Supply and Demand

Analytical Questions
1) For each of the following changes, show the effect on the demand
curve, and state what will happen to market equilibrium price and
quantity in the short run.
a. Consumers expect that the price of the good will be higher in the future.
b. The price of a substitute good rises.
c. Consumer incomes fall, and the good is normal.
d. Consumer incomes fall, and the good is inferior.
e. A medical report is published showing that this good is hazardous to your health.
f. The price of the good rises.

2) For
each of the following changes, show the effect on the supply
curve, and state what will happen to market equilibrium price
and quantity in the short run.
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 a. The government requires pollution control filters that raise good on costs.
b. Wages of workers in this industry fall.
c. There is an improvement in technology.
d. The price of the good fall.
e. Producers expect that the price of the good will fall in the future.
3) a. Supply decreases; equilibrium price rises and quantity falls.
4) Explanation:

5) Anything that raises cost of production will decrease supply. It means supply curve shifts leftward
leading to decrease in equilibrium quantity and increase in price level.
6) b. Supply increases; equilibrium price falls and quantity rises.
7) Explanation:

8) Anything that decreases cost of production (decrease in wages leads to fall in cost of production)
will increase supply. It means supply curve shifts rightward leading to increase in equilibrium
quantity and fall in price level.
9) c. Supply increases; equilibrium price falls and quantity rises.
10) Explanation:
11) Anything that decreases cost of production (technological improvement leads to fall in cost of
production) will increase supply. It means supply curve shifts rightward leading to increase in
equilibrium quantity and fall in price level.
12) d. A fall in the price of a good leads to a movement along the supply curve, and the quantity
supplied will decrease as price decreases. Because price and quantity supplied are directly related.
13) e. When Producers expect that the price of the good will fall in the future, Supply will increase
now and equilibrium price will fall and quantity will rise.

14) List the major non-price determinants of demand.

15) List the major non-price determinants of supply.
16) The market for milk is in equilibrium. Recent health reports
indicate that calcium is absorbed better in natural forms such as
milk, and at the same time, the cost of milking equipment rises.
Carefully analyze the probable effects on the market.
The heath reports are likely to cause an increase in the demand for milk. Alone, this would
increase both the equilibrium price and quantity of milk. The increase in equipment costs will
cause a decrease in the supply of milk, and this alone would cause an increase in equilibrium
price and a decrease in equilibrium quantity. Taken together, both effects will lead to an
increase in price, and thus we can be certain that the equilibrium price will rise. The effect on
quantity is unclear as the supply and demand shifts move quantity in different directions.

17) Suppose that macroeconomic forecasters predict that the economy will be expanding
in the near future. How might managers use this information?
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Economic expansion increases consumer incomes, which will increase the demand for normal goods and decrease the
demand for inferior goods. Thus a producer of normal goods might be anticipating a future increase in demand and thus
considering expansion, while a producer of inferior goods might be preparing for a decrease in demand and considering
contraction or a movement into a different good line
Demand Elasticity

Multiple-Choice Questions

1) 1. The price elasticity of demand is a measure of:

A) the responsiveness of the quantity demanded to price changes
B) the quantity demanded at a given price
C) The shift in the demand curve when price changes
D) The demand for a product holding price constant
2) The elasticity of demand for a product is likely to be greater
A) the smaller the number of substitute products available
B) the smaller the proportion of one’s income spent on the product
C) if the product is a luxury rather than an absolute necessity
D) if the product is an imported good rather than a domestically produced good
3) If O.P.E.C. increases its price of oil, and still the demand for oil decreases
by a very small amount, we can conclude that the demand for oil is:
A) Relatively elastic
B) Relatively inelastic
C) Perfectly elastic
D) Perfectly inelastic
4) If the consumption of sugar does not change at all following a price
increase from 50 cents per pound to 65 cents per pound, the
demand for sugar is considered to be
A) relatively inelastic. B) perfectly elastic.
C) perfectly inelastic. D) unitary elastic.
5) If the demand for a product is said to be relatively inelastic, the “absolute”
value of the elasticity coefficient will be:
A) Less than one
B) Greater than one

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 C) Equal to one
D) Zero
6) If an item has several good substitutes, the demand curve for that item is likely to be:
A) Relatively inelastic
B) Relatively elastic
C) Perfectly inelastic
D) Unit elastic
7) Remembering that demand elasticity is defined as the percentage
change in quantity divided by the percentage change in price, if
price decreases and, in percentage terms, quantity rises more
than price has dropped, total revenue will
A) increase. B) decrease.
C) remain the same. D) either increase or decrease.
8) Suppose the price of beans rises from $1.00 a pound to $2.00 a pound, quantity
demanded falls from 10 units to 6 units, the coefficient of elasticity of demand
for beans using the arc elasticity approach is:
A) -1.33 B) - 0.75 C) -0.4 D) - 0.25
9) In the above example, the demand for beans is said to be:
A) Relatively Elastic
B) Relatively Inelastic
C) Perfectly Elastic
D) Perfectly Inelastic
10) A perfectly elastic demand curve
A) can be represented by a line parallel to the vertical axis
B) is a 45 degree line
C) can be represented by a line parallel to the horizontal axis
D) cannot be represented on a two dimensional graph
11) The sensitivity of the change in quantity consumed of one good
to a change in the price of a related good is called
A) cross-elasticity. B) substitute elasticity.
C) complementary elasticity. D) price elasticity of demand.
12) The Cross-price-elasticity of demand for coffee and tea is likely to be:
A) Greater than zero
B) Less than zero
C) Zero
D) Infinity
13) The Cross-price-elasticity of demand for coffee and coffee-cream is likely to be
A) Greater than zero
B) Less than zero
C) Zero
D) Infinity
14) The Cross-price-elasticity of demand for coffee and caskets is likely to be:
A) Less than zero

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 B) Greater than zero
C) Zero
D) Infinity
15) When purchases of tennis socks decline following an increase in
the price of tennis sneakers (other things remaining equal), the
relationship between these two items can be described as
A) substitutable. B) complementary.
C) unique. D) ordinary.
16) The owner of a produce store found that when the price of a head
of lettuce was raised from 50 cents to $1, the quantity sold per
hour fell from 18 to 8. The arc elasticity of demand for lettuce is
A) -0.56. B) -1.15. C) -0.8. D) -1.57.
17) Suppose the price of crude oil drops from $150 a barrel to $120 a barrel.
The quantity bought remains unchanged at 100 barrels. The coefficient of
price elasticity of demand in this example would be:
A) 0.5
B) Infinity

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C) 1.0
D) 0
18) If a firm decreases the price of a good and total revenue decreases, then
A) the demand for this good is price elastic.
B) the demand for this good is price inelastic.
C) the cross elasticity is negative.
D) the income elasticity is less than 1.
19) When total revenue reaches its peak (elasticity equals 1), marginal revenue reaches
A) 1.
B) zero.
C) -1.
D) Cannot be determined from the information provided.
20) If the income elasticity of a particular good is negative 0.2, it would be considered
A) a superior good. B) a normal good.
C) an inferior good. D) an elastic good.

Table 1
The following information is provided for Tony Romo’s
income and expenditures.

Quantity Purchased Per Month

Monthly Steak Pizza
Income s s
$2,000 2 8
$3,000 4 6

21). In TABLE 1, Tony’s income elasticity of

demand for steaks is: A) 1.0
B) Greater than 1.0
C) Less than 1.0
D) Zero
22). In TABLE 1, pizzas are classified as a (n):
A) Normal good B) Positive good C) Inferior goods D) Marginal
good
23) In TABLE 1, Steaks are classified as a(n):
A) Normal good B) Positive good C) Inferior
good D) Marginal good 24). In TABLE 1, Tony’s income
elasticity of demand for pizzas is:
A) 0
B) Less than zero
C) Greater than 1.0
D) 1.0
25) The government unit that wants to achieve "revenue
enhancement" will find it considerably more favorable to enact
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 an excise tax on goods whose demand is
A) highly elastic. B) relatively elastic.
C) highly inelastic. D) unitary elastic.
26) Which of the following instances will total revenue or receipts decline?
A) Price rises and demand is inelastic
B) Price falls and demand
is elastic C) Price rises
and demand is elastic
D) Price falls and demand is unit elastic
27) If the price of a good is increased and total revenue received
from the sale of this good increases, then the price elasticity
of demand for the good is
A) elasti
B)inelati
c.
C) unitary.
D) None of the above.
28) If the price of a good is decreased and total revenue received
from the sale of this good does not change, then the price
elasticity of demand for the good is

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 A) elastic. B) inelastic. C) unitary. D) None of the above.
29) If the demand for a good is price inelastic and the good
price is increased, then the marginal revenue (MR)
received by the seller will
A) not change.
B) decrease.
C) increase.
D) Can't be determined from this information.
Analytical Questions
1) Suppose that the price elasticity of demand for wheat is known to be -0.75. Will a good
wheat crop (which increases the supply of wheat) be likely to increase or decrease the
revenues of farmers? Carefully explain.
2) The demand for salt is relatively price inelastic, while the
demand for pretzels is relatively price elastic. How can you best
explain why?
3) Unions have generally bee far more successful in organizing and raising wages
in skilled trades such as carpentry than in unskilled trades. Use the laws of derived
demand to explain why.
4) Governments impose excise taxes on goods that have inelastic
demand, such as cigarettes, more often than in other cases. Why?
5) You are told that the price elasticity of demand for widgets is -
0.75, the income elasticity of widgets is 2, and the cross-price
elasticity of widgets and gadgets is 4. Carefully explain what
information you can gather from each of these figures.
6) The income elasticity for most staple foods, such as wheat, is
known to be between zero and one.
a. As incomes rise over time, what will happen to the demand for wheat?
b. What will happen to the quantity of wheat purchased by consumers?
c. What will happen to the percentage of their budgets that consumers spend on wheat?
d. All other things equal, are farmers likely to be relatively better
off or relatively worse off in periods of rising incomes?

3) Suppose that the price elasticity of demand for wheat is known to be -0.75. Will a
good wheat crop (which increases the supply of wheat) be likely to increase or decrease
the revenues of farmers? Carefully explain. (Ch. 4)
A good wheat crop that increases the supply of wheat will cause the equilibrium price
of wheat to decrease (and quantity to increase). Since demand is inelastic, total
revenues will fall, as the percentage change in quantity will be less than the percentage
change in price.

4) The demand for salt is relatively price inelastic, while the demand for pretzels is
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 relatively price elastic. How can you best explain why? (Ch. 4)
Salt has few substitutes, and takes up a small percentage of the consumer's budget, and
thus demand is likely to be inelastic. While pretzels are also a small part of the budget,
there are many substitutes available.

5) Unions have generally been far more successful in organizing and raising wages in
skilled trades such as carpentry than in unskilled trades. Use the laws of derived
demand to explain why. (Ch. 4)
There are at least two reasons. One is that the elasticity of substitution between skilled
workers and other factors of production is low; thus firms cannot substitute some other
factor of production if wages rise. Secondly, skilled labor is likely to be a relatively
small percentage of total costs, and thus raising wages does not cause a large increase
in total costs (which would lead to a reduction in supply, an increase in price, and a
decrease in output). Unskilled labor has more substitutes and is likely to be a larger
share of costs for firms that employ it, and thus if unions raise wages, firms employ
other factors of production, and many workers will be laid off.

6) Governments impose excise taxes on goods that have inelastic demand, such as
cigarettes, more often than in other cases. Why? (Ch. 4)
Imposing an excise tax reduces the supply of the good, reducing equilibrium quantity
and raising the price. If demand is elastic, taxes will tend to reduce quantity by a
significant amount, and thus government tax revenues will be relatively small.
However, if demand is inelastic, the reduction in quantity will be small, and
government tax revenues will be higher. (Governments may also impose taxes to deter
consumption, but this is likely to be ineffective if elasticity is low.)

9) You are told that the price elasticity of demand for widgets is -0.75, the income
elasticity of widgets is 2, and the cross-price elasticity of widgets and gadgets is 4.
Carefully explain what information you can gather from each of these figures. (Ch. 4)
Demand for this good is inelastic with respect to price. This is a normal good as income
elasticity is greater than zero, and it is a luxury/superior good as income elasticity is greater
than one. Widgets and gadgets are substitutes, and they are good substitutes because cross-
price elasticity is elastic (large)

The income elasticity for most staple foods, such as wheat, is

known to be between zero and one.
e. As incomes rise over time, what will happen to the demand for wheat?
f. What will happen to the quantity of wheat purchased by consumers?
g. What will happen to the percentage of their budgets that consumers spend on wheat?
All other things equal, are farmers likely to be relatively better
9
a: Increase

 If the income elasticity of demand is positive, the demand for wheat will increase will income.

b: Increase

 When the demand for wheat increases, the quantity of wheat purchased rises.

c: Decrease

 Since the income elasticity of demand is between 0 and 1, the percentage increase of the amount
spent on wheat will be less than the percentage increase in income. This means the percentage of
budgets devoted to wheat will fall.

d: Worse off

 Farmers will be worse off since the demand for the products they produce is growing slower than the
demand for products overall. Farmers buy other products which would mean their real income might
fall

The Theory of Production

Multiple-Choice Questions

1) The term Production Function refers to the:

A) Use of machinery and equipment in production
B) Relationship between costs and output
C) Relationship between inputs and output
D) Role of labor unions
2) The production period in which at least one input is fixed in quantity is the:
A) Production run
B) Long run
C) Short run
D) Planning horizon
3) The difference between the short-run and the long-run is:

A) three months or one business quarter.

B) the time it takes for firms to change all production on inputs.
C) the time it takes for firms to change only their variable inputs.
D) More information is required to answer this question.
4) In a call center, which of the following situations be
considered as a variable input in the short- run?

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 A) the level of computer-telephony software being utilized
B) the number of call center representatives on duty at the center
C) the number of call center managers or supervisors
D) the size (e.g., square footage) of the call center
5) Which of the following holds true?

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 A) When the Marginal Product (MP) is rising, Marginal cost (MC) is rising;
and when MP is falling, MC is falling.
B) When MP is rising, MC is falling, and when MP is falling, MC is rising.
C) When MP is rising, MC is constant, and when MP is falling, MC is negative
D) There is no relationship between
MP and MC. 6). The marginal product
of the variable input:
A) is always positive
B) typically falls then rises
C) is equal to the total product divided by the total amount of the variable input
employed
D) none of the above
7) Which of the following statements about the short-run production function is true?

A) MP always equals AP at the maximum point of MP.

B) MP always equals zero when TP is at its maximum point.
C) TP starts to decline at the point of diminishing returns.
D) When MP diminishes, AP is at its minimum point.
E) None of the above is true.
Answer the questions based on the following information.

Number of Units of
Workers Ouput
0 0
1 40
2 90
3 126
4 150

8) The marginal product of the fourth worker is:

A) 150 units of output
B) 24 units of output
C) Negative
D) 36 units of output
9) Average product is at a maximum when the number of workers that are hired is:
A) 1
B) 2
C) 3
D) 4
10) Output (Total Product) is maximized when

A) average productivity is at its maximum.

B) the "law of diminishing returns" sets in.

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 C) marginal productivity is zero.
D) marginal productivity is at its maximum.
11) If a firm finds itself operating in Stage I, it implies that

A) variable inputs are extremely expensive.

B) it overinvested in fixed capacity.
C) it underinvested in fixed capacity.
D) fixed inputs are extremely expensive.
12) A firm that operates in Stage III of the short-run production function

A) has too much fixed capacity relative to its variable inputs.

B) has too little fixed capacity relative to its variable inputs.
C) has greatly overestimated the demand for its output.
D) should try to increase the amount of variable input used.

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13) Which of the following indicate when Stage I ends and Stage
II begins in the short‐run production?

A) when AP = 0 B) when MP = 0
C) when MP = AP D) when MP starts to diminish
14) Which of the following indicates when Stage II ends and Stage
III begins in the short-run production function?

A) when AP = 0 B) when MP = 0
C) when MP = AP D) when MP starts to diminish
15) Stage III of the short-run Production Function is

A) the most efficient mix of inputs.

B) the least costly level of output.
C) where additional units of inputs will lead to less output.
D) where additional units of inputs will lead to more output.
16) A firm using two inputs, X and Y, is using them in the most efficient manner when

A) MPx = MPy. B) Px = Py and MPx = MPy.

C) MPx/Py = MPy/Px. D) MPx/MPy = Px/Py.
17) The "Law of Diminishing Returns" states that

A) additional inputs will reduce output.

B) additional inputs will decrease average productivity.
C) the supply of inputs is becoming scarce.
D) additional inputs will lead to less additional output.
18) Which of the following is not true about the law of diminishing returns?

A) It is a short-run phenomenon.
B) It refers to diminishing marginal product
C) It will have an impact on the firm's marginal cost.
D) It divides Stage I and II of the production process.
• All of the above are true.
19) When the law of diminishing returns takes effect

A) firms must add increasingly more input if they are to

maintain the same extra amount of output.
B) firms must add decreasingly more input if they are to maintain
the same extra amount of output.
C) more input must be added in order to increase its output.
D) a firm must always try to add the same amount of input to the production process.
20) Assume a firm employs 10 workers and pays each $15 per hour.
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 Further assume that the MP of the 10th worker is 5 units of output
and that the price of the output is $4. According to economic
theory, in the short run,

A) the firm should hire additional workers.

B) the firm should reduce the number of workers employed.
C) the firm should continue to employ 10 workers.
D) More information is required to answer this question.
21) Decreasing returns to scale

A) indicates that an increase in all inputs by some proportion

will result in a decrease in output.
B ) must always occur at some point in the production process.
C) is directly related to the law of diminishing returns.
D) All of the above are true.

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 E) None of the above is true.
22) In the long run, a firm is said to be experiencing decreasing
returns to scale if a 10 percent increase in inputs results in

A) an increase in output from 100 to 110. B) a decrease in output from 100 to 90.
C) an increase in output from 100 to 105. D) a decrease in output from 100 to 85.
23) Increasing Returns to Scale results when

A) in the long-run, an increase in inputs will lead to an increase

in the average products of inputs.
B) in the long run, an increase in inputs will lead to an equivalent increase in output.
C) labor becomes more skilled.
D) All of the above.
24) In the short run, finding the optimal amount of variable input involves which
relationship?

A) MP = MC B) AP = MP C) MP = 0 D) MRP = MFC
25) The perfect substitution of two inputs implies that

A) two inputs can be substituted at a ratio of 1 to 1.

B) one input can be substituted for another up to some point.
C) two inputs can be substituted at some constant ratio.
D) one input can be substituted for another.
26) If MRP > MLC, it means that a firm should

A) use less labor. B) use more labor.

C) increase its fixed capacity. D) decrease its fixed capacity.
27) In economic theory, if an additional worker adds less to the
total output than previous workers hired, it is because

A) there may be less that this person can do, given the fixed capacity of the firm.
B) he/she is less skilled than the previously hired workers.
C) everyone is getting in each other's way.
D) the firm is experiencing diminishing returns to scale.
28) When is it not in the best interest of a company to hire additional workers in the short
run?

A) when the average good of labor is decreasing

B) when the firm is in Stage II of the production process
C) when the marginal revenue good equals zero
D) when the wage rate is equal to or greater than labor's marginal revenue good
29) An isoquant indicates
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 A) different combinations of two inputs that can be purchased
for the same amount of money.
B) different combinations of two inputs that can produce the same amount of output.
C) different combinations of output that can be produced with the same amount of
input.
D) different combinations of output that cost the same amount to produce.
30) Marginal rates of technical substitution (MRTS) represent

A) the optimum combinations of inputs.

B) cost minimizing combinations of inputs.
C) the degree to which one input can replace another without output changing.
D) All of the above.

31) Which of the following is the best example of two inputs that
would exhibit a constant marginal rate of technical
substitution?

A) trucks and truck drivers

17
 B) natural gas and oil
C) personal computers and clerical workers
D) company employed computer programmers and temporary
supplemental computer programmers
32) Which of the following combination of inputs is most closely
reflective of decreasing marginal rate of technical
substitution (MRTS)?

A) oil and natural gas B) sugar and high fructose corn syrup
C) computers and clerks D) keyboards and computers
33) Isocost curves represent

A) least
cost combinations of inputs.
B) combinations of inputs that can be purchased given their prices and the funds
available.
C) a producer’s cost function.
D) None of the above.
Analytical Questions

Number Of Workers Output

0 0
1 50
2 110
3 300
4 450
5 590
6 665
7 700
8 725
9 710
10 705

1) The table above shows the weekly relationship between output

and number of workers for a factory with a fixed size of plant.
a. Calculate the marginal product of labor.
b. At what point does diminishing returns set in?
c. Calculate the average product of labor.
d. Find the three stages of production.

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e. In the first stage of production, production increases every time something is added in the form of an
input. Increasing marginal returns are a sign of this stage. In stage two, diminishing marginal returns
occur. When an input is added, the production increases still, but at a decreasing rate. This follows the
law of diminishing returns. The total production slowly decreases with other inputs held constant. In the
third and last stage, marginal returns become negative. When labor is added by one unit, it leads to
lower production. For example, hiring an extra employee results in a decrease in the total output.

The Theory of Cost

Multiple-Choice
Questions

1). To an Economist, total costs include:

A) Explicit, but not implicit costs
B) Implicit, but not explicit costs
C) Explicit and implicit costs
D) Neither explicit nor implicit costs
2) Economists consider which of the following costs to be
irrelevant to a short-run business decision?

A) opportunity cost B) out-of-pocket cost

C) historical cost D) replacement cost
3) Changes in the Short Run total costs result from changes in only:
A) Variable costs
B) Fixed costs
C) Zero

19
 D) Total fixed costs
4) Which of the following cost relationships is not true?

A) AFC = AC - MC
B) TVC = TC - TFC
C) The change in TVC/the change in Q = MC.
D) The change in TC/ the change in Q = MC.
5) When a firm increased its output by unit, its AFC decreased. This is an indication that

A) the law of diminishing returns has taken effect.

B) MC < AFC.
C) AVC < AFC.
D) the firm is spreading out its total fixed cost.
6) The distinction between sunk and incremental costs is most
helpful in answering which question?

A) How many more people should be added to the production process?

B) What is the correct price to charge?
C) Should we begin to build a new factory?
D) Should we continue developing a new software application that we began last
year?
7) Which of the following relationships is correct?

A) When marginal product starts to decrease, marginal cost starts to decrease.

B) When marginal cost starts to increase, average cost starts to increase.
C) When marginal cost starts to increase, average variable cost starts to increase.
D) When marginal product starts to decrease, marginal cost starts to increase.
8) The relationship between MC and AC can best be described as follows:

A) when AC increases, MC starts to increase.

B) when MC increases, AC starts to increase.
C) when MC decreases, AC decreases.
D) when MC exceeds AC, AC starts to increase.
9) The law of diminishing returns begins first to affect a firm's short-run cost structure when

A) average variable cost begins to increase.

B) marginal cost begins to increase.
C) average cost begins to increase.
D) average fixed cost begins to decrease.
10) The marginal cost will intersect the average variable cost curve

A) when the average variable cost curve is rising.

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 B) where average variable cost curve equals price.
C) at the minimum point of the average variable cost curve.
D) the two will never intersect.
11) Which of the following statements best represents a
difference between short-run and long-run cost?

A) Less than one year is considered the short run; more than one year the long run.
B) There are no fixed costs in the long run.
C) In the short-run labor must always be considered the variable
input and capital the fixed input.
D) All of the above are true.
12) When a firm increased its output by one unit, its AC decreased. This implies that

A) MC < AC.
B) MC = AC.

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 C) MC < AFC.
D) the law of diminishing returns has not yet taken effect.
13) Which of the following relationships implies that a firm's short-run cost function is
linear?

A) MC = AC B) MC = AVC
C) AC = AFC + AVC D) MC > AC
14) As a firm attempts to increase its production, its long-run
average costs eventually rise because of
A) the law of diminishing returns.
B) diseconomies of scale.
C) fixed capital.
D) insufficient demand.
15) Economies of Scale are created by greater efficiency of capital and by:
A) longer chains of command in management
B) better wages for labor
C) smaller plant sizes
D) increased
specialization of labor
16) Economies of scale is
indicated by

A) declininglong-run AVC. B) declining long-run AFC.

C) declining long-run AC. D) declining long-run TC.
17) Which of the following is a reason for economies of scale?

A) Fixed costs are spread out as volume increases.

B) The law of diminishing returns does not take effect.
C) Input productivity increases as a result of greater specialization.
D) There is greater savings in transportation costs.
18) Diseconomies of scale can be caused by

A) thelaw of diminishing returns.

B) bureaucratic inefficiencies.
C) increasing advertising and promotional costs.
D) All of the above.
Analytical Questions

1) You have opened your own word-processing service. You bought a personal computer,
and paid $5,000 for it. However, due to the cost changes in the computer industry, the
current price of an equivalent machine is $2,500. You could sell any used machine for
$1,000. If you were not word processing, you could earn $20,000 per year at an alternative
job. Assume that the interest rate is 10%. You can also hire an assistant who can do
22
 everything that you can do for $20,000 per year (you would continue to do word
processing).
One person using one computer can produce 11,000 typed pages per year,
and the price per page for your service is $2.
You are considering three options: (1) expand your business by hiring an
assistant. (2) leave your business the way it is (3) shut down. Based on the costs and
revenues above, which should you do? Explain and show any relevant calculations.
Answer:

Option 1:
You still earn $1,900 as above.
Revenue from additional worker = 22,000
Wages = 20,000
Opportunity cost of interest on purchase of new computer = 250
Depreciation = 1,500= 2500-1000
Economic profit from additional worker = $250=2000-1500-250
Total economic profit = $2,150

Option 2:
Revenue = $22,000
Opportunity cost of your time = 20,000
Opportunity cost of interest on salvage value of existing computer = 100
Economic profit = $1,900

Option 3:
Revenue = 0
No costs, since opportunity costs no longer apply, and fixed costs are sunk.
Economic profit = 0
(Could possibly view the $1,000 you get from selling the used computer as revenue, but makes
no difference to final solution of problem.)
Option 1, expand your business, is the best option.

2) Consider a firm that has just built a plant, which cost $20,000.
Each worker costs $5.00 per hour. Based on this information, fill
in the table below.

Numbe Avera Aver

r of ge age
Worker Outp Margi Fix Varia Tot Margi Varia Total
Hours ut nal ed ble al nal ble Cost
Produ Co Cost Co Cost Cost
ct st st
0 0 -- 20,000 -- -- --
50 400 20,250
23
100 900 20,500

24
 150 1300 20,750

200 1600 21,000

250 1800 21,250

300 1900 21,500

350 1950 21,750

3) How would each of the following affect the firm's marginal, average, and average variable
cost curves?
a. An increase in wages
b. A decrease in material costs
c. The government imposes a fixed amount of tax.
d. The rent that the firm pays on the building that it leases decreases.

4) Carefully explain if the following statements are true, false, or uncertain.

a. If average cost is increasing, marginal cost must be increasing.
b. If there are diminishing returns, the marginal cost curve must be positively sloped.
The law of diminishing returns is reflected in the downward-sloping portion of the short-
run marginal cost curve.
c. Marginal costs decrease as output increases because the firm can spread fixed costs over
more units. true

Pricing and Output Decisions: Perfect Competition

Multiple-Choice Questions

1) Which of the following markets comes closes to the model of perfect competition?
A) Automobile industry B) Information Technology industry
C) Aerospace industry D) Agriculture
2) A feature of Perfect Competition is

25
 A) use of non-price competition by firms. B) mutual interdependence among firms.
C) unique products. D) standardized products.
3) Which is a required characteristic of a perfectly competitive industry?
A) There are few firms so that none can influence market price.
B) Products are highly differentiated.
C) Barriers to entry are high
D) None of the above
4) Which of the following characteristics is most important in
differentiating between perfect competition and all other types
of markets?

A) whether or not the product is standardized

B) whether or not there is complete market information about price
C) whether or not firms are price takers
D) All of the above are equally important.
5) Demand facing an individual, perfectly competitive firm is:
A) perfectly inelastic at the quantity the firm chooses to produce.
B) perfectly inelastic at the quantity determined by market forces.
C) perfectly elastic at the price the firm chooses to charge.
D) perfectly elastic at the price determined by market forces.
6) In perfect competition:
A) The firm’s demand curve is relatively inelastic
B) The firm’s demand curve is relatively inelastic
C) The firm’s demand curve is perfectly elastic
D) The firm’s demand curve is perfectly inelastic
7) For a demand curve that is horizontal, the marginal revenue curve:
A) will be to the right of the demand curve and half as steep.
B) will be to the left of the demand curve and half as steep.
C) will be to the right of the demand curve and twice as steep.
D) will be the same as the demand curve
8) According to the shutdown rule, a firm should produce no output in the short run if:
A) price is below minimum average total cost.

26
 B) priceis above minimum average total cost.
C) total revenues are lower than total fixed costs.
D) price is below minimum average variable costs.
9) Which of the following conditions would definitely cause a
perfectly competitive company to shut down in the short run?

A) P
< MC B) P = MC < AC C) P < AVC D) P = MR
10) A normal profit is:
A) revenues minus opportunity cost only.
B) revenues minus accounting costs only.
C) a zero accounting profit.
D) revenues minus accounting and opportunity costs.
11) In economic analysis, any amount of profit earned above zero is
considered "above normal" because:

A) normally firms are supposed to earn zero profit.

B) this would indicate that the firm's revenue exceeded both its
accounting and opportunity cost.
C) this would indicate that the firm was at least earning a profit equal to its opportunity
cost.
D) this would indicate that the firm's revenue exceeded its accounting cost.
12) If a perfectly competitive firm incurs an economic loss, it should:

A) shut down immediately.

B) try to raise its price.
C) shut down in the long run.
D) shut down if this loss exceeds variable cost.
13) A perfectly competitive firm sells 15 units of output at the
going market price of $10. Suppose its average fixed cost is
$15 and its average variable cost is $8. Its contribution margin
(i.e. contribution to fixed cost) is

A) $30.
B) $150.
C) $105.
D) Cannot be determined from the above information.
14) Mars Inc. produces 100,000 boxes of Snickers bars which sell
for $4 a box. If variable costs are $3 per box, and it has
$150,000 fixed operating costs, in the short run, it should:
A) shut down as fixed costs are not being covered.
B) keep producing as profits are $50,000.

27
 C) keep producing as variable costs are being met.
D) keep producing as total costs are being recovered
16) In perfect competition, if firms enter the market in the long run.
A) total supply will increase causing market price to increase.
B) total supply will decrease causing market price to decrease.
C) total supply will decrease causing market price to increase.
D) total supply will increase causing market price to decrease.
17) In long-run equilibrium a perfectly competitive firm will operate where the price is:
A) greater than MR but equal to MC and minimum ATC.
B) greater than MR and MC, but equal to minimum ATC.
C) greater than MC and minimum ATC, but equal to MR.
D) equal to MR, MC and minimum to ATC.
18). The principle marginal revenue equal-marginal-cost rule for maximizing profit:
A) Does not apply to firms in the monopoly or oligopolistic industries
B) Applies only for firm in perfect competition but not in monopolistic competition
C) Applies to new firms but not to existing firms in an industry
D) Applies to all the firms in all industries
19) Assume a profit maximizing firm's short-run cost is TC = 700 + 60Q. If its demand curve
is

28
 P = 300 - 15Q, what should it do in the short run?

A) shut down
B) continue operating in the short run even though it is losing money
C) continue operating because it is earning an economic profit
D) Cannot be determined from the above information.
20) Assume a perfectly competitive firm's short-run cost is TC =
100 + 160Q + 3Q2. If the market price is $196, what should it
do?

A) produce 5 units and continue operating

B) produce 6 units and continue operating
C) produce zero units (i.e., shut down)
D) Cannot be determined from the above information.
21. Which of the following is false? A monopolist
A) will sell less at a higher price
B) has a marginal revenue that is less than the price.
C) will produce where MR = MC.
D) is a price taker
22). A monopolist sells 100 units at $10 per unit and 90 units at
$15 per unit. The marginal revenue from the tenth unit is:
A) $1000B) $1350 C) $100 D) $350
23). For a demand curve that is downward sloping, the marginal revenue curve:
A) Will be to the left of the demand curve and half as steep.
B) Will be to the right of the demand curve and twice as steep.
C) Will be to the left of the demand curve and half as steep.
D) The same as the demand curve.
24). If an industry could be organized either perfectly competitively or
as monopoly, a monopoly would
A) Produce less output
B) Produce where P > MC
C) Charge higher prices.
D) All of the above
25) Which of the following correctly completes this statement?
The monopolist’s marginal revenue
A) will be greater than price
B) will be less than price
C) will be equal to price.
D) will be greater than total revenues
26) At the point at which P=MC, suppose that a perfectly
competitive firm's MC = $100, its AVC = $80 and its AC =
$110. This firm should

29
 A) shut down immediately.
B) continue operating in the short run.
C) try to take advantage of economies of scale.
D) try to increase its advertising and promotion.
27) When a firm produces at the point where MR = MC, the profit
that it is earning is considered to be

A) maximum. B) normal.
C) above normal. D) Not enough information is provided.
28) When a firm has the power to establish its price,

A) P= MR. B) P = MC. C) P > MR. D) P < MR.

29) When MR = MC,

A) marginal profit is maximized. B) total profit is maximized.

30
 C) marginal profit is positive. D) total profit is zero.
30) In the short run, which of the following would indicate that a
perfectly competitive firm is producing an output for which it is
receiving a normal profit?

A) P > AC B) AVC < P < AC C) P = AC D) P = AVC

31) A firm that seeks to maximize its revenue is most likely to adhere to which of the
following?

A) MR = MC B) MR =0 C) MR =P D) MR < MC
31) Which of the following is true for a monopoly?

A) P= MC B) P = MR C) P > MR D) P < MR
32) Which of the following is true about a monopoly?

A) Its demand curve is generally less elastic than in more competitive markets.
B) It will always earn economic profit.
C) It will always produce the same as a perfectly competitive firm.
D) It will always be subject to government regulation.
E) None of the above is true.
33) A monopoly will usually produce

A) where its demand curve is inelastic.

B) where its demand curve is elastic.
C) where its demand curve is either elastic or inelastic.
D) only when its demand curve is perfectly inelastic.
34) The main difference between the price-quantity graph of a
perfectly competitive firm and a monopoly is

A) that the competitive firm's demand curve is horizontal,

while that of the monopoly is downward sloping.
B) that a monopoly always earns an economic profit while a
competitive company always earns only normal profit.
C) that a monopoly maximizes its profit when marginal revenue is greater than marginal
cost.
D) that a monopoly does not incur increasing marginal cost.
35) When the slope of the total revenue curve is equal to the slope of the total cost curve

A) monopoly profit is maximized.

B) marginal revenue equals marginal cost.
C) the marginal cost curve intersects the total average cost curve.
D) the total cost curve is at its minimum.
E) Both A and B
31
36) Monopoly is characterized by

A) unique products.
B) market entry and exit difficult or impossible.
C) non-price competition not necessary.
D) All of the above.
37) The fact that a perfectly competitive firm has a perfectly elastic demand curve means
A) there is no limit to the firm's profits. B) there is no limit to the firm's revenues.
C) that it can sell all it wants at any price.D) None of the above
38) In the short run a firm should shut down if it cannot

A) make normal profits. B) make economic profits.

C) cover its variable costs. D) cover its fixed costs.
39) Firms are 'price makers" if they

A) have sufficient market power to set their product price.

32
 B) make the market price their product price.
C) make their product price competitive.
D) None of the above.
40) If a monopoly wants to maximize it profit, it should

A) produce
in the range where its average costs are declining.
B) produce in the range where its demand curve is elastic.
C) produce in the range where its marginal costs are declining.
D) produce in the range where its marginal costs are less than its average costs.
Analytical Questions

1) Why would a firm choose to remain in an industry in which it makes an economic profit of
zero?
Profit equals total revenue minus total cost.
•Total cost includes all the opportunity costs of the firm.
•In the zero-profit equilibrium, the firm’s revenue compensates the owners for the time
and money they expend to keep the business going
2) Suppose that a perfectly competitive industry is in long-run equilibrium, and
demand increases. Explain the short- and long-run effects on the firm and the
industry.
. When market demand increases, the market price of the good rises, and the
market quantity increases. Because price equals marginal revenue, the rise in the
price means marginal revenue rises. As a result, each firm moves up its marginal
cost curve and increases the quantity it produces. The firm’s profit rises (or its
economic loss decreases). If the firm had been making zero economic profit before
the increase in demand, after the increase the firm earns an economic profit.

In a perfectly competitive market in long-run equilibrium, an increase in demand

creates economic profit in the short run and induces entry in the long run; a
reduction in demand creates economic losses (negative economic profits) in the
short run and forces some firms to exit the industry in the long run.

3) Describe the process by which the competitive market establishes a price at

which all firms are just earning normal profits.
Normal profit is a situation where a firm makes sufficient revenue to cover its total
costs and remain competitive in an industry.
In measuring normal profit, we include the opportunity cost of working elsewhere.
When a firm makes normal profit, we say the economic profit is zero.

33
4) What are the limitations in using Break-Even analysis?
 Doesn’t predict demand – Although a break-even analysis can tell you when
you’ll break even, it doesn’t give you any insight into how likely that is to happen.
Plus, demand isn’t stable, so even if you think there’s a gap in the market, your
break-even point could end up being a lot more ambitious than you initially
thought.
 Depends on reliable data – In short, the accuracy of your break-even analysis is
dependent on the accuracy of your data. If your calculations are wrong or you’re
dealing with fluctuating costs, break-even analysis may not be the most useful
tool in your arsenal.
 Too simple – Break-even analysis is best for companies with one price-point. If
you have multiple products with multiple prices, then break-even analysis may be
too simple for your needs. In addition, it’s worth remembering that costs can
change, so your break-even point may need to be evaluated and adjusted at a later
time.
 Ignores competition – Another limitation of a break-even analysis concerns the
fact that competitors aren’t factored into the equation. New entrants to the market
34
 could affect demand for your products or cause you to change your prices, which
is likely to affect your break-even point.

Pricing and Output Decisions:

Monopolistic Competition and Oligopoly

Multiple-Choice Questions

1) Which of the following industries is most likely to represent the

Monopolistic competition market structure?

A) automobiles B) tobacco products

C) utility companies D) farm equipment
2) The main difference between perfect competition and monopolistic competition is:

A) the number of sellers in the market.

B) the ease of exit from the market.
C) the difference in the firm’s profits in the long run.
D) the degree of product differentiation.
3) If firms are earning economic profit in a monopolistically competitive
market, which of the following is most likely to happen in the long run?

A) Some firms will leave the market.

B) Firms will join together to keep others from entering.
C) New firms will enter the market, thereby eliminating the economic profit.
D) Firms will continue to earn economic profit.
4) Firms in monopolistic competition would:

A) persistently realize economic profits in both the short and long run
B) may realize economic profits in the long run and normal profits in the short run
C) tend to incur persistent losses in both the short and long run
D) tend to realize economic profits in the short run and normal profits in the long run

5) In
the long run, the most helpful action that a monopolistically
competitive firm can take to maintain its economic profit is to:

A) continue its efforts to differentiate its product.

B) raise its price.
C) lower its price.
D) do nothing, because it will inevitably experience a decline in profits.
35
6) Which of the following represents a good example of an Oligopoly?
A) The Agriculture industry B) A Public Utility
C) The Automobile industry D) The Restaurant Industry
7) In general, there is a(n) relationship between the
height/strength of the barriers and the number of firms in an
industry.
A) direct B) inverse C) constant D) random
8) Mutual interdependence occurs when:
A) All firms in an industry are affected by the same macro
economic conditions, such as a recession, inflation, interest
rates, exchange rates, etc.
B) The actions of firms are independent of each other
C) The actions of one firm in an industry are easily recognized and perhaps copied by
others
D) Monopolists recognize that they must face eventual competition in the long run
9) Mutual interdependence means that:

A) all firms are price takers.

B) each firm sets its own price based on its anticipated reaction by its competitors.
C) all firms collaborate to establish one price.
D) all firms are free to enter or leave the market.
10) The Herfindahl-Hirschman (HH) Index is used to

A) measure the degree of nonprice competition.

B) measure the degree of market concentration in an industry.
C) measure the extent of price leadership.
D) None of the above.
11) The demand curve, which assumes that competitors will follow
price decreases but not price increases, is called

A) an industry demand curve. B) an inelastic demand curve.

C) a kinked demand curve. D) a competitive demand curve.
12) The Kinked-Demand Curve model best reflects

A) mutual interdependence among sellers.

B) a game theory approach to price-output decisions.
C) price rigidities in oligopolistic markets.
D) All of the above.
13). In the Kinked Demand curve model, the demand curve is for prices increases and
for price decreases
A) unit elastic; relatively elastic
B) relatively inelastic; relatively elastic
C) relatively elastic; relatively inelastic
36
 D) perfectly elastic; perfectly inelastic
14) The existence of a kinked demand curve under oligopoly conditions may result in

A) priceflexibility. B) price rigidity.

C) competitive pricing. D) None of the above.
15) When a company is faced by a kinked demand curve, the marginal revenue curve:

A) will be upward sloping.

B) will be horizontal.
C) will always be zero at the quantity produced.
D) will be discontinuous.
16) In which of these markets would the firms be facing the least elastic demand curve?

A) perfect competition B) pure monopoly

C) monopolistic competition D) oligopoly
17) Porter's "Five Forces Model" is based on:

37
 A) thelaws of supply and demand.
B) the law of diminishing returns.
C) the Structure-Conduct-Performance model.
D) the key factors affecting demand.
18) The four-firm concentration ratio:

A) indicates
the total profitability among the top four firms in an industry.
B) is an indicator of the degree of monopolistic competition.
C) indicates the presence and intensity of an oligopoly market.
D) is used by the government as a basis for anti-trust cases.
Analytical Questions

1) Convenience stores with gas stations tend to sell an essentially

identical variety of products and services. Yet this is generally
considered to be a monopolistically competitive industry selling
differentiated products. How can this be considered a
differentiated product?
2) Describe the transition from short-run to long-run
equilibrium in a monopolistically competitive industry.
3) How is a monopolistically competitive industry like perfect
competition? How is it like monopoly?

Special Pricing Practices

Multiple-Choice Questions

1) A Cartel is defined to be:

A) Any oligopolistic industry with fewer than 4 firms

B) A form of oligopoly in which firms agree to sell at different
prices like in monopolistic competition
C) A form of oligopoly in which firms formally agree to establish
a common price, in effect acting like a monopoly
D) A form of oligopoly in which firms agree to compete with each other on an equal basis.
2) A successful and stable cartel can be established if there are:

A) many firms producing a storable product

B) many firms producing a perishable product
C) a few firms producing a storable product
D) a few firms producing a perishable product
3) All of the following are conditions which are favorable to the formation of cartels, except:

38
 A) the existence of a small number of firms.
B) geographic proximity of firms.
C) homogeneity of the product.
D) easy entry into the industry.
4) Prices under an ideal cartel situation will be equal to:

A) monopoly prices. B) competitive prices.

C) prices under monopolistic competition. D) marginal cost.
5) A cartel price will be established at the quantity where:

A) total cost equals the industry total revenue.

B) average cost equals the industry revenue.
C) the sum of the members' marginal costs equals industry marginal revenue.
D) marginal cost equals industry price.

39
6) Cartel agreements tend to break down:

A) during economic downturns.

B) because of price "chiseling" by one or more members.
C) when there is overcapacity in the industry.
D) because of all of the above.
7)The position of a cartel will become weaker if there is
excess-capacity among the firms belonging to the cartel.
A) minimum B) no C) zero D) high
8) Dominant price leadership exists when:

A) one firm drives the others out of the market.

B) the dominant firm decides how much each of its competitors can sell.
C)the dominant firm establishes the price at the quantity where
its MR = MC, and permits all other firms to sell all they want
to sell at that price.
D) the dominant firm charges the lowest price in the industry.
9) The oligopolistic situation in which a company's objective is to
maximize revenue subject to a minimum profit requirement is
usually referred to as:

A) the aggregate model. B) the Baumol model.

C) the aggressive model. D) the Marshall model.
10) In order that price discrimination can exist,

A) markets must be capable of being separated.

B) markets must be interdependent.
C) different demand price elasticities must exist in different markets.
D) demand price elasticities must be identical in all markets.
E) Both A and C.
11) The result for the seller of being able to practice price discrimination will be:

A) higher profits. B) lower demand elasticity.

C) lower quantity sold. D) cost minimization.
12) The practice by a monopolist of charging each buyer the
highest price he/she is willing to pay is called:

A) first-degree discrimination. B) second-degree discrimination.

C) third-degree discrimination. D) fourth-degree discrimination.
13) When state universities charge higher tuition fees to out-of-
state students than to local students, the universities are
practicing:
40
 A) first-degreediscrimination. B) second-degree discrimination.
C) third-degree discrimination. D) fourth-degree discrimination.
14) The following are possible examples of price discrimination, except:

A) prices in export markets are lower than for identical products in the domestic market.
B) senior citizens pay lower fares on public transportation than
younger people at the same time.
C) a product sells at a higher price at location A than at location
B, because transportation costs are higher from the factory to
A.
D) subscription prices for a professional journal are higher when
bought by a library than when bought by an individual.
15) Under conditions of first-degree price discrimination:

A) production may equal that which would exist under perfect competition.
B) production may exceed that which would prevail under perfect competition.
C) prices will be lower than under perfect competition.

41
 D) productionwill always be lower than under perfect competition.
16) Second-degree price discrimination occurs when:

A) different prices are charged for different blocks of services.

B)different groups of buyers are charged different prices based
on their price elasticities of demand.
C) a different price is charged is charged for each amount of a product purchased.
D) None of the above.
17) Third-degree price discrimination exists when:

A) the seller knows exactly how much each potential customer

is willing to pay and will charge accordingly.
B) different prices are charged by blocks of services.
C) when the seller can separate markets by geography,
income, age, etc., and charge different prices to these
different groups.
D) when the seller will bargain with buyers in each of the markets
to obtain the best possible price.
18) By far, the most frequently encountered price discrimination is the:

A) First-degree price discrimination

B) Second-degree price discrimination
C) Third – degree price discrimination
D) Fourth-degree price discrimination

42