C8 - Micro-Economics (5-15 Qs with C9) BC Flashcards
In the SHORT RUN, a firm operating in a perfectly competitive market will always produce where:
1. Total costs (TC) equals total revenue (TR)
2. Price (P) equals marginal cost (MC)
3. Marginal revenue (MR) equals average revenue (AR)
4. Average cost (AC) equals marginal revenue (MR)
A) 1 and 4 only
B) 2 and 3 only
C) 1, 2 and 3 but not 4
D) 1 and 4 only
B - 2 (P = MC) and 3 (MR = AR)
In perfect competition firms face a horizontal demand curve which means that price equals marginal revenue (in fact P = MR = AR = Demand Curve). The statement “price = marginal cost” is the same as saying MR = MC in this situation. Another feature of a horizontal demand curve is that MR = average revenue. In the sHORT RUN even in perfect competition supernormal (economic) profit can be earned. This means that total costs (TC) does NOT need to equal total revenue (TR) in the short run (although it should be noted that they will in the long run). Another way of view supernormal profit is that average revenue is GREATER than total average cost at the level of production. Note that average revenue and marginal revenue are the same with a horizontal demand curve.
If there is a free market in tomatoes and if demand is completely inelastic, the most likely effect of an outstandingly good crop will be:
A) A fall in supply
B) To increase the price of tomatoes
C) To increase the quantity demanded
D) To reduce the total income of tomato market gardeners
Good crop = high yielding crop = more tomatoes
D - To reduce the total income of tomato market gardeners
A good crop will increase supply (so A is incorrect) and the price will drop (so B is incorrect). As demand is perfectly inelastic, there will be no effect on demand (so C is incorrect). The drop in price given no change in demand will drop the revenue so total income of tomato market gardeners will reduce.
Economic profit is calculated as:
A) Accounting profit PLUS supernormal profit
B) Accounting profit MINUS supernormal profit
C) Accounting profit PLUS the cost of the entrepreneur’s time and capital
D) Accounting profit MINUS the cost of the entrepreneur’s time and capital
D - Accounting profit MINUS the cost of the entrepreneur’s time and capital
Accounting profit and economic profit are NOT the same.
Economic profit and supernormal profit ARE the same thing.
Accounting profit fails to take into account opportunity cost, in particular for capital and time the entrepreneur has tied up in his business. Economic profit therefore = Accounting Profit LESS the cost of the entrepreneur’s capital and time. Note that economic profit can be 0 when accounting profit is positive.
In a price monopoly, which of the following is TRUE of a monopolist?
A) The industry supply is LESS than the monopolist supply
B) The industry supply is GREATER than the monopolist supply
C) The industry supply is EQUAL to the monopolist supply
D) The supply curve is downward sloping
C - The industry supply is EQUAL to the monopolist supply
By definition, a monopolist is the single firm in the market and as a result firm and market supply are the same.
Which of the following definitions describes a production possibility frontier?
A) It shows all possible combinations of production for two goods
B) It shows the maximum quantities of goods which may be produced using all available resources
C) It is the outer boundary of the set of all optional combinations of goods
D) It shows the exact amount of each good which should be produced using all available resources
B - It shows the maximum quantities of goods which may be produced using all available resources
The production possibility frontier describes the maximjm quanities of goods using all available resources in the economy.
If the price of steel increases and simultaneously consumers obtain an increase in income then:
1. The quantity of cars demanded will increase
2. The price of cars will increase
3. Expenditure on cars will increase
Which of the following is correct:
A) 1 only
B) 1 and 2
C) 2 only
D) 2 and 3 only
B - 1 (the quantity of cars demanded will increase) and 2 (the price of cars will increase)
An increase in the price of steel will cause production cost to rise which inturn causes the supply curve to shift to the left as less is supplied at any given selling price. Assuming demand is constant a shift in the supply curve to the left will cause the price of cars to increase. An increase in income will typically cause the deamnd curve to shift to the right meaning more quantity is demanded at any given price. Whether the quantity of cars demanded/produced will increase will depend on the relative impact of the two factors. The leftward shift of the supply curve causes quantity to rise. Both movement (supply and demand) will cause price to rise. Expenditure on cars depends on the impact of both quantity and price and as result potentiallt could increase or decrease.
Which of the following characterise OLIGOPOLY markets:
1. Price competition
2. Interdependence of firms
3. Short-run individual sales revenue maximisation
4. Non-price competition
A) 1 and 3 only
B) 2 and 4 only
C) 1, 2 and 4 but not 3
D) 2, 3 and 4 but not 1
B - 2 (Interdependence of firms) and 4 (Non-price competition)
An oligopolist market contains relatively few producers with high barriers to entry (such as pharma). The key with oligopolistic markets is that the firms are interdependent. The individual firm cannot derive its demand curve without knowing the price and quantity that will be set by other producers. This means that the firm should work together to work out the industry profit maximising level of output (and hence supernormal profit) and then divide the total maket quantity between the market participants. This kind of action describes collusion in quantity and price setting which is illegal in many countries including the UK (but not all). If a firm was to compete on price (i.e. cutting price to sell more output) then it would find its competitors would follow suit which results in a downwardly spiraling price until all supernormal profit in the industry is eradicted. Given that price cutting leads to erosion of industry economic profits oligopolistic firms will tend to compete in other ways (for example product features and marketing).
The ability of a firm to charge different prices to different customers is called:
A) Brand loyalty
B) Price Discrimination
C) Product differentiation
D) Monopolistic competition
B - Price Discrimination
Price discrimination is where the same product is sold to two different groups of customers at different prices to exploit differences in their demand curves. Customers with more inelastic demand (unchanging quantity of a good or service when its price changes) will be charged a higher price than customers with more elastic demand. For this to work resale of the good between both sets of customers must be prevented. A good example of this in practice is peak and off peak train fares.
Which of the following is NOT true about a profit maximising monopolist?
A) The monopolist will produce where MC = MR
B) The monopolist will not necessarily produce at minimum average cost
C) The monopolist will face an upward sloping demand curve
D) The monopolist will always produce on the elastic portion of the demand curve.
C - The monopolist will face an upward sloping demand curve
Monopolists face downward sloping demand curves i.e. higher prices less demanded and lower prices more is demanded.
Monopolists control the market, which can be bad - so they are going downwards to hell
Consider the following statements about costs and revenues
1. If marginal costs are exceed marginal revenues a profit maximising firm should reduce output
2. If average costs are less than average revenues a profit maximising firm should increase output
3. If total costs equal total revenue a firm is maximising profit
Which of the followingare correct?
A) 1 only
B) 2 only
C) 3 only
D) 1 and 2
A - 1 only (If marginal costs are exceed marginal revenues a profit maximising firm should reduce output)
All firms should produce where MR = MC as this maximises profit. Profits can be increased by reducing output if MC > (greater than) MR as the cost of each additional unit is greater than the revenue earned from its sale.
Note that for monopolies, oligopolies (in both the short and long run) and perfect competition and monopolistic competition (short run only) can result in average revenue exceeding average cost even at the profit maximising level of output, which creates supernormal profit. If total cost equals total revenue no economic (supernormal) profit is earned this may or may not occur at the profit maxiimising level of output depending on the market structure.
Which of the following irs of commodities IS LIKELY to have POSITIVE cross-elasticity of demand?
A) Postage stamps and Envelopes
B) Foreign and domestic holidays
C) Airliners and aviation fuel
D) Computers and software
B - Foreign and domestic holidays
Products that are complements will tend to have NEGATIVE cross elasticity. For example, if the price of postage stamps increases dramatically, you would expect people to send fewer letters and as a result demand for envelopes would decline.
Substitutes tend to have a POSITIVE cross elasticity. For example, if the price of foreign holidays increased significanty then you would expect mre people to holiday at home and hence the demand of domestic holidays to rise.
Given the following data on costs, revenue and output, what is the firm’s profit maximising level of output?
Output / Total costs / Total Revenue
0 / 80 / –
1 / 105 / 60
2 / 118 / 100
3 / 130 / 135
4 / 140 / 160
5 / 152 / 175
6 / 165 / 180
7 / 180 / 175
8 / 196 / 160
9 / 250 / 135
A) 6 Units
B) 1 Unit
C) 5 units
D) Between 6 and 2
C - 5 Units
By review, look for the maximum profit by comparing marginal revenue to marginal costs. Producing at 5 units will maximise profits as MC exceeds MR when move up to 6 units.
MR = Change in Total Revenue / Change in Quantity Sold
Last year the price of A was 100 and the quantity sold 30,000 units and for B the price was 140 and the quantity sold was 25,000 units. This year the price and quantities sold of A were 120 and 28,000 and for B 150 and 24,000.
Which of the following is true for the PED?
A) A = -0.56, B = -0.33
B) A = -6.66, B = -4
C) A = -0.33, B = -0.56
D) A = -0.357, B = -0.587
C - A = -0.33, B = -0.56
Price elasticity of demand (PED) = (% CHANGE IN QUANTITY DEMANDED) / (% CHANGE IN PRICE)
PED PRODUCT A = ((28,000-30,000)/30,000) / ((120-100)/100) = -0.33
PED PRODUCT B = ((24,000-25,000)/25,000) / ((150-140)/140) = -0.56
*In the case of POSITIVE elasticity, an increase in price leads to an increase in volume. A real-world example of this could be luxury goods, where a high price can signal both quality and scarcity, driving up demand.
If NEGATIVE, this means that an increase in price leads to a fall in quantity demanded or the demand curve is downward sloping.
Where does profit maximising monopolist produce?
A) MC = AC
B) MC = VC
C) MC = AR
D) MC = MR
D - MC = MR
All profit maximising firms produce where marginal revenue (MR) = marginal cost (MC). Below this amount MR > MC so profit could be increased by expanding output. Above this amount MR < MC so profit could be increased by reducing output
If a firm is NOT breaking even, under which of the following circumstances will they continue to produce, at least in the short run?
A) Average revenue > Average fixed costs
B) The are covering fixed costs
C) Average revenue > Average variable cost
D) They are covering total costs
C - Average revenue > Average variable cost
In the short run firms will continue to produce if they are covering their vairable costs. Fized costs (like rent) by their nature cannot be avoided in the short run but variable costs can (by producing nothing). As fixed costs cannot be avoided in the short run they are irrelevent for short-run decision making. Total cost (i..e fixed and variable) must be covered in the long run if the firm is to survive.
In the short run a company in perfect competition will continue to produce even if losses are being made if:
A) Fixed costs are covered
B) Marginal costs are covered
C) Variable costs are covered
D) Excess costs are covered
C - Variable costs are being covered
In the short run firms will continue to produce if they are covering their variable costs. Fixed costs by their very nature cannot be avoidded in the short run, but variable costs can (by producing nothing). As fixed costs cannot be avoided in the short run, they are irrelevant for short run decisions making. Total cost (i.e. fixed and variable costs) must be covered in the long run if the firm is to survive.
Consider the following statements:
1. When the Marginal Cost (MC) is below average total cost (ATC), then average variable cost (AVC) must be falling
2. Average variable cost (AVC) plus average fixed cost (AFC) equals average total cost (ATC)
3. A sunk fixed cost will not have any opportunity cost
4. Marginal cost (MC) is defined as the difference between the average cost of one unit and the average cost of the next additional unit
Which of these statements is/are TRUE?
A) 2 and 3 only
B) All of the above
C) 4 only
D) 1, 2 and 3 only
A - 2 (AVC + AFC = ATC) and 3 (Sunk fixed cost has no opportunity cost) only
- WRONG - Statement 1 (MC below ATC, AVC must be falling) would be true if it said when MC is below AVC, then AVC must be falling. The MC curve intersects at the minimum point of both the average variable and average total cost curves.
- CORRECT - ATC is AVC + AFC. A sunk cost has no opportunity cost.
- CORRECT - Sunk cost are costs incurred in the past or unavoidable costs in the future. Given these costs cannot be avoided, they become irrelevent for decision making.
- WRONG - MC is defined as the change in the TOTAL variable cost (or TOTAL cost) of producing one extra unit, not the change in average costs.
From a position of equilibrium, what would be the impact on the demand for petrol if the price of all cars were reduced by 50% (all other factors remaining constant)?
A) The demand for petrol would rise
B) The demand for petrol would fall
C) Nothing, petrol demand and car prices are unrelated
D) There would be an equi proportionate in the demand for petrol
A - The demand for petrol would rise
Cars and petrol are complementary goods. If the price of cars falls, more cars will be pruchased leading to a higher demand for petrol. This is POSITIVE cross price elasticity.
What is the elasticity of demand under perfect competition?
A) 1
B) -1
C) 0
D) infinity
D - infinity
Under perfect competition the demand curve is perfectly elastic (horizontal). This results in an infinite measure for price elasticity of demand. A change in price will lead to no units being sold.
Which of the following would shift a demand curve to the RIGHT?
A) An increase in consumer income
B) A reduction in production costs
C) A decrease in a rival goods price
D) A reduction in unit labour costs
A - An increase in consumer income
A shift of the demand curve to the right mean more quantity is demanded at any given price. An increase in consumer incomes will lead to higher demand at any given price.
A reduction in production costs will shift the SUPPLY CURVE to the right (i.e. the firm would be willing to supply more at any given price). A decrease in competing products price will result dwa,md shifting away from the firm to the competing product (this will cause the demand curve to shift to the LEFT). A reduction in labour costs results in a reduced production costs.
A firm in equal perfect competition is in long run equilibrium
Which of the following conditions is/are necessarily true?
1. Marginal Cost (MC) equals Marginal Revenue (MR)
2. Average cost (AC) equals average revenue (AR)
3. Average revenue (AR) equals marginal revenue (MR)
A) All of the above
B) 1 and 2 only
C) 2 and 3 only
D) 3 only
A - All conditions are true
MR = MC gives the profit maximising for all firms in both short and long run. In perfect competition price = MR = AR (due to the horizontal demand curve). In perfect compeition no supernormal (economic) profit can be earned in the long run sue to low barrier to entry. This results in AR = AC in the long run.
At what point does the profit maximising monopolist determine its output?
A) Where the marginal revenue is equal to the marginal cost
B) Where the mariginal revenue is at it’s highest compared to the marginal cost
C) Where the marginal revenue curve cuts average revenue curve
D) Where average revenue is maximised
A - Where the marginal revenue is equal to the marginal cost
All profit maximising firms produce where marginal revenue (MR) = Marginal Cost (MC). Below this amount MR>MC so profit could be increased by expanding output. Above this amount MR<MC so pofit could be increased by reducing output.
In comparing equilibrium output and price of profit maximising monopolist and a perfectly competitive industry which of the following is true of the monopolist?
A) Higher price, higher output
B) Lower price, higher output
C) Lower price, lower output
D) Higher price, lower output
D - Higher price, lower output
A monopolist faces a downward sloping demand curve unlike a firm in a perfect compeitition which has a perfectly elastic (horizontal) demand curve. The result of this is that the price will be higher and the output lower when compared with perfect competition.
If the Price of a good falls from 60p to 50p and the Quantity demanded falls from 25m units to 10m units
The price of Elasticity of demand is?
A) -3
B) 3.6
C) 1/3
D) -1/3
B - 3.6
Price elasticity of demand (PED) = (% change in QUANTITY demanded) / (% change in PRICE)
SO PED = ((10M-25M)/25M) / ((50-60)/60) = +3.6.
*This is a very odd situation. Typically PED is negative as price and quantity demanded are inversely related (seesaw - when one increases the other decreases). However certain luxury goods where exclusivity is linked to price we can find that demand is positively related to price. The key is to focus on the formula.
