Economics 2306-10 & 1H Name________________________________

Principles of Economics

Professor James Henderson

Fall 1996

I. Multiple Choice. Answer the following on your Scantron.

1. When economists speak of the effect of the change in the relative price of a good, they mean
a. how the price has changed relative to what it was in the past
b. how the price has changed relative to individual income
c. how the price of the good has changed relative to the prices of other goods
d. that the dollar price of the good has remained constant but income has changed
e. that the dollar price of the good has changed but all other prices have changed by the same percentage

2. A demand curve shows how quantity demanded changes with price. This implies that
a. only price shifts a demand curve
b. everything else that affects demand is held constant
c. quantity demanded is unrelated to price
d. economists are concerned only with money
e. it is impossible to show how anything but price affects demand

3. Assume that black beans and rice are staples in the diet of one particular family. How could you tell if these goods were complements, substitutes, or unrelated goods?
a. If the price of black beans rose and the consumption of rice remained the same, they would be substitutes.
b. If the price of black beans rose and the consumption of rice increased, they would be substitutes.
c. If the price of black beans rose and the consumptions of rice decreased, they would be substitutes.
d. If the price of black beans rose and the consumption of both goods remained the same, they would be complements.
e. There is no way to determine whether these goods are complements, substitutes, or unrelated goods.

4. The relationship between price and the quantity supplied can be explained by which of the following?
a. In expanding output, firms will incur greater total costs.
b. As the price of a commodity falls, producers will find it more profitable to use higher priced inputs in their production process.
c. In the face of rising production costs, firms can increase profits by expanding output only if the price of output increases.
d. To expand output, firms must hire more resources, which are always of poorer quality.
e. Consumers want more at lower prices.

5. A shortage occurs whenever
a. quantity demanded exceeds quantity supplied at the equilibrium price
b. price is less than equilibrium price
c. quantity demanded is less than quantity supplied
d. goods are scarce
e. some of the people who need the product are not willing and able to buy it at the equilibrium price

6. If both demand and supply increase, price will
a. always increase
b. always decrease
c. increase only if supply increases more than demand does
d. increase only if demand increases more than supply does
e. decrease only if supply increases less than demand does

7. Two events occur simultaneously in the market for automobiles: (1) an improvement in assembly line technology and (2) the economy enters a recession (which decreases consumers income). An economist would predict with certainty that
a. equilibrium quantity will rise
b. equilibrium quantity will fall
c. equilibrium price will rise
d. equilibrium price will fall
e. the equilibrium will remain the same

8. Suppose a price ceiling is set below the equilibrium price in a market. Other things equal, the resulting shortage will be smallest if
a. the demand curve has a steep slope and the supply curve has a flat slope
b. the demand curve has a flat slope and the supply curve has a steep slope
c. both demand and supply curves have steep slopes
d. both demand and supply curves have flat slopes
e. there is insufficient information to answer the question

9. Firms would like to know the price elasticity of demand because it helps determine the effect of price changes on the firms'
a. property taxes
b. profits
c. quantity supplied
d. revenues
e. total costs

10. If the price of Pepsi-Cola increases by 20 percent per can and the quantity demanded decreases by 50 percent, then price elasticity of demand is equal to ______ and demand is said to be ________.
a. 0.4, inelastic
b. 0.2, inelastic
c. 1.0, unit elastic
d. 2.5, elastic
e. 0.5, elastic

11. If the managers of a theater plan to raise ticket prices to increase ticket revenues, then they must believe that demand is
a. elastic
b. inelastic
c. unit elastic
d. perfectly elastic
e. income elastic

12. A successful advertising campaign would likely
a. increase price elasticity of demand by stressing the uniqueness of the product
b. reduce price elasticity of demand by stressing the uniqueness of the product
c. reduce price elasticity of demand by informing consumers of the availability of substitutes
d. not alter the demand curve
e. generally makes the demand curve shift inward

13. The supply curve of dorm rooms on the Baylor campus is likely to be
a. downward sloping
b. relatively flat
c. vertical
d. horizontal
e. price elastic

14. Suppose the value of income elasticity of demand for a private college education is equal to 1.5. This means that
a. every $1 increase in income provides an incentive for a $1.50 increase in expenditures on private college education
b. every $1.50 increase in income provides an incentive for a $1 increase in expenditures on private college education
c. a 10 percent increase in income causes a 15 percent increase in the demand for a private college education
d. a 15 percent increase in income causes a 10 percent increase in the demand for a private college education
e. a 10 percent decrease in private college tuition will have a large enough income effect to increase spending on private college education by 15 percent

15. If Debbie goes shopping for shoes and she is willing to pay $50 for a pair of shoes but she only has to pay $20 because the shoes are on sale, then Debbie's consumer surplus on that pair of shoes is
a. $50
b. $20
c. $70
d. $30
e. $25

16. In general, as more consumers enter a market,
a. the marginal utility of consumers in the market declines
b. the total utility of consumers in the market declines
c. the market demand curve shifts leftward
d. the market demand curve shifts rightward
e. prices rise, so that there is movement upward along a fixed market demand curve

17. John moved his office from a building he was renting downtown to the carriage house he owns in back of his house. How will his costs change?
a. explicit and implicit costs rise
b. explicit costs rise; implicit costs fall
c. explicit and implicit costs fall
d. explicit costs fall; implicit costs rise
e. not enough information is given

18. If General Motors is earning only a normal profit,
a. it is making economic profit
b. it is breaking even
c. it is suffering an economic loss
d. it is covering only explicit costs
e. it is covering only implicit costs

19. Inputs that can be increased or decreased in the short run are called
a. fixed inputs
b. variable inputs
c. economic inputs
d. accounting inputs
e. normal inputs

20. If total cost at Q = 0 is $100 and total cost at Q = 10 is $500, then average variable cost at Q = 10 is
a. $500
b. $400
c. $50
d. $40
e. $10

21. A perfectly competitive firm's demand curve is
a. almost vertical at the market quantity
b. perfectly inelastic
c. perfectly elastic
d. horizontal at the price the firm wishes to charage
e. downward sloping

22. If a firm is producing at an output where the total revenue curve crosses the total cost curve,
a. revenue is maximized
b. cost is maximized
c. cost is minimized
d. profit is maximized
e. profit is zero

23. For a perfectly competitive firm,
a. P = MR at all output levels
b. P = MR at the profit-maximizing quantity only
c. P > MR at all output levels
d. P < MR at the profit-maximizing quantity only
e. P < MR at all output levels

24. The short-run significance of the minimum point on the average variable cost curve is that
a. it is the profit-maximizing level
b. it is the selling price
c. if price falls below this point, the firm should shut down
d. if the firm produces one more unit, its AVC will be less than MC
e. it shows the amount of total cost

25. Which of the following could not bar entry into an industry?
a. economies of scale
b. diseconomies of scale
c. patents
d. licenses
e. one firm's control of essential resources

26. What is true at the profit-maximizing quantity for a monopolist but not true of a perfectly competitive firm?
a. Price equals marginal cost
b. Price is greater than marginal cost
c. Marginal revenue equals marginal cost
d. Marginal revenue is less than marginal cost
e. Marginal revenue is greater than average revenue

27. For the perfectly competitive firm represented in the nearby exhibit, the short-run supply curve is
a. abcde
b. bcde
c. cde
d. de
e. abcd

28. A monopolist earning economic profit in the short run determines that as its present level of output, marginal revenue is $23 and marginal cost is $30. Which of the following should the firm do to increase profit?
a. Raise price and lower output
b. Lower price and lower output
c. Raise price and raise output
d. Lower price and raise output
e. Lower input but leave price unchanged

29. Eli Whitney III receives a patent for the rayon gin, a marketable good for which there are no close substitutes. Eli will maximize profits when
a. MR is maximized
b. MR = MC
c. MR > MC
d. MR < MC
e. P = MR > MC

30. In the short run, how will a profit-maximizing monopolist react if its marginal costs suddenly increase? It will
a. lower price to expand revenue possibilities
b. restrict output to extract a higher price from customers
c. maintain the current price if profits are still positive
d. increase plant size to lower marginal costs
e. decrease plant size to lower marginal costs

31. If Ford raises the price of its cars, the demand for GM cars
a. shifts to the left
b. is unaffected
c. becomes more elastic
d. shifts to the right
e. becomes vertical

32. Economies of scale yield
a. declining average cost
b. declining marginal cost
c. declining total cost
d. diminishing average returns
e. increasing marginal revenue

33. In general, a market supply curve of a resource is
a. downward sloping
b. upward sloping
c. horizontal at the market price
d. vertical
e. determined by firms

34. When all of the returns to a resource are in the form of economic rent,
a. the price of that resource is determined exclusively by supply
b. the price of that resource is determined exclusively by demand
c. the price and quantity of that resource are determined exclusively by supply
d. the price and quantity of that resource are determined exclusively by demand
e. the equilibrium price is zero

35. A price searcher in a resource market may be called a
a. monopolist
b. monopsonist
c. perfect competitor
d. oligopolist
e. monopolistic competitor

36. The marginal resource cost of labor will be greater than the price of labor (i.e., the wage rate) when the firm's
a. supply of a resource is downward-sloping
b. supply of a resource is upward-sloping
c. demand for a resource is downward sloping
d. demand for a resource is upward-sloping
e. supply of a resource is horizontal

37. To determine comparative advantage, the cost is measured in
a. foreign currency
b. domestic currency
c. gold only
d. units of weight and measure
e. opportunity cost

Spain France

Pounds of cheese 30 15

Gallons of wine 12 20

Note: Each entry in the table refers to the amount of each good that can be produced using one week of labor services.

38. Consider the nearby table. Which of the following is true regarding absolute advantage?
a. France has the absolute advantage in the production of both goods.
b. France has the absolute advantage only in the production of wine.
c. France has the absolute advantage only in the production of cheese.
d. Spain has the absolute advantage only in the production of wine.
e. Spain has the absolute advantage in the production of both goods.

39. Given the information in the table, which of the following is true concerning comparative advantage?
a. Spain has the comparative advantage in the production of both cheese and wine.
b. France has the comparative advantage in the production of both cheese and wine.
c. Spain has the comparative advantage in the production of cheese.
d. France has the comparative advantage in the production of cheese.
e. Spain has the comparative advantage in the production of wine.

40. Given the information in the table, which of the following is true?
a. It is impossible for the two countries to achieve mutual gains from trade because Spain has the absolute advantage in the production of both goods.
b. It is impossible for the two countries to achieve mutual gains from trade because France has the absolute advantage in the production of both goods.
c. Mutual gains from trade can be achieved only if France produces both goods.
d. Mutual gains from trade can be achieved only if France produces cheese and Spain produces wine.
e. Mutual gains from trade can be achieved in Spain produces cheese and France produces wine.

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

1. The substitution effect of a price change describes how the demand curve for a good shifts when its price changes.

2. If a $1 increase in price leads to a 1-unit decrease in quantity demanded, then demand must be unit elastic.

3. Marginal cost eventually rises because marginal product eventually diminishes.

4. If all a monopolist's costs are fixed costs, it will produce where demand is unit elastic.

5. The elasticity of demand for nurses depends on the elasticity of demand for hospital care.

III. Short Answer

1. If the United States has an absolute advantage in the production of computer components, should it export them worldwide? Explain.

2. What are the major reasons the United States favored a free-trade agreement with Mexico and why Mexico wanted a free-trade agreement with the United States?

IV. What are the likely consequences of the following events in the U.S. market for gasoline? In the blanks provided, indicate which curve will shift (S or D), and whether price and quantity increase, decrease, or stay the same (+, , NC). If the answer cannot be determined from the information given, mark the space with a "U". Show the results in the adjacent graph.

1. Congress lowers the excise tax on gasoline. Surprisingly, President Clinton does not veto the legislation.

P Curve __________

Price __________

Quantity __________

Q

2. The UN votes to lift the embargo on Iranian oil.

P Curve __________

Price __________

Quantity __________

Q

3. The EPA raises pollution standards on all cars.

P Curve __________

Price __________

Quantity __________

Q

4. GM finally discovers a way to build an electric-powered car that people will buy.

P Curve __________

Price __________

Quantity __________

Q

5. The economy falls into a recession that reduces after-tax income for the typical household.

P Curve __________

Price __________

Quantity __________

Q

V. Back-of-the-Envelope

Draw the graph that you would use to explain the following events.

1. Government imposed price floor in a perfectly-competitive market (e.g., farm commodities).

P

Q

2. Short-run equilibrium in a monopolistically competitive market with the firm suffering an economic loss.

P

Q

3. The impact of a minimum wage on a monopsonist.

P

Q

4. Long-run equilibrium for a firm in a perfectly competitive market.

P

Q

5. Equilibrium for a natural monopoly earning a positive economic profit.

P

Q