Download Sample questions for Exam II

Sample questions for Exam II
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Possible answers
1)
Which of the following is a good example of a pure public good?
a)
national defense
b)
police protection
c)
public education
d)
national parks
e)
none of the above
Answer:
national defense. Recall that a pure public good has to satisfy two properties:
non-rivalry in consumption, and non-excludability in consumption. It can be argued that police
and national parks do not meet the non-rivalry in consumption fully. For instance, as more
individuals visit the park at the same time, the degree of enjoyment that each visitor derives from
the park may be on the decline. This effectively implies that there is rivalry in consumption and
the provision of the service to an additional consumer reduces the quality (or quantity) available
to all other consumers. Education can fail to meet both, non-rivalry and non-excludability
properties. For instance, the lower the instructor/student ratio is the more difficult it may be for
each student to learn (non-rivalry is violated). It is relatively easy to exclude an individual from
attending a class (in fact, we use tuition in that way), which effectively means that the nonexcludability property is also not met. Non-excludability implies that once the service is extended
to one consumer, the costs of excluding another consumer become very high.
2)
Answer:
3)
Which of the following is not a characteristic of a pure public good?
a)
in the absence of government provision it will be underprovided
b)
provision of the good to one consumer (group) does not diminish the amount
available for other consumers
c)
provision of the good to one consumer (group) makes it difficult to exclude
another consumer (group)
d)
consumption by one consumer (group) reduces the availability of the
good to another consumer (group)
e)
none of the above
Statement in D is the exact opposite of the non-rivalry property.
Assume that the production of good X (for example, electricity) results in a negative
externality (pollution), then (assuming the law of demand and the law of supply hold)
which of the following statements is incorrect?
a)
the market price of electricity is lower than the socially optimal price of
electricity
b)
the level of output of electricity is above the socially optimal level of output
c)
the externality can be corrected through taxation of the producer, because
taxation can be used to internalize the external costs
d)
none of the above
Answer:
Statements A through C are correct. Recall that when a negative externality is
present in the production process, unless that externality is internalized through taxes or some
other corrective method, the firm that causes this external cost will not account for it in own its
costs of production and hence its pricing strategy will not take this external cost into account.
Note, this implies that the price will be based on the private (own costs of the firm) costs only,
and exclude the external costs. However, the total cost to the society includes both, the costs to
the firm and the external costs. Thus, a socially optimal price would tend to be based on a higher
cost than the market price. Because the price does not take into account all of the costs associated
with production, the quantity sold (the quantity demanded) will be higher than the one that would
be observed had the price been based on the correct, inclusive of the external effects, cost.
4)
Market equilibrium is
a)
Inefficient only if we have negative externalities present
b)
Inefficient only if we have positive externalities present
c)
Inefficient if we have either negative or positive externalities present
d)
Always efficient, regardless of the nature of externalities
Answer:
Presence of any externalities will make the supply function deviate from the
socially optimal supply function. In the case of negative externalities, the supply function will be
based on only internal, private costs to the firm, and hence the market equilibrium will not reflect
the total costs of production (overproduction will occur). However, if we have positive
externalities present, then the producer will not take into account the external benefits, and hence
the level of output will be below a socially optimal level of benefit.
Consider a simple setup: Flu vaccination: let’s assume that the marginal cost of a flu vaccination
is $25, and as a result it is sold on our campus for $25 dollars. Let’s assume that given this price,
500 people get vaccinated each year. The individuals who get vaccinated value the expected
benefit of vaccination (reduced probability of getting sick and hence suffering and missing
work/school) above the cost of the vaccination (25 dollars plus the pain of the injection). Now,
let’s assume that if an individual gets sick with flu, that individual can transmit the virus to other
students/faculty, which will increase the costs of the flu epidemic. These external costs will take
the form of reduced productivity, increased health care costs… If the individuals were to
incorporate these external benefits into their decision making when it comes to getting
vaccinated, then the expected benefit from the vaccination would have been greater: the reduced
probability of getting sick would still include reduced risk of suffering and missing work/school,
but it will also include reduced costs to other individuals in terms of their suffering and their
missing work/school. This increase in the expected benefit would induce more people to get
vaccinated, but the problem is that when an individual makes the decision to get vaccinated, they
ignore the external benefit (the positive externality), and hence fewer people would get
vaccinated than it is socially optimal.
5)
If the demand for a given product has a constant slope, then
a)
that demand has a constant elasticity of demand
b)
the elasticity of demand ranges from negative infinity to zero
c)
the elasticity of demand is one
d)
none of the above
Answer:
the point elasticity of demand = (slope of the demand)* (P/Q),
And since the ratio of P/Q is different at every point of a linear demand, the elasticity is not a
constant, even though the slope is. The elasticity of demand is zero at the Q-axis intercept,
because the price is zero. The elasticity of demand is infinite at the P-axis intercept, because the
quantity level is zero.
6)
Assume the following scenario, eBay reduces the insertion fees on their auctions by
10% on a given day, and as a result of that there are 4% more listings listed on that
day. What can we conclude about the value of the elasticity of demand for eBay
services by sellers on eBay?
a)
the elasticity is about -0.4
b)
the elasticity is about -2.5
c)
the elasticity is about -0.6
d)
none of the above
Answer:
elasticity: percent change in quantity / percent change in price = 4% / 10% = 0.4
On the exam I will not care about the sign, but it is worth mentioning that the value of the
elasticity is always negative, due to the law of demand: the price and quantity demanded move in
opposite directions.
7)
In the previous setup (question 6), we can conclude that at present, given the current
value of the fees charged, eBay is operating in (at) the
a)
elastic range of the demand
b)
inelastic range of the demand
c)
unit elastic point on the demand
d)
not enough information is provided
Answer:
Inelastic range is where the consumer is not very price sensitive: i.e. a quantity
response to a price change is relatively small. Relatively, in this case is defined as a change that is
smaller than the price adjustment that causes it. So, if the percent change in quantity demanded is
less than the percent change in the price that causes it, then we are in the inelastic range. This is
the case here, as a 10% change in the price caused only a 4% change in the quantity.
8)
Given the setup in question 6, and if the objective of eBay is to increase the profits
generated from the sale of its services to sellers on eBay, would you recommend that
eBay
a)
increase the fee
b)
decrease the fee
c)
maintain the same level of the fee
d)
not enough information is provided to make the decision
Answer:
Increase, since the response by the consumer is relatively small (inelastic range
of the demand).
9)
At what value of the elasticity of demand, the revenues would be maximized?
a)
negative infinity
b)
zero
c)
negative one
d)
any value that is between negative one and negative infinity
e)
any value that is between negative one and zero
Answer:
Recall the example in class. Also, note that when the elasticity of demand is one,
a small change in price leaves the revenues unchanged, as the response in quantity is equal to the
change in the price (in percentages).
10)
Assume that the industry is comprised of more than one firm. Which of the following
demands is likely to be more elastic?
a)
the demand faced by the entire industry
b)
the demand faced by an individual firm in that industry
c)
not enough information is provided
Answer:
Consider a simple scenario: the higher education. The industry includes all US
colleges and universities. For example, there are several schools operating in the area of WNY.
There are really no substitutes to higher education, while each of the schools has a number of
substitutes. For instance, NU competes against SUNY-Buffalo and so on. Now, consider that NU
increases its tuition by 25%, do you think that our enrollment will remain the same? Now,
imagine that all schools in the US increase their tuition costs by 25%, do you think our enrollment
will suffer? In the first case, NU is likely to lose its enrollment substantially, because there are
many substitutes to us who have just become relatively cheaper. In the second case, our
enrollment probably won’t change at all, because there are no substitutes to higher education.
This suggests that the demand for NU is more price sensitive than the demand for higher
education in general, i.e. the NU demand is more elastic!
11)
Product differentiation can
a)
make the demand relatively less elastic
b)
make the demand relatively more elastic
c)
none of the above
Answer: the whole point of differentiating one’s product is to reduce the substitutability
(competition) for the product. If the consumers believe that the product is different enough from
its competition that it is in the market by itself, then it’s demand will be less elastic. Recall that
one of the key determinants of the elasticity of demand is the availability of the substitutes.
12)
If the demand for a product increases, while the price is kept constant, then at that
price level the demand becomes
a)
less elastic
b)
more elastic
c)
the elasticity stays the same
Answer:
an increase in the demand implies that the consumer wants to purchase MORE at
the any price, hence the ratio of P/Q at any price (within the range of the original demand). And
since elasticity is the slope of the demand times P/Q, then the value of the elasticity in absolute
terms has decreased at the original price!
13)
If a sales tax is imposed on a product with a perfectly inelastic demand, then the
burden of the tax will
a)
Entirely fall onto the consumer
b)
Entirely fall onto the seller
c)
Will be shared equally by the consumer and the seller
d)
Mostly be paid by the seller
Answer: Perfectly inelastic demand means that the consumer is not price sensitive, i.e. there are
no substitutes to the product and the consumer needs to have a certain level of this product. Such
demands are “fixed” in terms of quantity. My demand for gasoline is an example of this. If a tax
is imposed on such a product, the consumer is effectively trapped and the supplier will be able to
pass the entire tax onto the consumer. Consider the effects of the rise in the price of oil on the
price of gasoline. The demand for gasoline tends to be relatively inelastic, and any increases in
the cost of oil are passed onto the consumer of gasoline.
14)
If the cross-price elasticity of demand between two goods is zero, then we can
conclude that these goods are
a)
substitutes in consumption
b)
complements in consumption
c)
unrelated in consumption
Answer:
cross price elasticity measures the impact a change in the price of one good has
on the demand for another good. If the cross-price elasticity is zero, then changes in the price of
one good have no impact on the demand for the other good: unrelated in consumption
If the goods were substitutes, then an increase in the price of one good would cause an increase in
the demand for the other good: cross price elasticity would be positive in value.
If the goods were complements, then an increase in the price of one good would cause an increase
in the demand for the other good: cross price elasticity would be negative
15)
Health insurance tends to make the demand for health care services
a)
more elastic
b)
less elastic
c)
unaffected
Answer:
if the consumer does not pay the whole price, but only a fraction, then the
consumer becomes less price sensitive
16)
Which of the following will not reduce the price sensitivity of the demand, i.e. will
not make the demand less elastic
a)
a rebate program of 5% based on the value of the purchase
b)
a discount program of 5% based on the value of the purchase
c)
a cash bonus of 5 USD regardless of the size of the purchase
d)
none of the above
Answer:
the first two connect the discount to the price, thus effectively reducing the price
sensitivity of the demand. The third choice does not connect the discount to the actual price,
hence leaving the price sensitivity unchanged.
17)
Which of the following problems will not be present in the private health insurance
market?
a)
asymmetry of information
b)
adverse selection
c)
moral hazard
d)
none of the above choices
Answer:
All of the three problems stated will be present.
Asymmetry of information: the insurer does not have the same information about the state of
health (and hence the expected future health care expenses) of an applicant as does the applicant
himself.
Adverse selection: this needs to be elaborated just so that the definition is clear. Selection here
DOES NOT refer to the selection by the insurer, but the selection by the applicants in terms of
which individuals select to apply for the insurance. If the selection is perfectly random, then there
are no problems, as those who apply for health insurance reflect the general population and hence
the cost of providing them with the health insurance reflects that associated with the overall
population. Adverse selection, is a form of self-selection. Self-selection simply means that the
selection process is not random, there is some particular characteristic involved in selection. For
example, we could argue that only good student who are interested in learning the material better
ask questions in class. Then we can argue that there is self-selection going on: students who ask
questions in class tend to have higher grades. Adverse selection refers to a situation where the
self-selection leads to the worst group selecting to apply. In the case of heal insurance, the
individuals who select to purchase health insurance are more likely to get sick and hence incur
health care costs.
18)
In a used car market, asymmetry of information problem helps sellers of cars with
a)
lower quality
b)
higher quality
c)
average quality
d)
none of the above
Answer:
the valuations tend to be based on the average expected quality, thus sellers with
lower quality (note asymmetry of information implies that it the buyer does not have a good way
of deducing the quality of the product) will benefit receiving valuations based on the average
quality.
19)
Graduates from elite schools typically tend to have an easier time finding a job than
their competitors from non-elite schools. One can argue that this is in part a result of
a)
asymmetry of information that exists in the labor market
b)
adverse selection that exists in the labor market
c)
moral hazard in the labor market
d)
none of the above
Answer:
employer does not know the true quality of the applicant. In this case, the
employer may use the education of a recent graduate as an indicator of the potential quality of the
employee.
* if the choice below was also included in the answers list for #19, how would that affect your
answer?
e)
adverse selection in the educational market
20)
Rationality in economics implies that
a)
the consumer maximizes his/her utility function
b)
the consumer follows certain moral principles
c)
the consumer does what the society perceives to be in the best interests for
that consumer
d)
none of the above, as there is no concept of rationality in economics
21)
Assume that the Utility function has the following form: (X^0.7) * (Y^0.3). Does this
function exhibit diminishing marginal utility in X?
a)
yes
b)
no
The power coefficient on X is less than one.
22)
Does the function from 21 exhibit diminishing marginal utility in Y?
a)
Yes
b)
No
Same logic as in 21
23)
Does the function in question 21 exhibit the property of?
a)
constant returns to scale
b)
diminishing returns to scale
c)
increasing returns to scale
d)
none of the above
Constant returns to scale requires the powers on X and Y to add up to one. This implies that a
given in crease in both X and Y will increase the total utility by the same proportion.
24)
In the example in question 21 can we argue that this consumer values each additional
dollar in income less than the preceding dollar?
a)
yes
b)
no
No, this would be the case if the function exhibited diminishing returns to scale.
Assume the following about the preferences of the consumer:
X
Q
1
2
3
4
5
6
Y
TUx
100
180
240
280
300
310
Q
1
2
3
4
5
6
TUy
20
38
54
68
80
90
25)
What is the level of MU of X when 4 units of X are purchased?
a)
80
b)
60
c)
40
d)
20
e)
10
f)
none of the above
Change in TUx from the fourth unit is 280-240 = 40
26)
Can we conclude that the consumer has an addiction to
a)
X
b)
Y
c)
Neither of the goods
MU in each good is diminishing.
27)
If the prices are: Px = $10, and Py = $5, and the consumer has in total $40, then a
utility maximizing combination of X and Y would be
a)
2 X and 4 Y
b)
1X and 6 Y
c)
3 X and 2 Y
d)
4 X and 0 Y
X
Q
1
2
3
4
5
6
Y
TUx
100
180
240
280
300
310
Q
1
2
3
4
5
6
TUy
20
38
54
68
80
90
MUx
100
80
60
40
20
10
Mux/Px
10
8
6
4
2
1
MUy
20
18
16
14
12
10
Muy/Py
4
3.6
3.2
2.8
2.4
2