# 2000 AP Microeconomics Exam Answers

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1 2000 AP Microeconomics Exam Answers 1. B Scarcity is the main economic problem!!! 2. D If the wages of farm workers and movie theater employee increase, the supply of popcorn and movies will decrease (shift to the left). If there is a technological advance in corn production, the supply of popcorn will increase (shift to the right). If there is more competition, price will decrease because of the increased number of sellers. New government regulations increase the cost of production and, therefore, cause supply to decrease. The release of three summer movies that sets records for movie attendance means the demand for movies has increased, thereby resulting in a greater quantity of popcorn sold at a higher price. 3. E Simply draw a market in equilibrium and physically shift the curves so that price and quantity will both definitely decrease. Remember, when shifting both supply and demand, the actual size of the shifts will matter when drawing your conclusions. Since this problem says definitely, we know that if the demand curve shifts to the left, while the supply curve remains constant, that both equilibrium price and quantity will decrease. 4. D An inferior good (by definition) is a good whose demand will decrease as income increases. Thus, an increase in consumer income will decrease the demand for bologna. Likewise, a decrease in consumer income would result in an increase in the demand for bologna. 5. A If the price of a substitute (pizza) increases, you ll demand more of the other good (hamburgers). If the price of a complement increases, the demand for both goods will decrease (shift left). A change in the price of a good is simply a movement along the curve. And, a decrease in the cost of producing a good would shift the supply curve to the right. 6. C Remember, ATC = AVC + AFC. Thus, the difference between the ATC and AVC curve must be AFC. If you look at the shape of the curves, this also tells you that AFC decreases as you produce more of the good because the distance between the ATC and AVC curves becomes smaller and smaller. 7. E A firm will always produce where MR = MC, therefore the firm will produce Q1 units of output. The firm will produce the efficient level of output since it is producing where P = MC = minimum ATC. The firm is achieving both allocative and productive efficiency. The firm will earn a normal profit (0 economic profit) since P = ATC. This also tells us that total revenue equals total costs when the firm

2 produces Q1 units of output. The firm will not increase production in the long run since it is already in equilibrium. 8. C The characteristics of a perfectly competitive market include many small firms, homogeneous products, and no significant barriers to entry. 9. E If consumer income decrease, the horizontal demand curve will decrease (or shift down). This results in a decrease in the short-run price, a decrease in short-run industry output, and firms exiting the industry. Output decreases because the firms will now produce where the new demand curve (price) equals marginal cost. Some firms will exit the industry because P < AVC. 10. A For a non-discriminating monopolist, the demand curve (price) is greater than marginal revenue simply because to sell more, the monopolist must lower her price which applies to all of the previous units as well. 11. B A normal good (by definition) is a good whose demand increases as income increases. Thus, if average income of consumers increase, the demand for a normal good will increase causing the demand curve to shift to the right. And, if the price of a variable input increases, the supply curve for that good will decrease (shift to the left) because the cost of producing that good has increased. With a rightward shift of the demand curve and a leftward shift of the supply curve, prices will definitely rise while quantity could possibly decrease. 12. D Monopolists produce where MR = MC and charge the corresponding price on the demand curve. But, since D > MR, the monopolist charges a higher price and produces less than a perfectly competitive firm. Thus, monopolies are inefficient since they charge a price greater than marginal cost. Remember, allocative efficiency occurs when P = MC. 13. E In deciding whether or not to work, a person weighs the benefits from working against the benefits from not working (or, in other words, her leisure time). 14. B The hiring rule states that a firm will hire up until the point where marginal resource cost equals marginal revenue product (MRC = MRP). Since the wage rate represents MRC, a firm will hire labor until its wage rate = MRP. 15. A In reducing the negative effects of a negative externality, one must always compare the marginal benefits versus the marginal costs (and NOT the total benefits versus the total costs). Society will be better off from the clean-up until the marginal benefit from cleaner water is equal to the marginal cost of making the water cleaner (MB = MC). This problem simply tests your understanding of marginal benefit and marginal cost analysis. 16. D The concept of opportunity cost entails the idea that things must be given up (or sacrificed) in order to do something. Money spent on clothing expenses aren t

3 included in the opportunity cost of attending college simply because you would spend that money on clothes regardless of whether or not you attended college. 17. A Trade is one way for a country to expand its PPC curve since specialization through trade allows for greater efficiency. Other than trade, a country would have to discover a new supply of resources or technological advancement to shift its current PPC curve. 18. B Consumer surplus is the area under the demand curve above the market equilibrium price. 19. C Quantity demanded is determined by the demand curve. Without the price floor, quantity demanded is 0S. But, once the price floor is implemented and the price increases to X, people are going to demand less at that higher price. Thus, we move back along the demand curve and the new quantity demanded (where X hits the demand curve) will be 0R. 20. E This is the total revenue test. If revenues increase when the price increase, then people aren t really responsive to the change in prices. The quantity demanded decreased slightly, but the increase in price was relatively greater causing the revenues of farmers to actually increase. This unresponsiveness to a price level change, tells us that the demand for wheat is price inelastic. (Remember, for inelastic goods the arrows move in the same direction P, TR ). 21. D As the price of a good increases, consumers are going to turn to substitutes because the higher price reduces the consumers purchasing power. 22. C This is a total product (output) graph. This graph illustrates the concept of diminishing marginal returns in production. After point A, diminishing returns begin to set in. And, after point B, returns actually become negative. 23. B Perfectly competitive firms are price-takers whereas monopolies are pricemakers. Thus, a perfectly competitive firm cannot affect the market price for its good, but a monopoly can! 24. B Monopolists produce too little of a good and charge too high a price. So, if a perfectly competitive industry were monopolized, you would expect prices to increase and quantity to decrease. 25. C A firm should always produce where MR = MC. In this situation, the firm is currently producing where MR < MC since \$12 < \$16. The firm should decrease output until its MC = \$12 and it should keep producing because at that price, P > AVC since \$12 > \$ E Its total revenue will increase at a constant rate since all units are sold for the same amount.

4 27. B This is the main problem with monopolies. They produce too little and charge too high a price. They are not efficient since P > MC and P > minimum ATC. 28. A Since the price of a product increased, its marginal revenue product also increased because MRP = MP x P (Marginal Revenue Product = Marginal Product x Product Price). Since MRP has increased (shifted to the right), the demand for labor and the number of workers hired both increase. 29. D Economic rent is a surplus payment. If supply is perfectly elastic, there will never be any economic rent. 30. C By definition, a negative externality results when marginal social cost (MSC) is greater than marginal private cost (MPC). There is some marginal external cost (MEC) that the private producer is not incurring. Thus, the cost to society is higher than the firm s marginal cost. 31. B This chart deals with the number of resources it takes to produce clothing and food. Omega has the absolute advantage in both clothing and food production since it takes Omega fewer resources to produce one unit or clothing or food. Despite this absolute advantage, Omega has a comparative advantage in clothing production while Gamma has a comparative advantage in food production. To know that Omega has a comparative advantage in clothing production, simplify to make things obvious. If you do this, you ll see that it takes Gamma two times as many resource units than Omega to produce one unit of food and, it takes Gamma three times as many resource units than Omega to produce one unit of clothing. 32. D Opportunity cost represents what must be given up in order to have more of good Y. Thus, in order to increase the production of good Y form 0 to 200, we must produce 20 fewer units of good X (1, ). 33. C The law of demand states that consumers will consume more of a good as price decreases. There is an inverse relationship between quantity demanded and price. Thus, as the price of a product decreases, we would expect the quantity sold to increase. 34. A Marginal utility is determined by calculating the change in utility from consuming an additional candy bar. Due to the law of diminishing marginal utility, we know that Juan s marginal utility will eventually decline with each candy bar consumed. It s just a matter of doing some calculations so that you know his utility is already diminishing. 35. E A price ceiling is a maximum price at which a producer may sell his or her product. In order for a price ceiling to be effective, it must be set below the market equilibrium price. Thus, there will be neither a surplus nor a shortage of gasoline since the current market price will prevail.

5 36. E The total variable cost of producing 3 units of output = = 40. The total fixed cost of producing 3 units of output = 20. Thus, the total cost of producing 3 units of output = = 60 (since TC = TVC + TFC). To get the average total cost, we simply need to divide by the number of units produced (3). This gives us 60/3 = 20 for the average total cost of producing 3 units of output. 37. C Costs of production are one of the non-price determinants of supply. Thus, a decrease in production costs will only shift the supply curve to the right in the shortrun. 38. B Total profit must increase by the difference in price per unit (\$20 - \$18 = \$2) times the number of additional units sold (1 unit). Therefore, the total profit from selling 101 units is \$2 greater than the total profit from selling 100 units. 39. C The industry s demand curve is downward sloping and the firm s demand curve is horizontal (because firms are price-takers ). 40. B A firm will always produce where MR = MC. Thus, the firm depicted will produce 200 units and charge the corresponding price on the demand curve of \$20 per unit. 41. D Firms within an oligopoly often depend on each other since only a few firms dominate the industry and collusion is present. 42. A Monopolistically competitive firms still produce at a price > marginal cost and at a price > minimum average total cost. This is because demand > marginal revenue. 43. C An increase in the supply of nurses would result in lower wages for nurses. 44. E The profit-maximizing rule states that the MRP/P of each resource unit must equal 1. In order for that to occur, the price of labor must be \$60 and the price of capital must be \$100 so that each ratio is equal to B Taxes are the main way in which the United States federal government redistributes income. 46. A Remember, if we produce more capital goods now, chances are there will be more technological advancements in the future. These advancements would enable us to expand our current production possibilities curve and, therefore, consume more goods in the future. 47. C This is an application of the total revenue test. A good is elastic if total revenue increases when price decreases (arrows move in opposite directions). Remember, the demand curve becomes inelastic when marginal revenue is negative. And, it s unit elastic when MR = B

6 An increase in wages in the automobile industry would shift the supply curve to the left (supply decreases) because wages are a cost of production for the automobile industry. And, if costs rise, supply will decrease. An increase in efficiency would shift supply to the right. A decrease in the number of consumers purchasing automobiles or a decrease in consumer income would shift demand to the left (demand decreases). And, a decrease in interest rates for automobile loans would shift the demand curve to the right (demand increases). 49. B A price that is set by law above the equilibrium price is known as a price floor and would most likely result in a long-run surplus of a product since quantity supplied would be greater than quantity demanded. An increase in the number of suppliers would shift the supply curve to the right (supply increases). An increase in the demand for the product would shift the demand curve to the right. An increase in the costs of resources used to produce the product would shift the supply curve to the left (supply decreases). And, and increase in the expected price of the product would cause demand to increase now (before the price goes up). 50. D This is the utility maximization rule. A consumer will be in equilibrium if the marginal utility received from the last dollar spent on one good is equal to the marginal utility received from the last dollar spent on another good. The correct answer (D) states this idea in mathematical form.

7 51. C To start, you must know that average product equals total product (or output) divided by the number of laborers. Thus AP = TP / L. Since AP = 5 when TP =10, we can find the number of laborers it took to produce 10 units. 5 = 10 / L. Solving for L we get L = 10 / 5 = 2. Now, we must find our total variable cost. TVC (total variable cost) is simply the number of workers times the wage rate. Thus, TVC = 2 x \$12 = \$24. If we add TVC to our TFC (total fixed cost), we get our total cost of producing 10 units of output. TC = \$24 + \$46 = \$70. Last off, to find ATC (average total cost), we simply need to divide total cost by the number of units produced. ATC = TC / Q = \$70 / 10 = \$ E The problem with collusion is that there is always incentive to cheat! Remember our in class experiments of auctioning off a twenty dollar bill or our student s dilemma. 53. C If you can produce 3 units in one hour, then it will only take you 1/3 of the time to produce one unit. Thus, the cost of producing one unit would be \$15 / 3 = \$5 since it should only take a third of the time to produce that unit. 54. A A firm should always produce where MR = MC. For a perfectly competitive firm, MR = Demand (Price). If P > MC, the firm should actually produce more in order to maximize profits. Thus, this firm is currently producing too little output. 55. E We know the marginal product (MP) of the last worker hired is 5. Thus the additional revenue as the result of that worker would be \$15 per unit times 5 units = \$75. Remember, this is known as the marginal revenue product (MRP = MP x P). The firm s marginal resource cost (MRC) is simply the wage rate of \$75. Since \$75 = \$75, the firm s profits will remain unchanged. 56. A Allocative efficiency occurs when P = MC. This is violated when firms are price makers since P > MC. 57. E A toll on a congested bridge would hopefully deter some people from using that bridge, thus making it les congested. Taxing a positive externality (the chocolate factory) worsens the situation since people enjoy that smell. Monopolies already produce too little of a good so regulation that reduces their output would be wrong. A lump-sum tax on a monopolist would also lead to less production or higher prices. A subsidy on a negative externality simply encourages more production, which is causing harm to others. 58. A Derived demand is the concept that demand for resources is based on the demand for the products that they produce. In other words, the demand for factor resources is derived from the demand for the products. The only answer that illustrates derived demand is the situation involving theater tickets (product demand) and actresses / actors (factor resources). You need actresses / actors to produce theater, but if there is no demand to see theater productions, there will be no demand for actresses / actors.

8 59. D A negative externality exists when a third party incurs a cost of production. There is an extra cost, which is not borne by the producers nor consumers of a product. Oil leakages have a negative effect on the environment and, therefore, represent a negative externality. 60. A Remember, one of the main reasons why we have public goods is due to the freerider problem. When you can t exclude everyone from using a good or paying for its benefits, less than the efficient level will be provided if a private firm is producing that good simply because they need to cover their costs. A privately produced good may provide additional benefits to others who aren t paying for the good, yet since the firm doesn t reap those benefits, they choose to produce less than the efficient amount.

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