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Eco 301 Test Questions
Test 2
For the following, please answer "True" or "False" and explain why.
8) When buying a piece of equipment, it is always best for the firm to pay cash instead of borrowing the
funds since this renders the equipment less costly.
9) Four years after graduating from college you must decide if you want to go on as an accountant (your
college major) or if you want to make a career change and become a singer. The cost of your education will
matter for your decision.
10) An accountant may amortize the expense of a durable good by dividing the total amount spent on the
good by the number of years the good is expected to last. An economist may amortize the expense of a
durable and never fully account for the total expense.
11) Your company makes copper pipes. Over the years, you have collected a large inventory of raw
copper. The production process involves melting the copper and shaping it into pipes. You also have a large
stockpile of pennies. Suppose the price of copper rises so much that the copper in the penny becomes worth
more than one cent. Should you melt down your pennies?
12) You have two career options. You can work for someone else for $50,000 a year, or, you can run your
own business, with annual revenue of $100,000, and explicit costs of $40,000 annually. Explain which
career option a profit-maximizer would select and why.
For the following, please answer "True" or "False" and explain why.
27) The "Law of Diminishing Marginal Returns" could also be termed the "Law of Increasing Marginal
Costs."
28) The marginal cost curve intersects the average fixed cost curve at its minimum.
29) A consumer purchases a book by driving across town to a bookstore, standing in line for five minutes
to pay the cashier, and then pays $5. The same book is purchased by another consumer who spends 2
minutes placing the order over the internet for $10. The book necessarily cost the first consumer less.
8.1
For the following, please answer "True" or "False" and explain why.
19) A market is perfectly competitive even if firms have the ability to set their own price as long as the
price difference reflects differences in the product.
20) If transaction costs are high, then it is more likely a firm's demand curve is downward sloping.
21) Explain why individual firms in competitive markets face more elastic demand curves than the market
as a whole.
8.2
For the following, please answer "True" or "False" and explain why.
14) Even though fixed costs do not affect the output decision, an increase in fixed costs results in a wider
range of prices for which the firm operates at a loss.
15) If a firm sets marginal revenue equal to marginal cost it will make an economic profit.
16) If a firm does not make an economic profit it will shut down.
18) Explain why shutting down and going out-of-business are different concepts.
19) Suppose a firm has the following total cost function: TC = 100 + 4q 2. What is the minimum price
necessary for the firm to earn profit? Below what price will the firm shut down in the short run?
20) The above figure shows the cost curves for a typical firm in a competitive market. Note that if p = 10,
then MC = p at both q = 5 and q = 60. Can they both yield maximum profit? Explain.
8.3
For the following, please answer "True" or "False" and explain why.
22) If a firm cannot earn profits in the short run, it will shut down.
23) If the market price in a competitive market is below the minimum of average variable cost the firm
will shut-down.
24) If a competitive firm has to pay a lump sum tax it will produce less.
25) A competitive firm's supply curve is identical to its marginal cost curve.
26) The above figure shows the cost curves for a typical firm in a competitive market. From the graph,
estimate the firm's profits when price equals $10 per unit.
29) Suppose a firm has the following total cost function TC = 100 + 2q 2. If price equals $20, what is the
firm's output decision? What are its short-run profits?
31) Suppose there are 1000 identical Kumquat farmers. For each, TC = 10 + q2. Derive the market supply
curve.
For the following, please answer "True" or "False" and explain why.
12) If firms in a competitive market are identical, the long-run market supply curve is horizontal.
6) If entry is limited due to a limited input, firms in that market earn long run economic profit. Provide an
example of a limited input that prevents entry.
7) In the long-run firms in a competitive market make zero economic profit. This induces most firms to
leave the industry.
8) Even if two competitive firms in the same market have different production technologies, they will each
earn long-run zero profits. Why?
14) Consumers who are more sensitive to changes in price suffer a greater loss of consumer surplus from
any given price increase.
21) A per unit subsidy increases both consumer and producer surplus, but results in a deadweight loss.
1) As the quantity produced of a good increases, the social welfare generated by that good increases.
2) The competitive output maximizes welfare (e.g., see Figure 14.25 or Figure 15.9).
8) Policies that restrict supply could generate an increase in social welfare because the increase in producer
surplus could exceed the decrease in consumer surplus.
9) If a city decides to lift restrictions of how many taxi cabs can operate social welfare will increase.
Economic Analysis
5. Suppose anyone with a driver's license is capable of supplying one trip from the airport to the
downtown business center on any given day. The long-run supply curve of such trips is horizontal at p =
$50, which is the average cost of such trips. Suppose daily demand is Q = 1000 - 10p. Calculate the change
in consumer surplus, producer surplus and social welfare if the city government requires those people
supplying such trips to possess a special license, and the government will issue only 300 licenses.
6. By 1996, the world price for raw sugar, $11.750 per pound, was about half the domestic price,
22.50 per pound, because of quotas and tariffs on sugar imports. As a consequence, American-made corn
sweetener, which costs $1.20 a pound to make, can be profitably sold. Archer-Daniels-Midland made an
estimated profit of $290 million in 1994 from selling corn sweetener. The U.S. Commerce Department
says that the quotas and price support reduce American welfare by about $3 billion a year. If so, each
dollar of Archer-Daniels-Midland's profit costs Americans about $10. Model the effects of a quota on
sugar in both the sugar and corn sweetener markets.
15) Suppose an industry trade group has convinced legislators that a price floor should be used so that
producer surplus is maximized in the market for milk. The group argues that such a policy would save the
"family farm." Assuming a downward-sloping linear demand curve and a horizontal long-run supply curve,
determine the resulting price, output and social welfare from such a policy. Compare this result to the
competitive equilibrium.
16) Ann and Bill each spend $30 per month on cigarettes when the price is $1 per pack. Draw a graph to
illustrate that the consumer with the less elastic demand will suffer the greater loss of consumer surplus
when the price of cigarettes increases. Explain and label the figure.
25) The above figure shows the demand and supply curves in the market for milk. Currently the market is
in equilibrium. If the government establishes a $4 per gallon price support, estimate the change in p, Q, and
social welfare.
26) The above figure shows the demand and supply curves in the market for milk. Currently the market is
in equilibrium. If the government establishes a $2 per gallon price ceiling to ensure that children are
nourished, estimate the change in p, Q, and social welfare.