Module 4 – Markets

Question 1

Here we have the graph of the market for recent law school graduates from 4.1.2

Imagine there are currently 80,000 lawyers in the market. Approximately what is the short-run equilibrium salary paid to lawyers?

• $280,000
• $160,000
• $100,000
• $30,000

Answer 1

$280,000

At a price of $280,000, firms would demand less than 10,000 lawyers. This would result in many unemployed lawyers which would not be an equilibrium result in the short-run.

$160,000

At a price of $160,000, firms would demand 50,000 lawyers. This would result in 30,000 unemployed lawyers which would not be an equilibrium result in the short-run.

$100,000

At a price of $100,000, firms demand 80,000 lawyers. This answer can be found by looking at the 80,000 mark on the quantity axis and then moving up to where the demand curve “intersects” the 80,000 quantity mark. In the short-run, the supply curve can be thought of as a straight vertical line at 80,000.

$30,000

At a price of $30,000, firms would demand more than 100,000 lawyers. This would result in an excess demand of over 20,000 lawyers which would not be an equilibrium result in the short-run.

Question 2

In the previous example, what will happen to the market for recent law school graduates in the long-run?

Here is the graph again for reference:

• Less students will enter law school and thus the quantity of lawyers will decrease in the long-run.
• Firms will eventually raise salaries to the point where 80,000 students are willing to enter law school.
• Since the market is in short-run equilibrium, neither salaries nor the quantity of lawyers will change.

Answer 2

Less students will enter law school and thus the quantity of lawyers will decrease in the long-run.

In order for there to be 80,000 lawyers in equilibrium, firms would have to be willing to pay $280,000 salaries which they are not willing to do. Thus there is an excess supply of lawyers and the number of students entering law school will decrease.

Firms will eventually raise salaries to the point where 80,000 students are willing to enter law school.

See correct answer for explanation.

Since the market is in short-run equilibrium, neither salaries nor the quantity of lawyers will change.

In the short-run, law school graduates cannot leave the work force due to lower salaries. Potential students however can choose to not enter law school and as a result in the future there will be less law school graduates.

Question 3

Here we again have the graph of the market for lawyers from 4.1.2

From the last question we know that the number of students entering law school will decrease from 80,000. Given that there are 80,000 new law student graduates in the market, approximately how many new students will enter law school this year (round to the nearest 5,000)?

Number:

Answer 3

30,000

Currently there are 80,000 new law school graduates, resulting in a wage of $100,000. At this wage, only 35,000 new law school graduates are supplied. In this example, that means that only 35,000 prospective law students will enter law school.

Question 4

Which of the following is likely to increase unemployment the most?

• A law implements a minimum wage under the market equilibrium wage and the labor supply is elastic.
• A law implements a minimum wage under the market equilibrium wage and the labor supply is inelastic.
• A law implements a minimum wage above the market equilibrium wage and the labor supply is elastic.
• A law implements a minimum wage above the market equilibrium wage and the labor supply is inelastic.

Answer 4

A law implements a minimum wage under the market equilibrium wage and the labor supply is elastic.

A minimum wage is a price floor which limits how low a price can be charged. Setting a price floor under the equilibrium wage will have no impact on the market regardless of the elasticity of the labor supply.

A law implements a minimum wage under the market equilibrium wage and the labor supply is inelastic.

A minimum wage is a price floor which limits how low a price can be charged. Setting a price floor under the equilibrium wage will have no impact on the market regardless of the elasticity of the labor supply.

A law implements a minimum wage above the market equilibrium wage and the labor supply is elastic.

An elastic supply of labor means that an increase in wages will result in a larger increase in the number of hours employees want to work. This would make a price floor (minimum wage) more likely to lead to a surplus of labor and unemployment.

A law implements a minimum wage above the market equilibrium wage and the labor supply is inelastic.

An inelastic supply of labor means that an increase in wages will result in a smaller increase in the number of hours employees want to work. Thus the minimum wage will increase unemployment, but not as much as it would have if the labor supply was elastic.

Question 5

The graph below depicts a price floor on the sale of electrician services. Which region or regions represent producer revenues?

• Producer revenues are given by D + E + F.
• Producer revenues are given by A.
• Producer revenues are given by B + C + D + E.
• Producer revenues are given by B + D + E + F.

Answer 5

Producer revenues are given by D + E + F.

D, E, and F are all part of revenues, but not all of it. B is also revenue earned by electricians.

Producer revenues are given by A.

A represents consumer surplus and is not a part of revenues.

Producer revenues are given by B + C + D + E.

C is part of deadweight loss and represents lost surplus due to the market intervention. It is not a part of revenues.

Producer revenues are given by B + D + E + F.

The revenue earned can be calculated by multiplying the quantity sold by the price, which in this case gives the tall rectangle made by B + D + E + F. The height of the rectangle represents the price, and the width of the rectangle represents the quantity sold.

Question 6

Consumers bear more of the incidence of a tax when supply is:

• more elastic.
• less elastic.

Answer 6

more elastic.

When the supply curve is less steep, or more elastic, firms are more sensitive to the price change caused by the tax, and as a result are able to adjust quantity supplied accordingly. Thus firms will end up “paying” a smaller portion of the tax and consumers will bear more of the incidence of the tax.

less elastic.

When the supply curve is steeper, or less elastic, firms are less sensitive to the price change caused by the tax, and are not as able to adjust quantity supplied accordingly. Thus firms will end up “paying” a greater portion of the tax and consumers will bear less of the incidence of the tax.

Question 7

Firms bear more of the incidence of a tax when demand is:

• more elastic
• less elastic

Answer 7

more elastic.

When the demand curve is less steep, or more elastic, consumers are more sensitive to the price change caused by the tax, and as a result are able to adjust quantity demanded accordingly. Thus consumers will end up “paying” a smaller portion of the tax and firms will bear more of the incidence of the tax.

less elastic.

When the demand curve is steeper, or less elastic, consumers are less sensitive to the price change caused by the tax, and are not as able to adjust quantity demanded accordingly. Thus consumers will end up “paying” a greater portion of the tax and firms will bear less of the incidence of the tax.

Question 8

A university is hoping to limit the amount of junk food that is consumed by students at the university food halls. The university is considering putting a tax on junk food. Which of the following taxes will be the most efficient at limiting the amount of junk food consumed?

• A tax imposed on the students
• A tax imposed on the vendors selling the food
• The impact of the tax will be the same regardless of whom the tax is imposed on.
• The tax will not decrease consumption of junk food

Answer 8

A tax imposed on the students

See correct answer for explanation.

A tax imposed on the vendors selling the food

See correct answer for explanation.

The impact of the tax will be the same regardless of whom the tax is imposed on.

The impact of the tax does not depend on whom it is imposed on because in either case, the price will change and students and the vendors will adjust their quantity demanded and supplied accordingly. The magnitude of the reduction depends solely on the price elasticity of demand and supply.

The tax will not decrease consumption of junk food

See correct answer for explanation.

Question 9

Consider the market for print encyclopedias. In the last 10 years, the cost of producing encyclopedias has decreased substantially due to lower printing and information acquisition costs. At the same time, more and more people have started using the internet as their primary source of information. What can we infer about the change in the price and quantity in the encyclopedia market over the last 10 years?

• Price and quantity have decreased.
• Price has increased and quantity has decreased.
• Price has decreased and the effect on quantity cannot be determined
• Price has increased and the effect on quantity cannot be determined.

Answer 9

Price and quantity have decreased.

See correct answer for explanation.

Price has increased and quantity has decreased.

See correct answer for explanation.

Price has decreased and the effect on quantity cannot be determined

With a greater number of alternative sources of information, demand for encyclopedias will decrease. This fall in demand will result in both lower prices and quantity. At the same time, the supply of encyclopedias will increase due to lower costs. This lowers the price and increases quantity. Thus, we can only say for certain that price decreases. The overall change in quantity will be determined by the relative magnitudes of the two effects.

Price has increased and the effect on quantity cannot be determined.

See correct answer for explanation.

Question 10

Consider the market for chocolate bars. A major chocolate company is trying to project their revenue for the upcoming year. Due to excellent predicted weather conditions, the cost of cocoa, a key ingredient in chocolate, will decrease for next year. At the same time, a popular magazine has started promoting the health benefits of chocolate. Just from this information, what can the company know about next year’s revenue?

• Revenues will increase from the current year.
• Revenues will decrease from the current year.
• Revenues will be unchanged from the current year.
• The impact on revenues cannot be determined.

Answer 10

Revenues will increase from the current year.

See correct answer for explanation.

Revenues will decrease from the current year.

See correct answer for explanation.

Revenues will be unchanged from the current year.

See correct answer for explanation.

The impact on revenues cannot be determined.

Due to the increased demand, prices and quantity increase. Due to the increased supply, prices decreases and quantity increases. Thus quantity increases but the impact on price cannot be determined. Revenue is equal to price multiplied by quantity. As a result, the effect on revenue cannot be determined.

Question 11

Computer prices in the last year have gone down due to technological advancements. At the same time, there has been a large decrease in the supply of new software developers, raising the costs of producing computer software. What will be the impact on the equilibrium price and quantity of computer software?

• The price and quantity will increase.
• The price will increase and quantity will decrease.
• The price will increase and the impact on quantity cannot be determined.
• The impact on price cannot be determined and quantity will decrease.

Answer 11

The price and quantity will increase.

See correct answer for explanation.

The price will increase and quantity will decrease.

See correct answer for explanation.

The price will increase and the impact on quantity cannot be determined.

Computers and computer software are complements. As a result of the fall in computer prices, demand for computer software will increase. The increased demand will cause both prices and quantity to rise. At the same time, the supply of software will fall due to the higher costs. This raises the price of software and causes quantity to fall. Thus we can only say for certain that price increases. The overall change in quantity will be determined by the relative magnitudes of the two shifts.

The impact on price cannot be determined and quantity will decrease.

See correct answer for explanation.

Question 12

The cost of rare earth metals used in electronics is steadily rising due to the increasing difficulty of mining them as they become scarcer. At the same time, laptops, tablets, and smartphones are becoming increasingly popular as substitutes to desktop computers. What impact will these two events have on the equilibrium price and quantity of desktop computers?

• The price and quantity will decrease.
• The price will decrease and quantity will increase.
• The price will increase and quantity will decrease.
• The impact on price cannot be determined and the quantity will decrease.

Answer 12

The price and quantity will decrease.

See correct answer for explanation.

The price will decrease and quantity will increase.

See correct answer for explanation.

The price will increase and quantity will decrease.

See correct answer for explanation.

The impact on price cannot be determined and the quantity will decrease.

Higher costs will decrease the supply of desktop computers. This fall in supply causes quantity to fall and prices to rise. The greater prevalence of substitutes for desktop computers will decrease demand. This also causes quantity to fall, but lowers prices. Thus we can only say for certain that quantity decreases. The direction of price will be determined by the relative magnitude of the previous two shifts.

Question 13

Assume that there are 150 firms, each of which gains a different benefit from polluting. Each firm is allocated one pollution permit by the government, and it can either use it or trade it for money in the market. Suppose the demand and supply curves for permits look like the following:

The market equilibrium is at a price of $11,500 and 115 permits sold. What does this market equilibrium say about firms’ willingness to pay to be able to pollute? Select all that apply.

• That most firms are not willing to pay $11,500 for one pollution permit.
• That no firm has more than half of the permits.
• That some firms are willing to pay more than $11,500 for one pollution permit.
• That no firm is willing to pay over $15,000 for one pollution permit.

Answer 13

That most firms are not willing to pay $11,500 for one pollution permit.

115 firms sell their permits, thus all of those firms are not willing to pay $11,500 for the right to pollute, or they would buy back their permit at that price. 115 is more than half of the total number of firms (150).

That no firm has more than half of the permits.

Since 115 permits were sold, that means that 35 firms bought those 115 permits. It is possible that one firm bought 100 of those 115 permits, giving that firm more than half of the total permits.

That some firms are willing to pay more than $11,500 for one pollution permit.

The demand curve shows us that some permits are demanded at prices higher than $11,500. For example, 100 permits are demanded at a price of $12,500.

That no firm is willing to pay over $15,000 for one pollution permit.

At a price of $15,000 and higher, all firms are willing to sell their permit. Thus none of those firms would be willing to buy back that permit at a price higher than $15,000.

Question 14

A local government implements a price ceiling of $4/gallon on milk. If the equilibrium price is $3 what will be the effect on the market for milk?

• There will be a shortage of milk.
• There will be a surplus of milk.
• There will be no effect on the market for milk.

Answer 14

There will be a shortage of milk.

See correct answer for explanation.

There will be a surplus of milk.

See correct answer for explanation.

There will be no effect on the market for milk.

A price ceiling limits how high a price can be charged. Setting a price ceiling above the equilibrium price will have no impact on the market, since the equilibrium price already conforms to the law.

Question 15

The graph below depicts a price ceiling limiting the hourly rate that can be charged by electricians. Which region or regions on the graph represent deadweight loss and the revenue earned by electricians?

• B is the revenue earned by electricians and C is the deadweight loss.
• D + E is the revenue earned by electricians and C is the deadweight loss.
• D + E is the revenue earned by electricians and F is the deadweight loss.
• D + E + F is the revenue earned by electricians and C is the deadweight loss.

Answer 15

B is the revenue earned by electricians and C is the deadweight loss.

C is the deadweight loss, but B is not revenue earned by the electricians.

D + E is the revenue earned by electricians and C is the deadweight loss.

D and E are both part of the revenue earned by electricians, but not all of it. F is also revenue earned by electricians. C is the deadweight loss.

D + E is the revenue earned by electricians and F is the deadweight loss.

D and E are both part of the revenue earned by electricians, but not all of it. F is also revenue earned by electricians, not deadweight loss.

D + E + F is the revenue earned by electricians and C is the deadweight loss.

The revenue electricians earn can be calculated by multiplying the quantity sold by price, which in this case gives the rectangle made by D + E + F. C is the deadweight loss because it represents the surplus (WTP - WTS) from additional transactions that would take place in equilibrium, but do not occur under the price ceiling.

Question 16

How is consumer surplus calculated and which region or regions on the graph below represent consumer surplus?

• Consumer surplus is the difference between the WTP of the consumer and the price paid by the consumer for every item sold. It is represented by A + B + C.
• Consumer surplus is the difference between the WTP of the consumer and the price paid by the consumer for every item sold. It is represented by A + B.
• Consumer surplus is the difference between the WTP of the consumer and the WTS of the producer for every item sold. It is represented by A + B + D.
• Consumer surplus is the difference between the WTP of the consumer and the WTS of the producer for every item sold. It is represented by A + B + C + D.

Answer 16

Consumer surplus is the difference between the WTP of the consumer and the price paid by the consumer for every item sold. It is represented by A + B + C.

C is deadweight loss and represents surplus that would have been created in equilibrium but was not due to the price ceiling.

Consumer surplus is the difference between the WTP of the consumer and the price paid by the consumer for every item sold. It is represented by A + B.

A + B represents the area between the demand curve (WTP) and the price ceiling (price) for all items sold. This is consumer surplus.

Consumer surplus is the difference between the WTP of the consumer and the WTS of the producer for every item sold. It is represented by A + B + D.

The difference between the WTP of the consumer and the WTS of the producer for every item sold is total surplus. A + B + D represents total surplus here.

Consumer surplus is the difference between the WTP of the consumer and the WTS of the producer for every item sold. It is represented by A + B + C + D.

The difference between the WTP of the consumer and the WTS of the producer for every item sold is total surplus, not consumer surplus.

Question 17

A polling agency decides to set up a prediction market for the presidential election. There are only two candidates in the election, Candidate A and Candidate B. The polling agency sets up a security that pays $100 to the owner if Candidate A wins the election and $0 otherwise. The current price for the security is $50. Which of the following is the best conclusion that the polling agency can make given the security price?

• That the number of people who believe Candidate A will win is equal to the number that believe Candidate B will win.
• That, on average, people believe that Candidate A is less likely to win the election than Candidate B.
• That, on average, people believe that Candidate A and Candidate B are equally likely to win the election.
• That, on average, people believe that Candidate A is more likely to win the election than Candidate B.

Answer 17

That the number of people who believe Candidate A will win is equal to the number that believe Candidate B will win.

It is possible that more than half of people believe Candidate A will beat Candidate B, but simply believe it less strongly than people who believe Candidate B will beat Candidate A, or vice versa. Thus, this conclusion cannot be made.

That, on average, people believe that Candidate A is less likely to win the election than Candidate B.

A $50 security indicates that market participants, on aggregate, believe the security is worth $50 – that is, Candidate A has a 50% chance of winning.

That, on average, people believe that Candidate A and Candidate B are equally likely to win the election.

A $50 security indicates that market participants, on aggregate, believe the security is worth $50 – that is, Candidate A has a 50% chance of winning. Since there are only two candidates this means that on aggregate market participants believe both candidates have a 50% chance of winning.

That, on average, people believe that Candidate A is more likely to win the election than Candidate B.

A $50 security indicates that market participants, on aggregate, believe the security is worth $50 – that is, Candidate A has a 50% chance of winning.

Question 18

If one Chinese Yuan (CNY) can buy 12.5 Bangladeshi Taka (BDT), which of the following are proper ways of stating the exchange rate? Select all that apply.

• BDT/CNY = 12.5
• BDT/CNY = 0.08
• CNY/BDT = 12.5
• CNY/BDT = 0.08
• 1 CNY = 12.5 BDT
• 1 BDT = 12.5 CNY

Answer 18

BDT/CNY = 12.5

This states that the price of 1 BDT is 12.5 CNY.

BDT/CNY = 0.08

This states that the price of 1 CNY is 12.5 BDT

CNY/BDT = 12.5

This states that the price of 1 CNY is 12.5 BDT

CNY/BDT = 0.08

This states that the price of 1 BDT is 12.5 CNY.

1 CNY = 12.5 BDT

This states that the price of 1 CNY is 12.5 BDT

1 BDT = 12.5 CNY

This states that the price of 1 BDT is 12.5 CNY.

Question 19

If Bangladesh increases its machinery imports from China, what will most likely happen to the exchange rate?

• Increase CNY/BDT
• Decrease CNY/BDT
• It will have no effect on CNY/BDT

Answer 19

Increase CNY/BDT

The new demand for Chinese machinery imports will increase the demand for Chinese Yuan needed to buy the machinery from China. The increased demand for Chinese Yuan (CNY) will increase the price of CNY and thus the exchange rate CNY/BDT.

Decrease CNY/BDT

See correct answer for explanation.

It will have no effect on CNY/BDT

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Question 20

A price ceiling is set at 10% below the market equilibrium price. Which of the following must result from the price ceiling? Select all that apply.

• Consumer surplus decreases
• Producer surplus decreases
• Total surplus decreases
• Deadweight loss increases
• There is no effect because the price ceiling is below the market equilibrium price.

Answer 20

Consumer surplus decreases

Under the price ceiling, fewer consumers will be able to purchase the good than would have bought the good at the equilibrium price, decreasing consumer surplus. However, the consumers that do purchase the good are buying it at a lower price, which increases their own consumer surplus. Thus, total consumer surplus could increase or decrease, depending on the relative size of each effect.

Producer surplus decreases

Under the price ceiling, fewer consumers are purchasing the good and they are each buying it at a lower price. Both effects lower producer surplus.

Total surplus decreases

Total surplus is WTP – WTS for each item sold. Under the price ceiling, the WTP and the WTS are not changing, but the number of items sold has decreased. Thus, total surplus has decreased.

Deadweight loss increases

Deadweight loss is the amount of total surplus that would have been created at the equilibrium price but is not created due to the market intervention. If total surplus decreases, then deadweight loss must increase.

There is no effect because the price ceiling is below the market equilibrium price.

A price ceiling ABOVE the market equilibrium price would have no effect. A price ceiling below the market equilibrium price does have an impact on the market.

Question 21

A new restaurant has introduced a wildly popular macaroni and cheese dish made with goat cheese. However, at approximately the same time, an outbreak of disease has decreased the local goat population (without impacting the safety of goat cheese). How do the price and quantity of goat cheese change?

• Price and quantity increase
• Price increases and the effect on quantity cannot be determined
• Quantity increases and the effect on price cannot be determined
• Quantity decreases and the effect on price cannot be determined

Answer 21

Price and quantity increase

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Price increases and the effect on quantity cannot be determined

Demand has increased due to the new dish, but supply has decreased due to the goat disease. Price will definitely increase, but the effect on quantity depends on the magnitude of the impact of these two events.

Quantity increases and the effect on price cannot be determined

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Quantity decreases and the effect on price cannot be determined

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Question 22

A country has passed a law setting a minimum wage for factory workers 5% below the equilibrium price. How will this law impact the labor market?

• The law will likely cause a shortage of labor.
• The law will likely increase unemployment.
• The law will have no impact on the market.
• The law will increase prices without affecting quantity.

Answer 22

The law will likely cause a shortage of labor.

See correct answer for explanation.

The law will likely increase unemployment.

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The law will have no impact on the market.

Since the minimum wage is below the equilibrium price, it will have no impact on market outcomes.

The law will increase prices without affecting quantity.

See correct answer for explanation.

Question 23

After an earthquake disrupts the supply of clean drinking water to many residents of a city, the city restricts grocery stores from raising the prices they charge for bottled water. If no side markets arise, which of the following statements is true?

• The law restricting a price increase will exacerbate the water shortage (or “excess demand”).
• Water will be allocated to the consumers with the highest willingness to pay for it.
• Water will be allocated to the consumers who need it most.

Answer 23

The law restricting a price increase will exacerbate the water shortage (or “excess demand”).

Some residents might be able to limit their water consumption and would purchase less water if prices rose. If prices are kept low, the quantity of water demanded will be very high, creating more of a water shortage.

Water will be allocated to the consumers with the highest willingness to pay for it.

At artificially low prices, water is unlikely to be allocated to consumers with the highest WTP. Rather, it is likely to be allocated on a first-come, first-served basis.

Water will be allocated to the consumers who need it most.

Keeping prices low does not guarantee that the consumers who need water most will get it. Rather, water is likely to be allocated on a first-come, first-served basis.

Question 24

A year of unusually good rainfall has made it cheaper to irrigate farmlands. However, a popular new diet has persuaded some consumers to stop eating vegetable oil, a product often made from canola. What impact have these two changes had on the equilibrium price and quantity sold of canola?

• Price has decreased and the effect on quantity cannot be determined
• Price has decreased and quantity has increased
• Price has increased and quantity has decreased
• Price and quantity have both decreased

Answer 24

Price has decreased and the effect on quantity cannot be determined

Supply increases and demand decreases. Price will certainly decline, but the effect on quantity will depend on the relative magnitude of the two shifts.

Price has decreased and quantity has increased

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Price has increased and quantity has decreased

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Price and quantity have both decreased

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Question 25

A day care program frequently has a few parents picking up their children late. In an attempt to curb this, the daycare decides to charge a fine to parents who are more than 10 minutes late. However, after the fine was implemented, the number of late parents increased. Which of these conclusions can be true?

• The fine eliminated the non-financial incentives to be on time
• The fine was not high enough to discourage being late
• The fine was perceived as a price
• All of the above

Answer 25

The fine eliminated the non-financial incentives to be on time

Parents may previously have felt guilty if they were late to pick up their children, and now, if they perceive the fine as a “price” of being late, they may consider it a fair trade to arrive late and pay for it.

The fine was not high enough to discourage being late

Since the number of late parents increased, we can conclude that those parents are willing to pay at least the fine amount in order to be late.

The fine was perceived as a price

Parents may previously have felt obliged to pick up their children on time, and now see the fine as a price which they can fairly pay in order to arrive late.

All of the above

See explanations above.

Question 26

A bakery famous for its cupcakes opens its doors at 9 a.m. and allows each customer to purchase up to 2 cupcakes until the day’s supply of cupcakes runs out. Customers begin lining up around 8 a.m. each day and the cupcakes usually run out around 9:30, leaving dozens of unserved customers disappointed. Which of the following statements about this market are true? Select all that apply.

• The cupcakes are being sold below their equilibrium price.
• The bakery is maximizing its short-run producer surplus.
• The customers who receive cupcakes are the customers with the highest willingness to pay for cupcakes.
• The bakery is not using price as the only means of allocating cupcakes to its customers.
• Consumer surplus is being maximized.

Answer 26

The cupcakes are being sold below their equilibrium price.

If the cupcakes were being sold at or above their equilibrium price, there would not be dozens of disappointed customers left over when the bakery runs out of cupcakes.

The bakery is maximizing its short-run producer surplus.

The bakery could increase its surplus by raising prices.

The customers who receive cupcakes are the customers with the highest willingness to pay for cupcakes.

The cupcakes are allocated on a first-come, first-served basis, rather than based on willingness to pay.

The bakery is not using price as the only means of allocating cupcakes to its customers.

The bakery is using a queue to allocate its cupcakes.

Consumer surplus is being maximized.

Although low prices can increase consumer surplus, decreased quantity decreases consumer surplus. We cannot know that consumer surplus is being maximized.

Question 27

Three years ago, law school admits deciding whether or not to attend the schools they were admitted to typically underestimated the future demand for lawyers. This forecasted demand corresponded with salaries that many admits were unwilling to accept, and fewer students than usual ended up attending law school. Now that these students have completed law school, the small graduating classes have led to a more limited supply of lawyers than is generally available. What will be the result of this mismatch?

• The lower supply of lawyers will lead to high salaries, and current law school admits will be more likely to decide to attend
• The lower supply of lawyers will lead to high salaries, and current law school admits will be less likely to decide to attend
• The lower supply of lawyers will lead to low salaries, and current law school admits will be more likely to decide to attend
• The lower supply of lawyers will lead to low salaries, and current law school admits will be less likely to decide to attend

Answer 27

The lower supply of lawyers will lead to high salaries, and current law school admits will be more likely to decide to attend

Salaries will rise as law firms compete to hire the smaller supply of lawyers, and higher salaries will attract more admits to law school.

The lower supply of lawyers will lead to high salaries, and current law school admits will be less likely to decide to attend

See correct answer for explanation.

The lower supply of lawyers will lead to low salaries, and current law school admits will be more likely to decide to attend

See correct answer for explanation.

The lower supply of lawyers will lead to low salaries, and current law school admits will be less likely to decide to attend

See correct answer for explanation.

Question 28

A state has strict laws stating that all employees, including part-time workers, must be compensated with employer-provided health benefits. Which of the following could result from this legislation?

• More workers will be hired “informally” and be paid surreptitiously in cash.
• Wages will decrease.
• Unemployment will increase.
• Any of the above could result from the legislation.

Answer 28

More workers will be hired “informally” and be paid surreptitiously in cash.

The mandated health benefits act as a price floor, and some employers may prefer to hire workers unofficially, in order to avoid paying the benefits.

Wages will decrease.

Employers could offset the cost of the health benefits by decreasing wages, and, assuming that employees derive value from the health benefits, they will be willing to accept lower wages.

Unemployment will increase.

The mandated health benefits act similarly to a price floor, and could lead to increased unemployment.

Any of the above could result from the legislation.

See answers above for explanations.

Question 29

In an unregulated, competitive market consumer surplus exists because:

• some sellers are willing to take a lower price than the equilibrium price.
• some consumers are willing to pay more than the equilibrium price.
• some sellers will only sell at prices above equilibrium price (or actual price).
• some consumers are willing to make purchases only if the price is below the actual price.

Answer 29

some sellers are willing to take a lower price than the equilibrium price.

This is the reason that producer surplus exists.

some consumers are willing to pay more than the equilibrium price.

Consumer surplus is defined as the difference between equilibrium price and willingness to pay.

some sellers will only sell at prices above equilibrium price (or actual price).

These potential sellers will not make any sales and are irrelevant to consumer surplus.

some consumers are willing to make purchases only if the price is below the actual price.

The consumers will not make any purchases and do not capture any consumer surplus.

Question 30

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

Answer 30

The companies that sell the drinks

See correct answer for explanation.

The consumers who purchase the drinks

See correct answer for explanation.

The impact of the tax will be the same regardless of who pays the tax

Prices will adjust so that the impact on consumers and producers will be the same regardless of who officially pays the tax.

The quantity of drinks consumed will not decrease as a result of the tax

The quantity will decrease since demand is unlikely to be perfectly inelastic.

Question 31

A movie theater substantially decreases the price of its soda during the same week that a heavily advertised new movie is being released to theaters. Assuming consumers like to enjoy movies, soda, and popcorn together, how does this impact the equilibrium price and quantity of popcorn?

• Price and quantity both increase.
• Price decreases and quantity increases.
• Price increases and the impact on quantity cannot be determined.
• Quantity decreases and the impact on price cannot be determined.

Answer 31

Price and quantity both increase.

The new movie and the low soda prices will both lead to an increase in demand for popcorn, leading to an increase in both price and quantity.

Price decreases and quantity increases.

See correct answer for explanation.

Price increases and the impact on quantity cannot be determined.

See correct answer for explanation.

Quantity decreases and the impact on price cannot be determined.

See correct answer for explanation.

Question 32

A price ceiling on apartment rentals, commonly called “rent control,” can lead to all of the following except:

• increases in landlords discriminating against potential renters
• improvements in apartment quality
• decreases in efficiency of the rental market
• decreases in future supply of apartments

Answer 32

increases in landlords discriminating against potential renters

Due to the rent control, landlords will have more renters to select from, and will gain less in rent payments from any renter. Both of these factors decrease the cost of discrimination.

improvements in apartment quality

If landlords are restricted from raising rents, they have less motivation to improve their apartments.

decreases in efficiency of the rental market

There will be potential renters willing to pay more than the price ceiling, and potential landlords willing to rent out apartments to these renters, who are unable to make a trade due to the regulations.

decreases in future supply of apartments

There is no incentive to build new apartments at market prices if the rental income will be below market prices.

Question 33

The Namibian government has assigned ownership rights of many endangered species to local communities, who have in turn sold hunting licenses for some of the species. Will this process preserve the endangered species?

• No, the hunting will reduce the population and lead to its eventual extinction.
• No, the black market for species will definitely lead to the population’s extinction.
• Yes, if the price of licenses motivates the local community to protect the endangered population.
• Yes, since poachers (people who hunt illegally) will respect the new ownership rights.

Answer 33

No, the hunting will reduce the population and lead to its eventual extinction.

The revenues from hunting may motivate the local community to protect the animals from poachers, which could prevent the species’ extinction.

No, the black market for species will definitely lead to the population’s extinction.

Although hunting can still occur outside of the legal market (by poachers), creating a hunting market can motivate the community to protect the species from black market poachers.

Yes, if the price of licenses motivates the local community to protect the endangered population.

The local community may believe that the revenues it will receive over time from legal hunting are worth the cost of protecting the animals from poaching.

Yes, since poachers (people who hunt illegally) will respect the new ownership rights.

Poachers are unlikely to respect the new ownership rights, but poaching may still decrease if the local community establishes an enforcement mechanism.

Question 34

Which of the following statements is true of active secondary markets?

• They can undo some of the intended effects of a price ceiling
• They exacerbate excess demand for a product
• They exacerbate excess supply for a product
• All of the above

Answer 34

They can undo some of the intended effects of a price ceiling

A secondary market can allow consumers with low WTP to resell the product to consumers with high WTP, undermining a price ceiling.

They exacerbate excess demand for a product

See correct answer for explanation.

They exacerbate excess supply for a product

See correct answer for explanation.

All of the above

See correct answer for explanation.

Question 35

A market’s equilibrium outcome maximizes:

• producer surplus.
• consumer surplus.
• the sum of producer surplus and consumer surplus.
• All of the above.

Answer 35

producer surplus.

Producer surplus could be higher at higher prices.

consumer surplus.

Consumer surplus could be higher at lower prices.

the sum of producer surplus and consumer surplus.

Total surplus is maximized at the market outcome.

All of the above.

See explanations above.

Question 36

In which of the following scenarios would both the price and quantity sold of paperback books increase?

• The government passes new environmental regulations that increase the price of paper.
• The price of e-books, a substitute for paperback books, decreases.
• Printers develop processes that significantly decrease their costs.
• The price of bookmarks, a complementary good to paperback books, decreases.

Answer 36

The government passes new environmental regulations that increase the price of paper.

This would shift supply to the left, decreasing quantity but increasing price.

The price of e-books, a substitute for paperback books, decreases.

A decrease in the price of e-books, a substitute good, would shift demand for paperback books to the left, resulting in a lower price and a lower quantity demanded.

Printers develop processes that significantly decrease their costs.

This would shift supply to the right, decreasing prices but increasing quantity.

The price of bookmarks, a complementary good to paperback books, decreases.

This would shift demand to the right, increasing both price and quantity.

Question 37

The American Medical Association is considering putting a permanent cap on the number of medical residents (which effectively would cap the number of licensed doctors). What effect would this cap have if it were set below the current number of doctors?

• Lower wages for existing and future doctors
• Higher wages for existing doctors
• Higher wages for existing and future doctors
• The cap would have no impact on wages for doctors

Answer 37

Lower wages for existing and future doctors

See correct answer for explanation.

Higher wages for existing doctors

See correct answer for explanation.

Higher wages for existing and future doctors

A cap will limit the number of doctors now and in the future, making wages higher.

The cap would have no impact on wages for doctors

See correct answer for explanation.

Question 38

A region is in the middle of a very cold and snowy winter. As a result, hot chocolate has become more desirable, and many of the shipping channels for imported goods have closed due to the weather. What will happen to the price and quantity sold of hot chocolate made with imported cocoa?

• Price and quantity will both increase
• Price will increase and the effect on quantity cannot be determined
• Price will increase and quantity will decrease
• Neither the effect on quantity nor the effect on price can be determined

Answer 38

Price and quantity will both increase

See correct answer for explanation.

Price will increase and the effect on quantity cannot be determined

The cold weather will increase the demand for hot chocolate, but the snow and blocked shipping channels will reduce the supply of hot chocolate. Price will certainly increase, but without knowing the relative magnitude of the effects of these changes, we cannot determine the effect on quantity.

Price will increase and quantity will decrease

See correct answer for explanation.

Neither the effect on quantity nor the effect on price can be determined

See correct answer for explanation.

Question 39

This graph shows a price ceiling, representing the maximum rate that taxi drivers are permitted to charge for a ride from the airport in a city. Assuming that the price ceiling is effective, what regions on the graph represent total surplus and deadweight loss?

• Total surplus is A+B+D+E and deadweight loss is F
• Total surplus is A+B+D+E and deadweight loss is C
• Total surplus is D+E and deadweight loss is C
• Total surplus is A+B+D and deadweight loss is C

Answer 39

Total surplus is A+B+D+E and deadweight loss is F

C is deadweight loss, and E is not included in surplus

Total surplus is A+B+D+E and deadweight loss is C

E is not included in surplus

Total surplus is D+E and deadweight loss is C

E is not included in surplus

Total surplus is A+B+D and deadweight loss is C

Total surplus is the difference between the demand curve and supply curve for all of the units sold, A+B+D. Deadweight loss (C) is the difference between the demand curve and the supply curve for all of the units that could have been sold, but were not, due to the price ceiling.

Question 40

This graph shows a price ceiling, representing the maximum rate that taxi drivers are permitted to charge for a ride from the airport in a city. Assuming that the price ceiling is effective, what regions on the graph represent total surplus and deadweight loss?

• Total surplus is A+B+D+E and deadweight loss is F
• Total surplus is A+B+D+E and deadweight loss is C
• Total surplus is D+E and deadweight loss is C
• Total surplus is A+B+D and deadweight loss is C

Answer 40

Total surplus is A+B+D+E and deadweight loss is F

C is deadweight loss, and E is not included in surplus

Total surplus is A+B+D+E and deadweight loss is C

E is not included in surplus

Total surplus is D+E and deadweight loss is C

E is not included in surplus

Total surplus is A+B+D and deadweight loss is C

Total surplus is the difference between the demand curve and supply curve for all of the units sold, A+B+D. Deadweight loss (C) is the difference between the demand curve and the supply curve for all of the units that could have been sold, but were not, due to the price ceiling.

Question 41

A prediction market has been formed through which participants can bet with each other on the outcomes of the World Cup. One security in this market is priced at $30. This security gives its owner the right to $100 if Country A wins the World Cup and $0 otherwise. Which of the following is true?

• Every participant believes that Country A has less than a 50% chance to win.
• Most participants believe that Country A has less than a 50% chance to win.
• A person who believes that Country A has a 25% chance of winning should buy the security for $30.
• On average, the participants in this prediction market think Country A has a 30% chance to win.

Answer 41

Every participant believes that Country A has less than a 50% chance to win.

On average, participants believe that Country A only has a 30% chance to win, but some may believe that Country A has a higher than 50% chance to win.

Most participants believe that Country A has less than a 50% chance to win.

It is possible that most people believe Country A has a higher than 50% chance to win. Consider if 5 people believe Country A has a 0% chance and 6 people believe Country A has a 55% chance to win. This averages to a 30% chance for Country A to win.

A person who believes that Country A has a 25% chance of winning should buy the security for $30.

If a person believes that Country A has a 25% chance of winning then the security should have a value of $25 to that person which is lower than the price of the security.

On average, the participants in this prediction market think Country A has a 30% chance to win.

On average, participants believe there is a 30% chance Country A will win and the security will be worth $100. Conversely, there is a 70% chance Country A will not win and the security will be worth $0. This equates to a security worth $30.