ECON1001

MICROECONOMICS FOR BUSINESS DECISIONS

UNIVERSITY OF NEWCASTLE

FINAL EXAMINATION GUIDE AND NOTES

 TA B L E O F C O N T E N T S

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Final Exam Hints & Tips for students
 Part
TITLE OFATHIS > CHAPTER
Revision Notes – High Distinction
SHALL GO HERE
 TOPIC 1 - INTRODUCTION
Society has only a limited amount of resources to satisfy its needs and wants

Goods and services are produced by

• Humans/machines
• Replacing capital goods with another
• Micro and macro scales

Rational decisions made on well thought ideas

• Make best possible decision to make profit

Opportunity cost
• The next best alternative

Thinking at the margin

• Compare major benefit with the marginal cost of buying

Ceteris paribus
• Hold everything constant except for a singular change

Positive analysis
• Analysis concerned with what is and involves value-free statements that can
be checked using facts

Normative analysis
• Analysis concerned with what ought to be and involves making value
judgments which cannot be tested
Scarce resources and unlimited wants
 • Individual, govt and firms

These involve a trade off

• The next best alternative foregone
• Includes implicit costs
• And explicit costs

Resources
• Land
• Labour
• Capital
• Entrepreneurial ability

Production Possibilities

The production possibility frontier (PPF)

• Shows which combo of goods can be produced

• Describes set of possible output choices when limited resources are used

efficiently

• Production efficiency achieved when it is not possible to produce more of

one good without producing less of another

• Points inside are inefficient

o Some unused resources or used inefficiently

 Points out here are

infeasible

Points in here are

inefficient

Opportunity costs

• Highest value of alternative foregone

• OC increasers as we produce more of a good
o Not all resources are equally productive
o Hence shape of the curve (concave towards the origin)

Economic Growth
 • Reflects an economy's expansion over time
• Two factors
o Technological change: Development of new Goods and Services and
better ways of producing them
o Capital accumulation: Growth of capital resources - Infrastructure,
factories

(Economic growth will push the PPF outwards – Figure below)

Gains from exchange

Bike example
o Baz does not value bike
o Chloe values the bike at $100
o Baz sells to Chloe for $40
o Chloe better off as she gets $60 off the value
o Baz better off as he gains $40
o A Pareto improving trade made by rational economic agents

Exchange is therefore voluntary

o Leaves both parties better off
o How much they benefit depends on the terms of trade
 TOPIC 2 – THE GAINS OF TRADE

GAINS OF SPECIALISATION

Countries have a different endowment of resources and skills

• Determines what they specialise in

Consider individuals

• B and I work 10 hours a week and have different skills. This is their
endowment
• B can produce 2 units of wine and 3 units of cheese
• F can produce 4 units of wine and 8 units of cheese

Consumption w/o trade

Consumption w/ trade
• B only produces wine
• F spends 3 hours producing wine and 7 hours producing Cheese
• B trades 9 units of wine for 15.5 units of cheese
• B consumes 11 wine and 15.5 cheese
• F consumes 21 wine and 40.5 cheese
ABSOLUTE ADVANTAGE & COMPARATIVE ADVANTAGE

Absolute advantage
• One can produce greater output from given resources

Comparative advantage
• One has a lower OC of producing a good than the other

Bundy
• 2 wine 3 cheese
• OC of 1 wine is 1.5 cheese
• OC of 1 cheese is 2/3 wine

Fifi
• 4 wine and 8 cheese
• OC of 1 unit wine is 2 cheese
• OC of 1 cheese is 0.5 wine

Bundy has comparative advantage in wine

Fifi has comparative advantage in cheese
 [SUMMARY] DEMAND AND SUPPLY
DEMAND
The term Demand refers to the entire relationship
between the price of the good and quantity demanded of
the good. A Demand Curve shows the relationship
between the quantity demanded of a good and its price,
when all other influences on consumers’ planned
purchases remain the same.
Law of Demand
Holding everything else constant, when the price of a
product increases the quantity demanded will decrease,
and when the price of a product decreases, the quantity
demanded will increase.
If the price falls, there is an increase in quantity demanded.
NOTE: this is not an increase in demand!
IMPORTANT: FACTORS THAT SHIFT DEMAND CURVE
• Income
• Prices of related goods
• Tastes
• Population and Demographics
• Expected Future Prices
SUPPLY
The term Supply refers to the entire relationship
between the price of the good and quantity supplied
of the good. A Supply Curve shows the relationship
between the quantity supplied of a good and its
price, when all other influences on consumers’
planned purchases remain the same.
Law of Supply
Holding everything else constant, when the price of
a product increases the quantity supplied will
increase, and when the price of a product decreases,
the quantity demanded will decrease.
If the price increases, there is an increase in quantity
supplied. NOTE: this is not an increase in supply!
IMPORTANT: FACTORS THAT SHIFT SUPPLY CURVE
• Input Prices
• New Technology
• Expectations
• Number of sellers
• Government Policies

Price elasticity of Demand
% 𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑄𝑄𝐷𝐷
𝑃𝑃𝐸𝐸𝐷𝐷 =
% 𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
(𝑄𝑄2 − 𝑄𝑄1 )/𝑄𝑄1 ∗ 100
𝑃𝑃𝐸𝐸𝐷𝐷 =
(𝑃𝑃2 − 𝑃𝑃1 )/𝑃𝑃1 ∗ 100
A measure of the responsiveness of the
quantity demanded of a good to a
change in its price.
Case 1: Elastic (Demand)
Price fell from $3 to $2 and Quantity
increased from 10 to 20
(20 − 10)/10 ∗ 100
𝑃𝑃𝐸𝐸𝐷𝐷 = = −3
(2 − 3)/3 ∗ 100
Price elasticity of demand is -3, or elastic.
Case 2: Inelastic (Demand)
Price fell from $3 to $1 and Quantity
increased from 10 to 15
(15 − 10)/10 ∗ 100
𝑃𝑃𝐸𝐸𝐷𝐷 = = −0.75
(1 − 3)/3 ∗ 100
Price elasticity of demand is -0.75, or
inelastic.
What will make demand more elastic?
• More substitutes
• More time to respond to a Price
change
• If the good is a luxury
• Market in general
• Very expensive
TOPIC: ELASTICITY
Income Elasticity of Demand Price Elasticity of Supply
% 𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑄𝑄𝐷𝐷 % 𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑄𝑄𝑆𝑆
𝐼𝐼𝐸𝐸𝐷𝐷 = 𝑃𝑃𝐸𝐸𝑆𝑆 =
% 𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 % 𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
(𝑄𝑄2 − 𝑄𝑄1 )/𝑄𝑄1 ∗ 100 (𝑄𝑄2 − 𝑄𝑄1 )/𝑄𝑄1 ∗ 100
𝐼𝐼𝐸𝐸𝐷𝐷 = 𝑃𝑃𝐸𝐸𝑆𝑆 =
(𝐼𝐼2 − 𝐼𝐼1 )/𝐼𝐼1 ∗ 100 (𝑃𝑃2 − 𝑃𝑃1 )/𝑃𝑃1 ∗ 100
A measure how much the quantity A measure of the responsiveness of
demanded of a good responds to a change the quantity supplied of a good to a
in consumers’ income. change in its price.
Total Revenue & Elastic Demand Case 1: Elastic (Supply)
When demand is elastic: Price increases from $3 to $3.20, then
• An increase in Price decreases Total Quantity increased from 10 to 20
Revenue (20 − 10)/10 ∗ 100
𝑃𝑃𝐸𝐸𝐷𝐷 = = 15
• A decrease in Price increases Total (3.20 − 3)/3 ∗ 100
Revenue Price elasticity of supply is 15, or elastic.
Total Revenue & Inelastic Demand Case 2: Inelastic (Supply)
Price increases from $3 to $5 and Quantity
When demand is inelastic:
increased from 10 to 15
• An increase in Price increases Total
(15 − 10)/10 ∗ 100
Revenue 𝑃𝑃𝐸𝐸𝐷𝐷 = = 0.75
(5 − 3)/3 ∗ 100
• A decrease in Price decreases Total
Price elasticity of supply is 0.75, or
Revenue
inelastic.
RULES What will make demand more inelastic?
• If Price Elasticity of Demand > 1 then • Less substitutes
Demand is elastic • Less time to respond to a Price
• If Price Elasticity of Demand < 1 then change
Demand is inelastic • If the good is a necessity
• If Price Elasticity of Demand =1 then • Specific market
Demand is unitary elastic • Very cheap
 CONSUMER AND FIRM BEHAVIOUR

Economic profits
• Total revenue less total costs ( 𝜋𝜋 = TR – TC )
• Not the same as accounting profits

Revenue
• Price x Quantity

Costs
• Include all opportunity costs
• Implicit and explicit costs:

o Explicit costs are money costs

o Implicit cost Value of foregone opportunities

Opportunity cost and economic profits

• Costs of the owner’s resources (labour and capital) - Income the owner
could have earned in next best alternative job

Normal profits
• Expected return for supplying entrepreneurial ability
• Profit of entrepreneurship. Earned on average
• Normal profit is the cost of entrepreneurship and is a opp cost of production
• There are some costs that cannot be avoided or are 'fixed', others are
variable: TC = FC + VC
Note the slope of TR is 70 which is the same as MR change in total revenue is due
to change in 1 unit increase in quantity sold.

Similarly, not the slope of total cost curve same as marginal cost – change in cost
due to an increase in Q produced.
• Suppose MR = change in TR/change in quantity > MC = change in
TR/change in Q
 • If MR = 100 and MC = 50
• If you increase output by 1 unit
• TR increases by 100
• TC increases by 50; hence, increased profit
• Increase In output if it is interested in maximizing profit
• Therefore, the max profit a firm should choose the point where MR = MC.
That is slope of TR = Slope of TC.

Note following on the diagram

• Total revenue curve: Slope is given by marginal revenue
• Total cost curve: Slope is given by marginal cost
• Profit max occurs when the slope of TR curve = slope of TC curve
• Corresponds with the highest point of profit curve in lower diagram

Marginal costs and supply

• MC represent extra opp cost of producing an extra unit of output.

• Therefore, MC is also given by slope of TC curve (Slope tells us how TC
changes when we change output; MC = ΔTC/ ΔQ).
 • Determines a competitive firm supply curve.
• Intuitively MC reflects how much extra it costs the firm to produce another
unit of output.
• MC tells how much more a firm needs to be paid to supply another unit of
output.
• MC can be thought of as firms supply curve.

Diagram 1: Price determines QS; Diagram 2: Q determines min supply price

Market Supply
Horizontal summation of individual supply curves.

Producer Surplus
The value of the good less the opportunity costs of producing it
If a firm sells something for more than it costs to produce, a producer surplus
 TOPIC: CONSUMER BEHAVIOUR
CONSUMER SURPLUS PRODUCER SURPLUS
Consumer Surplus is equal to the difference between the Producer Surplus is equal to the difference between the
buyer’s willingness to pay and the actual price paid. price of a good and the marginal cost of producing it.

Consumer Surplus Producer Surplus

• Your willingness to pay for something equals the marginal benefit • The cost of one more unit of a good is its marginal cost,
– the maximum price that a person is willing to pay for a good. which reflects the minimum price a firm is willing to accept.

• A demand curve is a marginal benefit curve – the area under the • Producer Surplus is measured by the area below the price
D curve represents the total benefit from consumption. and above the supply curve.

Total Surplus (TS) The economic welfare of a

Consumer Surplus (CS) society is measured as the
sum of consumer surplus
Producer Surplus (PS)
and producer surplus
TS = CS + PS
Market efficiency is attained
At the equilibrium quantity, when the allocation of
Marginal Benefit = Marginal resources maximises total
Cost (efficient quantity) surplus

CHANGES IN CONSUMER SURPLUS CHANGES IN PRODUCER SURPLUS

How a change in price affects consumer surplus – as How a change in price affects producer surplus - as
supply shifts to the right. demand shifts to the right.
 PRICE CEILING & PRICE FLOOR
PRICE CEILING
Price ceiling: A legally established maximum price at which
a good can be sold.
IMPORTANCE
• If the price ceiling is set above the equilibrium price, it has NO
EFFECT.
• If the price ceiling is set below the equilibrium price, it creates a
SHORTAGE.
CASE 1:
Without rent control the equilibrium rent would be
$700 per month and 30,000 apartments would be
rented. If the government imposes a price ceiling in
this market at a price of $900, or maximum price of
$900, it is not binding (irrelevant) and has no effect
on the current market price and quantity.
CASE 2:
If the government imposes a price ceiling in this
market at a price of $500, or maximum price of
$500, it is binding because landlords cannot charge
their tenants for any price higher than $500. As a
result, rent control causes a shortage.
PRICE FLOOR
Price floor: A legally established minimum price at
which a good can be sold.
IMPORTANCE
• If the price floor is set below the equilibrium price, it has
NO EFFECT.
• If the price floor is set above the equilibrium price, it
creates a SURPLUS.
CASE 1:
In this market, the equilibrium price for beef is
$12 per kg, and equilibrium quantity for beef is 60
million kgs . If the government imposes a price
floor in this market at a price of $10, or minimum
price of $10, it is not binding (irrelevant) and has
no effect on the current market price and quantity.
CASE 2:
If the government imposes a price floor in this
market at a price of $14, or minimum price of
$14, it is binding because the market price hits
the floor, it can fall no further. Thus, a binding
price floor causes a surplus.
 Efficiency and DWL
Incidence of tax
• Consider a tax upon a buyer
• Shifts D curve down vertically by amount of the tax
• Gives D curve perceived by sellers

- Tax buyers
- Initially equilibrium was $2
- Imposition shifts it down
- New post tax D curve is in red
- New equilibrium is $1.80
- Sellers keeps $1.80 but total paid by the buyer is $1.80 + $0.50 for a total of $2.30
with 50cents going to the gov

Economic burden of tax

- Incidence of tax is unaffected by who we impose the tax on
- NB: In an exam it is acceptable if a question says to impose a tax on buyers to put it
on the sellers due to this!
Tax incidence and elasticity

- The more inelastic supply the more the seller pays and vice versa
- The more inelastic demand the more the buyer pays and vice versa
- In general the burden of the tax falls on the more inelastic side of the mkt

Tax incidence and supply elasticity

- Consider perfectly elastic supply

- Buyer pays all tax
- Consider perfectly inelastic supply
- Seller pays all the tax

P* +

P*
P*

Tax incidence and demand elasticity

- Consider perfectly elastic demand: Seller pays all tax

- Consider perfectly inelastic demand: Buyer pays all tax

When neither are perfectly elastic or inelastic

- Economic burden is shared

Consider:

- In 1 Price rises by a large amount when tax imposed: Burden falls largely upon
the buyer
- In 2 the price rises by a small amount when tax is imposed: Burden largely falls on
seller
- DWL from tax

Consider how tax creates a deadweight loss

- Assume tax on sellers, and Qd = 180 – 2p

- Qs = p; Tax of $15

- D: p = 90 – Qd/2; and S: p = 15 + Qs
- NE: p – 15 = 180 – 2p  P = 65 & Q = 50
- DWL = 0.5 x 15 x 10 = 75

Determinants of DWL
- Size depends on the change in mkt/equilibrium output that comes as a result of
the tax
- Depends on elasticity
- More elastic the larger the DWL

In brief
• Tax creates a DWL b/c it induces buyers and sellers to change their behavior compared
to mkt outcome w/ no tax  The mkt 'shrinks'
• In general the DWL increases more rapidly than the tax
• Doubling size of tax leads to quadrupling of DWL

Production and Costs

Technology and economic efficiency

Technological efficiency
- Occurs when its not possible to increase output without increasing inputs
- Firm uses given inputs efficiently

Economic efficiency
- Occurs when the cost of producing a given output is as low as possible
- Firm is using given inputs efficiently and firm chooses the most efficient mix of inputs

- Clearly method three is technically inefficient

- Now consider if cost of labour is high

- Here method 1 (capital intensive) is cheapest

- Now consider if the cost of capital is high
- Here method 4 (labour intensive) is cheapest
- Technological efficiency depends on what is feasible
- Economic efficiency depends on relative cost of inputs
- Economically efficient methods use
- Less of more expensive input
- More of less expensive input
- A firm that is not economically efficient will not maximize profits

Cost and production functions

- The production function relates inputs and outputs

- The firms cost function relates total cost of production and output
- There is a one-to-one relationship b/w production function and cost function
- Tell the same story

Production and Costs

Time Horizon
- Short run: Quantities of at least one input is fixed and Q's of others varied
- Long run: Q's of all inputs variable

Variable inputs
- Inputs varied in SR: Labor
- Fixed inputs: Cannot be varied in SR - Capital

Short run technology constraint

44
- Increase output in SR
- Firm increases labor
- Total Product = Total output
- Marginal product is the increase in TP resulting from a unit increase in output

- Average output is TP divided by quantity of inputs

TP, MP and AP

0 0
2 25
5 30
3 26.
5 7

Total Product curve

rate TP increases at

TP increases at inc.

Marginal Product curve

o Marginal product
o Increase in TP from unit increase in input
o Slope of TP curve (derivative of TP)
o MP is initially increasing but then decreasing
o Shape reflects
o Gains from specialisation
o Law of diminishing marginal returns
o Increasing marginal returns
o MP of an additional worker exceeds the MP of previous worker
o Diminishing marginal returns
o MP of additional worker is less than MP of previous worker
o Law of diminishing returns
o As a firm uses more of a variable input with given Q of fixed inputs, MP of variable input
eventually diminishes

MP and AP curve

Relationship b/w MP and AP

o USYD and UNSW example is online

o When the (marginal value) > (average value), then average value is
o increasing
o When the (marginal value) < (average value), then average value is
o decreasing

MP and AP curves a smooth version

o AP is increasing when MP>AP and AP is decreasing when MP<AP

o AP reaches max when MP passes through it
Short-run costs
o Total cost is cost of all productive resources used by a firm
o Total fixed cost (TFC) is the cost of all firms fixed inputs
o Can't be varied in SR
o Total variable cost (TVC) is cost of all firms fixed inputs

Average costs
o Average fixed cost (AFC) is TFC per unit of output
o AFC = TFC/Q
o Average variable cost (AVC) is TVC per unit of output
o AVC = TVC/Q
o Average total cost (ATC) is TC per unit of output
o ATC = TC/Q

Total cost curves

Marginal cost
o Marginal cost
o The increase in cost that results from unit increase in output
o Slope of TC curve

Marginal cost
- Decrease initially because of gains from specialisation
- Eventually increase dye to law of diminishing returns
- Marginal and average cost curves
 Marginal and average costs
Consider
• TC = 8 + 2𝑄𝑄2 , and FC = 8, and VC = 2𝑄𝑄2
• ATC = (8 + 2Q^2)/Q
• = 8/Q + 2Q
• MC = 4Q
- The MC curve intersects the ATC and AVC curves at their min points
o If MC < AC then AC must be falling
o If MC > AC then AC must be rising
- Consider MC = ATC when

Marginal and average cost curves

 Long run costs

- Cost of production when a firm uses the economically efficient Q's of labor
and capital
- Just as in SR, LR costs are affected by production function
o Inputs and outputs y = f(K,L)
Long run average cost curve

- Derived from SR ATC curves

- In LR firm chooses
o Most efficient production method
o Cheapest combo of inputs
- LRAC comprises combo of cheapest SRAC curve
 Economies and diseconomies of scale

- Returns to scale are increases in output resulting from an increase in all inputs by the
same %
o Relationship b/w inputs and outputs
- Constant returns to scale
o A x % increase in all inputs leads to the same % increase in output
- Increasing returns to scale
o A x % increase in all inputs leads to more % increase in output
- Decreasing returns of scale
o A x % increase in inputs leads to less % increase in output
Returns to scale and diminishing returns

- Returns to scale are a long run phenomenon all inputs are variable
- Diminishing returns is a short run phenomenon as one input is fixed

Returns to scale and economies of scale

- There's a direct relationship b/w returns to scale and economies of scale

- Economies of scale reflect relationship b/w output and costs
- Recall production function is a mirror of cost function
- When firm experiences increasing returns to scale it experiences economies of scale
or falling AC of production
- When a firm experiences decreasing returns to scale it also experiences
diseconomies of scale or increasing AC of production
- When a firm experiences constant returns to scale it experiences neither AC is
constant
 Perfect Competition

Perfect Competition

- Many firms each selling an identical product

- Many buyers
- Firms and buyers are well informed about prices of products of each firm
- No restrictions on the entry of new firms
o Freedom of entry and exit
Monopolistic competition
• Large number of firms selling slightly different products
• Many buyers
• No restrictions on entry of new firms
• Product differentiation gives monopolistically competitive firm an element of monopoly
power

Oligopoly
- A small number of firms compete
- Product can be identical or differentiated
- Could be substantial barriers to entry
- Strategic interaction is important

Market Structure
 Monopoly
• A single supplier
• No close substitutes for the product
• Substantial barriers to entry for new firms

Perfect Competition
- Firms believe they are too small to influence market price which means they are price
takers
Economic profit and revenue
o TR is the value of a firms sales = P x Q
- Marginal revenue
o Change in TR from unit increase in Q
- Average revenue
o TR divided by Q
- In perfect competition individual firms cannot influence price because each is small
relative to the mkt
o Take the price given
o MR = AR = Price
Demand, Price and revenue in perf comp
- The supply and demand curve represents what is happening at the industry and mkt
level
- For the firm in perf comp mkt they simply take the mkt price as given
- Hence the firm can sell as much or as little as it likes at the going mkt price
- AR = MR = P = 1.50
- TR is linear

PERFECT COMPETITION

Supply curve in
PC

- SR

o Each firms plant size given

 Some of inputs cant be altered
- LR o No. of firms is fixed
o Each firm can change size of plant
 All inputs varied
o Firms can enter the industry

In SR firm decides
o Whether to produce or shut down

o How much to produce

- In the SR to change output firm can change variable input only
- In LR firm decides

o Whether to increase or decrease plant size

 Stay or leave

Maximizing economic profit in SR

TR, TC and EP
 Maximizing profits

- Chooses outputs that max profit

o When profits maximize slope of profit fn is 0
o Find derivative of profit fn with respect to output that is find the slope of the
profit fn
 0 = MR – MC
- To max profits
o MR = MC
Marginal Analysis
- If MR > MC extra revenue exceeds extra cost
o Firm should increase output to increase profit
- If MR < MC extra revenue is less than extra cost
o Firm should decrease output to increase profit

- Note because firms are price takers

o P = MR
o Perfectly competitive firm produces here
- A firm in perfectly comp mkt has
o AR = MR = P
- MC curve is generally drawn U shaped

Profit Max Output

Firms’ short run supply curve

- Fixed costs must be paid for in SR
- Variable costs avoidable by laying off workers

o Reduce variable inputs to zero

- Firms shut down if P falls below min of AVC
- Considering what happens as mkt price changes
- Use the profit max rule to trace out firms supply curve
 Hence the short run supply curve is MC curve above the minimum of AVC

SR Industry Supply curve

- Shows Qs by industry at each price
o When the plant size of each firm and the no. of firms remains constant
- Constructed by summating horizontally the Qs supplied by indiv firms

Industry Supply curve

Output, price and profit in PC
- Changes in D bring in changes to SR industry equilibrium
- Consider an increase or decrease in demand

Short run equilibrium

 Profits and Losses in SR

- All short run firms may

o Earn profit
o Break even
o Economic loss
The firm earns the normal profit (no economic profit)

The firm earns an economic profit

 The firm earns an economic loss

LR adjustments
- In LR firms don't earn profits or losses
- Competitive industries adjust by
o Entry and exit
o Change in plant size
Entry and Exit

Prospect of persistent profit or loss causes entry or exit

o If firms are making profit, other firms enter as there is money to be made
o If firms are making losses some existing firms exit
- This entry and exit influences P Q and profit
- Assume initially firms making positive economic profit
As new firms enter
• Price falls  Economic profit decreases  As firms leave industry
• Price rises  Economic loss of firms decreases  A firm can also influence profits by
changing its plant size

LR adjustment
- Consider if in SR firm makes 0 profit but is not at the min of LRAC
o Firm will change its capital level and move to new SRAC
 If price was unchanged firm may earn positive profit
o But in LR other firms may enter ensuring no firm earns positive economic profit and
price will fall

Plant size and LR equilibrium

 LR equilibrium

- Occurs in comp. industry when firms are earning normal profit and economic profit is
0
- Economic profits draw in firms and cause existing firms to expand
- Economic losses cause firms to leave and cause existing firms to scale back

Changing Tastes and Advancing technology

- Whenever there's change in D conditions we move out of LR equilibrium

- There is an adjustment process as we move to new equilibrium LR

Rise of an industry
Decline of an industry

Decrease in Demand

Effect of Cost reduction

- Note in SR there is profit in LR no profit
- Also note that the price has dropped but cost has dropped even further
that's why there is still profit in SR

Summary – Firm supply plans

• SR  Firm chooses output so MR = MC
• LR  Some firms leave if there is loss or firms enter if there is profit

• Unless MR falls below min of AVC

• LR Industry supply
• External economies
• Factors beyond control of indiv firms that lower its cost as industry expands

• External diseconomies
• Factors outside control of firm that raise firms costs as industry output increases
• Existence of these determines LR industry supply curve

• External economies; For example suppose computer industry expands cost of chips fall
• External diseconomies; For example suppose that as wine expands cost of water
increases
• In both cases costs experienced by firm not caused by change in output
 LR changes in P and Q

LR supply curve

- LR S curve may slope up

o Some resources used in production only available in limited quantities

o Firms have different costs

- Congestion may arise with industry output  LR S curve slope down

o If there are economies of scale in input mkt's  Changing tastes and Advancing

technology

Technological change

o New tech allows firms to produce at lower costs

 Causes cost curves to shift down

o Firms adopting new tech make profit

 Draws in new firms

o Old tech firms disappear price falls and Q increases

MONOPOLY
What is a monopoly
• An industry comprised of a singular firm

• No close subs to product

• Firm is protected by strong barriers to entry

• In absence of close competition

• Has market power – ability to affect price

What is mkt power

• A firm with mkt power

• In perfectly competitive industry faces demand curve that is perfectly elastic

• A firm that has low price elasticity of demand for output can raise price and not lose

customers

• Mkt power captures the idea that a firm can raise its price above the level that would

exist in perfectly competitive industry and no lose all customer

How does a monopoly arise?

• No close subs

• If a good ahs close subs it faces heavy competition

 • Barriers to entry

• Barriers to entry may be legal that protect firm

Barriers to entry

• Legal barriers to entry

• Restricted by various mechanisms

• Public franchise

• Govt. license

• Intellectual property rights

Barriers to entry

- Natural barriers to entry

o Firm may have sole ownership of resources for the production

o A natural monopoly results from situation when one firm can supply entire mkt at

lower cost than other firms

Natural monopoly

- As output increases AC decreases, single firm could supply mkt Q at lower cost than
two indiv firms
 Monopoly price setting strategies

- Single price monopolist

o Sell each unit for same price
- Price discrimination is practice of setting diff units for diff prices

Single price monopoly

- Firms D curve is mkt D curve

- MR is not the same as mkt price
o To sell more units a monopolist must lower price
o MR has two effects

Selling more units -> extra revenue

Selling more price falls and lose revenue on existing units sold

- Consider
• P = AR
• MR = changeTR/changeQ

Demand and marginal revenue

• Example – consider linear demand curve
• Slope of MR curve is twice the value of the demand curve
• Consider
• P=a-bQ
• TR = p.Q
• (a-bQ)Q = aQ – bQ^2
• MR = a – 2bQ
• MR has the same intercept as the D curve but twice the slope
 Marginal revenue and elasticity

- When demand is elastic

o Decrease in price leads to a large increase in QD and TR increases and MR is

positive
- When demand is inelastic
o A decrease in price leads to small increase QD a decrease in TR and MR is negative

TR & elasticity

MR & elasticity

- Profit maximizing monopolist never produces at output in inelastic range of D curve

o If you increase price QD decreases and TC decreases
o TR increases because demand is inelastic
o Therefore profit can always be increased by increasing P when operating on inelastic
part of D curve
 Profit max monopolist decision

- Chooses level of output where profit fn is maximized

o Slope is 0
- Alternatively when MR = MC

Monopoly and Output Price

Profit Maximizing compared

Monopoly and competition compared

- Hence comparing
o In a monopoly price increases and Q decreases
o CS is lower in monopoly
o DWL due to monopolists rustication of output
Inefficiency of Monopoly

- MB > MC hence restricting output creates DWL

Worked example
Rent seeking behaviour

• Activity of trying to obtain monopoly in order to earn eco profits

• Firm willing to spend up to the monopoly profit in order to obtain monopoly
• Buying monopoly
• Creating monopoly
• Creating barriers to entry

Price discrimination
 • Charging diff price for diff units of output not related to cost of production
• Converting CS to profit
• Works by
• Setting higher price to inelastic segment
• Setting lower price to elastic segment

Is monopoly bad?
• Economies of scale and scope
• Monopolist may produce at lower AC
• Incentives to innovate
• R and D activity
• Public policy towards monopoly

Govt. responds by
o Making monopoly industries more competitive
o Regulate behavior
Pricing Strategies

Price discrimination
• First degree price discrimination
• Monopolist charges diff price for each unit sold
• Monopolist charges max WTP
• Called perfect price discrimination because monopolist extracts all consumer surplus
• Requires knowledge of WTP for each unit consumed

• In example above monopolist sells first unit for 9.5 then 8.5 etc.
• Monopolists MR curve is the D curve
• Monopolist continues to sell unit as long as MR > MC

CS captured by monopolist
• Note when compared to perfectly comp mkt there is no DWL from perfectly price
discriminating monopolist. However, the CS that exists in perf comp is now captured by
monopolist
Second degree price discrimination
• Monopolist offers menu of pricing options to consumers and allows them to choose
which one they want  Cannot distinguish b/w groups
• Knows D curve of diff groups
• Need to design prices to induce more inelastic groups to pay higher prices
Consider
• Assume cost of production is 0
• Buyers purchase only one unit of software alternatively cinema might only purchase one
copy of movie even though there are diff types of cinemas
• They choose version that gives them higher CS
 Pricing Strategies – Monopolistic competition

Price discrimination

• Ideal outcome  Profit is $120

• If Pd = 84 and Ps = 20  Profit 104
• If Pd = 86 and Ps = 20  Profit 40
• If Pd = 100 only  Profit 100
• If Ps = 20 only  Profit 40

Third degree price discrimination

• Monopolist charges different prices to different groups of consumers

• Monopolist must be able to distinguish b/w groups
• Monopolist knows D curve of diff groups
• Charge higher price to inelastic segment

• Monopolist wants to max profits

• Requires they act like monopolist in each mkt
• Should equate MC and MR in each of mkt's they operate

Worked example
• Pa = 10 – Qa
• Pb = 8 – Qb
 • MC = 2 and AC

How should monopolist set prices to max profit

• For first customer
• Pa = 10 – Qa; and MRa = 10 – 2Qa
• Pb = 8 – Qb; and MRb = 8 – 2Qb

Monopolist sets MR = MC for each

• MRa = 10 – 2Qa = 2; and Qa = 4 and Pa = 6
• MRb = 8 – 2Qb = 2; and Qb = 3 and Pb = 5
• Total Profit = Qa.Pa + Qb.Pb – AC(Qa + Qb) = 24 + 15 – 14 = 25

Other pricing strategies

• Two part tariffs
• Set fixed price for access and per unit price
• Firms can use it to extract CS
Firms behave like monopolist
• MR = MC
• Can earn SR profit
• Produces less than capacity

Less than level of output that minimizes ATC

Long run: Eco profit = 0

Attracts new entrants: Firms D curve and MR curve shift left - Profit max P and Q fall

Monopolistic Competition
Mark up over MC

Excess capacity
• In LR in perf comp. firms produce min of ATC
• Produce as the min efficient scale
• In monopolistic comp costs exceed min of AC
• Firms produce less than the min efficient scale
Efficiency
• Firms charge P > MC
• DWL
• But consumers do gain variety
• Loss of efficacy needs to be weighed up against gain of greater product variety

Monopolistic comp excess capacity

• Likely to innovate
• Mkt offers greater range of products

Mono comp – zero profits

• Can innovate and reduce costs quicker than rivals.
 Part
TITLE OFBTHIS > CHAPTER
Sample Final Examination Paper
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 FINAL EXAMINATION
PREPARATION
Question 1

The CMC Ltd. presents to you, as their economic advisor, the cost data for their firm as set

out in the table below. The directors of the company are concerned about the future viability

of their company in a highly competitive market subject to rapid changes in consumer

sentiment and the introduction of new suppliers as there are virtually no barriers to entry

or exit from the industry.

Average Fixed Average Variable Average Total Marginal Cost

Quantity
Cost ($) Cost ($) Cost ($) ($)
0 - - - -
1 5 9.55 15.55 9.55
2 2.50 7.98 14.55 6.41
3 1.67 7.65 9.32 7.00
4 1.25 7.65 8.90 7.65
5 1.00 7.66 8.66 7.70
6 0.83 7.83 8.66 8.66
7 0.71 8.00 8.71 9.00
8 0.63 9.15 9.78 17.20
9 0.56 10.13 10.69 18.00

They require you to analyse the data and advise them on the desirable course of action,

giving reasons.
 (a) If the price operating in the market is $8.66, what is their profit (loss) position and

should they continue to operate in the short and long run?

(b) If the price rises to $9.00, what is their profit (loss) position and should they continue

to operate in the short and long run?

(c) If the price falls to $7.00, what is their profit (loss) position and should they continue

to operate in the short and long run?

(d) What will be the long run market price and the profit position of the CMC Ltd.?

(2 + 2 + 1 + 1) = 6 marks

Question 2

Consider the market for coal for the generation of electricity. In each case consider whether

there is a movement along the supply curve (and in which direction) or a shift in the supply

curve (and whether it is to the right or left). Draw a market diagram (demand and supply

curves) and illustrate the initial and new equilibrium and explain why this has occurred.

(a) New coal mines commence production

(b) The demand for electricity rises

(c) The price of gas falls

(d) New technology decreases the cost of coal production

(2 + 2 + 2 + 2) = 8 marks
Question 3

The following table illustrates the production of cars and airplanes that Japan and USA

can produce with the same employment level of 1 person and in the same time period

Units of Cars from 1 unit of Units of Airplanes from 1 unit of

Country
Labour Labour

USA 40 16

Japan 25 50

Assume that each country has 500 workers.

(a) Draw the production possibility curves for both countries (on separate diagrams)

(b) Explain what is meant by absolute advantage? Which country has an absolute

advantage in airplanes

(c) Explain what is meant by comparative advantage? Which country has a comparative

advantage in car?

(d) Which country has a comparative advantage in airplanes?

(e) Assume that trade takes place and that the terms of trade are established at a rate or

10 cars for 10 airplanes. The country that produces airplanes consumes 8,000

airplanes domestically and exports the rest. What will be its imports of cars?

(f) What will be the consumption of airplanes in the country that produces cars?

(2 + 2 + 1 + 2 + 2) = 9 marks
Question 4

From the early 2000’s to the 2015’s Australian consumers were subject to government-

imposed price floors in markets for the majority of agricultural products. The first diagram

above illustrates the market outcome of a non-regulated agriculture market. The second

diagram illustrates the outcome of a market with a government-imposed price floor of $12

per tonne.

(a) What was the consumer surplus prior to and after the introduction of the price floor?

(b) What is the loss of consumer surplus due to the introduction of the price floor?

(c) What was the producer surplus prior to and after the introduction of the price floor?

(d) What is the gain of producer surplus due to the introduction of the price floor?

(e) What was the level of society’s welfare prior to the introduction of the price floor?

(f) What is the society’s welfare after the introduction of the price floor?

(g) What is the level of deadweight loss to society due to the introduction of the price

floor?
 (h) What is the tax contribution that the government must make to support the price

floor?

(i) What action should government take to eliminate (dispose of) the supply of

agricultural products that it has purchased?

(j) What level of support should the agriculturalists contribute to the political parties

that supported the price floor?

(1 + 1 + 1 + 1 + 2 + 2 + 2 + 3 + 2 + 2) = 17 marks

Question 5

(a) How does a monopoly firm decide -

i. How much to produce?

ii. What price to charge?

(b) Profit making monopolist

i. Draw a diagram of a profit-making monopolist

ii. Why would a monopolist (or any firm with monopoly power) price

discriminate? What conditions are necessary for price discrimination to

occur?

(2 + 3) = 5 marks

TOTAL: 60 MARKS

END OF EXAMINATION
 Part
TITLE OFCTHIS > CHAPTER
Suggested Solutions to Final Exam Paper
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 SUGGESTED SOLUTIONS

Question 1

Part a

Quantity AVC ($) ATC ($) MC ($) MR = P

6 7.83 8.66 8.66 8.66

Firm earns economic profits when and only when Price > Average Total Costs

Firms earns normal profits because Market Price (P = $8.66) = Average Total

Costs (ATC = $8.66)

The firm should stay in the business in short-run because Market Price >

Average Variable Cost, or Market Price = $8.66 > $7.83 = Average Variable

Cost.

Part b
 Quantity AVC ($) ATC ($) MC ($) MR = P

7 8.00 8.71 9.00 9.00

If the price goes up to $9.00, firm earns economic profits because Price >

Average Total Costs, or Price = $9.00 > $8.66 = Average Total Cost.

The firm therefore earns normal profits

The firm should stay in the business in short-run because Market Price >

Average Variable Cost, or Price = $9.00 > $8.00 = Average Variable Costs

Part c

Quantity AVC ($) ATC ($) MC ($) MR = P

7 8.00 8.71 9.00 9.00

If the price goes down to $7.00, firm makes a loss in both economic profit and

normal profit because Price ($7.00) < Average Total Cost ($9.32)

Loss = (Average Total Cost – Price) * units = (9.32 – 7) * 3 = $6.96

The firm should leave in short-run because Market Price < Average

Variable Costs ($7.00 < $7.65)

Part d

Long run market price = Minimum ATC = $8.66 at output = 6.

Question 2

Part a – New coal mines commence production

New coal mines commence production make price for coal reduced; hence, more

electricity will be generated at the same level of costs.

Supply for coal will increase, and supply curve shifts to the right. At new

equilibrium point, coal price is lower, and quantity demanded for coal increases.
Part b – The demand for electricity rises

The demand for electricity rises leading to more coals demanded to produce

electricity; supply curve will shift to the right. With the increase in supply, a new

lower equilibrium price and greater equilibrium quantity will be established.

Part c – The price of gas falls

The price of gas falls leading to an increase in demand for gas; demand for

electricity will be lower; hence, less coals will be demanded to produce

electricity. Supply curve for coal will shift to the left. With the decrease in supply

a higher equilibrium price and lower equilibrium quantity will be established

Part d – New technology decreases the cost of coal production

Cost of coal production decreased will lead to more coal producing effectively;
hence, more electricity will be generated given a level of cost for coals. Then
supply curve will shift to the right. With the increase in supply, a new lower
equilibrium price and greater equilibrium quantity will be established.
Question 3

Part a

PP Curve Cars Airplanes

USA 20,000 = 40 * 500 8,000 = 16 * 500

Japan 12,500 = 25 * 500 25,000 = 50 * 500

Part b
Absolute advantage: the ability of an individual or country to carry out a

particular economic activity more efficiently than another individual or country.

USA has absolute advantage in cars (20,000 > 8,000); and Japan has absolute

advantage in Airplanes (25,000 > 12,500).

Part c

Comparative advantage occurs when a country (or person) to carry out a

particular economic activity more efficiently than another individual or country.

Opportunity cost to produce a car in

8,000
USA: 1 ∗ = 0.4 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
20,000

25,000
Japan: 1 ∗ = 2 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
12,500

To produce a car, opportunity costs in Japan is 2 Airplanes, while it is only 0.4

Airplanes in USA; hence, USA has comparative advantage in producing cars

compared to Japan.
Part d

Opportunity cost to produce an Airplane in

20,000
USA: 1 ∗ = 2.5 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶
8,000

12,500
Japan: 1 ∗ = 0.5 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶
25,000

To produce an airplane, opportunity costs in Japan is 0.5 cars, while it is 2.5 cars

in USA; hence, Japan has comparative advantage in producing airplanes

compared to USA.

Part e

If each country specialize completely in the product which they have

comparative advantages

USA produces 20,000 cars (export cars)

Japan produces 25,000 airplanes (export airplanes)

Japan will consume 8,000 airplanes domestically; hence, number of airplanes

export will be
 25,000 − 8,000 = 17,000 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

With regard to terms of trade at a rate of 1 car for 1 airplane; number of cars for

imports will be 17,000 cars.

Part f

Ourland imports 17,000 airplanes with the terms of trade – 1 airplane = 1 car;

hence, number of cars export will be 17,000 cars. Number of cars consuming

domestically will be

20,000 − 17,000 = 3,000 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐

Question 4

Part a

Consumer surplus prior the introduction of price floor

1
CS PRIOR = ∗ 8 ∗ 16 = 64 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
2

Consumer surplus after the introduction of the price floor

1
CS AFTER = ∗ 4 ∗ 10 = 20 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
2
Part b

Loss of consumer surplus due to the introduction of the price floor

CS LOSS = 𝐶𝐶𝐶𝐶 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 − 𝐶𝐶𝐶𝐶 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 = 64 − 20 = 44 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑

Part c

Producer surplus prior to the introduction of the price floor

1
PS PRIOR = ∗ 4 ∗ 16 = 32 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
2

Producer surplus after the introduction of the price floor

1
PS AFTER = ∗ 8 ∗ 20 = 80 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
2

Part d

Gain of Producer Surplus due to the introduction of the price floor

PS GAIN = 𝑃𝑃𝑃𝑃 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 − 𝑃𝑃𝑃𝑃 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 = 80 − 32 = 48 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑

Part e

Society’s welfare prior to the introduction of the price floor

SOCIETY’S WELFARE PRIOR = 𝐶𝐶𝐶𝐶 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 + 𝑃𝑃𝑃𝑃 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 = 64 + 32 =

96 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑

Society’s welfare after the introduction of the price floor

SOCIETY’S WELFARE AFTER = 𝐶𝐶𝐶𝐶 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 + 𝑃𝑃𝑃𝑃 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 = 20 + 80 = 100

million dollars

Part f

Deadweight loss to society due to the introduction of the price floor

1
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷ℎ𝑡𝑡 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 (𝐷𝐷𝐷𝐷𝐷𝐷) = ∗ 4 ∗ 8 = 16 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
2

Part g

Tax government must make = Unsold output (20 – 10) x price ($12) = 120

million dollars.
Part h

Back to the previous question, the government must buy the amounts of unsold
products. To avoid buying these products, the government can solve the problem
by either ways:

Increasing the demand for the products on a par with 20 million tones (for
example, by promotion, advertising, rewards ….)

Reducing the supply for the products on a par with 10 million tones;
consequently, no excess supply (for example, pay subsidy not to produce or to
shift to new production).

Question 5

Part a

A monopoly will produce the quantity of output dictated by the intersection of

the Marginal Revenue (MR) and MC curves, charging a price set by the demand
curve.

Part b

Necessary conditions for price discrimination to occur

Each group must have different demand elasticity

It must be possible to figure out which group an individual customer belongs to
at low cost

The consumer must be unable to resell the goods or services in question

 Part
TITLE OFDTHIS > CHAPTER
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 FINAL EXAMINATION
PREPARATION

MULTIPLE CHOICE QUESTIONS

Question 1

The scarcity problem

(a) Persists only because countries have failed to eliminate unemployment.

(b) Persists because society cannot give every individual the highest standard of

living to which he or she might aspire.

(c) Has been solved in all industrialised nations.

(d) Has been eliminated in affluent societies such as Australia.

Question 2

A rational decision maker takes an action only if the

(a) Marginal benefit is greater than the marginal cost.

(b) Marginal benefit is less than the marginal cost.

(c) Average benefit is greater than the average cost.

 (d) Marginal benefit is greater than both the average cost and the marginal cost.

Read the following analysis to answer questions 3 and 4.

Richard and Tommy are on an island. They live on coconuts and fish and work eight hours

per day. Each hour he works, Richard can produce either two coconuts or one fish. Each

hour he works, Tommy can produce either 1.5 coconuts or four fishes.

Question 3

Richard has a comparative advantage in ______ and Tommy has an absolute advantage in

_____.

(a) Fish, fish

(b) Fish, coconuts

(c) Coconuts, fish

(d) Coconuts, coconuts

Question 4

If they agree to trade, then

(a) They cannot gain from trade because they have the same opportunity cost of

getting coconuts.

(b) They can gain from trade as long as one specialises in getting coconuts and the

other specialises in getting fish, but it does not matter who specialises in what.

(c) They can produce collectively 28 coconuts and 40 fishes in eight hours.
 (d) They can gain from trade if Richard specialises in getting fish and Tommy

specialises in getting coconuts.

Use the following graph to answer question 5

Question 5

The movement from point A to point C could have been caused by

(a) Inflation.

(b) An increase in income if CDs are normal goods.

(c) The imposition of a price ceiling.

(d) A decline in the cost of producing CDs

Question 6

Graphically, the market demand curve is

(a) Steeper than any individual demand curve that comprises it

(b) Greater than the sum of the individual supply curves

(c) The horizontal sum of individual demand curves

(d) The vertical sum of individual demand curves

Question 7

What is market demand curve for the two consumers who have the following demand

functions? (1) 60 − 1.2𝑄𝑄 and (2) 𝑃𝑃 = 60 − 2𝑄𝑄

(a) 𝑃𝑃 = 60 − 3.2𝑄𝑄

(b) 𝑃𝑃 = 120 − 3.2𝑄𝑄

(c) 𝑃𝑃 = 60 − 0.75𝑄𝑄

(d) 𝑃𝑃 = 60 − 0.8𝑄𝑄

Question 8

What is the point elasticity for the demand curve 𝑃𝑃 = 100 − 4𝑄𝑄 at the price of 20?

(a) −0.25

(b) −1.2

(c) −1.0

(d) −0.2
Question 9

If you were in business and had the demand curve 𝑃𝑃 = 100 − 4𝑄𝑄 and your price was 30.

Which of the following would definitely be a good strategy?

(a) You should raise your price because your revenues would increase and you

would be producing less.

(b) You should lower your price to gain more revenue.

(c) You should hold price where it is because you are profit maximising now.

(d) You do not have enough information to make any of the statements listed above.

Question 10

If the slope of a demand curve for good X is constant, then the price elasticity of the good

(a) Increases as the price falls.

(b) Decreases as the price falls.

(c) Has a constant elasticity.

(d) Increases up to the midpoint of the demand curve and then begins to decrease.

Question 11

A production possibility frontier (PPF) is negatively sloped because

(a) Some resources are not fully utilised

 (b) More goods are purchased as price falls

(c) There is not enough capital in the economy

(d) Of opportunity cost

Question 12

Which of the following is an example of market failure?

(a) A firm becomes insolvent and is forced out of the market

(b) A firm’s research and development fails to develop a new product

(c) A firm closes down a factory due to poor sales

(d) A firm’s pollution into a river reduces the number of fish that can be caught

Question 13

If you have a choice of consuming (i) one candy bar or (ii) two apples or (iii) three oranges,

the opportunity cost of the candy bar is:

(a) Three oranges

(b) Two apples and three oranges

(c) Two apples or three oranges, whichever you most prefer

(d) The difference in the prices of the three options

Use the following table to answer questions 14 and 15

 Production possibilities for CNC Limited
Computers Cheese
250 0
200 500
150 900
100 1200
50 1400
0 1500

Question 14

What is the opportunity cost to CNC Limited of increasing the production of computers

from 150 to 200?

(a) 300kg cheese

(b) 400kg cheese

(c) 500kg cheese

(d) As the production costs for computers and cheese are unknown, it is not possible

to tell

Question 15

What is the most accurate statement about the opportunity cost of producing an additional

50 computers in CNC Limited?

(a) The opportunity cost of an additional 50 computers is 300kg of cheese

 (b) The opportunity cost of an additional 50 computers is 200kg of cheese

(c) It is impossible to determine the opportunity cost of an additional 50 computers

(d) The opportunity cost of an additional 50 computers increases as more computers

are produced

Question 16

Which of the following would not shift the demand curve for beef?

(a) A change in the incomes of beef consumers

(b) An effective advertising campaign by pork producers

(c) A widely publicised study that indicates beef increases one’s cholesterol

(d) A reduction in the price of cattle feed

Question 17

The demand for a good tends to be more elastic -

(a) The greater the availability of close substitutes

(b) The narrower the definition of the market

(c) The longer the period of time

(d) All of the above are correct

Question 18

When demand is inelastic, a decrease in price will cause:

(a) An increase in total revenue.

(b) A decrease in total revenue.

(c) No change in total revenue.

(d) There is insufficient information to answer this question.

The table below shows Richard’ consumption of ouzo as his income and the prices of ouzo

and beer vary. Use this to answer Questions 19 and 20.

Income ($) Price ouzo Price beer Quantity Ouzo

30,000 10 2 20
30,000 10 4 25
30,000 12 4 22
50,000 12 4 28

Question 19

For Richard, ouzo is

(a) A normal good.

(b) An inferior good.

(c) Underpriced.

(d) There is not enough information to determine.

Question 20

For Richard, ouzo and beer

(a) Both have inelastic demands

(b) Are substitute goods

(c) Are complement goods

(d) There is not enough information to determine

Question 21

Studies in the price elasticity of alcohol indicate that

(a) Addictive products are very price inelastic.

(b) The income effect of a price increase does reduce alcohol consumption.

(c) There is no substitution effect when the alcohol price changes.

(d) Price elasticity is positive because the income effect discourages people making

them more alcohol dependent.

Question 22

Which product is likely to have the most elastic demand?

(a) Toothpicks

(b) The cholesterol lowering drug Lipitor

(c) Your textbook

(d) Ford Focus sedan

Question 23

What is the amount of consumer surplus reaped by the consumer in the graph below when

the consumer faces the price of 6?

(a) 90

(b) 120

(c) 60

(d) 30

Question 24

You run a health club and all your customers have the demand curve 𝑃𝑃 = 100 − 2𝑄𝑄. If

your marginal costs of providing the club benefits are 50 and you price at marginal cost,

what would be the maximum club membership fee you could charge to extract all the

welfare you could possibly get.

 (a) 625

(b) 1250

(c) 2500

(d) 3750

The following two questions 25 & 26 - relate to the supply and demand graph below

Question 25

Due to the story of the Army lawyer who was defending Captain MacDonald in a capital

case. The advice to examine the lawyers’ shoes was an attempt to

(a) Shift the demand curve for information leftward and lower its price.

(b) Shift the demand rightward to acquire more information.

(c) Shift the supply curve leftward by raising the cost of acquiring information.

(d) Shift the supply curve rightward by getting the needed information at lower cost.
Question 26

If the graph above shows the government intelligence market for information that existed

prior to the terrorism of September 11, 2001, what is the most likely effect of those acts on

the market in the short run.

(a) Supply shifts left and demand stays constant.

(b) Demand shifts right and supply stays constant.

(c) Supply shifts right and demand stays constant.

(d) Supply and demand both shift rightward.

Question 27

The market demand for duct tape is 𝑃𝑃 = 100 − 9𝑄𝑄. Ten firms supply the tape and each

has a marginal cost function 𝑀𝑀𝑀𝑀 = 10𝑄𝑄. What is the going price for duct tape that each

producer must take as given and what is the total market quantity produced?

(a) 𝑄𝑄 = 5.26 and 𝑃𝑃 = 52.70

(b) 𝑄𝑄 = 10 and 𝑃𝑃 = 10

(c) 𝑄𝑄 = 1 and 𝑃𝑃 = 91

(d) None of the above is the correct answer

Question 28

In Question 27 above, all firms together will have ____ producer surplus if the demand

shifts making equilibrium output equal to 8. Nothing changes on the cost side of the market.
 (a) 80

(b) 28

(c) 64

(d) 32

Question 29

If the price in a perfectly competitive market is 10, ATC is 11 and there are no fixed costs,

then the

(a) Firm should shut down in the short-run.

(b) Firm should stay open in the short run look to change or close in the long-run.

(c) Firm should raise its price to at least 11.

(d) Firm must seek more information before it can answer questions.

Question 30

Which is false, in a perfect competition model, a firm is making economic profit?

(a) More resources will flow into the industry in the long-run.

(b) The firm’s marginal cost is higher than its ATC.

(c) The firm’s ATC will rise until ATC = P.

(d) The firm’s price will fall in the long-run.

Question 31
Given a market demand curve 𝑃𝑃 = 480 − 10𝑄𝑄 and a market supply curve 𝑀𝑀𝑀𝑀 = 2𝑄𝑄, how

much producer surplus is generated in the entire market?

(a) 1,600

(b) 3,200

(c) 8,400

(d) 11,600

Question 32

Economic and accounting profit usually differ primarily because -

(a) The opportunity cost of the owners’ time is included as a cost in calculating

economic profit but is not included in accounting calculations of profit.

(b) Employee labour costs are not counted in the former but are counted in the latter.

(c) Rental costs of land are valued much higher in accounting profit than they are in

economic profit.

(d) Accounting overestimates capital costs and economic accounting tends to

underestimate capital costs.

Question 33

The market demand for wedding reception meals is 𝑃𝑃 = 100 − 0.1𝑄𝑄. Ten restaurants in

town supply the meals and each has a marginal cost function 𝑀𝑀𝑀𝑀 = 1𝑄𝑄. The meals are

perfect substitutes for each other. What is the going price for these meals that each

restaurant will take as given and what is the total market quantity produced?
 (a) 𝑄𝑄 = 50 and 𝑃𝑃 = 50

(b) 𝑄𝑄 = 500 and 𝑃𝑃 = 50

(c) 𝑄𝑄 = 91 and 𝑃𝑃 = 9

(d) None of the above is the correct answer

Question 34

In a constant cost industry where the long-run supply curve is horizontal and the LAC curve

is U-shaped, an increase in demand will, in the long-run

(a) Increase the size of each firm and decrease the number of firms in the industry.

(b) Increase the number of firms in the industry but not the size of existing firms.

(c) Lead to a lower price, larger firms, and more of them.

(d) Lead to any one of the above because the outcome is indeterminate.

Answer the following 3 questions (35, 36 & 37) by examining the graph below
Question 35

In a graph above the firm

(a) Is pursuing a profit maximising position if it produces at 0d where it makes

normal but no economic profits.

(b) Is breaking even if it produces at either 0a or 0d.

(c) Is making no economic profit if it produces at 0b.

(d) Should shutdown at any output less than 0b.

Question 36

In the graph above we can be sure that the shutdown point of the firm is at

(a) The output 0b

(b) The output 0a

(c) A point to the left of 0b

(d) A point to the left of 0a

Question 37

If demand increased in the market for X above, in the short-run we would expect to see

(a) The firm increases its output but price to stay the same

(b) The price rise and the firm increases its output

(c) New firms enter to make up the shortage in the market

 (d) The firm increases output & profit because the ATC will go down as production

goes up

Question 38

Which statement about perfectly competitive markets if false?

(a) Innovations do not occur frequently because economic profits cannot be reaped

from the effort.

(b) If firms have U shaped long-run ATC curves and input prices stay constant, then,

over time, firms will pass along to the consumer an entire per unit tax that might

be levied on the firm

(c) Agricultural price supports tend to bid up the price of land in the long run.

(d) The long run supply curve of the industry is more likely to be horizontal that the

short run supply curve of any given firm.

Question 39

Market supply is the horizontal summation of

(a) The average variable cost function of the firms in the market.

(b) The average total cost function of the firms in the market.

(c) The marginal cost function of the firms in the market.

(d) None of the above since it is derived from total market data rather than data from

individual firms.
Question 40

Exchange in a market brings benefits to both consumer and producer if it is voluntary and

well informed. From the graph of a market below, what is the value of the net benefits from

exchange to both consumer and producer.

For Richard, ouzo and beer

(a) 150

(b) 100

(c) 250

(d) 400

Question 41

If the demand curve for the monopolist is 𝑃𝑃 = 100 − 20𝑄𝑄, then the marginal revenue of

that firm is

(a) 𝑃𝑃 = 200 − 20𝑄𝑄

(b) 𝑃𝑃 = 50 − 40𝑄𝑄
 (c) 𝑃𝑃 = 100 − 20𝑄𝑄

(d) 𝑃𝑃 = 100 − 40𝑄𝑄

Question 42

Monopoly differs from perfect competition in that

(a) The industry demand curve in perfect competition is horizontal while the

demand curve facing a monopolist is downward sloping.

(b) The cost structure of a monopolist is higher than the cost structure of a perfectly

competitive firm producing the same product.

(c) The total revenue function of a perfectly competitive firm is linear and a

monopolist’s total revenue function increases and then decreases with respect to

quantity sold.

(d) A monopolist has a specific supply curve and a perfectly competitive firm has

no specific supply curve.

Question 43

For airlines to effectively price discriminate they must

(a) Be selling tickets in more than one market and the elasticities in the markets must

be different for any given market price.

(b) Be sure that the two markets can sell to each other.

(c) Have a horizontal marginal cost function

(d) Be sure that all of the above are true

Question 44

Natural monopolies exist because

(a) Of patent laws.

(b) One company controls key inputs into production.

(c) Of government regulations which privilege one company.

(d) Economies of scale

Question 45

Which of the following is not true?

(a) Perfectly competitive firms have a linear positive sloped total revenue function

while monopolies have an increasing and then decreasing total revenue function.

(b) Perfectly competitive firms face a horizontal demand curve and monopolies face

a downward sloping demand curve.

(c) Perfectly competitive firms and monopoly firms both generally have U shaped

ATC curves.

(d) Both perfectly competitive firms and monopolies control prices by altering their

output.

Question 46

A monopoly should definitely shut down if its

 (a) Marginal revenue is below its average total cost at all output levels.

(b) Marginal revenue is below its marginal cost at all output levels.

(c) Demand curve is below its average variable cost at all output levels.

(d) Marginal revenue is below its average variable cost at all output levels.

Question 47

Which statement about a profit maximising price discriminating monopolist is false?

(a) To price the two segregated markets effectively, the firm will need to know the

marginal revenue function in each separate market.

(b) The output of the firm occurs where the vertical sum of the marginal revenue

curves equals the marginal cost of producing.

(c) The market with the most elastic demand will have the lowest price.

(d) Firms that sell services have an easier time price discriminating than firms that

sell generic type products.

Question 48

If a firm has significant economies of scale with constantly falling ATC so that producing

at lowest costs are possible only if one firm produces in the industry, then

(a) The firm cannot price at marginal cost and make a profit.

(b) A profit maximising strategy will create substantial deadweight loss to society.

(c) Social efficiency can only be attained if the firm is subsidised by the public.
 (d) All of the above are true.

Question 49

From the graph of a firm’s situation shown below, what is a good estimate of the short run

profit maximising output and price? Estimate from the numbers shown

(a) 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 = 70, 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 = 40

(b) 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 = 110, 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 = 40

(c) 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 = 70, 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 = 60

(d) 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 = 50, 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 = 75

Question 50

Given the demand curve 𝑃𝑃 = 500 − 5𝑄𝑄 and a constant marginal cost of 100, if the firm

is a single price profit maximising monopolist, how much deadweight loss to society will

result from the monopolist behaviour?

(a) 3,000

(b) 4,000

(c) 8,000

(d) 9,000

Total: 50 marks

You will get 1 mark for each correct answer

END OF EXAMINATION
 SOLUTIONS & HINTS

MULTIPLE CHOICE QUESTIONS

• Question 1: b
Hints: The management of society’s resources is important because resources are

scarce. Scarcity means that society has limited resources and therefore cannot produce

all the goods and services people wish to have. Just as a household cannot give every

member everything he or she wants, a society cannot give every individual the highest

standard of living to which he or she might aspire.

• Question 2: a
Hints: individuals and firms can make better decisions by thinking at the margin. A

rational decisionmaker takes an action if and only if the marginal benefit of the action

exceeds the marginal cost. Imagine that a plane is about to take off with ten empty seats,

and a standby passenger is waiting at the gate willing to pay $300 for a seat. Should the

airline sell it to him? Of course, it should. If the plane has empty seats, the cost of adding

one more passenger is minuscule. Although the average cost of flying a passenger is

$500, the marginal cost is merely the cost of the bag of peanuts and can of soda that the

extra passenger will consume. As long as the standby passenger pays more than the

marginal cost, selling him a ticket is profitable.

 • Question 3: c
Hints: Productions each hour of work

Outputs per each hour of work Coconuts Fish

Richard 2 1
Tommy 1.5 4

 Richard has absolute advantage in coconuts (𝟐𝟐 > 𝟏𝟏. 𝟓𝟓)

 Tommy has absolute advantage in fish (𝟒𝟒 > 𝟏𝟏)

• For each coconut, Richard has to give up ½ fish (or 0.5), Tommy has to give up

4/1.5 fish (or 2.67); hence, Richard has comparative advantage in producing

coconuts.

• For each fish, Richard has to give up 2/1 fish (or 2), Tommy has to give up 1.5/4

fish (or 0.375); hence, Tommy has comparative advantage in producing fishes.

• Question 4: c
Hints: if they agree to trade, then Richard and Tommy can produce (in 8 hours)

Outputs per each hour of work Coconuts Fish

Richard 2 * 8 = 16 1*8=8
Tommy 1.5 * 8 = 12 4 * 8 = 32
Total 28 40

• Question 5: d
Hints: A reduction in the price of CDs would lead to a shift in demand curve (rightward).

That is, at a given level of price, the quantity of CDs is demanded more.

• Question 6: c
Hints: Graphically, the market demand curve is horizontal summation of individual

demand curve.

• Question 7: c
Hints: Horizontally summing both equations gives the right answer.

• Question 8: a
Hints: P/Q is 20/20 and 1/slope is 1/-4. Thus 1 times 1/-4 = -0.25.

• Question 9: a
Hints: Since you are below the midpoint of the demand curve, a will be true.

• Question 10: b
Hints: Price elasticity of demand is a measure of the change in the quantity demanded

or purchased of a product in relation to its price change. Expressed mathematically, it

is:

%∆ (𝑸𝑸𝑸𝑸𝑸𝑸𝑸𝑸𝑸𝑸𝑸𝑸𝑸𝑸𝑸𝑸 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫)
𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷 𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆 𝒐𝒐𝒐𝒐 𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅 =
%∆ (𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷)
If the slope of a demand curve for good X is constant, then the price elasticity of the

good decreases as the price fall.

• Question 11: d
Hints: If the PPF is a STRAIGHT LINE, then the slope is CONSTANT. This means the

opportunity cost is also CONSTANT. In real life, the PPF will NOT be linear; it will be

a downward sloping curve because of the law of diminishing marginal returns.

The slope of the PPF represents the opportunity cost of moving from one combination of

goods to another. The slope will always be NEGATIVE, because there is a tradeoff

between the two goods, demonstrating the principles of scarcity and opportunity cost.

• Question 12: d
Hints: In economics, market failure is a situation in which the allocation of goods and

services by a free market is not efficient, often leading to a net social welfare loss. Hence,

d is the correct answer.

• Question 13: a
Hints: The opportunity cost is the value (not a benefit) of the choice of a best alternative

cost while making a decision. In other words, opportunity costs refer to the value of the

next-best alternative use of that resource given limited resources.

If you have a choice of consuming (i) one candy bar or (ii) two apples or (iii) three

oranges, the opportunity cost of the candy bar is three oranges (since two apples option

is not available).

• Question 14: b
Hints:

Production possibilities for CNC Limited

Computers Cheese
250 0
200 500
150 900
100 1200
50 1400
0 1500

The opportunity cost to CNC Limited of increasing the production of computers from

150 to 200 is a scarify in production of cheese from 900 units to 500 units, or 900 - 500

= 400 units.

• Question 15: d
Hints: To understand the law of increasing opportunity costs, let's first define

opportunity costs. Opportunity cost is the cost of what you are giving up to do what you

are currently doing. If you can either go to work or go to the beach, and you choose to
work, the opportunity cost of working is the value you would have gotten had you gone

to the beach.

The law is best explained along with a graphical representation of the production

possibility frontier, also known as the PPF. The PPF is a graph showing all

combinations of two goods that can be produced given the available resources. The law

of increasing opportunity costs states that as you increase production of one good, the

opportunity cost to produce an additional good will increase.

• Question 16: d
Hints: These factors could shift the demand curve for beef: expectation in changing price

of beef in the future, changing prices of pork, income level and change in tastes.

However, changing in the price of beef will make the demand for beef moving along the

demand curve (but not shift).

• Question 17: d
Hints: The demand for a good tends to be more elastic – a greater availability of close

substitutes (since customers have more choices, it leads them to switch to other brands

if the price of one good increases). The narrower the definition of the markets tend to be

more elastic because it is easier to find substitutes for narrow definitions (for example,

vanilla ice cream has an elastic demand because it can easily be replaced by different

flavors by fro-yo). Demand is generally inelastic in the short run because people find it

difficult to change their habits and preferences in a short period in response to any
change in prices. However, in long run, it is comparatively easier for consumers to go

for other alternatives, shift to substitutes, if the price of a given commodity rises. Hence,

d is the correct answer.

• Question 18: b
Hints: The relationship between elasticity of demand and a firm's total revenue is an

important one. When demand is inelastic – a rise in price leads to a rise in total revenue.

When demand is elastic – a fall in price leads to a rise in total revenue .

• Question 19: a
Hints: Normal goods are ones whose demand rises when incomes or the economy grow.

People spend a greater proportion of their income on luxury goods as their income rises,

whereas people spend an equal or lesser proportion of their income on normal and

inferior goods as their income increases. People with lower incomes spend a greater

proportion of their income on normal and inferior goods than people with higher

incomes, on average. Hence, for Richard ouzo is normal good since quantity consumed

increases when Richard’s income rises.

• Question 20: d
Hints: A substitute good is when the price increases for one good, the demand for the

substitute will increase. Complementary goods are items that go together, so if the price
of one increases the demand for the other will decrease. Hence, in this case, the

information is not enough to determine (price is constant & quantity is fluctuated).

• Question 21: b
Hints: A study estimated alcohol elasticity at -1.8 which is more elastic than anticipated.

The income effect was considered to be the likely explanation.

• Question 22: d
Hints: The first three options are either a small part of one's budget or are not easily

substituted for in the market basket.

• Question 23: d
Hints: Consumer surplus is the upper triangle which is (4 x 15)/2 = 30.

• Question 24: a
Hints: The consumer surplus triangle has a vertical distance of 50 and a horizontal

distance of 25 for an area of 625.

• Question 25: d
Hints: The shine on the shoes was a low cost way of finding out whether the lawyer was

beholden to his superiors in the Army.

• Question 26: b
Hints: The key here is the short run requirement. Demand instantly shifted right but the

technology of intelligence supply could not change as quickly. In the long run the correct

answer should be (d) as new methods of intelligence are developed. In both cases the

quantity of intelligence increased beyond Q1.

• Question 27: b
Hints: By summing the ten firms supply horizontally the market supply is MC = Q or P

= Q since the profit maximizing position is P = MC. By setting the market supply equal

to market demand the answer is letter b.

• Question 28: d
Hints: From the supply curve we find that output of 8 brings a price of 8. Thus producer

surplus is 8 times 8 divided by 2.

• Question 29: a
Hints: Since this firm has no fixed cost its variable costs are above the price so it could

save the loss by shutting down which would make costs and revenue zero.

• Question 30: c
Hints: There is nothing in the scenario that leads to a cost increase, but the economic

profits will attract new entrants which will increase supply and bring down price in the

long-run.
 • Question 31: a
Hints: Since equilibrium quantity is 40 and price is 80, the producer surplus will be 80

times 40 divided by 2 to get the area above the MC curve and the price.

• Question 32: a
Hints: Answers b, c, and d are simply not true while a is definitely true. Thus, economic

profit is generally smaller than accounting profit.

• Question 33: b
Hints: By summing the ten firms supply horizontally the market supply is MC = 0.1Q.

Demand is P = 100 – 0.1Q. Equating the two gives the answer b.

• Question 34: b
Hints: The economic profits will attract new entrants, but no exiting firm or new entrant

will become larger than the firm size at the bottom of the LATC where existing forms

already are. Therefore, the new demand will be provided by more entrants but no

increase in size.

• Question 35: b
Hints: Since all opportunity costs are covered in the ATC curve, the firm is making

normal profit at both 0a or 0d.

 • Question 36: c
Hints: Since the shutdown point is where the AVC and the MC intersect, and since we

know that the AVC intersects MC to the left of where the ATC and the MC intersect we

know that the shutdown point is to the left of output 0b.

• Question 37: b
Hints: As market price rises, the firm moves up its MC curve to the point where MC = P

which means higher output. New firms cannot enter in the short-run and ATC rises as

the firm moves up its MC curve.

• Question 38: a
Hints: In the short-run profits can be obtained as others try to catch up with the

innovation.

• Question 39: c
Hints: Since all firms respond along their MC function the summation of these outputs

will be the total market supply.

• Question 40: c
Hints: Because equilibrium price is 30 and equilibrium quantity is 10, consumer surplus

is 100 and producer surplus is 150 so the total is 250. It is the area under the demand

curve and above the supply curve up to the point of equilibrium.

 • Question 41: d
Hints: the MR is the demand curve with twice the slope.

• Question 42: c
Hints: Only c is a true statement since revenue rises as price falls to the midpoint of the

demand curve after which revenue falls for further price reductions. Letter a is wrong

because the market demand for a competitive industry is downward sloping. Letter c is

wrong because market structure does not impact technological cost conditions. Finally,

monopoly has no specific supply curve while competitive firms have a supply curve equal

to their marginal cost curve above the shutdown point.

• Question 43: a
Hints: Only a is relevant to the issue. Letter b is something that must not be true.

• Question 44: d
Hints: Letters a through c create monopolies, but not natural monopolies.

• Question 45: d
Hints: Perfectly competitive firms are price takers and cannot change the market price

of their commodity if they want to stay in business.

• Question 46: c
Hints: This is the same principle that applies to perfect competition since to not cover

the variable costs is to be worse off operating than to shut down.

• Question 47: b
Hints: The marginal revenue curves must be summed horizontally so they must be

known. Services cannot be resold from the low priced market to the high priced market

as easily as a product.

• Question 48: d
Hints: Since marginal cost is everywhere below average total cost it is impossible to

produce at a profit and price at marginal cost where social efficiency would be. Only a

subsidy can make this industry efficient

• Question 49: c
Hint: The marginal revenue function intersects the marginal cost function at

approximately 70 and the demand curve shows that at that output the market will bear a

price of approximately 60.

• Question 50: b
Hint: The output will be 40 and the price 300 for the firm. If the firm operated at the MC

= demand competitive point, output would be 80 and price 100. That leaves the
deadweight triangle with a quantity of 40 wide and 200 high. This 8,000 divided by 2 =

4,000.

1 mark for each correct answer

END OF EXAMINATION
The Best Way to Study for your exams One to Three Weeks in Advance

Congratulations on starting to study early! Here's what to do:

1. Ask your instructor for an exam outline and what to expect on the exam.

2. Create an overview. Review your notes and any assignments you had.

3. Review the course's main ideas.

4. For each big idea, review its sub-topics and supporting details.

5. Practice. Use old exams to get a feel for the style of questions you might be asked.

Hints

 Be realistic. No one can study for 8 hours a day.

 Make sure you get plenty of food, sleep, and relaxation.

 Try to study in the same place at the same time every day.

 At the beginning of each study period review the last thing you studied for 10 minutes.

 Rewrite your notes. It can help you retain information.

 Read your notes out loud.

 If you don't complete a particular task, don't worry just carry it over to your next session.

 Don't simply memorize facts. Ask yourself broad open-ended questions about the material

that's been covered.

The Night Before the Exam

1. Sleep!

2. Try to stick to review. Don't try to learn anything new.

3. Picture yourself succeeding. One of the key elements for many world-class performers is

visualization.
The Day of the Exam

1. Eat. Don't skip the meal before your exam because not eating can result in tiredness and

poor concentration.

1. Arrive just a few minutes before your exam to avoid the usual wide-spread and contagious

panic

During the Exam

1. Use a cheat sheet even if you're not allowed to bring one into the exam. Make a cheat sheet

of the material you are certain will help. Take it to the exam; throw it out before you sit

down, then recopy it from memory, somewhere on the exam booklet, as soon as you can.

2. Read all of the questions (except multiple choice) before beginning and write notes on the

paper for anything important that occurs to you as you read.

3. If you're having a problem with one question move on and return to the problem question

if you have time left at the end.

4. Watch the clock.

The Best Way to Study If Your Exam Is Tomorrow

While no one really recommends cramming, sometimes that's what you have to do. So here are

some hints to get you through it:

1. Pick the most important subjects from your material.

2. Look over your lecture notes, or someone else's if you don't have any, and see what the

lecturer focused on. Concentrate your cramming on these broad areas. You don't have time

to learn specifics.
3. The key to cramming is memorization, so it only works for "knowledge" questions. Focus

on material that can be memorized.

4. Spend 25% of your time cramming and 75% drilling yourself. Recite and repeat the

information.

5. Relax: being upset at yourself for not studying earlier won't help and may hurt your

performance in the class

6. Remember how you felt while studying and while writing the exam and plan to study

earlier next time!