Answer Sheet for Multiple Choice Questions worth 1 p each

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Name: ________________________________ Personal no: __________________

Part A, Multiple Choice
Use the Answer Sheet!

1 The percentage change in quantity demanded that results from the percentage change in price
is known as the
A) price elasticity of supply D) cross-price elasticity of demand
B) price elasticity of demand E) cross-price elasticity of supply
C) income elasticity of demand

2. If Leslie can produce two pairs of pants in an hour while Eva can make one pair an hour,
then it must be the case that
A) Leslie has a comparative advantage.
B) Eva has an absolute advantage.
C) Leslie has an absolute advantage.
D) Eva has a comparative advantage.
E) Leslie has both comparative and absolute advantage.

3. As the price of gasoline increases, the quantity demanded of gasoline decreases. This is an
application of
A) the law of supply
B) environmental economics
C) the law of demand
D) how government organizations deal with pollution
E) needs versus wants

4. Choosing to study for an exam until the extra benefit (improved score) equals the extra
cost (mental fatigue) is
A) not rational.
B) an application of the cost-benefit principle.
C) an application of the scarcity principle.
D) the relevant opportunity cost.
E) less desirable than studying for the entire evening.

5. Market power measures the firm's ability to

A) under cut its competitors.
B) resist union wage demands.
C) raise its price without losing all of its sales.
D) influence the price its competitors charge.
E) force consumers to pay higher prices.

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

A) A local gas station owner wondering how his competition across the street will react
to his decision to lower prices.
B) Negotiating a salary when two firms have made offers.
C) Deciding whether to have an extramarital affair.
D) Firm behavior in a perfectly competitive market.
E) Playing poker.
Use the following to answer questions 7-9:
P
Social MC1
4

3 Private MC
Price ($/unit)

2
Social MC2

D
0 1000 2000 3000 4000
(Quantity (unit/week)

7. When the market has no external costs or benefits, the resulting equilibrium quantity is ____
and price is _____.
A) 0; $4 B) 1000; $3 C) 2000; $2 D) 3000; $1 E) 4000; $0

8. Suppose that production of this good is accompanied by an external cost, the market
equilibrium quantity is ____ and the market equilibrium price is ______.
A) 0; $4 B) 1000; $3 C) 2000; $2 D) 3000; $1 E) 4000; $0
Answer: B

9. Suppose that production of this good is accompanied by an external cost, the private market
equilibrium quantity is ______ the socially optimal quantity.
A) equal to D) 2000 units more than
B) 1000 units less than E) 2000 units less than
C) 1000 units more than

10 Which of the following strategy(s) could be used in collecting information about a good or
service
I. Visit stores and ask a salesperson about the product or service.
II. Ask friends and family members for opinions.
III. Read Consumer Reports.

A) I and II B) II and III C) I and III D) III E) I, II, and III.

11 The quantity demanded of Honda Civics went down as the price increased, and the
consumers that preferred Civics started to buy Toyota Corollas. This is because of
A) income effect
B) substitution effect
C) Japanese cars last longer
D) American cars cost more
E) Demand for Honda Civic shift to the left
12 Which one of the following determinants will cause movements along the supply curve of
good X?
A) the price of good X.
B) the price of labor used in the production of good X.
C) the amount of technology used in the production good X.
D) the cost of the plant used to produce good X.
E) the price of fuel used in the production of good X.

13 During Thanksgiving you participated in a pumpkin-pie eating contest since you love
pumpkin pie. You really enjoyed the first two pies, third one was OK, but as soon as you ate the
4th one you became ill and lost the contest.

Beyond the 3rd pie your total utility

A) increases B) decreases C) stays the same D) is zero E) no way to predict

. The economic surplus of a particular action is

A) the value of the action.
B) the cost of the action.
C) the difference between the benefit and the cost of the action.
D) the average of the benefits and costs.
E) the ratio of the benefits to the costs.

15 A profit maximizing perfectly competitive firm must decide

A) only on what price to charge, taking output as fixed.
B) both what price to charge and how much to produce.
C) only on how much to produce, taking price of the good as fixed.
D) only on which industry to join, taking price and output as fixed.
E) only on how much revenue it wishes to collect.

16 A variable factor of production

A) is fixed in the long run but variable in the short run.
B) plays no role in the law of diminishing marginal returns.
C) is variable in both the short run and the long run.
D) is irrelevant to profit maximization decisions.
E) is variable only in the short run.

17 The reason an efficient market outcome may not be considered a "good" outcome is
A) demand may not include all the benefits of consumption.
B) incomes of consumers are taken as given.
C) supply may not include all the costs of production.
D) the market is less than perfectly competitive.
E) consumers and producers lack information.

18 Deadweight loss is
A) present in all markets.
B) the difference between consumer surplus and producer surplus.
C) positive in markets where equilibrium is distorted by price controls or taxes.
D) always larger than consumer surplus.
E) always smaller than producer surplus.
19 Constant returns to scale occur when a doubling of all inputs
A) doubles the price of outputs.
B) more than doubles output.
C) less than doubles the price of the inputs.
D) exactly doubles output.
E) less than doubles output.

20 Game theory is important in understanding

A) how perfectly competitive firms behave. D) interdependent outcomes.
B) production decisions by firms. E) the behavior of a pure monopolist.
C) consumer demand.
Part B

Question 1. Comparative Advantages (14 points)

Daniel and Johan have the possibility to produce research papers and attending a number of
conferences. Their productivity of doing each during a month is:

Number of papers Number of conferences

Johan 4 2
Daniel 1 6

a) Who has the comparative advantage of producing papers (you need to illustrate in terms
of opportunity costs to get the points)? (3p)
b) Who has the absolute advantage of going to conferences? (2p)
c) What is the opportunity cost for Johan to go to a conference in terms of number of
papers? (3p)
d) What is the opportunity cost for Daniel to produce a research paper? (3 p)
e) Briefly explain (max two sentences) the difference between comparative and absolute
advantage. (3p)

Question 2 Monopoly (16 points)

Jada is a second-grader who sells lemonade on a street corner in your neighborhood. Each cup
of lemonade costs Jada 20 cents to produce. She has no fixed costs. The reservation prices for
the 10 people who walk by Jada’s lemonade stand each day are listed in the following table:

Person Reservation price

1 $ 1.00
2 $ 0.90
3 $ 0.80
4 $ 0.70
5 $ 0.60
6 $ 0.50
7 $ 0.40
8 $ 0.30
9 $ 0.20
10 $ 0.10

Jada knows the distribution of reservation prices (that is, she knows that one person is willing to
pay $ 1.00, another $ 0.90, and so on), but she does not know any specific individual’s reservation
price.

a. Calculate the marginal revenue of selling an additional cup of lemonade for each potential
customer (in other words, what is the marginal revenue for person 1, person 2, person 3
and so on)? (3 p)
b. What is Jada’s profit-maximizing price? Explain with max. 2 sentences (4 p)
c. At this price, what is Jada’s economic profit? (3 p)
d. At the profit-maximizing price, what is the consumer surplus? (3 p)
e. What price should Jada charge if she wants to maximize total economic surplus? (3 p)
Question 3. Elasticities (10 p)

Fill in the blank (in your answer sheet) 2 p per question.

a. When you drop by the only coffee shop in your neighborhood, you notice that the price
of a cup of coffee has increased considerably since last week. You decide it’s not a big
deal, since coffee isn’t a big part of your overall budget, and you buy a cup of coffee
anyway. Most other coffee drinkers who frequent the coffee shop make a similar
calculation. Thus, the demand for coffee in your neighborhood is relatively __________

b. You sell muffins for one dollar each. If you raise your price by even a penny, you will
lose all your customers. The demand curve for your muffin is thus _________________

c. The responsiveness of demand to income is known as the _____________________ of

demand.

d. The income elasticity of demand is _________________ for inferior goods and

____________ for normal goods.

e. When the demand is _______________, revenue to the seller is unaffected by a price

change.

Question 4. The Cost-Benefit Principle (10 p)

Matt has decided to purchase his textbooks for the semester. His options are to purchase the
books via the Internet with next day delivery to his home at a cost of $175, or to drive to
campus tomorrow to buy the books at the university bookstore at a cost of $170. Last week he
drove to campus to buy a concert ticket because they offered 25 percent off the regular price of
$16.

a. What is Matt’s benefit of buying his book at the bookstore? (2 p)

b. What was Matt’s benefit from driving to campus to buy the concert ticket last week? (2 p)

c. According to the cost-benefit principle:

1) It would not be rational for Matt to drive to campus to purchase the books because
the $5 saving is only two percent of the cost of the books, and that is much less than
the 25 percent he saved on the concert ticket.
2) It would be rational for Matt to drive to campus because it costs less to buy the
books there than via the Internet.
3) It would be rational for Matt to drive to campus because the $5 saving is more than
he saved by driving there to buy the concert ticket.
4) It would not be rational for Matt to drive to campus to purchase the books because
the cost of gas and his time must certainly be more than the $5 he would save.

Note the one answer that is correct in your answer sheet. (2 p)

d. Assume the minimum that Matt would be willing to accept to drive to the university
 campus is equal to the amount he saved on the concert ticket. What would be the
amount of his economic surplus if he bought his textbooks at the university bookstore
rather than via the Internet? (4 p)

Question 5. Consumption Theory (15 points)

a) Define the rule that sets the optimal level of consumption?

b) Show graphically using a budget line and indifference curves where the optimal level of
consumption between two goods (x and y) is found?
c) Given the utility function: U(x.y)=4xy, income of 100 and price of good x=2 and price
of good y=4, what is the optimal level of consumption of good x and good y.

Question 6. Behavioural economics (5 points)

When students in a large class were surveyed about how much they would be willing to pay for
a coffee mug with their university’s logo on it, their median willingness to pay was $5. At
random, half of the students in this class were then given such a coffee mug, and each of the
remaining students were given $5 in cash. Students who got mugs were then offered an
opportunity to sell them to students who had not gotten one. According to standard economic
models, how many mugs would be expected to change hands? How, if at all, would a
behavioral economist’s prediction differ?