Economic Concepts - Part 2

Question 1

Which of the following is not a characteristic of an oligopoly market?

A.  	Firms face a downward-sloping demand curve.

B.  	Barriers to enter the market are significant.
C.  	Firms tend to compete on non-price factors.
D.  	There are many sellers.

Answer 1

D. There are many sellers.

The presence of few sellers in the market is one of the basic characteristics of the oligopoly form of market structure.

Question 2

Definition of Oligopoly

Answer 2

Oligopoly is a market structure in which a small number of firms has the large majority of market share. An oligopoly is similar to a monopoly, except that rather than one firm, two or more firms dominate the market.

Question 3

Which of the following pricing policies results in establishment of a price to external customers higher than the competitive price for a given industry?
	A.  	Collusive pricing.
	B.  	Dual pricing.
	C.  	Predatory pricing.
	D.  	Transfer pricing.

Answer 3

A. Collusive pricing.

Collusive pricing occurs when the few firms in an oligopolistic market (or industry) conspire to set the price at which a good or service will be provided. Such collusion typically is carried out to establish a price higher than would exist under normal competition. Overt collusive pricing is illegal in the U.S.A.

Question 4

A group of firms that conspires to make price and output decisions for a product or service is called
	A.  	an oligopoly.
	B.  	a cartel.
	C.  	price leadership.
	D.  	monopoly.

Answer 4

A. an oligopoly.

A cartel is a group of firms that conspire to make price and output decisions for a product or service; it is overt collusion and illegal in the U.S. A prime example is OPEC, which meets regularly to set output quotas for oil for member oil-exporting countries.

Question 5

An air route between two cities is served by only three U.S. airlines. Every week, the largest of the three airlines posts its prices for future flights on the internet. The other two airlines immediately match the posted prices for future bookings. This practice illustrates which of the following?
	A.  	Overt collusion.
	B.  	Tacit collusion.
	C.      Price-war.
	D.  	An illegal cartel.

Answer 5

B. Tacit collusion.

The circumstances described illustrate price leadership, which is a form of tacit collusion. Tacit collusion is not illegal in the U.S.

Question 6

Which of the following market structures is least likely to be found in any industry in the U.S.?
	A.  	Perfect competition.
	B.  	Monopolistic competition.
	C.  	Oligopoly.
	D.  	Monopoly.

Answer 6

A. Perfect competition.

An industry or market that meets all of the characteristics of perfect competition is virtually nonexistent in the U.S. (or in other developed market systems).
While some industries or markets possess some of the characteristics of perfect competition, none possesses all of the essential characteristics of perfect competition.

For example, perfect competition assumes the product or service is perfectly homogeneous, such that there are no differences in size, quality, style, or other features and, therefore, no reason to advertise in order to compete.

Question 7

Which one of the following would not cause an increase in demand for a commodity?
A. An increase in the number of consumers.
B. An increase in the price of a substitute commodity.
C. An increase in consumers’ preference for the commodity.
D. A reduction in the price of the commodity.

Answer 7

D. A reduction in the price of the commodity.

A reduction in price will not cause an increase in demand for a commodity, but rather will change (increase) the quantity demanded. An increase in demand causes a shift of the demand curve (up and to the right). A change in price causes movement along a specific demand curve.

Question 8

When a demand schedule is plotted on a graph, the resulting demand curve will be
	A.  	positively sloped.
	B.  	negatively sloped.
	C.  	completely vertical.
	D.  	completely horizontal.

Answer 8

B. negatively sloped.

The demand schedule of an individual or of the market shows that more units of a commodity are demanded as the price decreases. Therefore, the demand curve would be negatively sloped; the quantity demanded would be lower at higher prices and would increase as price decreases. The quantity demanded varies inversely with price along a given demand curve:

Thus, a demand curve has a negative slope; quantity is inversely related to price.

Question 9

If a change in market variables causes a supply curve to shift inward, which one of the following will occur?

A.  	The price at which the same quantity will be provided after the shift will be less than the price before the shift.
B.  	At a given price, a greater quantity will be provided after the shift than the quantity provided before the shift.
C.  	The supply curve after the shift will intercept the Y axis at a lower point than before the shift.
D.  	In order for the same quantity to be provided after the shift as was provided before the shift, price will have to increase.

Answer 9

D. In order for the same quantity to be provided after the shift as was provided before the shift, price will have to increase.

If the supply curve shifts inward (to the left), the same quantity will be provided after the shift as was provided before the shift, only at a higher price.

Question 10

Which one of the following factors would not cause an increase in the supply curve of a commodity?
A. Improvements in related technology.
B. A decrease in the cost of production inputs.
C. An increase in the number of manufacturers of the commodity.
D. An increase in the price of the commodity.

Answer 10

D. An increase in the price of the commodity.

A change in price changes the quantity supplied, which is a movement along a supply curve, not a shift in the supply curve. An increase in the price of a commodity would increase the quantity supplied, but would not shift the supply curve.

Question 11

What is the effect on the quantity of a commodity supplied relative to demand as a result of a government-mandated price ceiling or price floor?

	 Price Ceiling 	 Price Floor 
	 Quantity Shortage 	 Quantity Shortage 
	 Quantity Shortage 	 Quantity Surplus 
	 Quantity Surplus 	 Quantity Shortage 
	 Quantity Surplus 	 Quantity Surplus

Answer 11

Price Ceiling Price Floor

Quantity Shortage Quantity Surplus

A price ceiling is a government-mandated maximum price that can be charged for a good or service. Rent controls, for example, establish the maximum price that can be charged for rent.
Price ceilings result in a lower price than would otherwise occur in a free market and cause the quantity of a commodity supplied to be less than would be demanded at a free market price.

Thus, a shortage exists as the difference between quantity supplied at the price ceiling and the greater quantity demanded at that price. A price floor is a government-mandated minimum price for a good or service. The minimum wage law, for example, establishes the minimum wage that can be paid to employees.
Price floors result in a higher price than would otherwise occur in a free market and cause the quantity of a commodity supplied to be greater than would be demanded at a free market price.
Thus, a surplus exists as the difference between quantity supplied at the price floor and the lesser quantity demanded at that price.

Question 12

An increase in the price of Commodity Y from $50 to $60 resulted in an increase in the quantity supplied, from 80 units to 88 units. Which one of the following is the price elasticity of supply?
	A.  	+ 2.
	B.  	+ 0.5.
	C.  	- 2.
	D.  	- 0.5.

Answer 12

B. + 0.5.

Elasticity of supply is measured by the formula: % change in quantity supplied divided by % change in price. For the facts given, the calculation would be .10/.20, or + .5. Since the elasticity factor is less than 1, a change in price results in a proportionately smaller change in quantity supplied.

Question 13

The elasticity of demand is measured by
A. The change in quantity divided by the change in price.
B. The change in price divided by the change in quantity.
C. The percentage change in quantity divided by the percentage change in price.
D. The percentage change in price divided by the percentage change in quantity.

Answer 13

C. The percentage change in quantity divided by the percentage change in price.

The elasticity of demand measures the percentage change in the quantity demanded of a commodity as a result of a given percentage change in the price of the commodity. The formula for a commodity is:

Elasticity = Percentage change in quantity demanded
Percentage change in price
The percentage change in quantity demanded is computed by dividing the change in quantity by the original quantity (or the new quantity or the average of the original and new quantities).
The percentage change in price is computed by dividing the change in price by the original price (or the new price or the average of the original and new prices).
The absolute value of the percentage change in quantity is then divided by the absolute value of the percentage change in price. The result is expressed as a positive number. The resulting demand elasticity can be:

Less than 1 = inelastic: quantity percentage change is less than the percentage change in price.
Equal to 1 = unitary: quantity percentage change is the same as the percentage change in price.
Greater than 1 = elastic: quantity percentage change is more than the percentage change in price.

Question 14

A company has a policy of frequently cutting prices to increase sales. Product demand is significantly elastic. What impact would this have on the company’s situation?
A. Quantity increases proportionally more than the price declines.
B. Quantity increases proportionally less than the price declines.
C. Price increases proportionally more than the quantity declines.
D. Price increases proportionally less than the quantity declines.

Answer 14

A. Quantity increases proportionally more than the price declines.

Elasticity of demand measures the percentage change in the quantity of a commodity demanded as a result of a given percentage change in the price of a commodity. When demand is elastic (an elasticity coefficient > 1), the percentage change in quantity is greater than the percentage change in price. Therefore, for a given price decline, there will be a greater than proportional increase in quantity.

Question 15

If demand for a product is elastic, what would be the effect of a price increase and a price decrease on total revenue (TR) generated?
	  Price Increase  	  Price Decrease  
	 TR Increase 	 TR Increase 
	 TR Increase 	 TR Decrease 
	 TR Decrease 	 TR Increase 
	 TR Decrease 	 TR Decrease

Answer 15

TR Decrease TR Increase

When demand is elastic (with a calculated elasticity coefficient greater than 1), the percentage change in demand is greater than the percentage change in price.
Therefore, an increase in price would result in a greater than proportionate decrease in quantity, which would cause a decrease in total revenue. A decrease in price would result in a greater than proportionate increase in quantity, which would cause an increase in total revenue.

Question 16

Which of the following characteristics would indicate that an item sold would have a high price elasticity of demand?
A. The item has many similar substitutes.
B. The cost of the item is low compared to the total budget of the purchasers.
C. The item is considered a necessity.
D. Changes in the price of the item are regulated by governmental agency.

Answer 16

A. The item has many similar substitutes.

Price elasticity of demand measures the percentage change in the quantity of a commodity demanded as a result of a given percentage change in the price of the commodity. A high price elasticity of demand means that the percentage change in demand would be greater than the percentage change in price. For example, an increase in price would result in a greater than proportionate decrease in demand. Such a result would likely indicate that there are many similar substitutes for the commodity for which the price was increased; buyers would have many other options when the price of the commodity of concern is increased.

Question 17

A 4% increase in the market price of Commodity X resulted in an 8% increase in the quantity of Commodity X supplied. Which one of the following statements is correct?
	A.  	Supply is inelastic.
	B.  	Supply is unitary.
	C.  	Supply is elastic.
	D.  	Supply is price neutral.

Answer 17

C. Supply is elastic.

Since the percentage change in supply (8%) was greater than the percentage change in price (4%), supply is elastic.

Question 18

Allen buys only beer and pizza. When the price of beer is $2.00 per bottle and the price of pizza is $10.00, Allen maximizes his total utility (satisfaction) by buying 5 beers and 4 pizzas. If the marginal utility of the 5th beer is 100 utils, which one of the following would be the marginal utility of the 4th pizza?
	A.   40 utils.
	B.  	100 utils.
	C.  	200 utils.
	D.  	500 utils.

Answer 18

D. 500 utils.

When total utility is maximized, the marginal utility (MU) of the last dollar spent on each and every item acquired must be the same. Thus, total utility is maximized when: MU of beers/price of beers = MU of pizza/price of pizza. Using the values given: 100 utils/$2.00 = MU of pizza/$10.00. The equation for beers = 100/$2 = 50 utils per dollar. The MU of pizza also must be 50 utils per dollar. Therefore, 50 = MU of pizza/$10 = 500 utils.

Question 19

Which one of the following cost curves does not have a general "U-shape"?
	A.  	Average variable cost (AVC) curve.
	B.  	Average fixed cost (AFC) curve.
	C.  	Average total cost (ATC) curve.
	D.  	Marginal cost (MC) curve.

Answer 19

B. Average fixed cost (AFC) curve.

Since, by definition, fixed costs do not change with changes in output over the relevant range of production, the more units produced, the lower the average fixed cost. Simply put, more units are being produced for a fixed cost. Therefore, the average fixed cost decreases continuously over the relevant range of production. It is not “U-shaped.”

Question 20

According to the law of diminishing returns, which one of the following is correct?
A. The marginal product (output) falls as more units of a variable input are added to fixed inputs.
B. The marginal product (output) increases as more units of a variable input are added to fixed inputs.
C. The total product (output) falls as more units of a variable input are added to fixed inputs.
D. Marginal utility falls as more units of goods are consumed.

Answer 20

A. The marginal product (output) falls as more units of a variable input are added to fixed inputs.

According to the law of diminishing returns, as more units of a variable input are added to fixed inputs, a point is reached at which the continued addition of variable inputs results in decreasing output per unit of variable input. Generally, this diminishing return results when the increasing variable inputs overwhelm the fixed inputs, which results in inefficiencies.

Question 21

Which of the following is a characteristic of monopolistic competition?
A. There are a very few sellers.
B. The product or service is only slightly differentiated.
C. There are no close substitutes for the product or service.
D. Firms cannot easily enter or leave the market.

Answer 21

B. The product or service is only slightly differentiated.

In monopolistic competition, firms sell a product or service that is only slightly differentiated; the product or service is similar to, but not identical with, other products or services.
In addition, monopolistic competition has the following characteristics:

A large number of sellers.
Close substitutes for the product or service.
Ease of entry into or exit from the market.

Question 22

In which of the following market structures are firms most likely to avoid price competition for fear of creating a "price war"?
	A.  	Perfect competition.
	B.  	Monopolistic competition.
	C.  	Oligopoly.
	D.  	Monopoly.

Answer 22

C. Oligopoly.

In an oligopoly, there are few sellers and the actions of each firm are known by and affect the other firms in the industry. Therefore, if one firm lowers its price in an effort to increase market share, other firms are likely to lower their prices.

This could create a “chain reaction,” whereby the few firms are continuously lowering their prices, constituting a “price war.”

Question 23

Which of the following characteristics is common to the four basic market structures–perfect competition, monopolistic competition, oligopoly, and pure monopoly?
A. Firms can make profits in the long run.
B. Firms face a negatively sloped demand curve.
C. Firms have control over the price charged.
D. Firms will seek to produce at the quantity where marginal revenue (MR) equals marginal cost (MC).

Answer 23

D. Firms will seek to produce at the quantity where marginal revenue (MR) equals marginal cost (MC).

Under each of the four basic market structures firms, will seek to produce where marginal revenue (MR) equals marginal cost (MC). At the quantity of output where marginal revenue equals marginal cost, a firm will maximize profits or minimize losses in the short run, and in the long run, for firms in oligopoly and pure monopoly.

For production under any of the market structures, if MR > MC, any additional output will increase profit or reduce losses, and if MC > MR, any additional output will decrease profit or increase losses.

Question 24

Which of the following is not a characteristic of perfect competition?
A. A large number of independent buyers and sellers.
B. All firms sell a homogeneous product or service.
C. Each selling firm is too small to separately affect the price of the commodity.
D. Firms cannot easily enter or leave the market.

Answer 24

D. Firms cannot easily enter or leave the market.

In a perfectly competitive market, firms can easily enter or leave the market. In addition, a perfectly competitive market has the following characteristics:

A large number of independent buyers and sellers, each of whom is too small to separately affect the price of a commodity.
All firms sell a homogeneous product or service.
Resources are completely mobile.
Buyers and sellers have perfect information.
Government does not set prices.

Question 25

Which one of the following could be the basis for a natural monopoly?
A. Control of a raw material necessary for a commodity.
B. A patent on a commodity.
C. A government license granting an exclusive right.
D. Economics of (or increasing return to) scale.

Answer 25

D. Economics of (or increasing return to) scale.

A monopoly exists when there is a single provider of a commodity for which there is no close substitute and entry into the industry is restricted.
A natural monopoly is defined as a monopoly that results from the economics associated with providing a good or service.
Specifically, a natural monopoly results in industries in which there is increasing returns to scale over a sufficient quantity of output, such that a single firm can satisfy the entire market demand at a lower cost per-unit of output than two or more firms. Traditional “public utilities” are examples of natural monopolies.
Other reasons for monopolies include:

1. Exclusive control of raw materials.
2. Government-granted franchise, including patents.

Question 26

In which of the following market structures, if any, is a firm assured of making a profit in the short run?
Perfect Competition Monopolistic Competition Oligopoly Pure Monopoly
Yes Yes Yes Yes
No Yes Yes Yes
No Yes No Yes
No No No No

Answer 26

PerfectCompetition MonopolisticCompetition Oligopoly PureMonopoly

No No No No

A firm is not assured of making a short-run profit in any of the four basic market structures. Whether or not a firm makes a profit in any market structure depends on the firm’s ability to produce a good or service at a cost that is less than the price at which it can sell the product in the market.

A firm in any of the market structures can make a profit, break even, or suffer a loss, depending on the relationship between average cost to produce and sales price.

Question 27

Which of the following forms of economic activity is considered in macroeconomics, but not in microeconomics?
A. Individuals providing economic resources to business entities.
B. Individuals paying taxes to the federal government.
C. Individuals paying business entities for goods/services.
D. Individuals receiving payments from business entities.

Answer 27

B. Individuals paying taxes to the federal government.

Individuals paying taxes to the federal government is not considered in microeconomics (which considers only the relationship between individuals and businesses), but is considered in macroeconomics, which includes the government sector (as well as the financial sector and imports/exports).

Question 28

As a result of the recession in 2009 and the related decline in tourism, several thousand hospitality industry workers in Florida became unemployed. These workers were
	A.  	frictionally unemployed.
	B.  	structurally unemployed.
	C.  	cyclically unemployed.
	D.  	seasonally unemployed.

Answer 28

C. cyclically unemployed.

Workers who are unemployed because of a recession are considered cyclically unemployed. They are unemployed because a downturn in the business cycle (including a recession) has reduced the current need for workers.

Question 29

Which of the following is not included in what is considered the natural rate of unemployment?
	A.  	Cyclical unemployment.
	B.  	Structural unemployment.
	C.  	Frictional unemployment.
	D.  	Seasonal unemployment.

Answer 29

A. Cyclical unemployment.

Cyclical unemployment, which results from a downturn in the business cycle that has reduced the current need for workers, is not considered an element of the natural rate of unemployment. The natural rate of unemployment would include structural, frictional, and seasonal unemployment.

Question 30

Which of the following issues is least likely to be relevant to the study of macroeconomics?
	A.  	Business cycles.
	B.  	Aggregate supply.
	C.  	Elasticity of demand.
	D.  	Inflation and deflation.

Answer 30

C. Elasticity of demand.

Elasticity of demand is the issue that is least likely to be studied in macroeconomics, as it is concerned with the effects of a change in price on the demand for an individual good or service and not with the activity or outcome of an entire economy.

Question 31

Which of the following indicates that the economy is in a recessionary phase?
A. The rate of unemployment decreases.
B. The purchasing power of money declines.
C. Potential national income exceeds actual national income.
D. There is a shortage of essential raw materials and costs are rising.

Answer 31

C. Potential national income exceeds actual national income.

National income is the total payments for economic resources included in the production of all goods and services. During the recessionary phase of a business cycle, actual national income is typically less than potential national income as a result of decreased demand, which is characteristic of the recessionary phase of a business cycle and the resulting decrease in payments for goods and services.

Question 32

The following information is available for economic activity for year 1:

	In billions
Financial transactions 	$60 
Second-hand sales 	50
Consumption by households 	40
Investment by businesses 	30
Government purchases of goods and services 	20
Net exports 	10

What amount is the gross domestic product for year 1?
	A.  	$210 billion.
	B.  	$160 billion.
	C.  	$100 billion.
	D.  	$90 billion.

Answer 32

C. $100 billion.

Gross domestic product (GDP) is the total output of final goods and services produced during a period. It can be measured using either the expenditures approach or the income approach. The information provided permits GDP to be measured using the expenditures approach, which is the sum of:

Consumption by individuals/households $40B
Investment by businesses 30
Government purchases 20
Net exports (net purchases by foreign buyers) 10
Total Expenditures (GDP) $100B

Question 33

Which of the following changes in unemployment is most likely to be associated with a period of economic contraction?
A. Decrease in the cyclical unemployment rate.
B. Increase in the natural unemployment rate.
C. Increase in the cyclical unemployment rate.
D. Increase in the structural unemployment rate.

Answer 33

C. Increase in the cyclical unemployment rate.

Cyclical unemployment results from a contraction in economic activity (i.e., a decrease in aggregate demand). During a period of economic contraction, the cyclical unemployment rate would be expected to increase.

Question 34

An economy is at the peak of the business cycle. Which of the following policy packages is the most effective way to dampen the economy and prevent inflation?
A. Increase government spending, reduce taxes, increase money supply, and reduce interest rates.
B. Reduce government spending, increase taxes, increase money supply, and increase interest rates.
C. Reduce government spending, increase taxes, reduce money supply, and increase interest rates.
D. Reduce government spending, reduce taxes, reduce money supply, and reduce interest rates.

Answer 34

C. Reduce government spending, increase taxes, reduce money supply, and increase interest rates.

All four of these fiscal and monetary policy actions would function to dampen demand and, therefore, the economy and would (help) prevent inflation.

Question 35

Which of the following changes is most likely to be a lagging indicator of a change in the business cycle?
A. Change in building permits.
B. Change in consumer expectations.
C. Change in duration of unemployment
D. Change in weekly manufacturing hours.

Answer 35

C. Change in duration of unemployment

Changes in employment normally are a result of changes in the business cycle. Therefore, the length of time workers are unemployed would lag behind a change in the business cycle. After a business cycle has turned down (is recessionary), the length of unemployment would increase, and vice versa.

Question 36

Assume that the Gross Domestic Product (GDP) Deflator index is:

Year GDP Deflator
Year 1 175
Year 2 180
Year 3 184

If nominal GDP for 2003 is $11,500 billion, which of the following amounts is closest to real GDP for 2003?
	A.  	$11,058 billion.
	B.  	$11,275 billion.
	C.  	$9,660 billion.
	D.  	$6,250 billion.

Answer 36

D. $6,250 billion.

Real GDP is determined by adjusting nominal (current dollar) GDP for the effects of inflation, such that current-year GDP is expressed in terms of base period dollars (price level). The Year 3 GDP deflator of 184 shows that the price level has increased by 84% since the base period. The calculation is:

100 - 184 = 84 = .84
100 100

Thus, Year 3 prices are 184% of the base period prices. To get real GDP, nominal GDP is divided by 1.84. Thus, $11,500/1.84 = $6,250 billion. In terms of base period dollars, Year 3 GDP would be $6,250 billion.

Question 37

The U.S. M1 measure of money supply includes:
Paper Currency Check-Writing Deposits Savings Deposits
Yes Yes Yes
Yes Yes No
Yes No Yes
Yes No No

Answer 37

Paper Currency Check-Writing Deposits Savings Deposits

Yes Yes No

The M1 measure of money supply includes paper currency, coins, and check-writing deposits, which are the primary financial instruments used for transactions.
Check-writing deposits are amounts held by banks, savings and loan associations, and credit unions for which ownership can be transferred by writing a check. Savings deposits are not an element of the M1 definition of money.

Question 38

Which of the following actions is the acknowledged preventive measure for a period of deflation?
	A.  	Increasing interest rates.
	B.  	Increasing the money supply.
	C.  	Decreasing interest rates.
	D.  	Decreasing the money supply.

Answer 38

B. Increasing the money supply.

When an economy is in deflation, increasing the money supply (for example, by lowering the reserve requirement or, in most circumstances, lowering the discount/interest rate) will stimulate demand and increase the general price level.

Question 39

Freely fluctuating exchange rates perform which of the following functions?
A. They automatically correct a lack of equilibrium in the balance of payments.
B. They make imports cheaper and exports more expensive.
C. They impose constraints on the domestic economy.
D. They eliminate the need for foreign currency hedging.

Answer 39

A. They automatically correct a lack of equilibrium in the balance of payments.

A lack of equilibrium in the balance of payment results when a country has imports from abroad and investments made abroad that are different than (greater than or less than) exports to other countries and investments made in the country (i.e., “outflows” are different than “inflows”). That imbalance causes the relative demand for the currency of each country to be different. Fluctuating exchange rates permit these changing demands to be realized, which enables a return to equilibrium. For example, with a U.S. deficit in the balance of payments, the U.S. demand for foreign currencies will exceed the foreign currencies provided by foreign currency inflows. As a result, there will be an increase in demand for foreign currencies relative to the U.S. dollar, and freely fluctuating exchange rates will enable the value of the dollar relative to other currencies (i.e., the exchange rate) to fall and help move the balance of payments back into equilibrium.

Question 40

Which of the following types of exchange risk derives from changes in currency exchange rates that alter the value of future transactions?
	A.  	Translation exchange risk.
	B.  	Economic exchange risk.
	C.  	Transaction exchange risk.
	D.  	Investment exchange risk.

Answer 40

B. Economic exchange risk.

Economic exchange risk derives from changes in currency exchange rates that alter the value of future revenues or costs. Exchange rate changes may make future foreign revenues convert to fewer units of a domestic currency (or other currency) or make future costs convert to more units of a domestic currency (or other currency). These types of changes may reduce the financial viability of future transactions between entities for which the currency exchange rate has changed.