Econ Practice Exam Flashcards
A city government hopes to decrease the quantity of sugary drinks consumed, and is planning to implement a tax on the drinks. Should the government tax companies that sell sugary drinks, or the consumers who purchase them?
- The companies that sell the drinks
- The consumers who purchase the drinks
- The impact of the tax will be the same regardless of who pays the tax
- The quantity of drinks consumed will not decrease as a result of the tax
The impact of the tax will be the same regardless of who pays the tax
Which of the following statements is true?
- If demand is linear, slope will vary across different points on the demand curve whereas the elasticity will be the same at all points on the curve.
- A linear demand curve has a constant slope, but each point on the curve has a different elasticity.
- Elasticity does not depend on units whereas slope does.
- A demand curve’s slope might change if the unit’s demand is measured in change.
- The data needed to know the demand curve’s entire slope are more likely to be available than the data needed to calculate elasticity at a given price.
- Elasticity at a point on the demand curve can be approximated if you know how quantity demanded changes with a small price change.
- Price elasticity of demand and slope are two names for the same concept.
- Slope measures how much quantity changes as price changes, but elasticity gives a unit-less measure of how significant that change is.
Elasticity does not depend on units whereas slope does.
Suppose that the table below shows the daily demand for high-speed train tickets from London to Paris. As the price increases from £250 to £350, what is the price elasticity of demand?
- 1/7
- 3/5
- 5/3
- 7
1/7
Elasticity is the absolute value of the percent change in quantity demanded divided by the percent change in price.
3/5
Elasticity is the absolute value of the percent change in quantity demanded divided by the percent change in price.
5/3
Elasticity is the absolute value of the percent change in quantity demanded divided by the percent change in price. Quantity demanded decreases by 1000, or 2/3 of 1500. Price increases by £100, or 2/5 of £250. Elasticity is 2/3 divided by 2/5, or 5/3.
7
7 would be the elasticity if price decreased from £350 to £250.
The table below shows a Red Sox fan’s demand for tickets to a game:
Which of the following statements is true?
- WTP for the third ticket is $100.
- WTP for the third ticket is between $90 and $100.
- WTP for the fifth ticket is $0.
- The fan is willing to pay any amount greater than $90 for the second ticket.
WTP for the third ticket is $100.
- At a price of $100, the fan only purchases one ticket. WTP therefore cannot be more than $100 for the third ticket—otherwise the fan would purchase at least 3 tickets at that price.
WTP for the third ticket is between $90 and $100.
- Since the third ticket is purchased at $90 but not at $100, the fan must have WTP between $90 and $100 for it.
WTP for the fifth ticket is $0.
- The fan is willing to purchase a five tickets at a price of $90, so WTP for the fifth ticket must be at least $90.
The fan is willing to pay any amount greater than $90 for the second ticket.
- The fan is willing to pay at least $90 for the second ticket, but not ANY amount greater than $90. Since the fan purchases only 1 ticket at a price of $100, we know that the fan is not willing to pay $100 for the second ticket.
An entrepreneur is considering starting a business baking and selling cupcakes. The entrepreneur estimates that average total costs per cupcake would be $1.00, and variable costs per cupcake would be $0.50.
An incumbent bakery in the neighborhood sells cupcakes at $3 per cupcake. The entrepreneur estimates that this bakery spends $1.50 in total costs on each cupcake, $0.75 of which is variable costs.
Should the entrepreneur start the new cupcake business?
The entrepreneur should start the new business as long as customers are not willing to pay more than $0.25 more for the incumbent’s cupcakes than for the entrepreneur’s cupcakes.
- See correct answer for explanation.
The entrepreneur should start the new business ONLY if customers are willing to pay at least $0.25 more for the new cupcakes than for the incumbent’s cupcakes.
- If customers have a higher WTP for the new cupcakes (by at least $0.25) the entrepreneur will be able to charge enough to cover total costs, even if the incumbent engages in a price war.
The entrepreneur should start the new business ONLY if customers are willing to pay at least $0.50 more for the new cupcakes than for the incumbent’s cupcakes.
- See correct answer for explanation.
The entrepreneur should definitely not start the new business.
- See correct answer for explanation.
Which of the following is NOT a factor that directly impacts a consumer’s WTP for a good?
- Availability of substitute goods
- Consumers’ income
- Weather
- Prices of the inputs used to produce the good
Availability of substitute goods
- WTP and the shape of the demand curve are influenced by the availability of acceptable substitutes for a good.
Consumers’ income
- A consumer with higher income is typically willing to pay more for a good.
Weather
- Weather can influence WTP for many goods, such as outdoor events and certain types of clothing.
Prices of the inputs used to produce the good
- Although the price of a good affects quantity demanded, the prices of inputs used to produce the good do not affect WTP – and therefore demand – directly.
A car collector wishes to sell a rare Porsche. There are two prospective buyers, and each buyer knows the willingness to pay of the other. The first buyer’s valuation is $200K, and the second buyer’s valuation is $300K. Which of the following methods would generate the greatest revenue?
- A fixed price of $200k.
- A fixed price of $250k.
- A sealed first-price auction.
- A sealed second-price (Vickrey) auction.
A fixed price of $200k.
- At this price, the car will definitely sell for $200k.
A fixed price of $250k.
- At this price, the higher-WTP customer will purchase the car for $250k. This is the only option that allows the seller to earn substantially more than $200k.
A sealed first-price auction.
- In a sealed first-price auction, the higher-WTP customer will bid just slightly above the lower-WTP customer’s WTP, and the car will sell for just over $200k.
A sealed second-price (Vickrey) auction.
- In a Vickrey auction, customers will bid their WTP, and the car will sell to the higher-WTP customer at a price of $200k.
An increase in the popularity of corn ethanol as a fuel increases the demand for corn around the world, causing the price to rise. What is the reason behind the higher price?
- To meet higher demand, the industry relies more on less cost efficient producers of corn.
- Higher fixed costs incurred in order to meet demand end up increasing the cost of production.
- Corn ethanol’s relative inefficiency as a fuel raises production costs for corn producers.
- The opportunity cost for supplying corn is higher than before.
To meet higher demand, the industry relies more on less cost efficient producers of corn.
- As more corn is demanded, the additional corn will be produced by less efficient suppliers, and prices will increase to cover their costs.
Higher fixed costs incurred in order to meet demand end up increasing the cost of production.
- The price charged by producers is based on their variable, rather than fixed, costs of production.
Corn ethanol’s relative inefficiency as a fuel raises production costs for corn producers.
- The corn producers do not have to use corn ethanol themselves, so its relative inefficiency will probably not impact their costs.
The opportunity cost for supplying corn is higher than before.
- We have no reason to believe that the opportunity cost of supply corn has increased in general
Two products have a cross-price elasticity of demand of approximately 0. Which of the following pairs of products could be the ones in question?
- High-speed internet access and online streaming of TV shows.
- Live concerts and iTunes downloads.
- Dishwashers and houseplants.
- Bicycles and public transportation.
High-speed internet access and online streaming of TV shows.
- These products are complements.
Live concerts and iTunes downloads.
- These products could be seen as substitutes or complements.
Dishwashers and houseplants.
- If the CPED is 0, the two goods are neither complements nor substitutes.
Bicycles and public transportation.
- These goods are substitutes.
A museum curator is bidding in a sealed first-price auction on a painting. The curator should place a bid:
- Less than the museum’s willingness to pay for the painting
- Equal to 30% of the museum’s willingness to pay for the painting
- Equal to the museum’s willingness to pay for the painting
- Greater than the museum’s willingness to pay for the painting
Less than the museum’s willingness to pay for the painting
- The curator hopes to capture some value for the museum, and can only accomplish this if the price paid is less than the museum’s WTP. A bid below WTP will also protect the museum against the winner’s curse.
Equal to 30% of the museum’s willingness to pay for the painting
- We cannot know the exact optimal bid without having some idea of what the other bidders are willing to pay.
Equal to the museum’s willingness to pay for the painting
- If the museum wins the auction, it will pay its full WTP and capture no value.
Greater than the museum’s willingness to pay for the painting
- If the museum wins the auction, it will pay more than it is willing to pay, which is never a desirable outcome.
A traveler’s willingness to pay for a room in a hotel in a remote location is $200. The traveler’s willingness to pay for internet access is $10. If the traveler views hotel rooms and internet access as complementary products, what is most likely the traveler’s willingness to pay for a room in a hotel that offers free internet access?
- $200
- Between $200 and $210
- $210
- More than $210
$200
- See correct answer for explanation.
Between $200 and $210
- See correct answer for explanation.
$210
- See correct answer for explanation.
More than $210
- Since the two goods are complementary, the traveler’s WTP for a bundle of the two should be higher than the sum of WTP for the two individual products.
A startup company is currently selling each unit of its product for $10.00 less than its total costs per unit. If the startup has an opportunity to expand its customer base by 10% through a marketing campaign, should the company consider the campaign?
- No, the company should shut down to avoid further losses.
- Yes, if the additional customers would lower the average cost enough to make the firm profitable.
- No, since the company is losing money on each unit sold, a greater quantity would lower profits further.
- Yes, because more customers now will result in more profit in the future.
No, the company should shut down to avoid further losses.
- Expanding the customer base might decrease per-unit costs sufficiently to make the company profitable.
Yes, if the additional customers would lower the average cost enough to make the firm profitable.
- As output increases, fixed costs per unit will decrease. This may lead to low enough average costs that the firm will be profitable.
No, since the company is losing money on each unit sold, a greater quantity would lower profits further.
- Price might be higher than the variable costs, in which case producing a greater quantity of the good will actually decrease losses.
Yes, because more customers now will result in more profit in the future.
- We do not know whether the price is higher than the variable cost. If it is not, additional customers will simply result in greater losses.
After running an advertising campaign for its line of dishwashers, an appliance store notices that consumer WTP for its dishwashers seems to have increased. However, the store has not captured any market share from its competitors. Which of the following might explain this outcome?
- The advertising campaign focused on negative features of competitors’ dishwashers rather than the positive features of the store’s own product.
- The advertising campaign focused on the advantages of owning a dishwasher, but did not mention the store’s specific brand of dishwasher.
- The advertising campaign alerted consumers that the store was having a major sale on dishwashers, without emphasizing the desirable features of the dishwashers.
- Dishwashers exhibit network effects, and the store is therefore operating in a “winner-take-all” industry.
The advertising campaign focused on negative features of competitors’ dishwashers rather than the positive features of the store’s own product.
- If the campaign had badmouthed a competitor, the store probably would have seen increased market share as consumers left the other store.
The advertising campaign focused on the advantages of owning a dishwasher, but did not mention the store’s specific brand of dishwasher.
- The campaign increased WTP for dishwashers in general, but without specifically promoting the store. Other dishwasher sellers have probably profited from the campaign in the same way.
The advertising campaign alerted consumers that the store was having a major sale on dishwashers, without emphasizing the desirable features of the dishwashers.
- Advertising the sale might not change consumer WTP for dishwashers, but should bring more customers to the store rather than to its competitors.
Dishwashers exhibit network effects, and the store is therefore operating in a “winner-take-all” industry.
- Dishwashers do not exhibit notable network effects.
Exotic Getaway Inc. is selling vacation packages to Bahamas. The company’s CEO thinks that the consumers’ willingness to pay for the packages is $4,000 each, but she is not quite sure. The company has a month to sell the tickets. What price should she set?
- $3,000
- $3,999
- $4,000
- $5,000
$3,000
- The company has a whole month to sell the tickets, and should probably see if it can sell them at a higher price.
$3,999
- The company has a whole month to sell the tickets, and should probably see if it can sell them at a higher price.
$4,000
- The company has a whole month to sell the tickets, and should probably see if it can sell them at a higher price.
$5,000
- The company can price the tickets at $5,000 to see if they will sell. If they do not, there is plenty of time to decrease the price before the month is up.
In order to test a new customer loyalty program, a store sends an email to its current customers in one of its existing markets, inviting them to opt into the new program. After several months, management observes that participants in the new program are much more frequent shoppers than the average customer. The management can conclude:
- That introducing the new loyalty program in all its markets will boost sales in the future
- That the new loyalty program has boosted sales among its test participants
- That the experiment was poorly designed
- All of the above
That introducing the new loyalty program in all its markets will boost sales in the future
- Other regions may not respond to the loyalty program in the same was that this region did.
That the new loyalty program has boosted sales among its test participants
- The shoppers who opted into the program may have been more frequent shoppers than the average customer already. The program itself may not have changed their behavior at all.
That the experiment was poorly designed
- By focusing on one region and selecting participants by allowing anyone to opt in, the store has created a potentially biased sample.
All of the above
- See explanations above.
A factory currently manufactures and sells 1000 boats per year. Each boat costs $8,000 to produce. $7,000 of the per-boat costs are for materials and other variable costs, while the per-boat fixed costs (incurred on yearly rent, administrative, and other fixed costs) are $1,000. If boat orders decrease to 800 boats per year, how do per-unit costs change?
- Variable costs are unchanged at $7,000 per boat and fixed costs are unchanged at $1,000 per boat
- Variable costs rise to $8,750 per boat and fixed costs rise to $1,250 per boat
- Variable costs fall to $5,600 per boat and fixed costs are unchanged at $1,000 per boat
- Variable costs are unchanged at $7,000 per boat and fixed costs rise to $1,250 per boat
Variable costs are unchanged at $7,000 per boat and fixed costs are unchanged at $1,000 per boat
- See correct answer for explanation.
Variable costs rise to $8,750 per boat and fixed costs rise to $1,250 per boat
- See correct answer for explanation.
Variable costs fall to $5,600 per boat and fixed costs are unchanged at $1,000 per boat
- See correct answer for explanation.
Variable costs are unchanged at $7,000 per boat and fixed costs rise to $1,250 per boat
- The $1,000,000 in fixed costs is now spread across only 800 boats. This results in $1,250 in fixed costs per boat. Variable costs are unchanged.
A farm equipment manufacturer has already spent $3 million in research and development to design a new model of tractor. To produce the tractors, the company will have to contract to rent a factory for a year at a cost of $20 million, and will then spend an additional $10,000 per tractor in materials and wages.
The company estimates that it can sell 2,000 tractors per year at a certain price, and concludes that it should produce the tractors. What is the lowest price the company could be using in this calculation?
- $10,000
- $11,500
- $20,000
- $20,000
$10,000
- Since the company is deciding whether to start producing tractors, it needs to cover the $20 million in fixed costs as well as the $10,000 in variable costs.
$11,500
- $11,500 would be enough to cover the variable costs of the tractors, plus the $3 million spent on research and development. However, the $3 million is sunk, and should not be included in calculations. Moreover, the $20 million in yearly fixed costs is not sunk, and should be taken into account.
$20,000
- The company needs to earn enough on each tractor to cover the fixed costs of operating for a year. $20 million spread over 2,000 tractors is $10,000 per tractor, so adding in the variable costs, the company needs to sell each tractor for $20,000
$21,500
- $21,500 per tractor would be enough to cover even the sunk costs of research and development. However, since these costs have already been incurred, they should not factor into forward-looking decisions.
An apparel company recently introduced a new dress, which sold out within days. Which of the following strategies could management use to determine the best price for the dress?
- Send customers a survey asking how much they would be willing to pay for the dress
- Increase the quantity of dresses stocked in each store in order to satisfy demand at the current price
- Set a price equal to the cost of manufacturing the dress, plus a standard mark-up.
- Gradually increase the price of the dress until profits begin to fall
Send customers a survey asking how much they would be willing to pay for the dress
- Respondents have a strong motivation to lie on the survey.
Increase the quantity of dresses stocked in each store in order to satisfy demand at the current price
- Maximizing the quantity sold is not the store’s goal, as you may recall from the lesson on elasticity.
Set a price equal to the cost of manufacturing the dress, plus a standard mark-up.
- To determine an ideal price, the company should consider demand rather than focusing solely on cost.
Gradually increase the price of the dress until profits begin to fall
- The dress probably sold out because it was priced too low.
The table below shows fixed and variable costs per-unit for an ice cream shop, “Company A,” and its local competitor, “Company B”.
Costs for rent and utilities are fixed by contract, and the two shops produce the same flavor of ice cream. The owner of Company A is considering lowering the price of its ice cream, starting a price war with Company B in an effort to grab market share from its competitor. Would it be a wise decision for Company A to enter a price war with Company B?
- Yes, because price wars are always an effective way to increase market share.
- Yes because Company A’s cost structure allows it to lower prices further than Company B.
- No, because Company B has greater market share than Company A.
- No, because Company B can produce the product for less than Company A can.
Yes, because price wars are always an effective way to increase market share.
- See correct answer for explanation.
Yes because Company A’s cost structure allows it to lower prices further than Company B.
- A price war would be won by the company that can lower its prices the most. The ability to lower prices is based off of the variable costs per unit.
No, because Company B has greater market share than Company A.
- See correct answer for explanation.
No, because Company B can produce the product for less than Company A can.
- See correct answer for explanation.
Refer to the figure below showing the market demand for bottled beer in Massachusetts. The arrows are consistent with which of the following events?
- Due to health concerns, people are demanding less bottled beer at any price and producers have raised their prices in response.
- Producers have increased the price of bottled beer and hence quantity demanded has decreased.
- As wine consumption has increased in popularity, the quantity of beer demanded at any price has decreased and producers have raised their prices in response.
- The arrows are consistent with all of these events.
Due to health concerns, people are demanding less bottled beer at any price and producers have raised their prices in response.
- A reduction in demand would cause a shift in the demand curve, whereas this diagram only depicts a move along the existing demand curve.
Producers have increased the price of bottled beer and hence quantity demanded has decreased.
- The diagram depicts how the change in the price of a good reduces quantity demanded.
As wine consumption has increased in popularity, the quantity of beer demanded at any price has decreased and producers have raised their prices in response.
- A reduction in demand would cause a shift in the demand curve, whereas this diagram only depicts a move along the existing demand curve.
The arrows are consistent with all of these events.
- A reduction in demand would cause a shift in the demand curve, whereas this diagram only depicts a move along the existing demand curve.
The chart below shows consumers’ willingness to pay for cups of coffee. If these are the only four buyers in the market, then the market quantity demanded at a price of $4 is:
- 12 cups
- 15 cups
- 20 cups
- 22 cups
12 cups
- Customers will continue buying cups of coffee as long as their WTP for a certain cup is higher than its price.
15 cups
- At a price of $4, John is willing to buy a fourth cup of coffee, but not a fifth. Similarly, Anton, Julie, and Sarah each buy 5, 4, and 2 cups of coffee, respectively. Hence total market demand at a price of $4 is 15 cups.
20 cups
- The value John derives from his fourth cup of coffee is $6, so by purchasing it for $4, he gains $2 of value. However, he values a fifth cup at $3, and would be unwilling to spend $4 on it. Hence John buys 4 cups. Similar calculations can be made for the other three customers.
22 cups
- The value John derives from his fourth cup of coffee is $6, so by purchasing it for $4, he gains $2 of value. However, he values a fifth cup at $3, and would be unwilling to spend $4 on it. Hence John buys 4 cups. Similar calculations can be made for the other three customers.
