Part A: Multiple Choice Questions, each worth 1 point.

THERE WILL BE 20 OF THIS TYPE OF QUESTION ON THE FINAL EXAM

1. Which of the following is not an example of an externality?

a. A drought increases the price of meat
b. Acid rain affects agricultural production
c. A factory discharges waste into a local river
d. Flowers are planted on street verges in a city

2. The most efficient goal for society with regard to the environment is to clean up
pollution until:
a. All pollution is eliminated
b. The total benefit from pollution cleanup is maximised
c. We have eliminated all pollution that does not cost us any jobs
d. The marginal benefit to society from the last dollar spent on pollution cleanup is
exactly one dollar

3. Which of the following statements is true:

a. Social cost = private cost – the external cost of pollution
b. Social cost = private cost + the external cost of pollution
c. Social cost = cost of pollution
d. Social cost + cost of pollution = private cost.

4. If the last unit of output produced at a factory has a value to society of $10 and a social
cost of $15, but the private cost to the producer is $10 and the current price is $10,
then the:
a. Market is in equilibrium, but a lower output would make society better off
b. Market is in equilibrium, but a higher output would make society better off
c. Output is too low, and price is too high for equilibrium
d. Output is too high, and price is too low for equilibrium

5. Private firms are not likely to fund the socially optimal level of basic research because
basic research:
a. Yields benefits that cannot be measured in dollars
b. Provides long term but not short term benefits
c. Produces benefits to society as a whole, including those who do not pay for it
d. None of the above – when free, the market will provide the optimal amount of
research.

6. Private goods are:

a. Excludable
b. Non-rival
c. Subject to diseconomies of scale
d. Consumable by additional users without making existing users worse off.
7. Public goods are:
a. Both excludable and rival
b. Excludable but not rival
c. Rival but not excludable
d. Neither excludable nor rival.

8. For both public goods and common resources, externalities arise because:
a. They do not cost anything
b. There is no price attached to them
c. Both are rival but non-excludable
d. The owners do not value these resources.

9. Economic profit is:

a. Total revenue minus total costs
b. Total revenue minus total explicit costs
c. Total revenue minus explicit variable and fixed costs
d. Price minus average cost.

10. Which of the following is an example of an implicit cost:

a. Wages paid to workers hired to produce a product
b. Wages not paid to the factory owner
c. Wages paid to the factory owner’s partner who works in the factory
d. Wages paid to a consultant hired to assist in marketing the product.

11. In the long run a competitive firm will operate at:

a. Its efficient scale
b. Minimum marginal cost
c. Maximum total revenue
d. Maximum marginal revenue.

12. The shutdown point is the output and price at which:

a. The firm just covers its average total cost
b. The firm just covers its fixed cost
c. The firm just covers its total variable cost
d. The firm just covers its total cost.

13. In a market with free entry and exit there is only one price consistent with zero profit.
It is the price at which:
a. Marginal Cost=Marginal Revenue =Price
b. Marginal Cost =Average Variable Cost =Price
c. Marginal Cost =Average Revenue =Price
d. Marginal Cost =Average Total Cost =Price.

END.
14. Which of the following statements about a competitive firm is not true:
a. It cannot charge different prices to different customers
b. It produces where Price = Marginal Cost
c. Its demand curve is downward sloping
d. It and its competitors produce a homogeneous product.

15. A firm whose Average Total Cost continually declines, at least to the quantity that
could supply the entire market, is known as a:
a. Perfect competitor
b. Natural monopoly
c. Government monopoly
d. Regulated monopoly.

16. Regulating natural monopolies by setting price equal to marginal cost would:
a. Maximise monopoly profits
b. Produce the socially optimal output
c. Cause the monopolist to break even
d. Create an oligopoly.

17. Tying is a practice of:

a. Only selling one product with another product
b. Only selling a product in a fixed quantity
c. Charging different prices per unit for different quantities of the same product
d. Charging different types of buyers different prices for the same product.

END.
Part B. True/False questions each worth 4 points

THERE WILL BE 5 OF THIS TYPE OF QUESTION ON THE FINAL EXAM

YOU WILL HAVE SPACE TO ANSWER EACH QUESTION ON THE EXAM
PAPER.

1. The efficiency problem of monopoly is that monopolists tend to overproduce goods of

little social value. False
2. In the long run a monopolist is guaranteed a positive economic profit. False
3. To maximise profits a natural monopolist should set price equal to marginal cost. False
4. Tradable pollution permits have the same effect on output and the level of pollution as
a Pigovian tax on polluters. True
5. A positive externality in consumption results in a demand curve that understates the
social value of a product. True
6. The free rider problem results when exclusion is not feasible True
7. A public good is one that doesn’t cost anything to produce False
8. Marginal Cost rises as output rises because of diminishing Marginal Product. True
9. Sunk costs are part of opportunity costs. False
10. A firm that is not covering its variable costs should shut down unless it is at least
covering its fixed costs. False
11. The free rider problem prevents private markets from supplying the optimal amount of
public goods, because public goods are non-rival. False

END.
Part C. Questions that ask you to provide numerical answers and sometimes
brief explanations or definitions.

THIS SECTION WILL BE WORTH 44 POINTS ON THE FINAL EXAM.

WHERE YOU ARE ASKED TO EXPLAIN YOU WILL BE GIVEN SPACE TO
DO SO ON THE EXAM PAPER

1. [8 points] Two firms in the airline industry can choose either to maintain prices or to
reduce prices. The CHANGE in profits for each firm under each possible outcome is
shown in the Table

Firm B
Cut Price Maintain Price
Firm A Cut Price A = -50 A = 75
B = -75 B = -150
Maintain Price A = -100 A=0
B = 50 B=0
a. If the two firms agree to act together, which options would they choose and why?
b. If the two firms do not cooperate, which actions will they choose and why?
c. If the two firms agree to collude, is there an incentive to cheat? Explain.
d. Is this game a Prisoners’ Dilemma? YES/NO. Explain.

2. [8 points] Fred owns 5 hectares of farming land. He can farm the land himself
producing a crop worth $120,000. The explicit costs involved are $30,000. His best
alternative is to rent the land to his neighbour for $60,000 and work in the local town
earning $50,000.
a. His accounting profits from farming are $_________
b. His economic profits from farming are $__________
c. His (select one) GAIN/LOSS from quitting farming and working in the local town is
$________

Fred is told that he can hire a competent farm manager for $35,000. If he hires a
manager:
d. His accounting profits are $__________
e. His economic profits are $__________

Explain what Fred should do if he wants the highest income.

END.
 3. (10 points) Consider a competitive industry where all firms are identical and each has
the following costs:

OUTPUT TOTAL COSTS Marginal Cost ($) Average Total Average Variable
($) Cost ($) Cost ($)
0 10
1 14
2 16
3 24
4 36

a. (3 points) Fill in the Table

b. The long run equilibrium price is $_________. Explain how you derived this number.
c. If in the short run price is to $12, the output of the representative firm will be ____and
its profits will be_______.
d. If in the short run the price is $2, the output of the representative firm will be ____
and its profits will be_______.

4. (23 points) Steve sells specialist sports equipment. The following table shows the
willingness to pay of 5 potential customers for a particular piece of equipment.

Buyer Identifier Willingness to pay ($) Member of the Sports Club

A 6 No
B 5 Yes
C 4 Yes
D 3 No
E 2 Yes
The cost to Steve of selling this equipment is $2 per unit.
a. In the social optimum buyers ___________________ would be served and the price would
be $_____

Suppose Steve cannot identify buyers but knows the distribution of their willingness to
pay. Complete the following Table (3 points) and use that information to answer the
following questions (5 points):
Price 6 5 4 3 2
Number of 1 2 3 4 5
Sales
Total Revenue 6 10 12 12 10
Marginal 6 4 2 0 -2
Revenue
b. The profit maximising price is $4
c. Total profits are $6
d. The customers served are 3
e. Total consumer surplus is $3
f. Total surplus is $9

Now suppose Steve knows the distribution of willingness to pay of the members and
non-members of the Sports Club. Complete the following tables (5 points) and use that
information to answer the following questions (8 points):
Members
Price 5 4 2
Number of sales 1 2 3
Total revenue 5 8 6
Marginal Revenue 5 3 -2

END.
Non-Members
Price 6 3
Number of sales 1 2
Total revenue 6 6
Marginal Revenue 6 0
g. The profit maximising price to Members is $4
h. The profit maximising price to non-members is $6
i. Total profits are $10
j. Total consumer surplus is $1
k. Do Members gain from this price discrimination? YES/NO. Explain: Decrease in surplus
l. Do non-members gain from this price discrimination? YES/NO. Explain: Decrease in
surplus

Part D. Short Answer Questions

THERE WILL BE 4 OF THIS TYPE OF QUESTION ON THE FINAL EXAM
YOU WILL HAVE SPACE TO ANSWER THE QUESTIONS ON THE EXAM
PAPER
1 Why is cooperation among oligopolists undesirable?
2. What does it mean to say that a good is excludable?
3. How can the establishment of individual property rights eliminate the problems
associated with a common resource?
4. What is the difference between economic profit and accounting profit?
5. What constitutes the competitive firm’s supply curve?
6. How would a profit maximising competitive firm respond in the short run to an
increase in fixed costs? Would there be any change in equilibrium price or quantity
in the short run?

END.