of workers as machines, you can replace 1 or more workers with two machines (for each worker) and get just as many chips produced. Alternatively (and again starting at the production plan where you use exactly as many workers as machines), you can replace 1 or more machines with 2 workers (for each machine) and get just as many chips produced.

Suppose the daily wage and rental rate are both equal to $100 and the firm currently has 120 units of capital.
a. Illustrate the short run production function (assuming labor is variable in the short run but capital is not). (Label the intercept as well as any kink points.)
b. Derive the short run cost function. (Label the intercept as well as any kink points.)
c. Derive the short run marginal and average cost functions.
d. How low can price fall in the short run before a firm shuts down?
e. What does the average expenditure – i.e. the curve that includes all short run costs but also expenditures that are not costs in the short run – look like? Explain how this curve relates to the long run average cost curve.
f. We have said that the long run supply responses to output price changes are larger than short run supply responses. In what sense is this true for the firm you have analyzed here?

ANSWER:   a. b.

c.

d. The lowest point on the short run AC curve is at 0. Price can therefore fall to zero without the firm shutting down (because the firm can produce with just machines whose cost is sunk in the short run.)

e. The AE curve is illustrated in the graph above. It shares one point in common with the LR average cost curve — the minimum point. Everywhere else it is higher because the fixed SR level of capital (k=120) is not cost-minimizing for any output level other than 1,800.

f. From the graph above, you can see that the firm will not deviate from producing 1800 units of output so long as the price remains between $7.50 and $60.00. The lowest point of the AE and LR AC curves occurs at $13.33. The long run MC above 1800 units of output is $40. Thus, in the long run the firm will not deviate from producing 1800 units so long as price falls in the interval between $13.33 and $40. Thus, it takes less of a price change in the long run to induce a supply response from this firm.

POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

31. Suppose GE produces 1 million light bulbs per month While labor is variable both in the short run and the long run, capital is fixed in the short run. Labor is sold at a rate w and capital is rented at a rate r.

a. On a graph with labor on the horizontal axis, illustrate the current isocost and isoquant for GE. Carefully label the slope of the isocost.
b. For the rest of the problem, suppose a new tax on capital is implemented but GE intends to continue to produce 1 million light bulbs per year. What will GE do differently in the short run and the long run? Explain using your graph from part (a).
c. Using your answer to part (b), explain what happens to the short run cost curve in the short run. What happens to this short run curve in the long run? Do costs rise more or less in the long run than they do in the short run?
d. Do total costs rise more or less in the long run than total expenditures do in the short run? Explain.

ANSWER:   a.

b. Short run — no change; long run — less capital, more labor

c. In the short run, the firm continues to use the same input bundles (A) for any given level of output (because it cannot adjust capital and therefore operates on a short run slice of the production frontier.) This implies the short run costs — i.e. labor costs — do not change. In the long run, however, the firm will adjust its capital level (to input bundle B) — and hire more labor. Thus, with labor being the only short run cost, the short run cost curve shifts up in the long run (despite the wage not having changed).

d. The shallower isocost curve through A is higher than the isocost curve through B — implying the short run expense is greater than the long run cost.

POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:53 PM
DATE MODIFIED:   2/11/2015 10:53 PM

 

True / False

 

1. Unlike perfectly competitive firms, monopolists produce where marginal revenue intersects marginal cost.

a. True
b. False

 

ANSWER:   False
RATIONALE:   The second part of the statement is true, but the “unlike perfectly competitive firms” part is not. All firms produce where MR=MC — it’s just that for competitive firms, MR=p and thus they produce where p=MC.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

2. Since revenue increases with increases in price when demand is relatively inelastic, monopolists produce on the inelastic part of demand.

a. True
b. False

 

ANSWER:   False
RATIONALE:   The first part is true, the second part is not. It is precisely because revenue increases with an increase in price on the inelastic part of demand that monopolists will produce on the elastic part of demand.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

3. A monopolist will not produce at all if the intersection of marginal revenue and marginal cost occurs at a quantity at which average cost lies above the demand curve.

a. True
b. False

 

ANSWER:   True
RATIONALE:   In this case, there must be recurring fixed costs that are larger than the profit the firm can make in the absence of such recurring fixed costs — and producing would therefore result in negative profit.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

4. Suppose a monopolist produces a positive level of output. If marginal costs are zero, this output level will occur where price elasticity of demand is exactly -1 unless there are recurring fixed costs.

a. True
b. False

 

ANSWER:   False
RATIONALE:   If a monopolist produces, he produces where MC=MR regardless of recurring fixed costs. (If those recurring fixed costs are too high, he will not produce a positive quantity.) And MR=0 when price elasticity is -1. The statement is thus true except for the last part that starts with “unless”.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

5. Depending on the shape of the marginal cost curve, a monopolist might produce an output level on the elastic or the inelastic part of demand.

a. True
b. False

 

ANSWER:   False
RATIONALE:   A monopolist always produces on the price inelastic part of demand.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

6. In the presence of positive production externalities, a monopolist might produce the efficient output level.

a. True
b. False

 

ANSWER:   False
RATIONALE:   In the presence of positive externalities, the efficient quantity is larger than the quantity produced if only private MC is set to MR. The quantity where MC=MR is the monopolist quantity. Introducing a positive externality then moves the efficient quantity further out without changing the quantity the monopolist would produce — implying the monopolist will deviate even further from efficiency.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

7. First degree price discrimination is efficient and therefore preferred by everyone to no price discrimination on the part of a monopolist.

a. True
b. False

 

ANSWER:   False
RATIONALE:   It is indeed efficient, but consumers lose all surplus to the monopolist. So only the monopolist prefers it.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

8. When perfect price discrimination comes in the form of a two-part tariff, one part of the “tariff” just covers marginal costs.

a. True
b. False

 

ANSWER:   True
RATIONALE:   To implement perfect price discrimination with a two part tariff, the per-unit price would be set to MC — thus covering all marginal costs. (The other part is set to be equal to the consumer surplus that the consumer would get if he were simply charged p=MC.)
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

9. Consumers prefer inefficient third degree price discrimination to efficient first degree price discrimination.

a. True
b. False

 

ANSWER:   True
RATIONALE:   They get some consumer surplus under third degree price discrimination but no consumer surplus under first degree price discrimination. The latter is efficient while the former is not.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

10. Low demand consumers are indifferent between second degree and first degree price discrimination.

a. True
b. False

 

ANSWER:   True
RATIONALE:   In both cases, the monopolist takes all consumer surplus from low demanders.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

11. The more profit a monopolist makes, the more inefficient is the monopoly outcome.

a. True
b. False

 

ANSWER:   False
RATIONALE:   Monopoly profit is maximized under first degree price discrimination — yet that results in the efficient output level being produced.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

12. The more consumer surplus is generated in a market dominated by a single monopoly, the more efficient the outcome.

a. True
b. False

 

ANSWER:   False
RATIONALE:   First degree price discrimination leads to no consumer surplus but the output level is efficient.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

13. If a monopolist were allowed (and able) to first degree price discrimination, there would be no efficiency/equity tradeoff so long as the government can tax the profits of the firm and redistribute the tax revenues in a lump sum way.

a. True
b. False

 

ANSWER:   True
RATIONALE:   The efficient output level is produced under first degree price discrimination — and neither a profits tax nor a lump sum subsidy creates inefficiencies. Thus, one could achieve a more “equitable” outcome without any efficiency distortions.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

14. Under second degree price discrimination, the average price per unit paid by high demand consumers is not equal to marginal willingness to pay for one additional unit.

a. True
b. False

 

ANSWER:   True
RATIONALE:   Under second degree price discrimination, this average price includes a per-unit price equal to marginal cost plus some fixed fee equal to a portion of the consumer surplus for high type consumers. The quantity for high demand consumers arises where MC intersects demand — i.e. the marginal willingness to pay is MC.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

15. If the market demand curve has constant price elasticity of -1, the monopolist’s price should approach infinity.

a. True
b. False

 

ANSWER:   True
RATIONALE:   Constant price elasticity of -1 implies that price can always be raised without revenue changing. This implies that, whatever price the monopolist charges, he can always to better by increasing his price (so long as MC>0).
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

16. If a monopolist has no marginal costs and only recurring fixed costs, then, if he produces, any quantity that he produces is profit maximizing if the price elasticity of market demand is -1.

a. True
b. False

 

ANSWER:   True
RATIONALE:   If price elasticity of demand is -1, revenue is the same regardless of how much is produced. In the absence of marginal costs, this implies that profit maximization is the same as revenue maximization, Since any quantity is revenue maximizing, any quantity is profit maximizing — so long as revenue is greater than the recurring fixed cost.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

17. For any constant-elasticity market demand curve, a monopolist is profit maximizing regardless of what quantity he produces so long as marginal costs are zero.

a. True
b. False

 

ANSWER:   False
RATIONALE:   This is true only if the constant price elasticity is -1.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

18. Suppose a monopolist has zero marginal cost. If he faces a market demand curve with constant price elasticity of -2, the profit maximizing output level approaches infinity.

a. True
b. False

 

ANSWER:   True
RATIONALE:   If demand is always price elastic, then an increase in output always results in an increase in revenue. In the absence of costs, this implies that, whatever quantity is being produced right now, the monopolist can always do better by producing more.
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

19. In the absence of recurring fixed costs, a monopolist will always produce a positive output quantity.

a. True
b. False

 

ANSWER:   False
RATIONALE:   Only if MR crosses MC — which it will not if MC lies entirely above the market demand curve.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

20. A (non-price discriminating) monopolist with zero marginal cost but recurring fixed costs may end up not producing even if it would be efficient for him to produce.

a. True
b. False

 

ANSWER:   True
RATIONALE:   Efficiency implies that production should occur so long as the consumer surplus at price equal to zero exceeds the recurring fixed costs. But a non-price discriminating monopolist cannot capture all of consumer surplus — so it is possible that recurring fixed costs are higher than the monopoly profit in the absence of fixed costs and lower than consumer surplus at p=0. In that case, the monopolist will not produce but it would be efficient to produce.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

21. Suppose a monopolist has marginal cost of zero but recurring fixed costs. Then the monopolist will produce the efficient level of output so long as he can first degree price discriminate.

a. True
b. False

 

ANSWER:   True
RATIONALE:   It is efficient to produce so long as consumer surplus when price is set to zero is greater than recurring fixed costs. Since the monopolist can capture all consumer surplus under first degree price discrimination, the monopolist will therefore produce whenever it is efficient to produce.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

22. If a monopolist has downward sloping average costs, he will not produce if he cannot price discriminate.

a. True
b. False

 

ANSWER:   False
RATIONALE:   So long as average cost does not lie fully above demand, the monopolist will produce.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

23. If a monopolist faced a downward sloping average cost curve that lies fully above market demand, he will not produce if he can only charge a single per-unit price, but it would also be inefficient for him to produce.

a. True
b. False

 

ANSWER:   False
RATIONALE:   If AC does not lie too far above demand, it is still efficient for production to take place even though a monopolist who can only charge a single per-unit price will not produce. With constant marginal cost,, so long as the recurring fixed costs are not larger than consumer surplus at the output level at p=MC, it is efficient to produce.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

24. Suppose a monopolist has zero marginal cost but positive recurring fixed costs. Then, if it is efficient to produce, the efficient quantity to produce occurs where demand crosses the horizontal (quantity) axis.

a. True
b. False

 

ANSWER:   True
RATIONALE:   Efficiency always implies that MC=D unless the efficient quantity is zero.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

25. One way to deal with the efficiency problem of monopolies is to tax the profits of monopolists.

a. True
b. False

 

ANSWER:   False
RATIONALE:   Taxing monopoly profits does not change monopoly behavior — because whatever was profit maximizing at a zero profit tax will still be profit maximizing at a positive profit tax.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

26. Because of the monopoly power that comes with being the only firm to produce a product, it is always more efficient to have multiple firms in an industry.

a. True
b. False

 

ANSWER:   False
RATIONALE:   In the presence of high recurring fixed costs that result in downward sloping AC curves in the relevant range of output (relative to demand), it is in fact inefficient to have multiple firms producing because of the duplication of the recurring fixed costs.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

27. Consider a commonly owned fishery in a market with no other fisheries. Given the Tragedy of the Commons, it is more efficient to let a single firm take over the fishery even if that gives the firm monopoly power.

a. True
b. False

 

ANSWER:   False
RATIONALE:   It might be more efficient, but it might not be. The Tragedy of the Commons tells us that there will be over-fishing (relative to the efficient level), while the monopoly model tells us that there will be under-fishing (relative to the efficient level). Which of these produces a greater deadweight loss depends on the specifics of the situation.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

28. ​Monopoly power can last only if there are legal barriers to entry for other firms.

a. True
b. False

 

ANSWER:   False
RATIONALE:   ​Monopoly power can last only if there are legal barriers or technological barriers to entry for other firms
POINTS:   1
DIFFICULTY:   A section material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   10/14/2015 10:34 AM
DATE MODIFIED:   10/14/2015 10:44 AM

 

29. There are many policies that can discipline market power, but often the most powerful discipline comes from potential consumers. ​

a. True
b. False

 

ANSWER:   False
RATIONALE:   There are many policies that can discipline market power, but often the most powerful discipline comes from potential COMPETITORS. ​
POINTS:   1
DIFFICULTY:   A section material
QUESTION TYPE:   True / False
HAS VARIABLES:   False
DATE CREATED:   10/14/2015 10:34 AM
DATE MODIFIED:   10/14/2015 10:46 AM

 

Multiple Choice

 

30. Under which of the following monopoly pricing methods is the average price paid by a consumer equal to the marginal willingness to pay by that consumer:

a. First degree price discrimination
b. Second degree price discrimination
c. Third degree price discrimination
d. Both (a) and (b)
e. Both (b) and (c)
f. Both (a) and (c)
g. All of the above
h. None of the above

 

ANSWER:   c
RATIONALE:   Under first degree price discrimination, the MWTP is equal to MC but the average price is larger than MC (since all surplus is part of the overall payment made by consumers). Under second degree price discrimination, MWTP is equal to MC for high demand consumers but average price is higher since consumers are charged part of their consumer surplus as a fee. Under third degree price discrimination, there is a single per-unit price for each consumer type — which means the marginal and average prices are the same. Consumers buy where MWTP is equal to price — so MWTP is equal to average price.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

31. Suppose you observe that output in an industry occurs on the inelastic part of the market demand curve. Which of the following can you conclude from this?

a. The industry is definitely behaving as a monopoly that is protected by barriers to entry.
b. The industry is definitely not behaving as a monopoly that is protected by barriers to entry.
c. The industry could be perfectly competitive.
d. The industry is definitely not perfectly competitive.
e. Both (a) and (d)
f. Both (b) and (c)
g. Both (b) and (d)
h. None of the above

 

ANSWER:   f
RATIONALE:   Monopolists always produce on the elastic part of demand (because if they were to produce on the inelastic part of demand, they could raise revenue and reduce costs by increasing price and producing less). Thus, this industry is definitely not behaving like a monopolist (i.e. (b) is true and (a) is false). In competitive industries, supply could intersect demand on the inelastic portion of demand — thus (c) is true.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

32. Suppose market demand facing a monopolist is given by . Then the monopolist’s marginal revenue curve (in the absence of price discrimination) is

a. b.
c. d.
e. f. None of the above

 

ANSWER:   d
RATIONALE:   The demand curve is and the marginal revenue has the same intercept but twice the slope.
POINTS:   1
DIFFICULTY:   B-Section Material — but A-Section students could solve it
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

33. Suppose a monopolist faces a constant elasticity market demand curve with price elasticity equal to -2. What will be the price charged by this monopolist assuming constant marginal cost of 10.

a. 100 b. 80
c. 50 d. 30
e. 20 f. 10
g. infinity h. None of the above

 

ANSWER:   e
RATIONALE:   The monopoly markup of price above MC has to satisfy the equation Thus, which solves to p=20.
POINTS:   1
DIFFICULTY:   B-Section Material
QUESTION TYPE:   Multiple Choice
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

Subjective Short Answer

 

34. Explain why the deadweight loss from monopoly power may be exacerbated if the barrier to entry that creates monopoly power is created through exclusive government granting of a monopoly. For what types of government grants of monopoly power might this not be the case?

ANSWER:   The firm that gets the right to be a monopoly will earn positive economic profit. Thus, we would expect firms to expend effort to get that right — and if that effort is socially wasteful, the deadweight loss is larger than the usual depiction of deadweight loss that arises from restricting quantity to raise price. But if the effort is socially useful — such as the effort of investing in R&D to gain a patent for something that creates more consumer surplus, the deadweight loss might be less than what our usual picture shows.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

35. How would a regulator of a monopoly think differently about regulating price discrimination depending on whether the regulator’s objective is to maximize efficiency or to maximize consumer surplus?

ANSWER:   This  is most clearly demonstrated for the case of perfect (first degree) price discrimination where such price discrimination leads to full efficiency but no consumer surplus. A regulator would view perfect price discrimination favorably if his objective is to maximize efficiency and unfavorably if his objective is to maximize consumer surplus. It becomes less clear when we think about second and third degree price discrimination where the regulator’s views would depend on the particulars of an industry.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

36. Explain what the Saudi oil minister meant when he warned OPEC of using its market power too much by saying “Remember, the Stone Age did not end because we ran out of stones.”

ANSWER:   The oil minister warned that if OPEC uses its market power to raise oil prices too much, there is a stronger incentive for entrepreneurs to come up with alternatives to oil — and once a cost-effective alternative is developed, that competition may reduce or eliminate the monopoly power of OPEC.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

37. What are some obstacles to price discrimination that a monopolist who is protected by high barriers to entry might face?

ANSWER:   The monopolist will not be able to price discriminate if he cannot prevent re-sale of the output from consumers who are offered low prices to consumers who are offered high prices. He also cannot price discriminate if he cannot find a way to segment the market into different types of consumers. In first and third degree price discrimination, this implies that he needs to be able to tell whether a consumer has high or low demand, and under second degree price discrimination, he needs to know the distribution of demands across different consumer types in order to structure price/quantity packages that cause consumers to self-identify as high or low demand consumers.
POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM

 

38. Suppose a single firm has constant marginal cost and faced the demand curve

a. Illustrate in this graph how a monopolist who cannot price discriminate would price this good. What is the monopoly price and quantity?
b. Assuming no recurring fixed costs, how much profit does the monopolist make? How much consumer surplus is generated?
c. If the monopolist were able to first-degree price discriminate instead, how much would he produce? How much profit would he make? How much consumer surplus is generated?
d. Which outcome is more efficient and why?

ANSWER:   a. Price=80; Quantity = 60.

b. Profit = 60(60) = 3,600
Consumer Surplus = 60(60)/2 = 1,800

c. He would produce 120 and get profit 120(120)/2 = 7,200.
Consumer Surplus = 0

d. The latter is more efficient — total surplus is 7,200 rather than 5,400.

POINTS:   1
DIFFICULTY:   A-Section Material
QUESTION TYPE:   Subjective Short Answer
HAS VARIABLES:   False
DATE CREATED:   2/11/2015 10:54 PM
DATE MODIFIED:   2/11/2015 10:54 PM