Final Fall 2003EC 202-008 Instructor: W. Hudson

December 16, 2002Name ______________________________

Part I – Multiple Choice (40 Questions, 5 Points Each, 200Points Total)

1. The concept of opportunity cost is based on the principle ofa. need.b. consumption.c. scarcity.d. profit.

2. Refer to Figure 2.5. The economy is currently at Point A. The opportunity cost of moving from Point A to Point B is thea. 60 desktop computers that must be forgone to produce 10 additional laptop computers.b. 20 desktop computers that must be forgone to produce 30 additional laptop computers.c. 80 desktop computers that must be forgone to produce 20 additional laptop computers.d. 20 desktop computers that must be forgone to produce 10 additional laptop computers.

3. According to the law of supply, there is aa. negative relationship between price and the quantity of a good supplied.b. positive relationship between price and the quantity of a good supplied.c. negative relationship between price and the change in supply.d. positive relationship between price and the change in supply.

4. The economic problem can best be stated as:a. How can the economy improve technology so as to shift the production possibility frontier up

and to the right?b. Given scarce resources, how exactly do societies go about deciding what to produce, how

to produce it, and for whom to produce?c. Given the fact that the economy is inefficient, how much and what type of government

intervention should be used to improve the efficiency of the economy?d. What is the best rate of economic growth for a society?

Total L Units Total Product Price per (employees) (shirts/day) shirt 0 0 - 1 20 $5 2 50 5 3 75 5 4 95 5 5 110 5 Table 9.15. Refer to Table 9.1. The marginal revenue product of the ______ worker is $100.

a. secondb. thirdc. fourthd. fifth

6. Assume leisure is a normal good. The substitution effect of a wage decrease implies a ______ labor supply and a ______ demand for leisure.a. lower; higherb. higher; lowerc. higher; higherd. lower; lower

7. Constant marginal returns of labor impliesa. decreasing average variable costs.b. constant marginal costs.c. increasing marginal costs.d. constant average fixed costs.

8. Investment is measured as a ______ variable and capital is measured as a ______ variable.a. flow; stockb. flow; flowc. stock; flowd. stock; stock

9. Efficiency occurs whena. the economy is producing what people want at least possible cost.b. the economy has a fair and just distribution of income.c. all markets are in equilibrium.d. unemployment is low and prices are stable.

10. When ______ substitutes exist, a monopolist has ______ power to raise price.a. more; moreb. more; lessc. fewer; lessd. no; infinite

11. If the income effect of a wage change outweighs the substitution effect of a wage change, the labor-supply curve isa. upward sloping.b. horizontal.c. vertical.d. backward bending.

12. Total revenue minus total cost is equal toa. the rate of return.b. marginal revenue.c. profit.d. net cost.

13. Monopolistic competition differs from perfect competition in that:a. firms have market power.b. their product is homogeneous.c. there are few firms.d. entry is restricted.

14. In Los Angeles there is a large number of retail clothing stores. Each store sells the same product as the other stores. Here, retail clothing stores are an example of what market structure?a. perfect competitionb. monopolistic competitionc. oligopolyd. monopoly

15. The Specialty Cake Store, a monopolistically competitive firm, is producing 456 decorated cakes per day and selling each cake for $50. At that production level ATC is $36, AVC is $22, AFC is $14, and both MR=25 and MC= $19. This firm should (in the short-run):a. continue to produce 456 cakes, as price is greater than AFC.b. increase output to increase profits.c. decrease output to the point where marginal cost equals average cost.d. produce zero cakes and just pay fixed costs.

17. NOT COVERED If the industry is an oligopoly, the price charged and the quantity produced would be the same as if the industry was a monopoly ifa. the oligopolist faces a kinked demand curve.b. the oligopolists behave as Cournot assumed.c. one of the oligopolists acts as a dominant price leader.d. the oligopolists collude.

18. A firm that is producing to the right of the minimum average total cost would be an example ofa. a market failure.b. an externality.c. a public good.d. impossible.

19. NOT COVERED Refer to Figure 14.1. The efficient amount of fertilizer isa. zero because any level of production involves an external cost.b. 50 bags.c. 60 bags.d. indeterminate from this information.

20. NOT COVERED Refer to Figure 14.2. To force this firm to produce the efficient level of output, the government should impose a tax ofa. $5.00 per car.b. $10.00 per car.c. $15.00 per car.d. an amount that is indeterminate from this information.

Tons of Salt MC MSC 1 10 20 2 20 30 3 30 40 4 40 50 5 50 60 Table 14.1

21. NOT COVERED Refer to Table 14.1. This salt processing firm is perfectly competitive and is forced to take damage costs into account. If the market price of the product is $30, the firm will producea. 0 tons of salt.b. 2 tons of salt.c. 3 tons of salt.d. 4 tons of salt.

22. It is assumed that the marginal benefit of consumptiona. remains constant as more units of the good are consumed.b. increases as more units of the good are consumed.c. decreases as more units of the good are consumed.d. could either increase or decrease as more units of the good are consumed.

23. NOT COVERED Refer Figure 14.4. At 20 units of output there are externala. costs of $2 per unit.b. benefits of $2 per unit.c. costs of $5 per unit.d. benefits of $5 per unit.

24. A market is defined as perfectly contestable if entry to ita. is costless, but exit from it is costly.b. is costly, but exit from it is costless.c. and exit from it are both costly.d. and exit from it are both costless.

25. NOT COVERED Refer to Figure 13.10. Section d1 of the demand curve assumes that competing firms willa. raise their price in response to this firm's price increase.b. decrease their price in response to this firm's price increase.c. not change their price in response to this firm's price increase.d. raise their price in response to this firm's price decrease.

26) In perfect competition, the condition that ensures that the right things are produced is _______ A) P = ATC. B) MRPL = ATC. C) P = MC. D) MUX = PX.

27) Firms stop producing tapes and start producing compact discs because people prefer compact discs to tapes. This will _______

A) make the economy less stable. B) make the economy more stable. C) make the distribution of outcome more equitable. D) improve efficiency.

28) A person who chooses not to be in the labor force reveals that _______ A) either leisure or the value of nonpaid labor is worth more to him or her than the value that society

places on his or her potential product in the market. B) either leisure or the value of nonpaid labor is worth zero to him or her. C) either leisure or the value of nonpaid labor is worth less to him or her than the value that society places

on his or her potential product in the market. D) his or her potential product in the market is zero.

29) When a monopolist incurs a loss it will _______ A) always shut down. B) produce as long as total revenue is sufficient to cover fixed costs. C) always produce where marginal cost equals marginal revenue. D) produce as long as total revenue is sufficient to cover variable costs.

30) Relative to a competitively organized industry, a monopoly produces ______ A) less output, charges lower prices and, earns only a normal profit. B) less output, charges higher prices and, earns economic profit. C) more output, charges higher prices and, earns economic profits.

D) less output, charges lower prices and, earns economic profits.

32) NOT COVERED If a tax is imposed on externality-producing activities by perfectly competitive firms so that the market is producing the efficient level of output, then ______

A) P = MC. B) P = MSC. C) P > MC. D) P > MSC.

33) NOT COVERED If a firm's production process generates external costs, the firm will produce the socially efficient level of the output if the government imposes a tax equal to the marginal ______

A) private cost. B) benefit. C) external cost. D) social cost.

34) Suppose you know that the breakfast cereal industry is characterized by significant "barriers to entry." Which of the following is a correct inference? ______

A) The government must be artificially restricting entry into the breakfast cereal industry. B) The breakfast cereal industry is producing a type of public good. C) Economic profits in the breakfast cereal industry are likely to persist, ceteris paribus. D) The breakfast cereal industry could be an unregulated, perfectly competitive industry.

36) For monopolistically competitive firms in long-run equilibrium, ______ A) at the profit-maximizing quantity, the demand curve must intersect the average total cost curve quantity. B) at the profit-maximizing quantity, the demand curve must be tangent to the average total cost

curve. C) the demand curve must be tangent to the average total cost curve at its minimum. D) the demand curve must intersect average total cost at its minimum.

37) NOT COVERED When the government taxes a firm that generates external costs, the firm will produce ______

A) the same number of units of output as before the tax was imposed to continue maximizing profits. B) fewer units of output than before the tax was imposed in order to continue maximizing profits. C) either more or fewer units of output than before the tax was imposed depending upon what happens to

the profit maximizing level of output. D) more units of output than before the tax was imposed in order to continue maximizing profits.

38) Marginal cost is a good measure of ______ A) the social value of a marginal unit of a good. B) what society gains by using resources to produce more of a good or service. C) what society gives up by using resources to produce more of a good or service. D) the least costly way to produce all units of a good.

39) It would be inefficient to break up a ______ A) patent monopoly. B) profit-maximizing monopoly. C) natural monopoly. D) strategic resource monopoly.

Part II Short Answer ( 50 points each, 200 points total)

1. Looking at a perfectly competitive market in Chicken, show (graphically and discuss in words):A) The initial long-run equilibrium condition for the market/firms (15 points).B) Show what would happen, in the SR and LR, if a firm just decided to enter

this industry for no particular reason. (In both parts be sure to label everything and discuss price and quantity changes that may or may not occur.)

Answer: Use the Market/Firm graphs from perfect competition (pc) to set up part A. In part B, the change is just one firm entering – therefore the market supply, which is the summation of all the marginal cost curves, will shift to the right. This will cause the market price to fall, thereby lowering the MR=AR=d line on the Firm graph. This results in profits falling below zero in the Short Run (SR), which will ensure exit in the Long Run (LR). When a firm exits, the Market supply curve will shift back to the left and reestablish the original market price, which brings the MR=AR=d curve (on the Firm graph) back to its original level and profits return to zero. This “mistake” is self correcting.

Why do we study perfectly competitive markets – list and describe as many reasons as possible, the more the better.

Answer: 1) We need to learn how to walk before moving on to running. It sets up a

simplified version of the world that is easier to work with. Later on we can complicate the model be slowly changing assumptions to more accurately reflect real world behavior.

2) It does model some industries fairly well, such as financial markets, agricultural markets, etc.

3) It is the benchmark by which all real world industries are judged, in terms of social surplus and allocative efficiency.

4) Turning to the market for Flu shots;C) Show (graphically and in words) what the market equilibrium would be

and the social solution (20 points).

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D) Now assume that the production of the Flu shot involves a production process that generates air pollution that negatively impacts individuals from the surrounding area – the Flu shot still generates positive spill-over effects for those not getting the shot but benefiting from reduced risk of catching the flu. Now compare the market result with the social optimum, being careful in identifying what will happen and what may or may not occur in terms of price and quantity changes (30 points).

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4. Within a monopolistically competitive setting, the role of advertising is always positive, negative, unclear/uncertain/good and bad? Defend your answer using the tools and discussions from this course (50 points).

ANSWER:Any response is acceptable as long as it uses concepts and models from class.

BAD – Cold War Scenario Coke/Pepsi start with no advertising and a 50/50 market share, then Coke kicks off an expensive ad campaign that captures some of Pepsi’s customers, resulting in a 75/25 division of market share. Then in retaliation Pepsi launches their own ad campaign to get market share back to 50/50. Lots of resources are being expended to ensure that market share stays at 50/50, but no other benefits are being obtained.

GOOD – Information/Reputation/Intangible characteristicsMarketing simply provides new information about new products, sales, location and time, etc. Reputation allows consumers to sort numerous firms quickly as well as punish/reward the firms that are bad/good.Dolphin Safe Tuna or Michael Jordan Shoes both provide intangible benefits to the consumer that improves their welfare (that’s why the buy them), therefore consumers are willing and happy to pay a little more.

Uncertain – Bad and Good discussed, for a mixed result.