Economics 2306 Name___________________________

Principles of Economics

Professor James Henderson

Spring 1996

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

1. The resource market is different from the product market in that
a. in the resource market, firms don't maximize profit.
b. in the resource market, households don't maximize utility.
c. in the resource market, firms are demanders and households are suppliers.
d. supply and demand do not apply in the resource market.
e. supply and demand do not apply in the product market.

2. Which of the following best illustrates the concept of derived demand?
a. As income rises, the demand for TVs rises.
b. A fall in the price of cameras will increase the demand for film.
c. A fall in the demand for tires will reduce the demand for rubber.
d. When the price of gasoline rises, the demand for automobile repair falls.
e. If consumers expect the price of coffee to rise, demand for coffee rises.

3. The market supply curve of labor is __________ and the market supply curve for capital is __________.
a. upward sloping, upward sloping
b. perfectly inelastic, perfectly elastic
c. upward sloping, downward sloping
d. downward sloping, upward sloping
e. perfectly elastic, perfectly inelastic

4. In a perfectly competitive labor market a firm will maximize total profit by hiring labor up to the point where
a. wage = MRC.
b. wage < MRP.
c. wage = MRP.
d. wage > MRP.
e. wage = MPP.

5. If the wage is below the marginal revenue product, then profit-maximizing firms will
a. employ more workers.
b. employ fewer workers.
c. see an increase in the demand for labor.
d. see an increase in the supply of labor.
e. see a fall in the demand for labor.

6. The market price of final goods affects
a. the supply of the resources used to produce them.
b. the demand for the resources used to produce them.
c. the marginal physical product of the resources used to produce them.
d. the marginal resource cost of the resources used to produce them.
e. the total resource cost of the resources used to produce them.

7. If two resources, such as labor and farm machinery, are complementary,
a. one can be used in place of the other.
b. an increase in the price of one will increase the demand for the other.
c. an increase in the price of one will increase the supply of the other.
d. a decrease in the price of one will increase the productivity of the other, which will decrease its demand.
e. a decrease in the price of one will increase the demand for the other.

8. The more price elastic the demand for a final product,
a. the more price elastic the demand for the resource used to produce it.
b. the less price elastic the demand for the resource used to produce it.
c. the more price elastic the supply of the resource used to produce it.
d. the less price elastic the supply of the resource used to produce it.
e. the easier it is to substitute for the resources used in production.

9. Suppose Ace Hardware teaches all of its clerical workers to use WordPerfect. This can be viewed as an investment in what type of capital?
a. Physical
b. Financial
c. Human
d. Goodwill
e. DOS

10. Market interest rates are determined by
a. banks.
b. Wall Street.
c. the demand for loanable funds.
d. the supply of loanable funds.
e. the demand for and supply of loanable funds.

11. The formula for optimal employment of more than one resource, where x and y are resources is
a. MPP_x - MPP_y.
b. MRP_x = MRP_y.
c. MPP_x P_x = MPP_y P_y.
d. MRC_x = MRC_y.
e. MRP_x/MRC_x = MRP_y/MRC_y.

12. If MRP_labor/MRC_labor > MRP_capital/MRC_capital, then the firm should
a. substitute labor for capital.
b. substitute capital for labor.
c. not change anything.
d. buy more capital.
e. decrease the amount of labor.

13. Because leisure is a normal good, an increase in income
a. decreases your demand for leisure time and reduces your allocation of time to market work.
b. decreases your demand for leisure time and increases your allocation of time to market work.
c. increases your demand for leisure time and reduces your allocation of time to market work.
d. increases your demand for leisure time and increases your allocation of time to market work.
e. has no impact on your demand for leisure time.

14. For a person currently earning a low wage,
a. the substitution effect of a wage increase usually is stronger than the income effect.
b. the substitution effect of a wage increase usually is weaker than the income effect.
c. the income effect of a wage increase is usually zero.
d. the substitution effect of a wage increase is usually zero.
e. the substitution and income effects of a wage increase tend to work in the same direction.

15. If the substitution effect is always greater than the income effect, then an individual's labor supply curve will
a. bend backward.
b. always have a positive slope.
c. always have a negative slope.
d. be vertical.
e. be horizontal.

16. Which of the following could not contribute to differences in wages across markets?
a. Differences in training and education requirements
b. Job discrimination
c. Differences in risk
d. Problems of labor mobility
e. A national help-wanted newspaper

17. One of the reasons that doctors earn more than nurses is that
a. doctors require more training, which decreases the demand for doctors.
b. doctors require more training, which increases the supply of doctors.
c. doctors require more training, which both decreases the demand for and increases the supply of doctors.
d. doctors require more training, which both increases the demand for and decreases the supply of doctors.
e. nurses are licensed, but doctors are not.

18. In the above exhibit, a monopsonist will hire
a. Q₁ workers and pay W₃.
b. Q₁ workers and pay W₂.
c. Q₂ workers and pay W_2.
d. Q₃ workers and pay W₁.
e. Q₁ workers and pay W₁.

19. Suppose a union is formed to bargain with the monopsony. What is the maximum wage rate the union could bargain for, in the above exhibit, that would not cost any union members their jobs?
a. W₁
b. W₃
c. Between W₂ and W₃
d. W₂
e. Between W₁ and W₂

20. A cheerleader-turned-pop-vocalist is offered a choice by her producer of either a lump sum of $20 million for all future work or a stipend of $1 million per year, payable to her and her heirs forever. She should choose the $1 million
a. no matter what the interest rate is.
b. if the interest rate is greater than 20 percent.
c. if the interest rate is less than 20 percent.
d. if the interest rate is greater than 5 percent.
e. if the interest rate is less than 5 percent.

21. By requiring that applicants for insurance policies fill out lengthy forms and take a physical examination, insurers guard against
a. symmetrical information
b. adverse selection
c. natural selection
d. moral hazard
e. the winner's curse

22. Moral hazard occurs when a person's behavior changes in a way that
a. is immoral
b. is inherently dangerous
c. increases the chances of an unfavorable outcome
d. increases the likelihood of profit
e. raises the net welfare of society

23. A regulated natural monopoly that must set price equal to average cost will earn
a. an economic loss.
b. a net economic profit.
c. a normal profit.
d. a net economic profit of less than 10 percent.
e. no profits of any kind.

24. Economists view pollution as an economic problem that arises because
a. private enterprise always minimizes the amount of pollution produced.
b. profitable firms rarely pollute.
c. as the economy grows the level of pollution declines.
d. firms that pollute do not pay the full social cost of producing their output.
e. pollution costs are borne by the consumer.

25. In 1991, the lowest fifth of families earned _______ of the income earned by the top fifth.
a. one tenth
b. one fifth
c. half
d. one twentieth
e. one third

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

1. Professions that pay higher salaries must be riskier than lower-paying professions.

2. On average, women in the United States earn 65 percent of what men earn, which shows that there is sex discrimination in the labor market.

3. The distribution of income in the United States in 1991 was more uneven than at any other time in U.S. history.

4. Rent controls help reduce the problem of homelessness.

5. The marginal revenue product curve slopes downward only if the firm is a price searcher in the product market.

III. Short Answer

1. Explain what determines the wage gap between men and women and why it has narrowed somewhat over time.

2. Explain how breaking up the monopsony that baseball team owners had in the players' market could raise the incomes of the players.

BONUS

Moral hazard is a major concern for health insurance companies. Why?