Economics 2306 - 10 & 1H Name ________________________________

Principles of Economics

Professor Henderson Test No. 2

I. Answer the following multiple choice questions on your Scantron.

1. The difference between a firm's total revenue and what must be paid to attract resources from their best alternative use is called
a. total revenue
b. utility
c. economic profit
d. cost
e. production efficiency

2. Accounting profit is
a. always less than economic profit
b. never less than economic profit
c. equal to economic profit if a normal profit is earned
d. less than economic profit only when implicit costs are greater than explicit costs
e. greater than economic profit only when implicit costs are greater than explicit costs

3. Suppose a professor gives up her teaching job to devote her time to writing textbooks. If salaries of professors rise,
a. her accounting profit will rise
b. her accounting profit will fall
c. her explicit costs will rise
d. her economic profit from textbooks will fall
e. her economic profit from textbooks will rise

4. What is the relationship between marginal cost and marginal product?
a. The two are not related.
b. When marginal product increases, marginal cost increases.
c. When marginal product increases, marginal cost decreases.
d. When marginal product is negative, marginal costs are negative.
e. When diminishing marginal returns set in, marginal costs fall.

5. Suppose Guild produces 5,000 guitars per year. Its average total cost (ATC) is $90, and its fixed cost (FC) is $250,000. What is its variable cost (VC)?
a. $250,000
b. $450,000
c. $25,000
d. $56,000
e. $200,000

6. In the nearby exhibit, at a quantity of 100, total fixed cost
a. equals $6
b. equals $150
c. equals $100
d. equals $900
e. cannot be determined

7. The marginal cost curve (MC) intersects the average total cost curve (ATC)
a. at the ATC's minimum point
b. only when the ATC is sloping upward
c. at the ATC's maximum point
d. only when the ATC is sloping downward
e. when the ATC intersects the fixed cost curve

8. Adopting a uniform menu across all sites provides the McDonald's Corporation _______ by spreading the cost of menu development over a large output.
a. economies of scale
b. diminishing returns
c. constant returns to scale
d. rising marginal product
e. more flexibility

9. A cartel is
a. a group of oligopolistic firms that engage in formal collusion
b. a group of monopolistically competitive firms which charge the same price
c. usually legal in the United States
d. an agreement among rival firms to set prices independently
e. illegal throughout the world

10. In perfect competition, if one firm raises its price,
a. others will follow
b. that firm will increase its revenues
c. that firm will lose revenues because other firms will not follow
d. all consumers will be adversely affected
e. the market demand curve will shift

11. The total revenue curve for a perfectly competitive firm
a. is horizontal
b. is vertical
c. rises at a diminishing rate
d. rises at an increasing rate
e. rises at a constant rate

12. Firms A and B are producers in the same perfectly competitive industry. If Firm A earns a marginal revenue of $17,
a. it earns an average revenue less than $17
b. Firm B earns an average revenue of $17
c. Firm B will try to charge $16 per unit
d. it earns an average revenue greater than $17
e. Firm B earns an average revenue greater than $17

13. If a firm has a downward-sloping AFC curve and a U-shaped AVC curve, what must be true of the firm?
a. It is earning positive economic profit.
b. It has chosen the least-cost plant size.
c. It is operating in the short run.
d. It is a perfectly competitive firm.
e. There are no diminishing marginal returns at this firm.

14. A perfectly competitive firm's profit per unit of output equals
a. price minus average variable cost
b. price minus marginal cost
c. total revenue minus total cost
d. price time quantity
e. price minus average total cost

15. Suppose a price-taking firm produces 400 units at profit maximization (or loss minimization) output. At that output rate marginal cost is $200, average total cost is $240, and average variable cost is $170. What can you determine about the market price that would force the firm to shut down in the short run?
a. It equals $200.
b. It is between $170 and $240.
c. It is less than $170.
d. It is between $170 and $200.
e. It equals $240.

16. If two perfectly competitive firms produce the same quantity at the market price, then, at that quantity, they must have the same
a. marginal cost and average total cost
b. marginal cost and average fixed cost
c. average total cost and average fixed cost
d. average fixed cost and average variable cost
e. marginal cost

17. If price-taking firms are required to install wet scrubbers on their chimneys to meet EPA regulations and their costs increase as a result, we would expect
a. demands for the product to fall
b. the market supply curve to shift to the left
c. the long-run economic profit of individual firms in the industry to fall
d. the short-run economic profit of individual firms in the industry to remain unchanged
e. short-run profits to rise as the industry raises price more than the cost of pollution control devices

18. If a perfectly competitive firm is operating in long-run equilibrium and market demand suddenly falls, the short-run result will be
a. greater economic profit
b. a normal profit
c. lower average total cost
d. lower average variable cost
e. an economic loss

19. Firms in perfect competition are price takers because
a. all small firms must take the price set by the largest firm in the market
b. firms take the price that government determines is a "fair" price
c. each firm is small and goods are perfect substitutes for one another
d. free entry and exit in the short run creates a constant market price in the long run
e. high barriers to entry force firms to compete by charging lower prices than other firms in the industry

20. Which of the following is true in both perfect competition and monopoly?
a. Firms produce a differentiated product
b. Firms cannot earn economic profit in the long run
c. Individual firms have no ability to control the price of their output but must accept the market price
d. Firms go out of business in the long run if total revenue cannot cover total cost
e. Firms can earn economic profit in the long run

21. The demand curve any monopolist uses in making its output decision is
a. the same as the demand curve facing a perfectly competitive firm
b. vertical because there are no close substitutes for its product
c. horizontal because there are no close substitutes for its product
d. the same as the market demand curve
e. perfectly inelastic

22. A monopolist must choose between two points on its demand curve; it can sell 100 units for $3, or it can sell 160 for $2. Which of the following is true?
a. The monopolist is facing elastic demand
b. The monopolist is facing demand "unit elastic."
c. The monopolist is facing inelastic demand.
d. The monopolist is facing perfectly elastic demand.
e. The elasticity of the demand curve the monopolist faces cannot be determined with the information given.

23. A monopolist
a. can charge whatever price it wants
b. charges more than almost any consumer is willing to pay
c. is constrained by marginal cost in setting price
d. is constrained by demand in setting price
e. always earns economic profit

24. Output and price for the nondiscriminating monopolist which maximizes profits in the nearby exhibit are
a. 90 and $18
b. 1,500 and $24
c. 1,700 and $22
d. 1,100 and $28
e. 1,500 and $22

25. You are hired as a production analyst at Monopoly-R-Us and you estimate that, at current output, demand is inelastic and marginal cost is positive. You advise your superiors that they can increase profit by
a. raising price until demand becomes unit elastic
b. raising price into the elastic range
c. lowering price until demand becomes unit elastic
d. lowering price into the elastic range
e. reduce output without changing price

II. Answer the following true, false, or uncertain. Explain.

1. When we say production is subject to the law of diminishing marginal returns, we mean marginal product is negative.

2. In the long run in perfect competition, no firm can earn a normal profit.

3. Monopolists can earn positive economic profits in the long run because they tend to be more production efficient than perfectly competitive firms.

4. The defining characteristic of oligopoly is product differentiation.

5. The greater the degree of product differentiation in an oligopoly, the easier it is to form a successful cartel.

III. Short Answer in the space provided.

1. Show, or explain, how perfectly competitive markets maximize the sum of consumer and producer surplus.

2. Explain the rationale behind patents; specifically, what are the benefits and costs of such guarantees of monopoly rights?

Bonus:

Assume a monopolistic publisher has agreed to pay an author 15 percent of the total revenue from the sales of a textbook. Will the author and the publisher want to charge the same price for the book? Explain with a graph.