1. PART I (1.

0 point)

PART I

Multiple Choice Questions

Please choose the correct answer for each question. There are 20 multiple choice
questions worth 2 pts each, for a total of 40 pts.

2. MCh#001 (1.0 point)

Economic models

a. Are not very useful if they incorporate simplifying

assumptions.
b. Cannot be tested if they are based on assumptions.
*c. Allow managers to consider hypothetical situations.
d. None of the above.

3. MCh#002 (1.0 point)

Consider the market for gasoline in Metro Vancouver as shown in the following
diagram. Gasoline is a normal good. Which of the following events might have
caused the demand curve to shift to the left (from D1 to D2)?

a. An increase in the price of gasoline. No, this results in a

movement along the demand curve, not a shift of the curve.
b. An increase in consumer incomes. No, the question noted that
gasoline is a normal good, in which case the curve should have shifted out –
not in.
c. An increase in the price of hybrid cars (which use less
gasoline than other cars). No, a higher price for hybrid cars will decrease
 the demand for hybrid cars, and thus increase the demand for gas guzzling
cars. This will shift the demand for gasoline out – not in.
*d. A decrease in the price of rapid transit. Yes, people will tend to
use more rapid transit and less driving, and this will cause the demand for
gasoline to shift in.

4. MCh#003 (1.0 point)

Thomas Malthus described the law of diminishing marginal returns and predicted
that, as land is in fixed supply, increases in population would cause increasing
undernourishment. Yet, in the past seventy years, population has risen substantially
but undernourishment has fallen. The most important reason is

a. Increases in the amount of agricultural land.

b. Increasing returns to scale in agriculture.
*c. Technological progress causing the production function Q(L)
to shift up.
d. All of the above.

5. MCh#004 (1.0 point)

The following diagram shows an estimated cost function.

a. The average cost curve is U-shaped. Yes, there are two conditions
necessary for an AC curve to be U shaped. One is the presence of fixed
costs to ensure that AC initially drops as Q increases. The second is the
presence of rising average variable cost to ensure that AC eventually
increases after AFC dies away. Both of these conditions are present.

b. Marginal cost is well-approximated by a quadratic function.

Yes, if you take the derivative of the cost function to get the marginal cost
function you will see that the marginal cost function is quadratic.
 c. In the underlying data, factors other than quantity have
little effect on cost. Yes, with R2 at 0.99 we know that 99 percent of the
variation in cost is explained by the variation in Q. This means that only 1
percent of the variation in cost is explained by other factors.
*d. All of the above.

6. MCh#005 (1.0 point)

Figure 3.6 from the textbook illustrates the effect of different levels of advertising
expenditure A on quantity demanded. Two different regressions are illustrated.

a. The R2 statistic is smaller for the quadratic regression,

indicating a better fit to the data. No, the R2 is higher (not smaller)
for the better fitting model.
*b. We would expect that the coefficient on A2 in the quadratic
regression is statistically significant. Yes. We need the coefficient
on the A2 term to be negative and significant in order for the curve to bend to
fit the data in the way illustrated.
c. The linear regression line illustrates the saturation effect
of advertising. No, just the opposite. The linear regression shows that the
marginal benefit of advertising is constant at all levels of advertising – it is not
possible to have saturation.
d. All of the above.

7. MCh#006 (1.0 point)

Limited liability for the shareholders of publicly traded corporations:

a. Ensures that banks which lend money to these organizations

will always be fully repaid in the event of bankruptcy.
b. Allows the shareholders to pay income tax at the corporate
rate rather than at their own personal rate.
*c. Ensures that shareholders cannot lose more than the amount
they paid for their shares.
 d. Allows these organizations to provide senior managers with
stock options.

8. MCh#007 (1.0 point)

Anne and Frank are CEOs of two publicly traded corporations. The two corporations
have the same revenue and cost functions, as illustrated in the diagram below.
Anne’s annual compensation is a base salary plus 3 percent of revenues, and
Frank’s compensation is a base salary plus 6 percent of profits. Assuming that Anne
and Frank have complete control over the choice of quantity, q, the theory of
managerial incentives tells us that:
Marginal Reveneue

Profit max q Rev max q

*a. Anne’s firm will have higher total cost than Frank’s firm.
Yes, Anne will choose q to maximize revenue whereas Frank will choose q to
maximize profits. The revenue maximizing q is higher than the profit
maximizing q. The diagram shows that costs are higher with the revenue
maximizing q.
b. Frank’s firm will have higher revenue than Anne’s firm. No, see
diagram.
c. The difference in output for the two firms will depend on the
difference in the base salary for Anne and Frank. No, the pair of qs
which maximize profits and revenues are independent of the base salary.
d. Neither CEO will choose the q that maximizes their company’s
stock price. No, maximizing stock price necessarily requires maximizing
profits. Thus, Frank will implicitly maximize stock price.

9. MCh#008 (1.0 point)

The cost function for a perfectly competitive firm is C(q) = 100 + 8q + 2q2. In the
short run the $100 fixed cost must be paid even if the firm shuts down. Let p* denote
the short-run shut-down price (i.e. the firm would shut down if p < p*).

a. Average variable cost is equal to marginal cost when p = p*.

Yes. MC = 8 + 4q and AVC = 8 + 2q. In the SR, the firm should keep
operating provided that P > AVC. We know that P = MC, and so the firm
should keep operating in the SR provided that MC >= AVC. This holds for
all q >= 0. When q = 0 we see MC = AVC = 8 = p*. This result is much
easier to see on a diagram.
 MC
AC

AVC

8
Shut down point in SR

b. As price p falls toward p*, output q falls toward 0. Yes, the

previous diagram shows this.
c. p* = 8. Yes, see above.
*d. All of the above.

10. MCh#009 (1.0 point)

Which of the following is an accurate description of producer surplus?

*a. Revenue minus variable cost. Yes, in the diagram below the
rectangle implied by P and Q represents revenue. The area under MC
represents variable cost. Thus, PS = Revenue – Variable Cost.
b. Revenue minus variable cost minus sunk cost. No. Sunk cost never
shows up in our surplus diagrams.
c. Revenue minus consumer surplus. No, dumb!
d. The area between a downward sloping demand curve and an upward
sloping supply curve and to the left of the equilibrium quantity.
No, this is a measure of total surplus in a competitive market: CS + PS.

Supply  MC

P
PS

Var Cost

11. MCh#010 (1.0 point)

A monopoly maximizes profit when output is chosen according to, where

where ε is the price elasticity of demand. This equation

demonstrates that:

a. A monopoly always sets price in the inelastic portion of its

demand curve. No if -1 < ε < 0 we see from the formula above that P < 0,
which does not make sense.
 b. A decrease in a monopoly’s fixed cost results in an increase
in the monopoly’s profit maximizing quantity. No, the above formula
shows that fixed costs has no role in the setting of the optimal price.
c. The price elasticity ε remains constant if the firm changes
price in response to change in marginal cost. No, moving along a
demand curve in response to a change in MC always results in a change in
the elasticity (remember that elasticty varies between 0 and negative infinity
as we move from the bottom to the top of the demand curve.
*d. None of the above.

12. MCh#011 (1.0 point)

A profit-maximizing monopolist sells to 100 identical consumers, each of whom has
demand given by p = 100 – Q. Marginal cost is constant and equal to 40.

a. Uniform pricing is more profitable than two-part pricing. No,

when customers are identical, two-part pricing converts all CS and DWL into
profits. With uniform monopoly pricing there is both positive CS and DWL
which has not been converted into profits.
b. Nonlinear pricing with price equal to 80 for the first 20
units and price equal to 60 for all subsequent units maximizes
total surplus. No, the fact that the second block price of 60 is above MC of
40 implies that DWL remains with nonlinear pricing.
*c. Total surplus is maximized when Q = 60. Yes, surplus is maximized
when price is set competitively (i.e., P = MC). In this case we have p = 100 –
Q = 40. Solving this equation gives the competitive price Q* = 60.
d. All of the above.

13. MCh#012 (1.0 point)

Each student is willing to pay $3 for a first cup of coffee and $1.50 for a second cup.
Each faculty member is willing to pay $4 for a first cup of coffee and $3 for a second
cup. Nobody is willing to pay for more than two cups. The marginal cost of providing
coffee is $1 per cup. There is only one coffee shop in the relevant area.

a. If the coffee shop were able to charge different prices to

students and faculty, it would charge $1.50 to students and $3 to
faculty. No, if the student price is set at $3, the profit per student is (3 -1)*1
= 2. If instead the price is set at $1.50 then the profit per student is (1.50 –
1)*2 = 1. Therefore, profits are not maximized if the price for students is set at
$1.50.
b. Charging different prices to students and faculty is an
example of non-linear pricing. No. There is no block pricing since the
lower price is paid for both cups if two cups are ordered.
*c. A profit-maximizing two-part pricing system with different
monthly subscription fees for faculty and students would maximize
total surplus. Yes, suppose a student buys 20 times per month. Set the
price of coffee equal to MC = 1 and this will ensure the student will buy two
cups per visit. The student earns 3 – 1 = 2 units of surplus on the first cup,
and 1.50 – 1 – 0.50 units of surplus on the second cup for a total surplus of
 $2.50 per visit. Based on 20 visits per month, set the monthly subscription fee
equal to 2.50*20 = $50. This will result in all surplus being extracted from
students. Now repeat these calculations for faculty. The monthly subscription
fee will be higher. By discriminating with respect to the subscription fee, the
surplus from both students and faculty can be fully extracted by the coffee
shop.
d. All of the above.

14. MCh#013 (1.0 point)

QuickieFood sells small fries (70g) for $2, large fries (150g) for $3, hamburgers for
$4, and a combination of large fries and a hamburger for $6.

a. QuickieFood uses a nonlinear pricing strategy. No, non-linear

pricing is used but it is not an exclusive strategy.
b. QuickieFood uses a mixed bundling strategy. No, mixed bundling is
used but it is not an exclusive strategy,
c. QuickieFood uses individual price discrimination. No, individual
price discrimination is when different individuals are charged different prices
but pricing falls short of perfect price discrimination. This is not what is
happening here.
*d. QuickieFood uses nonlinear pricing and mixed bundling. Yes,
there is non-linear price discrimination because the cost per gram is lower if
the large order of fries is purchased. There is also mixed bundling because
the fries and hamburger can be purchased individually or as a bundle.

15. MCh#014 (1.0 point)

This diagram compares perfect competition, perfect price discrimination, and uniform
monopoly pricing. Which statement is correct?

a. Under uniform monopoly pricing, consumer surplus is A + B + C.

No, the monopoly price is the upper price and thus CS = area A.
 *b. Under perfect price discrimination, total surplus is A + B +
C + D + E. Yes, with perfect price discrimination all of the CS and DWL is
converted into profits, which means that profits equal the sum of CS and PS
with competition. This is given by area A + B + C + D + E.
c. Under perfect competition, producer surplus is zero. No, PS =
area D + E with competition.
d. Only perfect price discrimination eliminates deadweight loss.
No, two-part pricing with identical customers also eliminates DWL.

16. MCh#015 (1.0 point)

A car-sharing company charges an annual membership fee of $20 and a fee per
minute of $0.40. The marginal cost per minute (for gas, wear and tear, etc.) is $0.20.

*a. This pricing structure is an example of two-part pricing. Yes.

This should be obvious.
b. The pricing structure suggests consumers in this market are
close to identical. No, if customers were close to identical then we would
see the optimal fee per minute very close to MC. In fact the fee is twice as
high as MC.
c. Consumers who buy one or more hours for any given trip get a
discount on the per-minute price. This is best described as group
price discrimination. No, this is an example of non-linear price
discrimination.
d. None of the above.

17. MCh#016 (1.0 point)

Consider the Bertrand model with two firms producing identical products. Firm A’s
marginal cost of production is $5 while that of Firm B is $10. Neither firm has fixed
costs. The market demand for the product is given by Q = 60 – 2P. Assuming that
firms must charge prices that are whole numbers, what is the market equilibrium
quantity? Not covered on the 2020 midterm.

*a. Q = 42.
b. Q = 50.
c. Q = 60.
d. Q = 38.

18. MCh#017 (1.0 point)

Which of the following statements about cartel is TRUE?
Not covered on the 2020 midterm.

a. A cartel can be more successful when demand is more elastic.

*b. A cartel may fail when fringe firms (non-members) produce a
significant fraction of the market output.
c. When two firms each with marginal cost of production equal to
$2 collude and form a cartel, the MC of the cartel = $4.
 d. Once two or more firms collude to form a cartel, there is no
incentive for cheating as the firms make higher profits in the
cartel than by acting independently.

19. MCh#018 (1.0 point)

Consider an airline route with only two firms: Sky Airlines (SL) and Fly Airlines (FL).
The two firms produce identical products and each firm has a marginal cost of $100.
There are no fixed costs. Not covered on the 2020 midterm.

a. The Bertrand-equilibrium profits are higher than Cournot-

equilibrium profits.
b. If the two firms collude and form a cartel, the profit-
maximizing cartel price is $100.
c. If SL’s marginal cost increases to $120 while FL’s marginal
cost remains $100, SL cannot earn positive profits in the Cournot
equilibrium.
*d. If SL’s marginal cost increases to $120 while FL’s marginal
cost remains $100, SL cannot earn positive profits in the
Bertrand equilibrium.

20. MCh#019 (1.0 point)

In the following payoff matrix, Coke and Pepsi have two choices available to them
regarding advertising. In each cell the number on the left is the profit of Coke and the
number on the right is the profit of Pepsi. Not covered on the 2020 midterm.

a. This is a prisoners’ dilemma game.

b. Neither firm has a dominant strategy.
*c. The Nash equilibrium is for both firms to advertise.
d. There are multiple Nash equilibria in this game.

21. MCh#020 (1.0 point) Not covered on the 2020 midterm.

Consider a monopolistically competitive market with symmetric firms. The following
diagram illustrates the current situation of a typical firm in the market.
a. The market is in long run equilibrium.
*b. In the long run, the demand curve for a typical firm
remaining in the market shifts to the right.
c. In the long run, the demand curve facing a typical firm
remaining in the market shift to the left.
d. The long run equilibrium price equals the minimum average cost
of production.