Eastern Mediterranean University Faculty of Business and Economics Department of Economics Fall Semester

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1 Eastern Mediterranean University Faculty of Business and Economics Department of Economics Fall Semester Duration: 110 minutes ECON101 - Introduction to Economics I Final Exam Type A 11 January 2017 Name: Student ID: Group No: Part A: Multiple Choice Questions (2 points each, total 60 points) Please mark your answers on both the exam paper and the optic sheet. 1. If Kevin s children run a lemonade stand for a day and sell 200 glasses of lemonade at $0.50 each, their total revenues are a. $100. b. $ c. $200. d. $ A difference between explicit and implicit costs is that a. explicit costs must be greater than implicit costs. b. explicit costs do not require a direct monetary expenditure by the firm, whereas implicit costs do. c. implicit costs do not require a direct monetary expenditure by the firm, whereas explicit costs do. d. implicit costs must be greater than explicit costs. 3. The difference between accounting profit and economic profit is a. explicit costs. b. implicit costs. c. total revenue. d. marginal product. 4. When a factory is operating in the short run, a. it cannot alter variable costs. b. total cost and variable cost are usually the same. c. average fixed cost rises as output increases. d. it cannot adjust the fixed costs. 5. Diseconomies of scale occur when a. average fixed costs are falling. b. average fixed costs are constant. c. long-run average total costs rise as output increases. d. long-run average total costs fall as output increases. 6. Competitive markets are characterized by a. a small number of buyers and sellers. b. unique products. c. the interdependence of firms. d. free entry and exit by firms. 7. A seller in a competitive market a. can sell all he wants at the going price, so he has little reason to charge less. b. will lose all his customers to other sellers if he raises his price. c. considers the market price to be a take it or leave it price. d. All of the above are correct. 8. Suppose that a firm operating in perfectly competitive market sells 50 units of output. Its total revenues from the sale are $500. Which of the following statements is correct? (i) Marginal revenue equals $5. (ii) Average revenue equals $10. (iii) Price equals $15. a. (i) b. (ii) c. (i) and (ii) d. (i), (ii), and (iii) Page 1 of 6

2 9. If a competitive firm is currently producing a level of output at which marginal cost exceeds marginal revenue, then a. average revenue exceeds marginal cost. b. the firm is earning a positive profit. c. decreasing output would increase the firm's profit. d. All of the above are correct. 10. In order to maximize profits in the short run, a firm should produce where a. marginal revenue exceeds marginal cost by the greatest amount. b. marginal cost is minimized. c. average total cost is minimized. d. marginal cost equals marginal revenue. 11. Profit-maximizing firms enter a competitive market when existing firms in that market have a. total revenues that exceed fixed costs. b. total revenues that exceed total variable costs. c. average total costs that exceed average revenue. d. average total costs less than market price. 12. A nonbinding price ceiling (i) causes a surplus. (ii) causes a shortage. (iii) is set at a price above the equilibrium price. (iv) is set at a price below the equilibrium price. a. (i) b. (iii) c. (i) and (iii) d. (ii) and (iv) only 13. Suppose the government imposes a $40 tax on the buyers of refrigerators. The tax would a. shift the demand curve downward by less than $40. b. raise the equilibrium price by $40. c. create a $20 tax burden each for buyers and sellers. d. discourage market activity. 14. Assume the demand for cigarettes is relatively inelastic, and the supply of cigarettes is relatively elastic. When cigarettes are taxed, we would expect a. most of the burden of the tax to fall on sellers of cigarettes, regardless of whether buyers or sellers of cigarettes are required to pay the tax to the government. b. most of the burden of the tax to fall on buyers of cigarettes, regardless of whether buyers or sellers of cigarettes are required to pay the tax to the government. c. the distribution of the tax burden between buyers and sellers of cigarettes to depend on whether buyers or sellers of cigarettes are required to pay the tax to the government. d. a large percentage of smokers to quit smoking in response to the tax 15. When a buyer s willingness to pay for a good is equal to the price of the good, the a. buyer s consumer surplus for that good is maximized. b. buyer will buy as much of the good as the buyer s budget allows. c. price of the good exceeds the value that the buyer places on the good. d. buyer is indifferent between buying the good and not buying it 16. Producer surplus equals a. Value to buyers - Amount paid by buyers. b. Amount received by sellers - Costs of sellers. c. Value to buyers - Costs of sellers. d. Value to buyers - Amount paid by buyers + Amount received by sellers - Costs of sellers. 17. Which of the following statements is NOT correct about a market in equilibrium? a. The price determines which buyers and which sellers participate in the market. b. Those buyers who value the good more than the price choose to buy the good. c. Those sellers whose costs are less than the price choose to produce and sell the good. d. Consumer surplus will be equal to producer surplus. 18. An optimizing consumer will select a consumption bundle in which a. income is maximized, and prices are minimized. b. utility is maximized, and prices are minimized. c. utility is maximized, subject to budget constraints.d. utility is maximized, and indifference curves are linear. 19. The slope of the budget constraint is all of the following except a. the relative price of two goods. b. the rate at which a consumer can afford to trade one good for another. c. the marginal rate of substitution. d. constant Page 2 of 6

3 20. A consumer chooses an optimal consumption point where the a. marginal rate of substitution equals the relative price ratio. b. slope of the indifference curve equals the slope of the budget constraint. c. ratio of the marginal utilities equals the ratio of the prices. d. All of the above are correct. 21. A natural monopoly occurs when a. the product is sold in its natural state, such as water or diamonds. b. there are economies of scale over the relevant range of output. c. the firm is characterized by a rising marginal cost curve. d. production requires the use of free natural resources, such as water or air. 22. Monopolies use their market power to a. charge prices that equal minimum average total cost. b. increase the quantity sold as they increase price. c. charge a price that is higher than marginal cost. d. lower excess supplies of their product on the market 23. Which of the following is NOT a characteristic of a monopoly? a. the seller has market power b. one seller c. free entry and exit d. a product without close substitutes 24. Which of the following are necessary characteristics of a monopoly? (i) The firm is the sole seller of its product. (ii) The firm's product does not have close substitutes. (iii) The firm generates a large economic profit. (iv) The firm is located in a small geographic market. a. (i) and (ii) b. (i) and (iii) c. (i), (ii), and (iii) d. (i), (ii), (iii), and (iv) 25. For a monopoly firm, a. price always equals marginal revenue. b. price always exceeds average revenue. c. any price-quantity combination will maximize profits. d. None of the above is correct. 26. Which of the following formulas would correctly calculate a monopolist s profit? a. profit = price marginal cost b. profit = price average total cost c. profit = (price marginal cost) quantity d. profit = (price average total cost) quantity 27. Deadweight loss a. measures monopoly inefficiency. b. exceeds monopoly profits. c. equals monopoly profits. d. equals monopoly revenues minus profits. 28. Which of the following is not correct? a. The demand curve facing a competitive firm is perfectly elastic. b. The demand curve facing a monopolist is the market demand curve. c. A monopolist can charge any price and sell any quantity that it chooses. d. A monopolist can alter the market price by adjusting the quantity that it produces. 29. In order to sell more of its product, a monopolist must a. sell to the government. b. sell in international markets. c. lower its price. d. use its market power to force up the price of complementary products. 30. When a firm experiences continually declining average total costs, a. the firm is a price taker. b. society is better served by having one firm supply the product. c. the firm will earn higher profits than if average total costs are increasing. d. All of the above are correct. Page 3 of 6

4 Part B: Problems (55 points) Question 1. Consider the following table of long-run total costs for two different firms: Firm A Firm B Quantity TC ATC TC ATC 1 $60.00 $60.00 $11.00 $ a. On the table above, calculate the long run average total cost (LAC) curves of the firms. (5 pts.) Answer: See the values above in bold. b. Does each of these firms experience economies of scale or diseconomies of scale? (12 pts.) Answer: Firm A has economies of scale because its long-run average total cost declines as output increases. Firm B has diseconomies of scale because its long-run average total cost rises as output rises Question 2. The graph shows the cost structure of a monopolistic firm. Use the graph to answer the following questions. a. What is the profit-maximizing output and price level of the monopolist? (2+2 pts.) Answer: Q = 12, P = 20 Page 4 of 6

5 b. Calculate the economic profit/loss (indicate which one). Show it on the graph. (5+2 pts.) Answer: Economic profit = (P - ATC)*Q = (20-10)*12 = $120, which is the shaded area on the graph above. c. Calculate the deadweight loss from monopoly. Explain in words what this means. (5+3 pts.) Answer: Deadweight loss is the social cost created by the monopoly as less output is produced and higher price is charged relative to perfect competition. It is shown on the graph above as a shaded triangle. Its value is the area of this triangle which is $12. This the total loss of economic surplus due to the monopoly. d. Find the price and quantity that would maximize social welfare. (2+2 pts.) Answer: The social welfare is maximized when the market is in perfect competition. If so the profit-maximizing price and quantity (which maximize the social welfare) would be $15 and 15, respectively. e. Show the supply curve of the monopolist on the graph above. Explain. (Bonus 5 pts.) Answer: There is no supply curve of the monopolist. The production occurs where the MR = MC. Bonus Question. Consider the following diagram where the income of the consumer is $1000, a litre of pepsi initially costs $2 then costs $1, and a pizza costs $10. a. What is the maximum amount of pizza and maximum amount of pepsi that the consumer can buy after the price of pepsi decreases from $2 to $1 (there is no change either in income or the price of pizza)? (2 pts.) Answer: Given the budget of $1000, the consumer can buy 1000 litres of pepsi or 100 pizzas, if s/he spends all of her/his income on of the goods. b. What is the value of the marginal rate of substitution (MRS) at point C? (2 pts.) Answer: At point C the MRS is equal to the slope of the budget line (relative prices) as the line and the indifference curve are tangent to each other. Therefore, the MRS at point C is 10/1 = 10 (or 1000/100 = 10) Page 5 of 6

6 c. What is the value of the slope of the new budget constraint? (2 pts.) Answer: P(pizza) / P(pepsi) = 10 d. Show the income effect and the substitution effect for both goods (Hint: In your explanation, you may use the points A, B, and C) (2 pts.) Answer: For both of the goods, the substitution effect is the movement from point A to B, and the income effect is that from B to C. e. Considering the answer in section D, are pizza and pepsi normal or inferior goods? (2 pts.) Answer: Given the decrease in the price of pepsi, consumer s purchasing power increases. We see from the income effects above that higher income leads the consumer to increase the consumption of both pizza and pepsi. Therefore, both goods are normal good. Page 6 of 6