Waddell Questions 3 Flashcards
If demand is downward-sloping, supply is upward-sloping and the good in question is a normal good, an increase in income would result in:
(a) an increase in equilibrium price; an increase in equilibrium quantity.
(b) an increase in equilibrium price; a decrease in equilibrium quantity.
(c) a decrease in equilibrium price; a decrease in equilibrium quantity.
(d) a decrease in equilibrium price; an increase in equilibrium quantity.
(e) None of the above.
(a) an increase in equilibrium price; an increase in equilibrium quantity.
Here’s why:
Demand is downward-sloping: This implies that as the price decreases, the quantity demanded increases, and vice versa. This is a standard characteristic of most goods in economics, reflecting the law of demand.
Supply is upward-sloping: This means that as the price increases, the quantity supplied increases, and as the price decreases, the quantity supplied decreases. This behavior is guided by the law of supply, indicating that producers are willing to supply more of a good at higher prices due to the increased profit potential.
The good is a normal good: Normal goods are those for which demand increases as consumer income increases. This is because consumers have more purchasing power and are willing to buy more of the good as they become wealthier.
Given these conditions, an increase in income would lead to an increase in demand for the normal good because consumers can afford to buy more of it. This shift in demand causes the demand curve to move to the right. With an upward-sloping supply curve, this increase in demand leads to both a higher equilibrium price and a higher equilibrium quantity. Producers respond to the higher prices by supplying more, and consumers are able to purchase more because their increased income allows them to afford the higher prices. Thus, the outcome is an increase in both the equilibrium price and the equilibrium quantity.
Consumers’ total expenditures (or a firm’s total revenue) is maximized where:
(a) the price is relatively high and the quantity is relatively low.
(b) price-elasticity of demand is equal to -1.
(c) price-elasticity of demand is more-negative than -1 (e.g., -1.4, -2.7)
(d) None of the above.
(b) price-elasticity of demand is equal to -1.
Here’s why:
Price elasticity of demand measures how responsive the quantity demanded of a good is to a change in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. The elasticity can be negative, reflecting the inverse relationship between price and quantity demanded, as per the law of demand.
When the price elasticity of demand is equal to -1, it means that the percentage change in quantity demanded is exactly equal to the percentage change in price. This point is known as the unit elastic point. At this point, any change in price is exactly offset by a proportional change in quantity demanded in the opposite direction, so total revenue (or total expenditures) is maximized. Total revenue is calculated as price multiplied by quantity, and when elasticity is -1, the product of these two factors is at its maximum because the proportional increase in quantity demanded offsets the proportional decrease in price, and vice versa.
Option (a), where the price is relatively high and the quantity is relatively low, does not necessarily correspond to the maximization of total revenue. It could lead to less total revenue if the demand is highly elastic at high prices, meaning quantity demanded significantly decreases as price increases.
Option (c), where the price-elasticity of demand is more negative than -1 (e.g., -1.4, -2.7), indicates that demand is elastic. In this range, reducing the price leads to a more than proportional increase in quantity demanded, which can increase total revenue, but it does not represent the point of maximum total revenue. Instead, it indicates that total revenue could still be increasing with price decreases or decreasing with price increases.
Therefore, (b) correctly identifies the condition under which consumers’ total expenditures or a firm’s total revenue is maximized.
The market demand curve will always:
(a) be flatter than the individual demand curves that contribute to it.
(b) be steeper than the individual demand curves that contribute to it.
(c) have the same slope as the demand curves that contribute to it.
(d) be unrelated to the individual demand curves that contribute to it.
(a) be flatter than the individual demand curves that contribute to it.
Here’s why:
The market demand curve is derived from horizontally summing all individual demand curves. This means that at any given price, the total quantity demanded in the market is the sum of the quantities demanded by all individuals at that price.
When individual demand curves are aggregated in this way, the resulting market demand curve tends to be flatter than the individual demand curves. This is because even if some individuals have relatively inelastic demand (not very responsive to price changes), others may have more elastic demand (more responsive to price changes). As a result, at any given price change, the market demand will reflect some individuals buying significantly more (or less) of the good while others buy slightly more (or less). This variation in responses tends to make the overall market demand more price-sensitive (elastic) than the demand of individual consumers, hence resulting in a flatter curve.
Option (b), suggesting the market demand curve is steeper, would imply that the market as a whole is less responsive to price changes than individuals, which is generally not the case due to the aggregation of diverse individual behaviors.
Option (c), that the market demand has the same slope as the individual demand curves, overlooks the aggregation process’s effect on responsiveness to price changes.
Option (d), suggesting the market demand curve is unrelated to individual demand curves, contradicts the fundamental principle of how market demand is constructed from individual demands.
Where demand is less elastic, the imposition of a binding price ceiling yields a smaller difference between market prices and a consumer’s willingness to pay. Therefore, it is
in such markets that we would expect black markets to arise.
(a) True.
(b) False.
True
Companies will tend to “over pollute” when:
(a) they don’t pay all of the marginal costs associated with the pollution.
(b) the costs of pollution are shared with society and not borne entirely by the firm.
(c) the government attaches a fine to the existence of pollution, not to the level of
pollution.
(d) All of the above.
The concept underlying the tendency of companies to “over pollute” relates to the economic principle of externalities, specifically negative externalities. A negative externality occurs when the production or consumption of a good or service imposes costs on third parties which are not reflected in the market prices. This discrepancy can lead to market failure, where the level of production or consumption of the good or service diverges from the socially optimal level.
(a) When companies do not pay all of the marginal costs associated with the pollution they generate, they face lower private costs than the actual social costs. This situation leads to overproduction of the polluting good or service, as the market price does not fully capture the external costs imposed on society.
(b) If the costs of pollution are shared with society and not borne entirely by the firm, this represents a classic case of a negative externality. The firm’s private cost curve does not include the external costs borne by society, leading to a higher level of production and pollution than what would be socially optimal.
(c) When the government imposes a fine on the existence of pollution but does not scale the fine according to the level of pollution, firms lack the incentive to reduce pollution beyond the threshold that triggers the fine. This can lead to situations where firms pollute up to the fine limit without facing additional costs for increasing pollution levels within that limit, resulting in pollution levels higher than would be socially optimal.
Given the explanations above, the correct answer is:
(d) All of the above.
Each option describes a scenario in which the market fails to internalize the full costs of pollution, leading to excessive pollution from a social welfare perspective. This highlights the importance of policies that align private costs with social costs, such as pollution taxes or tradable permits, to mitigate over-pollution and achieve a more socially optimal outcome.
Of the nine (i.e., 3×3) pure strategies in the game below (where higher payoffs are better), how many are Nash equilibria?
(a) 0
(b) 1
(c) 2
(d) 3
(e) 6
A Nash equilibrium occurs in a game when no player can benefit by changing their strategy while the other player’s strategy remains unchanged. In other words, each player’s strategy is the best response to the strategy of the other player. In the game matrix provided, which is a representation of Rock-Paper-Scissors, we need to examine whether any of the strategy combinations constitute a Nash equilibrium.
Let’s analyze each of the player’s strategies:
When Player 1 chooses Rock, Player 2’s best responses are to choose Rock or Scissors (0,0) or (1,-1).
When Player 1 chooses Paper, Player 2’s best responses are to choose Paper or Rock (-1,1) or (0,0).
When Player 1 chooses Scissors, Player 2’s best responses are to choose Scissors or Paper (-1,1) or (0,0).
However, because this is a zero-sum game and each player’s strategy is a best response to exactly one strategy of the other player, there are no combinations where both players would not have an incentive to deviate if given the chance. In Rock-Paper-Scissors, each option (Rock, Paper, Scissors) is effectively beaten by one of the other options.
Given that neither player has a dominant strategy and that any strategy can be bested by another, no pure strategy in this matrix is a Nash equilibrium. Therefore, the correct answer is:
(a) 0
There are no pure strategy Nash equilibria in the standard Rock-Paper-Scissors game. The Nash equilibrium for this game is a mixed strategy where each player randomly chooses between Rock, Paper, and Scissors with equal probability.
Where property rights are not well defined:
(a) the decision maker must bear all of the marginal benefits of any decision.
(b) the decision maker must bear all of the marginal costs of any decision.
(c) society does not bear all of the marginal costs and marginal benefits of any decision.
(d) None of the above.
D. None of the above
If property rights were defined such that individuals received marginal benefits from their actions (e.g., benefiting from using a public golf course) but didn’t pay any of the
marginal costs of such use, we would predict that:
(a) public golf courses would be “over used.”
(b) public golf courses would be “under used.”
If property rights are defined in a way that allows individuals to receive the marginal benefits from their actions without paying any of the marginal costs, this creates a situation in which the private incentive is to use the resource as much as possible, because the user does not incur the full cost of their usage. This disconnect between private incentives and social costs leads to overconsumption of the resource. Thus, we would predict that:
(a) public golf courses would be “over used.”
This overuse occurs because there is no financial disincentive to limit the use of the golf course, and the absence of cost to the individual users leads to a greater quantity of use than is socially optimal. This is a classic example of a negative externality where the external costs are not borne by the users, leading to a market failure.
If you are told that at the current level of production of a particular good the marginal value exceeds the marginal cost, you know that
(a) the market allocation is efficient.
(b) too much of the good is being produced and exchanged.
(c) too little of the good is being produced and exchanged.
(d) None of the above.
If at the current level of production the marginal value exceeds the marginal cost, this indicates that the value to consumers of an additional unit of the good is greater than the cost of producing that additional unit. In an efficient market allocation, the marginal cost of producing a good should equal the marginal value (or price) that consumers place on that good, as this indicates that resources are being used in a way that maximizes total surplus.
Given this understanding, the correct interpretation is:
(c) too little of the good is being produced and exchanged.
This is because there is still some net benefit to society — in terms of increased consumer and producer surplus — to be gained from producing additional units of the good, since the value those units bring exceeds their cost of production. Efficiency would be achieved only when the marginal cost rises to meet the marginal value, at which point no further gains from trade can be made.
Suppose a manufacturing firm earns $1 billion in economic profit each year, but pollution is a by-product of their production process. If this firm is fined $10 million per year for as long as they continue to pollute, we would expect them to:
(a) increase pollution rates.
(b) decrease pollution rates.
(c) continue producing the same amount of pollution.
When evaluating the firm’s response to the fine, we consider the relative size of the fine compared to the economic profit and the costs associated with reducing pollution. A fine is meant to serve as a deterrent or an incentive for the firm to change its behavior—in this case, to reduce pollution. However, the effectiveness of the fine in altering behavior depends on whether the fine is large enough to impact the firm’s decision-making.
If the firm earns $1 billion in economic profit and is fined only $10 million for pollution, the fine constitutes 1% of their economic profit. Without further information on the cost of reducing pollution versus the cost of paying the fine, we can consider the following:
If the cost of reducing pollution is significantly higher than the fine, the firm may opt to simply pay the fine and continue with their current level of production and pollution, treating the fine as a cost of doing business.
If the cost of reducing pollution is lower than the fine or if the fine threatens the firm’s public image, market position, or future regulatory interventions, the firm may invest in reducing pollution.
Given the choices provided and the fact that the fine is relatively small compared to the firm’s economic profit, the most likely expectation, in the absence of other considerations like public relations or potential for increased regulatory action, is:
(c) continue producing the same amount of pollution.
This option reflects a scenario where the fine is not substantial enough to incentivize the firm to change its behavior. However, it’s essential to note that the actual decision would depend on a more detailed cost-benefit analysis by the firm, considering all relevant factors, not just the fine itself.
In answering questions 11 and 12 consider the following game, where more is preferred to less (i.e., higher numbers are better.)
- What is the Nash equilibrium of the game?
(a) Top, Left
(b) Bottom, Left
(c) Top, Right
(d) Bottom, Right - What is the cooperative outcome of the game?
(a) Top, Left
(b) Bottom, Left
(c) Top, Right
(d) Bottom, Right
Nash Equilibrium:
(a) Top Left
Cooperative Outcome:
(d) Bottom, Right
Suppose that the route from Eugene to San Francisco is served by United and three other airlines but the route from Eugene to Seattle is served only by United. All else equal, the demand for tickets from Eugene to San Francisco is likely to be:
(a) less price elastic than the demand for tickets from Eugene to Seattle.
(b) more income elastic than the demand for tickets from Eugene to Seattle.
(c) less income elastic than the demand for tickets from Eugene to Seattle.
(d) more price elastic than the demand for tickets from Eugene to Seattle.
The demand elasticity for a product or service reflects how sensitive the quantity demanded is to changes in its price or consumers’ income. Price elasticity of demand measures the responsiveness of the quantity demanded of a good to a change in its price, while income elasticity of demand measures the responsiveness of the quantity demanded to a change in consumer income.
In the context provided, where the route from Eugene to San Francisco is served by United and three other airlines, while the route from Eugene to Seattle is served only by United, we consider the competition and availability of substitutes in assessing price elasticity.
With more airlines serving the Eugene to San Francisco route, consumers have more alternatives if one airline raises its prices, making them more likely to switch to another carrier. This scenario indicates a higher price elasticity of demand because the presence of substitutes (other airlines) makes consumers more responsive to price changes. Therefore, the demand for tickets from Eugene to San Francisco would be more price elastic than the demand for tickets from Eugene to Seattle, where United is the only provider, and consumers have fewer alternatives if prices change.
This explanation aligns with option (d) more price elastic than the demand for tickets from Eugene to Seattle, as the presence of more substitutes (other airlines) for the Eugene to San Francisco route increases the price sensitivity of demand compared to the Eugene to Seattle route, where such substitutes are absent.
The options concerning income elasticity (b and c) are less directly relevant to the situation described, as income elasticity relates to changes in consumer income, not the availability of substitutes or the competitive landscape, which are the key factors affecting price elasticity in this scenario.
Where property rights are well defined:
(a) the decision maker bears all of the marginal costs and marginal benefits of any decision.
(b) the decision maker bears all of the marginal costs of any decision.
(c) society bears all of the marginal costs and marginal benefits of any decision.
In economics, the concept of property rights is fundamental to understanding how resources are utilized and managed. Well-defined property rights mean that individuals or entities have clear ownership over resources, including the rights to use those resources, earn income from them, and transfer them to others. This clarity encourages efficient resource use and investment because the owners can reap the benefits of their investments and are responsible for their actions regarding those resources.
Option (a) “the decision maker bears all of the marginal costs and marginal benefits of any decision” aligns most closely with the principle of well-defined property rights. When property rights are clearly defined and enforced, the owner (or decision maker) of a resource is incentivized to consider the full impact of their decisions. This is because they directly receive the benefits of positive decisions (marginal benefits) and directly suffer the consequences of negative decisions (marginal costs). This dynamic encourages owners to make decisions that maximize their utility, which, under certain conditions, can lead to outcomes that are efficient from both a personal and societal perspective.
Options (b) and (c) describe scenarios that don’t fully capture the essence of well-defined property rights. Option (b) suggests that the decision maker only bears the marginal costs, which is incomplete without considering that they also enjoy the marginal benefits. Option (c) implies a communal or societal bearing of costs and benefits, which strays from the principle that well-defined property rights focus on individual or specific entity ownership and responsibility.
Therefore, well-defined property rights are crucial for aligning individual incentives with efficient resource use, as they ensure that those who make decisions about the use of resources directly experience the consequences of those decisions, promoting accountability and stewardship.
For questions 15 and 16, consider the following game (where higher payoffs are better).
- In the above game, does either player have a dominant strategy?
(a) Playing L is a dominant strategy for P1
(b) Playing R is a dominant strategy for P1
(c) Playing L is a dominant strategy for P2
(d) Playing R is a dominant strategy for P2
- In the above game, what is the most P2 would be willing to pay P1, for P1 to sign a contract that bound P1 to play R?
(a) P2 would pay P1 up to $16 to sign such a contract.
(b) P2 would pay P1 up to $12 to sign such a contract.
(c) P2 would pay P1 up to $5 to sign such a contract.
(d) P2 would pay P1 up to $10 to sign such a contract.
To address question 15, let’s examine the provided game to determine if there is a dominant strategy for either player.
A dominant strategy is defined as a strategy that results in a higher payoff for a player, no matter what the other player chooses. For P1:
If P2 chooses L, P1 gets a higher payoff by choosing L (10 > 9).
If P2 chooses R, P1 gets a higher payoff by choosing R (4 > 3).
Since P1 does not have a higher payoff with either L or R regardless of P2’s choice, P1 does not have a dominant strategy.
Now, for P2:
If P1 chooses L, P2 gets a higher payoff by choosing L (5 > 1).
If P1 chooses R, P2 gets a higher payoff by choosing R (17 > 5).
In every case, P2 has a higher payoff by choosing R. Therefore, playing R is a dominant strategy for P2. The correct answer for question 15 is:
(d) Playing R is a dominant strategy for P2.
For question 16, we need to calculate how much P2 would be willing to pay P1 to play R:
If P1 chooses L, P2’s best response is L, giving P2 a payoff of 5.
If P1 is bound to choose R, P2’s best response is R, giving P2 a payoff of 17.
The most P2 would be willing to pay is the difference between the payoffs of the two scenarios, which is 17 - 5 = $12. P2 would want to retain some of the benefits of P1 playing R, so they would pay up to just below that differential. Therefore, the answer to question 16 is:
(b) P2 would pay P1 up to $12 to sign such a contract.
Suppose that female demand for cigarettes is more “price inelastic” than male demand for cigarettes. An implication of this is that:
(a) if cigarette taxes were increased cigarette smoking would decrease more (in percentage terms) among females than males.
(b) if cigarette taxes were increased cigarette smoking would decrease less (in percentage terms) among females than males.
(c) if income falls, a female would be more likely to quit smoking than a male.
(d) if income falls, a female would be less likely to quit smoking than a male.
Price elasticity of demand measures the responsiveness of the quantity demanded of a good to a change in its price. If female demand for cigarettes is more “price inelastic” than male demand, this means that females are less responsive to changes in the price of cigarettes compared to males.
(a) This option is incorrect because if cigarette taxes were increased and female demand is more price inelastic, we would expect the percentage decrease in cigarette smoking to be smaller for females than for males.
(b) This is the correct implication. If cigarette taxes are increased, the quantity of cigarettes demanded by females would decrease less, in percentage terms, than the quantity demanded by males, because female demand is more price inelastic.
(c) and (d) are addressing income elasticity, not price elasticity. Price inelasticity doesn’t provide direct information about how changes in income would affect the decision to quit smoking.
Therefore, the correct answer is:
(b) if cigarette taxes were increased cigarette smoking would decrease less (in percentage terms) among females than males.
