Practice Final Examination 1 Flashcards
The labour force in a car plant has approached management with the following proposition: ‘We shall raise average labour productivity (cars per worker) by 5 per cent if you agree to increase our wages by 5 per cent.’ Assuming all additional cars produced can be sold at current prices, what would happen to the payments to all other factors of
production if management agreed?
They would
A. increase by 5 per cent.
B. be unchanged.
C. decrease by 5 per cent.
D. decrease by more than 5 per cent.
The correct answer is A. The effect of selling 5 per cent more cars at the current price is to increase total revenue by 5 per cent. It is therefore possible to increase the payments to all factors of production, including labour, by 5 per cent.
Suppose that the highly competitive market for electronic calculators is in equilibrium
today. If the government decided that every school pupil should be given a calculator,
bought at government expense, and at the same time the average total cost of produc-
ing calculators were to decrease because of another technological breakthrough in the
electronics industry, what would be the joint effects of the government decision and the technological breakthrough?
A. An increase in the equilibrium price of calculators and an increase in the equilibrium quantity.
B. An increase in the equilibrium quantity of calculators; the equilibrium price might rise, fall or be unaltered.
C. A decrease in the equilibrium price of calculators; the equilibrium quantity might rise, fall or be unaltered.
D. A decrease in the number of firms in the industry, and an increase in the equilibrium price of calculators.
The correct answer is B. The government decision to buy every school pupil a calculator would shift the demand curve to the right. The reduction in the costs of producing calculators, i.e. a lowering of the average total cost curve, would shift each firm’s short-run marginal cost curve to the right and consequently shift the industry short-run supply curve to the right. Whether the new equilibrium price would be higher, the same or lower than the original price will depend upon the relative shifts of the demand and supply curves. Thus the joint effect on price cannot be determined from the information given. However, both curves will intersect to the right of the original equilibrium position
It has been said that the fundamental fact of scarcity is no longer applicable to the UK economy.
Which of the following is correct? This statement is
A. true, because the welfare system in the UK ensures that the basic needs of the poor are met.
B. true, because goods such as tea and coffee, which are not produced in the UK, can be imported from abroad.
C. false, because not all wants of all UK citizens are fully satisfied.
D. false, because a significant number of families in the UK have incomes below what is generally accepted as the poverty level.
The correct answer is C. No country today has sufficient resources to satisfy all the wants of every member of its population; this is the ‘fundamental fact of scarcity’. The fact that society’s basic needs, however defined, might be being met or that commodities not produced in the UK can be imported from abroad does not imply that scarcity no longer exists. Even if every family in the UK were above poverty level, however defined, scarcity would still remain.
The table below shows how the factors of production may be combined to produce 100 units of a certain good. Using only the information in the table, which one of the methods can be dismissed by the producer on the grounds of technical inefficiency?
The correct answer is C. Since no prices are provided, it is not possible to compare options A and B since A uses less labour and more capital than B. However, it is possible to compare B and C since they use the same quantity of capital, but C uses more labour; B is therefore more efficient than C, which can be dismissed on the grounds of technical efficiency. B and C is the only pair that it is possible to compare in this way.
Which one of the following quotations is not an example of the ‘law’ of diminishing marginal utility?
A. ‘The second glass of beer tastes just as good as the first.’
B. ‘There’s a limit to how much ice cream you can eat in a day.’
C. ‘After a while, even TV gets boring.’
D. ‘All work and no play makes Jack a dull boy.’
The correct answer is A. Any statement that suggests diminishing additional utility derived from additional consumption is consistent with the ‘law’ of diminishing marginal utility. Diminishing marginal utility is consistent with a limit to the amount of ice cream that can be eaten in a day, with boredom watching TV after a time, and with dullness from spending too much time working. However, to say that the second glass of beer tastes just as good as the first suggests that the utility is the same for the second as for the first glass of beer, and is not consistent with dimin- ishing marginal utility.
A consumer’s typical demand curve for a good is downward-sloping to the quantity axis because at higher prices the consumer
I. encounters a leftward-shifting supply curve for that good, resulting in a lesser equilibrium quantity.
II. buys less of the good in place of other goods, which are now relatively less expen-sive.
Which of the following is correct?
A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.
The correct answer is B. A demand curve shows the quantity of a good that a consumer would buy at different prices, cet. par. This is independent of the condi- tions of supply; therefore statement I is incorrect. As the price increases, the quantity typically decreases for a number of reasons, one of which is that other goods become relatively more attractive; this is the substitution effect. Thus statement II is correct.
The correct answer is C. In deciding which policy contributes most to economic efficiency, it is necessary to compare marginal costs and marginal benefits of each. Since no cost information is provided, it is not possible to draw a conclusion.
Perfect weather conditions in Brazil have produced a bumper coffee crop this year.
Although the whole crop could be sold at a price that would more than cover the cost of storing and delivering it, a Brazilian economist has suggested that sufficient coffee be burned to prevent the price of Brazilian coffee beans from falling.
Which of the following would result from acting upon this suggestion?
A. A reduction in Brazilian coffee growers’ real income.
B. A reduction in world real income.
C. An increase in Brazilian coffee growers’ real income.
D. An increase in Brazilian real income.
The correct answer is B. The Brazilian economist’s advice was probably based on his belief that the demand for coffee is price-inelastic, i.e. that the bumper crop could only be sold as the result of a price reduction, which would lead to a decrease in total revenue. However, no such definite information on the market is provided. The only definite outcome of burning the coffee would be to reduce the total of consumption goods available to the world, i.e. to decrease world real income.
The diagram shows two production frontiers for catching mackerel, in other words the maximum amount of fish that can be caught with two different amounts of a fixed factor of production (boat) and with different amounts of a variable factor of production (labour). The rental costs of the boats are $100 and $200 respectively. All units of
labour are identical.
I. A movement from X to Y exhibits increasing marginal returns to labour.
II. A movement from X to Z exhibits increasing returns to scale.
Which of the following is correct?
A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.
The correct answer is D. The output of the first 6 man-days, as shown by point X, was 300 kilos; the addition of a further 6 man-days, as shown by point Y, added just over 100 kilos, thus the marginal product of labour decreased between points X and Y; statement I is thus incorrect. The movement from X to Z involves doubling both the input of labour and of capital; if there were increasing returns to scale, output would more than double. However, the output of mackerel also doubled from 300 to 600 kilos, exhibiting constant returns to scale. Statement II is incorrect.
People buy more fuel when prices are reduced and less when they are raised. Suppose that advertising does not increase the amount of fuel bought but does influence the choice of brand. Suppose also that fuel of any one grade is for practical purposes a
homogeneous product across brands and that any change in industry cost is passed on in part to the public in higher or lower fuel prices. Which of the following would necessarily be true?
A. If all fuel refiners increase advertising expenditure, refining industry total profits will increase but the general public will be worse off.
B. If all fuel refiners increase advertising expenditure, refining industry total profit will decrease and the general public will be worse off.
C. If one fuel refiner increases his advertising expenditure, that refiner’s profit will decrease but other refiners’ profits will increase.
D. If one fuel refiner increases his advertising expenditure, that refiner will have higher profit, higher sales and lower costs per gallon sold than other refiners.
The correct answer is B. The effect of increased advertising is to increase the cost of production and alter the distribution of expenditure between brands, while leaving total expenditure unchanged. Thus, if all refiners increased their advertising, there would be a redistribution of consumer expenditure between brands, depending on how much additional advertising each refiner carried out, and industry total profit would decrease. When the increased advertising costs were passed on in price increases, the general public would become worse off. Option A is therefore incorrect and B is correct. Since the amount of brand switching in response to changed advertising is unknown, it is not possible to predict the effect on an individual refiner of a change in his advertising.
When travelling to an airport from a city centre, most people use the airport bus or travel by taxi. In response to rising fuel costs, taxi fares have risen although the bus fare has remained unaltered. If some travellers change their mode of transport in response to the change in fares, what impact will this have on taxi and bus revenues?
A. Taxi revenues will rise and bus revenues will remain unaltered.
B. Taxi revenues will fall and bus revenues will remain unaltered.
C. Bus revenues will rise and taxi revenues may rise, fall or remain unaltered.
D. Bus revenues will rise and taxi revenues will rise.
The correct answer is C. Since more people now use the bus (because taxi fares have risen) and the fares are unchanged, bus revenues will rise. The effect of increased taxi fares on total revenues depends on the price elasticity of demand. Since this is unknown, taxi revenues may rise, fall or be unaltered.
For several decades the Eastfield iron foundry has been processing iron ore and has been an important employer in the local area. Until recently, no one complained about the ash particles, the bulk of which fell on vacant land. However, a farmer who bought the vacant land and is now cultivating it has complained to the government that the ash particles are polluting his fields and causing wheat yields to be less than they would otherwise be. If the government wishes to promote efficient resource use in the area, which of the following policies should it adopt?
A. Force the iron foundry to stop polluting the area or put it out of business.
B. Allow the iron foundry to continue as it is but charge the owners for any resultant decrease in the value of the farmer’s output.
C. Refuse to intervene and let market forces resolve the conflict between the farmer and the foundry owners.
D. Provide the farmer with an alternative field and compensate him for any loss of income incurred.
The correct answer is B. The social cost of producing iron is greater than the private cost of production by an amount equal to the decrease in the farmer’s output; consequently, because of this externality, setting output at the level where marginal revenue equals private marginal cost is not economically efficient. The solution is to include the decrease in the farmer’s output as a cost to the firm, i.e. to charge it according to how much output the farmer loses as a result of iron production. The firm’s private marginal cost will now be equal to marginal social cost and the iron foundry will set its output at a lower profit-maximising level. Consequently B is correct. None of the other responses contributes to equalising private and social cost.
Approximately one-half of a city university’s students live in rooms/flats that they rent in the private market. The others live in university rooms or flats. Average housing expenditure does not vary significantly between the two groups. In the light of govern-
ment cutbacks in university finance, the university has decided to convert its student accommodation to offices and seminar rooms. The 3000 students who will be affected have been told they will have to find their own accommodation in the private housing
market in the city. Other things being unchanged, such as population, what effect will the university’s decision have on the market for private rental housing when the university housing service ceases?
A. An increase in rent, followed later by an increase in the quantity of private rental housing supplied.
B. A decrease in the number of non-student tenants and simultaneously a decrease in rent.
C. A decrease in rent as home owners and landlords anticipate the increased student demand.
D. No effect, because the students who occupy university housing will not be able to afford private housing.
right of the demand curve for rented accommodation. The stock of rented accom- modation is fixed in the short run; therefore this will result in an increase in the market rent. In the long run, potential landlords will be attracted into the private renting sector because of the higher rents obtainable, and thus there will later be an increase in the quantity of private rental housing supplied.
‘The more money there is in the economy, the more people spend. The more people spend, the higher is GNP. Therefore, the greater the supply of money, the better off people must be.’ Which of the following is correct?
A. The statement is correct because increases in the money supply lead to decreases in interest rates, which in turn lead to increases in investment.
B. The statement is incorrect because real GNP is limited by the economy’s potential to produce goods and services.
C. The statement is correct because increases in the money supply lead to increases in interest rates, which in turn lead to increases in consumer saving.
D. The statement is incorrect because the supply of money has no effect on consumer, government or investment expenditure.
The correct answer is B. While it is possible to increase aggregate demand by increasing the supply of money, potential output sets an upper limit to real GNP. Therefore it does not always follow that the greater the supply of money, the better off people will be.
It is rumoured that the government intends to increase the sales tax on alcohol and tobacco from 5 per cent of the selling price to 20 per cent and to use this tax revenue to subsidise gas and electricity production, i.e. to lower the prices of these commodities. If the government carries out such a plan
I. the average consumer will have a lower real income because the cost of living will be higher.
II. income inequality will be increased if people with lower incomes spend a greater proportion of their incomes on alcohol and tobacco but no higher a proportion on gas and electricity than higher-income groups.
Which of the following is correct?
A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.
The correct answer is B. For any given consumer, the greater the proportion of income spent on alcohol and tobacco, the greater will be the amount of tax paid and, since the smaller will be the amount of income available for all other purchases, including gas and electricity, the less will be the amount of the subsidy received. Thus, if people with lower incomes spend a greater proportion of their incomes on alcohol and tobacco than do people with higher incomes, but not a higher propor- tion on gas and electricity, then the scheme will increase income inequality. Thus statement II is correct. Real income is determined by the nation’s resources and you might argue that distortions caused by the tax subsidy programme would cause real income to fall. However, this fall would not be because the cost of living would be higher; this cost of living, e.g. the consumer price index or GNP deflator, could be rising, constant or falling. Thus statement I is incorrect.
The following table shows Money GNP and Real GNP in a hypothetical closed economy for three years:
Assuming a constant number of workers, it follows that I. the supply of money increased by $7 million between Year t and Year t + 2. II. output per worker was higher in Year t + 2 than in Year t.
Which of the following is correct?
A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.
The correct answer is B. The fact that money GNP has risen faster than real GNP indicates rising prices. This could be associated with an increasing money supply, increasing velocity of circulation of money, or both. There is no proof that the money supply increased by £7 million. Statement I is therefore incorrect. Output per worker is real GNP divided by the number of workers; since real GNP in- creased between Year t and Year t + 2 and the number of workers did not, it follows that output per worker was higher in Year t + 2 than in Year t. Statement II is therefore correct.
