unit 5 to 8 Notes/revision/Questions

Question 1

Institutions

Answer 1

Institutions are written and unwritten rules that govern:
- what people do when they interact in a joint project
- the distribution of the products of their joint effort

Question 2

Power

Answer 2

The ability to do and get the things we want in opposition to the intentions of others.

Question 3

The pareto criterion

Answer 3

According to the Pareto criterion, allocation A dominates allocation B if at least one party would be better off with A than B, and nobody would be worse off.

We say that A Pareto dominates⁠ B.

Question 4

Pareto efficiency

Answer 4

An allocation that is not Pareto dominated by any other allocation is described as Pareto efficient
- A Pareto-efficient⁠ allocation has the property that there is no alternative technically feasible allocation in which at least one person would be better off, and nobody worse off.

Question 5

Which of the following statements about the outcome of an economic interaction is correct?

A. If the allocation is Pareto efficient, then you cannot make anyone better off without making someone else worse off.

B. All participants are happy with what they get if the allocation is Pareto efficient.

C. There cannot be more than one Pareto-efficient outcome.

D. According to the Pareto criterion, a Pareto-efficient outcome is always better than an inefficient one.

Answer 5

A. If the allocation is Pareto efficient, then you cannot make anyone better off without making someone else worse off.

Question 6

Allocations can be judged unfair because of

Answer 6

How unequal they are: In terms of income, for example, or subjective wellbeing. These are substantive judgements of fairness

How they came about: For example by force, or by competition on a level playing field. These are procedural judgements of fairness⁠.

Question 7

Substantive judgements
These are based on inequality in some aspect of the allocation such as:

Answer 7

Income: The reward in money (or some equivalent measure) of the individual’s command over valued goods and services.

Happiness: Economists have developed indicators by which subjective wellbeing can be measured.

Freedom: The extent that one can do (or be) what one chooses without socially imposed limits.

Question 8

Procedural judgements
The rules of the game that brought about the allocation may be evaluated according to aspects such as:

Answer 8

Voluntary exchange of private property acquired by legitimate means: Were the actions resulting in the allocation the result of freely chosen actions by the individuals involved, for example each person buying or selling things that they had come to own through inheritance, purchase, or their own labour? Or was fraud or force involved?

Equal opportunity for economic advantage: Did people have an equal oppor­tunity to acquire a large share of the total to be divided up, or were they subjected to some kind of discrimination or other disadvantage because of their race, sexual preference, gender, or who their parents were?

Deservingness: Did the rules of the game that determined the allocation take account of the extent to which an individual worked hard, or otherwise upheld social norms?

Question 9

Figure 5.3 Feasible outcomes of the interaction between Angela and Bruno.
= shows Angela and Bruno’s combined feasible set, and four allocations that might result from an interaction between them.

A. If Angela has very flat indifference curves, she may prefer G to the other three allocations.
B. If Angela has very steep indifference curves, she may prefer F to the other three allocations.
C. Allocation G is the best of the four for Bruno.
D. It is possible that Angela is indifferent between G and E.

Answer 9

Correct answers A and E
Angela’s indifference curves are downward-sloping. If the indifference curve through G was sufficiently flat, the other three points would all lie below it.

Angela could be indifferent between G and E—one of her indifference curves could pass through both points.

Question 10

Technically feasible allocations

Answer 10

1. The biological survival constraint = If Angela does not work at all, she needs 2.5 bushels to survive (point Z). If she gives up some free time and expends energy working, she needs more food, so the curve is higher when she has less free time.
2. Points below the biological survival constraint are biologically infeasible, while points above the feasible frontier are technically infeasible.
3. Angela’s maximum working day = Given the feasible frontier, there is a maximum amount of work above which Angela could not survive, even if she could consume everything she produced.
4. The technically feasible allocations are the points in the lens-shaped area bounded by the feasible frontier and the biological survival constraint - the middle part

Question 11

Angela and Bruno’s feasible frontier, and Angela’s biological survival constraint.

Based on this figure, which of the following is correct?

A. If Angela works 24 hours she can survive.

B. There is a technically feasible allocation in which Angela does not work.

C. A new technology that boosted grain production would result in a bigger technically feasible set.

D. If Angela did not need so much grain to survive the technically feasible set would be smaller.

Answer 11

C = Technology that boosted grain production would increase the amount of grain that could be produced for any given number of working hours, shifting the feasible frontier up and thus expanding the technically feasible set.

Question 12

• MRT of work hours into grain output=MRS of work hours into subsistence requirements
  If Bruno can impose the allocation:

A. He will choose the technically feasible allocation where Angela produces the most grain.

B. His preferred choice will be where the marginal rate of transformation (MRT) on the feasible frontier equals the marginal rate of substitution (MRS) on the biological survival constraint.

C. He will not choose 8 hours of work, because the MRS between Angela’s work hours and subsistence requirements exceeds the MRT between work hours and grain output.

D. He will choose 13 hours of free time for Angela, and consume 10 bushels of grain.

Answer 12

B = The distance between the feasible frontier and Angela’s survival constraint, and thus Bruno’s share, is maximised where MRS = MRT.

Question 13

indifference curve⁠:

Answer 13

all of the allocations that have the same value for her as the reservation option. Below or to the left of the curve she is worse off than in her reservation option. Above and to the right she is better off.

Question 14

reservation option

Answer 14

if she refuses bruno’s offer, she has this option as a backup. Z is the allocation in which angela does not work and gets only survival rations from the government.

Question 15

Angela and Bruno’s feasible frontier, Angela’s biological survival constraint, and her reservation indifference curve.Based on this figure, which of the following is correct?

A. The economically feasible set is the same as the technically feasible set.

B. For any given number of hours of free time, the marginal rate of substitution on the reservation indifference curve is smaller than that on the biological survival constraint.

C. Some points are economically feasible but not technically feasible.

D. If the ration Angela gets from the government increases from 2 to 3 bushels of grain, her reservation indifference curve will be above her biological survival constraint whatever her working hours.

Answer 15

D = When the ration is 2 bushels, Angela’s reservation option is Z = (24, 2). If it increases to 3 bushels, her reservation option is (24, 3), which is on a higher indifference curve that lies above the survival constraint at all points. This will now be her reservation indifference curve.

Question 16

Angela and Bruno’s feasible frontier, Angela’s biological survival constraint and her reservation indifference curve. B is the outcome under coercion, while D is the outcome under voluntary exchange when Bruno makes a take-it-or-leave-it offer.Looking at this graph, we can conclude that:

A. With a take-it-or-leave-it offer, Bruno’s economic rent is equal to the joint surplus.

B. Both Bruno and Angela are better off under voluntary exchange than under coercion.

C. When Bruno makes a take-it-or-leave-it offer, Angela accepts because she receives an economic rent.

D. Angela works longer under voluntary exchange than under coercion

Answer 16

A = Bruno’s reservation option is to receive nothing. Under voluntary exchange, Bruno receives the whole of the surplus: the amount in excess of what Angela needs to either survive or be willing to work. So this is his economic rent.

Question 17

Pareto efficiency curve CD for the interaction between Angela and Bruno.Which of the following statements is correct?

A. The allocation at C Pareto dominates the one at D.
B. Angela’s marginal rate of substitution is equal to the marginal rate of transformation at all points on the Pareto efficiency curve.

C. The mid-point of CD is the most Pareto-efficient allocation.

D. Angela and Bruno are indifferent between all the points on CD, because they are all Pareto efficient.

Answer 17

B = The Pareto efficiency curve, by definition, joins all the economically feasible points where MRS = MRT.

Question 18

D and F are the outcomes before and after the introduction of a new law that limits Angela’s work time to four hours a day while requiring a minimum pay of 4.5 bushels. Based on this information, which of the following statements are correct?

A. The change from D to F is a Pareto improvement.
B. The new outcome F is Pareto efficient.
C. Both Angela and Bruno receive economic rents at F.
D. As a result of the new law, Bruno has less bargaining power.

Answer 18

C and D - At F, Angela is above her reservation indifference curve and is thus receiving an economic rent. Bruno’s reservation option is to receive nothing, so the grain he receives at F is an economic rent for him.
At D, Bruno obtained rent equal to CD, and Angela obtained no rent. At F his rent is much lower. The law has increased Angela’s bargaining power and reduced Bruno’s.

Question 19

Angela and Bruno are at allocation F, where she receives 4.5 bushels of grain for 4 hours of work. From the figure, we can conclude that:

A. All the points on EF are Pareto efficient.
B. Any point in the area between G, H and F would be a Pareto improvement.
C. Any point between G and D would be a Pareto improvement.
D. They would both be indifferent between all points on GH.

Answer 19

B = In area GHF, Angela is on a higher indifference curve than IC2, and Bruno has more grain than EF, so both are better off.

Question 20

Lorenz curve for market income in the Netherlands in 2010.Which of the following is true?

A. If area A increases, income inequality falls.

B. The Gini coefficient can be calculated as the proportion of area A to area A + B.

C. Countries with lower Gini coefficients have less equal income distributions.

D. The Gini coefficient takes the value 1 when everyone has the same income.

Answer 20

B = This method can be used when the population is large, as it is for a whole country such as the Netherlands.

Question 21

The person who receives the income left over from a firm or other people after the payment of all contractual costs (for example the cost of hiring workers and managers, paying taxes and subcontractors is called:
select one or more

a. the government
b. residual claimant
c.owners
d. taxpayers
e. empolyees

Answer 21

b. residual claimant
c. owner

Question 22

Which of the following are reasons why employment contracts are incomplete?
Select one or more:

a.The firm cannot contract an employee not to leave.

b.The contract is unfinished.

c.The firm is unable to observe exactly how an employee is fulfilling the contract.

d.The firm cannot specify every eventuality in a contract.

Answer 22

A, C,D

Question 23

In which of the following employment situations would the employment rent be high, ceteris paribus?
Select one or more:

a.When the worker is paid a high salary because the firm’s customers know and trust her.

b. In a job that provides many benefits, such as housing and medical insurance

c. In an economic boom, when the ratio of job-seekers to vacancies is low.

d. In an economic boom, when the ratio of job-seekers to vacancies is low.

Answer 23

A, B
- If the employee loses the job, all these benefits would be lost, so the economic rent from employment is high.
- This worker is paid a high salary because of firm-specific assets that will be lost if she leaves. Other firms would pay a lower salary (at least initially) so the economic rent is high.

Question 24

The figure above depicts the efficiency wage equilibrium of a worker and a firm. According to this figure:
Select one:
a. Along the isocost line tangent to the best response curve, doubling of the per-hour effort from 0.45 to 0.90 would lead to an increased profit for the firm.

b. At the equilibrium point, the marginal rate of transformation on the isocost line equals the marginal rate of substitution on the worker’s best response curve.

c. Points C and A both represent Nash equilibria because they are on the best response curve.

d. The slope of each isocost line is the number of units of effort per dollar.

Answer 24

D = Isocost lines have a constant ratio of effort to wage, e/w. Since e is on the vertical axis, and w is on the horizontal axis, the slope is e/w, which is the number of units of effort per dollar.

Question 25

The figure above depicts Maria’s best response curve when the expected duration of unemployment is 44 weeks. Which of the following statement(s) is(are) correct? Select one or more:

a.If the expected unemployment duration increased to 50 weeks, Maria’s best response to a wage of $12 would be an effort level above 0.5.

b.Over the range of wages shown in the figure, Maria would never exert the maximum possible effort per hour.

c.Increasing effort from 0.5 to 0.6 requires a bigger wage increase than increasing effort from 0.8 to 0.9.

d.If the unemployment benefit was reduced, then Maria’s reservation wage would be higher than $6.

Answer 25

A,B

Question 26

Which of the following statements are true?Select one or more:

a. If the wage doesn’t change, employees will work harder in periods of high unemployment.

b. If unemployment benefits are increased, the minimum cost of a unit of effort for the employer will rise.

c. If an employee’s disutility of effort increases, the reservation wage will rise.

d. If workers continue to receive benefits however long they remained unemployed, an increase in the level of unemployment will have no effect on the best response curve.

Answer 26

A, B
- An increase in unemployment benefits shifts the best response curve to the right. The employer will no longer be able to reach the isocost line tangent to the original best response curve, so the cost of effort must rise.

• In periods of high unemployment, the cost of job loss is higher. At any given wage level, employees will choose higher effort to reduce the chance of losing their jobs.

Question 27

A labour contract transfers ownership of the employee from the employee to the employer.
True / False

Answer 27

False

Question 28

A firm is a structure that involves decentralisation of power to the employees.
True/False

Answer 28

False

Question 29

A firm’s cost of production is £12 per unit of output. If P is the price of the output good and Q is the number of units produced, which of the following statements is correct?

A. Point (Q, P) = (2,000, 20) is on the isoprofit curve representing the profit level £20,000.

B. Point (Q, P) = (2,000, 20) is on a lower isoprofit curve than point (Q, P) = (1,200, 24).

C. Points (Q, P) = (2,000, 20) and (4,000, 16) are on the same isoprofit curve.

D. Point (Q, P) = (5,000, 12) is not on any isoprofit curve.

Answer 29

C. At (Q, P) = (2,000, 20), profit = (20 – 12) × 2,000 = £16,000. At (Q, P) = (4,000, 16), profit = (16 – 12) × 4,000 = £16,000. Therefore, these two points are on the same isoprofit curve.

Question 30

Consider a firm whose unit cost (the cost of producing one unit of output) is the same at all output levels. Which of the following statements are correct?

A. Each isoprofit curve depicts the firm’s profit for different outputs for a given price of the output good.

B. Isoprofit curves can be upward-sloping when at high profit levels.

C. Every price-quantity combination lies on an isoprofit curve.

D. Isoprofit curves slope downward when the price is above the unit cost.

Answer 30

C and D
If the price is above the unit cost, then if output is increased the price must be lowered to keep profit constant, so isoprofit curve slopes downward.

Question 31

The table represents market demand Q for a good at different prices P.
Q 100, 200, 300,400,500 600,700,800,900,1,000
P £270, £240, £210, £180, £150,£120, £90,£60,£30,£0

The firm’s unit cost of production is £60. Based on this information, which of the following is correct?

A. At Q = 100, the firm’s profit is £20,000.

B. The profit-maximizing output is Q = 400.

C. The maximum profit that can be attained is £50,000.

D. The firm will make a loss at all outputs of 800 and above.

Answer 31

B = At Q = 400, profit = (180 – 60) × 400 = £48,000. If you calculate the profit for each point on the demand curve you will see that profit is lower at the other points.

Question 32

Which of the following statements is correct?

A. If a firm’s technology exhibits constant returns to scale, doubling the inputs leads to doubling of the output level.

B. If a firm’s technology exhibits decreasing returns to scale, doubling the inputs more than doubles the output level.

C. If a firm’s technology exhibits economies of scale, costs per unit will fall as the firm expands its production.

D. If a firm’s technology exhibits diseconomies of scale, doubling the inputs leads to less than doubling of the output level.

Answer 32

A, C, B
With constant returns, increasing the inputs leads to the same proportional increase in output.

Since the firm can increase output with a less than proportional increase in inputs, its cost per unit will fall.

With decreasing returns, increasing the inputs leads to a less than proportional increase in output.

Question 33

Consider a firm with fixed costs of production. Which of the following statements about its average cost (AC) and marginal cost (MC) is correct?

A. When AC = MC, the AC curve has a zero slope.

B. When AC > MC, the MC curve is downward-sloping.

C. When AC < MC, the AC curve is downward-sloping.

D. The MC curve cannot be horizontal.

Answer 33

A = When AC = MC, the cost of an additional unit equals the average cost of all existing units. Therefore, the new AC will be the same and the slope is zero.

Question 34

Suppose that the unit cost of producing a pound of cereal is $2, irrespective of the level of output. (This means there are no fixed costs, that is, costs that are present for any level of output, including zero.) Which of the following statements is correct?

A. The total cost curve is a horizontal straight line.

B. The average cost curve is downward-sloping.

C. The marginal cost curve is upward-sloping.

D. The average cost and the marginal cost curves coincide.

Answer 34

D = Both the average and the marginal cost are 2 for all outputs, so the curves representing them coincide.

Question 35

The diagram depicts two alternative demand curves, D and D′, for a product. Based on this graph, which of the following are correct?

A. On demand curve D, when the price is £5,000, the firm can sell 15 units of the product.

B. On demand curve D′, the firm can sell 70 units at a price of £3,000.

C. At price £1,000, the firm can sell 40 more units of the product on D′ than on D.

D. With an output of 30 units, the firm can charge £2,000 more on D′ than on

Answer 35

B and C
When Q = 70, the corresponding price on D′ is £3,000.
D′ can be seen as just a rightward shift of D, by 40 units. So for any price, the firm can sell 40 more units on D′ than on D.

Question 36

The diagram depicts the marginal cost curve (MC), the average cost curve (AC), and the isoprofit curves of a firm. What can we deduce from the information in the diagram?
A. The profit level at A is 500.
B. The profit level at B is 150.
C. The price at C is 50.
D.The price at B is 36.

Answer 36

C. The profit level for the isoprofit curve going through C can be calculated at Q = 10, where AC = 20, and P = 70. So the profit is (70 − 20) × 10 = 500. At C, Q = 20, so profit per unit is (P − AC) = 25. Since AC is 25, P must be 50.

Question 37

Figure 7.11 depicts the demand curve for Beautiful Cars, together with the marginal cost and isoprofit curves. The quantity-price combination at point E is (Q, P) = (32, 5,440). The average cost of producing 50 cars is the same as the average cost of producing 32. Suppose that the firm keeps the price at P = $5,440 but now produces 50 cars instead of 32. Which of the following is correct?

A. The firm will now sell all 50 cars at $5,440.
B. The firm’s profit will increase.
C. The firm’s profit remains the same.
D. The firm’s profit is now reduced.

Answer 37

D = The firm’s profit is reduced by the cost of producing the extra 18 cars that now remain unsold.

Question 38

Figure 7.11 depicts the demand curve for Beautiful Cars, together with the marginal cost and isoprofit curves. At point E, the quantity-price combination is (Q, P) = (32, 5,440) and the profit is $63,360. Suppose that the firm chooses instead to produce Q = 32 cars and sets the price at P = $5,400. Which of the following statements is correct?

A. The profit remains the same at $63,360.
B. The profit is reduced to $62,080.
C. The average cost of production is $3,400.
D. The firm is unable to sell all the cars.

Answer 38

B = Since Q is still 32, production costs remain the same. Revenue falls by $40 on each car, so by $1,280 in total. So profit is $63,360 – $1,280 = $62,080.

Question 39

Figure 7.11 depicts the demand curve for Beautiful Cars, together with the marginal cost and isoprofit curves.Suppose that the firm decides to switch from P* = $5,440 and Q* = 32 to a higher price, and chooses the profit-maximizing level of output at the new price. Which of the following statements is correct?

A. The quantity of cars produced is reduced.

B. The marginal cost of producing an extra car is higher.

C. The total cost of production is higher.

D. The profit is increased due to the new higher price.

Answer 39

A = At a higher price than P*, the maximum number of cars that can be sold is less than 32, and the firm will not produce more cars than it can sell.

Question 40

This figure shows the marginal cost and marginal revenue curves for Beautiful Cars. Which of the following statements is correct, based on the information shown?
A. When Q = 40, the marginal cost is greater than the marginal revenue so the firm’s profit must be negative.
B. Revenue is greater when Q = 10 than if Q = 20.
C. The firm would not choose to produce at point E because marginal profit is zero.
D. Profit is greater when Q = 20 than when Q = 10.

Answer 40

D = At all levels of output up to point E, marginal revenue is greater than marginal cost. So profit increases as output increases—it is higher at Q = 20 than Q = 10.

Question 41

Which of the following statements is correct?

A. Consumer surplus is the difference between the consumers’ willingness to pay and what they actually pay.

B. Producer surplus equals the firm’s profit.

C. Deadweight loss is the loss incurred by the producer for not selling more cars.

D. All possible gains from trade are achieved when the firm chooses its profit-maximising output and price.

Answer 41

A = each consumer receives a surplus equal to the difference between the WTP and the price, and consumer surplus is the sum of the surpluses of all consumers.

Question 42

A shop sells 20 hats per week at $10 each. When it increases the price to $12, the number of hats sold falls to 15 per week. Which of the following statements are correct?

A. When the price increases from $10 to $12, demand increases by 25%.
B. A 20% increase in the price causes a 25% fall in demand.
C. The demand for hats is inelastic.
D. The elasticity of demand is approximately 1.25.

Answer 42

B and D
The percentage price increase is 100 × 2/10 = 20%. It causes a percentage decrease in demand of 100 × 5/20 = 25%.
The percentage price increase is 100 × 2/10 = 20%; the percentage decrease in demand is 100 × 5/20 = 25%. So the elasticity can be estimated as 25/20 = 1.25.

Question 43

The figure depicts two demand curves, D1 and D2.
Based on this figure, which of the following statements are correct?

A. At E, demand curve D1 is less elastic than D2.
B. The elasticity is the same at A and C.
C. At E, both demand curves have the same elasticity.
D. The elasticity is higher at E than at B.

Answer 43

A and D = At E, the price and quantity are the same on both demand curves, but D1 is steeper, so it is less elastic than D2.
The slope is the same at E and B. But at E the price is higher and quantity is lower, so the elasticity is higher.

Question 44

Suppose that in a small town a multinational retailer is planning to build a new superstore. Which of the following arguments could be correct?

A. The local protestors argue that the close substitutability of some of the goods sold between the new retailer and existing ones means that the new retailer faces inelastic demand for those goods, giving it excessive market power.
B. The new retailer argues that the close substitutability of some of the goods implies a high elasticity of demand, leading to healthy competition and lower prices for consumers.
C. The local protestors argue that once the local retailers are driven out, there will be no competition, giving the multinational retailer more market power and driving up prices.
D.The new retailer argues that most of the goods sold by local retailers are sufficiently differentiated from its own goods that their elasticity of demand will be high enough to protect the local retailers’ profits

Answer 44

B and C
Close substitutability between goods implies competition between providers, which typically results in lower prices.
If the local retailers are driven out, the multinational will have more market power. It will face less elastic demand, and be able to raise prices without losing customers.

Question 45

As a student representative, one of your roles is to organize a second-hand textbook market between the current and former first-year students. After a survey, you estimate the demand and supply curves to be the ones shown in Figures 8.1 and 8.2. For example, you estimate that pricing the book at $7 would lead to a supply of 20 books and a demand of 26 books. Which of the following statements is correct?

A. A rumour that the textbook may be required again in Year 2 would change the supply curve, shifting it upwards.
B. Doubling the price to $14 would double the supply.
C. A rumour that the textbook may no longer be on the reading list for the first-year students would change the demand curve, shifting it upwards.
D. Demand would double if the price were reduced sufficiently.

Answer 45

A = The rumour would make the former first-year students less willing to sell. Their WTAs would rise, shifting the supply curve upwards. Equivalently, the number of students willing to supply their book at each price would be lower.

Question 46

The diagram shows the demand and the supply curves for a textbook. The curves intersect at (Q, P) = (24, 8). Which of the following is correct?

A. At price $10, there is an excess demand for the textbook.
B. At $8, some of the sellers have an incentive to increase their selling price to $9.
C. At $8, the market clears.
D. 40 books will be sold in total.

Answer 46

C = At $8, the quantity demanded is equal to the quantity supplied—that is, the market clears.

Question 47

Figure 8.5 shows a price-taking bakery’s marginal and average cost curves, and its isoprofit curves. The market price for bread is P*= €2.35. Which of the following statements is correct?

A. The firm’s supply curve is horizontal.
B. At the market price of €2.35, the firm will supply 62 loaves, at the point where the firm makes zero profit.
C.At any market price, the firm’s supply is given by the corresponding point on the average cost curve.
D. The marginal cost curve is the firm’s supply curve.

Answer 47

D = At each price, the firm maximises profit by choosing the corresponding quantity on the marginal cost curve. So the marginal cost curve is its supply curve.

Question 48

There are two different types of producers of a good in an industry where firms are price-takers. The marginal cost curves of the two types are given below: Type A is more efficient than Type B: for example, as shown, at the output of 20 units, the Type A firms have a marginal cost of $2, as opposed to a marginal cost of $3 for the Type B firms. There are 10 Type A firms and 8 Type B firms in the market. Which of the following statements is correct?
A. At price $2, the market supply is 450 units.
B.The market will supply 510 units at price $3.
C.At price $2, the market’s marginal cost of supplying one extra unit of the good will depend on the type of the firm that produces it.
D. With different types of firms, we cannot determine the marginal cost curve for the market.

Answer 48

B = At $3, type A firms supply 35 units and type B firms supply 20 units. So the market supply is (10 × 35) + (8 × 20) = 510.

Question 49

In Figure 8.9a, the market equilibrium output and price of the bread market is shown to be at (Q, P) = (5,000, €2). Suppose that the mayor decrees that bakeries must sell as much bread as consumers want, at a price of €1.50. Which of the following statements are correct?

A. The consumer and producer surpluses both increase.
B.The producer surplus increases but the consumer surplus decreases.
C.The consumer surplus increases but the producer surplus decreases.
D.The total surplus is lower than at the market equilibrium.

Answer 49

C and D = The consumers benefit from the lower price, but producers lose because the price is below marginal cost.
There is a deadweight loss, equal to the area of the triangle between the supply and demand curves to the right of equilibrium.

Question 50

Which of the following statements about a competitive equilibrium allocation are correct?

A. It is the best possible allocation.
B. No buyer’s or seller’s surplus can be increased without reducing someone else’s surplus.
C. The allocation must be Pareto efficient.
D.The total surplus from trade is maximized.

Answer 50

B and D = This must be true, since the allocation maximizes the total surplus.
This is a general property of competitive equilibrium.

Question 51

Figure 8.8 shows the equilibrium of the bread market to be 5,000 loaves per day at price €2. A year later, we find that the market equilibrium price has fallen to €1.50. What can we conclude?

A.The fall in the price must have been caused by a downward shift in the demand curve.
B.The fall in the price must have been caused by a downward shift in the supply curve.
C. The fall in price could have been caused by a shift in either curve.
D.At a price of €1.50, there will be an excess demand for bread.

Answer 51

C = A downward shift in either curve would cause the price to fall. If we knew whether output had increased or decreased, we could determine which curve had shifted.

Question 52

Which of the following statements are correct?

A. A fall in the mortgage interest rate would shift up the demand curve for new houses.
B.The launch of a new Sony smartphone would shift up the demand curve for existing iPhones.
C.A fall in the oil price would shift up the demand curve for oil.
D.A fall in the oil price would shift down the supply curve for plastics.

Answer 52

A and D = If mortgage borrowing becomes cheaper, more people will want to buy houses at each house price.
The marginal cost of producing plastics would fall, so the supply curve would shift down.

Question 53

Figure 8.14 shows the demand and supply curves for salt, and the shift in the supply curve due to the implementation of a 30% tax on the price of salt. Which of the following statements are correct?

A. In the post-tax equilibrium, the consumers pay P1 and the producers receive P.
B. The government’s tax revenue is given by (P – P0)Q1.
C.The deadweight loss is given by (1/2)(P1 – P0)(Q* – Q1).
D.As a result of the tax, the consumer surplus is reduced by (1/2)(Q1 + Q)(P1 – P).

Answer 53

C and D = This is the area of the triangle between the supply and demand curves, below AB.
This is the area of the trapezium between the horizontal dotted lines through A and B.

Question 54

Figure 8.17 shows the effect of a tax intended to reduce the consumption of butter. The before-tax equilibrium is at A = (2.0 kg, 45 kr) and the after-tax equilibrium is at B = (1.6 kg, 54 kr). The tax imposed is 10 kr per kg of butter. Which of the following statements is correct?

A. The producers receive 45 kr per kg of butter.
B. The tax policy would be more effective if the supply curve were less elastic.
C. The very elastic supply curve implies that the incidence of the tax falls mainly on consumers.
D. The loss of consumer surplus due to tax is (1/2) × 10 × (2.0 – 1.6) = 2.0.

Answer 54

C = The elastic supply curve means that the price paid by consumers changes much more than the price received by producers.

Question 55

Look again at Figure 8.18, which shows the market for Choccos and for all chocolate bars. Based on the two diagrams, which of the following statements is correct?

A. The firm that makes Choccos chooses to produce at the bottom of the U-shaped isoprofit curve.
B. All chocolate bars will be sold at the same price P*.
C. The existence of many competitors means that the firm is a price-taker.
D.The market marginal cost (MC) curve is approximately the sum of the MC curves of all the producers of the chocolate bars.

Answer 55

D = Each firm produces close to its MC curve, so the MC curve is approximately the firm’s supply curve, and so market supply is approximately the sum of the firms’ MC curves.