Economics 2306 Name___________________________

Principles of Economics

Professor James Henderson

Spring 1996

I. Multiple Choice. Answer the following on your Scan-tron.

1. The law of diminishing marginal returns states that
a. long-run aver age costs decline as output increases.
b. if the marginal product is above the average product, the average will rise.
c. as units of a variable input are added to a given amount of fixed units, the marginal physical product of the variable input eventually diminishes.
d. as a person consumes more of a good, the marginal satisfaction from that good eventually diminishes.
e. if marginal product is positive, total product rises.

2. A variable cost is one that changes
a. in the long run only.
b. in the short run only.
c. year to year.
d. month to month.
e. as quantity changes.

3. For a person who owns and operates an automobile, insurance premiums are a ______ and maintenance and repairs are a ______.
a. revenue; cost
b. fixed cost; fixed cost
c. variable cost; variable cost
d. variable cost; fixed cost
e. fixed cost; variable cost

4. Doubling the circumference of an oil pipeline more than doubles the volume of oil that can be pumped through. This is an example of
a. production inefficiency.
b. diminishing marginal returns.
c. diseconomies of scale.
d. constant returns to scale.
e. economies of scale.

5. Consider the graph below. Curve B represents
a. marginal cost.
b. average total cost.
c. average variable cost.
d. average fixed cost.
e. average marginal cost.

6. In the graph below, when output is 10,
a. total cost equals $10.
b. total fixed cost equals $70.
c. total variable cost equals $80.
d. marginal cost equals $7.
e. total fixed cost equals $7.

7. The price charged by a perfectly competitive firm is determined by
a. each individual firm.
b. a group of firms acting together as a cartel.
c. market demand and market supply.
d. the firm's total costs alone.
e. the firm's average variable cost.

8. Which of the following is always true for a perfectly competitive firm?
a. MC = AVC = ATC
b. MR = MC
c. P > AVC
d. AR = MR = P
e. MR = AR = MC

9. If price is less than its minimum average variable cost, a firm that continues to produce in the short run
a. cannot cover any of its variable costs.
b. incurs a loss greater than its fixed costs.
c. can cover all of its fixed costs and some of its variable costs.
d. can cover all of its variable costs and some of its fixed costs.
e. can cover both its fixed costs and its variable costs.

10. Many country inns shut down in the off-season because
a. the off-season market rate falls below average total cost.
b. the off-season market rate can't cover their average fixed costs.
c. the off-season revenue can't cover variable costs.
d. the off-season rates are below the marginal cost of providing a room.
e. innkeepers are interested in maximizing revenue.

11. If a perfectly competitive firm is currently maximizing profits and then the market demand curve shifts leftward, all of the following must decrease in the short run, except one. Which one?
a. Total revenue
b. Marginal revenue
c. Average revenue
d. Marginal cost
e. Average total cost

12. Firms achieve productive efficiency in the long run by
a. striving to minimize fixed cost.
b. striving to maximize revenue.
c. producing at their minimum long-run average cost.
d. producing at their minimum long-run marginal cost.
e. producing the output consumers want most.

13. A natural monopoly results when a firm has
a. a license.
b. a patent.
c. official approval to produce a product.
d. decreasing average costs over the range of market demand.
e. exclusive use of a natural resource.

14. Which of the following is not true of monopolists?
a. The entry of new firms is not a major concern.
b. Monopolists seek to maximize profits.
c. Monopolists can charge any price they want.
d. Monopolists can choose any point on the market demand curve.
e. Monopolists can raise price more than 10 percent.

15. Suppose it costs Minnie's Mini-Golf (a local monopolist) not a penny more to let another person on the course (in other words, MC = 0). If Minnie's faces a linear market demand curve, it will maximize profits by choosing the point on the demand curve where
a. MR is greatest.
b. price elasticity is equal to -1.
c. price elasticity is inelastic.
d. price exceeds average total cost by the greatest amount.
e. price exceeds marginal cost by the greatest amount.

16. The main reason a monopolist can earn long-run economic profit, whereas a perfectly competitive firm cannot, is that
a. monopolists operate under economies of scale.
b. perfectly competitive firms have opportunity costs.
c. demand for the monopolist's output is inelastic.
d. demand for the monopolist's output is elastic.
e. there are no barriers to entry in perfect competition.

17. An important difference between a perfectly competitive firm and a monopolist is that
a. the perfectly competitive firm tends to be larger.
b. only monopolists attempt to maximize profit.
c. only the perfectly competitive firm maximizes profit.
d. the perfectly competitive firm faces a horizontal demand curve and the monopolist faces a downward-sloping demand curve.
e. only the monopolist maximizes profit at the quantity where marginal cost equals marginal revenue.

18. Suppose that a price-discriminating monopolist divides its market into two segments. The firm will charge the lower price in the market segment where consumers
a. have relatively less elastic demand.
b. have relatively more elastic demand.
c. attach a higher marginal value to each unit of the good.
d. have perfectly inelastic demand.
e. attach higher average value to units of the good.

19. Why would we be likely to observe dentists engaging in price discrimination?
a. Dental care is expensive
b. All dentists are basically alike.
c. It is very important to exercise care in choosing a dentist.
d. It is nearly impossible to resell the services of a dentist.
e. The demand for dentists is very inelastic.

20. Monopolistically competitive markets consist of
a. one firm selling several products.
b. one firm selling one product.
c. many firms, all selling identical products.
d. many firms, each selling a slightly different product.
e. many firms, each selling a completely different product.

21. Collusion among firms to raise price is rare in monopolistically competitive markets because
a. there are too many firms. d. products are homogeneous.
b. there are too few firms. e. price leadership is used instead.
c. there is only one firm.

22. As new monopolistically competitive firms enter the market, the demand facing each firm in the market _____, causing the price received by each firm to _____. In the long run, each firm will earn a ______ profit.
a. falls; rise; positive d. rises; fall; normal
b. rises; fall; positive e. falls; fall; normal
c. falls; rise; normal

23. Using analogies from sports to explain interdependence, oligopoly is like ______, whereas perfect competition is more like _____.
a. a marathon; a ping-pong match.
b. a ping-pong match; a marathon
c. a bowling tournament; a marathon
d. the U.S. Open in golf; the Super Bowl
e. a marathon; a chess match

24. An intersection known as Four Corners lies 300 miles from the nearest town. At this intersection are three independently owned gas stations and one small pharmacy. Which of the following is true?
a. The firms are all perfectly competitive, because of their size.
b. It would be easier for all four firms to form a cartel than for only the gas stations to do so.
c. The gas stations are monopolistically competitive, because there are so few of them that they're almost monopolists.
d. The gas stations are perfectly competitive; the pharmacy is not.
e. The gas stations are oligopolists; the pharmacy is a monopolist.

25. Which of the following is an example of an actual cartel?
a. The three largest cereal producers in the United States
b. General Motors, Ford, and Chrysler (the "Big Three")
c. The Organization of Petroleum Exporting Countries (OPEC)
d. The three major U.S. cigarette manufacturers
e. ABC, NBC, and CBS

II. Answer True, False, or Uncertain. Explain.

1. For a perfectly competitive firm, price is identical to marginal revenue at every quantity.

2. The demand curve facing the monopolist is perfectly inelastic.

3. Cartels are naturally stable.

4. If a firm's economic profit is positive, its accounting profit must also be positive.

5. If a firm is experiencing diseconomies of scale, its long-run average cost curve is decreasing (sloping downward).

III. Short Answer

1. Given the data for a perfectly competitive firm shown in the above exhibit, answer the following.
a. What is the profit-maximizing output?
b. What is AVC at Q = 3?
c. How much profit can the firm earn in the short run?
d. How much profit can the firm earn in the long run?

2. Show or explain the deadweight loss of monopoly under conditions of constant long-run average and marginal cost.

EXTRA CREDIT

Show graphically and explain how a monopolist maximizes total revenue at the quantity where marginal revenue equals zero.