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Chapter 01: The Core Principles of Economics

Multiple Choice

1. The cost-benefit principle states that _____ are the incentives that shape decisions.
a. costs and benefits
b. incomes
c. opportunity costs
d. framing effects
ANSWER: a

2. The cost-benefit principle states that a decision should be pursued only if the
a. benefits are greater than the costs.
b. costs are greater than the benefits.
c. benefits are positive.
d. costs are negative.
ANSWER: a

3. The cost-benefit principle states that the full set of _____ should be evaluated when making any choice.
a. opportunity costs
b. economic surpluses
c. costs and benefits
d. interdependencies
ANSWER: c

4. Economists convert costs and benefits into money equivalents by evaluating an individual's
a. sunk costs.
b. marginal benefits.
c. opportunity costs.
d. willingness to pay.
ANSWER: d

5. Estimating willingness to pay quantifies _____ costs or benefits associated with a choice.
a. financial
b. nonfinancial
c. opportunity
d. marginal
ANSWER: b

6. _____ is estimated by asking: "What is the _____ I am willing to pay to get this benefit (or avoid that cost)?"
a. Willingness to pay; least
b. Willingness to pay; most
c. Opportunity cost; least
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d. Opportunity cost; most

ANSWER: b

7. Economists use money equivalents to compare costs and benefits because money is
a. critical to keeping an economy working smoothly.
b. what is used to measure opportunity costs.
c. a common measuring stick.
d. what economic agents are trying to maximize.
ANSWER: c

8. The key to using the cost-benefit principle is to think about _____ aspects of a decision.
a. both financial and nonfinancial
b. only financial
c. only nonfinancial
d. neither financial nor nonfinancial
ANSWER: a

9. The cost-benefit principle evaluates _____ costs and benefits, and willingness-to-pay considerations evaluate
_____ costs and benefits.
a. both monetary and nonmonetary; only nonmonetary
b. only monetary; both monetary and nonmonetary
c. only nonmonetary; only monetary
d. both monetary and nonmonetary; only monetary
ANSWER: a

10. Nerida Kyle could either commute to work via Uber or purchase a new car. The average cost of her one-way
Uber trip is $15. Nerida works five days a week for 50 weeks a year. Based solely on avoiding the cost of an
Uber, Nerida should purchase a car if the cost of the car is _____ than _____ per week.
a. less; $150
b. less; $75
c. greater; $150
d. greater; $75
ANSWER: a

11. Nerida Kyle can either commute to work using a bus or purchase a new car. The bus fare each way is $2.
Nerida works five days a week for 50 weeks a year. Based solely on the benefit of avoiding the cost of her bus
tickets, Nerida should purchase a car if the cost of the car is _____ than _____ per week.
a. less; $20
b. less; $10
c. greater; $20
d. greater; $10
ANSWER: a
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12. Nerida Kyle is thinking of buying a new car to avoid taking the bus to work. Each of the following is a cost
she should consider when using the cost-benefit principle to evaluate this decision EXCEPT
a. parking.
b. car insurance.
c. bus fare.
d. repairs.
ANSWER: c

13. Nerida Kyle is thinking of buying a car to avoid taking Lyft to work. She is using the cost-benefit principle
to evaluate this decision and is calculating the costs and benefits to owning the car over the next year. She's
gathered the following information to help her make her decision:

• The car costs $15,000 to purchase, but she can resell it after a year of use for $13,500.
• She thinks gas will cost her about $1,200 for the year.
• The annual insurance premium for her car is $800.
• Maintenance and repairs will cost about $300 for the year.
• Using Lyft to get to work would cost her $4,000 for the year.

The cost of the car for the year is:

a. $1,500.
b. $4,000.
c. $3,800.
d. $7,800.
ANSWER: c

14. The cost-benefit principle will lead you to make unselfish decisions if you
a. account for unselfish motivations.
b. maximize monetary costs and benefits.
c. pursue only decisions for which the benefits outweigh the costs.
d. maximize economic surplus.
ANSWER: a

15. How is the economic surplus generated by a decision calculated?

a. It is the total benefits minus total costs arising from the decision.
b. It is the total benefits plus total costs arising from the decision.
c. It is the sum of benefits arising from the decision.
d. It is the sum of costs arising from the decision.
ANSWER: a

16. _____ is a measure of how much your decision has _____ your well-being.
a. Willingness to pay; improved
b. Willingness to pay; reduced
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c. Economic surplus; increased

d. Economic surplus; decreased
ANSWER: c

17. Kevin Williamson goes to a local coffee shop and orders a medium-sized latte. His willingness to pay for
that latte is $6. The price of the latte is $2. The cost to the coffee shop to produce the latte is $1. How much
economic surplus does Kevin gain when he purchases the latte?
a. $6
b. $4
c. $2
d. $1
ANSWER: b

18. Kevin Williamson goes to a local coffee shop and orders a medium-sized latte. His willingness to pay for
that latte is $6. The price of the latte is $2. The cost to the coffee shop to produce the latte is $1. How much
economic surplus does the coffee shop receive when Kevin purchases the latte?
a. $6
b. $4
c. $2
d. $1
ANSWER: d

19. Amanda Mendez goes to a local café and orders a sandwich. Her willingness to pay for that sandwich is
$10. The price of the sandwich is $4. The cost to the cafe to produce that sandwich is $1. How much economic
surplus does Amanda receive when she purchases the sandwich?
a. $10
b. $6
c. $4
d. $3
ANSWER: b

20. Amanda Mendez goes to a local cafe and orders a sandwich. Her willingness to pay for that sandwich is
$10. The price of the sandwich is $4. The cost to the cafe to produce that sandwich is $1. How much economic
surplus does the café receive when Amanda purchases the sandwich?
a. $6
b. $4
c. $3
d. $1
ANSWER: c

21. Gary Parker is willing to pay $700 for a new iPad. Apple (the producer of iPads) is selling a new iPad for
$600. It costs Apple $400 to produce this iPad. How much economic surplus does Gary receive if he purchases
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this iPad?
a. $700
b. $600
c. $200
d. $100
ANSWER: d

22. Gary Parker is willing to pay $700 for a new iPad. Apple (the producer of iPads) is selling a new iPad for
$600. It costs Apple $400 to produce this iPad. How much economic surplus does Apple receive if Gary
purchases this iPad?
a. $700
b. $600
c. $200
d. $100
ANSWER: c

23. In a voluntary economic transaction between a buyer and a seller, _____ can earn economic surplus from
the transaction.
a. only the buyer
b. only the seller
c. both the buyer and the seller
d. neither the buyer nor the seller
ANSWER: c

24. Juan McDonald is willing to pay $600 for a new iPad. Apple (the producer of iPads) is selling a new iPad
for $700. It costs Apple $400 to produce this iPad. A voluntary economic transaction between Juan and Apple
_____ occur because ____ would be better off due to the transaction.
a. will; neither Juan nor Apple
b. will; both Juan and Apple
c. will not; only Juan
d. will not; only Apple
ANSWER: d

25. Juan McDonald is willing to pay $800 for a new iPad. Apple (the producer of iPads) is selling a new iPad
for $700. It costs Apple $400 to produce this iPad. A voluntary economic transaction between Juan and Apple
_____ occur because ____ would be better off due to the transaction.
a. will; neither Juan nor Apple
b. will; both Juan and Apple
c. will not; only Juan
d. will not; only Apple
ANSWER: b

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26. Juan McDonald is willing to pay $650 for a new iPad. He offers to pay $600 for an iPad at the Apple store.
It costs Apple $700 to produce this iPad. A voluntary economic transaction between Juan and Apple _____
occur because ____ would be better off due to the transaction.
a. will; neither Juan nor Apple
b. will; both Juan and Apple
c. will not; only Juan
d. will not; only Apple
ANSWER: c

27. Juan McDonald is willing to pay $900 for a new iPad. He offers to pay $800 for an iPad at the Apple store.
It costs Apple $700 to produce this iPad. A voluntary economic transaction between Juan and Apple _____
occur because ____ would be better off due to the transaction.
a. will; neither Juan nor Apple
b. will; both Juan and Apple
c. will not; only Juan
d. will not; only Apple
ANSWER: b

28. Ivan has inherited his grandmother's 1963 Chevrolet Corvette, which he values at $50,000. He decides that
he might be willing to sell it, so he posts it on Craigslist for $55,000. Samantha is interested and willing to pay
up to $72,000 for such a car. A voluntary economic exchange _____ between Ivan and Samantha because
_____ positive economic surplus from the transaction.
a. occurs; both Ivan and Samantha receive
b. occurs; only Samantha receives
c. does not occur; only Ivan receives
d. does not occur; neither Ivan nor Samantha receives
ANSWER: a

29. Ivan has inherited his grandmother's 1963 Chevrolet Corvette, which he values at $60,000. Samantha is
interested in buying the car and offers Ivan $55,000 for the car. Samantha is willing to pay up to $60,000 for
such a car. A voluntary economic exchange _____ between Ivan and Samantha because _____ positive
economic surplus from the transaction.
a. occurs; both Ivan and Samantha receive
b. occurs; only Ivan receives
c. does not occur; only Samantha receives
d. does not occur; neither Ivan nor Samantha receives
ANSWER: c

30. Ivan has inherited his grandmother's 1963 Chevrolet Corvette, which he values at $60,000. Samantha is
interested in buying such a car and is willing to pay up to $55,000. Ivan hears Samantha is looking for this
particular car and offers to sell it to her for $70,000. A voluntary economic exchange _____ between Ivan and
Samantha because _____ positive economic surplus from the transaction.
a. occurs; both Ivan and Samantha receive
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b. occurs; only Samantha receives

c. does not occur; only Ivan receives
d. does not occur; neither Ivan nor Samantha receives
ANSWER: c

31. According to the cost-benefit principle, framing effects or how a choice is described, should
a. affect a decision.
b. not affect a decision.
c. be considered costs.
d. be considered benefits.
ANSWER: b

32. You are considering whether you should go out to dinner at a restaurant with your friend. The meal is
expected to cost you $50, you typically leave a 20% tip, and a round-trip Uber ride will cost you $15. You value
the restaurant meal at $30 and the time spent with your friend at $50. You should ____ to dinner with your
friend because the benefit of doing so is _____ than the cost.
a. go; greater
b. go; less
c. not go; greater
d. not go; less
ANSWER: a

33. You are thinking of going out to dinner at a restaurant with your friends. The meal is expected to cost you
$50, you typically leave a 20% tip, and a round-trip Uber ride will cost you $20. You value the restaurant meal
at $20, and the time spent with your friends at $30. If you did not go out to the restaurant, you would eat at
home using groceries that cost you $10. You should ____ to dinner with your friends because the benefit of
doing so is _____ than the cost.
a. go; greater
b. go; less
c. not go; greater
d. not go; less
ANSWER: d

34. It is a rainy day, and you are considering taking an Uber one mile to meet some friends. You have decided
you are willing to pay $20 to avoid getting wet from the rain. The trip would normally cost you $8, but because
of the weather the surcharge is twice the regular cost. You should _____ because the benefit to you of taking the
Uber is _____ than the cost.
a. walk; less
b. walk; more
c. take an Uber; less
d. take an Uber; more
ANSWER: d
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35. It is a rainy day, and you are considering taking an Uber one mile to meet some friends. You have decided
you are willing to pay $20 to avoid getting wet from the rain. The trip would normally cost you $8, but due to
the weather the surcharge is triple the regular cost. You should _____ because the benefit to you of taking the
Uber is _____ than the cost.
a. walk; less
b. walk; more
c. take an Uber; less
d. take an Uber; more
ANSWER: a

36. Which principle tells you that the true cost of something is the next best alternative you have to give up to
get it?
a. The cost-benefit principle.
b. The opportunity cost principle.
c. The marginal principle.
d. The interdependence principle.
ANSWER: b

37. The opportunity cost principle states that the true cost of something is the
a. next best alternative you have to give up to get it.
b. least desired alternative you have to give up to get it.
c. economic surplus you give up to get it.
d. economic surplus you receive from getting it.
ANSWER: a

38. Decisions should reflect the _____ costs, rather than just the _____ costs.
a. financial; marginal
b. opportunity; nonfinancial
c. opportunity; financial
d. nonfinancial; financial
ANSWER: c

39. Opportunity cost arises from the fundamental economic problem of

a. interdependence.
b. marginal costs.
c. unlimited resources.
d. scarcity.
ANSWER: d

40. The opportunity costs of attending college includes the

a. cost of tuition.
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b. cost of room and board.

c. cost of clothes to wear at school.
d. time spent studying.
ANSWER: a

41. The opportunity costs of attending college include the:

a. potential income that could be earned working.
b. cost of room and board.
c. cost of clothes to wear at school.
d. effort and hard work.
ANSWER: a

42. The opportunity costs of a decision may include each of the following types of costs EXCEPT
a. out-of-pocket financial costs.
b. forgone financial costs.
c. sunk costs.
d. nonfinancial costs.
ANSWER: c

43. Jonathan Mendez is deciding whether to study for his economics exam at a café or go to a concert with
friends tonight. The cost of dinner at the fancy restaurant on the way to the concert is ____ in the calculation of
his opportunity cost and represents a _____ cost.
a. included; financial
b. included; nonfinancial
c. not included; financial
d. not included; sunk
ANSWER: a

44. Jonathan Mendez is deciding whether to study for his economics exam at a café down the street or go to a
concert a few cities over. The time spent commuting to the concert is ____ in his opportunity cost calculations
and represents a _____ cost.
a. included; financial
b. included; nonfinancial
c. not included; financial
d. not included; sunk
ANSWER: b

45. Jonathan Mendez is deciding whether to study for his economics exam at a café or go to a concert with
friends tonight. The cost of tuition for his economics course is _____ in his opportunity cost calculations for this
decision and represents a _____ cost.
a. included; financial
b. included; nonfinancial
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c. not included; financial

d. not included; sunk
ANSWER: c

46. It is a beautiful afternoon, and you are considering taking a leisurely stroll through the park. Your
alternatives to walking are streaming a movie that you value at $5, taking a nap that you value at $7, or reading
a new book that you value at $12. What is the opportunity cost to you of taking the stroll through the park?
a. $0
b. $5
c. $7
d. $12
ANSWER: d

47. Sunk costs are costs that are incurred

a. regardless of which decision is made.
b. if a particular decision is made.
c. if a particular decision is not made.
d. only for some decisions.
ANSWER: a

48. Sunk costs should ____ be considered as part of the opportunity costs of a decision.
a. always
b. never
c. sometimes
d. rarely
ANSWER: b

49. Sunk costs are costs that

a. are potential costs associated with a particular decision.
b. are part of the opportunity costs of a decision.
c. are incurred in the past and cannot be reversed.
d. should be considered in any decision.
ANSWER: c

50. Jonathan Mendez is deciding whether to study for his economics exam at a café or go to a concert with
friends tonight. The cost of the concert ticket that he purchased yesterday is ____ in his opportunity cost and
represents a _____ cost.
a. included; financial
b. included; nonfinancial
c. not included; financial
d. not included; sunk

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ANSWER: d

51. Rose Riley's parents have booked and paid for a family trip to Aspen, Colorado, during her spring break.
Rose's friends recently decided to drive to Destin, Florida, for spring break. Rose needs to decide whether to
join her parents in Aspen or drive to the beach with her friends. The opportunity costs of joining her friends on
the trip to Destin include each of the following EXCEPT
a. her parents' anger if she skips the family trip to Aspen.
b. her contribution to gas money for the drive to Destin.
c. the ski lift ticket her parents have already purchased for her.
d. the hotel costs she will split with her friends in Destin.
ANSWER: c

52. Rose Riley's parents have booked a family trip to Aspen, Colorado, during her spring break. They have
agreed to pay for everything except her plane ticket. Rose's friends recently decided to drive to Destin, Florida,
for spring break. Rose must now decide whether to join her parents in Aspen or drive to the beach with her
friends. The opportunity costs of joining her parents in Aspen include each of the following EXCEPT
a. the cost of her plane ticket to Aspen.
b. memories she will miss with her friends.
c. the stress of traveling via plane and navigating airports.
d. the nonrefundable deposit her friends paid for the beach house in Destin.
ANSWER: d

53. Carolyn Bates is a junior in college studying economics. She has created a new software application that
applies the four principles of economic decision making to any potential decision that a user faces. She is
considering leaving school after this academic year to pursue further development of her app. Carolyn should
consider all of the following costs when calculating the opportunity costs of leaving college EXCEPT the
a. potential future job security from her college degree.
b. 90 credit hours she has already completed for her degree.
c. potential memories from her senior year of college.
d. skills she may gain from her final year of economics courses.
ANSWER: b

54. Carolyn Bates is a junior in college studying economics. She has created a new software application that
applies the four principles of economic decision making to any potential decision that a user faces. She is
considering leaving school after this academic year to pursue further development of her app. Carolyn should
ignore all of the following costs when calculating the opportunity costs of leaving college EXCEPT the
a. time she will spend working on the app instead of studying.
b. 90 credit hours she has already completed for her degree.
c. tuition costs she has already paid to her college.
d. skills she may gain from her final year of economics courses.
ANSWER: d

55. Carolyn Bates is a junior in college studying economics. She has created a new software application that
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applies the four principles of economic decision making to any potential decision that a user faces. She is
considering leaving school after this academic year to pursue further development of her app. Carolyn should
consider all of the following costs when calculating the opportunity costs of staying in college EXCEPT the
a. time she will spend studying instead of working on the app.
b. potential forgone profits from selling her app.
c. potential fame that could come from creating a useful app.
d. cost of supplies and the technology fees she paid during the first three years of college.
ANSWER: d

56. Alan Patel is a college student living alone in a campus apartment. He finished cooking dinner when his
friends text him to join them at the dining hall on campus for dinner. He now has to decide whether to eat the
dinner he prepared or walk to campus to meet his friends at the dining hall. Alan should consider all the
following costs when making this decision EXCEPT the
a. time he spent cooking the dinner.
b. time it will take to walk, meet his friends, and walk back.
c. amount of money he will spend at the dining hall.
d. value he places on eating dinner with his friends.
ANSWER: a

57. Alan Patel is a college student living alone in a campus apartment. He finished cooking dinner when his
friends text him to join them at the dining hall on campus for dinner. He now has to decide whether to eat the
dinner he prepared or walk to campus to meet his friends at the dining hall. Alan should consider all the
following costs when making this decision EXCEPT the
a. time it will take to go meet his friends and walk back.
b. amount of money he will spend at the dining hall.
c. money spent on the groceries he used to cook dinner.
d. value he places on not eating dinner alone.
ANSWER: c

58. You are thinking of starting a tutoring service. You already have a part-time job on campus that pays $10
per hour. You think you can tutor fellow students for five hours each Saturday at $25 per hour. If you were not
tutoring, you could work another five hours at your campus job. How much economic surplus will you generate
each week if you start tutoring?
a. $125
b. $75
c. $65
d. $50
ANSWER: b

59. You are thinking of starting a tutoring service. You already have a part-time job on campus that pays $20
per hour. You think you can tutor fellow students for five hours each Saturday at $25 per hour, and you have
already printed $10 worth of flyers to hang on campus for advertising. If you were not tutoring, you could work
another five hours at your campus job. How much economic surplus will you generate each week if you start
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tutoring?
a. $125
b. $100
c. $25
d. $15
ANSWER: c

60. You have paid $100 for student season tickets to the football games at your university. It is halfway through
the season, and the team has not won any games. You are considering whether you will attend any future games
this season. All of the following are costs or benefits you should consider when making this decision EXCEPT
the
a. cost of a hotdog and soda you will inevitably buy at a future game.
b. time spent at the game rather than studying.
c. frustration experienced from watching the team lose in previous games.
d. $5 you will earn per game by selling the remaining tickets.
ANSWER: c

61. You have paid $100 for student season tickets to the football games at your university. It is halfway through
the season, and the team has not won any games. You are considering whether you will attend any future games
this season. All of the following are costs or benefits you should consider when making this decision EXCEPT
the
a. $100 you spent on the season tickets.
b. time spent to go to the game instead of studying.
c. satisfaction you will get if your team wins a game.
d. $5 you can make per game by selling your remaining tickets.
ANSWER: a

62. The __________ suggests, decisions about quantities are best made incrementally.
a. cost-benefit principle
b. opportunity cost principle
c. marginal principle
d. interdependence principle
ANSWER: c

63. The marginal principle says that decisions about quantities are best made
a. incrementally.
b. arbitrarily.
c. all at once.
d. in total.
ANSWER: a

64. The marginal benefit from an additional worker is

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a. the additional benefit from hiring one more worker.

b. the total benefit from all workers hired.
c. always equal to the benefit from the first worker hired.
d. always equal to the cost of hiring the additional worker.
ANSWER: a

65. The marginal cost of an additional worker is

a. always equal to the cost from the first worker hired.
b. always equal to the benefit of hiring the additional worker.
c. the total cost of all workers hired.
d. the additional cost of hiring one more worker.
ANSWER: d

66. Joshua Murphy is planning on studying late into the night for his economics exam. How many cups of
coffee should he buy tonight? Joshua should keep buying coffee throughout the evening until the marginal:
a. benefit of purchasing one more coffee equals the marginal cost.
b. benefit of purchasing one more coffee is less than the marginal cost.
c. benefit of purchasing one more coffee is positive.
d. cost of purchasing one more coffee is positive.
ANSWER: a

67. Joshua Murphy is planning on studying late into the night for his economics exam. He is contemplating how
many coffees to buy tonight. Joshua should not buy an additional coffee during the evening if the marginal
a. benefit of purchasing one more coffee exceeds the marginal cost.
b. benefit of purchasing one more coffee is less than the marginal cost.
c. benefit of purchasing one more coffee is positive.
d. cost of purchasing one more coffee is positive.
ANSWER: b

68. Kathleen Alvarado is binge-watching her favorite show on Netflix. She is attempting to decide how many
more episodes to watch. Kathleen should continue watching episodes as long as the marginal:
a. benefit of watching another episode exceeds the marginal cost.
b. benefit of watching another episode is less than the marginal cost.
c. benefit of watching another episode is positive.
d. cost of watching another episode is positive.
ANSWER: a

69. Kathleen Alvarado is binge-watching her favorite show on Netflix. She is trying to decide how many more
episodes to watch. Kathleen should continue watching episodes unless the marginal
a. benefit of watching another episode exceeds the marginal cost.
b. benefit of watching another episode is equal to the marginal cost.

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c. benefit of watching another episode is positive.

d. cost of watching another episode is positive.
ANSWER: b

70. According to the marginal principle, keep increasing quantity until the marginal benefit of an additional
item is _____ the marginal cost of an additional item.
a. greater than
b. equal to
c. less than
d. greater than or less than
ANSWER: b

71. When evaluating how much to produce, increase the quantity produced if the marginal benefit of an
additional item is _____ the marginal cost of the additional item.
a. greater than or equal to
b. equal to
c. less than or equal to
d. less than
ANSWER: a

72. The marginal principle breaks quantity decisions into iterative decisions that use the
a. cost-benefit principle.
b. opportunity cost principle.
c. interdependence principle.
d. sunk cost evaluation.
ANSWER: a

73. The rational rule summarizes the marginal principle. It says that if something is worth doing, keep doing it
until your marginal
a. benefits equal your marginal costs.
b. benefits exceed your marginal costs.
c. benefits are zero.
d. costs are less than your marginal benefits.
ANSWER: a

74. The rational rule suggests you should continue with an activity until your _____ benefit _____ your
marginal cost.
a. total; equals
b. total; exceeds
c. marginal; equals
d. marginal; is less than

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ANSWER: c

75. Ron is buying jeans online and has to decide how many to buy. He should buy an additional pair if the
a. marginal benefit of the next pair is less than the price of the jeans.
b. marginal benefit of the next pair is at least as high as the price of the jeans.
c. total benefit when purchasing one more pair is less than the total cost of the jeans.
d. total benefit when purchasing one more pair is at least as high as the total cost of the jeans.
ANSWER: b

76. Taryn is buying shirts online and has to decide how many shirts to buy. She should buy another shirt if the
a. marginal benefit of the next shirt is less than the price of the shirt.
b. marginal benefit of the next shirt is at least as high as the price of the shirt.
c. total benefit when purchasing one more shirt is less than the total cost of the shirts.
d. total benefit when purchasing one more shirt is at least as high as the total cost of the shirts.
ANSWER: b

77. Following the rational rule, the economic surplus is maximized when
a. total benefits equal total costs.
b. total benefits exceed total costs.
c. marginal benefits equal marginal costs.
d. marginal benefits exceed marginal costs.
ANSWER: c

78. To maximize economic surplus, keep increasing output as long as

a. total benefits equal total costs.
b. total benefits exceed total costs.
c. marginal benefits equal marginal costs.
d. marginal benefits exceed marginal costs.
ANSWER: d

79. When faced with a quantity decision, the economic surplus stops increasing when
a. total benefits equal to total costs.
b. total benefits exceed total costs.
c. marginal benefits equal marginal costs.
d. marginal benefits exceed marginal costs.
ANSWER: c

80. When faced with a quantity decision, the economic surplus is always maximized by following the
a. Rational Rule.
b. framing effect.
c. opportunity cost principle.
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d. interdependence principle.
ANSWER: a

81. The cost of your favorite coffee is $6.50 per cup at the coffee shop. The marginal cost of each cup you drink
is _____. The first cup of coffee you drink gives you a marginal benefit of $8. The marginal benefit from the
second cup is $6, $4 from the third, $2 from the fourth, and $0 from the fifth. You should drink _____ cups of
coffee.
a. $6.50; one
b. $0; five
c. $1; six
d. $6.50; five
ANSWER: a

82. The cost of your favorite coffee is $5 per cup at the coffee shop. The marginal cost of each cup you drink is
_____. The first cup of coffee you drink gives you a marginal benefit of $8. The marginal benefit from the
second cup is $6, $4 from the third, $2 from the fourth, and $0 from the fifth. You should drink _____ cups of
coffee.
a. $5; two
b. $0; three
c. $2; five
d. $5; three
ANSWER: a

83. Marie Johnston is a manager at an electronics store and has to decide how many workers to hire. If she hires
one worker, her revenue is $500 per day. If she hires another worker, she can make another $400 per day. The
marginal benefit of hiring another worker decreases by $100 with each additional hire. Assuming that workers
are paid $15 per hour and work eight hours, how many employees should Marie hire, and what will be the total
revenue of her store?
a. She will hire three workers and the revenue of the store will be $1,200.
b. She will hire four workers and the revenue of the store will be $1,400.
c. She will hire four workers and the revenue of the store will be $1,400.
d. She will hire six workers and the revenue of the store will be $1,500.
ANSWER: b

84. Marie Johnston is a manager at an electronics store, and she has to decide how many workers to hire. If she
hires one worker, her revenue is $400 per day. If she hires another worker, she can make another $350 per day.
The marginal benefit of hiring another worker decreases by $50 with each additional hire. Assuming that
workers are paid $20 per hour and work eight hours, how many employees should Marie hire, and what will be
the total revenue of her store?
a. She will hire four workers and the revenue of the store will be $1,300.
b. She will hire five workers and the revenue of the store will be $1,500.
c. She will hire six workers and the revenue of the store will be $1,650.
d. She will hire seven workers and the revenue of the store will be $1,750.
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ANSWER: b

85. Marie Johnston is a manager at an electronics store and has to decide how many workers to hire. If she hires
one worker, her revenue is $800 per day. If she hires another worker, she can make another $600 per day. The
marginal benefit of hiring another worker decreases by $200 with each additional hire. Assuming that workers
are paid $20 per hour and work eight hours, how many employees should Marie hire, and what will be the total
revenue of her store?
a. She will hire two workers and the revenue of the store will be $1,400.
b. She will hire three workers and the revenue of the store will be $1,800.
c. She will hire four workers and the revenue of the store will be $2,000.
d. She will hire five workers and the revenue of the store will be $2,000.
ANSWER: c

86. Marie Johnston is a manager at an electronics store and has to decide how many workers to hire. If she hires
one worker, her revenue is $800 per day. If she hires another worker, she can make another $600 per day. The
marginal benefit of hiring another worker decreases by $200 with each additional hire. Assuming that workers
are paid $20 per hour and work eight hours, how many employees should Marie hire, and what will be her total
cost for labor?
a. She will hire two workers at a total cost of $160.
b. She will hire three workers at a total cost of $480.
c. She will hire four workers at a total cost of $640.
d. She will hire five workers at a total cost of $2000.
ANSWER: c

87. Charles McCoy is a manager at a coffee shop, and he has to decide how many workers to hire. One worker
can make 25 drinks that sell for $5 on average in one hour. A second worker can make another 20 drinks in one
hour. The marginal benefit of each additional worker decreases by five drinks, with each additional hire. Given
that workers are paid $15 per hour and have eight-hour shifts, how many employees should Charles hire for
each hour?
a. Three
b. Four
c. Five
d. Six
ANSWER: c

88. Charles McCoy is a manager at a coffee shop and is making hiring decisions. With one worker, he can make
15 drinks that sell for $3 on average in a single hour. With a second worker, he can make an additional 12
drinks in a single hour. The marginal benefit of each additional worker decreases by three drinks with each
additional hire. Assuming that workers are paid $12 per hour and work eight hours, how many employees
should Charles hire for each hour?
a. Three
b. Four
c. Five
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d. Six
ANSWER: b

89. Charles McCoy is a manager at a coffee shop, and he has to decide how many workers to hire. One worker
can make 20 drinks that sell for $4 on average in one hour. A second worker can make another 16 drinks in one
hour. The marginal benefit of each additional worker decreases by four drinks, with each additional hire. Given
that workers are paid $15 per hour and have eight-hour shifts, how many employees should Charles hire for
each hour?
a. Four
b. Five
c. Six
d. Seven
ANSWER: b

90. Sarah Sandoval is a coffee farmer trying to decide how many tons of coffee to produce. She can sell each
ton of coffee for $2,500. The cost of producing the first ton of coffee is $500, for the second ton, it's $1000. For
each additional ton of coffee produced, the marginal cost increases by $500. How many tons of coffee should
Sarah produce, and what is the total cost of her coffee production?
a. She will produce four tons at a total cost of $5,000.
b. She will produce five tons at a total cost of $7,500.
c. She will produce six tons at a total cost of $10,500.
d. She will produce seven tons at a total cost of $14,000.
ANSWER: b

91. Sarah Sandoval is a coffee farmer trying to decide how many tons of coffee to produce. She can sell each
ton of coffee for $3,000. The cost of producing her first ton of coffee is $600, and the second ton costs $1,200.
Each additional ton of coffee costs $600 more to produce. How many tons of coffee should Sarah produce, and
what is the total cost of her coffee production?
a. She will produce three tons at a total cost of $3,600.
b. She will produce four tons at a total cost of $6,000.
c. She will produce five tons at a total cost of $9,000.
d. She will produce six tons at a total cost of $12,600.
ANSWER: c

92. Sarah Sandoval is a coffee farmer trying to decide how many tons of coffee to produce. She can sell each
ton of coffee for $1,500. The cost of producing her first ton of coffee is $300, and the second ton costs $500.
Each additional ton of coffee costs $200 more to produce. How many tons of coffee should Sarah produce, and
what is the total cost of her coffee production?
a. She will produce six tons at a total cost of $4,800.
b. She will produce seven tons at a total cost of $6,300.
c. She will produce eight tons at a total cost of $8,000.
d. She will produce nine tons at a total cost of $9,900.
ANSWER: b
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93. Vincent makes dining tables, and he is trying to decide how many tables to produce. He can sell each dining
table for $2,000. The cost of the first table is $750, and for the second it's $1,000. For each additional table he
produces, the marginal cost of each table increases by $250. How many dining tables should Vincent produce,
and what is the total cost of his production?
a. He will produce four tables at a cost of $4,500.
b. He will produce five tables at a cost of $6,250.
c. He will produce six tables at a cost of $8,250.
d. He will produce seven tables at a cost of $10,500.
ANSWER: c

94. Vincent Pearson makes dining tables, and he is trying to decide how many tables to produce. He can sell
each dining table for $3,000. The cost of the first table is $1,000, for the second it's $1,500. For each additional
table he produces, the marginal cost of each table increases by $500. How many dining tables should Vincent
produce, and what is the total cost of his production?
a. He will produce four tables at a cost of $12,000.
b. He will produce five tables at a cost of $10,000.
c. He will produce six tables at a cost of $13,500.
d. He will produce seven tables at a cost of $17,500.
ANSWER: b

95. Vincent Pearson makes dining tables, and he is trying to decide how many tables to produce. He can sell
each dining table for $1,000. The cost of the first table is $900, for the second it's $1,100. For each additional
table he produces, the marginal cost of each table increases by $200. How many dining tables should Vincent
produce, and what is the total cost of his production?
a. Vincent will not make any tables.
b. He will produce one table at a cost of $900.
c. He will produce two tables at a cost of $2,000.
d. He will produce three tables at a cost of $3,300.
ANSWER: b

96. The price of coffee at a local coffee shop is $3. Cheryl is willing to pay $6 for her first cup of coffee each
day. The marginal benefit to her of each additional cup of coffee falls by $2. How many cups of coffee should
Cheryl purchase?
a. One
b. Two
c. Three
d. Four
ANSWER: b

97. The price of coffee at a local coffee shop is $2.50. Cheryl is willing to pay $8 for her first cup of coffee each
day. The marginal benefit to her of each additional cup of coffee falls by $2. How many cups of coffee should
Cheryl purchase?
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a. One
b. Two
c. Three
d. Four
ANSWER: c

98. The principle that your best choice depends on your other choices, the choices others make, developments in
other markets, and expectations about the future is known as the _____ principle.
a. cost-benefit
b. opportunity cost
c. marginal
d. interdependence
ANSWER: d

99. The interdependence principle states that your best choice today depends on all of the following EXCEPT
a. past decisions you have made.
b. expectations about the future.
c. other decisions you are currently making.
d. decisions others are currently making.
ANSWER: a

100. Diane Jacobs is a student studying economics and currently working on her class schedule for next
semester. When she considers taking another economics course rather than taking a math class in the same time
slot, she is acknowledging that dependencies exist
a. between her own choices.
b. between people or businesses in the same market.
c. between markets.
d. through time.
ANSWER: a

101. Diane Jacobs is a student studying economics and currently working on her class schedule for next
semester. When she considers taking another economics course and how to meet prerequisites for future
economics courses, she is acknowledging dependencies that exist
a. between her own choices.
b. between people or businesses in the same market.
c. between markets.
d. through time.
ANSWER: d

102. Diane Jacobs is a student studying economics and is currently working on her class schedule for next
semester. She considers the fact that a popular class may fill up if she does not act quickly, she is
acknowledging the dependencies that exist
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a. between her own choices.

b. between people or businesses in the same market.
c. between markets.
d. over time.
ANSWER: b

103. Diane Jacobs is a student studying economics and currently working on her class schedule for next
semester. She considers the fact that more and more data is available every day and that data interpretation
skills are learned by taking additional economics courses in her course selection. This acknowledgment
highlights the dependencies that exist:
a. between her own individual choices.
b. between people or businesses in the same market.
c. between markets.
d. through time.
ANSWER: c

104. Harry Watson is an engineering student taking an economics elective in his senior year. He has the option
after college to work as a petroleum engineer or design rollercoasters. He is using concepts learned in his
economics course to help with this decision. By considering that he cannot be both a petroleum engineer and a
rollercoaster designer, he is acknowledging the dependencies that exist
a. between his own choices.
b. between people or businesses in the same market.
c. between markets.
d. through time.
ANSWER: a

105. Harry Watson is an engineering student taking an economics elective in his senior year. He has the option
to work as a petroleum engineer or to design rollercoasters after college. He uses concepts learned from his
economics course to help with this decision. When he considers the increasing popularity of electronic vehicles
and a decrease in demand for petroleum in the future, he is acknowledging the dependencies that exist
a. between his own choices.
b. between people or businesses in the same market.
c. between markets.
d. over time.
ANSWER: d

106. Harry Watson is an engineering student taking an economics elective in his senior year. He has the option
after college to work as a petroleum engineer or design rollercoasters. He is using concepts learned in his
economics course to help with this decision. By considering the effects that reduced financial investments in
petroleum companies will have on his expected salary, he is acknowledging the dependencies that exist
a. between his own choices.
b. between people or businesses in the same market.

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c. between markets.
d. through time.
ANSWER: c

107. Harry Watson is an engineering student taking an economics elective in his senior year. He has the option
after college to work as a petroleum engineer or to design rollercoasters. He is using concepts he learned in his
economics course to help with this decision. He thinks many engineers would prefer to design rollercoasters and
expects a lower salary in this field. With this analysis, he is acknowledging the dependencies that exist
a. between his own choices.
b. between people or businesses in the same market.
c. between markets.
d. through time.
ANSWER: b

108. Dependencies between your own choices reflect the fact that:
a. you have limited resources.
b. society has limited resources.
c. resources are spread across varying markets.
d. resources can be spread across time.
ANSWER: a

109. Dependencies between various people's choices reflect the fact that
a. you have limited resources.
b. society has limited resources.
c. resources are spread across different markets.
d. resources can be used across time.
ANSWER: b

110. Dependencies between markets reflect the fact that

a. you have limited resources.
b. society has limited resources.
c. resources are spread across different markets.
d. resources can be used across time.
ANSWER: c

111. Dependencies over time reflect the fact that

a. you have limited resources.
b. society has limited resources.
c. resources are spread across varying markets.
d. resources can be spread across time.
ANSWER: d
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112. According to the interdependence principle, when faced with a decision, you should ask what
a. else might my decision affect?
b. else might affect my decision?
c. else might my decision affect and what else might affect my decision?
d. past decisions might my decision affect?
ANSWER: c

113. The order in which you should apply the four core principles of economics is:
a. the cost-benefit principle, the opportunity cost principle, the marginal principle, the interdependence
principle.
b. the interdependence principle, the opportunity cost principle, the cost-benefit principle, the
interdependence principle.
c. the opportunity cost principle, the marginal principle, the cost-benefit principle, the interdependence
principle.
d. the marginal principle, the cost-benefit principle, the opportunity cost principle, the interdependence
principle.
ANSWER: d

114. Asking "One more?" allows the _____ principle to be analyzed as a simple question.
a. cost-benefit
b. opportunity cost
c. marginal
d. interdependence
ANSWER: c

115. Asking "Benefit beat cost?" allows the _____ principle to be boiled down to a simple question.
a. cost-benefit
b. opportunity cost
c. marginal
d. interdependence
ANSWER: a

116. Asking "Or what?" allows the _____ principle to be analyzed as a simple question.
a. cost-benefit
b. opportunity cost
c. marginal
d. interdependence
ANSWER: b

117. Asking "What else?" allows the _____ principle to be boiled down to a simple question.
a. cost-benefit
b. opportunity cost
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c. marginal
d. interdependence
ANSWER: d

118. Consider the decision to read your economics textbook. Which of the four core principles of economics
applies to the notion that reading this textbook will help you to establish a solid foundation of understanding
economics, which will be beneficial for future courses?
a. Cost-benefit principle
b. Opportunity cost principle
c. Marginal principle
d. Interdependence principle
ANSWER: d

119. Consider the decision to read your economics textbook regularly. Which of the four core principles of
economics applies to the notion that reading this textbook will require time and effort but that doing so will
improve your grade in this course?
a. Cost-benefit principle
b. Opportunity cost principle
c. Marginal principle
d. Interdependence principle
ANSWER: a

120. Consider the decision to read your economics textbook. Which of the four core principles of economics
applies to the notion that instead of reading this textbook you could be studying for your upcoming exam in a
different course?
a. Cost-benefit principle
b. Opportunity cost principle
c. Marginal principle
d. Interdependence principle
ANSWER: b

121. Consider the decision to read your textbook on economics regularly. Which of the four core principles of
economics applies to the notion that each extra page you read and each extra problem you complete will help
you increase your understanding of the material?
a. Cost-benefit principle
b. Opportunity cost principle
c. Marginal principle
d. Interdependence principle
ANSWER: c

122. Consider your decision to attend class each day or skip it. Which of the four core principles of economics
applies to the notion that attending class will most likely help you understand the material better and perform
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well on future exams?
a. Cost-benefit principle
b. Opportunity cost principle
c. Marginal principle
d. Interdependence principle
ANSWER: d

123. Consider your decision to attend class each day or skip it. Which of the four core principles of economics
applies to the notion that by attending class you are not doing the next best activity you would prefer to do, such
as napping or going to the gym?
a. Cost-benefit principle
b. Opportunity cost principle
c. Marginal principle
d. Interdependence principle
ANSWER: b

124. Consider your decision to attend class in college or skip it. Which of the four core principles of economics
applies to the notion that attending class today will require you to give up time and energy to pay attention, but
in doing so you will gain a better understanding of the material?
a. Cost-benefit principle
b. Opportunity cost principle
c. Marginal principle
d. Interdependence principle
ANSWER: a

125. Consider your decision to attend class in college or skip it. Which of the four core principles of economics
applies to the notion that each additional class you attend helps increase your likelihood of mastering the
material?
a. Cost-benefit principle
b. Opportunity cost principle
c. Marginal principle
d. Interdependence principle
ANSWER: c

Essay

126. Roger has inherited his grandmother's home, which he values at $150,000. He decides that he might be
willing to sell it, so he lists it on Zillow as for sale by owner for $185,000. Donna is interested in the home and
willing to pay $200,000 for it. Would Roger and Donna want to voluntarily engage in this exchange? How
much economic surplus is created for each of them as a result of this exchange? What is the total surplus?
ANSWER: Roger and Donna will engage in a voluntary economic exchange in this situation. Roger will receive
a $35,000 economic surplus from the exchange, and Donna will receive an economic surplus of
$15,000. The total economic surplus for the exchange is $50,000.
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127. Roger has inherited his grandmother's home, which he values at $150,000. He decides that he might be
willing to sell it, so he lists it on Zillow as for sale by owner for $185,000. Donna is interested in the home and
willing to pay $175,000 for it. Would Roger and Donna want to voluntarily engage in this exchange? How
much economic surplus is created for each of them as a result of this exchange? What is the total surplus?
ANSWER: Roger and Donna will not engage in a voluntary economic exchange in this situation. Although
Roger would receive a $35,000 economic surplus from the exchange, Donna would receive a
negative economic surplus of $10,000. Thus, Donna does not want to engage in the exchange even
though there would be a total economic surplus of $25,000.

128. Bruce has midterm exams tomorrow in economics and chemistry. He only has four hours left to study
tonight. The accompanying table provides the combinations of time spent studying economics and chemistry
and his expected exam scores.

Suppose that Bruce spends the first three hours studying economics. What is the opportunity cost of spending a
fourth hour? If Bruce's goal is to maximize his combined scores, how many hours should he spend studying
economics, and how many hours should he spend studying astronomy?
ANSWER: The opportunity cost to Bruce of spending a fourth hour studying economics is 10 points on his
chemistry exam. That is, if he spends the fourth hour studying chemistry, he will improve his
chemistry grade by 10 points. If Bruce wants to maximize his combined score of the two exams, he
should study two hours for each exam.

129. Bruce has midterms tomorrow in economics and chemistry. He has only four hours left to study tonight.
The accompanying table provides the combinations of time spent studying economics and chemistry and his
expected exam scores.

Suppose that Bruce spends the first two hours studying economics. What is the opportunity cost of spending a
third hour? If Bruce's goal is to maximize his combined scores, how many hours should he spend studying
economics, and how many hours should he spend studying astronomy?

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ANSWER: The opportunity cost to Bruce of spending a third hour studying economics is eight points on his
chemistry exam. That is, if he spends three hours studying economics, he can study chemistry for
only one hour. The marginal benefit to him of studying chemistry for a second hour is eight points.
If Bruce wants to maximize his combined score of the two exams, he should study two hours for
each exam.

130. Marie Johnston is a manager at a cell phone store and is making hiring decisions. The number of cell
phones her store sells per day depends on the number of workers she hires, as shown in the accompanying table.
She sells each cell phone for $300. Assuming that workers are paid $20 per hour and work eight hours, how
many employees should Marie hire? What will be the total revenue of her store per day?

ANSWER: Marie should hire five workers. Each additional worker she hires will be paid $160 per day, and the
marginal benefit of the fifth worker is $300. The total revenue for her store each day will be $6,900.

131. Marie Johnston is a manager at a cell phone store and is making hiring decisions. The number of cell
phones her store sells per day depends on the number of workers she hires, as shown in the accompanying table.
She sells each cell phone for $200. Assuming that workers are paid $20 per hour and work eight hours, how
many employees should Marie hire? What will be the total revenue of her store per day?

ANSWER: Marie should hire five workers. Each additional worker she hires will be paid $200 per day, and the
marginal benefit of the fifth worker is $200. The total revenue for her store each day will be $4,600.

132. Albert grows coffee beans and faces a decision about how many tons to produce. He can sell each ton of
coffee for $2,000. The total cost of production depends on the number of tons he decides to produce, as shown
in the accompanying table. How many tons of coffee beans should Albert produce?

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ANSWER: Albert should produce six tons of coffee beans. The marginal benefit to him of each ton of coffee
beans is $2,000. The marginal cost of the sixth ton of coffee is $2,000. According to the Rational
Rule, Albert should produce six tons of coffee beans.

133. Albert grows coffee beans and faces a decision about how many tons to produce. He can sell each ton of
coffee for $1,500. The total cost of production depends on the number of tons he decides to produce, as shown
in the accompanying table. How many tons of coffee beans should Albert produce?

ANSWER: Albert should produce three tons of coffee beans. The marginal benefit to him of each ton of coffee
beans is $1,500. The marginal cost of the third ton of coffee is $1,400. The marginal cost of the
fourth ton of coffee is $1,600. According to the Rational Rule, Albert should produce three tons of
coffee beans.

134. You are an engineer working at an engineering firm but are considering returning to school to get an MBA.
You know that an MBA is required for any further advancement at your current firm. Describe four types of
dependencies that will affect your decision, with at least one example for each.
ANSWER: Four types of dependencies that will affect the decision include the following : dependencies
between each of your individual choices (example), dependencies between people or businesses in
the same market (example), dependencies between markets (example), and dependencies through
time (example).

135. You are a college junior working as a summer intern at a firm. The firm is satisfied with your performance
over the summer and offers you a job that does not require you to finish your degree. Describe four types of
dependencies that will affect your decision to accept this job or return to school, with at least one example for
each.
ANSWER: Four types of dependencies that will affect the decision include the following : dependencies

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between each of your individual choices (example), dependencies between people or businesses in
the same market (example), dependencies between markets (example), and dependencies through
time (example).

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Multiple Choice

1. An individual demand curve is a graph:

a. that plots the quantity of an item that someone plans to buy, at each price.
b. that plots the quantity of an item that someone plans to buy, at one single price point.
c. that plots the quantity of an item that a seller plans to sell, at each price.
d. that plots the market price of a product at different points in time.
ANSWER: b

2. Quantity demanded is on the horizontal axis when you plot a demand curve and shows the:
a. amount of a good that a person is willing to buy at each price.
b. amount of a good that a person actually buys at the market price.
c. amount of a good that a seller is willing to sell at a particular price.
d. amount where opportunity cost is equal to the marginal benefit.
ANSWER: a

3. (Figure: Leonard's Demand for Pecan Pie) Look at Leonard's weekly demand curve for slices of pie. How
many slices of pie is Leonard willing to buy at $3 per slice?

a. 3 slices
b. 9 slices
c. 7 slices
d. 5 slices
ANSWER: d

4. (Figure: Leonard's Demand for Pecan Pie) Look at Leonard's weekly demand curve for slices of pie. How
many slices of pie is Leonard willing to buy at $2 per slice?

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a. 3 slices
b. 9 slices
c. 7 slices
d. 5 slices
ANSWER: c

5. (Figure: Mia's Demand Curve for Ice Cream) The accompanying graph shows Mia's demand curve for ice
cream, how many cones would Mia be willing to buy at $5 per cone?

a. 3 cones
b. 9 cones
c. 5 cones
d. 12 cones
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ANSWER: a

6. (Figure: Mia's Demand Curve for Ice Cream) Look at Mia's demand curve for ice cream, how many cones is
Mia willing to buy at $4 per cone?

a. 6 cones
b. 3 cones
c. 12 cones
d. 9 cones
ANSWER: a

7. Why does the demand curve slope downwards?

a. It slopes downward due to the positive relationship between price and quantity demanded.
b. It slopes downward due to buyers perceiving fall in price as a fall in quality.
c. It slopes downward due to the law of demand.
d. It slopes downward due to stores lowering the prices on their products.
ANSWER: c

8. A downward-sloping demand curve implies:

a. there is an inverse relationship between price and quantity demanded.
b. there is a positive relationship between price and quantity demanded.
c. there is no relationship between price and quantity demanded.
d. buyers are willing to buy less when prices are lower.
ANSWER: a

9. The law of demand refers to

a. the positive relationship between price and quantity supplied.

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b. the inverse relationship between price and quantity supplied.

c. the inverse relationship between price and quantity demanded.
d. the positive relationship between price and quantity demanded.
ANSWER: c

10. Which of the following scenarios does not illustrate the law of demand?
a. When Kit-Kats are cheaper, Mary opts to buy more Kit-Kats.
b. Darren buys two pairs of jeans when they are $40 each, but only one pair when it is $60.
c. Layla buys less tea when the price of tea rises.
d. Freya buys more doughnuts when the price of doughnuts is higher.
ANSWER: d

11. Which of the following scenarios illustrates the law of demand?

a. Francis does not care about the price of coffee at the coffee shop – he must buy two cappuccinos
every day, regardless of the price.
b. A research company finds that the more expensive a particular brand of a designer handbag, the more
that consumers are willing to purchase the brand.
c. John likes to drink spring water. At $2 he buys four bottles of water, and at $1.50 he still buys four
bottles of water.
d. Kathleen eats more steak when the price is low, and less when the price is high.
ANSWER: d

12. When plotting a demand curve,

a. quantity demanded is on the vertical axis.
b. price is on the horizontal axis.
c. quantity supplied is on the vertical axis.
d. quantity demanded is on the horizontal axis.
ANSWER: d

13. When plotting a demand curve

a. quantity demanded is on the vertical axis.
b. price is on the horizontal axis.
c. price is on the vertical axis.
d. quantity supplied is on the vertical axis.
ANSWER: c

14. A rational buyer will:

a. keep buying a product until marginal benefit equals price.
b. buy a product until the marginal benefit of consuming the product is less than the price of the
product.
c. buy the product only when the marginal benefit of consuming the product is twice as much as the
price of the product.
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d. not consider costs versus benefits when purchasing a product.

ANSWER: a

15. The Rational Rule for Buyers

a. compares the total benefit of all units to the total price of all units purchased.
b. compares the benefit of buying an additional unit of the item to the cost of that item.
c. only applies to buyers who are buying necessities as opposed to luxury items.
d. compares the cost of production of an item to the price of the item.
ANSWER: b

16. Which of the following scenarios depicts a rational buyer?

a. Mary values a bag of salad at $2, but she buys the bag of salad even when the price is $4.
b. John walks into a grocery store and purchases monthly groceries without paying attention to the
prices of groceries.
c. Darwin buys a can of shoe polish at $4.50 when his marginal benefit from it is $3.75.
d. Damien chooses to buy a sandwich for $5 when the marginal benefit of the sandwich to him is $7.
ANSWER: d

17. The demand curve

(i) is a curve that shows the maximum willingness to pay for a product.
(ii) is a curve that shows the marginal benefit gained from a product.
(iii) is a curve that shows the production cost of a product.
(iv) is a curve that shows the relationship between the price of a product and a consumer's willingness to buy at
each price.
a. (i), (ii), (iii) and (iv) are all correct.
b. (i), (ii) and (iv) are correct.
c. (ii) and (iv) are correct.
d. (i) and (ii) are correct.
ANSWER: b

18. Which of the following would be considered in a cost-benefit analysis to decide if a person should cycle to
work or ride the subway?

(i) The air pollution that the cyclist has to breathe.

(ii) The cost of subway tickets.
(iii) The time it takes to cycle to work versus the time it takes to ride the subway to work.
(iv) The cost per gallon of gasoline.
a. (i), (iii) and (iv)
b. (i), (ii), (iii) and (iv)
c. (i), (ii), and (iv)
d. (i), (ii) and (iii)
ANSWER: d

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19. Diminishing marginal benefit:
a. is when buying an additional item yields a larger marginal benefit than the previous item.
b. is when consumers do not follow the rational rule.
c. is not important in determining a consumer's purchase decision.
d. is when buying an additional item yields a smaller marginal benefit than the previous item.
ANSWER: d

20. Diminishing marginal benefit

a. does not affect a buyer's decision.
b. can be observed in the upward slope of the supply curve.
c. can be observed in the downward slope of the demand curve.
d. means that consumers are willing to pay more for additional units of an item.
ANSWER: c

21. On a hot sweltering day, you feel thirsty and buy an ice-cold soft drink, which you gulp down. Whether you
buy the second drink or not, will depend on
a. how you feel about soft drinks.
b. the total amount of soft drinks that you have consumed that week.
c. the price of the soft drink.
d. the marginal benefit from the second soft drink and if it will outweigh the price of the soft drink.
ANSWER: d

22. The table shows the monthly individual demand schedules of four students for soda. What is the total
monthly market demand for soda at $2 per can?

a. 99 cans
b. 45 cans
c. 125 cans
d. 148 cans
ANSWER: c

23. The table contains the monthly demand for soda cans for four students. If these four students make up the
entire market, what is the total monthly market demand for soda at $1.50 per can?

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a. 125 cans
b. 45 cans
c. 99 cans
d. 148 cans
ANSWER: d

24. The table shows the monthly individual demand schedules of four students for soda. What is the change in
the total market demand for soda when the price changes from $1.50 per can to $2 per can?

a. The total quantity demanded in the market falls by 23 cans.

b. The total quantity demanded in the market rises by 26 cans.
c. The total quantity demanded in the market falls by 18 cans.
d. The total quantity demanded in the market rises by 23 cans.
ANSWER: a

25. The table contains the monthly demand for soda cans for four students. If these four students make up the
entire market, what is the change in the total monthly market demand for soda when the price changes from $3
per can to $2.50 per can?

a. The total quantity demanded in the market rises by 23 cans.

b. The total quantity demanded in the market falls by 26 cans.
c. The total quantity demanded in the market rises by 36 cans.
d. The total quantity demanded in the market falls by 33 cans.

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ANSWER: c

26. As part of a market research project, you survey six random people to see how much gas per week they
would buy at various prices. The data you collect is in the accompanying table. What is the total demand for
gasoline at $2.50 per gallon in your survey?
Quantity of Gallons of Gas Demanded Per Week
Price per gallon of gasoline Marty Zain Doc Mikael Zoya Amirah
$1.50 10 15 6 20 20 6
$2.00 8 12 3 18 19 5
$2.50 6 9 1 14 17 4
$3.00 4 6 0 10 15 3
$3.50 2 3 0 4 12 1
a. 51 gallons
b. 38 gallons
c. 77 gallons
d. 22 gallons
ANSWER: a

27. As part of a market research project, you survey six random people to see how much gas per week they
would buy at various prices. The data you collect is in the accompanying table. What is the total demand in your
survey for gas at $1.50 per gallon?
Quantity of Gallons of Gas Demanded Per Week
Price per gallon of gasoline Marty Zain Doc Mikael Zoya Amirah
$1.50 10 15 6 20 20 6
$2.00 8 12 3 18 19 5
$2.50 6 9 1 14 17 4
$3.00 4 6 0 10 15 3
$3.50 2 3 0 4 12 1
a. 51 gallons
b. 77 gallons
c. 38 gallons
d. 22 gallons
ANSWER: b

28. As a part of a market research project, you survey six random people to see how much gas per week they
would buy at various prices. The data you collect is in the accompanying table. What is the change in the total
demand for gasoline in your survey when the price changes from $2 per gallon to $2.50 per gallon?
Quantity of Gallons of Gas Demanded Per Week
Price per gallon of gasoline Marty Zain Doc Mikael Zoya Amirah
$1.50 10 15 6 20 20 6

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$2.00 8 12 3 18 19 5
$2.50 6 9 1 14 17 4
$3.00 4 6 0 10 15 3
$3.50 2 3 0 4 12 1
a. The total quantity demanded in the market rises by 11 gallons.
b. The total quantity demanded in the market falls by 14 gallons.
c. The total quantity demanded in the market rises by 16 gallons.
d. The total quantity demanded in the market falls by 13 gallons.
ANSWER: b

29. As part of a market research project, you survey six random people to see how much gas per week they
would buy at various prices. The data you collect is in the accompanying table. What is the change in the total
demand for gasoline in your survey when the price changes from $3 per gallon to $2.50 per gallon?
Quantity of Gallons of Gas Demanded Per Week
Price per gallon of gasoline Marty Zain Doc Mikael Zoya Amirah
$1.50 10 15 6 20 20 6
$2.00 8 12 3 18 19 5
$2.50 6 9 1 14 17 4
$3.00 4 6 0 10 15 3
$3.50 2 3 0 4 12 1
a. The total quantity demanded in the market falls by 11 gallons.
b. The total quantity demanded in the market falls by 14 gallons.
c. The total quantity demanded in the market rises by 16 gallons.
d. The total quantity demanded in the market rises by 13 gallons.
ANSWER: d

30. What is the process that a manager can follow to estimate the total market demand for the United States?
a. Survey one consumer, and then scale up that individual demand to represent the entire market, and
plot the market demand curve.
b. Survey some representative customers, find the total quantity demanded for those customers, scale
up the quantities demanded to represent the entire market, and then plot the market demand curve.
c. Survey representative customers, find the total quantity demanded for those representative
customers, and then plot the market demand curve.
d. Generate random data to represent market quantity demanded for the entire market, and then plot the
market demand curve.
ANSWER: b

31. (Figure: Graph) Refer to the graph to answer the question.

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The movement from point M to point N represents:

a. a decrease in demand.
b. a decrease in quantity demanded.
c. an increase in quantity demanded.
d. an increase in demand.
ANSWER: c

32. (Figure: Graph) Refer to the graph to answer the question. In the graph, the movement from point P to point
Q represents

a. a decrease in quantity demanded.

b. an increase in demand.
c. a decrease in demand.
d. an increase in quantity demanded.
ANSWER: a

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33. (Figure: Graph) Refer to the graph to answer the question. In the graph, the movement from point M to
point Q represents

a. a decrease in demand.
b. a decrease in quantity demanded.
c. an increase in quantity demanded.
d. an increase in demand.
ANSWER: d

34. (Figure: Graph) Refer to the graph to answer the question. In the graph, the movement from point W to
point P represents:

a. an increase in quantity demanded.

b. an increase in demand.
c. a decrease in demand.
d. an increase in quantity demanded.
ANSWER: c

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35. (Figure: Graph) Refer to the graph to answer the question.

The movement from point S to point T is caused by

a. an increase in the price of the item.
b. a decrease in the price of the item.
c. a decrease in the demand for the item.
d. an increase in the demand for the item.
ANSWER: b

36. (Figure: Graph) Refer to the graph to answer the question.

The movement from point V to point W is caused by

a. an increase in the price of the item.
b. a decrease in the price of the item.
c. an increase in the demand for the product.
d. a decrease in the demand for the product.
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ANSWER: a

37. (Figure: Graph) Refer to the graph to answer the question.

An increase in the price of an item will cause the movement from

a. point W to point V.
b. point Q to point P.
c. point N to point M.
d. point Q to point T.
ANSWER: c

38. (Figure: Graph) Refer to the graph to answer the question.

A decrease in the price of an item will cause the movement from

a. point P to point W.
b. point N to point M.
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c. point T to point P.
d. point Q to point P.
ANSWER: d

39. The interdependence principle:

a. is the same as the cost-benefit principle.
b. refers to the marginal benefit of consuming additional units of an item.
c. implies that buyers decisions are affected by many factors other than the price of an item.
d. implies that consumers depend on each other to make purchase decisions in the market.
ANSWER: c

40. (Figure: Holly's Demand for Toffee) Holly doesn't care about the price of toffee. She loves toffee so much
that she must eat toffee every day. Which of the following figures most likely depicts Holly's demand for
toffee?

a. Figure A
b. Figure B
c. Figure C
d. Figure D
ANSWER: a

41. (Figure: Damien's Demand for Kit-Kats) Regardless of the price of Kit-Kats, Damien has decided to eat five
Kit-Kats every day. Which of the figures shows Damien's daily demand curve for Kit-Kats?

a. Figure A
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b. Figure B
c. Figure C
d. Figure D
ANSWER: b

42. Shifts in market demand can result from a change in

a. the price of a product.
b. the cost of production for an item.
c. the number of producers of an item in the market.
d. the type and number of buyers.
ANSWER: d

43. Which of the following is not a demand shifter?

a. The price of a substitute good.
b. The price of a complementary good.
c. The number of buyers in the market.
d. The price of the product.
ANSWER: d

44. A normal good is:

a. a good for which higher income causes an increase in demand.
b. a good which is normally purchased by many consumers.
c. a good which is only purchased by high-income consumers.
d. a good for which higher income causes a decrease in demand.
ANSWER: a

45. For normal goods

a. a tax cut on consumer income will lead to a rise in their demand.
b. a tax cut on consumer income will lead to a fall in their demand.
c. changes in consumer income do not affect their consumption.
d. most consumers will choose to purchase the good regardless of income changes.
ANSWER: a

46. An inferior good is

a. a good whose demand increases when income rises.
b. a good whose demand decreases when income rises.
c. an item that is only bought by rich people.
d. an item that is purchased by very few people.
ANSWER: b

47. Fast food is a good example of

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a. a normal good.
b. a good with a congestion effect.
c. an inferior good.
d. a luxury good.
ANSWER: c

48. Holding all else constant, if people eat out more at expensive restaurants when they earn more, then
expensive restaurant meals are
a. goods with a congestion-effect.
b. goods with a network-effect.
c. inferior goods.
d. normal goods.
ANSWER: d

49. Recent evidence suggests exercise promotes longevity and reverses aging. Based on this information, what
might happen in the market for exercise-related goods and services?
a. The demand for gyms will not change.
b. People will reduce their purchases of exercise equipment.
c. The demand for exercise machines and/or gyms will increase.
d. The demand for exercise equipment will not be affected.
ANSWER: c

50. In March 2019, airlines around the world grounded their Boeing 737 Max aircraft after two of them crashed.
What would we expect to happen in the market for this aircraft?
a. Airline companies would increase their demand for the Boeing 737 Max aircraft.
b. There would be a rise in the number of orders for the Boeing 737 Max aircraft.
c. Consumers would increase the number of flights they take per year.
d. The demand for the Boeing 737 Max would decrease due to concerns about the safety of the aircraft.
ANSWER: d

51. (Figure: Leather Wallets) Fossil has started an aggressive advertising campaign for its wallets. Which graph
shows how the demand in the market might change if the advertising campaign is successful?

a. Graph A
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b. Graph B
c. Graph C
d. Graph D
ANSWER: d

52. (Figure: Demand for Bus Rides) The city of Vaughan in Ontario, Canada, opened a new subway line that
extended the existing subway system between the greater Toronto area and the city of Vaughan. The route
previously only had bus service. Which of the following graphs depicts the effect you would expect to see on
the demand for bus rides on this route after the introduction of the subway?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

53. (Figure: Peanut Butter and Jelly) In the United States, peanut butter and jelly are considered complementary
items. Which graph illustrates the impact of a rise in the price of peanut butter on the jelly market?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

54. (Figure: Butter and Jam) Some people like to eat jam and butter sandwiches, and for them, these two foods
are complementary goods. For these people, which of the graphs illustrates the impact of a fall in the price of
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butter on the jam market?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

55. (Figure: Demand for Rental Housing) Fort Collins, CO is experiencing net immigration of people into the
area. Which of the following graphs illustrates the impact of this net immigration on the demand for rental
housing?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

56. (Figure: Market for Luxury Vehicles) Which graph shows what will happen in the market for luxury
vehicles if a recession is imminent?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

57. (Figure: Market for Holiday Cruises) Which graph shows the effect of an impending slowdown on the
market for cruise holidays?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

58. (Figure: Market for High-End Meals) What will happen to the demand for upscale restaurants, if an
economy goes into recession and unemployment rises?

a. Graph A
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b. Graph B
c. Graph C
d. Graph D
ANSWER: a

59. (Figure: Market for Community College) Which graph illustrates the effect on the demand for community
college, if an economy faces a recession, and there is rising unemployment?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

60. (Figure: Market for New Housing) Which of the graphs shows the effect on the housing market today, if the
realtor association predicts new housing prices to fall in a few months?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

61. (Figure: Market for New Housing) Which graph shows the effect on the housing market today, if the realtor
association predicts new housing prices to rise in a few months?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

62. (Figure: Market for Printing Paper) Which of the following graphs illustrates what we expect to see in the
market for printing paper if the price of printing paper rises?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c

63. (Figure: Market for Roses) Which graph illustrates what will happen in the market for roses if the price of
roses falls?

a. Graph A
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b. Graph B
c. Graph C
d. Graph D
ANSWER: b

64. Paint and paintbrushes are complements. If the price of paint rises, we can expect:
a. the quantity demanded of paint to increase.
b. the demand for paintbrushes to decrease.
c. the demand for paintbrushes to increase.
d. the quantity demanded of paintbrushes to remain unchanged.
ANSWER: b

65. If Tesla cars become less expensive, what will happen in the market for other electric cars?
a. The quantity demanded of Teslas will fall.
b. The demand for other electric cars will fall.
c. The demand for other electric cars will rise.
d. The quantity demanded of Teslas will not change.
ANSWER: b

66. (Figure: Market for Stevia) Stevia is a natural sweetener that is used as a sugar substitute. Which of the
following graphs illustrates the impact of a rise in the price of Stevia on the demand for sugar?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

67. (Figure: Market for Bread) Bread and cheese are often considered to be complementary foods. Which graph
shows what will happen in the market for bread if the price of bread rises?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c

68. (Figure: Market for Apple Computers) Dell and Apple are competitors in the computer market. Which graph
illustrates the effect of a rise in the price of Dell computers on the demand for Apple computers?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

69. Which of the following lists only factors that would cause a decrease in the demand for a good?
a. A decrease in popularity of a good; a rise in income (if the good is an inferior good); a fall in the
price of a substitute good.
b. A decrease in the number of consumers in the market; a rise in the price of a substitute good; a fall in
the price of a complementary good.
c. An increase in congestion effects; a decrease in the number of consumers in the market; increase in
popularity of a product.
d. An increase in network effects; a rise in income (if the good is a normal good); a rise in the price of a
substitute good.
ANSWER: a

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70. Which of the following lists only factors that would cause an increase in the demand for an item?
a. Information on possible side effects of using an item; a rise in income (if the good is a normal good);
a fall in the price of a substitute good
b. Information on possible side effects of using an item; a rise in income (if the good is a normal good);
a fall in the price of a substitute good
c. A decrease in the number of consumers in the market; a rise in the price of a substitute good; a fall in
the price of a complementary good
d. An increased congestion effect; a decrease in the number of consumers in the market; increase in
popularity of a product
ANSWER: b

71. Which of the following items is an inferior good?

a. Low-quality frozen meals
b. University textbooks
c. Restaurant a la carte dinners
d. Toll roads
ANSWER: a

72. Which of the following items is an inferior good?

a. Luxury SUVs
b. Discount stores
c. Airline tickets
d. Car rentals
ANSWER: b

73. Which of the following items is a normal good?

a. Canned food
b. Instant noodles
c. Steak
d. Third-hand cars
ANSWER: c

74. The relationship between price expectations and demand is

a. negative; when future prices are expected to rise, current demand will fall.
b. negative; when future prices are expected to fall, current demand will rise.
c. positive; when future prices are expected to rise, current demand will rise.
d. positive; future prices are generally expected to rise.
ANSWER: c

75. A product that can have congestion effects is

a. Tripadvisor reviews.
b. Facebook.
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c. roads.
d. Instagram.
ANSWER: c

76. A product with a network effect is

a. a drive-through window at a fast food restaurant.
b. a social media tool such as WeChat in China.
c. a broadband telecommunications network.
d. the customer service line at the Department of Motor Vehicles.
ANSWER: b

77. If Canadian consumers expect the value of the Canadian dollar to depreciate against the US dollar (the
Canadian dollar becomes weaker against the dollar), what impact would we expect this to have on Canadians'
demand for American made products?
a. The demand for American-made items would fall.
b. The demand for American-made items would not change.
c. The demand for American-made items would rise.
d. The demand for American-made items would double.
ANSWER: a

78. If Canadian consumers expect the value of the Canadian dollar to rise against the US dollar, what impact
would we expect this to have on Canadians' demand for American made products?
a. The demand for American-made items would fall.
b. The demand for American-made items would not change.
c. The demand for American-made items would rise.
d. The demand for American-made items would double.
ANSWER: c

79. Due to uncertainty around Brexit, the value of the British pound has been falling against the Euro. How will
this affect the demand for German goods in the UK?
a. The demand for German goods would increase.
b. The demand for German goods would not change.
c. The demand for German goods would double.
d. The demand for German goods would fall.
ANSWER: d

80. The table below shows data on quantity demanded for ATV tours at an ATV excursion company in Bali. In
June, many new tourists arrive in Bali and the additional demand from these tourists is indicated in the table.
Which of the following is true about the market for ATV tours in June?

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a. At a price of $149, the total market demand for ATV tours in June is 933.
b. At a price of $99, the total market demand for ATV tours in June is 272.
c. At a price of $189, the total market demand for ATV tours in June is 459.
d. At a price of $119, the total market demand for ATV tours in June is 245.
ANSWER: a

81. (Figure: Market for Tourism) A hotel in Cape Cod, Massachusetts, is completely booked during August.
However, in September, tourism drops significantly and some hotel rooms remain empty. Which of the graphs
depicts this scenario?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

82. The table shows data on quantity demanded for college textbooks in June. In August, the new incoming
freshmen join the university. The additional demand for college textbooks in August is shown in the last column
of the table. Which of the following is true about the market for textbooks in August?

a. At a price of $75, the total market demand for textbooks in August is 2700.
b. At a price of $99, the total market demand for textbooks in August is 1050.
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c. At a price of $149, the total market demand for textbooks in August is 417.
d. At a price of $300, the total market demand for textbooks in August is 967.
ANSWER: d

83. During the Great Recession of 2007-2009, unemployment shot up and a lot of people lost their jobs. All
over the United States, people worried about job security. Which of the following do you think happened as a
result of the Great Recession?
(i) Consumers ate out less often.
(ii) Consumers purchased fewer higher-end vehicles.
(iii) Purchases of new housing went down.
(iv) Consumers took fewer vacations outside the United States.
a. (i), (ii) and (iv) are correct.
b. (i) and (iv) are correct.
c. (ii) and (iii) are correct.
d. (i), (ii), (iii) and (iv) are all correct.
ANSWER: d

84. (Figure: Market for Oral Health Care) A recent article published in the Journal of the American Dental
Association talked about the impact of the Great Recession of 2007-2009 on the demand for oral health care in
the United States. Which of the graphs illustrates what this impact might have been?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

85. How will the demand for Gucci shoes change today, if the government decides to tax designer shoes next
year?
a. The demand for Gucci shoes will shift to the right today.
b. There will be no impact on the demand for Gucci shoes today.
c. People will stop buying Gucci shoes today.
d. The demand for Gucci shoes will shift to the left today.
ANSWER: a

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86. What would you expect to happen to the demand for a luxury good today, if the government announces it
will stop taxing that luxury good next year?
a. The demand for the luxury good will shift to the right today.
b. There will be no impact on the demand for the luxury good.
c. Consumers will stop their consumption of the luxury good altogether.
d. The demand for the luxury good will shift to the left today.
ANSWER: d

87. Which of the following businesses do you think will do well during a recession?
a. Luxury cruise lines
b. Discount clothing stores
c. Designer clothing stores
d. Upscale restaurants
ANSWER: b

88. Stores that are expected to perform better during recessions are those that sell
a. inferior goods.
b. normal goods.
c. luxury goods.
d. expensive goods.
ANSWER: a

89. The marginal benefit of consuming an item is

a. the difference between what the consumer is willing to pay and the actual market price of the item.
b. the total benefit from buying several units of the item.
c. the additional benefit from buying one more unit of that item.
d. the additional number of consumers who buy a unit of an item.
ANSWER: c

90. Jane goes to an all-you-can-eat restaurant and makes three trips to the buffet. After finishing food from her
third trip, she felt sick and throws up. Which of the following economic explanations best matches Jane's
situation?
a. Jane's marginal benefit from eating the third place was positive but less than that of the second plate.
b. Jane's marginal benefit from her third trip to the buffet was larger than her marginal benefit from her
second trip.
c. Jane was charged extra for the third plate at the buffet.
d. Jane's marginal benefit from eating the third plate was negative.
ANSWER: d

91. When you get hired for a well-paying job, you will most likely view older used cars as
a. complementary goods.
b. substitute goods.
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c. inferior goods.
d. normal goods.
ANSWER: c

92. As consumers consume more units of an item, the marginal benefit of each additional unit decreases at an
increasing rate. This can be seen through:
a. demand curves that are flatter at lower quantities and steeper at higher quantities.
b. demand curves that are vertical.
c. demand curves that are steeper at lower quantities and flatter at higher quantities.
d. demand curves that are positively sloped.
ANSWER: c

93. In May of 2019, the U.S. raised tariffs (import taxes) on a large variety of Chinese imports. In the U.S.
market for these Chinese imports, we would see:
a. an increase in the number of consumers.
b. a fall in price.
c. a rise in demand.
d. a rise in price.
ANSWER: d

94. If a product has a large network effect, it will lead to

a. a large congestion effect.
b. a small number of consumers using the product and a decreased demand for the product.
c. greater marginal benefits from using the product and increased demand for the product.
d. smaller marginal benefits from using the product.
ANSWER: c

95. If the price of airline tickets goes up, there will be

a. an increase in the demand for bus tickets, but a decrease in the demand for train tickets.
b. a decrease in the demand for bus tickets, but an increase in the demand for train tickets.
c. an increase in the quantity demanded of airline tickets.
d. an increase in the demand for both bus and train tickets.
ANSWER: d

96. Air Canada announces a 15% off sale on its flights, so fans can watch Toronto Raptors play against the
Golden State Warriors in the NBA Finals. What effect will this sale have on Air Canada's flights to destinations
other than Canada?
a. The supply of Air Canada tickets will shift to the right.
b. The demand for Air Canada tickets will shift to the right.
c. The supply of Air Canada tickets will shift to the left.
d. The demand for Air Canada tickets will shift to the left.

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ANSWER: b

97. Dental services can be classified as

a. normal goods.
b. expenses that do not change with income.
c. inferior goods.
d. fixed in their demand.
ANSWER: a

98. The aim of a marketing campaign is to

a. decrease the number of consumers in the market.
b. shift the demand curve to the left.
c. decrease the demand for the product.
d. increase the demand for the product.
ANSWER: d

Essay

99. Find and explain the error in reasoning in each of the following three statements.
Statement 1: If the price of steak rises, then the demand for steak will fall.
Statement 2: When incomes rise, consumers demand fewer inferior goods because these goods are lower in
quality than normal goods.
Statement 3: The law of demand refers to the inverse relationship between the price of a product and the
demand curve for that product.
ANSWER: Statement 1's error is the failure to distinguish between a change in quantity demanded and a change
in demand. If the price of steak rises, then the quantity demanded of steak will fall, leading to a
movement along the same demand curve. The demand curve would not shift as a result of the
change in the price of steak.
Statement 2's error is in defining inferior goods. Inferior goods do not have to be low in quality –
when income rise, the demand for inferior goods falls because consumers can afford more expensive
items.
Statement 3's error is in the failure to distinguish between demand and quantity demanded. The law
of demand refers to the inverse relationship between the price of a product and the quantity
demanded of that product.

100. Find and explain the error in reasoning in each of the following three statements.
Statement 1: If prices are expected to rise in the future, this will lead to a fall in quantity demanded at the
present time.
Statement 2: A decrease in demand is the same as saying that there is a decrease in the quantity demanded for
the product.
Statement 3: An increase in demand is the same as saying that there is an increase in the quantity demanded for
the product.
ANSWER: Statement 1's error is in failing to distinguish between a change in price today and a change in the
expected future price. If the product price changes today, this will lead to a change in quantity
demanded. However, if the future price of the product is expected to change, this will lead to a shift
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in the demand curve.

Statements 2 and 3 have the same error – a failure to distinguish between a change in demand and a
change in quantity demanded. A change in demand is a shift of the entire demand curve. A change
in quantity demanded is a movement along the same demand curve.

101. As a part of a market research project, you survey six random people to see how much gas per week they
would buy at various prices. The data you collect is in the accompanying table. Assuming that these are the only
six consumers in the market, plot the market demand curve for gas.
Quantity of Gallons of Gas Demanded Per Week
Price per gallon of gasoline Marty Zain Doc Mikael Zoya Amirah
$1.50 10 15 6 20 20 6
$2.00 8 12 3 18 19 5
$2.50 6 9 1 14 17 4
$3.00 4 6 0 10 15 3
$3.50 2 3 0 4 12 1
ANSWER:

102. The table shows the demand data for four different consumers who drinks sodas. Assuming that these are
the only four consumers in the market, plot the market demand curve for sodas.

Price per can Quantity of sodas demanded per month

of soda
Joanna Jeffrey Jason Jeremy
$1.50 50 15 8 75
$2.00 40 11 4 70
$2.50 30 7 2 60
$3.00 20 3 0 40
$3.50 10 0 0 35

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ANSWER:

103. You are studying the demand for cruise ship tickets. Determine how the demand for these tickets might be
affected by each of the three factors below.
(a) A major marketing campaign successfully advertises the cruise ship sailings.
(b) The government lowers income taxes on its population and so consumers have more after-tax income.
(c) Consumers begin to prefer ocean travel as opposed to airline travel.
ANSWER: (a) Demand increases (b) Demand increases (c) Demand increases

104. Suppose you find out that Domino's is having a promotion where you buy the first 3-topping large pizza
for $8 and get the second one for $4. Why does the store not simply sell each pizza for $6? Explain your answer
using the Rational Rule for Buyers.
ANSWER: The rational buyer will only buy an item if the marginal benefit is greater than or equal to the price
of the product. The first pizza that a consumer buys will have a larger marginal benefit than the
second pizza. Therefore, in order to sell the second pizza, Domino's will have to lower the price.

105. For each of the four scenarios below, explain which way the demand curve shifts and why.
Scenario 1: In the market for automobiles, a credible forecast is released which says that prices will fall in the
near future.
Scenario 2: You are studying the market for jackfruits. A report is released which details the health benefits of
eating jackfruits.
Scenario 3: You are studying the market for farmed salmon. You now get information that consumers have
developed a strong preference for wild-caught salmon.
ANSWER: Scenario 1: Demand will decrease at the current time as consumers will wait to purchase vehicles
when they are cheaper.
Scenario 2: The demand for jackfruits will increase as consumers will want to benefit from the
health properties of jackfruits.
Scenario 3: The demand for farmed salmon will decrease as consumers will opt for the wild-caught
variety.

106. For each of the four scenarios below, explain which way the demand curve shifts and why.
Scenario 1: In the market for automobiles, a credible forecast is released which says that prices will rise in the
near future.
Scenario 2: Many young people leave a small town to look for jobs in the capital city. What happens to the
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demand for college education in the small town?
Scenario 3: There is news of an E. coli outbreak caused by contaminated lettuce.
ANSWER: Scenario 1: Demand will increase at the current time as consumers will hurry to buy vehicles before
prices rise.
Scenario 2: The demand for college education in the small town will decrease as young people will
have moved away to the capital city.
Scenario 3: The demand for lettuce will fall as consumers will want to avoid the contaminated
lettuce.

107. For each of the four scenarios below, draw demand curves to illustrate the effects.
(a) During the cold and flu season, consumers choose to drink more orange juice to get the health benefits of
Vitamin C. What happens to the demand curve for orange juice?
(b) The government provides tax incentives to consumers who trade in their old vehicles for electric vehicles.
What happens to the demand curve for electric vehicles?
(c) The Canadian dollar weakens against the US dollar. In Canada, what happens to the demand for American-
made goods?
(d) The US dollar strengthens against the Canadian dollar. In the United States, what happens to the demand for
Canadian-made goods?
ANSWER: (a)

(b)

(c)
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(d)

108. Computer hardware and computer software are complementary goods. What happens to the demand curves
for computer hardware and computer software if the price of computer hardware rises? Show your answer using
two graphs – one for computer hardware and the other for computer software.
ANSWER: Computer hardware market

Computer software market

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109. Orange juice and apple juice are substitute goods. What happens to the demand curves for apple juice and
orange juice if the price of apple juice rises? Show your answer using two graphs – one for apple juice and the
other for orange juice.
ANSWER: Apple juice market

Orange juice market

110. McDonald's and Wendy's are substitute fast food restaurants. What would happen to the demand curve for
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fish sandwiches from these two restaurants if McDonald's decreases the price of fish sandwiches? Show your
answer using two graphs – one for McDonald's fish sandwiches and the other for Wendy's fish sandwiches.
ANSWER: Vegemite market

Bread market

111. Graphically illustrate how the demand curve for electric vehicles will be affected in each of these cases
below.
(a) A major climate change awareness campaign is instituted which teaches consumers about clean energy
vehicles.
(b) The price of gas-powered vehicles falls significantly, due to lower costs of production.
(c) Gas prices experience a significant and long-standing increase.
(d) The price of electric vehicles falls due to a fall in the cost of production.
ANSWER: (a)

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(b)

(c)

(d)

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112. Consider the demand for strawberry ice-cream. For each of the following scenarios, identify whether the
market would experience a change in quantity demanded or a change in demand, and specify the direction of
the change.
a. Strawberry orchards are affected by disease, and the supply of strawberries to ice-cream manufacturers falls.
b. The market price of strawberry ice-cream rises.
c. More consumers begin to prefer chocolate ice-cream to strawberry ice-cream.
ANSWER: a. The fall in the supply of strawberries will cause a reduction in the supply of strawberry ice-cream.
This will lead to a rise in the price of strawberries and a decrease in the quantity demanded of
strawberry ice-cream.
b. The rise in the price of strawberries and a decrease in the quantity demanded of strawberry ice-
cream
c. The demand for strawberry ice-cream will decrease as more consumers choose chocolate ice-
cream instead.

113. Consider the demand for antibiotic-free eggs. For each of the following scenarios, identify whether the
market would experience a change in quantity demanded or a change in demand, and specify the direction of
the change.
a. A major news article is published, which shows that eating antibiotic-free eggs is much healthier than eating
eggs from farms where antibiotics are used.
b. Where there used to be just one producer of antibiotic-free eggs, now several new producers of antibiotic-free
eggs also begin to supply eggs to supermarkets in the region. This causes a fall in the price of antibiotic-free
eggs.
c. The price of eggs produced using antibiotics falls significantly.
ANSWER: a. An increase in the demand for antibiotic-free eggs.
b. An increase in the quantity demanded of antiobiotic-free eggs.
c. A decrease in demand for antiobiotic-free egg, as some onsumers will now switch back to the
eggs produced using antiobiotics (since they are now much cheaper).

114. You are provided with the following table, which shows price and quantity demanded data for soccer game
tickets.

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(a) A major advertising campaign doubles the demand for soccer game tickets. Fill in the table to show the
new demand data.

(b) Which way has the demand curve shifted?

ANSWER: (a)

(b) Demand has shifted to the right (an increase in demand).

115. You are provided with the following table, which shows price and quantity demanded data for boats.

(a) A credible forecast is then released which indicates that the prices of boats will fall in the near future. At
each current price level, this forecast causes a reduction of 25% of the current consumers, as these consumers
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opt to wait to purchase the boats when the prices have actually fallen. Fill in the table to show what the new
demand for boats will be.

(b) Which way has the demand curve shifted?

ANSWER: (a)

(b) Demand has shifted to the left (a decrease in demand).

116. (Figure: Graph) Use the graph to answer the following questions.

Here are 5 different options based on the graph above. These 5 options show movements from one point to
another on the graph.
(i) Point M to Point N
(ii) Point W to Point V
(iii) Point Q to point T
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(iv) Point W to point P
(v) Point N to point W

Now answer the following three questions:

(a) Which of the 5 options could be caused by a change in the price of the product?
(b) Which of the 5 options could be caused by a decrease in the price of the product?
(c) Which of the 5 options could be caused by an increase in the expected future price of the product?
ANSWER: (a) Options (i) and (ii)
(b) Options (i) and (ii)
(c) Options (iii) and (v)

117. (Figure: Graph) Use the graph to answer the following questions.

Here are 5 different options based on the graph above. These 5 options show movements from one point to
another on the graph.
(i) Point M to Point N
(ii) Point W to Point V
(iii) Point Q to point T
(iv) Point W to point P
(v) Point N to point W

Now answer the following three questions:

(a) Which of the 5 options could be caused by an increased congestion effect?
(b) Which of the 5 options could be caused by an increased network effect?
(c) Which of the 5 options could be caused by decreased consumer preferences for the product?
ANSWER: (a) Option (iv)
(b) Options (iii) and (v)
(c) Option (iv)

118. (Figure: Graph) Use the graph to answer the following questions.

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(a) What change caused the movement from point V to point W?

(b) What change caused the movement from point T to point W?
(c) If the item is a normal good, in what direction did income change to cause the shift from point P to point W?
(d) If the item is an inferior good, in what direction did income change to cause the shift from point T to point
Q?
ANSWER: (a) An increase in price caused the movement from V to W.
(b) A decrease in price caused the movement from T to W.
(c) An increase in income.
(d) An increase in income

119. (Figure: Graph) Use the graph to answer the following questions.

(a) What change caused the movement from point S to point T?

(b) What change caused the movement from point W to point T?
(c) Fishing rods and fishing reels are complementary goods. In which direction did the price of fishing rods
change to cause the shift from point Q to point M in the demand for fishing reels?
(d) Abu Garcia fishing rods and Shimano fishing rods are substitute goods. In which direction did the price of
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Abu Garcia fishing rods change to cause the shift from point N to point P in the demand for Shimano fishing
rods?
ANSWER: (a) A decrease in price caused the movement from S to T.
(b) An increase in price caused the movement from W to T.
(c) There was an increase in the price of fishing rods.
(d) There was an increase in the price of Abu Garcia fishing rods.

120. Fill in the blanks below using the following choices: increases OR decreases.
(a) If the congestion effect of using a highway increases, then the demand curve for that highway __________.
(b) If the network effect of using a social media platform increases, the demand for advertising by businesses on
that platform ________.
(c) On heavy smog days in Beijing, the demand for face masks _______.
ANSWER: (a) decreases (b) increases (c) increases

121. Fill in the blanks below using the following choices: increases OR decreases.
(a) When Canadian fans travel to Oracle Arena in California to watch the Toronto Raptors play the Golden
State Warriors in the NBA Finals, we observe that the demand for airline tickets __________.
(b) As the Toronto Raptors reach the final rounds of the NBA Finals, the demand for Raptors merchandise
__________.
(c) If the demand for hot dogs at basketball games increases, then the price of hot dogs sold at basketball games
___________.
ANSWER: (a) increases (b) increases (c) increases

122. Fill in the blanks below using the following choices: increases OR decreases.
(a) As the price of roses increases, the quantity demanded of roses _________.
(b) As the expected price of airline tickets rises, the current demand for airline tickets _________.
(c) As the demand for cruise ship vacations falls, the price of cruise ship tickets _________.
(d) When the tourist season begins in Bali, the price of hotels rooms _________.
ANSWER: (a) decreases (b) increases (c) decreases (d) increases

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Multiple Choice

1. An individual supply curve is

a. a graph with quantities of a product that a seller is willing to supply at different price points.
b. a graph that plots how much a seller produces at different points in time.
c. a graph that plots the quantities of an item that a buyer plans to buy at different prices.
d. the quantity a seller is willing to supply at one particular price.
ANSWER: a

2. What is quantity supplied?

a. It is a graph that plots the quantities of an item that a seller plans to sell at different prices.
b. It is the amount of an item that a buyer is willing to buy at a particular price.
c. It is the amount of an item that a seller is willing to sell at a particular price.
d. It is a graph that plots how much a seller produces at different points in time.
ANSWER: c

3. (Figure: Spice King Burgers' Supply Curve) Take a look at Spice King Burgers' supply curve for burgers.
How many burgers will they supply at a market price of $1.50 per burger?

a. 200 units
b. 300 units
c. 400 units
d. 500 units
ANSWER: a

4. (Figure: Spice King Burgers' Supply Curve) Take a look at Spice King Burgers' supply curve for burgers.
How many burgers is Spice King Burgers willing to supply at a market price of $3.50 per burger?

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a. 200 units
b. 300 units
c. 500 units
d. 600 units
ANSWER: d

5. Why are supply curves typically upward-sloping?

a. They slope upward because sellers prefer to sell more when prices are lower.
b. They slope upward because higher prices lead individual businesses to supply a larger quantity and
more businesses are willing to supply goods and services.
c. They slope upward because sellers demand more when prices are lower.
d. They slope upward due to the law of demand.
ANSWER: b

6. An upward-sloping supply curve shows that

a. there is an inverse relationship between price and quantity supplied.
b. there is a positive relationship between price and quantity supplied.
c. there is no relationship between price and quantity supplied.
d. sellers are willing to sell less when the prices are higher in the market.
ANSWER: b

7. The law of supply refers to

a. the positive relationship between price and quantity supplied.
b. the inverse relationship between price and quantity supplied.
c. the inverse relationship between price and quantity demanded.
d. the positive relationship between price and quantity demanded.
ANSWER: a
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8. Which of the following scenarios describes a business that is NOT following the law of supply?
a. The higher the price of custom-made cakes in the market, the more Manfred is willing to bake and
sell cakes.
b. Delilah is less willing to chauffeur people to the airport when the price of airport rides falls.
c. Automobiles fall in price, and Maria's Autorama Ltd. is now willing to sell more vehicles.
d. When the price of car detailing rises, Ermo's Auto Garage hires more workers to do car detailing.
ANSWER: c

9. The accompanying table provides data for five different oatmeal cookie sellers. Out of the sellers listed, who
all are following the law of supply?

a. Ren only
b. Ken and Ben
c. Len, Ken, Ren, and Ben
d. Len, Ren, and Jen
ANSWER: d

10. Look at the chart which shows data for five different oatmeal cookie producers. Which sellers are NOT
following the law of supply?

a. Ren only
b. Ken and Ben
c. Len, Ken, Ren, and Ben
d. Len, Ren, and Jen
ANSWER: b

11. When plotting a supply curve

a. the quantity supplied goes on the vertical axis.
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b. the price goes on the horizontal axis.

c. the quantity supplied goes on the horizontal axis.
d. the quantity demanded goes on the vertical axis.
ANSWER: c

12. The supply curve is upward-sloping because

a. sellers can make more profit per unit if the market prices rise.
b. the government determines the relationship between price and quantity supplied.
c. it follows the law of demand.
d. the number of sellers rises as prices rise.
ANSWER: a

13. The Rational Rule for Sellers involves applying

a. only the cost-benefit principle.
b. only the marginal principle.
c. the marginal principle, the cost-benefit principle, and the opportunity cost principle.
d. only the opportunity cost principle.
ANSWER: c

14. The Rational Rule for Sellers says that a seller should sell one more unit of an item if the price is:
a. less than the marginal cost.
b. greater than or equal to the marginal cost.
c. less than the marginal benefit.
d. greater than or equal to the marginal benefit.
ANSWER: b

15. When you calculate marginal costs, they should include:

a. only fixed costs.
b. only variable costs.
c. both the variable and fixed costs.
d. the market price of the product.
ANSWER: b

16. Which of the following scenarios does NOT depict a rational seller?
a. The Flowery Bower calculates the marginal cost of a bouquet of red roses as $10 and sells it at $45.
b. United Airlines determines the marginal cost of an extra passenger to be $55 and sells a discount seat
for $150.
c. An auto-rickshaw driver in New Delhi, India, calculates a trip to have a marginal cost of 350 rupees
and accepts a ride request for 500 rupees.
d. Main Street Bakery calculates the marginal cost of a multilayer red velvet cake sd $9 and sells it for
$8.
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ANSWER: d

17. Which of the following scenarios depicts a seller who is following the Rational Rule for Sellers?
a. American Airlines determines the marginal cost of an extra passenger to be $75 and sells a discount
seat for $250.
b. Andy's Diner finds that the marginal cost of a fish and chips meal is $7 and lists the item for sale at
$6.50.
c. An auto-rickshaw driver in New Delhi, India, calculates a trip to have a marginal cost of 350 rupees
and accepts a ride request for 315 rupees.
d. Mindy sets up a lemonade stand and calculates the cost of an additional cup of lemonade at 50 cents,
and sells it for 25 cents.
ANSWER: a

18. Rising marginal costs imply

a. falling variable costs.
b. rising fixed costs.
c. a downward-sloping demand curve.
d. an upward-sloping supply curve.
ANSWER: d

19. A supply curve

(i) plots the quantities a seller is willing to sell at different prices.
(ii) shows the total cost to the seller.
(iii) shows rising marginal costs.
(iv) shows rising fixed costs.
a. only (i)
b. (i) and (iii)
c. (i), (ii), (iii), and (iv)
d. (i), (ii), and (iii)
ANSWER: b

20. Consider the data in the table. The price of gasoline is $3.99 per gallon at the gas station. If Rexhall Fuel
Supplies is a rational seller, how many gallons of gasoline should this seller be willing to sell?

a. 14 million gallons per week

b. 30 million gallons per week
c. 20 million gallons per week
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d. 42 million gallons per week

ANSWER: c

21. The market supply curve is upward-sloping because a higher price implies that
(i) individual sellers can increase the output supplied.
(ii) more sellers can supply to the market.
(iii) the government supplies goods and services to the market.
a. (i) and (ii)
b. (i) and (iii)
c. only (iii)
d. (ii) and (iii)
ANSWER: a

22. A bakery hires a baker who can make 15 cakes per day. The bakery then decides to hire a second baker who
will use the kitchen at the same time as the first baker. The bakery finds that the second baker can produce only
an additional nine cakes per day. What concept does this scenario illustrate?
a. The cost-benefit principle
b. The marginal principle
c. The opportunity cost principle
d. Diminishing marginal product
ANSWER: d

23. The market supply is

a. a graph that plots the total quantity of an item supplied by the entire market at each price.
b. a graph that plots the quantity supplied at each price by one seller.
c. a graph that plots the total quantity demanded of an item by the entire market at each price.
d. the total cost of production of the item for the entire market.
ANSWER: a

24. The market supply is the

a. sum of all prices that sellers charge for a particular quantity.
b. quantity supplied at each price by one seller.
c. total quantity produced by all sellers in the market at each price.
d. total cost of production of an item for the entire market.
ANSWER: c

25. A market consists of ten similar suppliers that are making the same supply decisions. To find the market
supply of these ten suppliers, you:
a. find the average quantity produced by the ten suppliers.
b. multiply the individual supply of one of the suppliers by ten.
c. take the individual supply of one supplier.
d. take one-tenth of the individual supply of each supplier and add it up.
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ANSWER: b

26. Which of the following are correct about fixed costs?

(i) They do not change with the level of production in the short run.
(ii) They include variable costs.
(iii) They are present even when the firm is producing zero units.
(iv) They are irrelevant to marginal cost.
a. (i), (ii), (iii), and (iv)
b. (i), (ii), and (iii)
c. (ii) and (iv)
d. (i), (iii), and (iv)
ANSWER: d

27. Variable costs are the costs that

a. are incurred to build factories and assembly plants.
b. are independent of the amount of output produced.
c. stay fixed with the quantity of output produced.
d. vary with the quantity of output produced.
ANSWER: d

28. Amul Food Factory in India makes ice cream and produces processed and condensed milk. In the factory,
the firm's employees use raw milk and sugar. The firm runs on electricity and purchases raw milk every day.
Large robotic assembly lines fill and package the ice cream containers. Large industrial freezers store the ice
cream. Based on this scenario, can you identify the fixed costs for Amul Food Factory?
a. The cost of the raw milk purchased from the farmers.
b. The cost of building the factory, purchasing the robotic assembly lines and industrial freezers.
c. The cost of the employees hired and the number of packages purchased.
d. The cost of purchasing electricity, raw milk, and sugar.
ANSWER: b

29. Amul Food Factory in India makes ice cream and produces processed and condensed milk. In the factory,
the firm's employees use milk and sugar. The firm runs on electricity and purchases raw milk every day. Large
robotic assembly lines fill and package the ice cream containers. Large industrial freezers store the ice cream.
Which of the following are variable costs for Amul Food Factory?
(i) The cost of the raw milk purchased from farmers.
(ii) The cost of buying the robotic assembly lines.
(iii) The cost of buying electricity.
(iv) The cost of buying industrial freezers.
(v) The cost of sugar.
a. (i), (ii), (iii), and (iv)
b. (iii) and (v)
c. (i), (iii), and (v)
d. (ii) and (iv)
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ANSWER: c

30. A beach resort in Bali builds 24 villas with private pools. They also establish two restaurants using state-of-
the-art equipment (such as multipurpose ovens, freezers, and food processors). Meals are prepared using
organic, locally sourced vegetables and meat. The hotel also uses water from the town supplier. Based on this
scenario, what are the variable costs for the beach resort?
a. Organic vegetables and water.
b. Multipurpose ovens and freezers.
c. Food processors.
d. The construction of the villas.
ANSWER: a

31. A beach resort in Bali builds 24 villas with private pools. They also establish two restaurants using state-of-
the-art equipment (such as multipurpose ovens, freezers, and food processors). Meals are prepared using
organic, locally sourced vegetables and meat. The hotel also uses water from the town supplier. Based on this
scenario, what are the fixed costs for the beach resort?
a. The construction of the villas.
b. Organic vegetables.
c. Organic meat products.
d. Water from the town supplier.
ANSWER: a

32. A seller in a perfectly competitive market

a. sells the same product that other sellers sell.
b. is a single producer in the market.
c. sets the market price of the product.
d. can increase its profitability by charging a higher price than other sellers.
ANSWER: a

33. A seller in a perfectly competitive market cannot

a. raise the market price of a product.
b. increase the amount he supplies.
c. decrease its marginal cost.
d. leave the industry.
ANSWER: a

34. Daisy is a milk farmer in a perfectly competitive market where there are many milk farmers. The market
price of milk is $0.15 per gallon, which is also the marginal cost per gallon of milk. If Daisy charges $0.25 per
gallon, she will
a. not sell any milk.
b. sell more milk than the other farmers.
c. sell the same amount of milk as she did when she charged $0.15 per gallon.
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d. increase her profitability by $0.10 per gallon.

ANSWER: a

35. Frank is a barley farmer in a perfectly competitive market. The market price of barley is $250 per ton. If
Frank charges $245 per ton, he will
a. not sell any barley.
b. raise his profitability by $5 per ton.
c. sell less barley than other farmers.
d. lower his profitability by $5 per ton.
ANSWER: d

36. Price takers

a. set their market prices.
b. charge the prevailing prices and do not have any effect on the market price.
c. can control the market prices of the products they sell.
d. produce only agricultural items in the market.
ANSWER: b

37. The table shows the monthly individual supply schedules for four firms in the packed-meals market. What is
the market supply at $5.75 per meal?

a. 183,000 meals
b. 895,000 meals
c. 297,000 meals
d. 730,000 meals
ANSWER: c

38. The table shows the monthly individual supply schedules for the four firms in the packed-meals market.
What is the market supply at $6.75 per meal?

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a. 183,000 meals
b. 895,000 meals
c. 297,000 meals
d. 730,000 meals
ANSWER: b

39. There are four suppliers in the packed meals market. The quantity of packed meals that each one is willing
to supply per week at various prices is provided in the accompanying table. What is the change in the market
supply for packed meals when the price rises from $6.25 per meal to $6.50 per meal?

a. The quantity supplied in the market rises by 152,000.

b. The quantity supplied in the market rises by 132,000.
c. The quantity supplied in the market falls by 165,000.
d. The quantity supplied in the market falls by 132,000.
ANSWER: a

40. There are four suppliers in the packed meals market. The quantity of packed meals that each one is willing
to supply per week at various prices is provided in the accompanying table. What is the change in the market
supply for packed meals when the price falls from $6.25 per meal to $6.00 per meal?

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a. The quantity supplied in the market rises by 152,000.

b. The quantity supplied in the market rises by 149,000.
c. The quantity supplied in the market falls by 165,000.
d. The quantity supplied in the market falls by 149,000.
ANSWER: d

41. As a part of a market research project, you survey six food trucks across the city to gather data on how many
meals they would plan to sale at various prices. The data you collect is in the accompanying table. What is the
total supply of meals in your survey at $8 per meal?
Quantity of Meals Supplied Per Week
Price per Mario's Taco Curbside Chargrilled Chuckin' Clouds Burrito La Jefa What a Jerk
meal Stand Burgers BBQ Dan's Cubanos Jamaican Food
$6.00 100 150 125 200 100 160
$7.00 120 180 150 220 120 190
$8.00 140 210 175 240 150 220
$9.00 160 240 200 260 190 250
$10.00 180 270 225 280 250 280
a. 835 meals
b. 980 meals
c. 1,485 meals
d. 1,135 meals
ANSWER: d

42. As a part of a market research project, you survey six food trucks across the city to gather data on how many
meals they would plan to sale at various prices. The data you collect is in the accompanying table. What is the
total supply of meals in your survey at $10 per meal?
Quantity of Meals Supplied Per Week
Price per Mario's Taco Curbside Chargrilled Chuckin' Clouds Burrito La Jefa What a Jerk
meal Stand Burgers BBQ Dan's Cubanos Jamaican Food
$6.00 100 150 125 200 100 160
$7.00 120 180 150 220 120 190
$8.00 140 210 175 240 150 220

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$9.00 160 240 200 260 190 250

$10.00 180 270 225 280 250 280

a. 835 meals
b. 980 meals
c. 1,485 meals
d. 1,135 meals
ANSWER: c

43. As a part of a market research project, you survey six food trucks across the city to gather data on how many
meals they would plan to sale at various prices. The data you collect is in the accompanying table. What is the
change in the total supply of meals in your survey when the price increases from $8 per meal to $9 per meal?
Quantity of Meals Supplied Per Week
Price per Mario's Taco Curbside Chargrilled Chuckin' Clouds Burrito La Jefa What a Jerk
meal Stand Burgers BBQ Dan's Cubanos Jamaican Food
$6.00 100 150 125 200 100 160
$7.00 120 180 150 220 120 190
$8.00 140 210 175 240 150 220
$9.00 160 240 200 260 190 250
$10.00 180 270 225 280 250 280
a. The quantity supplied rises by 165.
b. The quantity supplied falls by 155.
c. The quantity supplied rises by 155.
d. The quantity supplied falls by 185.
ANSWER: a

44. As a part of a market research project, you survey six food trucks across the city to gather data on how many
meals they would plan to sale at various prices. The data you collect is in the accompanying table. What is the
change in the total supply of meals in your survey when the price falls from $7 per meal to $6 per meal?
Quantity of Meals Supplied Per Week
Price per Mario's Taco Curbside Chargrilled Chuckin' Clouds Burrito La Jefa What a Jerk
meal Stand Burgers BBQ Dan's Cubanos Jamaican Food
$6.00 100 150 125 200 100 160
$7.00 120 180 150 220 120 190
$8.00 140 210 175 240 150 220
$9.00 160 240 200 260 190 250
$10.00 180 270 225 280 250 280
a. The quantity supplied rises by 165.
b. The quantity supplied falls by 155.
c. The quantity supplied rises by 155.
d. The quantity supplied falls by 145.
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ANSWER: d

45. (Figure: Graph) In the graph, the movement from point E to point F represents

a. a decrease in supply.
b. a decrease in quantity supplied.
c. an increase in quantity supplied.
d. an increase in supply.
ANSWER: b

46. (Figure: Graph) In the graph, the movement from point H to point G represents

a. a decrease in supply.
b. a decrease in quantity supplied.
c. an increase in quantity supplied.
d. an increase in supply.
ANSWER: b
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47. (Figure: Graph) In the graph, the movement from point H to point L represents

a. a decrease in supply.
b. a decrease in quantity supplied.
c. an increase in quantity supplied.
d. an increase in supply.
ANSWER: d

48. (Figure: Graph) In the graph, the movement from point M to point G represents

a. a decrease in supply.
b. a decrease in quantity supplied.
c. an increase in quantity supplied.
d. an increase in supply.
ANSWER: a

49. (Figure: Graph) In the graph, the movement from point J to point K must have been caused by:

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a. a rise in the price of the item.

b. a fall in the price of the item.
c. a decrease in the total supply of the item.
d. an increase in the total supply of the item.
ANSWER: b

50. (Figure: Graph) In the graph, the movement from point L to point K is caused by

a. an increase in the price of the item.

b. a decrease in the price of the item.
c. a decrease in the supply of the item.
d. an increase in the supply of the item.
ANSWER: a

51. (Figure: Graph) In the graph, an increase in the price of the item will cause the movement from

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a. point E to point F.
b. point F to point G.
c. point F to point E.
d. point H to point G.
ANSWER: c

52. (Figure: Graph) In the graph, a decrease in the price of the item will cause the movement from

a. point G to point L.
b. point H to point G.
c. point M to point J.
d. point L to point K.
ANSWER: b

53. (Figure: Market for Coffee) A coffee shop opens next to an existing coffee shop. Which of the following
graphs shows the effect of this new coffee shop on the market supply curve for coffee in this area?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

54. (Figure: Change in Supply) There are four gas stations in your town. Which graph shows the effect on the
local supply curve for gasoline if one of them shuts down?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c

55. Which of the following is NOT a factor that can shift supply?
a. The expected future price of a product.
b. The price of a substitute-in-production.
c. The market price of a product.
d. The price of a complement-in-production.
ANSWER: c

56. Which of the following is NOT a factor that can shift supply?
a. The price of the product.
b. The cost of raw materials used in the production process.
c. The state of technology used for production.
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d. The change in the price of a complement-in-production.

ANSWER: a

57. (Figure: Market for Leather Wallets) Producers of hand-made leather wallets have made manufacturing
changes that have improved quality but reduced efficiency. Which graph shows this change in the market?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c

58. (Figure: Market for Drones) If companies frequently start using drones to deliver products, which graph
shows the effect this will have on the market for drones.

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

59. (Figure: Market for Tropicana Juices) Tropicana produces both orange juice and lemonade. What will
happen to the supply of Tropicana orange juice when the price of lemonade rises in the market and the price of
orange juice stays the same?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c

60. (Figure: Market for Tropicana Juices) Tropicana produces both orange juice and tropical juice blends. What
will happen to the supply of Tropicana orange juice when the opportunity cost of producing tropical juice
blends rises, and the opportunity cost of producing orange juice stays the same? (Hint: Opportunity costs are
part of a producer's marginal cost.)

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

61. (Figure: Market for Steel Bars) Which graph illustrates what will happen in the market for processed,
industrial steel bars when the price of raw steel falls?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

62. (Figure: Market for Luxury SUVs) Which of the following graphs shows what will happen to the supply
curve for luxury SUVs, if economists predict an increase in demand for these vehicles?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

63. (Figure: Market for New Housing in Dubai) Which graph shows the effect on the supply curve for new
housing in Dubai, if economists predict a decrease in demand for new housing?

a. Graph A
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b. Graph B
c. Graph C
d. Graph D
ANSWER: b

64. A large amount of harvested grain used to make flour grows mold due to flooding. How will this affect the
supply of flour in the market?
a. The supply of flour will increase in the market.
b. The supply of flour will decrease in the market.
c. The supply of flour will remain unchanged in the market.
d. Suppliers of flour will switch to supplying grain.
ANSWER: b

65. (Figure: Market for Furniture) Which graph shows what will happen in the market for furniture if an excess
supply of timber drives down wood prices?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

66. (Figure: Market for Automobiles) Which graph shows what will happen in the market for automobiles if
there is an advancement in production technology?

a. Graph A
b. Graph B
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c. Graph C
d. Graph D
ANSWER: a

67. How will the supply of clothing change if the forecast is that clothing prices will rise in the next few
months?
a. The supply of clothing will increase in the market today.
b. The supply of clothing will remain unchanged today.
c. The supply of clothing will decrease in the market today.
d. Suppliers will stop producing clothing and switch to an alternate item.
ANSWER: c

68. How will the supply of clothing change if the forecast is that clothing prices will fall in the next few
months?
a. The supply of clothing will increase in the market today.
b. The supply of clothing will remain unchanged today.
c. The supply of clothing will decrease in the market today.
d. Suppliers will stop producing clothing and switch to an alternate item.
ANSWER: a

69. (Figure: Market for Printing Paper) Which of the following graphs shows what will happen in the market for
printing paper if the price of printing paper rises?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

70. (Figure: Market for Roses) Which graph shows what will happen to the supply of roses if the price of roses
falls?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: b

71. Peanut butter and peanut oil are complements-in-production. When the price of peanut butter rises, the
a. quantity supplied of peanut butter will fall.
b. supply of peanut oil will rise.
c. supply of peanut oil will fall.
d. quantity supplied of peanut butter will remain unchanged.
ANSWER: b

72. Due to a decline in demand and popularity, Ford Motor Company is planning to phase out traditional sedans
such as 'Fusion' and 'Taurus' to focus on SUVs and trucks. Ford's sedans and trucks/SUVs are
a. complements-in-production.
b. substitutes-in-production.
c. inputs in production.
d. products that do not follow the law of supply.
ANSWER: b

73. (Figure: Market for Stevia) Stevia is a natural sweetener that is used as a substitute for sugar. Which of the
following graphs shows the effect on the supply of bakery desserts made with stevia when the price of stevia
rises?

a. Graph A
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b. Graph B
c. Graph C
d. Graph D
ANSWER: c

74. (Figure: Market for Bread) Which of the following graphs shows what will happen in the market for bread if
the price of organic wheat used in bread production rises?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c

75. (Figure: Market for Lenovo Desktops) Lenovo produces laptops and desktop computers. Which graph
shows what will happen in the market for Lenovo desktops if the demand for laptops increases?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c

76. Which of the following lists only the factors that would cause a decrease in the supply of an item?
a. A fall in input prices; an increase in productivity; a fall in the price of a substitute-in-production.
b. A rise in the price of a substitute-in-production; a rise in the price of a complement-in-production; an
expectation that the price of the item will rise in the future.
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c. A decrease in the number of sellers in the market; a fall in the price of a complement-in-production;
an increase in productivity.
d. A rise in input prices; a decrease in the number of sellers in the market; a rise in the price of a
substitute-in-production.
ANSWER: d

77. Which of the following lists only factors that would cause an increase in the supply of an item?
a. A decrease in input prices; a technological innovation; a fall in the price of a substitute-in-
production.
b. A rise in the price of a substitute-in-production; an increase in the price of a complement-in-
production; an expectation that the price of the item will increase in the future.
c. A decrease in the number of sellers in the market; a fall in the price of a complement-in-production; a
technological setback.
d. An increase in input prices; a decrease in the number of sellers in the market; an increase in the price
of a substitute-in-production.
ANSWER: a

78. (Figure: Market for Lenovo Tablets) Lenovo produces laptops and tablets. What will happen to the supply
of Lenovo tablets, if laptops lose popularity and their demand falls?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

79. (Figure: Market for Video Games) Microsoft's Project Scarlett Xbox release date is 2020. Which graph
shows what will happen to the development and supply of new compatible video games once the Xbox launches
in the market?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

80. If expected future profits in an industry fall,

a. the number of sellers in the market does not change.
b. supply is not affected.
c. supply will shift left.
d. supply will shift right.
ANSWER: c

81. If expected future profits in an industry rise

a. the number of sellers in the market does not change.
b. supply will shift right.
c. supply will shift left.
d. supply is not affected.
ANSWER: b

82. If a seller expects prices to rise in the future

a. there will no change in the seller's actions today.
b. the quantity supplied will increase today.
c. the supply will increase today.
d. it will stock up today and sell the goods when the price rises.
ANSWER: d

83. If a firm expects lower prices in the future

a. it will increase supply today.
b. the quantity supplied will decrease today.
c. it will decrease supply today.
d. there will be a movement along the same supply curve for the firm.
ANSWER: a
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84. Substitutes-in-production
a. are always priced the same.
b. use substitute inputs in production.
c. allows a business to have alternative uses of its resources by manufacturing other products using the
same inputs.
d. allows a business to produce goods together.
ANSWER: c

85. Complements-in-production
a. are always priced the same.
b. use substitute inputs in production.
c. allows a business to have alternative uses of its resources by manufacturing other products using the
same inputs.
d. allows a business to produce goods together.
ANSWER: d

86. What will the impact be on the supply of long-haul truck transportation services if diesel fuel becomes
cheaper?
a. The supply of diesel fuel will increase.
b. The supply of truck transportation services will increase.
c. The supply of truck transportation services will decrease.
d. There will be no change in the supply of truck transportation services.
ANSWER: b

87. Paper producers can manufacture both printing and drawing paper. What effect would rising prices for
printing paper have on the market for drawing paper?
a. The quantity supplied of drawing paper will increase.
b. The supply of drawing paper will decrease.
c. The supply of drawing paper will increase.
d. The supply of drawing paper will double as compared to before.
ANSWER: b

88. A meat processing plant produces both steak and ground beef. What effect would rising market prices for
steak have on the market for ground beef?
a. There will be an increase in the quantity supplied of ground beef.
b. The supply of ground beef will increase.
c. The supply of ground beef will decrease.
d. The supply of steak will decrease.
ANSWER: c

89. What happens to the supply curve for new housing when there is a significant amount of new housing
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construction?
a. The supply curve will shift to the left.
b. The supply of new housing will decrease.
c. The supply curve will shift to the right.
d. There will be no effect on the supply of new housing.
ANSWER: c

90. Exxon imports a significant amount of oil from Canada. What would happen to Exxon's supply curve if the
value of the U.S. dollar falls against the Canadian dollar?
a. The supply curve will shift to the left.
b. The quantity supplied will rise.
c. The supply curve will shift to the right.
d. There will be no effect on the supply.
ANSWER: a

91. Anderson windows and doors imports wood from Canada. What would happen to the supply curve of
Anderson if the value of the U.S. dollar rises against the Canadian dollar?
a. The supply curve will shift to the left.
b. The quantity supplied will rise.
c. The supply curve will shift to the right.
d. There will be no effect on the supply.
ANSWER: c

92. German firms import machinery from the UK. What will happen to the supply of German goods
manufactured using machinery from the UK, if the value of the euro falls against the British pound?
a. The quantity supplied will rise.
b. The supply curve will shift to the left.
c. The supply curve will shift to the right.
d. There will be no effect on the supply.
ANSWER: b

93. German firms import machinery from the UK. What will happen to the supply of German goods
manufactured using machinery from the UK, if the value of the euro rises against the British pound?
a. The quantity supplied will rise.
b. The supply curve will shift to the left.
c. The supply curve will shift to the right.
d. There will be no effect on the supply.
ANSWER: c

94. When using the marginal principle, a seller has to

a. decide whether to supply one more unit of the item.
b. focus on the opportunity cost of producing an item.
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c. consider the choices made by other sellers in the market.

d. decide whether to charge the perfectly competitive price.
ANSWER: a

95. When using the opportunity cost principle, a seller has to

a. decide whether to supply one more unit of the item.
b. focus on the opportunity cost of producing an item.
c. consider the choices made by other sellers in the market.
d. decide whether to charge the perfectly competitive price.
ANSWER: b

96. When using the cost-benefit principle, a seller has to

a. decide whether to supply one more unit of the item.
b. focus on the opportunity cost of producing an item.
c. consider the choices made by other sellers in the market.
d. compare the marginal cost of producing an item to the price it gets for that item in the market.
ANSWER: d

97. Rising input costs lead to

a. decreased profitability for a seller.
b. increased supply of the item in the market.
c. rising marginal costs for a seller.
d. lower opportunity costs of producing the item.
ANSWER: c

98. Diminishing marginal product leads to

a. decreased profitability for a seller.
b. increased supply of the item in the market.
c. rising marginal costs for a seller.
d. lower opportunity costs of producing the item.
ANSWER: c

99. An individual supply curve is

a. the marginal cost curve.
b. the same as the total market supply curve.
c. positively sloped because of technological advancement.
d. lower than the marginal cost of producing an item.
ANSWER: a

100. If the price of jet fuel rises, the

a. supply of airline flights increases.
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b. supply of jet fuel decreases.

c. supply of jet fuel increases.
d. quantity supplied of jet fuel increases.
ANSWER: d

101. If the price of jet fuel rises, the

a. supply of airline flights decreases.
b. supply of jet fuel decreases.
c. supply of jet fuel increases.
d. quantity supplied of jet fuel falls.
ANSWER: a

102. A business manages to become more efficient. As a result of this improved efficiency, it will
a. shift its supply curve to the right.
b. reduce the quantity that it supplies to the market.
c. shift its supply curve to the left.
d. automatically charge higher prices for its product.
ANSWER: a

Essay

103. In each of the following three statements, find and explain the error in reasoning.
(i) If the price of video games rises, then the supply of video games will rise.
(ii) If two goods are complements-in-production, then when the price of one of the goods rises, the seller will
reduce the supply of the second good.
(iii) The law of supply refers to the positive relationship between the price of a product and supply of that
product.
ANSWER: (i) Statement 1's error is the failure to distinguish between a change in quantity supplied and a
change in supply. If the price of video games rises, then the quantity supplied of video games will
rise, leading to a movement along the same supply curve. The supply curve would not shift as a
result of the change in the price of video games.
(ii) Statement 2's error is in understanding the relationship between price changes and complements-
in-production. If two goods are complements-in-production, the rise in the price of one of the goods
will lead to an increase in the supply of the second good.
(iii) Statement 3's error is in the failure to distinguish between supply and quantity supplied. The law
of supply refers to the positive relationship between the price of a product and the quantity supplied
of that product.

104. In each of the following three statements, find and explain the error in reasoning.
(i) If prices are expected to rise in the future, this will lead to a fall in quantity supplied at the present time.
(ii) A decrease in supply is the same as saying that there is a decrease in the quantity supplied for the product.
(iii) An increase in supply is the same as saying that there is an increase in the quantity supplied for the product.
ANSWER: (i) Statement 1's error is in failing to distinguish between a change in price today and a change in the
expected future price. If the product price changes today, this will lead to a change in quantity
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supplied. However, if the future price of the product is expected to change, this will lead to a shift in
the supply curve.
(ii) and (iii) Statements 2 and 3 have the same error — a failure to distinguish between a change in
supply and a change in quantity supplied. A change in supply is a shift of the entire supply curve. A
change in quantity supplied is a movement along the same supply curve.

105. The table shows the supply data for four different bakeries that produce muffins. Assuming that these are
the only four sellers in the market, plot the market supply curve for muffins.

ANSWER: This graph shows the market supply curve for muffins for the four different bakeries that produce
muffins.

106. You are studying the supply of cruise ship tickets. For each of the three factors below, explain how the
supply of these tickets might be affected.
(i) Two new ships are added to the existing cruise ship fleet.
(ii) The port taxes and docking fees for cruise ships increase significantly.
(iii) A major renovation in cruise ship design allows for a 25% increase in staterooms in existing ships.
ANSWER: (i) When two new ships are added to the existing cruise ship fleet, supply increases.
(ii) When the port taxes and docking fees for cruise ships increase significantly, supply decreases.
(iii) When a major renovation in cruise ship design allows for a 25% increase in staterooms in
existing ships, supply increases.

107. Which of the following examples shows diminishing marginal product?

(i) Kenneth has just opened a new bakery. In the second week, he becomes better organized and is able to
produce 25% more cakes.
(ii) Frances hires a second cook in her restaurant, but the kitchen in now crowded, and the cooks are fighting
over space.
(iii) Domenic plants double the seeds that he normally plants in his garden, but only half the plants produce
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vegetables due to overcrowding.
ANSWER: Examples (ii) and (iii) show diminishing marginal product.

108. For each of the three scenarios below, explain which way the supply curve shifts and why.
(i) In the market for automobiles, a credible forecast is released that says that prices will fall in the near future.
(ii) You are studying the market for timber. Wildfires destroy 20% of the timber forests.
(iii) You are studying the market for farmed salmon. Fisheries are now able to increase their yields by using
more efficient hatcheries.
ANSWER: (i) In the first scenario, supply will increase at the current time because sellers will wait to sell
vehicles when prices are higher.
(ii) In the second scenario, supply will decrease because 20% of the forests have been destroyed.
(iii) In the third scenario, the supply for farmed salmon will increase because efficiency increases.

109. For each of the three scenarios below, explain the impact on supply.
(i) In the market for automobiles, a credible forecast is released that says that prices will rise in the near future.
(ii) Publishers begin to offer low-cost paperback versions of textbooks. What happens in the market for
hardcover textbooks?
(iii) On a cruise ship, the washing and cutting of lettuce by hand is replaced by an automated washer and
chopper that processes the lettuce for salads. What happens to the supply of salads on the cruise ship?
ANSWER: (i) In the first scenario, supply will decrease at the current time because sellers will hold back stock
until the prices rise.
(ii) In the second scenario, consumers will demand lower-cost paperback textbooks, and so the
demand for hardcover textbooks will fall. This will lead to a fall in the price of hardcover textbooks
and a reduction in the quantity supplied of hardcover textbooks.
(iii) In the third scenario, the supply of salads will increase because the cruise ship is now more
efficient in producing the salads.

110. For each of the four scenarios below, draw supply curves to illustrate the effects of the factor that is
changing.
(i) The demand for rice falls. What happens to the supply of rice?
(ii) The demand for electric vehicles rises in Canada. What happens to the supply curve for electric vehicles in
Canada?
(iii) The Canadian dollar weakens against the U.S. dollar. In Canada, what happens to the supply of Canadian
products that are made using U.S. inputs?
(iv) The U.S. dollar strengthens against the Canadian dollar. In the United States, what happens to the supply of
U.S. products that are made using Canadian inputs?
ANSWER: (i) The supply curve in this graph shows what happens to the supply of rice when the demand for
rice falls.

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(ii) This graph shows what happens to the supply curve for electric vehicles in Canada when the
demand for electric vehicles rises in Canada.

(iii) The supply curve in this graph shows what happens to the supply of Canadian products in
Canada that are made using U.S. inputs when the Canadian dollar weakens against the U.S. dollar.

(iv) The supply curve in this graph shows what happens to the supply of U.S. products in the United
States that are made using Canadian inputs when the U.S. dollar strengthens against the Canadian
dollar.

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111. Lenovo produces laptops and tablets. What would happen to the supply curve for laptops and the supply
curve for tablets if the price of laptops falls significantly? Show your answer using two graphs — one for
laptops and one for tablets.
ANSWER: (i) This graph shows what would happen to the supply curve for laptops if the price of laptops falls
significantly.

(ii) This graph shows what would happen to the supply curve for tablets if the price of laptops falls
significantly.

112. Doughnuts and doughnut holes are complements-in-production. What would happen to the supply curve
for doughnuts and the supply curve for doughnut holes if the price of doughnuts rises? Show your answer using
two graphs — one for doughnuts and one for doughnut holes.
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ANSWER: (i) This graph shows what would happen to the supply curve for doughnuts if the price of doughnuts
rises.

(ii) This graph shows what would happen to the supply curve for doughnut holes if the price of
doughnuts rises.

113. Butter and ghee (clarified butter) are substitutes in production. What would happen to the supply curve for
butter and the supply curve for ghee if the price of butter falls? Show your answer using two graphs — one for
butter and the other for ghee.
ANSWER: (i) This graph shows what would happen to the supply curve for butter if the price of butter falls.

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(ii) This graph shows what would happen to the supply curve for ghee if the price of butter falls.

114. Printing paper and drawing paper are substitutes-in-production. What would happen to the supply curve for
printing paper and the supply curve for drawing paper if the price of printing paper rises? Show your answer
using two graphs — one for printing paper and one for drawing paper.
ANSWER: (i) This graph shows what would happen to the supply curve for printing paper if the price of
printing paper rises.

(ii) This graph shows what would happen to the supply curve for drawing paper if the price of
printing paper rises.

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115. Graphically illustrate how the supply curve for electric vehicles will be affected in each of these cases
below.
(i) Producers of electric vehicles now face increased taxes on imported parts (from other countries) used to
produce the vehicles.
(ii) Producers of electric vehicles are now able to produce the vehicles more efficiently due to advances in
production techniques.
(iii) Producers of electric vehicles now get new production subsidies from the government.
(iv) The cost of production of electric vehicles falls.
ANSWER: (i) This graph shows how the supply curve for electric vehicles will be affected when producers of
electric vehicles face increased taxes on the imported parts (from other countries) used to produce
the vehicles.

(ii) This graph shows how the supply curve for electric vehicles will be affected when producers of
electric vehicles are able to produce the vehicles more efficiently due to advances in production
techniques.

(iii) This graph shows how the supply curve for electric vehicles will be affected when producers of
electric vehicles get new production subsidies from the government.

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(iv) This graph shows how the supply curve for electric vehicles will be affected when the cost of
production of electric vehicles falls.

116. Consider the supply of car-service rides in a city. Holding all else constant, for each of the following
scenarios, identify whether the market would experience a change in quantity supplied or a change in supply,
and specify the direction of the change.
(i) City taxi cabs are the only providers of car-service rides, but Uber and Lyft enter the market.
(ii) The market price of taxi rides increases.
(iii) The price of taxi cab licenses increases significantly.
ANSWER: (i) When city taxi cabs are the only providers of car-service rides and Uber and Lyft enter the car-
service market, the supply of car-service rides increases.
(ii) When the market price of taxi rides increases, the quantity supplied of taxi rides increases
because it is more profitable for taxi cab providers to provide rides.
(iii) When the price of taxi cab licenses increases significantly, the supply of taxi rides falls because
it is now more expensive to acquire the licenses to provide taxi rides.

117. Consider the supply of chicken patties at a chicken-processing plant. Holding all else constant, for each of
the following, identify whether the market would experience a change in quantity supplied or a change in
supply, and specify the direction of the change.
(i) Raw chicken can now be acquired at lower prices.
(ii) There is only one producer of chicken patties, but several new producers of chicken patties enter the market.
(iii) The demand for chicken patties increases.
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ANSWER: (i) When raw chicken can be acquired at lower prices, there will be an increase in the supply of
chicken patties.
(ii) When there is only one producer of chicken patties but several new producers of chicken patties
enter the market, there will be an increase in the supply of chicken patties.
(iii) When there is an increase in the demand for chicken patties, there will be a rise in the price of
chicken patties, and as a result, the quantity supplied of chicken patties will rise.

118. You are provided with the following table, which shows data for the price and quantity supplied of soccer
balls.

(i) A robotic production technology advance allows the firm to increase production by 30% at every price. Fill
in the table below to show the new supply data.

(ii) Which way has the supply curve shifted?

ANSWER: (i) This table shows the quantity supplied of soccer balls when a robotic production technology
advance allows the firm to increase production by 30% at every price.

(ii) Supply has shifted to the right (an increase in supply).

119. You are provided with the following table, which shows data for the price and quantity supplied of
embossed T-shirts.

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(i) The minimum wage for workers is increased, which leads to an increase in the cost of production for
embossed T-shirts. The firm now produces 20% fewer shirts at each price. Fill in the table below to show what
the new supply of embossed T-shirts will be.

(ii) Which way has the supply curve shifted?

ANSWER: (i) This table shows what the new supply of embossed T-shirts will be when the minimum wage for
workers is increased, which leads to an increase in the cost of production for embossed T-shirts and
to the firm's production of 20% fewer shirts at each price.

(ii) Supply has shifted to the left (a decrease in supply).

120. (Figure: Graph) Use the graph to answer the following questions.

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Here are five different options based on the graph above. These five options show movements from one point to
another on the graph.
(i) point M to point L
(ii) point K to point L
(iii) point H to point K
(iv) point L to point H
(v) point G to point M

Now answer the following three questions:

(A) Which of the five options could be caused by a change in the price of the product?
(B) Which of the five options could be caused by a decrease in the price of the product?
(C) Which of the five options could be caused by an increase in the expected future price of the product?
ANSWER: (A) Options (i) and (ii) could be caused by a change in the price of the product.
(B) Option (ii) could be caused by a decrease in the price of the product.
(C) Option (iv) could be caused by an increase in the expected future price of the product.

121. (Figure: Graph) Use the graph to answer the following questions.

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Here are five different options based on the graph above. These five options show movements from one point to
another on the graph.
(i) point G to point H
(ii) point K to point L
(iii) point H to point K
(iv) point K to point H
(v) point G to point M

Now answer the following three questions:

(A) Which of the five options could be caused by a decrease in the price of a substitute-in-production?
(B) Which of the five options could be caused by a technological advancement in production?
(C) Which of the five options could be caused by a decrease in the market supply of the item?
ANSWER: (A) Options (iii) and (v) could be caused by a decrease in the price of a substitute-in-production.
(B) Options (iii) and (v) could be caused by a technological advancement in production.
(C) Option (iv) could be caused by a decrease in the market supply of the item.

122. (Figure: Graph) Use the graph below to answer the following questions.

(A) What change caused the movement from point M to point L?

(B) What change caused the movement from point H to point G?
(C) If the item is hand-made antique-style wooden furniture, in what direction did labor costs change to cause
the shift from point M to point G?
(d) If the item is wheat, in what direction did wheat farming technology change to cause the shift from point G
to point M?
ANSWER: (A) An increase in price caused the movement from M to L.
(B) A decrease in price caused the movement from H to G.
(C) If the item is hand-made antique-style wooden furniture, labor costs increased, which caused the
shift from point M to point G.
(D) If the item is wheat, technology change increased, which caused the shift from point G to point
M.

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123. (Figure: Graph) Use the graph below to answer the following questions.

(A) In what direction did market supply change to cause the shift from point M to G?
(B) A firm can produce apple snacks or apple juice. In what direction did the price of apples change to cause the
shift from point G to point M?
(C) A firm can produce apple snacks or apple juice. In what direction did the price of apples change to cause the
shift from point K to point H?
(D) In what direction did productivity change to cause the shift from point H to point K?
ANSWER: (A) A decrease in market supply caused the shift from point M to point G.
(B) The price of apples decreased to cause the shift from point G to point M.
(C) The price of apples increased to cause the shift from point K to point H.
(D) There was an increase in productivity, which caused the shift from point H to point K.

124. Fill in the blanks below using the following choices: increases OR decreases.
(A) If the tolls on highways across the United States increase significantly, the supply of items that need to be
shipped across the country _____.
(B) A bakery can produce cheesecakes and chocolate cakes. If the price of cheesecakes rises significantly, the
supply of chocolate cakes _____.
(C) With the development of fast pay-by-phone methods for farmers in rural areas in Kenya, the availability of
fresh produce in Kenyan cities _____.
ANSWER: (A) decreases
(B) decreases
(C) increases

125. Fill in the blanks below using the following choices: increases OR decreases.
(A) When trucking and transportation costs rise across the country, the price of processed and canned food
_____.
(B) If the government institute high taxes on the production of palm oil, the supply of palm oil _____.
(C) If the supply of peanuts rises, then the price of peanuts _____.
ANSWER: (A) increases
(B) decreases
(C) decreases
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126. Fill in the blanks below using the following choices: increases OR decreases.
(A) As the price of gold increases, the quantity supplied of gold _____.
(B) As the expected price of copper rises, the supply of copper _____.
(C) As the supply of steel falls, the price of steel _____.
(D) When a new all-terrain vehicle (ATV) tour company opens in Bali, the supply of ATV tours _____.
ANSWER: (A) increases
(B) decreases
(C) increases
(D) increases

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Multiple Choice

1. Which of the following five scenarios illustrate markets in action?

(i) You rent a book at the university bookstore.
(ii) You bargain at a street stall.
(iii) You mow your own lawn.
(iv) You get a manicure at a nail salon.
(v) You grow your own vegetables and consume them yourself.
a. (i), (ii), and (iii)
b. (i), (iii), and (v)
c. (iii) and (v)
d. (i), (ii), and (iv)
ANSWER: d

2. A market is a
a. a place where governments decide what is sold.
b. set of demand curves for a product.
c. setting that brings together potential buyers and sellers.
d. set of supply curves for a product.
ANSWER: c

3. A planned economy is an economy where

a. centralized decisions are made about what is produced, how, by whom, and who gets what.
b. decentralized decisions are made about what is produced, how, by whom, and who gets what.
c. the government does not have any role in decision making related to products, prices, and markets.
d. a surplus exists for all goods and services.
ANSWER: a

4. A market economy is an economy where

a. the government makes decisions on what is produced, how it is produced, by whom and how much is
allotted to each person.
b. each individual makes his or her production and consumption decisions and buys and sells in
markets.
c. centralized decisions are the norm.
d. one individual makes decisions for the entire market.
ANSWER: b

5. The difference between a centralized economy and a market economy is that

a. the centralized economy does not have any markets for goods and services, whereas a market
economy has fully functioning markets.
b. governments make production decisions in a centralized economy, and individuals make production
decisions in a market economy.

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c. governments have maximum decision-making power in a centralized economy but have zero
decision-making power in a market economy.
d. individuals make production decisions in a centralized economy, and the government makes
production decisions in a market economy.
ANSWER: b

6. A seller at a farmer's market wants $10 for a bag of 10 apples. You think his price is too high, so you counter
with an offer of $6 for the bag. The seller then offers you a much smaller bag of five apples for $6. You bargain
again, and the seller lets you buy the 10 apples for $8. This scenario is an example of:
a. a centrally planned market.
b. a shortage.
c. a market in action.
d. perfect competition.
ANSWER: c

7. You buy two loaves of bread at a price set by the government. The price of the bread never changes, and it is
the only kind of bread produced. This scenario is an example of a
a. centrally planned market.
b. shortage.
c. market-based economy.
d. perfectly competitive market.
ANSWER: a

8. Equilibrium is the
a. point at which there is no tendency for change.
b. halfway point in a price range.
c. halfway point on a demand curve.
d. level of prices as set in a centralized economy.
ANSWER: a

9. An equilibrium in a market occurs:

a. at the halfway point on a demand curve.
b. at the halfway point on the price axis.
c. when suppliers have sold all the goods and services that they have produced.
d. when the quantity supplied equals the quantity demanded.
ANSWER: d

10. An equilibrium price is a price where the

a. demand curve is identical to the supply curve.
b. amount that buyers are willing to buy is equal to the amount that buyers are able to buy.
c. quantity demanded no longer changes.
d. quantity supplied equals the quantity demanded.
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ANSWER: d

11. An equilibrium price is:

a. the price that prevails when there is a shortage.
b. the price that prevails when quantity supplied is less than quantity demanded.
c. determined by the intersection of the demand and supply curves.
d. the price that occurs when there is a surplus.
ANSWER: c

12. If a store runs a sale on a product to clear out its stock, we can conclude that:
a. there was a surplus of the product in the store.
b. there was a shortage of the product in the store.
c. the demand for the product is larger than the supply of the product.
d. the product must be very close to its expiration date.
ANSWER: a

13. If Beyoncé concert tickets are sold out within five minutes of being released, we can conclude that
a. there is a control on how high the ticket prices can go.
b. there is a shortage of Beyoncé concert tickets in the market.
c. the price of the tickets is above the equilibrium price in the market.
d. the quantity supplied of Beyoncé concert tickets is more than the quantity demanded.
ANSWER: b

14. Graphically, the equilibrium quantity can be identified as the:

a. maximum quantity that buyers are willing to buy.
b. quantity corresponding to the intersection of the demand and supply curves.
c. quantity corresponding to the intersection of the demand curve and the price axis.
d. maximum quantity that sellers are willing to sell.
ANSWER: b

15. The Bangtan Boys (BTS) sold out their first US concert, almost as soon as the tickets became available.
Moreover, tickets for the BTS tour were, on average, twice as expensive as tickets for Taylor Swift's 2018
Reputation tour. How can you explain this difference in ticket prices?
a. Consumers must prefer BTS to Taylor Swift.
b. There is a shortage of BTS tickets compared to Taylor Swift tickets.
c. The supply of BTS tickets is larger than the supply of Taylor Swift tickets.
d. The demand for BTS tickets is larger than the demand for Taylor Swift's tickets.
ANSWER: b

16. You're shopping online, and you place an item in your virtual cart. Two days later, you return to the virtual
cart to check out and find that the item is now more expensive. Assuming that the market is competitive, what
could explain the price increase?
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a. There is a shortage of the item.

b. There is decreased demand for the item.
c. There is a surplus of the item.
d. New sellers are offering the same product.
ANSWER: a

17. You eat M&Ms every day. When you go to the store to buy some, you find that M&Ms are more expensive
than they were last month. Which of the following could explain why M&Ms are more expensive?
a. Consumers are now purchasing fewer M&Ms compared to other types of chocolates.
b. A new robot has been installed at the Mars chocolate company that reduces the time needed to
produce M&Ms by half.
c. A new study finds that the benefits of eating chocolate are not as great as previously thought.
d. The supply of cacao beans, used to produce chocolate, has fallen around the world.
ANSWER: d

18. Grapes become more expensive in the market. Which of the following can explain the increase in price?
a. Farmers are now able to produce larger grapevine yields using the same level of inputs.
b. The government reduces fuel taxes, which lowers transportation costs.
c. Grape production is the same, but wine production has gone up, which requires more grapes.
d. Consumers are purchasing fewer grapes as opposed to other types of fruits.
ANSWER: c

19. A shortage occurs when:

a. quantity supplied exceeds quantity demanded.
b. quantity demanded exceeds quantity supplied.
c. there is excess production.
d. when there is insufficient demand.
ANSWER: b

20. When quantity demanded exceeds quantity supplied, _____ exists.

a. a shortage
b. equilibrium
c. fixed demand
d. a surplus
ANSWER: a

21. A surplus is
a. excess supply.
b. excess demand.
c. fixed demand.
d. fixed prices.
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ANSWER: a

22. When quantity supplied exceeds quantity demanded, _____ exists.

a. a shortage
b. fixed supply
c. equilibrium
d. a surplus
ANSWER: d

23. Graphically, shortages will always occur:

a. at the equilibrium price.
b. at prices below the equilibrium price.
c. at prices above the equilibrium price.
d. when the quantity supplied exceeds the quantity demanded.
ANSWER: b

24. Surpluses always occur

a. at the equilibrium price.
b. at prices below the equilibrium price.
c. at prices above the equilibrium price.
d. when the quantity demanded exceeds the quantity supplied.
ANSWER: c

25. At the local grocery store, the blueberry jam is less expensive than last month. Which of the following can
explain why blueberry jam costs less now?
a. Consumers are now purchasing fewer jars of blueberry jam as compared to other types of jam.
b. Blueberry farms are negatively affected by the weather, and blueberries are in short supply.
c. A research article reports on the benefits of eating blueberries.
d. The grocery store is experiencing a shortage of blueberry jam.
ANSWER: a

26. As a result of technological innovation, automated water pumps are being installed on the farms of Kenyan
tomato farmers. As a result of the increased use of automated water pumps, the equilibrium price of tomatoes
will:
a. rise, due to a rise in demand.
b. fall, due to a fall in demand.
c. rise, due to a fall in supply.
d. fall, due to a rise in supply.
ANSWER: d

27. Suppose that you have a pumpkin stall at a farmer's market, and the Halloween season arrives. You know
that your customers will want to buy many pumpkins to decorate their houses and make pumpkin pies. Which
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of the following is a likely result of this scenario?
a. You can charge a higher price per pumpkin.
b. You will wind up with many unsold pumpkins.
c. You will take fewer pumpkins to the market to sell.
d. You will be able to sell only the highest-quality pumpkins.
ANSWER: a

28. At the store, Hershey's Kit Kat candy bars are now cheaper than usual. Which of the following explains why
Kit Kats are cheaper?
a. There is an excess demand for Kit Kats.
b. There is a shortage of Kit Kats.
c. There is a surplus of Kit Kats.
d. There is an increase in the demand for Kit Kats.
ANSWER: c

29. Use the table to answer the question.

What is the equilibrium price in this market?

a. $11
b. $3
c. $9
d. $7
ANSWER: c

30. Use the table to answer the question.

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What is the equilibrium quantity in this market?

a. 70 units
b. 160 units
c. 250 units
d. 200 units
ANSWER: b

31. Use the table to answer the question.

At what price does this market experience a shortage of 140 units?

a. $3
b. $5
c. $13
d. $15
ANSWER: b

32. Use the table to answer the question.

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At what price does this market experience a shortage of 70 units?

a. $5
b. $7
c. $13
d. $15
ANSWER: b

33. Use the table to answer the question.

At what price does this market experience a surplus of 70 units?

a. $7
b. $9
c. $11
d. $15
ANSWER: c

34. Use the table to answer the question.

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At what price does this market experience a surplus of 140 units?

a. $9
b. $11
c. $13
d. $15
ANSWER: c

35. Use the table to answer the question.

What is the equilibrium price in this market?

a. $60
b. $45
c. $35
d. $50
ANSWER: d

36. Use the table to answer the question.

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What is the equilibrium quantity in this market?

a. 240 units
b. 100 units
c. 300 units
d. 330 units
ANSWER: c

37. Use the table to answer the question.

At what price does this market experience a shortage of 50 units?

a. $45
b. $50
c. $25
d. $55
ANSWER: a

38. Use the table to answer the question.

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At what price does this market experience a shortage of 100 units?

a. $60
b. $30
c. $50
d. $40
ANSWER: d

39. Use the table to answer the question.

At what price does this market experience a surplus of 100 units?

a. $60
b. $30
c. $40
d. $50
ANSWER: a

40. Use the table to answer the question.

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At what price does this market experience a surplus of zero units?

a. $60
b. $30
c. $40
d. $50
ANSWER: d

41. The United Kingdom plans to end the use of gas-powered and diesel-powered cars by the year 2040. At the
same time, car manufacturers, such as General Motors and Nissan, are increasing the number of electric car
models they produce. Based on this information, which of the following statements is/are correct?
(i) If the supply of new electric cars is greater than the demand for new electric cars, then the price of electric
cars will fall in the future.
(ii) The demand for gasoline will fall in the future.
(iii) The demand for electricity will rise in the future.
(iv) The demand for diesel will rise in the future.
a. only (i)
b. (i) and (ii)
c. (i), (ii), and (iii)
d. (ii) and (iv)
ANSWER: c

42. You go to Starbucks and see that the price of your favorite tall vanilla latte has gone up by 25 cents. All
sizes of the vanilla lattes are now more expensive. As a result of this price increase, you would expect to see a
a. fall in the demand for vanilla lattes.
b. fall in the quantity demanded of vanilla lattes.
c. rise in the demand for vanilla lattes.
d. rise in the quantity demanded of vanilla lattes.
ANSWER: b

43. Cedar point amusement park reduces its entry fees. As a result of this price fall,
a. the demand will decrease.
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b. the quantity demanded will be smaller.

c. the demand will rise.
d. the quantity demanded will be higher.
ANSWER: d

44. At Trader Joe's, the price of chocolate chip cookies falls. As a result, you would expect to see
a. an increase in the demand for chocolate chip cookies.
b. a rise in the quantity demanded of chocolate chip cookies.
c. a decrease in the demand for chocolate chip cookies.
d. a drop in the quantity demanded of chocolate chip cookies.
ANSWER: b

45. (Figure: Shift in Supply 1) Use the figure to answer the question.

Which of the following market changes would lead to a shift of the supply curve from Old supply to New
supply?
a. Lower costs of transportation for the producers.
b. A smaller number of consumers for the product.
c. A decrease in consumer incomes.
d. An increase in consumer incomes.
ANSWER: a

46. (Figure: Shift in Supply 2) Use the figure to answer the question.

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Which of the following market changes would lead to a shift of the supply curve from Old supply to New
supply?
a. An increase in production efficiency
b. An increase in the number of sellers for the product
c. An increase in the price of an input used in production
d. Fewer consumers in the market
ANSWER: c

47. (Figure: Shift in Supply 2) Use the figure to answer the question.

Which of the following market changes would lead to a shift of the supply curve from Old supply to New
supply?
a. Fewer sellers in the market.
b. A drop in the number of consumers for this product.
c. An expectation that future prices for the product will be lower.
d. A decrease in income taxes on consumers.
ANSWER: a

48. (Figure: Shift in Supply 1) Use the figure to answer the question.

Which of the following events would lead to a shift of the supply curve from Old supply to New supply?
a. a natural disaster that causes a shutdown of production
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b. increased taxation of raw materials used by producers

c. a decrease in the size of the market
d. technological advance in production techniques
ANSWER: d

49. (Figure: Shift in Supply 2) Use the figure to answer the question.

Which of the following market changes would lead to a shift of the supply curve from Old supply to New
supply?
a. A rise in the price of a product that is a substitute-in-production.
b. A fall in the price of a product that is a substitute-in-production.
c. An increase in the price of a product that is a complement-in-production.
d. An increase in production efficiency.
ANSWER: a

50. (Figure: Shift in Supply 1) Use the figure to answer the question.

Which of the following market changes would lead to a shift of the supply curve from Old supply to New
supply?
a. A fall in the price of a product that is a substitute-in-production.
b. A rise in the price of a product that is a substitute-in-production.
c. A rise in the price of a product that is a complement-in-production.
d. An increase in production efficiency.
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ANSWER: c

51. If there is a technological advance in the production of the Amazon Echo smart speaker, you would expect
to see _____ overtime.
a. a rise in its equilibrium price
b. a fall in its equilibrium price
c. no change in its equilibrium price
d. a fall in the equilibrium quantity sold
ANSWER: b

52. What affect will the release of the new Mercedes E-Class sedan have on last year's models that are still on
the dealers' lots? Use supply and demand concepts to do your analysis.
a. The arrival of the new E-Class would lead to a decrease in demand for last year's model and their
prices would fall.
b. The arrival of the new E-Class would cause the demand for the older model to fall to almost zero.
c. The arrival of the new E-Class would lead to an increase in demand for last year's model, and their
prices would rise.
d. The arrival of the new E-Class would lead to an increased supply of last year's model, and their
prices would fall.
ANSWER: a

53. A new economic report discusses the high probability that sugar prices will rise soon. The expectation of
sugar prices rising soon will lead to
a. decreased demand today and a fall in sugar prices.
b. increased supply today and a fall in sugar prices.
c. the government issuing subsidies for sugar production.
d. decreased supply today and a rise in sugar prices.
ANSWER: d

54. If an aircraft is found to have software problems that could lead to a malfunction, the effect on the aircraft
market will be that the
a. demand will increase, and the price of the aircraft will rise.
b. demand will remain unchanged.
c. supply will increase, and the price of the aircraft will fall.
d. demand will decrease, and the price of the aircraft will fall.
ANSWER: d

55. (Figure: Shift in Demand 1) Use the figure to answer the question.

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Which of the following market changes would lead to a shift of the demand curve from Old demand to New
demand?
a. A technological improvement in the production of the product.
b. A lower cost of production for the product.
c. More sellers in the market.
d. Increase in popularity of the product by buyers.
ANSWER: d

56. (Figure: Shift in Demand 2) Use the figure to answer the question.

Which of the following market changes would lead to a shift of the demand curve from Old demand to New
demand?
a. An increase in the popularity of the product with consumers.
b. A fall in the price of a substitute product.
c. A fall in the price of a complementary product.
d. Fewer sellers in the market.
ANSWER: b

57. (Figure: Shift in Demand 1) Use the figure to answer the question.

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Which of the following market changes would lead to a shift of the demand curve from Old demand to New
demand?
a. The publication of a report indicating the product is harmful.
b. A fall in the price of a substitute product.
c. Fewer sellers in the market.
d. A fall in the price of a complementary product.
ANSWER: d

58. (Figure: Shift in Demand 2) Use the figure to answer the question.

Which of the following market changes would lead to a shift of the demand curve from Old demand to New
demand?
a. A report is published noting that the product has adverse health effects.
b. There is a decrease in the price of a substitute product.
c. There is an increase in the number of consumers in the market for the product.
d. There is an improvement in production technology used by sellers.
ANSWER: a

59. There are empty candy shelves at Walmart on the day before Halloween. Which of the following explains
this event?
a. There is a rise in the equilibrium price of candy.
b. There is a surplus in the candy market.
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c. There is a shortage in the candy market.

d. Walmart decided that kids should not have candy on Halloween.
ANSWER: c

60. (Figure: Market for Shrimp) Use the figure to answer the question.

In 2018, Hurricane Michael hit Florida and destroyed some shrimp wholesale facilities. Which graph correctly
depicts the effect of the hurricane on the equilibrium price and quantity in the shrimp market?
a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c
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61. (Figure: Market for Train Rides) Use the figure below to answer the question.

A major technological advancement occurs in transportation technology, which leads to faster and more
efficient train systems. Which graph depicts the effect on the supply of train rides?
a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

62. (Figure: Market for Used Books) Use the figure to answer the question.

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A campus bookstore sells both new and used books and rents them as well. In a particular semester, the
percentage of students who opt for used books and rentals increases, and the percentage of students who opt for
new books decreases. Which graph shows the new equilibrium that would result in the market for used books?
a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

63. (Figure: Market for Juice) Use the figure to answer the question.

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You are studying the demand for Minute Maid and Tropicana orange juice. Minute Maid improves the taste of
its juice and people start preferring Minute Maid over Tropicana. Which graph depicts the impact of these
changes on both Minute Maid and Tropicana?
a. Graph A shows what happens in the market for Minute Maid, and Graph D shows what happens in
the market for Tropicana.
b. Graph A shows what happens in the market for Minute Maid, and Graph B shows what happens in
the market for Tropicana.
c. Graph B shows what happens in the market for Minute Maid, and Graph A shows what happens in
the market for Tropicana.
d. Graph B shows what happens in the market for Minute Maid, and Graph D shows what happens in
the market for Tropicana.
ANSWER: b

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64. (Figure: Market for Cars) Use the figure to answer the question.

In 2011, Japan suffered a major earthquake and tsunami. Honda parts that were sourced from Japan could no
longer be produced, which caused Honda to cut its production of cars. Which graph shows the effect of this
shortfall?
a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c

65. (Figure: Market for Canadian Goods with US Inputs) Use the figure to answer the question.

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The Canadian dollar has strengthened against the US dollar, meaning that it takes fewer Canadian dollars to
purchase a US dollar. What will happen to the supply of Canadian goods that use inputs made in the US?
Choose the graph that correctly depicts your answer.
a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

66. (Figure: Market for Canadian Goods with US Inputs) Use the figure to answer the question.

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The Canadian dollar has weakened against the US dollar, meaning that it takes more Canadian dollars to
purchase a US dollar. What will happen to the supply of Canadian goods that use inputs made in the US?
Choose the graph that correctly depicts your answer.
a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: c

67. (Figure: Canadian Demand for Floridian Cruises) Use the figure to answer the question.

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The Canadian dollar has weakened against the US dollar, meaning that it takes more Canadian dollars to
purchase a US dollar. What will happen to the Canadian demand for US cruises from Florida? Choose the graph
that correctly depicts your answer.
a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: b

68. (Figure: Canadian Demand for US designer goods) Use the figure to answer the question.

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Canadians who live in border towns sometimes cross the border into the United States to buy goods and
services from there. You find the Canadian dollar has strengthened against the US dollar, meaning that it takes
fewer Canadian dollars to buy a US dollar. What would happen to the Canadian demand for US designer goods
sold in the US? Choose the graph that depicts your answer.
a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

69. You are studying the international market for coffee. The world production of coffee beans increases, and at
the same time, consumers worldwide start favoring tea over coffee. What is the effect on the equilibrium price
and the equilibrium quantity in the coffee market?
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a. The equilibrium price rises, and the equilibrium quantity falls.

b. The equilibrium price falls, and the equilibrium quantity rises.
c. The equilibrium price falls, and the change in the equilibrium quantity is ambiguous.
d. The equilibrium quantity falls, and the change in the equilibrium price is ambiguous.
ANSWER: c

70. A growing number of utility companies are using drones for site inspections. What is the effect of these
changes on the equilibrium price and quantity, in the market for drones?
a. Both the equilibrium price and the equilibrium quantity will rise.
b. The equilibrium price falls, and the equilibrium quantity rises.
c. The equilibrium price rises and the equilibrium quantity falls.
d. The equilibrium price rises and the change in equilibrium quantity is ambiguous.
ANSWER: a

71. A new study discovers the health benefits of eating fish regularly. At the same time, some consumers decide
to become vegetarians. What is the effect of these events on the equilibrium price and quantity in the fish
market?
a. The equilibrium price rises, and the equilibrium quantity falls.
b. The equilibrium price falls, and the equilibrium quantity rises.
c. The equilibrium price falls, and the change in the equilibrium quantity is ambiguous.
d. The change in both the equilibrium price and quantity is ambiguous.
ANSWER: d

72. What happens to the equilibrium price and equilibrium quantity when demand and supply increase
simultaneously, but the relative size of the shifts are not known?
a. The equilibrium price rises, and the change in the equilibrium quantity is ambiguous.
b. The equilibrium price falls, and the change in the equilibrium quantity is ambiguous.
c. The equilibrium quantity rises, and the change in the equilibrium price is ambiguous.
d. The equilibrium quantity falls, and the change in the equilibrium price is ambiguous.
ANSWER: c

73. What happens to the equilibrium price and equilibrium quantity when demand and supply decrease
simultaneously, but the relative size of the shifts are not known?
a. The equilibrium price rises, and the change in equilibrium quantity is ambiguous.
b. The equilibrium price falls, and the change in equilibrium quantity is ambiguous.
c. The equilibrium quantity rises, and the change in equilibrium price is ambiguous.
d. The equilibrium quantity falls, and the change in equilibrium price is ambiguous.
ANSWER: d

74. What happens to the equilibrium price and quantity when demand decreases and at the same time supply
increases, but the relative size of the shifts are not known?
a. The equilibrium price rises, and the change in the equilibrium quantity is ambiguous.
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b. The equilibrium price falls, and the change in the equilibrium quantity is ambiguous.
c. The equilibrium quantity rises, and the change in the equilibrium price is ambiguous.
d. The equilibrium quantity falls, and the change in the equilibrium price is ambiguous.
ANSWER: b

75. What happens to the equilibrium price and quantity when demand increases and simultaneously supply
decreases, and the relative size of the shifts is not known?
a. The equilibrium price rises, and the change in the equilibrium quantity is ambiguous.
b. The equilibrium price falls, and the change in the equilibrium quantity is ambiguous.
c. The equilibrium quantity rises, and the change in the equilibrium price is ambiguous.
d. The equilibrium quantity falls, and the change in the equilibrium price is ambiguous.
ANSWER: a

76. What happens to the equilibrium price and quantity when demand increases and at the same time supply
decreases, but the demand shift is larger than the supply shift?
a. The equilibrium price rises, and the equilibrium quantity falls.
b. Both the equilibrium price and the equilibrium quantity rise.
c. The equilibrium price falls, and the equilibrium quantity rises.
d. Both the equilibrium price and the equilibrium quantity fall.
ANSWER: b

77. What happens to the equilibrium price and quantity when demand increases and at the same time supply
decreases, but the demand shift is smaller than the supply shift?
a. The equilibrium price rises, and the equilibrium quantity falls.
b. Both the equilibrium price and the equilibrium quantity will rise.
c. The equilibrium price falls, and the equilibrium quantity rises.
d. Both the equilibrium price and the equilibrium quantity will fall.
ANSWER: a

78. What happens to the equilibrium price and quantity when demand decreases and at the same time supply
increases, but the demand shift is relatively larger than the supply shift?
a. The equilibrium price rises, and the equilibrium quantity falls.
b. Both the equilibrium price and the equilibrium quantity will rise.
c. The equilibrium price falls, and the equilibrium quantity rises.
d. Both the equilibrium price and quantity will fall.
ANSWER: d

79. What happens to the equilibrium price and quantity when demand decreases and at the same time supply
increases, and the demand shift is relatively smaller than the supply shift?
a. The equilibrium price rises, and the equilibrium quantity falls.
b. Both the equilibrium price and quantity will rise.
c. The equilibrium price falls, and the equilibrium quantity rises.
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d. Both the equilibrium price and quantity will fall.

ANSWER: c

80. Shifts in supply

a. always lead to increases in equilibrium price.
b. lead to price and quantity to move in the same direction.
c. always lead to increases in equilibrium quantity.
d. lead to price and quantity to move in opposite directions.
ANSWER: d

81. Shifts in demand

a. always lead to increases in equilibrium price.
b. lead to price and quantity to move in the same direction.
c. always lead to increases in equilibrium quantity.
d. lead to price and quantity to move in opposite directions.
ANSWER: b

82. Saudi Arabia is a member of the Organization of the Petroleum Exporting Countries (OPEC). The countries
in OPEC produce oil according to preset amounts (quotas). When Saudi Arabia cuts oil production, the
a. supply of crude oil will fall, and the prices of oil in world markets will rise.
b. supply of crude oil will rise, and the prices of oil in world markets will fall.
c. demand for crude oil will fall, and the prices of oil in world markets will rise.
d. demand for crude oil will fall, and the prices of oil in world markets will fall.
ANSWER: a

83. Fish farmers find that a form of bacteria is negatively affecting the reproductive capability of the fish in the
fish farms. Which graph depicts what will happen in the market for farmed fish?
a. Graph A

b. Graph B

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c. Graph C

d. Graph D

ANSWER: c

84. An economics conference is scheduled to take place in San Diego. Several thousand attendees from around
the world are expected to arrive in San Diego for the conference. Which graph depicts what will happen in the
market for hotel rooms in San Diego?
a. Graph A

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b. Graph B

c. Graph C

d. Graph D

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ANSWER: a

85. The fidget spinner toy fad is over, and children are not buying them with the same enthusiasm as they did
earlier. Which graph depicts the situation in the market for fidget spinners?
a. Graph A

b. Graph B

c. Graph C

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d. Graph D

ANSWER: d

86. When the holiday season arrives this year, people prefer to buy gifts online. Which graph depicts how the
market of parcel delivery services change during this holiday season?
a. Graph A

b. Graph B

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c. Graph C

d. Graph D

ANSWER: b

87. In 2017, Kenya banned the use of disposable plastic shopping bags due to concern over plastics pollution.
Which graph depicts what happened in the country's market for reusable cloth bags?
a. Graph A

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b. Graph B

c. Graph C

d. Graph D

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ANSWER: a

88. These days people prefer electric vehicles over gasoline-powered vehicles. Which graph shows what will
happen in the gasoline-powered vehicle market as a result of this?
a. Graph A

b. Graph B

c. Graph C

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d. Graph D

ANSWER: d

89. Why are diamonds more expensive than water? Pick the statements below that answer this question.
(i) Water is scarcer than diamonds.
(ii) Diamonds are more difficult to mine and produce than water.
(iii) Diamonds are scarcer than water.
(iv) Many more people buy diamonds as compared to water.
a. (i) and (iv)
b. (i) and (ii)
c. (ii) and (iii)
d. (iii) and (iv)
ANSWER: c

90. Which of the following explains why a seller might charge a high price when a new video game console is
first released and then lower the price as time goes by?
a. The seller can charge a high price to consumers who want to be the first ones to own a newly
released product.
b. The seller wants to test the market to see how consumers react to the product.
c. The buyers want to buy the new video game console only if the price is high because a high price
signals good quality.
d. The seller has to sell the newly released video game console at the government-mandated price.
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ANSWER: a

91. A hurricane is expected to hit the Carolinas. Why might the prices of batteries, candles, and bottled water
rise?
a. The government will raise taxes on these products and cause the prices to rise.
b. Sellers will hold back the supply of these items to induce a rise in prices.
c. Buyers will flock to purchase these items, and the excess demand will cause prices to rise.
d. Sellers will lower the supply of these items, which causes prices to rise.
ANSWER: c

92. When there is a shortage of highly skilled workers in a particular region:

a. the incomes of highly skilled workers fall.
b. highly skilled workers can negotiate higher salaries.
c. unemployment rises among highly skilled workers.
d. there is a corresponding surplus of low-skilled workers in the region.
ANSWER: b

93. When there is a shortage of highly skilled workers in a particular region, the:
a. supply of jobs for highly skilled workers increases.
b. demand for skills education decreases.
c. demand for highly skilled workers increases.
d. demand for skills education increases.
ANSWER: d

94. What will happen in the market for clothing when a major department store shifts its production of clothing
to a low-labor-cost country?
a. The shift in production will lead to a decrease in supply and a rise in the price of clothing.
b. The lower cost of production will lead to an increase in supply and a fall in the price of clothing.
c. Buyers will stop buying clothing from this department store.
d. Supply will remain unchanged, and so there will be no change in the price of the clothing.
ANSWER: b

Essay

95. (Figure: Market) Use the figure to answer the questions.

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(i) What is the equilibrium price?

(ii) What is the equilibrium quantity?
(iii) At the price of $400, the market is experiencing a _____ (shortage/surplus) of _____ units.
(iv) At the price of $200, the market is experiencing a _____ (shortage/surplus) of _____ units.
ANSWER: (i) The equilibrium price is $350.
(ii) The equilibrium quantity is 500 units.
(iii) At the price of $400, the market is experiencing a surplus of 200 units.
(iv) At the price of $200, the market is experiencing a shortage of 600 units.

96. (Figure: Market) Use the figure to answer the questions.

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(i) At what price is the market experiencing a shortage of zero units?

(ii) At what price is the market experiencing a surplus of zero units?
(iii) At what price is the market experiencing a surplus of 200 units?
(iv) At what price is the market experiencing a shortage of 600 units?
ANSWER: (i) The market is experiencing a shortage of zero units at $350.
(ii) The market is experiencing a surplus of zero units at $350.
(iii) The market is experiencing a surplus of 200 units at $400.
(iv) The market is experiencing a shortage of 600 units at $200.

97. In each of the cases below, explain whether the change will lead to a shift in supply or a shift in demand and
in which direction.
(i) You are studying the market for bananas. Suppose that the minimum wage that is paid to banana farm
workers increases significantly.
(ii) You are studying the market for bananas. Suppose that a new and popular research report emerges that
discusses previously unknown benefits of eating bananas.
(iii) You are studying the market for cars. Suppose that public transportation becomes free in the particular
market that you are studying.
ANSWER: (i) If the minimum wage that is paid to banana farm workers increase significantly, then the supply
of bananas would be expected to shift left.
(ii) If a new and popular research report emerges that discusses previously unknown benefits of
eating bananas, then the demand for bananas would be expected to shift right.
(iii) If public transportation becomes free in the particular market that you are studying, then the
demand for cars would be expected to shift left.

98. In each of the cases below, explain whether the change will lead to a shift in supply or a shift in demand and
in which direction.
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(i) You are studying the market for gasoline-powered cars in the United States. Suppose that there is a major
shift in auto production from gasoline-powered vehicles to electric vehicles.
(ii) You are studying the tourism market in Egypt. Suppose that there is a political disturbance that causes a
heightened sense of insecurity in the country.
(iii) You are studying the market for acai berry juice. Suppose that there is a significant increase in the price of
acai berries.
ANSWER: (i) If there is a major shift in auto production from gasoline-powered vehicles to electric vehicles,
then the supply of gasoline-powered vehicles would be expected to shift left.
(ii) If there is a political disturbance that causes a heightened sense of insecurity in Egypt, then the
demand for tourism in Egypt would be expected to shift left.
(iii) If there is a significant increase in the price of acai berries, then the supply of acai berry juice
would be expected to shift left.

99. In each of the cases below, explain whether the change will lead to a shift in supply or a shift in demand and
in which direction.
(i) You are studying the demand for and supply of coffee for a particular coffee chain. Suppose that this coffee
chain is concerned about the environment and bans the use of single-use disposable cups. Consumers are
therefore asked to bring in reusable cups or drink their coffee in the store.
(ii) You are studying the market for preschool education. Suppose that the birth rate in the United States
increases.
(iii) You are studying the market for a particular beauty product. A YouTube influencer now endorses that
beauty product.
ANSWER: (i) If a coffee chain is concerned about the environment, bans the use of single-use disposable cups,
and asks consumers to bring in reusable cups or drink their coffee in the store, then the demand for
the coffee from this coffee chain would fall because consumers would find it less convenient to
purchase their coffee from this chain.
(ii) If the birth rate in the United States increases, then in the near future, the demand for preschool
education would be expected to shift right.
(iii) If a YouTube influencer now endorses a particular beauty product, then the demand for the
beauty product would be expected to shift to the right.

100. You are studying the market for public transportation in a particular region. In each of the cases below,
explain whether the change will lead to a shift in supply, a shift in demand, a movement along the supply curve,
or a movement along the demand curve and in which direction.
(i) Suppose that several thousand residents move away from the region you are studying.
(ii) Suppose that several thousand new residents move into the region you are studying.
(iii) Suppose that the local government decides to raise the price of public transportation tickets.
ANSWER: (i) If several thousand residents move away from the region that is being studied, then the demand
for public transportation in the region would be expected to shift left.
(ii) If several thousand new residents move into the region that is being studied, then the demand for
public transportation in the region would be expected to shift right.
(iii) If the local government decides to raise the price of public transportation tickets, then the rise in
ticket prices would cause the quantity demanded of tickets to fall, and this is illustrated by a leftward
(or upward) movement along the same demand curve.

101. (Figure: Market) Use the graph to answer the questions.

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(i) What is the equilibrium price?

(ii) What is the equilibrium quantity?
(iii) At the price of $450, the market is experiencing a _____ (shortage/surplus) of _____ units.
(iv) At the price of $300, the market is experiencing a _____ (shortage/surplus) of _____ units.
ANSWER: (i) The equilibrium price is $400.
(ii) The equilibrium quantity is 300 units.
(iii) At the price of $450, the market is experiencing a surplus of 150 units.
(iv) At the price of $300, the market is experiencing a shortage of 400 units.

102. (Figure: Market) Use the graph to answer the questions.

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(i) At what price is the market experiencing a shortage of zero units?

(ii) At what price is the market experiencing a surplus of zero units?
(iii) At what price is the market experiencing a shortage of 400 units?
(iv) At what price is the market experiencing a surplus of 150 units?
ANSWER: (i) The market is experiencing a shortage of zero units at $400.
(ii) The market is experiencing a surplus of zero units at $400.
(iii) The market is experiencing a shortage of 400 units at $100.
(iv) The market is experiencing a surplus of 150 units at $450.

103. You are studying the market for a particular new smartphone. You notice that several changes are
happening in the market at the same time. The company that makes the smartphones has just opened a
production plant in Malaysia where the cost of labor is lower than it is in the United States. The company has
also switched to using a more cost-effective material for the outer shell of the phone. In addition, a new
advertising campaign for the phone has gone viral, and now everybody wants this phone. What do you expect
will happen to the equilibrium price and the equilibrium quantity? Explain your answer.
ANSWER: If the smartphone producer is now producing the phones in a low-labor-cost environment and using
a more cost-effective material to build the phone, these changes will cause the supply of the phones
to increase. This shift puts downward pressure on the price and upward pressure on quantity
demanded. The popularity of the advertising campaign leads to an increase in demand, which puts
upward pressure on the price and quantity. Because both supply and demand are increasing but we
do not know the relative sizes of the shifts, we cannot determine exactly where the equilibrium price
will end up. We can conclude, however, that the equilibrium quantity will rise.

104. You are studying the market for a particular brand of perfume. You notice that a couple of changes are
happening in the market at the same time. The flower that creates the perfume scent has been affected by a
disease. In addition, consumers begin to worry about the safety of the ingredients that are used in the perfume.
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What do you expect will happen to the equilibrium price and the equilibrium quantity? Explain your answer.
ANSWER: If the flower that creates the perfume scent has been affected by a disease, this will cause the supply
of the flower to decrease. This will, in turn, cause input prices for the perfume supplier to rise.
Rising input prices cause the supply curve to shift to the left. This shift puts upward pressure on the
price and downward pressure on quantity demanded. If consumers begin to worry about the safety
of the ingredients in the perfume, the demand for the perfume will decrease. This will lead to a
lower price and less quantity. Supply and demand are decreasing simultaneously, but we do not
know the relative sizes of the shifts. We cannot determine the new equilibrium price, but we can
conclude the equilibrium quantity will fall.

105. You are the market analyst for a major clothing company that sells high-end designer clothing. The
company has a production factory in a different country where the costs of labor are low. Thereafter, the
company imports the clothing to the United States. You notice that a couple of changes are happening in the
market at the same time. Rising unemployment in the economy leads consumer demand for luxury goods to fall.
Simultaneously, a news exposé highlights the poor working conditions in the factory where the clothes are
produced. These events lead to a consumer backlash against your company. What do you expect will happen to
the equilibrium price and the equilibrium quantity? Explain your answer.
ANSWER: Both of the changes described — rising unemployment in the economy that leads consumer demand
for luxury goods to fall and a news story that highlights the poor working conditions in the factory
where the clothes are produced — cause demand to decrease. Consumers are now demanding fewer
luxury goods, including high-end clothing, and this will cause demand to decrease. At the same
time, the backlash against your company will also cause the demand for the clothing to decrease.
The equilibrium price and the equilibrium quantity will both fall.

106. An aircraft manufacturer is experiencing problems with one of its aircrafts and, this aircraft is subsequently
grounded by the Federal Aviation Administration (FAA). What do you expect will happen to the price of last-
minute airline tickets? Explain your answer.
ANSWER: Suggested Answer:
The grounding of the aircraft will lead to a reduction in seat availability. The supply curve shifts to
the left, and the price of last-minute airline tickets will rise.

107. A market is described by these two equations: Qd = 120 – 2P and Qs = 20 + 2P. Using this information,
answer the following questions.
(i) Calculate the equilibrium price.
(ii) Calculate the equilibrium quantity.
ANSWER: (i) To calculate the equilibrium price, set Qd = Qs, and solve for P. Therefore, 120 – 2P = 20 + 2P.
Thus, 100 = 4P. Solving for P yields the equilibrium price of $25.
(ii) To calculate the equilibrium quantity, this price can now be substituted back into either the
demand equation or the supply equation. Thus, the equilibrium quantity is 70 units.

108. A market is described by these two equations: Qd = 75 – 5P and Qs = 5P. Using this information, answer
the following questions.
(i) Calculate the equilibrium price.
(ii) Calculate the equilibrium quantity.
ANSWER: (i) To calculate the equilibrium price, set Qd = Qs, and solve for P. Therefore, 75 – 5P = 5P. Thus,

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75 = 10P. Solving for P yields the equilibrium price of $7.50.

(ii) To calculate the equilibrium quantity, this price can now be substituted back into either the
demand equation or the supply equation. Thus, the equilibrium quantity is 37.5 units.

109. A market is described by these two equations: Qd = 1,200 – 4P and Qs = –200 + P. Using this information,
answer the following questions.
(i) Calculate the equilibrium price.
(ii) Calculate the equilibrium quantity.
ANSWER: (i) To calculate the equilibrium price, set Qd = Qs, and solve for P. Therefore, 1,200 – 4P = –200 +
P. Thus, 1,400 = 5P. Solving for P yields the equilibrium price of $280.
(ii) To calculate the equilibrium quantity, this price can now be substituted back into either the
demand equation or the supply equation. Thus, the equilibrium quantity is 80 units.

110. A market is described by these two equations: Qd = 90 – 3P, and Qs = 10 + P. Using this information,
answer the following questions.
(i) Calculate the equilibrium price.
(ii) Calculate the equilibrium quantity.
ANSWER: (i) To calculate the equilibrium price, set Qd = Qs, and solve for P. Therefore, 90 – 3P = 10 + P.
Thus, 80 = 4P. Solving for P yields the equilibrium price of $20.
(ii) To calculate the equilibrium quantity, this price can now be substituted back into either the
demand equation or the supply equation. Thus, the equilibrium quantity is 30 units.

111. The production costs of laptop computers have decreased, and consumers are now demanding more
laptops. What are the possible outcomes for the equilibrium price and the equilibrium quantity of laptop
computers? Draw graphs to illustrate your answer.
ANSWER: There are three possible outcomes for the equilibrium price, and the corresponding effect on
equilibrium quantity is to increase for all three possible outcomes.
In the first graph, the relative shifts in supply and demand are equal, which leads the price to remain
unchanged and the equilibrium quantity to increase. The two curves exactly offset each other as far
as the effect on price is concerned.
In the second graph, the increase in demand is larger than the increase in supply. This leads both
equilibrium price and equilibrium quantity to increase. Whenever demand shifts are larger than
supply, the demand effect dominates, and both price and quantity rise.
In the third graph, the increase in supply is larger than the increase in demand. The result is that
price falls and quantity rises. In this outcome, the increase in supply dominates the increase in
demand, and the result is a fall in price.

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112. More steak is being produced, but a larger percentage of consumers are becoming vegetarians. What are
the possible outcomes for the equilibrium price and the equilibrium quantity in the market for steak? Draw
graphs to illustrate your answer.
ANSWER: As more steak is produced, the supply curve shifts to the right. Conversely, as more consumers
become vegetarian, the demand for steak falls, and the curve shifts to the left. There are three
possible outcomes for the equilibrium quantity, based on the relative change in demand and supply.
In all these outcomes, the equilibrium price decreases.
In the first graph, the relative increase in supply is the same as the relative decrease in demand. The
effect on price is that it decreases, and the equilibrium quantity is unchanged.
In the second graph, the relative increase in supply is greater than the relative decrease in demand.
The effect on the equilibrium price is that it falls, and the effect on the equilibrium quantity is that it
increases. In this outcome, supply dominates, and the resulting effect on price and quantity is in
opposite directions.
In the third graph, the relative decrease in demand is larger than the relative increase in supply. The
result is that both the equilibrium quantity and the equilibrium price fall. In this outcome, demand
dominates, and the change in price and quantity is in the same direction.

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113. Suppose that half of the existing airline companies shut down and more consumers are opting for land
transportation instead of air transportation. What are the possible outcomes for the equilibrium price and the
equilibrium quantity in the market for airlines tickets? Draw graphs to illustrate your answer.
ANSWER: When a large number of airline companies shut down, this decreases supply, and the supply curve
shifts to the left. This leads to an increase in the equilibrium price and a fall in the equilibrium
quantity. On the demand side, as more consumers opt for land transportation, the demand for air
transportation falls, and the demand curve shifts to the left as well. The final effect on the
equilibrium price and quantity depends on the relative change in supply and demand.
In the first graph, the relative decrease in both supply and demand is the same. This results in a
lower equilibrium quantity. The equilibrium price remains unchanged because the two changes
cancel each other out.
In the second graph, the relative decrease in supply is larger than the relative decrease in demand.
This results in a decrease in the equilibrium quantity and an increase in the equilibrium price. The
bigger change in supply dominates the effect on the equilibrium price.
In the third graph, the relative decrease in demand is larger than the relative decrease in supply. This
results in a decrease in the equilibrium quantity and the equilibrium price. The bigger change in
demand dominates the effect on the equilibrium price, and it decreases.

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114. Wage disagreements cause workers in automobile factories to stop working at a time of the year when
consumers desire to buy more vehicles to take road trips during the summer. What are the possible outcomes for
the equilibrium price and the equilibrium quantity in the market for automobiles? Draw graphs to illustrate your
answer.
ANSWER: Workers in automobile factories stop working, which leads to a fall in the production of
automobiles. Hence, the supply decreases, and the supply curve shifts to the left. On the demand
side, consumer desire to buy more vehicles leads to an increase in demand, and the demand curve
shifts to the right. There are three possible outcomes for the equilibrium price and the equilibrium
quantity, depending on the relative impact of the demand and supply shift.
In the first graph, the relative shift of the demand and supply curves is the same, so the combined
effect on the equilibrium price is that it increases. The effect on the equilibrium quantity is that it
remains unchanged because the shift of demand and the shift of supply cancel each other out.
In the second graph, the supply decreases relatively more than the increase in demand. The effect on
equilibrium price is that increases, and the effect on the equilibrium quantity is that it decreases.
In the third graph, the increase in demand is relatively larger than the decrease in supply. The effect
is that the demand shift dominates, and both the equilibrium price and the equilibrium quantity
increase.

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115. There is an increased demand for online courses and an increased supply of professors teaching online
courses. What are the possible outcomes for the equilibrium price and the equilibrium quantity of online
courses? Draw graphs to illustrate your answer.
ANSWER: There are three possible outcomes for the equilibrium price, and the corresponding effect on
equilibrium quantity is to increase for all three possible outcomes.
In the first graph, the relative shifts in supply and demand are equal, which results in the price
remaining unchanged and an increase in equilibrium quantity. The two curves exactly offset each
other as far as the effect on price is concerned.
In the second graph, the increase in demand is larger than the increase in supply. This leads both
equilibrium price and equilibrium quantity to increase. Whenever demand shifts are larger than
supply, the demand effect dominates, and both price and quantity rise.
In the third graph, the increase in supply is larger than the increase in demand. The result is that
price falls and the quantity rises. In this outcome, the increase in supply dominates the increase in
demand, and the result is a fall in price.

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116. The following data shows the monthly demand and supply of wild-caught fish from the seafood market.

(i) What is the equilibrium price per pound of wild-caught fish?

(ii) What is the equilibrium quantity of wild-caught fish?
(iii) At the price of $5.99 per pound, is there a shortage or a surplus of wild-caught fish, and what is the amount
of the shortage or surplus?
(iv) At the price of $11.99 per pound, is there a shortage or a surplus of wild-caught fish, and what is the
amount of the shortage or surplus?
ANSWER: (i) The equilibrium price per pound of wild-caught fish is $9.99.
(ii) The equilibrium quantity of wild-caught fish is 1,150 pounds per month.
(iii) At the price of $5.99 per pound, there is a shortage of 1,000 pounds of fish.
(iv) At the price of $11.99 per pound, there is a surplus of 500 pounds of fish.

117. The following data shows the weekly demand and supply of strawberries at the local grocery store.

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(i) What is the equilibrium price per pound of strawberries?

(ii) What is the equilibrium quantity of strawberries?
(iii) At the price of $2.49 per pound, is there a shortage or a surplus of strawberries, and what is the amount of
the shortage or surplus?
(iv) At the price of $4.99 per pound, is there a shortage or a surplus of strawberries, and what is the amount of
the shortage or surplus?
ANSWER: (i) The equilibrium price per pound of strawberries is $2.99.
(ii) The equilibrium quantity of strawberries is 670 pounds per week.
(iii) At the price of $2.49 per pound, there is a shortage of 50 pounds of strawberries.
(iv) At the price of $4.99 per pound, there is a surplus of 200 pounds of strawberries.

118. The following data shows the yearly demand and supply of staterooms on board a cruise ship.

(i) At what price does the cruise ship experience a shortage of 300 rooms?
(ii) At what price does the cruise ship experience a surplus of 300 rooms?
ANSWER: (i) There is a shortage of 300 rooms at the price of $699 per stateroom.
(ii) There is a surplus of 300 rooms at the price of $899 per stateroom.

119. Canada removes an import tax on certain types of steel. What effect does this have on the steel market in
Canada? What happens to the equilibrium price of steel in Canada?
ANSWER: If Canada removes an import tax on certain types of steel, this would cause an increase in the supply
of steel in Canada, and the equilibrium price would fall.

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Multiple Choice

1. Mary loves avocados and must consume avocados every week, regardless of the price. Which of the
following must be true?
a. Mary has an inelastic demand for avocados.
b. Avocados are in large supply in the market.
c. Mary has an elastic demand for avocados.
d. All consumers in the market have a high demand for avocados.
ANSWER: a

2. A measure of how responsive buyers are to price changes is the:

a. price elasticity of demand.
b. price elasticity of supply.
c. cross-price elasticity of demand.
d. income elasticity of demand.
ANSWER: a

3. Price elasticity of demand measures how responsive _____ are to _____ changes.
a. buyers; quantity
b. buyers; price
c. buyers; income
d. sellers; quantity
ANSWER: b

4. Price elasticity of demand is calculated by dividing the _____ by the _____.

a. percent change in price; percent change in quantity demanded
b. percent change in price; percent change in quantity supplied
c. percent change in quantity demanded; percent change in income
d. percent change in quantity demanded; percent change in price
ANSWER: d

5. Lyft cuts the price of a ride in New York City by 20%. Thereafter, the quantity of rides demanded rises by
25%. What is the absolute value of the price elasticity of demand for Lyft rides?
a. 0.8
b. –0.8
c. 1.25
d. –1.25
ANSWER: c

6. Lyft cuts the price of a ride in New York City by 10%. Thereafter, the quantity of rides demanded rises by
25%. What is the absolute value of the price elasticity of demand for Lyft rides?
a. 0.4
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b. –0.4
c. 2.5
d. –2.5
ANSWER: c

7. Uber cuts the price of a ride in Los Angeles by 15%. Thereafter, the quantity of rides demanded rises by
45%. What is the absolute value of the price elasticity of demand for Uber rides?
a. 0.33
b. –0.33
c. 3
d. –3
ANSWER: c

8. The price of milk at the local grocery store is cut by 25%. In response to this price cut, the quantity of milk
demanded increases by 10%. What is the absolute value of the price elasticity of demand for milk?
a. 2.5
b. –2.5
c. 0.4
d. –0.4
ANSWER: c

9. The price of milk at the local grocery store is cut by 15%, and the quantity of milk demanded increases by
10% in response. What is the absolute value of the price elasticity of demand for milk?
a. 1.5
b. –1.5
c. 0.67
d. –0.67
ANSWER: c

10. The price of milk at the local grocery store is cut by 10%. The quantity of milk demanded increases by 5%
in response to this price cut. What is the absolute value of the price elasticity of demand for milk?
a. 2
b. –2
c. 0.5
d. –0.5
ANSWER: c

11. The price of a loaf of sourdough bread falls from $2 to $1. In response to this price change, the quantity
demanded for sourdough bread increases by 30%. What is the absolute value of the price elasticity of demand
for sourdough bread?
a. 1.67
b. –1.67
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c. 0.6
d. –0.6
ANSWER: c

12. The price of a car wash falls from $10 to $9. In response to this price change, the quantity demanded for car
washes increases by 20%. What is the absolute value of the price elasticity of demand for car washes?
a. 2
b. –2
c. 0.5
d. –0.5
ANSWER: a

13. The price of a dozen eggs falls from $2.50 to $1.50. In response to this price change, the quantity demanded
for eggs increases by 10%. What is the absolute value of the price elasticity of demand for eggs?
a. 4
b. –4
c. 0.25
d. –0.25
ANSWER: c

14. The price of chicken breast rises from $3.50 per pound to $4.25 per pound. In response to this price change,
the quantity demanded for chicken breast falls by 30%. What is the absolute value of the price elasticity of
demand for chicken breast?
a. 0.83
b. –0.83
c. 1.4
d. –1.4
ANSWER: c

15. The price of turkey breast rises from $3.00 per pound to $3.60 per pound. In response to this price change,
the quantity demanded for turkey breast falls by 40%. What is the absolute value of the price elasticity of
demand for turkey breast?
a. 0.5
b. –0.5
c. 2
d. –2
ANSWER: c

16. The price of cheddar cheese increases from $2.50 per pound and is now $3.50 per pound. In response to this
price change, the quantity demanded for cheddar cheese falls by 50%. What is the absolute value of the price
elasticity of demand for cheddar cheese?
a. 0.8
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b. –0.8
c. 1.25
d. –1.25
ANSWER: c

17. When the absolute value of the price elasticity of demand is greater than 1, demand is:
a. elastic.
b. inelastic.
c. unit elastic.
d. perfectly inelastic.
ANSWER: a

18. When the absolute value of the price elasticity of demand is less than 1, demand is:
a. elastic.
b. inelastic.
c. perfectly elastic.
d. unit elastic.
ANSWER: b

19. When the absolute value of the price elasticity of demand is infinite, demand is:
a. elastic.
b. inelastic.
c. perfectly elastic.
d. perfectly inelastic.
ANSWER: c

20. When the absolute value of the price elasticity of demand is zero, demand is:
a. elastic.
b. inelastic.
c. perfectly elastic.
d. perfectly inelastic.
ANSWER: d

21. The price elasticity of demand for a good with a vertical demand curve is:
a. elastic.
b. inelastic.
c. perfectly elastic.
d. perfectly inelastic.
ANSWER: d

22. The price elasticity of demand for a good with a horizontal demand curve is:
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a. elastic.
b. inelastic.
c. perfectly elastic.
d. perfectly inelastic.
ANSWER: c

23. Uber cuts the price of a ride in New York City by 20%, and the quantity of rides demanded rises by 40%.
The absolute value of the price elasticity of demand for Uber rides is _____, and the price elasticity of demand
for Uber rides is _____.
a. 0.5; elastic
b. 0.5; inelastic
c. 2; elastic
d. 2; inelastic
ANSWER: c

24. Uber increases the price of a ride in New York City by 10%, and the quantity of rides demanded falls by
30%. The absolute value of the price elasticity of demand for Uber rides is _____, and the price elasticity of
demand is _____.
a. 0.33; elastic
b. 0.33; inelastic
c. 3; elastic
d. 3; inelastic
ANSWER: c

25. The price of milk at the local grocery store rises by 25%, and the quantity of milk demanded falls by 10%.
The absolute value of the price elasticity of demand for milk is _____, and demand is _____.
a. 2.5; elastic
b. 2.5; inelastic
c. 0.4; elastic
d. 0.4; inelastic
ANSWER: d

26. The price of milk at the local grocery store is cut by 15%. In response to the price cut, the quantity of milk
demanded falls by 5%. The absolute value of the price elasticity of demand for milk is _____, and the price
elasticity of demand is _____.
a. 3; elastic
b. 3; inelastic
c. 0.33; elastic
d. 0.33; inelastic
ANSWER: d

27. The price of a dozen eggs falls from $2.50 to $1.50. In response to the price change, quantity demanded for
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eggs increases by 30%. The absolute value of the price elasticity of demand for eggs is _____, and the price
elasticity of demand is _____.
a. 1.33; elastic
b. 1.33; inelastic
c. 0.75; elastic
d. 0.75; inelastic
ANSWER: d

28. The price of a gallon of milk rises from $2 to $2.60. In response to this price change, the quantity demanded
for milk falls by 5%. The absolute value of the price elasticity of demand for milk is _____, and the price
elasticity of demand is _____.
a. 6; elastic
b. 6; inelastic
c. 0.17; elastic
d. 0.17; inelastic
ANSWER: d

29. The price of chicken breast rises from $3.00 to $3.60 per pound. In response to the price change, the
demand for chicken breast falls by 25%. The absolute value of the price elasticity of demand for chicken breast
is _____, and the price elasticity of demand is _____.
a. 0.8; elastic
b. 0.8; inelastic
c. 1.25; elastic
d. 1.25; inelastic
ANSWER: c

30. The price of chicken breast rises from $3.30 per pound to $3.63 per pound. In response to this price change,
the quantity demanded for chicken breast falls by 40%. The absolute value of the price elasticity of demand for
chicken breast is _____, and the price elasticity of demand is _____.
a. 0.25; elastic
b. 0.25; inelastic
c. 4; elastic
d. 4; inelastic
ANSWER: c

31. If a certain item has many substitutes, its demand curve will be:
a. perfectly elastic.
b. perfectly inelastic.
c. relatively steep.
d. relatively flat.
ANSWER: d

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32. The percent change in insulin demanded for any price change is zero. The demand curve for insulin is
_____, and the price elasticity of demand is _____.
a. vertical; perfectly elastic
b. vertical; perfectly inelastic
c. horizontal; perfectly elastic
d. horizontal; perfectly inelastic
ANSWER: b

33. Suppose the percentage change in newspapers demanded for any price change is infinite. The absolute value
of the elasticity of demand for newspapers is _____, and demand is _____.
a. 0; perfectly elastic
b. 0; perfectly inelastic
c. infinity; perfectly elastic
d. infinity; perfectly inelastic
ANSWER: c

34. You are given some data for four different products — milk, eggs, beef, and orange juice. The absolute
value of the price elasticity of demand for milk is 3. The absolute value of the price elasticity of demand for
eggs is 1.2. The absolute value of the price elasticity of demand for beef is 0.9. The absolute value of the price
elasticity of demand for orange juice is 3.5. Which product has the most elastic demand?
a. milk
b. eggs
c. beef
d. orange juice
ANSWER: d

35. You are given some data for four different products — milk, eggs, beef, and orange juice. The absolute
value of the price elasticity of demand for beef is 0.9. The absolute value of the price elasticity of demand for
orange juice is 3.5. Which product has the most inelastic demand?
a. milk
b. eggs
c. beef
d. orange juice
ANSWER: c

36. You are given data on four products — toothpaste, shampoo, soap, and laundry detergent. The absolute
value of the price elasticity of demand for toothpaste is 4. The absolute value of the price elasticity of demand
for shampoo is 0.2. The absolute value of the price elasticity of demand for soap is 0.5. The absolute value of
the price elasticity of demand for laundry detergent is 2. Which product has the most inelastic demand?
a. toothpaste
b. shampoo
c. soap
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d. laundry detergent
ANSWER: b

37. You are given some data for four different products — dryer sheets, shampoo, soap, and laundry detergent.
The absolute value of the price elasticity of demand for dryer sheets is 4. The absolute value of the price
elasticity of demand for shampoo is 0.2. The absolute value of the price elasticity of demand for soap is 0.5. The
absolute value of the price elasticity of demand for laundry detergent is 2. Which product has the most elastic
demand?
a. dryer sheets
b. shampoo
c. soap
d. laundry detergent
ANSWER: a

38. Suppose the percent change in the quantity demanded for water for any price change is zero. The demand
curve for water is _____, and the price elasticity of demand is perfectly _____.
a. vertical; perfectly elastic
b. vertical; perfectly inelastic
c. horizontal; perfectly elastic
d. horizontal; perfectly inelastic
ANSWER: b

39. (Figure: Demand Curves) The figure shows four different demand curves for four products: A, B, C and D.
Which of the products has the most elastic demand curve?

a. product A
b. product B
c. product C
d. product D
ANSWER: b

40. (Figure: Demand Curves) The figure shows four different demand curves for four products: A, B, C, and D.
Which of the products has the most inelastic demand curve?

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a. product A
b. product B
c. product C
d. product D
ANSWER: a

41. (Figure: Demand Curves) The figure shows four different demand curves for four products: A, B, C and D.
Which of the products has a perfectly elastic demand curve?

a. product A
b. product B
c. product C
d. product D
ANSWER: b

42. (Figure: Demand Curves) The figure shows four different demand curves for four different products: A, B,
C and D. Which of the products has a perfectly inelastic demand curve?

a. product A

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b. product B
c. product C
d. product D
ANSWER: a

43. (Figure: Jane's Demand for Medication) It is mandatory for Jane to take several pills of a certain medication
each day in order to remain healthy. The medication has no substitutes and is produced by only one
pharmaceutical company. Which of the following demand curves represents Jane's demand for the medication?

a. A
b. B
c. C
d. D
ANSWER: a

44. Demand is more elastic when you are shopping in Walmart than when you shop at a small convenience
store because:
a. more competing products means greater elasticity.
b. specific brands tend to have more elastic demand than categories of goods.
c. necessities have less elastic demand.
d. consumer search makes demand more elastic.
ANSWER: a

45. Demand for a particular fast-food chain inside an airport is less elastic than outside of the airport because:
a. necessities have less elastic demand.
b. fewer choices means more inelastic demand.
c. specific brands tend to have more elastic demand than categories of goods.
d. consumer search makes demand more elastic.
ANSWER: b

46. Demand for soda outside an airport is more elastic than inside of the airport because:
a. necessities have less elastic demand.
b. fewer choices means more inelastic demand.
c. specific brands tend to have more elastic demand than categories of goods.
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d. more choices makes demand more elastic.

ANSWER: b

47. If an item is a necessity rather than a luxury, its demand curve will be:
a. perfectly elastic.
b. perfectly inelastic.
c. relatively steep.
d. relatively flat.
ANSWER: c

48. The demand curve for one particular brand of cough syrup will _____ the demand curve for cough syrup as
a general category.
a. be more elastic than
b. have the same elasticity as
c. be more inelastic than
d. have perfectly elastic demand when compared to
ANSWER: a

49. If a consumer has more time to search for a low-cost alternative for an item, the demand curve for that item
will be:
a. relatively more elastic.
b. relatively more inelastic.
c. relatively steep.
d. equal to zero.
ANSWER: a

50. Suppose the price of gasoline rises. As time passes, people adjust to the higher price, and the demand for
gasoline becomes:
a. more elastic.
b. more inelastic.
c. steeper.
d. higher.
ANSWER: a

51. If demand is _____, a higher price yields _____ total revenue.

a. inelastic; lower
b. inelastic; higher
c. elastic; higher
d. elastic; no change in
ANSWER: b

52. If demand is _____, a higher price yields _____ total revenue.

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a. inelastic; lower
b. inelastic; no change in
c. elastic; higher
d. elastic; lower
ANSWER: d

53. Which of the following sellers will achieve their desired result for total revenue?
a. A pharmacy raises the price of its store-brand pain medication in order to raise revenue from sales.
The store-brand medication has many brand-name substitutes.
b. A florist raises the price of roses before and on Valentine's Day and hopes to raise total revenue. The
florist is the only flower shop in town.
c. An airline maintains higher prices in the hopes of maintaining sales. However, a new low-cost
competing airline has just entered the market.
d. In a market with a relatively inelastic demand curve, a coffee shop lowers coffee prices in the hopes
of raising total revenue.
ANSWER: b

54. The cross-price elasticity of demand measures how responsive the:

a. demand for one good is to a change in the price of another good.
b. demand for one good is to a change in the demand for another good.
c. price of a good is to a change in the price of another good.
d. supply of one good is to a change in the price of another good.
ANSWER: a

55. Two products have a cross-price elasticity of demand of 1.5. Based on this value of cross-price elasticity,
which of the following products are they most likely to be?
a. a brand of tea and a brand of sugar
b. a brand of hot dog and a brand of hot dog bun
c. a brand of juice and a brand of computer
d. two competing brands of soft drinks
ANSWER: d

56. Taking the absolute value of the cross-price elasticity of demand is incorrect because it would:
a. remove the ability to tell whether the two products have inelastic demand or elastic demand.
b. cause the value of the cross-price elasticity of demand to become smaller.
c. remove the ability to tell whether the two products are substitutes or complements.
d. cause the value of the cross-price elasticity of demand to become zero.
ANSWER: c

57. The price of product A is cut by 30%. As a result, the quantity demanded of product B rises by 40%. The
cross-price elasticity of demand between product A and product B is _____, and they are _____.
a. –0.75; substitutes
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b. –1.25; complements
c. –1.33; complements
d. 1.25; complements
ANSWER: c

58. The price of product C rises by 10%. As a result, the quantity demanded of product D rises by 20%. The
cross-price elasticity of demand between product C and product D is _____, and they are _____.
a. –2; substitutes
b. 0.5; substitutes
c. 2; substitutes
d. 1.5; complements
ANSWER: c

59. The price of product A is cut by 50%. As a result, the quantity demanded of product B rises by 50%. The
cross-price elasticity of demand between product A and product B is _____, and they are _____.
a. –0.75; complements
b. –1.25; complements
c. –1; complements
d. 1.25; complements
ANSWER: c

60. The price of product C is cut by 10%. As a result, the quantity demanded of product D rises by 20%. The
cross-price elasticity of demand between product C and product D is _____, and they are _____.
a. –0.75; complements
b. –1.25; complements
c. –2; complements
d. 1.25; complements
ANSWER: c

61. Income elasticity of demand measures how responsive the:

a. quantity demanded of a good is to changes in income.
b. quantity demanded of one good is to changes in demand for another good.
c. price of good is to price changes of another good.
d. quantity supplied of one good is to price changes of another good.
ANSWER: a

62. Good M has an income elasticity of demand of –0.7. Which of the following items is good M?
a. bologna
b. organic eggs
c. cruise line tickets
d. designer handbags
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ANSWER: a

63. Good M has an income elasticity of demand of 0.5. Which of the following items is good M?
a. frozen pizza
b. electricity
c. a low-cost brand of noodle
d. steak dinner at a relatively expensive restaurant
ANSWER: b

64. Taking the absolute value of the income elasticity of demand is incorrect because it would:
a. remove the ability to tell whether the two products have inelastic demand or elastic demand.
b. cause the value of the cross-price elasticity of demand to become smaller.
c. remove the ability to tell whether the product is an inferior good or a normal good.
d. cause the value of the cross-price elasticity of demand to become zero.
ANSWER: c

65. Which of the following individuals is LEAST likely to lose their job if the economy is doing poorly?
a. Francesca, who works as a computer repair technician
b. Mercy, who works as a server in a high-end restaurant
c. Kamau, who works at a designer handbag store
d. Maruichi, who works as a manager at a fast-food restaurant
ANSWER: d

66. If income rises by 20% and the quantity demanded of an item rises by 10%, the income elasticity of demand
for this item is:
a. 2.
b. –2.
c. 0.5.
d. –0.5.
ANSWER: c

67. If income rises by 10% and the quantity demanded of an item rises by 20%, the income elasticity of demand
for this item is:
a. 2.
b. –2.
c. 0.5.
d. –0.5.
ANSWER: a

68. If income rises by 20% and the quantity demanded of an item falls by 20%, the income elasticity of demand
for this item is:
a. –1.
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b. 1.
c. –2.
d. –0.5.
ANSWER: a

69. If income rises by 10% and the quantity demanded of an item falls by 30%, the income elasticity of demand
for this item is:
a. 0.67.
b. –0.33.
c. 0.33.
d. –3.
ANSWER: d

70. Delilah's income rises by 8%. She decides to increase the number of movie tickets she purchases by 20%.
Her income elasticity of demand for movie tickets is:
a. 2.5.
b. 0.4.
c. 0.8.
d. –2.5.
ANSWER: a

71. Jonathan's income falls by 15%. He decides to cut down his purchases of high-end restaurant meals by 20%.
His income elasticity of demand for high-end restaurant meals is:
a. 1.33.
b. –0.75.
c. 0.75.
d. –1.33.
ANSWER: a

72. Good M has an income elasticity of demand of –0.7. Which of the following items might good M be?
a. champagne
b. cognac
c. organic, fresh juice
d. generic-brand toothpaste
ANSWER: d

73. You are told that good M has an income elasticity of demand of 5. Which of the following items might good
M be?
a. a hamburger
b. a hot dog
c. a premium computer

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d. a used, 1999 budget four-door sedan

ANSWER: c

74. Price elasticity of supply measures how responsive:

a. sellers are to changes in the prices of competing goods.
b. sellers are to price changes.
c. buyers are to price changes.
d. sellers are to changes in cost of production.
ANSWER: b

75. The price of a dozen eggs falls from $3 to $2.70. In response to this price change, the quantity supplied of
eggs falls from 100,000 dozen eggs to 75,000 dozen eggs. What is the price elasticity of supply for eggs?
a. 2.7
b. 0.37
c. 0.5
d. 2
ANSWER: a

76. The price of cakes rises by 15%. In response, the quantity supplied of cakes rises by 30%. The price
elasticity of supply for cakes is:
a. 2.
b. 0.5.
c. –0.5.
d. 0.33.
ANSWER: a

77. The price of gluten-free buns falls by 7%. In response, the quantity supplied of gluten-free buns falls by
3.5%. The price elasticity of supply for gluten-free buns is:
a. 2.
b. 0.5.
c. –0.5.
d. 0.33.
ANSWER: b

78. The price of a dozen eggs rises from $3 to $4.70. In response to this price change, quantity supplied
increases from 100,000 dozen eggs to 127,000 dozen eggs. What is the approximate price elasticity of supply
for eggs?
a. 1.86
b. 3.52
c. 0.48
d. 2.5
ANSWER: c
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79. If a firm produces a product that has easily available variable inputs, its supply curve will be:
a. perfectly elastic.
b. perfectly inelastic.
c. relatively steep.
d. relatively flat.
ANSWER: d

80. (Figure: Supply Curves) The figure shows four different supply curves for four products: A, B, C, and D.
Which of the products has the most elastic supply curve?

a. product A
b. product B
c. product C
d. product D
ANSWER: c

81. (Figure: Supply Curves) The figure shows four different supply curves for four products: A, B, C and D.
Which of the products has a perfectly elastic supply curve?

a. product A
b. product B
c. product C
d. product D
ANSWER: c

82. (Figure: Supply Curves) The figure shows four different supply curves for four products: A, B, C and D.
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Which of the supply curves most likely shows a product that uses variable inputs that are the most readily
available?

a. product A
b. product B
c. product C
d. product D
ANSWER: c

83. (Figure: Supply Curves) The figure shows four different supply curves for four products: A, B, C and D.
Which of the products has a perfectly inelastic supply curve?

a. product A
b. product B
c. product C
d. product D
ANSWER: a

84. (Figure: Supply Curves) The figure shows four different supply curves for four products: A, B, C and D.
Which of the products has an elastic, but not perfectly elastic, supply curve?

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a. product A
b. product B
c. product C
d. product D
ANSWER: d

85. (Figure: Supply Curves) The figure shows four different supply curves for four products: A, B, C and D.
Which of the products has an inelastic, but not perfectly inelastic supply curve?

a. product A
b. product B
c. product C
d. product D
ANSWER: b

86. (Figure: Supply Curves) The figure shows four different supply curves for four products A, B, C and D.
Which one of the supply curves probably belongs to a crop that takes a long time to grow?

a. product A
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b. product B
c. product C
d. product D
ANSWER: b

87. (Figure: Supply Curves) The figure shows four different supply curves for four products: A, B, C and D.
Which one of the supply curves probably belongs to an automobile producer who has a large inventory of cars?

a. product A
b. product B
c. product C
d. product D
ANSWER: d

88. (Figure: Supply Curves) The figure shows four different supply curves for four products: A, B, C and D.
Which one of the supply curves probably belongs to a seller who has a large stock of product available for sale?

a. product A
b. product B
c. product C
d. product D
ANSWER: d

89. (Figure: Market for Movie Tickets) The figure shows the market for movie tickets. If the movie theater
changes the price per ticket from $12 to $13.50, the change in total revenue is:

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a. $180,000
b. $-18,000
c. $162,000
d. $18,000
ANSWER: b

90. (Figure: Market for Avocados) The figure shows the market for avocados. If the seller changes the price per
avocado from $1.50 to $1.75, the change in total revenue is:

a. $312,750
b. $12,750
c. $150,000
d. $162,750
ANSWER: b

91. (Figure: Market for Avocados) The figure shows the market for avocados. Which of the following is correct
about this market between points A and B?

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a. The demand curve is elastic, and thus the seller loses revenue by raising price from $1.50 to $1.75.
b. The demand curve is elastic, and thus the seller gains revenue by raising price from $1.50 to $1.75.
c. The demand curve is inelastic, and thus the seller loses revenue by raising price from $1.50 to $1.75.
d. The demand curve is inelastic, and thus the seller gains revenue by raising price from $1.50 to $1.75.
ANSWER: d

Essay

92. Rank these absolute values of price elasticity of demand from most inelastic demand to most elastic demand
— 0.25, 2.5, 1.3, 0.12, 1.
ANSWER: 0.12, 0.25, 1, 1.3, 2.5

93. Ron needs your help in calculating the price elasticity of demand for eggs, salt, and oranges. Calculate the
price elasticity of demand for each of these products (using the midpoint formula).

ANSWER: Eggs, –1.3; salt, –1; oranges, –0.8

94. Calculate the price elasticity of demand for the following products using the midpoint formula, and rank
them from most elastic demand to most inelastic demand.

ANSWER: Beef, –1.8; chicken, –1; pork, –0.73

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95. Using the midpoint formula, calculate the price elasticity of demand using the midpoint formula for the
following four products.

ANSWER: Apples, –1.24; grapes, –0.75; peaches, –0.29

96. Explain four factors that affect the price elasticity of demand for a product.
ANSWER: Four possible factors that affect the price elasticity of demand for a product are (1) the availability
of substitutes, (2) brand specificity, (3) necessity versus luxury, and (4) consumer search.

97. Using the midpoint formula, calculate the price elasticity of supply for the following three products.

ANSWER: Corn, –0.7; squash, –2.15; onions, –1.17

98. Using the midpoint formula, calculate the price elasticity of supply for the following three products.

ANSWER: Milk, –0.71; cheese, –1.24; sour cream, –0.43

99. A grocery store raises the price of organic oranges from $1.50 per orange to $1.95 per orange. The quantity
of oranges sold then changes from 4000 oranges per month to 3200 oranges per month. (a) Calculate the change
in total revenue. (b) Based on the change in total revenue, can you tell whether the demand for organic oranges
is elastic or inelastic?
ANSWER: (a) The total revenue at $1.50 per orange is ($1.50*4000) = $6000. The total revenue at $1.95 per
orange is ($1.95*3200) = $6240. Thus the total revenue changes by $240. (b) The change in total
revenue is positive when the price per orange is increased, and so the demand for organic oranges is
inelastic.

100. Explain four factors that affect the price elasticity of supply for a product.
ANSWER: Four possible factors that affect the price elasticity of supply for a product include (1) inventories,
(2) available variable inputs, (3) excess capacity, and (4) easy entry and exit from market.

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Chapter 07: Welfare and Efficiency

Multiple Choice

1. Analysis based on value judgments is called _____ analysis.

a. subjectivity-based
b. valuative
c. positive
d. normative
ANSWER: d

2. Normative analysis is analysis that focuses on:

a. identifying cyclical patterns that are repetitive.
b. what has happened and how the past varies from the present.
c. actual relationships, predictions of what will happen, and what the situation is.
d. what should happen or what ought to be, and it involves value judgments.
ANSWER: d

3. Normative analysis focuses on making decisions based on:

a. values.
b. facts.
c. relationships.
d. predictions.
ANSWER: a

4. Statements about what option should be chosen are _____ statements.

a. positive
b. normative
c. valuation
d. assessment
ANSWER: b

5. Analysis that describes what would happen if various actions were taken is _____ analysis.
a. partitioning
b. valuation
c. positive
d. normative
ANSWER: c

6. The type of analysis that describes what is happening and makes predictions based on identified relationships
is called _____ analysis.
a. positive
b. normative

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c. valuation
d. voluntary
ANSWER: a

7. Positive analysis is based on identifying _____ and _____.

a. values; judgments
b. facts; relationships
c. beliefs; options
d. priorities; scruples
ANSWER: b

8. What is positive analysis?

a. It prescribes what should happen, which involves value judgments.
b. It puts the options that are available in order of the priorities held by the decision maker.
c. It is based on beliefs about what is most important.
d. It describes what is happening, explains why it is happening, or predicts what will happen.
ANSWER: d

9. Which of the following statements is based on normative analysis?

a. We should protect the environment.
b. The temperature in the office room is 22 degrees centigrade.
c. When the burner beneath a pot of water on the stove is turned on, the water will heat up.
d. Mario is 24 years old.
ANSWER: a

10. Which of the following is a positive economic statement?

a. The government ought to balance its budget and eliminate the deficit.
b. That company with a 50% profit rate made too much profit at the expense of consumers.
c. If the government raises taxes, people will have less income available for purchases and saving.
d. A 10% inflation rate is too high and should be reduced.
ANSWER: c

11. Which of the following is a normative statement?

a. If John works five extra hours a week at his job, he will have less time to study.
b. Mary is 20 years old.
c. There is a negative or inverse relationship between price and quantity demanded.
d. Unequal incomes are unfair.
ANSWER: d

12. Which of the following statements is based on positive analysis?

a. If the price of cars rises, fewer cars will be sold.
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b. Wages are too low and should be raised.

c. The quality of education ought to be improved.
d. The best option is to raise the productivity expectations.
ANSWER: a

13. A government leader determines that the 5% unemployment rate is too high. She asks her staff to research
policy options to reduce the rate and a few weeks later is given four options. Each option would reduce the rate
by a different amount and at a different cost. The leader studies the options and chooses the one she feels is best
for the country. In order, what types of analysis were used in this three-stage chain of events?
a. positive; positive; normative
b. positive; normative; positive
c. normative; positive; normative
d. normative, positive; positive
ANSWER: c

14. Ian's research indicates that at a price of $12, his firm would sell 100,000 units of output. He determines that
sales of 100,000 units is too low for his preferences. He then explores his options to increase sales. In order,
what types of analysis are used in this three-stage chain of events?
a. positive; positive; normative
b. positive; normative; positive
c. normative; positive; normative
d. normative, positive; positive
ANSWER: b

15. Which of the following statements reflects positive analysis?

a. Looking at the options, Mario should reduce the number of employees.
b. Mario's staff identifies four options for reducing costs.
c. Mario determines that his costs are too high.
d. Mario believes that his employees are his most important asset.
ANSWER: b

16. Which of the following claims involves positive analysis?

a. Those with high incomes do not pay a fair share of their income in taxes.
b. Firms should pay workers based on their productivity.
c. Higher prices will cause the purchasing power of income to fall.
d. Wages should be higher so that those who work have a living wage.
ANSWER: c

17. Which of the following claims reflects normative analysis?

a. The minimum wage should be higher so that workers earn a living wage.
b. Higher prices mean that the purchasing power of income falls.
c. If the minimum wage were higher, companies that employ minimum wage workers would have
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higher costs.
d. Fewer people will buy cars if their price rises.
ANSWER: a

18. Economic surplus measures the value of a decision's:

a. total costs minus its net benefits.
b. total benefits minus its total costs.
c. total costs minus its benefits minus gains from exploitation.
d. benefits minus its costs plus externalities.
ANSWER: b

19. What standard is used to determine the most efficient economic outcome?
a. lowest cost
b. highest benefit
c. largest economic surplus
d. smallest inequality
ANSWER: c

20. The most efficient outcome in a set of options is the one with the:
a. largest economic surplus.
b. lowest total costs.
c. lowest total benefit.
d. smallest positive difference between benefits minus total cost.
ANSWER: a

21. From an economic perspective, the outcome that yields the greatest economic surplus is the:
a. least cost outcome.
b. outcome with the highest benefit.
c. outcome of least benefit-cost gap.
d. most efficient outcome.
ANSWER: d

22. The criterion of economic efficiency is that the _____ economic surplus that is generated, the _____ the
outcome.
a. wider; deeper
b. narrower; better
c. more; better
d. more; worse
ANSWER: c

23. If raising taxes through Policy A yields more economic surplus than raising taxes through Policy B, then:
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a. Policy A is more efficient and equitable than Policy B.

b. Policy A is more efficient than Policy B but may not be more equitable than Policy B.
c. Policy A is more equitable than Policy B but may not be more efficient than Policy B.
d. Policy A is less efficient and equitable than Policy B.
ANSWER: b

24. Which of the following statements is TRUE regarding economic efficiency?

a. Efficient outcomes will make everyone better off.
b. Efficient outcomes are also equitable.
c. Efficient outcomes rarely make everyone happy.
d. Efficiency is associated with minimizing economic surplus.
ANSWER: c

25. Which of the following statements is FALSE regarding economic efficiency?

a. Efficient outcomes will not make everyone happy.
b. If it is efficient, it is also equitable.
c. Efficient outcomes have the possibility of making everyone better off.
d. The most efficient outcome is the one with the greatest economic surplus.
ANSWER: b

26. How are people affected when economic efficiency increases?

a. Everyone will be better off and happier.
b. Overall gains exceed any change in costs, but some people may be worse off.
c. Dissatisfaction is a risk because the higher output will be spread across a larger number of people.
d. Efficiency squeezes people, so they end up worse off.
ANSWER: b

27. When economic efficiency rises, the _____, and the benefits _____ be spread across all the people.
a. total gains may or may not exceed costs; will
b. total gains may or may not exceed costs; may or may not
c. total gains exceed the costs; will
d. total gains exceed the costs; may or may not
ANSWER: d

28. The concept of equity focuses on:

a. efficiency.
b. fairness.
c. the level of economic surplus.
d. profit.
ANSWER: b

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29. Which of the following statements is FALSE regarding economic efficiency?
a. Everyone may not gain from a more efficient outcome.
b. It is possible for everyone to gain from a more efficient outcome.
c. Equity is a separate issue from efficiency.
d. Efficiency means minimizing surplus.
ANSWER: d

30. A key difference between equity and efficiency is that equity deals with _____ and efficiency focuses on
_____.
a. equality; minimizing costs
b. minimizing costs; equality
c. maximizing welfare; fairness
d. fairness; maximizing economic surplus
ANSWER: d

31. Efficient outcomes:

a. will make everyone better off.
b. are equitable outcomes.
c. may not make everyone happy.
d. minimize wasteful economic surplus.
ANSWER: c

32. Which of the following alternatives would yield the greatest economic surplus?
a. the most wasteful option
b. the most economically equitable option
c. the one that will make everyone happy
d. the most economically efficient option
ANSWER: d

33. Which of the following statements is TRUE?

a. Economically efficient outcomes hold the possibility of making everyone better off.
b. Economically efficient outcomes will make everyone better off.
c. Economically efficient outcomes will increase equity.
d. Economically efficient outcomes will always reduce equity.
ANSWER: a

34. Marginal benefit minus price equals:

a. economic efficiency.
b. economic equity.
c. consumer surplus.
d. producer surplus.
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ANSWER: c

35. Consumer surplus equals:

a. total benefit minus total expenditure.
b. marginal benefit minus price.
c. marginal revenue minus price.
d. total revenue minus consumer expenditure.
ANSWER: b

36. People gain consumer surplus when they purchase an item:

a. at a price below the value of the benefit they receive from the item.
b. at an equitable price.
c. at a price above marginal revenue but lower than the cost of production.
d. with a marginal benefit below the price of the item.
ANSWER: a

37. Pule purchases four bottles of bathroom cleaner for $3 each. The maximum prices she would have been
willing to pay for each bottle are $6 for the first bottle, $5 for the second bottle, $4 for the third bottle, and $3
for the fourth bottle. The marginal cost of producing the bottles is $2.50. What is Pule's consumer surplus on the
fourth bottle of bathroom cleaner?
a. $6
b. $1
c. $.50
d. $0
ANSWER: d

38. Chin purchases five protein bars at a price of $3 each. The marginal benefit he receives from each bar is $5
for the first bar, $4.50 for the second bar, $4 for the third bar, $3.50 for the fourth bar, and $3 for the fifth bar.
The marginal cost of producing the bars is $2 each. What is Chin's consumer surplus on the fifth bar?
a. $0
b. $.50
c. $1
d. $2
ANSWER: a

39. Chin purchases five protein bars at a price of $3 each. The marginal benefit he receives from each bar is $5
for the first bar, $4.50 for the second bar, $4 for the third bar, $3.50 for the fourth bar, and $3 for the fifth bar.
The marginal cost of producing the bars is $2.50 each. What is Chin's total consumer surplus from the five bars
that he purchased?
a. $0
b. $.50
c. $2.50
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d. $5
ANSWER: d

40. The highest price that Dara would be willing to pay for a particular vase is:
a. her consumer surplus on the vase.
b. the marginal benefit she would receive from the vase.
c. the most economically efficient price for the vase.
d. the most equitable price for the vase.
ANSWER: b

41. The highest price that Duke would be willing to pay for a particular video game is:
a. the most equitable price for the game.
b. the most economically efficient price for the game.
c. the marginal benefit he would receive from the game.
d. his consumer surplus on the game.
ANSWER: c

42. In a market graph, consumer surplus is the area:

a. between the demand curve and the supply curve.
b. above the price.
c. below the demand curve.
d. above the price and below the demand curve.
ANSWER: d

43. (Figure: Demand Curve) Use the graph of a demand curve for balsamic vinegar to answer the question.

What is the total consumer surplus when three bottles of vinegar are sold at a price of $3 each?
a. $21
b. $16.50
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c. $10.50
d. $0
ANSWER: c

44. (Figure: Demand Curve 2) Use the graph of a demand curve for monthly music streaming subscriptions to
answer the following question. The vertical axis is the monthly price of a subscription and the horizontal axis is
millions of monthly subscriptions for the market. What is the total consumer surplus if three million
subscriptions are sold at a price of $4 each?

a. $8,000,000
b. $12,000,000
c. $15,000,000
d. $24,000,000
ANSWER: b

45. (Figure: Demand Curve 3) Use the graph of a demand curve for jars of laundry detergent to answer the
question.

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What is the total consumer surplus if 50 jars are sold at a price of $6?
a. $14
b. $350
c. $700
d. $750
ANSWER: b

46. Carlos buys six new plants for his garden. If he has purchased according to the rational rule, his consumer
surplus on the sixth plant is equal to:
a. total benefit minus price.
b. price plus marginal benefit.
c. price minus marginal cost.
d. zero.
ANSWER: d

47. Pule is purchasing four bottles of bathroom cleaner for $3 each. The maximum prices she would have been
willing to pay for each bottle are $6 for the first bottle, $5 for the second bottle, $4 for the third bottle, and $3
for the fourth bottle. The marginal revenue for each bottle is $2.50. What is Pule's total consumer surplus from
purchasing the four bottles of bathroom cleaner?
a. $6
b. $2
c. $.50
d. $0
ANSWER: a

48. When Chandra is hiking on a hot day without any water, she is willing to pay up to $6 for a bottle of water.
When she does her grocery shopping, she is not willing to pay more than $3.60 for a case of 36 bottles of water.
If Chandra buys a case of 36 bottles for $3.60, or $.10 per bottle, her consumer surplus is _____ on the first
bottle and is _____ on the 36th bottle.
a. $106.20; $.10
b. $212.40; $106.20
c. $6; $.10
d. $5.90; $0
ANSWER: d

49. The producer surplus on a unit sold equals:

a. (price minus marginal cost) multiplied by (1/2 quantity sold).
b. price minus marginal cost.
c. marginal benefit minus price.
d. 1/2 (price times quantity minus marginal cost).
ANSWER: b
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50. Price minus marginal cost equals the:

a. producer surplus of a unit sold.
b. consumer surplus of a unit purchased.
c. marginal benefit of a unit.
d. economic efficiency of total sales.
ANSWER: a

51. Portia produces and sells headbands. Her marginal cost for one headband is $6, and her average cost is $4.
She gains producer surplus only when she sells headbands at a price above:
a. $4.
b. $6.
c. $5.
d. $10.
ANSWER: b

52. Joachim produces and sells baskets. His marginal cost for one basket is $10, and his average cost is $7. He
gains producer surplus every time that he sells a basket at a price:
a. below $10.
b. below $7.
c. above $10.
d. above $7.
ANSWER: c

53. Jorge sells a hammock for $85. His marginal cost for one hammock is $40, and his average cost is $50.
What is Jorge's producer surplus on the sale of one hammock?
a. –$5
b. $45
c. $35
d. $40
ANSWER: b

54. On a market graph, producer surplus is the area that is:

a. above the demand curve.
b. below the demand curve.
c. above the demand curve and below the supply curve.
d. above the supply curve and below the price.
ANSWER: d

55. The area on a market graph that lies below the price and above the supply curve is equal to:
a. producer surplus.
b. consumer surplus.
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c. economic equity.
d. economic efficiency.
ANSWER: a

56. If you are a seller making decisions according to the rational rule, you will:
a. earn some producer surplus on every unit sold.
b. earn producer surplus on all except the last unit sold.
c. ensure that all consumers earn consumer surplus.
d. ensure that consumers lose maximum surplus in order to lower producer surplus.
ANSWER: b

57. When price equals marginal cost for the last unit sold, a seller will:
a. earn consumer surplus on every unit sold.
b. earn consumer surplus.
c. earn producer surplus on all except the last unit sold.
d. not earn any producer surplus overall.
ANSWER: c

58. (Figure: Supply Curve) The graph shows the supply curve for jars of laundry detergent.

If 18 units are sold at a price of $20, what is the producer surplus on the last jar sold?
a. $0
b. $15
c. $135
d. $270
ANSWER: a

59. (Figure: Supply Curve) Use the graph of a supply curve for jugs of laundry detergent to answer the question.

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If 18 jugs are sold at a price of $20, what is the total producer surplus?
a. $0
b. $15
c. $135
d. $270
ANSWER: c

60. (Figure: Supply Curve 2) Use the supply curve for bottles of dish soap in the graph to answer the question.

If 15 bottles are sold at a price of $8, what is the producer surplus on the last unit sold?
a. $0
b. $6
c. $45
d. $90
ANSWER: a
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61. (Figure: Supply Curve 2) Use the supply curve for bottles of dish soap in the graph to answer the question.

If 15 bottles are sold at a price of $8, what is the total producer surplus?
a. $0
b. $6
c. $45
d. $90
ANSWER: c

62. When trade is voluntary, who gains from it?

a. Either the seller or the buyer gains but not both.
b. Both the seller and the buyer gain, although not necessarily equally.
c. Both the seller and the buyer must gain equal amounts.
d. Neither the seller nor the buyer gains, but society in general gains.
ANSWER: b

63. Voluntary exchange occurs when:

a. either the buyer or the seller will gain from the trade with no loss to the other.
b. either the buyer or the seller will gain from the trade at the expense of the other.
c. society in general rather than the participants will gain from the trade.
d. both the buyer and the seller will gain from the trade.
ANSWER: d

64. Which principle helps buyers and sellers make decisions about whether to trade?
a. the cost-benefit principle
b. the equity principle
c. the law of diminishing returns
d. the law of surplus
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ANSWER: a

65. When trade is voluntary, neither the buyer nor the seller will:
a. gain from the trade.
b. generate surplus.
c. be worse off after the trade.
d. need to make any payments.
ANSWER: c

66. Which of the following statements about economic surplus is FALSE?

a. Economic surplus equals marginal benefit minus marginal cost.
b. Economic surplus is the area below the supply curve, above the demand curve, and to the right of
quantity sold.
c. Economic surplus is the area between the supply curve and the demand curve to the left of quantity
sold.
d. Economic surplus is consumer surplus plus producer surplus.
ANSWER: b

67. The marginal benefit minus the marginal cost equals:

a. the efficiency balance.
b. the consumer surplus minus the producer surplus.
c. the consumer surplus.
d. the economic surplus.
ANSWER: d

68. Two ways to calculate economic surplus are _____ and _____.
a. consumer surplus minus producer surplus; marginal benefit plus marginal cost
b. marginal benefit minus marginal cost; consumer surplus plus producer surplus
c. marginal benefit minus price; marginal cost minus price
d. price minus marginal benefit; price minus marginal cost
ANSWER: b

69. Bae is willing to pay up to $160 for a particular pair of boots. She is able to buy the boots for $120. The
marginal cost of producing the boots is $70. How large is the economic surplus associated with her purchase of
the boots?
a. $40
b. $50
c. $90
d. $120
ANSWER: c

70. Bae is willing to pay up to $160 for a particular pair of boots. She is able to buy the boots for $120. The
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marginal cost of producing the boots is $70. Which of the following is TRUE regarding the economic surplus
associated with her purchase of the boots?
a. Consumer surplus is $40, and producer surplus is $50.
b. Consumer surplus is $50, and producer surplus is $40.
c. Consumer surplus is $90, and producer surplus is $120.
d. Consumer surplus and producer surplus are the same.
ANSWER: a

71. (Figure: Market) Use the bath towel market graph to answer the question.

The bath towel market is at equilibrium. How large is the economic surplus?
a. $60
b. $75
c. $120
d. $150
ANSWER: a

72. (Figure: Market 2) Use the market graph for pairs of socks to answer the question.

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The sock market is at equilibrium. How much economic surplus is being generated in the sock market?
a. $45
b. $60
c. $90
d. $150
ANSWER: a

73. On a market graph, economic surplus can be identified as the area that is to the:
a. right of the quantity, above the demand curve, and below the supply curve.
b. left of the quantity, above the demand curve, and below the supply curve.
c. right of the quantity and between the demand and supply curves.
d. left of the quantity and between the demand and supply curves.
ANSWER: d

74. The price of a carton of eggs is $2, and 100 cartons are sold. The consumer surplus is $80, and total surplus
equals $150. What is the producer surplus?
a. $200
b. $120
c. $70
d. $50
ANSWER: c

75. In modern society, most goods are allocated by:

a. governments.
b. banks.
c. ethnicities.
d. markets.

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ANSWER: d

76. Producing a given quantity of output at the lowest possible cost and lowest marginal cost is called:
a. minimizing production.
b. marginal minimization.
c. efficient production.
d. efficiency surplus.
ANSWER: c

77. Efficient production occurs when:

a. the marginal cost curve is downward sloping.
b. a given level of output is produced at the lowest possible cost.
c. output is minimized and cost is falling.
d. a given level of cost is able to produce a higher output level than before.
ANSWER: b

78. Efficient production decisions occur when _____ forces lead firms to produce the output level where ____.
a. market; average cost is at a minimum
b. market; price equals marginal cost
c. cost; average cost is at a minimum
d. cost; price equals marginal benefit
ANSWER: b

79. When market forces lead to efficient production, each producer is _____, and the product is produced
_____.
a. acting in self-interest; at the lowest possible marginal cost
b. coordinating with others; at a cost equal to price
c. alternating production; at minimum cost
d. maximizing production; at maximum marginal cost
ANSWER: a

80. Markets distribute production across companies in a way that:

a. maximizes the number of firms.
b. minimizes production.
c. minimizes costs.
d. maximizes production.
ANSWER: c

81. When goods are allocated in a way that creates the largest economic surplus:
a. output is evenly allocated across firms.
b. production is minimized.

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c. efficient allocation has been achieved.

d. the marginal benefit of the last unit bought is the maximum marginal benefit.
ANSWER: c

82. Efficient allocation of output requires that:

a. each unit of output will go to the person who will get the highest marginal benefit from it.
b. each unit of output will be produced at minimum fixed cost.
c. output will be distributed evenly across consumers and producers.
d. consumers will each pay a price equal to the marginal benefit received from the good.
ANSWER: a

83. (Figure: Marginal Benefit Curves) Use the graph of marginal benefit curves for slices of cheesecake to
answer the question.

If Becca and Marcella are the only buyers in the market, how many slices will be sold if the market price is $3?
a. four
b. nine
c. six
d. eight
ANSWER: c

84. (Figure: Marginal Benefit Curves) Use the graph of marginal benefit curves for slices of cheesecake to
answer the question.

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When the market price is $3, Becca will purchase _____ slices, and Marcella will purchase _____ slices.
a. two; six
b. six; ten
c. four; two
d. two; four
ANSWER: c

85. (Figure: Marginal Benefit Curves) Use the graph of marginal benefit curves for slices of cheesecake to
answer the question.

When the market price is $1, what is the total amount of cheesecake slices purchased across Becca and
Marcella?
a. ten
b. nine
c. six

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d. twelve
ANSWER: d

86. (Figure: Marginal Benefit Curves) Use the graph of marginal benefit curves for slices of cheesecake to
answer the question.

When the price is $1, Becca will buy _____ slices, and Marcella will buy _____ slices.
a. nine; 15
b. two; four
c. six; nine
d. six; six
ANSWER: d

87. Which of the following statements is FALSE regarding the way that a market allocates output across
buyers?
a. Each buyer is pursuing their own self-interest.
b. Each unit of output goes to the person who would enjoy it the most.
c. There may be an unequal distribution of the product across buyers.
d. Willingness to pay has little impact on the distribution of goods.
ANSWER: d

88. Markets allocate goods to those with the:

a. most money to spend.
b. lowest marginal cost.
c. highest marginal benefit.
d. least surplus.
ANSWER: c

89. (Figure: Marginal Benefit Curves 2) Use the graph of marginal benefit curves for cans of shaving cream to
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answer the question.

When the market price is $3, the total quantity of cans purchased across Bruno and Martin will be:
a. five.
b. six.
c. seven.
d. nine.
ANSWER: b

90. (Figure: Marginal Benefit Curves 2) Use the graph of marginal benefit curves for cans of shaving cream to
answer the question.

When the price is $3, Bruno will buy _____ can(s), and Martin will buy _____ can(s).
a. one; five
b. two; seven
c. six; nine

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d. two; nine
ANSWER: a

91. (Figure: Marginal Benefit Curves 2) Use the graph for marginal benefit curves for cans of shaving cream to
answer the question.

When the market price is $2, how many cans will be purchased across Bruno and Martin?
a. six
b. seven
c. nine
d. ten
ANSWER: c

92. (Figure: Marginal Benefit Curves 2) Use the graph of marginal benefit curves for cans of shaving cream to
answer the question.

When the price is $2, Bruno will buy _____ cans, and Martin will buy _____ cans..
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a. one; five
b. two; seven
c. six; nine
d. seven; seven
ANSWER: b

93. The efficient quantity prevails in a market when the market:

a. has the lowest average cost.
b. has benefit equal to cost.
c. yields the largest possible economic surplus.
d. costs exceed benefit by the largest margin.
ANSWER: c

94. An efficient producer will keep increasing production until:

a. total benefit equals total cost.
b. minimum average cost has been reached.
c. maximum benefit equals maximum cost.
d. price equals marginal cost.
ANSWER: d

95. The rational rule for markets is to produce:

a. the output level with minimum average cost and buy the quantity with maximum benefit.
b. more if the unit's marginal benefit exceeds its marginal cost.
c. at the output where efficient quantity equals benefit.
d. less if marginal benefit exceeds marginal cost.
ANSWER: b

96. The efficient market quantity is the quantity where _____ equals _____.
a. marginal cost; marginal benefit
b. minimum cost; marginal cost
c. benefit; cost
d. maximum benefit; marginal benefit
ANSWER: a

97. At quantities less than equilibrium in a market, _____ exceeds _____.

a. demand; supply
b. quantity demanded; quantity supplied
c. selling price; buying price
d. marginal benefit; marginal cost
ANSWER: d

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98. (Figure: Market 3) Use the graph for the watermelon market to answer the question.

What is the economically efficient quantity of watermelons?

a. two
b. five
c. seven
d. 10.5
ANSWER: b

99. (Figure: Market 3) Use the watermelon market graph to answer the question.

At a quantity of two melons, the value of marginal benefit is _____, and marginal cost is _____.
a. $6; $6
b. $6; $3
c. $2; $10.50
d. $2; $5
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ANSWER: b

100. (Figure: Market 4) Use the watermelon market graph to answer the question.

What is the value of the total surplus at the quantity of melons with economic efficiency?
a. $12.50
b. $35
c. $17.50
d. $25
ANSWER: a

101. Efficient outcomes in markets are NOT dependent on:

a. perfect competition.
b. well-informed sellers.
c. well-informed buyers.
d. advanced technology.
ANSWER: d

102. Market failure occurs when market forces lead to:

a. high price.
b. high quantity.
c. an inefficient outcome.
d. a marginal benefit that is equal to marginal cost.
ANSWER: c

103. Which of the following is NOT a source of market failure?

a. excessive information
b. externalities
c. irrationality
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d. market power
ANSWER: a

104. Which of the following is NOT a source of market failure?

a. side effects of externalities
b. irrational decisions
c. government regulations that impede market forces
d. lack of market power
ANSWER: d

105. The efficiency problem that results from market power is that the market:
a. has side-effects.
b. has too many producers.
c. overproduces.
d. underproduces.
ANSWER: d

106. When market power is a significant force in a product market, the market tends to _____ compared to a
market where there is no market power.
a. underproduce
b. be more efficient
c. have lower prices
d. overproduce
ANSWER: a

107. When negative externalities occur as a result of a product market's activity, the market will _____ than is
desirable.
a. function further from equilibrium
b. charge a higher price
c. produce more
d. produce less
ANSWER: c

108. Which of the following problems occurs when some participants in a market have information that other
participants in the market do not have?
a. excessive trust
b. private information
c. overproduction
d. excessive surplus
ANSWER: b

109. Which of the following occurs when private information is a market problem?
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a. Low trust levels lead to a lower quantity than would be efficient.

b. Excessive trust levels lead to a higher quantity than would be efficient.
c. Exploitation leads to more producers than would be desirable.
d. Overproduction leads to lower prices than would be desirable.
ANSWER: a

110. Irrational decision making in markets results in:

a. consistent overproduction.
b. externalities.
c. evidence that the rational rules do not lead to their claimed outcomes.
d. some supply decisions not matching marginal costs, and some demand decisions not reflecting
marginal benefits.
ANSWER: d

111. How does government regulation affect market efficiency?

a. Regulations only increase the efficiency of how markets function.
b. Regulations are a substitute for market efficiency.
c. Some regulations correct for market failure; other regulations cause inefficient outcomes.
d. Regulations only move markets further from efficiency.
ANSWER: c

112. A market's deadweight loss is calculated as:

a. the economic loss that a firm has when it is not producing its profit-maximizing output.
b. the loss to consumers when a product malfunctions or fails to meet expectations.
c. the economic surplus at the efficient quantity minus the economic surplus at the actual quantity.
d. the price at equilibrium minus the price at actual quantity.
ANSWER: c

113. When the economic surplus in a market is less than it would be if the market were efficient, the market is
experiencing:
a. deadweight loss.
b. a situation in which marginal benefit equals marginal cost.
c. asymmetry problems.
d. an inverse externality.
ANSWER: a

114. (Figure: Market 4) Use the graph for pounds of grapes to answer the question.

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When the actual pounds produced and sold is two, economic surplus in the market is represented by the area
between the demand and supply curves:
a. to the right of equilibrium.
b. to the left of equilibrium.
c. to the left of the quantity of two.
d. between quantities two and five.
ANSWER: c

115. (Figure: Market 4) Use the graph for the grape market (with quantity in pounds) to answer the question.

When the market produces and sells a quantity of two pounds, the deadweight loss is the area between the
demand and supply curves:
a. to the right of equilibrium.
b. to the left of equilibrium.
c. to the left of the quantity of two.

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d. between quantities two and five.

ANSWER: d

116. (Figure: Market 5) The graph shows the market for teddy bears.

When the market produces and sells nine teddy bears, the deadweight loss is represented by the:
a. rectangle between prices $6.50 and $2 and quantities of zero to 5.
b. rectangle between prices of $6.50 and $2 and quantities of 5 and 9.
c. area between the demand and supply curves to the left of a quantity of 5.
d. area between the demand and supply curves between quantities of 5 and 9.
ANSWER: d

117. Which of the following is NOT a reason for government failure?

a. Elected officials are more concerned about reelection than efficiency.
b. Government leaders are focused on enriching themselves.
c. Regulators are overly focused on efficiency.
d. Regulators act in the interest of the industries they regulate.
ANSWER: c

118. The deadweight loss in an inefficient market is calculated by first identifying the:
a. marginal cost benefit ratio.
b. average cost of production.
c. actual quantity produced and sold.
d. price compared to the ideal price.
ANSWER: c

119. _____ determines the amount of economic surplus; ______ determines whether buyers or sellers get the
surplus.
a. Price; quantity
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b. Quantity; price
c. Marginal benefit; marginal cost
d. Marginal cost; marginal benefit
ANSWER: b

120. Competitive markets do NOT result in:

a. the largest possible economic profit for firms.
b. goods going to the consumers who will receive the highest marginal benefit from the good.
c. the largest possible economic surplus.
d. goods produced at the lowest possible marginal cost.
ANSWER: a

121. Which of the following is NOT a result of an efficient market?

a. Goods go to the consumers who will gain the highest marginal benefit from the good.
b. Allocative efficiency is achieved.
c. Goods are produced by the firms that can do so at the lowest marginal cost.
d. Economic surplus is minimized to reduce waste.
ANSWER: d

122. When government policies lead to outcomes that are worse than those that would occur in unregulated
markets:
a. marginal costs occur.
b. liveweight loss occurs.
c. government failure occurs.
d. government efficiency occurs.
ANSWER: c

123. Which of the following is NOT a common criticism of the focus on economic efficiency as a measure of
welfare?
a. A situation can be economically efficient but also considered to be unfair.
b. Economic efficiency is based only on results and not on process.
c. Using monetary values for measurements ignores feelings and perceptions.
d. The assumption that willingness to pay measures marginal benefit ignores ability to pay.
ANSWER: c

124. Placing importance on achieving economic efficiency:

a. implies no role for government.
b. is a normative judgment.
c. is a positive judgment.
d. implies that government should be the main coordinating force.
ANSWER: b
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125. Which of the following is NOT one of the main concerns about putting a high priority on economic
efficiency?
a. Demand reflects ability to pay and not solely marginal benefit.
b. Incentives for efficiency can reduce innovation.
c. Efficient results can be unfair.
d. Efficiency focuses on outcomes, but means also matter.
ANSWER: b

126. The economic term for "who gets what" is:

a. allocative results.
b. proportional allocation.
c. output dispersion.
d. distributional consequences.
ANSWER: d

127. One problem with assuming that people's willingness to pay is a measure of the marginal benefit they
would receive from the product is that:
a. marginal benefit reflects more than just willingness to pay.
b. a person's perceived marginal benefit from a product is not related to their willingness to pay.
c. willingness to pay reflects ability to pay as well as marginal benefit.
d. marginal benefit is negatively rather than positively related to willingness to pay.
ANSWER: c

128. Measurement of economic efficiency is based on _____ and fails to consider the _____ that leads to the
level of efficiency.
a. monetary measures; result
b. outcomes; process
c. process; fairness
d. impacts; monetary measure
ANSWER: b

Essay

129. Why are both positive analysis and normative analysis needed for decision making?
ANSWER: Positive analysis presents the facts and relationships. It lays out the situation, the options, and the
potential result if each option is chosen. Normative analysis prescribes what should happen based on
value judgments. It provides a guide, based on values, for sorting through the options identified in
the positive analysis. This allows a decision maker to choose what is the "best" option in terms of
achieving what is most important to the decision maker.

130. Why don't efficient outcomes make everyone happy?

ANSWER: Efficient outcomes have maximum economic surplus. To move from an inefficient outcome to a
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more efficient one, there is an increase in net benefit or welfare in society. However, there some
members of society may not have an increase in welfare or may actually experience a decrease in
welfare. Any loss of welfare by some is more than offset by increases in welfare among others to
yield the increase in net benefit or economic surplus.

131. Explain the differences between equity and efficiency.

ANSWER: Equity deals with fairness and often focuses on how something is distributed across a population.
Efficiency focuses on how the maximum possible economic surplus can be gained, without regard
to how the surplus is distributed across the population. A result could be considered efficient yet not
equitable, or a different result could be considered equitable but not efficient.

132. (Figure: Demand Curve 4) Jane's demand curve for a particular candy bar is shown below. Use the graph
to answer the question.

The candy bar has a price of $4, and Jane buys five bars. Explain why Jane earns consumer surplus on all but
her last candy bar.
ANSWER: Jane's consumer surplus on each bar is the amount by which her willingness to pay, or marginal
benefit, exceeds the price she must pay. She is willing to pay more than $4 for her first, second, and
third bars, and so she earns consumer surplus on those bars. The most she is willing to pay for a
fourth bar is $4, so she does not earn any surplus on her fourth bar. On her fourth bar, the extra
benefit she receives is worth exactly the $4 she pays for the bar.

133. Why will voluntary trade always result in gains to both consumers and producers?
ANSWER: Rational decision makers will not willingly do something that makes them worse off. If trade is
voluntary, then producers and consumers each choose whether or not to participate in the trade. If
they are behaving rationally, they will choose to trade only if they stand to gain from the transaction.
Thus, the result of voluntary trade should be gains to both consumers and producers.

134. (Figure: Market 6) Use the market graph to answer the question.

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How much economic surplus is being generated in this market if the market price is $4? Explain how you
calculate the amount.
ANSWER: Economic surplus can be calculated by adding consumer surplus and producer surplus. The formula
for consumer surplus is the area of the triangle between the demand curve and the $4 price going
from a quantity of zero to five. This area would be calculated as (1/2 × 5) × ($7 – $4) = 2.5 × $3 =
$7.50.
The producer surplus is the area of the triangle between the supply curve and the price of $4
between quantities of zero and five. This area would be calculated as (1/2 × 5) × ($4 – $1) = 2.5 ×
$3 = $7.50.
Economic surplus is the sum of the consumer surplus and the producer surplus, or $7.50 + $7.50 =
$15.

135. How does a market with efficient production distribute the production of output across the firms in the
market?
ANSWER: Production is efficient when a given quantity is produced at the lowest possible cost or the lowest
marginal cost. If a market is efficient, each firm will produce only the quantity that it is able to
produce that has a marginal cost below or equal to the selling price. It would hurt a firm's profits to
produce any units with marginal cost above the price. Thus, the market output will be produced only
by the firms that can produce the product at a marginal cost that is no higher than the price. How the
output is distributed across firms will depend on each firm's marginal cost curve and the number of
units that the firm is able to produce with marginal cost no higher than price. Thus, output is limited
to lower costs of production.

136. How does the interaction of supply and demand in a competitive market lead to the quantity that
maximizes economic surplus?
ANSWER: A competitive market will move to an equilibrium quantity and price. Economic surplus is the area
between the demand curve and the supply curve to the left of the market quantity (as long as it is no
higher than equilibrium). When a market is at equilibrium, the area between the two curves is the
maximum possible area. When the market is at a lower quantity, the area is smaller. When the
market functions at a quantity higher than the equilibrium quantity, there is a deadweight loss that
needs to be subtracted to get the economic surplus that would have existed at equilibrium in the
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market.

137. What are the causes of market failure?

ANSWER: Market failure occurs when market forces fail to lead to an efficient result. There are five main
causes of market failure. First, market power can distort outcomes, leading to an inefficient result.
Second, externalities can distort outcomes because producers and consumers do not consider the
impact of their actions on others. Third, markets can be inefficient when all decision makers do not
have complete information. Fourth, sometimes people do not behave rationally. Fifth, sometimes
government regulation causes markets to be inefficient.

138. How does producing more or less than equilibrium output create a deadweight loss in a market?
ANSWER: A deadweight loss is the amount by which economic surplus falls below the surplus that would exist
if the market were efficient. A market at equilibrium has maximum economic surplus because it
produces and sells every unit for which marginal benefit exceeds marginal cost. It captures every bit
of available surplus. If a market produces less than this equilibrium quantity, then there are units that
are not produced for which marginal benefit would exceed marginal cost. The market is missing out
on this surplus, and thus the market has a deadweight loss. If a market produces more than the
equilibrium quantity, the deadweight loss occurs on the units produced in excess of equilibrium. For
these extra units, marginal cost is greater than marginal benefit, creating a deadweight loss that must
be subtracted from the surplus on the left side of equilibrium to determine the economic surplus in
the market.

139. What is the difference between an efficient allocation in a market and an equitable allocation in a market?
ANSWER: An efficient allocation in a market occurs in a market with the maximum economic surplus. In this
situation, the goods are allocated to the consumers with the greatest willingness to pay, or greatest
marginal benefit.
An equitable allocation in a market distributes goods across consumers in a way that is considered to
be fair. There may be differing perceptions of what is fair. To some, fair means "equal." To others,
fair might mean that those who need the product the most get the most of it. To others, a fair
distribution is based on how much the individuals contributed to production.

140. Measurement of economic efficiency provides important information about the functioning of a market.
Why should this information be used cautiously?
ANSWER: Economic efficiency measurement conveys information about the waste or lack of waste in a market
and the ways the market contributes to overall welfare. It focuses on results. However, efficiency is
not the only goal that society may have, and the measurement of efficiency is not perfect. There are
three concerns about a heavy focus on efficiency: (1) it does not address the issue of equity, (2) the
demand curve may reflect both the ability to pay as well as marginal benefit rather than solely
marginal benefit, and (3) the means may be as important to some as the results.

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Multiple Choice

1. The term "gains from trade" means the

a. total surplus in a market.
b. higher prices that firms get when they sell abroad rather than in home markets.
c. benefits that come from reallocating resources, goods, and services to better uses.
d. alliances that nations make with each other when trade occurs between them.
ANSWER: c

2. The benefits that come from reallocating resources, goods, and services to better uses when trade occurs are
called
a. interactive benefits.
b. the gains from trade.
c. comparative gains.
d. absolute advantages.
ANSWER: b

3. Markets allocate
a. resources, goods, and services.
b. money and services but not goods and resources.
c. money and resources but not goods and services.
d. resources and goods but not services.
ANSWER: a

4. Which of the following is NOT an example of the allocating function of markets?

a. When the price of tomatoes rises, Jose buys fewer tomatoes.
b. Sunil gets a job to save for a car.
c. Nina knits a sweater and gives it to her niece.
d. Penina buys gas at the station with the lowest price.
ANSWER: c

5. What is the function of the markets?

a. Markets create demand to earn profits.
b. Markets sell goods to make use of inputs.
c. Markets produce output to cover costs.
d. Markets reallocate resources, goods, and services to better uses.
ANSWER: d

6. The main role of markets is:

a. facilitating consumption.
b. preventing waste in choices.

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c. reallocating resources to better uses.

d. providing jobs and products.
ANSWER: c

7. When you assign tasks to employees based on comparative advantage, task assignments go to those with the
a. highest wage.
b. lowest wage.
c. highest opportunity cost.
d. lowest opportunity cost.
ANSWER: d

8. You have an absolute advantage in producing a product if you:

a. can produce the product using the fewest inputs.
b. can produce the product at the lowest opportunity cost.
c. have training in producing it.
d. have the most capital to work with.
ANSWER: a

9. The person who can produce a product using the fewest inputs has _____ in that product.
a. a comparative advantage
b. an absolute advantage
c. market power
d. maximum profit
ANSWER: b

10. The person who has an absolute advantage in a task

a. can perform the task at a lower opportunity cost than anyone else.
b. is the person who should do the task.
c. can perform the task at a higher opportunity cost than anyone else.
d. is the one who is best at the task.
ANSWER: d

11. Ang can mow the lawn in two hours. Bill takes three hours to mow the same lawn. What can you conclude
from this information?
a. Ang has a comparative advantage over Bill in mowing the lawn.
b. Bill has a comparative advantage over Ang in mowing the lawn.
c. Ang has an absolute advantage over Bill in mowing the lawn.
d. Bill has an absolute advantage over Ang in mowing the lawn.
ANSWER: c

12. Chanda can change the oil in a particular car in 30 minutes. It takes 45 minutes for Deepa to change the oil
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in the same type of car. Which of the following statements is TRUE?
a. Chanda has an absolute advantage over Deepa in changing the oil.
b. Deepa has an absolute advantage over Chanda in changing the oil.
c. Chanda has a comparative advantage over Deepa in changing the oil.
d. Deepa has a comparative advantage over Chanda in changing the oil.
ANSWER: a

13. You have a comparative advantage if you can complete a task:

a. using more inputs than anyone else.
b. using fewer inputs than anyone else.
c. at a lower opportunity cost than anyone else.
d. at a higher opportunity cost than anyone else.
ANSWER: c

14. If you can complete a task at a lower opportunity cost than anyone else, then you
a. produce the good using fewer inputs than anyone else.
b. produce the good using more inputs than anyone else.
c. have an absolute advantage in that task.
d. have a comparative advantage in that task.
ANSWER: d

15. To get maximum output, you should allocate each task to the person who:
a. can do the task with the smallest amount of input.
b. can do the task with the lowest opportunity cost.
c. has an absolute advantage in completing the task.
d. has a cost advantage in completing the task.
ANSWER: b

16. Mana has a comparative advantage in baking cakes. This means that she
a. produces better-quality cakes than any other cake baker.
b. has more education than other cake bakers.
c. can bake a cake using fewer resources than any other baker.
d. gives up less to bake a cake than other bakers give up to bake a cake.
ANSWER: d

17. To maximize production, people should

a. focus on the task in which they have an absolute advantage.
b. focus on the task in which they have a comparative advantage.
c. learn all the skills so that they can perform any task needed.
d. focus on improving their weakest skills.
ANSWER: b
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18. (Table: Eray and Ata's opportunity cost) Data for Eray's and Ata's decorating is given in the table. Which
statement explains who has the comparative advantage in decorating cakes?

a. Eray, who can decorate a cake in 120 minutes.

b. Ata, who can decorate a cake in 130 minutes.
c. Eray who gives up decorating 24 cupcakes when he decorates a cake.
d. Ata, who gives up decorating 20 cupcakes when he decorates a cake.
ANSWER: d

19. (Table: Eray and Ata's opportunity cost) Data for Eray's and Ata's cake decorating is given, which statement
explains who has the absolute advantage in decorating cakes?

a. Eray can decorate a cake in 120 minutes.

b. Ata can decorate a cake in 130 minutes.
c. Eray gives up decorating 24 cupcakes when he decorates a cake.
d. Ata gives up decorating 20 cupcakes when he decorates a cake.
ANSWER: a

20. (Table: Comparative Advantage for Asha and Sabra) Data for Asha and Sabra are given in the table. Which
statement explains who has the comparative advantage in making a sandwich?

a. Asha, she can make a sandwich in 10 minutes.

b. Sabra, as she can make a sandwich in 13 minutes.
c. Asha, she gives up slicing three carrots into carrot sticks every time she makes a sandwich.
d. Sabra, she gives up slicing two carrots into carrot sticks every time she makes a sandwich.
ANSWER: d

21. Use the data in the table to answer the question. The table provides data on how long it takes Maia and
Juanita to mow the lawn and weed the flower beds.

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Who has a comparative advantage in mowing lawns?

a. Maia because she can mow the lawn more quickly
b. Juanita because she takes the time to mow carefully
c. Maia because she has a lower opportunity cost
d. Juanita because she has a lower opportunity cost
ANSWER: d

22. (Table: Maia and Juanita's opportunity cost) The table provides data on how long it takes Maia and Juanita
to mow the lawn and weed the flower beds.

Who has a comparative advantage in weeding the flower beds?

a. Maia because she can weed the beds more quickly.
b. Juanita because she takes the time to weed the beds carefully.
c. Maia because she has a lower opportunity cost.
d. Juanita because she has a lower opportunity cost.
ANSWER: c

23. (Table: Comparative Advantage for Mia and Juanita) The table provides data on how long it takes Maia and
Juanita to mow the lawn and weed the flower beds.

Maia's opportunity cost for mowing the lawn is _____, and Juanita's opportunity cost for mowing the lawn is
_____.
a. weeding three flower beds; weeding two flower beds
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b. weeding one flower bed; weeding two flower beds

c. weeding one-third of a flower bed; weeding one-half of a flower bed
d. weeding one-half of a flower bed; weeding three-quarters of a flower bed
ANSWER: a

24. (Table: Joachim and Zane's opportunity cost) The table provides data on how long it takes Joachim and
Zane to clean the bathrooms and wash the windows at a home.

Joachim's opportunity cost for cleaning bathrooms is _____, and Zane's opportunity cost for cleaning bathrooms
is _____.
a. the windows washed 2.5 times; the windows washed two times
b. .4 of the windows washed; .5 of the windows washed
c. the windows washed 10 times; the windows washed six times
d. .75 of the windows washed; .6 of the windows washed
ANSWER: b

25. (Table: Joachim and Zane's opportunity cost) The table shows data on how long it takes Joachim and Zane
to clean the bathrooms and wash the windows at a home.

Who has a comparative advantage in washing windows?

a. Zane because he has absolute advantage.
b. Joachim because he has absolute advantage.
c. Zane because he has a lower opportunity cost.
d. Joachim because he has a lower opportunity cost.
ANSWER: c

26. (Table: Time taken to clean). The table provides data on how long it takes Joachim and Zane to clean the
bathrooms and wash the windows at a home. Who has a comparative advantage in cleaning bathrooms and
why?

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a. Zane because he has absolute advantage in cleaning bathrooms.

b. Joachim because he has absolute advantage in cleaning bathrooms.
c. Zane because he has a lower opportunity cost in cleaning bathrooms.
d. Joachim because he has a lower opportunity cost in cleaning bathrooms.
ANSWER: d

27. People are capable of completing many different tasks, each person's comparative advantage is in the
particular task that they
a. can do better than anyone else.
b. enjoy doing the most.
c. can produce more of than any other task.
d. are least bad at doing, relative to other tasks.
ANSWER: d

28. Which of the following statements is TRUE regarding comparative advantage and absolute advantage?
a. People can have a comparative advantage without having an absolute advantage in a task.
b. People can have a comparative advantage only if they also have an absolute advantage in a task.
c. People can have an absolute advantage only if they also have a comparative advantage in a task.
d. People can have no comparative and no absolute advantages in any of the tasks.
ANSWER: a

29. Which of the following is NOT used in identifying who has a comparative advantage in a particular task
when multiple people can perform that task and another one? (Note: The tasks are not necessarily listed in
chronological order.)
a. Identify who has the lowest opportunity cost in performing the task.
b. For each person, calculate how much of the alternative task could have been done in the time it takes
to perform the desired task.
c. For each person, calculate the total time it takes to perform both tasks consecutively.
d. Identify how long it takes each person to perform each task.
ANSWER: c

30. People have different abilities for performing the same two tasks, and you want to identify who has a
comparative advantage in one of the tasks. Which of the following is NOT one of the three steps for identifying,
who has a comparative advantage in performing the selected task?
a. Determine how many hours it takes to perform each task for each person.
b. For each person, calculate the time it takes to do one task in terms of the other.
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c. Determine which person has the lowest opportunity cost in performing the selected task.
d. Identify which person can perform the selected task most quickly.
ANSWER: d

31. (Table: Cooking time). The table provides data on how long it takes Marla and Jason to cook lasagna and
cook chicken curry.

Marla's opportunity cost of making lasagna is _____, and Jason's opportunity cost is _____.
a. .75 of an hour; .33 of an hour
b. .75 of a chicken curry; .33 of a chicken curry
c. 1.33 hours; three hours
d. 1.33 chicken curries; three chicken curries
ANSWER: d

32. (Table: Cooking times). The table provides data on how long it takes Marla and Jason to cook lasagna and
cook chicken curry.

Marla's opportunity cost of making chicken curry is _____, and Jason's opportunity cost is _____.
a. .75 of an hour; .33 of an hour
b. .75 of a lasagna; .33 of a lasagna
c. 1.33 hours; three hours
d. 1.33 lasagna; three lasagna
ANSWER: b

33. (Table: Cooking time) The table provides data on how long it takes Marla and Jason to cook lasagna or
chicken curry.

Which statement explains who has a comparative advantage in cooking lasagna?

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a. Marla because she has a lower opportunity cost than Jason.

b. Jason because he has a lower opportunity cost than Marla.
c. Marla because she can cook lasagna faster than Jason.
d. Jason because he can cook lasagna faster than Marla.
ANSWER: a

34. (Table: Cooking time) The table provides data on how long it takes Marla and Jason to cook lasagna and
cook chicken curry.

Which statement explains who has a comparative advantage in cooking chicken curry?
a. Marla because she has a lower opportunity cost than Jason.
b. Jason because he has a lower opportunity cost than Marla.
c. Marla because she can cook lasagna faster than Jason.
d. Jason because he can cook lasagna faster than Marla.
ANSWER: b

35. (Table: Fazio and Gabriella's opportunity cost) The table provides data on how long it takes Fazio and
Gabriella to learn to play a particular new song on the piano and to complete a given person's tax return. Use the
data to answer the question.

Fazio's opportunity cost of learning the song is _____, and Gabriella's opportunity cost is _____.
a. two tax returns; 1.25 tax returns
b. .5 of a tax return; .8 of a tax return
c. nine hours; two hours
d. .8 of an hour; .5 of an hour
ANSWER: a

36. (Table: Fazio and Gabriella's opportunity cost) The table provides data on how long it takes Fazio and
Gabriella each to learn to play a particular new song on the piano and to complete a given person's tax return.
Use the data to answer the question.

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Fazio's opportunity cost of completing tax returns is _____, and Gabriella's opportunity cost is _____.
a. two new songs learned; 1.25 new songs learned
b. .5 of a new song learned; .8 of a new song learned
c. nine hours; two hours
d. .8 of an hour; .5 of an hour
ANSWER: b

37. (Table : Fazio and Gabriella's opportunity cost) The table provides data on how long it takes Fazio and
Gabriella each to learn to play a particular new song on the piano and to complete a given person's tax return.
Use the data to answer the question.

Which statement explains who has a comparative advantage in learning a new song?
a. Fazio because he learns a new song more quickly than Gabriella.
b. Gabriella because she can learn the song more quickly than Fazio.
c. Fazio because he gives up fewer completed tax returns when he learns a new song.
d. Gabriella because she gives up fewer completed tax returns when she learns a new song.
ANSWER: d

38. (Table: Fazio and Gabriella's opportunity cost) The table provides data on how long it takes Fazio and
Gabriella each to learn to play a particular new song on the piano and to complete a given person's tax return.
Use the data to answer the question.

Which statement explains who has a comparative advantage in completing tax returns?
a. Fazio because he completes a tax return more quickly than Gabriella.

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b. Gabriella because she completes a tax return more quickly than Fazio.
c. Fazio because he gives up learning fewer new songs when he completes a tax return.
d. Gabriella because she gives up learning fewer new songs when she completes a tax return.
ANSWER: c

39. (Table: Bruno and Sasha's comparative advantage) The table provides data on the number of minutes it
takes for Bruno and Sasha to change a tire and iron a dress shirt. Use the data to answer the question.

Which statement explains who has a comparative advantage in changing a tire?

a. Sasha because she has a higher opportunity cost
b. Bruno because he has a higher opportunity cost
c. Sasha because she has a lower opportunity cost
d. Bruno because he has a lower opportunity cost
ANSWER: d

40. (Table: Bruno and Sasha's opportunity cost) The table provides data on the number of minutes it takes for
Bruno and Sasha to each change a tire and iron a dress shirt. Use the data to answer the question.

Which statement explains who has a comparative advantage in ironing a dress shirt?
a. Sasha because she has a higher opportunity cost.
b. Bruno because he has a higher opportunity cost.
c. Sasha because she has a lower opportunity cost.
d. Bruno because he has a lower opportunity cost.
ANSWER: c

41. (Table: Bruno and Sasha's opportunity cost) The table provides data on the number of minutes it takes for
Bruno and Sasha to each change a tire and iron a dress shirt. Use the data to answer the question.

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When changing a car's tire, Bruno's opportunity cost is _____, and Sasha's opportunity cost is _____.
a. .6 of an ironed dress shirt; .67 of an ironed dress shirt
b. .67 of an ironed dress shirt; .6 of an ironed dress shirt
c. 1.67 ironed dress shirts; 1.5 ironed dress shirts
d. 1.5 ironed dress shirts; 1.67 ironed dress shirts
ANSWER: d

42. (Table: Bruno and Sasha's opportunity cost) The table provides data on the number of minutes it takes for
Bruno and Sasha to each change a tire and iron a dress shirt. Use the data to answer the question.

When ironing a dress shirt, Bruno's opportunity cost is _____, and Sasha's opportunity cost is _____.
a. .6 of a tire changed; .67 of a tire changed
b. .67 of a tire changed; .6 of a tire changed
c. 1.67 tires changed; 1.5 tires changed
d. 1.5 tires changed; 1.67 tires changed
ANSWER: b

43. Barlow and Rusia own a nail salon. A manicure takes Barlow 60 minutes to complete and takes Rusia 45
minutes to complete. Completing a pedicure takes Barlow 45 minutes and takes Rusia 30 minutes. Who has a
comparative advantage in pedicures?
a. Barlow because he is faster.
b. Rusia because she is faster.
c. Barlow because he has a lower opportunity cost.
d. Rusia because she has a lower opportunity cost.
ANSWER: d

44. Barlow and Rusia own a nail salon. A manicure takes Barlow 60 minutes to complete and takes Rusia 45
minutes to complete. Completing a pedicure takes Barlow 45 minutes and takes Rusia 30 minutes. Who has a
comparative advantage in manicures?
a. Barlow because he is faster.
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b. Rusia because she is faster.

c. Barlow because he has a lower opportunity cost.
d. Rusia because she has a lower opportunity cost.
ANSWER: c

45. (Table: Four individuals )The table lists the hours that it will take four individuals to clean out a garage and
to trim a property's hedges.

Who has a comparative advantage in cleaning out the garage?

a. Frank
b. Matt
c. Amy
d. Jane
ANSWER: a

46. (Table: Four individuals) The table lists the hours that it will take four individuals to clean out a garage and
to trim a property's hedges.

Who has a comparative advantage in trimming the hedges?

a. Person B
b. Person A
c. Person C
d. Person D
ANSWER: b

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47. (Table: Four persons) The table lists the minutes that it will take four people to wash a car and to sort and
fold a load of laundry. Use the data to answer the question.

Who has a comparative advantage in washing a car?

a. Asad
b. Junko
c. Jason
d. Jen
ANSWER: d

48. (Table: Four Persons) The table lists the minutes that it will take four persons to wash a car and to sort and
fold a load of laundry. Use the data to answer the question.

Who has a comparative advantage in sorting and folding a load of laundry?

a. Asad
b. Junko
c. Jason
d. Jen
ANSWER: a

49. (Table: Four persons) The table lists the minutes that it will take four persons to wash a car and to sort and
fold a load of laundry. Use the data to answer the question.

What is Junko's opportunity cost for washing a car?

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a. 0.42 of a load of laundry will not be sorted and folded.

b. 2.4 loads of laundry will not be sorted and folded.
c. 70 minutes will be given up.
d. 50 minutes will be given up.
ANSWER: b

50. (Table: Four Persons) The table lists the minutes that it will take four persons to wash a car and to sort and
fold a load of laundry. Use the data to answer the question.

What is Jason's opportunity cost for sorting and folding a load of laundry?
a. 0.5 of a car will not be washed.
b. Two cars will not be washed.
c. 45 minutes will be given up.
d. 90 minutes will be given up.
ANSWER: a

51. (Table: Both Joyce and Simeon can cook) Both Joyce and Simeon can cook chicken gumbo and pork chops.
Use the data to answer the question.

What will be the total output of chicken gumbo and pork chops if Joyce and Simeon each work for 24 hours on
the task for which they each have a comparative advantage?
a. Eight chicken gumbos and eight pork chops.
b. 7.5 chicken gumbos and 24 pork chops.
c. 15.5 chicken gumbos and 24 pork chops.
d. 15.5 chicken gumbos and 32 pork chops.
ANSWER: b

52. When people focus their efforts, on the tasks they have a comparative advantage in, what will happen to
output?
a. There will be less total output, but the output will grow for highly valued goods.
b. The total output will shrink because it is not produced by the person who can do it fastest.

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c. Total output will rise and automatically be equally distributed across persons.
d. More of all goods will be produced than if everyone produced everything for themselves.
ANSWER: d

53. Nguyen manages a supply chain team. If she uses the concept of comparative advantage for assigning tasks
to members of her team, then
a. the team's output will consist of a wide range of goods.
b. the team's output will vary more in quality.
c. more can be accomplished.
d. less will be accomplished.
ANSWER: c

54. Otto manages a consulting firm. If Otto wants his employees to produce as much as possible from the
resources available, how should tasks be assigned?
a. The employee who is best at each task should be the one assigned to do it.
b. Each task should be assigned to the employee who can do it at the lowest opportunity cost.
c. Each employee should be cross-trained in all tasks to increase flexibility in assignments.
d. Each task should be assigned to the employee who can do it at the highest absolute advantage.
ANSWER: b

55. What concept would a factory manager make use of to assign tasks if he wants to maximize output and has a
fixed amount of resources?
a. Opportunity revenues
b. Trade incentives
c. Absolute advantage
d. Comparative advantage
ANSWER: d

56. Mara manages a yogurt factory where four main tasks are performed to produce the yogurt. What basis
should she use to assign workers to the tasks if she wants to produce as much yogurt as possible?
a. Workers should specialize in the task for which they have a comparative advantage.
b. Workers should specialize in the task for which they have an absolute advantage.
c. Workers should be cross-trained in all tasks to maximize flexibility in assignments.
d. Each task should be done by the worker who can do it fastest.
ANSWER: a

57. When a manager uses comparative advantage to assign tasks in a workplace, then each
a. task is assigned to the worker who is best at doing the task.
b. worker is assigned to the tasks for which he or she has the highest aptitude and efficiency.
c. worker learns how to do all tasks to increase flexibility in assignments.
d. task is assigned to the worker with the lowest opportunity cost for performing the task.

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ANSWER: d

58. When your employees receive work assignments based on who has the lowest opportunity cost in
performing each task, the basis for the work assignments is
a. work-based efficiency.
b. absolute advantage.
c. comparative advantage.
d. absolute cost.
ANSWER: c

59. Artem manages a coat factory where the main tasks are cutting, sewing, and pressing. Workers vary in their
abilities to do each task. What basis should Artem use to assign the workers?
a. Each worker should do all tasks to see who produces a coat most quickly.
b. Each worker should do the task that he or she can do most quickly, compared to other workers.
c. Each worker should do the task that he or she can do at the lowest opportunity cost, compared to
other workers.
d. Each worker should do two of the three tasks, omitting the one that takes the longest to do.
ANSWER: c

60. Helena works in a factory that makes plastic phone cases. The four main tasks are mixing, molding, curing,
and polishing. Out of all the workers, she is the fastest mixer, has the lowest opportunity cost for molding, is the
most careful in curing, and enjoys polishing the most. If her manager makes assignments in a way that
maximizes output, then she will be assigned to
a. mixing.
b. molding.
c. curing.
d. polishing.
ANSWER: b

61. Raul works at a factory that produces wooden benches. The four main tasks are cutting the wood,
constructing, sanding, and staining. Out of all the workers, Raul enjoys cutting the most, is the slowest at
constructing, has the lowest opportunity cost for sanding, and is the fastest at staining. If his manager wants to
maximize factory output, he will assign Raul to
a. cutting.
b. constructing.
c. sanding.
d. staining.
ANSWER: c

62. Which of the following is a FALSE statement about assigning work based on comparative advantage?
a. Assign the person who is fastest or best at a task to do that task.
b. The person who has absolute advantage in the task will sometimes be assigned to do it.

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c. Workers will be specialists and not generalists.

d. The person with the lowest opportunity cost at a task should perform it.
ANSWER: a

63. Which of the following is a TRUE statement about work assignments based on comparative advantage?
a. The person who is fastest at a task should be assigned to perform it.
b. Absolute advantage in the task should be the basis for making task assignments.
c. Workers should be cross-trained as generalists and should not be specialists.
d. The person with the lowest opportunity cost at a task should perform it.
ANSWER: d

64. If Ilona wants to live her life based on comparative advantage, then she should
a. try to earn as much as possible so that she can buy as much as possible.
b. do those things for herself that she can do most quickly and then trade with others.
c. focus her time on the things she can do.
d. do for herself the things for which she has low opportunity cost and trade with others for things she
has a high opportunity cost.
ANSWER: d

65. The principle of comparative advantage applies to interactions

a. between people but not in business production decisions.
b. in business production decisions but not between people.
c. between people as well as in business production decisions.
d. in neither business production decisions nor between people.
ANSWER: c

66. When everyone produces according to their comparative advantage, then they
a. gain from trade.
b. produce things for which they have a high opportunity cost.
c. are self-reliant, producing most of the things they need.
d. trade very little.
ANSWER: a

67. Comparative advantage explains why people

a. try to gain a wide range of skills.
b. work at the job they love the most.
c. specialize and trade.
d. lack focus in their production decisions.
ANSWER: c

68. Specialization will increase output when it is based on:

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a. who can produce at the least comparative cost.

b. absolute advantage.
c. who can produce the fastest.
d. comparative advantage.
ANSWER: d

69. If Bishan wants to capitalize on comparative advantage in his life, then he should:
a. compare his preferences to those of others and trade with those who like things he does not like.
b. produce either goods or services but not both.
c. do more of what he is relatively good at and then trade for other things.
d. do more of what he has an absolute advantage in and trade for other things.
ANSWER: c

70. Katie is much faster than her husband, Brett, at putting up a tent and starting a fire. Who should take care of
these tasks on their camping trip if they want to maximize their time sitting around a campfire?
a. They each have a comparative advantage in a particular task, and they should focus on doing that.
Katie can help Brett when she finishes her task.
b. They should complete both tasks together, sharing all the work.
c. Katie should complete both tasks because she is a more efficient worker. Brett could watch and learn
from her.
d. Katie should be in charge, directing the work while Brett does it.
ANSWER: a

71. What institution allows people to gain access to others who have different comparative advantages without
meeting them or communicating directly with them?
a. Families
b. Community gatherings
c. Government
d. Markets
ANSWER: d

72. When people focus on their comparative advantage and then trade for other things, they:
a. improve their standard of living or increase their leisure time.
b. focus their consumption on just a few things.
c. increase the time they spend working and reduce the variety in their consumption.
d. have a lower standard of living than if they focused on their absolute advantage.
ANSWER: a

73. Why would Emerald benefit from specializing based on comparative advantage?
a. She could enhance her living standards.
b. She would be doing what she loves most.

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c. She would have a wide variety of skills.

d. She could save her income rather than spend it.
ANSWER: a

74. Which of the following pieces of advice is consistent with the principle of comparative advantage?
a. If someone else is faster than you at a task, trade with them, so they do it for you.
b. Focus on what you do best.
c. Focus on what you are relatively good at doing, even if you are not the best at it.
d. Relative preferences are key to understanding who should do what.
ANSWER: c

75. Which of the following headlines is NOT consistent with the principle of comparative advantage?
a. Island lessens welfare by promoting trade.
b. Famous actress hires a new nanny.
c. Providers of household services see growth in demand.
d. Consultant recommends workforce specialization.
ANSWER: a

76. What is the basis of specialization?

a. Absolute advantage
b. Comparative advantage
c. Trade enhancement
d. Incentive enhancement
ANSWER: b

77. Which of the following statements is FALSE?

a. The principle of comparative advantage applies to trade between buyers and sellers in different
countries.
b. The principle of comparative advantage applies to trade between people and companies.
c. The principle of comparative advantage explains why people specialize.
d. The principle of comparative advantage explains why companies do not specialize.
ANSWER: d

78. When trade is based on comparative advantage

a. output may fall.
b. specialization will diminish.
c. both trading partners end up better off.
d. one trading partner gains at the expense of the other.
ANSWER: c

79. Which of the following statements about international trade is TRUE?

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a. After trade, one country gains, and the other is worse off.
b. If trade occurs, people's welfare will worsen.
c. Producers in different countries should specialize in the production of goods for which their
opportunity cost is low.
d. International trade is based on absolute advantage.
ANSWER: c

80. When a country's production mix becomes more specialized due to increased international trade based on
comparative advantage
a. some industries in the country will shrink and possibly disappear.
b. all industries in the country will grow as the economy grows from the trade.
c. the losses in industries without comparative advantage will offset the gains from trade.
d. the country will find it has less need for trade in the future.
ANSWER: a

81. Comparative advantage is about _____ resources to _____.

a. increasing the amount of; their highest-cost uses
b. increasing the productivity of; less labor-intensive production
c. investing in; higher-quality production
d. reallocating; their better uses
ANSWER: d

82. Trade based on comparative advantage does NOT result in _____ but DOES result in _____.
a. specialization; more generalization
b. focused production; enhanced skills
c. a zero-sum situation; a win-win for participants
d. a win-win for participants; a zero-sum situation
ANSWER: c

83. When resources are organized according to the principle of comparative advantage, producers become
a. more specialized so they can trade and end up with more of everything.
b. less specialized so they can trade and end up with more of everything.
c. more specialized but can end up with less of everything.
d. less specialized and can end up with less of everything.
ANSWER: a

84. When trade is based on comparative advantage

a. producers lose if they become more specialized.
b. any gains from trade are equally shared across the trading partners.
c. one trading partner may gain at the expense of the other.
d. both trading partners end up better off than when there is no trade.
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ANSWER: d

85. Which of the following will NOT happen if a country increases trade based on comparative advantage?
a. Some industries will grow, and others will shrink.
b. Overall, the country will have an increase in welfare.
c. Production in the country will become more specialized.
d. Some countries involved in the trade will have a loss in welfare.
ANSWER: d

86. Which of the following is NOT one of the three key roles that prices play in markets?
a. Prices aggregate information.
b. Prices have purchasing power.
c. Prices are signals.
d. Prices create incentives.
ANSWER: b

87. In markets, prices act as all of the following except

a. incentives.
b. signals.
c. productivity.
d. information.
ANSWER: c

88. How do rice farmers in rural Indonesian villages figure out that they need to produce more rice when the
demand for it has risen in other parts of the world?
a. A decrease in sales communicates to them that they need to advertise more.
b. An increase in sales communicates to them that inventories are rising.
c. A decrease in the price of rice gives them a signal that there is insufficient quantity.
d. An increase in the price of rice gives them a signal that rice is more valuable.
ANSWER: d

89. The price of celery rises, but nothing has changed on the supply side of the market. What does this mean to
celery farmers?
a. Celery production should be increased because the number of producers has fallen.
b. Celery production should be reduced because the number of producers has risen.
c. It is a signal that celery is more valuable to consumers than it was before.
d. It is a signal that they should reduce celery production because it is too expensive for consumers.
ANSWER: c

90. The price of macadamia nuts falls. This conveys all of the following signals EXCEPT
a. that macadamia nuts are in plentiful supply, so consumers should buy more.

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b. that demand for macadamia nuts is low, so producers should produce less.
c. that the price change will be understood in every language and helps coordinate the macadamia
market.
d. that the price of almonds is rising.
ANSWER: d

91. When price changes act as a line of communication between buyers and sellers, price is functioning as
a. an incentive.
b. a producer.
c. an information aggregator.
d. a signal.
ANSWER: d

92. Price is functioning as a signal when it

a. is a line of communication between buyers and sellers in a market.
b. creates incentives for changes in production and consumption.
c. broadcasts useful information.
d. summarizes all that is happening in the market.
ANSWER: a

93. When price functions as a signal, it

a. inspires buyers and sellers to change behavior.
b. aggregates information on the market in one measure.
c. strengthens a buyer's or seller's position in the market.
d. creates a line of communication between buyers and sellers.
ANSWER: d

94. When price functions as a communication line between buyers and sellers around the world, it is
functioning as
a. an incentive.
b. a substitute for money.
c. a signal.
d. a bundle of information.
ANSWER: c

95. Which of the following is TRUE when the price is functioning as a signal?
a. It serves as a bundle of information.
b. It communicates to buyers and sellers.
c. It changes the purchasing power of money.
d. It inspires action.
ANSWER: b
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96. Which of the following is a description of price functioning as a signal when the price of gasoline rises?
a. Change in the price of gasoline helps coordinate market outcomes.
b. The price change reflects and summarizes information about what is going on in the market for
gasoline.
c. Buyers and sellers change their demand and supply in response to the price change.
d. The purchasing power of money is affected by the price change.
ANSWER: a

97. When a price is referred to as a signal, this means that price

a. bundles information together.
b. encourages action.
c. communicates.
d. provides purchasing power.
ANSWER: c

98. The price of a cup of coffee goes up. This communicates to Stella that coffee has become more valuable.
Price is functioning as
a. a signal.
b. an incentive.
c. a bundle of information.
d. a producer.
ANSWER: a

99. When the price of firewood changes, Dan realizes that something must be different in the firewood market.
Price is functioning as
a. a bundle of information.
b. a signal.
c. an incentive.
d. a monetary unit.
ANSWER: b

100. The price of firewood rises, which encourages Marcella to buy less firewood. Price is functioning as
a. a signal.
b. a bundle of information.
c. a buyer.
d. an incentive.
ANSWER: d

101. The price of coffee goes up, and Stella cuts back on her coffee consumption. This illustrates price
functioning as
a. a signal.
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b. an incentive.
c. a bundle of information.
d. a producer.
ANSWER: b

102. Chantelle grows tomatoes and sells them at the farmer's market. Because the price of tomatoes rises, she is
encouraged to grow and sell more. This is an example of price functioning as
a. a bundle of information.
b. a currency.
c. an incentive.
d. a signal.
ANSWER: c

103. Giselle buys doughnuts for breakfast once a week. The price of doughnuts falls, and the lower price
induces her to buy doughnuts twice a week. This is an example of price functioning as
a. an incentive.
b. an advertisement.
c. a signal.
d. a bundle of information.
ANSWER: a

104. Harvey pays $8 to skate at the indoor ice rink once a month. The price rises to $10, and Harvey starts
skating once every six weeks. This is an example of price functioning as
a. a bundle of information.
b. a signal.
c. a challenge.
d. an incentive.
ANSWER: d

105. When sellers and buyers adjust supply and demand in response to a price change signal, price is
functioning as
a. a signal.
b. a bundle of information.
c. an incentive.
d. a precursor.
ANSWER: c

106. Price is functioning as an incentive when a price change

a. communicates that the market is changing.
b. causes people to have higher incomes.
c. provides information about the state of the market.

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d. causes buyers and sellers to change their behavior.

ANSWER: d

107. When price functions as an incentive, it

a. encourages companies to develop new types of products.
b. communicates with buyers and sellers about the market.
c. collects information about the market.
d. encourages buyers and sellers to change the quantity they will buy and sell.
ANSWER: d

108. Aree has a smoothie business. The average price of smoothies in her city rises, and this encourages Aree to
increase the price and the quantity that she produces. Her response to the price increase is an example of price
functioning as
a. a bundle of information.
b. an incentive.
c. a reflex.
d. a signal.
ANSWER: b

109. Jane sells bowls of noodles for $6 at her noodle shop. The average price of a bowl of noodles in the city
starts rising. In response to this, Jane starts to produce more bowls of noodles and raises her price to $6.50. This
is an example of price functioning as
a. an incentive.
b. a currency.
c. a bundle of information.
d. a signal.
ANSWER: a

110. Marta's family buys a dozen eggs each week. The price of a dozen eggs rises from $2 to $3. In response to
this, Marta's family starts to buy eggs every two weeks instead of every week. This is an example of price
functioning as
a. a currency.
b. an incentive.
c. a bundle of information.
d. a signal.
ANSWER: b

111. Markets whose payoffs are linked to whether an uncertain event occurs are called _____ markets.
a. signal
b. information
c. incentive
d. prediction
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ANSWER: d

112. A prediction market is a market where:

a. signals lead to future actions.
b. information is disaggregated.
c. payoffs are linked to whether an uncertain event occurs.
d. information is missing to make a good decision.
ANSWER: c

113. How does the accuracy of prediction markets compare to public opinion polls?
a. Prediction markets' accuracy varies widely.
b. They both are equally accurate.
c. Prediction markets provide less accurate forecasts.
d. Prediction markets provide more accurate forecasts.
ANSWER: d

114. How does price aggregate information?

a. Price reflects the preferences of the dominant market.
b. The actions of many buyers and sellers impact the price in the market.
c. If the purchasing power of currency changes, the price will change in response.
d. Prices across markets allow for comparisons.
ANSWER: b

115. Many buyers and sellers participate in the rice market. All their decisions in the rice market lead to the
market equilibrium price. This describes which function of price?
a. Price provides signals.
b. Price creates incentives.
c. Price leads to inventions.
d. Price aggregates information.
ANSWER: d

116. Prices in currency futures markets and bond markets provide

a. signals that past decisions were based on false information.
b. predictions of future exchange rates and inflation rates.
c. commentary on the past.
d. incentives to buy more when the price rises.
ANSWER: b

117. As prices _____, they provide useful business intelligence.

a. create incentives
b. aggregate information

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c. vary randomly
d. are constant
ANSWER: b

118. Managers can harness market forces by setting up internal markets, which:
a. have a geographic scope limited to one country with no international transactions.
b. trade only with employees rather than companies and governments.
c. buy and sell raw materials rather than finished products.
d. are organized within a company to buy and sell scarce resources.
ANSWER: d

119. When a manager sets up markets within the company to buy and sell scarce resources, these markets are
called
a. internal markets.
b. domestic markets.
c. company towns.
d. closed corporate markets.
ANSWER: a

120. Why would a company set up internal markets?

a. To reduce the price that it pays to acquire resources for producing its product.
b. To keep all profits within the company.
c. To allocate the company's resources more efficiently.
d. To ensure demand for its output.
ANSWER: c

121. A knowledge problem exists when

a. a decision-maker refuses to believe or make use of available information.
b. so much information is available to decision-makers that it is difficult to process all the relevant
information.
c. the information available to a decision-maker is not accurate and based on opinion.
d. the information needed to make a good decision is not available to a decision-maker.
ANSWER: d

122. If you need to make a decision and all the information needed to make a good decision is not available,
then you:
a. have a knowledge problem.
b. have to make a prediction.
c. are dealing with a partitioning issue.
d. face an analysis hurdle.
ANSWER: a
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123. Internal markets, which are markets that managers set up within their organization, are:
a. allowed to sell only to customers on an approved list of buyers.
b. based on predetermined prices rather than equilibrium prices.
c. set up to allocate resources of a company more efficiently, often not using real money.
d. required to use real money to allocate real resources across firms in an industry.
ANSWER: c

124. Why would a company set up internal markets?

a. To solve a problem with product design.
b. To solve the knowledge problem.
c. To gain access to resources that were previously unavailable.
d. To prevent the product price from falling.
ANSWER: b

125. Internal markets can be used to _____ and _____.

a. make predictions; allocate resources
b. get better prices in input markets; reduce the customer base
c. set the product price; gain customers
d. reduce costs; increase demand
ANSWER: a

126. Which of the following benefits could a company gain from using internal markets?
a. Increased profits and reduced competition.
b. Access to more input markets and greater levels of competition.
c. Greater market power and reduced costs of production.
d. Better allocation of its resources and more accurate predictions.
ANSWER: d

127. Markets _____, and this generates _____.

a. sell goods; demand
b. produce goods; uses for resources
c. satisfy buyers; internal profits
d. reallocate resources; gains from trade
ANSWER: d

Essay

128. What is meant by the term "gains from trade"?

ANSWER: The gains from trade are the benefits that come from reallocating resources, goods, and services to
better uses. This increases the level of efficiency (economic surplus) and welfare across the
population. When trade is voluntary, there are always gains to both parties because a person would
not be rational to enter into a voluntary trade unless it improved the person's welfare.
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129. What is the basic idea behind comparative advantage?

ANSWER: Comparative advantage is based on the idea of opportunity cost. The person who gives up the least
to produce an item has a comparative advantage in producing that item. If each item is produced by
the person who gives up the least to produce the item, then society will be able to produce as much
as possible out of its limited resources.

130. The table provides data on the minutes it takes for Mara and Nishan to change the sheets on all the beds in
the house and to fix dinner. Use the data to answer the essay question.

Who has a comparative advantage each task? Use the data to explain how you arrived at this conclusion.
ANSWER: Mara has a comparative advantage in changing the sheets, and Nishan has a comparative advantage
in fixing dinner. People have a comparative advantage in a task if they have a lower opportunity cost
in performing the task than other producers. Opportunity cost is measured by how much of the other
product must be given up for every unit of a product that is produced. It takes 90 minutes for Mara
to change the sheets on all the beds. This is 90 minutes she cannot spend fixing dinner. In 90
minutes, she could fix three-quarters of a dinner (based on 90/120). Nishan gives up the chance to
fix one whole dinner when he changes the sheets (based on 60/60). Mara has a lower opportunity
cost, so she has the comparative advantage in changing sheets.

Every time Mara fixes dinner, 120 minutes are not available for changing the sheets. This means
that she gives up the chance to change the sheets 1.33 times for every dinner she prepares (based on
120/90). Nishan gives up changing the sheets just once (based on 60/60) for every meal he prepares.
Thus, Nishan has a lower opportunity cost in fixing dinner than Mara does. Nishan has a
comparative advantage in fixing dinner.

131. Why is comparative advantage NOT based on who does a task best?
ANSWER: Comparative advantage is based on opportunity cost, not on being the person who does a task fastest
or who uses the fewest resources. Doing a task faster or using fewer resources means that a producer
has an absolute advantage. One producer can have an absolute advantage in several or even all tasks.
However, if production were assigned to those with absolute advantage, some people (those with no
absolute advantages) might be idle, and we would lose the output they could have produced.

Everyone has a comparative advantage in something, and so when productive tasks are allocated to
individuals based on comparative advantage, everyone contributes to production. Beyond this,
production is done by the person who has the lowest opportunity cost in the task. This means that as
little other output as possible is forgone for every unit produced. This maximizes the total
production.

Production is maximized when we give up as little as possible for every unit that is produced.
Basing production on opportunity cost achieves this. Basing production on who has absolute
advantage does not.
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132. Summarize the three steps for identifying who has a comparative advantage in a task.
ANSWER: There are three basic steps to determining who has comparative advantage. At least two persons are
needed who can each perform two different tasks. First, identify how long it takes each person to
complete each task. Then use the data to calculate each person's opportunity cost for performing
each task. This is calculated by taking the minutes to perform the task of focus divided by the
minutes to perform the other task. The result is how much of the other task must be given up to
perform the task of focus. The last step is to identify which person has the lowest opportunity cost
for each task. The person with the lowest opportunity cost has a comparative advantage in that task.

133. How do competitive markets help economies capture the gains available through trade?
ANSWER: When markets are competitive, the incentives of producers and consumers lead to specialization and
trade whenever both parties (buyers and sellers) stand to gain from the trade. Both parties gain from
trade when it is voluntary and when it is based on comparative advantage. Trade based on
comparative advantage maximizes the gain because each item is produced by the worker with the
lowest opportunity cost. This leads to maximum output (and therefore maximum possible
consumption) across the economy.

134. Prices function as signals, incentives, and bundles of information. Explain what these functions are and
how each is a distinct function.
ANSWER: When price functions as a signal, price is communicating to buyers and sellers. A change in price
alerts buyers that something is going on related to supply and alerts sellers that something is going
in related to demand.
The direction of a change in price creates an incentive for buyers and sellers to change their
behavior. If price goes up, buyers are induced to buy less, and sellers want to produce and sell more.
If price goes down, the incentives are the opposite.
Price is determined by the interaction of supply and demand. Supply and demand are based on the
actions of many buyers and sellers. In a sense, the price pulls together and summarizes the desires of
all these decision makers. Thus, it provides information on how, in total, the actions of all these
decision makers come together. It gives insight.

135. The price of gasoline rises. Buyers of gasoline notice this and start to find ways to buy less gasoline.
Sellers and producers of gasoline notice the price change and start to produce more. Analysts start to predict
that sales of electric cars will rise and sales of gasoline-powered cars will stagnate. Use this scenario explain the
signal, incentive, and bundle of information roles of price.
ANSWER: Price is a signal when it communicates that a market is changing. The change in price of gasoline
alerts buyers and producers that something is happening.
Price is an incentive when it induces or encourages market participants to change their behavior. In
this example, consumers have an incentive to reduce consumption of gasoline, and producers want
to increase production of gasoline when the price rises.
Price provides information on the summative action of all buyers and sellers of the product, and this
information allows predictions to be made. In this example, the higher price of gasoline gives
information that leads to a prediction that the electric car market might see growth as people avoid
paying high gasoline prices.

136. How do prediction markets illustrate the ways that price aggregates information in a market?

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ANSWER: A market results from the interactions of many decision makers, some of whom are buyers and
some of whom are sellers. The equilibrium price that prevails in the market is determined by the
interactions of all these many market participants. In a sense, the price gives a summation of the
desires and actions of the participants. When price changes, it is because the actions of the
participants have changed. It is difficult to track all the individual actions of the market participants
because there are so many of them. Price provides an overall indication of how their actions come
together.
A prediction market is a market whose payoffs depend on whether an uncertain event occurs. The
price that prevails in this type of market is indicative of the summative or overall beliefs of all the
many market participants regarding the likelihood of the uncertain event occurring, which basically
provides the prediction of the body of market participants.

137. How do internal markets overcome a manager's knowledge problem?

ANSWER: Managers have a knowledge problem when they do not have enough information to make a good
decision. When there is a knowledge problem, the manager and firm are either immobilized until
enough information can be acquired, or the manager and firm risk making a less-than-optimal
decision.
If the information that is lacking is firm-specific information that is not available because it is
difficult to collect due to the firm having a large number of potential data points (locations or
employees), then creating an internal market within the firm can harness market forces to provide
the information that is lacking.
For example, if it is difficult to determine how to allocate limited resources most effectively across a
large number of limited firm locations, then the locations could each bid to "buy" the resources with
imaginary money that has been allocated to them. Those locations that bid the most must be the ones
that would benefit the most from the resources.
Using this internal market, managers do not need to survey each location regarding its need for
resources and balance all the competing requests against each other, and yet they can be relatively
confident that the resources are going where they will provide the greatest benefit to the firm.

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Multiple Choice

1. A Japanese-made automobile purchased by a U.S. citizen is an example of a U.S. _____, and a U.S.-made
automobile purchased by a Japanese citizen purchasing is an example of a U.S. _____.
a. import; import
b. export; export
c. import; export
d. export; import
ANSWER: c

2. A Korean-made washing machine purchased by a Chinese citizen is an example of a Korean _____, and a
Chinese-made washing machine purchased by a Korean citizen is an example of a Korean _____.
a. import; import
b. export; export
c. import; export
d. export; import
ANSWER: d

3. An import is a good or service:

a. purchased from a foreign seller.
b. purchased from a domestic seller.
c. sold to a foreign buyer.
d. sold to a domestic buyer.
ANSWER: a

4. An export is a good or service:

a. purchased from a foreign seller.
b. purchased from a domestic seller.
c. sold to a foreign buyer.
d. sold to a domestic buyer.
ANSWER: c

5. Argentina and Chile both produce copper and timber. If Chile produces copper much more efficiently than
Argentina and timber slightly more efficiently than Argentina, _____ can benefit from trading copper and
timber with each other.
a. both countries
b. only Chile
c. only Argentina
d. neither country
ANSWER: a

6. Russia and Kazakhstan both produce horses and oil. If Kazakhstan is much more efficient than Russia in the
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production of horses and slightly more efficient than Russia in the production of oil, _____ can benefit from
trading horses and oil with each other.
a. both countries
b. only Russian
c. only Kazakhstan
d. neither country
ANSWER: a

7. Suppose that one hour of labor in Singapore can produce 20 computers or 40 cellphones. Further, suppose
that one hour of labor in Ireland can produce 10 computers or 15 cellphones. _____ has a comparative
advantage in the production of computers. _____ has a comparative advantage in the production of cellphones.
a. Singapore; Singapore
b. Ireland; Ireland
c. Singapore; Ireland
d. Ireland; Singapore
ANSWER: d

8. One hour of labor in Mexico can produce 10 avocados or 20 bananas. One hour of labor in Canada can
produce four avocados or 16 bananas. _____ has a comparative advantage in the production of avocados. _____
has a comparative advantage in the production of bananas.
a. Mexico; Canada
b. Canada; Mexico
c. Mexico; Mexico
d. Canada; Canada
ANSWER: a

9. Countries benefit from trade by exporting goods in which their opportunity costs are relatively _____ and
importing goods in which their opportunity costs are relatively _____.
a. low; low
b. high; high
c. low; high
d. high; low
ANSWER: c

10. Countries benefit from trade by importing goods in which their opportunity costs are relatively _____ and
exporting goods in which their opportunity costs are relatively _____.
a. low; low
b. high; high
c. low; high
d. high; low
ANSWER: d

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11. (Table: U.S. International Trade in Goods and Services, 2016, in millions of dollars. Details may not equal
totals, due to seasonal adjustment and rounding.)

What is the value of goods that the United States exported (in millions of dollars) in 2016?
a. –$751,051
b. $758,888
c. $1,456,957
d. $2,208,008
ANSWER: c

12. (Table: U.S. International Trade in Goods and Services, 2016, in millions of dollars. Details may not equal
totals, due to seasonal adjustment and rounding.)

In 2016, the United States imported ____ million worth of goods.

a. –$751,051
b. $758,888
c. $1,456,957
d. $2,208,008
ANSWER: d

13. (Table: U.S. International Trade in Goods and Services, 2016, in millions of dollars. Details may not equal
totals due to seasonal adjustment and rounding.)

In 2016, the United States was a net _____ of _____ million in goods.
a. importer; $751,051
b. importer; $249,050

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c. exporter; $751,051
d. exporter; $249,050
ANSWER: a

14. (Table: U.S. International Trade in Goods and Services, 2016, in millions of dollars. Details may not equal
totals, due to seasonal adjustment and rounding.

In 2016, the United States was a net _____ of _____ million in services.
a. importer; $751,051
b. importer; $249,050
c. exporter; $751,051
d. exporter; $249,050
ANSWER: d

15. (Table: U.S. International Trade in Goods and Services, 2016, in millions of dollars. Details may not equal
totals due to seasonal adjustment and rounding.)

In 2016, the United States was a net _____ of _____ million in goods and services.
a. importer; $502,001
b. importer; $2,215,844
c. exporter; $502,001
d. exporter; $2,215,844
ANSWER: a

16. (Table: U.S. International Trade in Goods and Services, 2018, in millions of dollars. Details may not equal
totals, due to seasonal adjustment and rounding.)

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From January to September in 2018, the United States was a net _____ of _____ million in goods.
a. importer; $445,166
b. importer; $650,978
c. exporter; $445,166
d. exporter; $650,978
ANSWER: b

17. (Table: U.S. International Trade in Goods and Services, 2018, in millions of dollars. Details may not equal
totals due to seasonal adjustment and rounding.)

From January to September in 2018, the United States was a net _____ of _____ million in services.
a. importer; $205,812
b. importer; $650,978
c. exporter; $205,812
d. exporter; $650,978
ANSWER: c

18. (Table: U.S. International Trade in Goods and Services, 2018, in millions of dollars. Details may not equal
totals, due to seasonal adjustment and rounding.)

From January to September in 2018, the United States was a net _____ of _____ million in goods and services.
a. importer; $445,166
b. importer; $650,978
c. exporter; $445,166
d. exporter; $650,978
ANSWER: a

19. Which of the following is an example of a trade cost associated with a U.S. citizen importing a sweater
produced in India?
a. the final price of the sweater
b. the cost of the wool used in producing the sweater
c. the cost of the labor used in producing the sweater
d. the cost of the tariff on imported sweaters from India
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ANSWER: d

20. Which of the following is an example of a trade cost incurred when a German citizen imports a bottle of
wine produced in France?
a. the cost of the trucking services used in transportation
b. the cost of the grapes used in producing the wine
c. the final price of the bottle of wine
d. the cost of the labor used in producing the wine
ANSWER: a

21. A trade cost is:

a. the price of a good that is bought or sold abroad.
b. the cost associated with producing a good that is bought or sold abroad.
c. an extra cost incurred as a result of buying or selling a good abroad rather than domestically.
d. the difference in price between a good that is bought or sold abroad rather than domestically.
ANSWER: c

22. Which of the following is NOT a trade cost?

a. the cost of producing a good
b. the hassle of working across language barriers
c. dealing with foreign laws
d. adapting to different ways of doing business
ANSWER: a

23. Which of the following is MOST likely to be traded internationally?

a. land
b. hair gel
c. bowling alleys
d. taxi rides
ANSWER: b

24. Which of the following is LEAST likely to be traded internationally?

a. cloud computing
b. flowers
c. an afternoon bowling
d. bikes
ANSWER: c

25. Which of the following is MOST likely to be traded internationally?

a. skyscrapers
b. cosmetic surgery

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c. a haircut
d. computers
ANSWER: d

26. Which of the following is LEAST likely to be traded internationally?

a. sports arenas
b. sporting equipment
c. sports trading cards
d. sports broadcasts
ANSWER: a

27. (Figure: Imports and Exports) From 1930 to 2018, U.S. imports as a share of GDP have _____, and U.S.
exports as a share of GDP have _____.

a. increased; decreased
b. decreased; increased
c. increased; increased
d. decreased; decreased
ANSWER: c

28. (Figure: Imports and Exports) During the 2008 to 2009 financial crisis, imports as a share of GDP fell in the
United States. Which of the following could explain this phenomenon?

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a. The percentage decrease in imports was greater than the percentage decrease in GDP.
b. The percentage decrease in imports was less than the percentage decrease in GDP.
c. The percentage increase in imports was greater than the percentage decrease in GDP.
d. The percentage increase in imports was less than the percentage decrease in GDP.
ANSWER: a

29. (Figure: Imports and Exports) During the 2008 to 2009 financial crisis, exports as a share of GDP fell in the
United States. Which of the following could explain this phenomenon?

a. The percentage decrease in exports was greater than the percentage decrease in GDP.
b. The percentage decrease in exports was less than the percentage decrease in GDP.
c. The percentage increase in exports was greater than the percentage decrease in GDP.
d. The percentage increase in exports was less than the percentage decrease in GDP.
ANSWER: a
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30. Which of the following is NOT a reason for the increase in international trade over the past century?
a. the improvements in air travel
b. increases in tariff rates across countries
c. the increased adoption of English
d. the standardization of shipping containers
ANSWER: b

31. Which of the following is NOT a source of comparative advantage?

a. specialized skills
b. mass production
c. abundant inputs
d. global supply chains
ANSWER: d

32. Which of the following is a source of comparative advantage?

a. low tariff rates
b. abundant inputs
c. low trade costs
d. global supply chains
ANSWER: b

33. Which of the following is a source of comparative advantage?

a. small-scale production
b. scarce inputs
c. specialized skills
d. high tariff rates
ANSWER: c

34. The United States has a comparative advantage in _____-skilled labor. This explains why the U.S. is a net
_____ of manufactured goods.
a. high; importer
b. high; exporter
c. low; importer
d. low; exporter
ANSWER: a

35. The United States has a comparative disadvantage in _____-skilled labor. This explains why the U.S. is a
net _____ of high-skilled services.
a. high; importer
b. high; exporter
c. low; importer
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d. low; exporter
ANSWER: d

36. Vietnam has a comparative disadvantage in _____-skilled labor. This explains why Vietnam is a net _____
of high-skilled services.
a. high; importer
b. high; exporter
c. low; importer
d. low; exporter
ANSWER: a

37. Vietnam has a comparative advantage in _____-skilled labor. This explains why Vietnam is a net _____ of
manufactured goods.
a. high; importer
b. high; exporter
c. low; importer
d. low; exporter
ANSWER: d

38. Which of the following is a term economists use to explain why specific industries can become more
efficient over time?
a. cost-benefit principle
b. learning by doing
c. the marginal principle
d. opportunity cost
ANSWER: b

39. The world demand curve slopes downward because, as the world price of a product falls:
a. consumers want to buy a smaller quantity.
b. consumers want to buy a larger quantity.
c. producers want to sell a smaller quantity.
d. producers want to sell a larger quantity.
ANSWER: b

40. The world supply curve slopes upward because, as the world price of a product falls:
a. consumers want to buy a smaller quantity.
b. consumers want to buy a larger quantity.
c. producers want to sell a smaller quantity.
d. producers want to sell a larger quantity.
ANSWER: c

41. The world demand curve slopes downward because, as the world price of a product increases:
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a. consumers want to buy a smaller quantity.

b. consumers want to buy a larger quantity.
c. producers want to sell a smaller quantity.
d. producers want to sell a larger quantity.
ANSWER: a

42. The world supply curve slopes upward because, as the world price of a product increases:
a. consumers want to buy a smaller quantity.
b. consumers want to buy a larger quantity.
c. producers want to sell a smaller quantity.
d. producers want to sell a larger quantity.
ANSWER: d

43. (Figure: Market for TVs) According to the figure, the equilibrium world price of TVs is:

a. $50.
b. $100.
c. $500.
d. $1,000.
ANSWER: c

44. (Figure: Market for TVs) According to the figure, the equilibrium world quantity of TVs (in millions) sold
is:

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a. 50.
b. 100.
c. 500.
d. 1,000.
ANSWER: a

45. (Figure: Market for TVs) According to the figure, at a world price of $600:

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a. the quantity demanded exceeds the quantity supplied, and there is downward pressure on the world
price.
b. the quantity demanded exceeds the quantity supplied, and there is upward pressure on the world
price.
c. the quantity supplied exceeds the quantity demanded, and there is downward pressure on the world
price.
d. the quantity supplied exceeds the quantity demanded, and there is upward pressure on the world
price.
ANSWER: c

46. (Figure: Market for TVs) According to the figure, at a world price of $400:

a. the quantity demanded exceeds the quantity supplied, and there is downward pressure on the world
price.
b. the quantity demanded exceeds the quantity supplied, and there is upward pressure on the world
price.
c. the quantity supplied exceeds the quantity demanded, and there is downward pressure on the world
price.
d. the quantity supplied exceeds the quantity demanded, and there is upward pressure on the world
price.
ANSWER: b

47. (Figure: Market for TVs 2) According to the figure, if there is no international trade, the equilibrium price in
this market is:

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a. $50.
b. $60.
c. $500.
d. $600.
ANSWER: d

48. (Figure: Market for TVs 2) According to the figure, if there is no international trade, the equilibrium
quantity (in thousands) in this market is:

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a. 50.
b. 60.
c. 500.
d. 600.
ANSWER: b

49. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of a television is $500, buyers and sellers will make exchanges at a price of _____ because buyers
will refuse to pay _____ than the world price.

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a. $500; less
b. $500; more
c. $600; less
d. $600; more
ANSWER: b

50. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of televisions is $400, buyers and sellers will make exchanges at a price of _____ because buyers
will refuse to pay _____ than the world price.

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a. $400; less
b. $400; more
c. $600; less
d. $600; more
ANSWER: b

51. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of televisions is $500, the quantity demanded is _____, and the quantity supplied is _____ at the
world price.

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Name: Class: Date:

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a. 20,000; 80,000
b. 80,000; 20,000
c. 40,000; 70,000
d. 70,000; 40,000
ANSWER: d

52. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of a television is $400, the quantity demanded is _____, and the quantity supplied is _____ at the
world price.

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a. 80,000; 20,000
b. 20,000; 80,000
c. 40,000; 70,000
d. 70,000; 40,000
ANSWER: a

53. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of televisions is $500, the quantity demanded is _____, and domestic suppliers will sell _____ units
to domestic consumers.

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a. 70,000; 30,000
b. 70,000; 40,000
c. 80,000; 30,000
d. 80,000; 40,000
ANSWER: b

54. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of a television is $400, the quantity demanded is _____, and domestic suppliers will sell _____ units
to domestic consumers.

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a. 70,000; 20,000
b. 70,000; 60,000
c. 80,000; 20,000
d. 80,000; 60,000
ANSWER: c

55. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of televisions is $500, domestic consumers will purchase _____ units from domestic producers and
_____ units from foreign producers.

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Name: Class: Date:

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a. 20,000; 30,000
b. 20,000; 60,000
c. 40,000; 30,000
d. 40,000; 60,000
ANSWER: c

56. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of televisions is $400, domestic consumers will purchase _____ units from domestic producers and
_____ units from foreign producers.

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a. 20,000; 30,000
b. 20,000; 60,000
c. 40,000; 30,000
d. 40,000; 60,000
ANSWER: b

57. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of televisions is $500:

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Chapter 09: International Trade

a. domestic consumers will import 30,000 units.

b. domestic consumers will export 30,000 units.
c. domestic producers will import 40,000 units.
d. domestic producers will export 40,000 units.
ANSWER: a

58. (Figure: Market for TVs 2) According to the figure, if there is international trade in this market, and the
world price of televisions is $400:

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a. domestic consumers will import 60,000 units.

b. domestic consumers will export 60,000 units.
c. domestic producers will import 20,000 units.
d. domestic producers will export 20,000 units.
ANSWER: a

59. (Figure: Market for Pants) According to the figure, if there is no international trade in this market, the value
of the consumer surplus is:

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a. $1,600,000.
b. $800,000.
c. $2,500,000.
d. $1,250,000.
ANSWER: b

60. (Figure: Market for Pants) According to the figure, if there is international trade in this market, and the
world price of a pair of pants is $40, the value of the consumer surplus is:

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a. $1,600,000.
b. $800,000.
c. $2,500,000.
d. $1,250,000.
ANSWER: d

61. (Figure: Market for Pants) According to the figure, if there is international trade in this market, and the
world price of a pair of pants is $30, the value of the consumer surplus is:

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a. $1,600,000.
b. $800,000.
c. $3,600,000.
d. $1,800,000.
ANSWER: d

62. (Figure: Market for Pants) According to the figure, if there is no international trade in this market, the value
of the domestic producer surplus is:

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a. $1,600,000.
b. $800,000.
c. $2,500,000.
d. $1,250,000.
ANSWER: b

63. (Figure: Market for Pants) According to the figure, if there is international trade in this market, and the
world price of a pair of pants is $40, the value of the domestic producer surplus is:

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a. $1,600,000.
b. $800,000.
c. $900,000.
d. $450,000.
ANSWER: d

64. (Figure: Market for Pants) According to the figure, if there is international trade in this market, and the
world price of a pair of pants is $30, the value of the domestic producer surplus is:

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a. $1,600,000.
b. $800,000.
c. $400,000.
d. $200,000.
ANSWER: d

65. (Figure: Market for Pants) Suppose that the world price of a pair of pants is $40. According to the figure, the
total domestic surplus in the free-trade equilibrium _____ the total domestic surplus in the no-international trade
equilibrium by _____.

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a. exceeds; $100,000
b. falls short of; $200,000
c. falls short of; $100,000
d. exceeds; $200,000
ANSWER: a

66. (Figure: Market for Pants) Suppose that the world price of a pair of pants is $30. According to the figure, the
total domestic surplus in the free-trade equilibrium _____ the total domestic surplus in the no-international trade
equilibrium by _____.

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a. exceeds; $200,000
b. exceeds; $400,000
c. falls short of; $200,000
d. falls short of; $400,000
ANSWER: b

67. (Figure: Market for Pants) Suppose that the world price of a pair of pants is $40. According to the figure,
international trade will lead to _____ in the domestic producer surplus and _____ in the domestic consumer
surplus.

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a. an increase; an increase
b. an increase; a decrease
c. a decrease; an increase
d. a decrease; a decrease
ANSWER: c

68. (Figure: Market for Pants) The world price of a pair of pants is $30. According to the figure, opening up to
international trade will lead to _____ in the domestic producer surplus and _____ in the domestic consumer
surplus.

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a. an increase; an increase
b. an increase; a decrease
c. a decrease; an increase
d. a decrease; a decrease
ANSWER: c

69. (Figure: Market for TVs 2) The world price of televisions is $500. According to the figure, international
trade will lead to _____ in the domestic producer surplus and _____ in the domestic consumer surplus.

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a. an increase; an increase
b. an increase; a decrease
c. a decrease; an increase
d. a decrease; a decrease
ANSWER: c

70. (Figure: Market for TVs 2) The world price of televisions is $400. According to the figure, opening up to
international trade will _____ the domestic producer surplus and _____ the domestic consumer surplus.

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a. increase; increase
b. increase; decrease
c. decrease; increase
d. decrease; decrease
ANSWER: c

71. (Figure: Market for Washing Machines) According to the figure, the equilibrium world price of washing
machines is:

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a. $50.
b. $100.
c. $600.
d. $750.
ANSWER: c

72. (Figure: Market for Washing Machines) According to the figure, the equilibrium world quantity of washing
machines (in thousands) sold is:

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a. 50.
b. 100.
c. 600.
d. 750.
ANSWER: a

73. (Figure: Market for Washing Machines) According to the figure, at a world price of $700:

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a. the quantity demanded exceeds the quantity supplied, and there is downward pressure on the world
price.
b. the quantity demanded exceeds the quantity supplied, and there is upward pressure on the world
price.
c. the quantity supplied exceeds the quantity demanded, and there is downward pressure on the world
price.
d. the quantity supplied exceeds the quantity demanded, and there is upward pressure on the world
price.
ANSWER: c

74. (Figure: Market for Washing Machines) According to the figure, at a world price of $400:

a. the quantity demanded exceeds the quantity supplied, and there is downward pressure on the world
price.
b. the quantity demanded exceeds the quantity supplied, and there is upward pressure on the world
price.
c. the quantity supplied exceeds the quantity demanded, and there is downward pressure on the world
price.
d. the quantity supplied exceeds the quantity demanded, and there is upward pressure on the world
price.
ANSWER: b

75. (Figure: Market for Engines) According to the figure, if there is no international trade, the equilibrium price
in this market is:

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Chapter 09: International Trade

a. $500.
b. $600.
c. $700.
d. $800.
ANSWER: b

76. (Figure: Market for Engines) According to the figure, if there is no international trade, the equilibrium
quantity in this market is:

a. 500.
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Chapter 09: International Trade

b. 600.
c. 900.
d. 1,000.
ANSWER: b

77. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of engines is $800, buyers and sellers will make exchanges at a price of _____ because sellers will
refuse to sell for _____ than the world price.

a. $600; less
b. $600; more
c. $800; less
d. $800; more
ANSWER: c

78. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of engines is $1,000, buyers and sellers will make exchanges at a price of _____ because sellers will
refuse to sell for _____ than the world price.

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a. $1,000; less
b. $1,000; more
c. $600; less
d. $600; more
ANSWER: a

79. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of an engine is $800, the quantity demanded is _____, and the quantity supplied is _____ at the
world price.

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a. 500; 800
b. 800; 500
c. 400; 1,000
d. 1,000; 400
ANSWER: a

80. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of engines is $1,000, the quantity demanded is _____, and the quantity supplied is _____ at the
world price.

a. 500; 800
b. 800; 500
c. 400; 1,000
d. 1,000; 400
ANSWER: c

81. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of an engine is $800, the quantity demanded is _____, and domestic suppliers will sell _____ units
to domestic consumers.

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a. 500; 500
b. 500; 800
c. 800; 500
d. 800; 800
ANSWER: a

82. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of engines is $1,000, the quantity demanded is _____, and domestic suppliers will sell _____ units
to domestic consumers.

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a. 400; 400
b. 400; 600
c. 600; 400
d. 600; 600
ANSWER: a

83. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of an engine is $800, domestic consumers will purchase _____ units from domestic producers and
_____ units from foreign producers.

a. 500; 300
b. 500; 0
c. 600; 0
d. 600; 300
ANSWER: b

84. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of engines is $1,000, domestic consumers will purchase _____ units from domestic producers and
_____ units from foreign producers.

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a. 400; 0
b. 400; 600
c. 600; 0
d. 600; 600
ANSWER: a

85. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of an engine is $800:

a. domestic consumers will import 800 units.

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b. domestic consumers will export 800 units.

c. domestic producers will import 300 units.
d. domestic producers will export 300 units.
ANSWER: d

86. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of an engine is $1,000:

a. domestic consumers will import 1,000 units.

b. domestic consumers will export 1,000 units.
c. domestic producers will import 600 units.
d. domestic producers will export 600 units.
ANSWER: d

87. (Figure: Market for Engines) If there is no international trade in this market, the value of the consumer
surplus is:

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a. $720,000.
b. $360,000.
c. $1,080,000.
d. $540,000.
ANSWER: b

88. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of an engine is $800, the value of the consumer surplus is:

a. $720,000.
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Chapter 09: International Trade

b. $360,000.
c. $500,000.
d. $250,000.
ANSWER: d

89. (Figure: Market for Engines) According to the figure, if there is international trade in this market and the
world price of an engine is $1,000, the value of the consumer surplus is:

a. $720,000.
b. $360,000.
c. $320,000.
d. $160,000.
ANSWER: d

90. (Figure: Market for Engines) According to the figure, if there is no international trade in this market, the
value of the domestic producer surplus is:

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a. $360,000.
b. $180,000.
c. $1,080,000.
d. $540,000.
ANSWER: b

91. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of engines is $800, the value of the domestic producer surplus is:

a. $360,000.
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b. $180,000.
c. $640,000.
d. $320,000.
ANSWER: d

92. (Figure: Market for Engines) According to the figure, if there is international trade in this market, and the
world price of an engine is $1,000, the value of the domestic producer surplus is:

a. $360,000.
b. $180,000.
c. $1,000,000.
d. $500,000.
ANSWER: d

93. (Figure: Market for Engines) Suppose that the world price of an engine is $800. According to the figure, the
domestic total surplus _____ by _____ in the free-trade equilibrium relative to the no international trade
equilibrium.

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a. increases; $60,000
b. increases; $30,000
c. decreases; $60,000
d. decreases; $30,000
ANSWER: b

94. (Figure: Market for Engines) Suppose that the world price of engines is $1,000. According to the figure, the
domestic total surplus will _____ by _____ in the free-trade equilibrium relative to the no international trade
equilibrium.

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a. increases; $120,000
b. increases; $240,000
c. decreases; $120,000
d. decreases; $240,000
ANSWER: a

95. (Figure: Market for Engines) The world price of an engine is $800. According to the figure, international
trade will _____ the domestic producer surplus and _____ the domestic consumer surplus.

a. increase; increase
b. increase; decrease
c. decrease; increase
d. decrease; decrease
ANSWER: b

96. (Figure: Market for Engines) The world price of an engine is $1,000. According to the figure, international
trade will _____ the domestic producer surplus and _____ the domestic consumer surplus.

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a. increase; increase
b. increase; decrease
c. decrease; increase
d. decrease; decrease
ANSWER: b

97. Which of the following would be MOST likely to support an increase in barriers to international trade?
a. a firm in an export-intensive industry
b. a firm in an export-oriented industry
c. a firm in an import-competing industry
d. a firm in an import-dependent industry
ANSWER: c

98. Which of the following is NOT an argument for limiting international trade? An increase in international
trade may:
a. reduce our ability to produce strategically important goods.
b. expose infant industries to strong competitive pressures.
c. lead domestic firms to outsource jobs to workers in other countries.
d. lead to economic growth through specialization in comparative advantages.
ANSWER: d

99. Which of the following is an argument for limiting international trade? An increase in international trade
may:
a. reduce specialization, which has national security benefits.
b. reduce the amount of outsourcing by domestic firms.

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c. lead to anticompetitive practices, such as dumping.

d. lead to economic growth, stemming from specialization.
ANSWER: c

100. In 2018, the unemployment rate in the United States went as low as 3.7%, as measured by the Bureau of
Labor Statistics. This historically low level of unemployment occurred simultaneously with a large trade deficit.
This provides evidence against which of the following arguments against international trade?
a. International trade may hurt national security.
b. International trade may lead to job loss.
c. International trade may hurt infant industries.
d. International trade may promote unfair competition.
ANSWER: b

101. (Figure: Unemployment Rates) This figure shows the relationship between countries' unemployment rates
and the share of national income spent on imports. From this figure, we can determine that the United States
_____ relative to other countries.

a. spends a small share of income on imports

b. spends a small share of income on exports
c. employs a larger number of workers
d. has a large unemployment rate
ANSWER: a

102. (Figure: Unemployment Rates) This figure shows the relationship between countries' unemployment rates
and the share of national income spent on imports. From this figure, we can determine that the United States
_____ relative to other countries.

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a. spends less on imports

b. spends more on exports
c. employs a small number of workers
d. has a small import to GDP ratio
ANSWER: d

103. Which of the following is NOT true of the parable about harvesting the Iowa car crop?
a. International trade is similar to technological improvements in that it expands our ability to consume
more goods and services.
b. The public perception of job losses related to international trade is different than the public
perception of job losses related to technological improvement.
c. It's possible to acquire a product at a lower cost by producing something else first and then engaging
in trade.
d. Jobs producing goods or services for domestic consumption are preferable to the jobs producing
export goods.
ANSWER: d

104. A tariff is a:
a. tax on imported products.
b. limit on the quantity of a good that can be imported.
c. tax on exported products.
d. limit on the quantity of a good that can be exported.
ANSWER: a

105. An import quota is:

a. a tax on imported products.

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b. a limit on the quantity of a good that can be imported.

c. the revenue received from a tariff.
d. the cost of imposing a tariff.
ANSWER: b

106. Suppose that the world price of TVs is $400, and the government imposes a $100 tariff. The new price
domestic consumers pay for a TV is:
a. $400.
b. $500.
c. $600.
d. $700.
ANSWER: b

107. (Figure: Market for TVs 2) Suppose that the world price of TVs is $400, and the government imposes a
$100 tariff. According to the figure, domestic consumers purchase _____ units from domestic producers and
_____ units from foreign producers after the tariff.

a. 20,000; 60,000
b. 40,000; 30,000
c. 30,000; 40,000
d. 60,000; 20,000
ANSWER: b

108. (Figure: Market for TVs 2) Suppose that the world price of TVs is $400, and the government imposes a
$100 tariff. According to the figure, the tariff causes total surplus to decrease by:
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a. $1,500,000.
b. $3,000,000.
c. $4,500,000.
d. $6,000,000.
ANSWER: a

109. (Figure: Market for TVs 2) Suppose that the world price of TVs is $500, and the government imposes a
$100 tariff. According to the figure, the new price domestic consumers pay for a TV is:

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a. $400.
b. $500.
c. $600.
d. $700.
ANSWER: c

110. (Figure: Market for TVs 2) The world price of TVs is $500, and the government imposes a $100 tariff.
According to the figure, domestic consumers purchase _____ units from domestic producers and _____ units
from foreign producers after the tariff.

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Name: Class: Date:

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a. 60,000; 0
b. 40,000; 0
c. 60,000; 40,000
d. 40,000; 40,000
ANSWER: a

111. Suppose that the world price of TVs is $500 and the government imposes a $100 tariff. According to the
figure, the tariff causes total surplus to decrease by:

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a. $1,500,000.
b. $3,000,000.
c. $4,500,000.
d. $6,000,000.
ANSWER: a

112. The exchange rate between the U.S. dollar and the Chinese yuan shifts from 6 yuan per U.S. dollar to 7
yuan per U.S. dollar. The yuan has _____, making Chinese exports _____ expensive.
a. appreciated; less
b. depreciated; less
c. appreciated; more
d. depreciated; more
ANSWER: b

113. The exchange rate between the Saudi riyal and the euro shifts from 5 riyal per euro to 4 riyal per euro. The
riyal has _____, making Saudi exports _____ expensive.
a. appreciated; less
b. depreciated; less
c. appreciated; more
d. depreciated; more
ANSWER: c

114. (Figure: Average Tariff Rate by the United States) According to the figure, prior to 2018, the average tariff
rate imposed by the United States has generally _____. This is associated with _____ in international trade.

a. decreased; an increase
b. decreased; a decrease
c. increased; an increase
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d. increased; a decrease
ANSWER: a

115. Globalization:
a. is the increasing economic, political, and cultural integration of different countries.
b. is associated with a reduction in international trade.
c. has made all parties involved better off.
d. is associated with an increase in barriers to trade.
ANSWER: a

116. As globalization leads the United States to export more goods produced in skill-intensive sectors, real
wages in these sectors will generally _____. As globalization leads the U.S. to import more goods produced in
low-skilled sectors, real wages in these sectors will generally _____.
a. increase; increase
b. increase; decrease
c. decrease; increase
d. decrease; decrease
ANSWER: b

117. The theory of comparative advantage predicts that:

a. only developed countries can benefit from trade.
b. developed countries will benefit from trade more than developing countries.
c. only countries with no trade barriers will be able to trade.
d. developing countries can benefit from trade as much as developed countries can.
ANSWER: d

118. Which of the following is a downside for country that reduces its barriers to trade?
a. Prices of the goods in which the country has a comparative advantage will likely increase.
b. Prices of the goods in which the country does not have a comparative advantage will likely increase.
c. Unemployment in the sectors in which the country has a comparative advantage will likely increase.
d. Unemployment in the sectors in which the country does not have a comparative advantage will likely
increase.
ANSWER: d

119. Economist Joseph Stiglitz argues against free trade, stating that "a movement toward free trade brought
wages of unskilled workers around the world closer together, meaning, for example, that America's unskilled
workers' pay would fall towards that of India and China." Which of the following explains why this claim might
also be used to argue that free trade benefits the United States?
a. A reduction in wages in the United States will reduce the number of individuals on government
assistance (for example, Medicaid, food stamps, and unemployment insurance).
b. A reduction in wages in the United States is likely to hurt only individuals in some sectors of the
economy.
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c. Wages across countries moving closer together implies that wages would fall in developing
countries, which would create cheaper labor for U.S. firms that outsource production to other
countries.
d. Wages across countries moving closer together implies that wages would rise in developing
countries, which would allow them to purchase more goods produced in the United States.
ANSWER: d

120. In 2015, Donald Trump stated, "When did we beat Japan at anything? They send their cars over here by the
millions, and what do we do? When was the last time you saw a Chevrolet in Tokyo? It doesn't exist, folks."
Trump's argument fails to address which of the following economic arguments (that is, arguments based on a
correct interpretation of economic theory)?
a. Japan may have a comparative advantage in manufacturing cars, but the United States has a
comparative advantage in other goods, which it exports to Japan.
b. Americans in outsourced industries will easily find new jobs in industries focused on exports.
c. Competition from other nations is unfair because other countries don't necessarily have the same
costs of production.
d. The United States cannot benefit from trading manufactured goods with Japan.
ANSWER: a

121. In a 2016 speech, Donald Trump stated, "America has lost nearly 1/3 of its manufacturing jobs since 1997.
Even as the country has increased its population — think of this — by 50 million people. At the center of this
catastrophe are two trade deals pushed by Bill and Hillary Clinton." Which of the following statements is a true
reason for the reduction in manufacturing jobs?
a. Trade agreements reducing barriers to trade are not associated with a reduction of manufacturing jobs
in the United States.
b. The number of manufacturing jobs in the United States has declined for reasons that are unrelated to
trade policy.
c. An increase in trade barriers will increase the number of manufacturing jobs in the United States.
d. The United States has a comparative advantage in low-skilled manufacturing, which trade
agreements have encouraged.
ANSWER: b

122. In a 2016 debate, Hillary Clinton stated that she no longer supported the Trans-Pacific Partnership (TPP)
because "I want to make sure that I can look into the eyes of any middle-class American and say, 'This will help
raise your wages.' And I concluded I could not." Clinton's analysis of the TPP, a trade agreement that would
reduce trade barriers between the United States and a number of other countries, fails to acknowledge which of
the following benefits that the TPP would have for middle-class Americans? The reduction of trade barriers:
a. will not lead to any American jobs being lost.
b. may leave middle-class Americans better off even if their average wages fall because the prices of a
number of goods are likely to fall as well.
c. will not change wages for individuals working in the United States.
d. would likely increase the number of low-skill (blue-collar) jobs in the United States, which may
reduce average wages but would also reduce unemployment.

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ANSWER: b

123. In 2016, Hillary Clinton stated the following: "My message to every worker in Michigan and across
America is this. I will stop any trade deal that kills jobs or holds down wages, including the Trans-Pacific
Partnership [Trade Agreement]." Which of the following is a reason that Clinton's statement is not grounded in
economic theory?
a. Trade deals do not have an impact on wages.
b. Trade deals that reduce barriers to trade will reduce wages in all sectors of the economy.
c. Trade deals that reduce barriers to trade may not change the composition of jobs (that is, "kill" any
specific job) within a country.
d. Any trade deal that changes the terms of trade between countries will change the composition of jobs
within a country.
ANSWER: d

124. In a 2004 New York Times article entitled "Second Thoughts on Free Trade," Senator Charles ("Chuck")
Schumer argues the following: "While some economists and elected officials suggest that all we need is a robust
retraining effort for laid-off workers, we do not believe retraining alone is an answer, because almost the entire
range of 'knowledge jobs' [software engineers, in the context of the article] can be done overseas." In
advocating for more protectionism, Schumer fails to acknowledge which of the following benefits of a decrease
in trade barriers (a decrease in protectionism)?
a. A reduction in trade barriers will hurt political relationships between countries.
b. A reduction in trade barriers will increase the wealth of other countries, which would lead them to
demand fewer U.S. goods and services.
c. A reduction in trade barriers leads to lower prices for U.S. consumers.
d. A reduction in trade barriers can allow the United States to specialize in its comparative advantage
but become less productive.
ANSWER: c

125. In 2012, Marco Rubio argued that he would be in favor of getting rid of quotas on sugar imports (a trade
barrier) only if the United States got something in return from Brazil. Rubio's argument is not economically
sound (consistent with economic theory) for which of the following reasons?
a. Consumers in the United States would be hurt by the higher price of sugar if the quota was removed.
b. U.S. producers that use sugar as an input (for example, Lifesavers) would benefit from a higher price
of sugar.
c. A proportion of the gains to trade received by Brazil would be used to import U.S. goods and
services.
d. The United States cannot benefit from trade with a country that is less productive.
ANSWER: c

Essay

126. Explain the sources of comparative advantage, and provide an example of each source.
ANSWER: The sources of comparative advantage include specialized skills, mass production, and abundant
inputs. For example, businesses in many developed countries have about the same access to capital
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and skilled labor, but the production capabilities of the countries are vastly different. The Swiss are
the world's best watchmakers, and the French produce the greatest cheese. In each case, skilled
artisans produce watches or cheese in a way that their foreign counterparts can't. Ikea sells millions
of Billy bookcases each year to buyers all around the world. It sells many of them because the Billy
bookcase is cheap. And the Billy bookcase is cheap because Ikea sells many of them. Canada has
ample forests, so Canadian foresters export wood and related products like paper.

127. Explain how importing goods and services leads to lower prices, less domestic production, and more
domestic consumption.
ANSWER: Imports lead to lower domestic prices because the domestic price must fall to the world price for the
good or service in order for any domestic product to be sold. This lower price leads to a lower
quantity supplied by domestic sellers but a higher quantity demanded by domestic buyers. This
higher quantity demanded is met by imports, which fill the gap between the domestic quantity
demanded and the domestic quantity supplied.

128. Explain how importing goods and services increases economic surplus for domestic consumers.
ANSWER: Importing goods and services leads to lower prices in the domestic market. Consumers pay a lower
price for these goods and buy a larger quantity of these cheap goods. As a result, the consumer
surplus of domestic consumers rises (1) as the distance between the price they are willing to pay and
the price they actually pay widens and (2) as the quantity they purchase increases.

129. Explain how importing goods and services decreases economic surplus for domestic producers.
ANSWER: Importing goods and services leads to lower prices in the domestic market. Because it is no longer
as profitable to sell at these lower prices, domestic producers do not supply as many goods to the
market. In addition, the distance between the price they are willing to accept and the price they
actually get in the market shrinks. This leads to lower economic surplus for producers.

130. Explain how it is possible for an importing country to realize a net increase in economic surplus if
economic surplus decreases for domestic producers.
ANSWER: Importing goods and services leads to lower prices in the domestic market. This leads to lower
economic surplus for domestic producers but higher economic surplus for domestic consumers. The
increase in economic surplus for consumers is greater than the loss in surplus for producers, so the
country experiences a net gain in economic surplus.

131. Explain how exporting goods and services leads to higher prices, more domestic production, and less
domestic consumption.
ANSWER: Exports lead to higher domestic prices because the domestic price must rise to the world price for
the good or service. This higher price leads to a lower quantity demanded by domestic buyers but a
higher quantity supplied by domestic producers. This higher quantity supplied is partially exported,
which fills the gap between the domestic quantity demanded and the domestic quantity supplied.

132. Explain how exporting goods and services decreases economic surplus for domestic consumers.
ANSWER: Exporting goods and services leads to higher prices in the domestic market. Consumers pay a higher
price for these goods and buy a smaller quantity of these expensive goods. As a result, the consumer
surplus of domestic consumers falls as the distance between the price they are willing to pay and the
price they actually pay shrinks and as the quantity they purchase decreases.
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133. Explain how exporting goods and services increases economic surplus for domestic producers.
ANSWER: Exporting goods and services leads to higher prices in the domestic market. Because it is more
profitable to sell at these higher prices, domestic producers supply a greater quantity of these goods
to the market. In addition, the distance between the price they are willing to accept and the price
they actually get in the market expands. This leads to higher economic surplus for producers.

134. Explain how it is possible for an exporting country to realize a net increase in economic surplus if
economic surplus decreases for domestic consumers.
ANSWER: Exporting goods and services leads to higher prices in the domestic market. This leads to lower
economic surplus for domestic consumers but higher economic surplus for domestic producers. The
increase in economic surplus for producers is greater than the loss in surplus for consumers, so the
country experiences a net gain in economic surplus.

135. What are the five arguments for limiting international trade? Which one do you find most convincing?
Explain your answer.
ANSWER: The five arguments for limiting international trade are national security, infant industry, preventing
unfair competition, enforcing minimum standards, and saving jobs. Answers will vary regarding
which argument is most convincing, but the explanation should refer to the discussion in the
textbook.

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Multiple Choice

1. An externality is defined as:

a. the effect of an activity undertaken outside a building rather than inside a building.
b. an effect of market activity that impacts the opposite side of the market from the side whose decision
caused the effect.
c. a side-effect of an activity that affects bystanders whose interests are not taken into account.
d. the impact of an activity on buyers and sellers in the market where the activity takes place.
ANSWER: c

2. A side effect of an activity that affects bystanders whose interests are not taken into account is known as:
a. an indirect impact.
b. an outside impact.
c. a comparative effect.
d. an externality.
ANSWER: d

3. During the production of a good, pollution is emitted that affects people who are neither producers nor buyers
of the good. The term for the impact of the pollution on these people is:
a. externality.
b. exploitation.
c. intrusion.
d. outside impact.
ANSWER: a

4. Marjean walks to work every day along a busy road. As she does so, she breathes in the fumes of many cars,
often arriving at work coughing. The economic term for the impact of the cars on Marjean is:
a. an alternative action.
b. a nonmarket repercussion.
c. exploitative supply.
d. an externality.
ANSWER: d

5. When an activity has a side effect that harms bystanders, the side effect is referred to as:
a. an unintended harm.
b. an extra-activity effect.
c. a negative externality.
d. benefit negation.
ANSWER: c

6. A negative externality is:

a. a side effect of an activity when the side effect harms bystanders.
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b. a reduction in demand that occurs when agents outside a market influence market participants.
c. a change from a positive relationship between two variables to an inverse relationship.
d. an unintended consequence of an action that harms the decision maker.
ANSWER: a

7. When a market transaction has a beneficial effect on bystanders who were not involved in the transaction,
this effect is called:
a. an inverse externality.
b. a positive consequence.
c. nonmarket gains.
d. a positive externality.
ANSWER: d

8. Which of the following illustrates a positive externality?

a. Martin's company experiences an increase in profits due to his cost-cutting initiatives.
b. Artem loses sleep when an airport is built near his home, and planes fly overhead.
c. The value of Maria's house rises when the city builds a park nearby, enhancing her view.
d. Ella can buy a shirt at half price because someone else returned it.
ANSWER: c

9. Which of the following is an example of a negative externality?

a. When Fazio parks his big truck at the grocery store, people in the cars on each side of his parking
space have a hard time opening their car doors.
b. Bae's company has a decrease in profits when the demand for its product falls.
c. Raul loses weight because he wants to feel better, but the weight loss means that he needs new
clothes.
d. Rita gains weight while she is on vacation because she eats more than normal.
ANSWER: a

10. Why are externalities considered a cause of market failure?

a. Because decision makers become overly concerned about the impact of their actions on bystanders.
b. Because they lead to suboptimal outcomes.
c. Because they make markets so competitive that profits disappear.
d. Because they always cause a net loss in welfare.
ANSWER: b

11. Externalities tend to occur because decision makers consider _____ and do NOT consider _____.
a. their own needs as most important; the fact that others also have needs
b. their own income as limitless; their income as limited
c. the welfare of others; their own welfare
d. their own costs and benefits; the effects of their actions on others
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ANSWER: d

12. An externality is NOT:

a. an unintended impact on bystanders.
b. positive or negative.
c. a price change.
d. a side effect.
ANSWER: c

13. A price change will NOT cause:

a. a change in quantity demanded.
b. a change in the purchasing power of money.
c. the quantity supplied to adjust.
d. an externality.
ANSWER: d

14. Why is a price change NOT an externality?

a. A price change does not change total costs or benefits.
b. A price change affects bystanders, not market participants.
c. A change in price changes benefits rather than redistributes them.
d. A price change redistributes costs but not benefits.
ANSWER: a

15. Which of the following statements supports the idea that price changes are not externalities?
a. A price change redistributes costs and benefits but does not generate new costs or benefits.
b. Prices are a side effect of decisions making.
c. A drop in price is a clear signal that the market was negatively impacting buyers.
d. A change in price adversely affects all suppliers in the market.
ANSWER: d

16. Which of the following describes a situation with a negative externality?

a. When 10% more people get a flu shot, the incidence of the flu drops by 20%.
b. When the price of gasoline rises by 10%, the quantity sold drops by 8%.
c. The buyer of a skateboard falls when using it and is injured.
d. After a commercial poultry farm opens, neighbors on all sides complain of its smell.
ANSWER: d

17. Which of the following is a positive externality?

a. After measles vaccinations increase by 20%, the number of cases of measles falls by 35%.
b. After a large stadium is built in a neighborhood, homeowner property values in the neighborhood fall
because of noise and traffic.

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c. After the price of dental care decreases, more people can afford regular dental check-ups.
d. Researchers develop a new drug that effectively treats a devastating disease that previously had no
cure.
ANSWER: a

18. What is the difference between a positive externality and a negative externality?
a. Whether bystanders have a direct or inverse relationship to the decision maker.
b. Whether the price rises or falls.
c. Whether the perspective is the buyer's or the seller's.
d. Whether the welfare of bystanders rises or falls.
ANSWER: d

19. Your personal best interest is based on the _____, and society's best interest is based on _____.
a. costs and benefits you face personally; the costs and benefits of everyone else except you
b. interest rate on your savings; the average savings rate across all accounts
c. costs and benefits you face personally; the costs and benefits experienced by bystanders
d. costs and benefits you face personally; the costs and benefits of everyone
ANSWER: d

20. When your actions affect bystanders, then your _____ is in conflict with _____.
a. private interest; society's interest
b. external cost; society's marginal cost
c. externality; society's externality
d. interest in society; society's interest in that person
ANSWER: a

21. Marginal private cost is the:

a. the marginal cost that is kept secret and not reported to the public.
b. the marginal cost faced in the nongovernmental sector.
c. the cost paid by the seller in producing one additional unit of output.
d. the additional cost faced by private bystanders when a seller produces and sells an extra unit of
output.
ANSWER: c

22. The cost paid by the seller in producing one additional unit of output is known as the _____ cost.
a. marginal external
b. marginal private
c. external
d. marginal social
ANSWER: b

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23. A cost imposed on bystanders is _____ cost.
a. a private
b. a marginal private
c. a marginal public
d. an external
ANSWER: d

24. An external cost is:

a. a cost imposed on bystanders.
b. a cost paid for inputs by a producer to an entity outside the company.
c. an adjustment in costs when the output is sold outside the normal circle of customers.
d. the total of all costs minus those borne by bystanders.
ANSWER: a

25. The extra external cost imposed on bystanders from one extra unit is _____ cost.
a. a marginal public
b. a marginal private
c. a marginal external
d. an extra public
ANSWER: c

26. The marginal external cost is the:

a. extra cost borne by the producer of a good when the good is regulated by the public sector.
b. cost paid by the seller in producing one additional unit of output.
c. external cost imposed on bystanders by one additional unit of output.
d. additional margins of loss borne by sellers when sales are less than expected.
ANSWER: c

27. All marginal costs, no matter who pays them, are marginal _____ costs.
a. social
b. external
c. private
d. public
ANSWER: a

28. Marginal private cost plus marginal external cost equals _____ cost.
a. marginal public
b. marginal social
c. summative marginal
d. community marginal
ANSWER: b
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29. Marginal social cost equals marginal _____ cost plus marginal _____ cost.
a. consumer; production
b. government; private
c. private; external
d. public; internal
ANSWER: c

30. The marginal social cost is:

a. the extra cost imposed on bystanders when an extra unit is produced and consumed.
b. the extra cost faced by a producer when an extra unit is produced and sold to a member of society.
c. the difference between the marginal external cost and the marginal private cost.
d. the sum of marginal private costs and marginal external costs.
ANSWER: d

31. Mario is willing to sell an extra unit of his product as long as price is:
a. at least as high as the marginal private cost.
b. at least as high as the marginal social cost.
c. higher than the average cost.
d. not below the external cost.
ANSWER: a

32. Sellers must cover _____ costs, but a market does not require them to cover _____ costs.
a. variable; fixed
b. average; fixed
c. marginal private; marginal external
d. marginal total; marginal private
ANSWER: c

33. Costs that arise from a market transaction but that are borne by people not involved in the transaction are
called _____ costs.
a. outside
b. public
c. reversal
d. external
ANSWER: d

34. Margarite opened a successful restaurant two years ago on a block of connecting row houses. All of the
other businesses on the block are well-established accounting and law offices. Those businesses have
complained that the garbage bins in back of the restaurant are attracting mice, rats, and stray cats and dogs and
that they are spending more and more on exterminators. In economic terms, what is happening?
a. The other businesses on the block are dealing with a marginal social cost because Margarite
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considers only her marginal external cost as she makes decisions.

b. The other businesses on the block are dealing with an externality because Margarite considers only
her marginal private costs as she makes decisions.
c. Margarite is creating an externality that is imposing marginal private costs on the other businesses on
her block.
d. Margarite is creating marginal private costs that are adding internal costs to the other businesses on
the block.
ANSWER: b

35. (Figure: MSC and MPC Curves) Use the graph to answer the question.

The graph shows marginal social cost and marginal private cost curves. What is the marginal external cost?
a. $2
b. $4
c. $6
d. $12
ANSWER: a

36. (Figure: MSC and Supply Curves) Use the graph to answer the question.

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The graph shows the marginal social cost and supply curves in a market. What is the marginal external cost
imposed on society?
a. $2
b. $4
c. $8
d. $12
ANSWER: b

37. The supply curve of a firm is also its _____ cost curve.
a. average
b. social
c. marginal private
d. marginal external
ANSWER: c

38. (Figure: MSC and Supply Curves) Use the graph to answer the question.

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The graph shows the marginal social cost curve and supply curve for Jed's company. What is Jed's marginal
private cost when he produces eight units?
a. $2
b. $8
c. $6
d. $4
ANSWER: b

39. From a community perspective, the marginal cost that matters is the marginal _____ cost.
a. private
b. external
c. public
d. social
ANSWER: d

40. (Figure: MSC and Supply Curves) Use the graph answer the question.

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The graph shows the marginal social cost and supply curves in a market. When eight units are produced, the
relevant marginal cost facing the community is:
a. $2.
b. $4.
c. $12.
d. $8.
ANSWER: c

41. (Figure: MSC and Supply Curves) Use the graph to answer the question.

The graph shows the marginal social cost and supply curves in the market for shampoo. When four units are
produced, the marginal external cost is:
a. $2.
b. $4.
c. $6.
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d. $8.
ANSWER: b

42. (Figure: MSC and Supply Curves) Use the graph to answer the question.

The graph shows the marginal social cost curve and supply curve for Lin's business. When Lin produces eight
units, what is the relevant marginal cost facing the community?
a. $4
b. $8
c. $12
d. $20
ANSWER: c

43. (Figure: MSC and Supply Curves) Use the graph to answer the question.

The graph shows the marginal social cost curve and supply curve for Sasha's candy shop. When four units are
sold, what is the relevant marginal cost for the community where Sasha produces and sells her candy?
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a. $4
b. $8
c. $12
d. $20
ANSWER: b

44. The benefit enjoyed by a buyer as a result of purchasing one additional unit of a good is the marginal _____
benefit.
a. external
b. social
c. personal
d. private
ANSWER: d

45. The marginal private benefit is the:

a. extra benefit enjoyed by the buyer of one extra unit of a good or service.
b. addition to the satisfaction a buyer receives from the total quantity of a product consumed.
c. extra benefit that goes to bystanders for each additional unit of a good consumed by others.
d. total extra benefit society gains from the consumption of an extra unit of a good.
ANSWER: a

46. An external benefit is:

a. a benefit enjoyed by the buyer of a good.
b. the total benefit to society of a good being consumed.
c. the benefit that the buyer receives from consuming a good outside of a market.
d. a benefit accruing to bystanders.
ANSWER: d

47. A marginal external benefit is the:

a. extra benefit enjoyed by society as the result of consuming one extra unit.
b. additional gain to sellers when they profit from an extra unit of output.
c. extra benefit accruing to bystanders as a result of one extra unit of output.
d. additional gain that goes to buyers when they consume one additional unit of a good.
ANSWER: c

48. The extra external benefit accruing to bystanders from one extra unit is the marginal _____ benefit.
a. public
b. private
c. social
d. external
ANSWER: d
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49. Marginal social benefit is the term for:

a. the extra external benefit accruing to bystanders from one extra unit.
b. all marginal benefits, no matter who gets them.
c. all marginal benefits that go to the public sector.
d. the extra external benefit gained by consumers of an extra unit.
ANSWER: b

50. All marginal benefits, no matter who gets them, are referred to as the marginal _____ benefit.
a. external
b. public
c. private
d. social
ANSWER: d

51. The marginal private benefit plus the marginal external benefit equals the ____ benefit.
a. total public
b. total externality
c. marginal social
d. marginal public
ANSWER: c

52. (Figure: MSB and Demand Curves) Use the graph to answer the question.

The graph shows the marginal social benefit and demand curves in the shampoo market. What is the marginal
external benefit?
a. $2
b. $4
c. $6
d. $8
ANSWER: a
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53. (Figure: MSB and Demand Curves) Use the graph to answer the question.

The graph shows the marginal social benefit and demand curves in the market for pairs of socks. What is the
marginal social benefit when four pairs are bought?
a. $2
b. $4
c. $6
d. $8
ANSWER: b

54. (Figure: MSB and Demand Curves) Use the graph to answer the question.

The graph shows the marginal social benefit and demand curves in the hair brush market. What is the marginal
private benefit when four brushes are bought?
a. $2
b. $4
c. $6
d. $8
ANSWER: a
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55. (Figure: MSB and Demand Curves 2) Use the graph to answer the question.

The graph shows the marginal social benefit and demand curves in the dog food market. What is the marginal
private benefit when four bags of dog food are bought?
a. $4
b. $8
c. $12
d. $20
ANSWER: a

56. (Figure: MSB and Demand Curves 2) Use the graph to answer the question.

The graph shows the marginal social benefit and demand curves in the hamburger market. What is the marginal
external benefit when eight units are bought?
a. $2
b. $4
c. $6
d. $8
ANSWER: b
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57. The marginal private benefit curve is also the:

a. supply curve.
b. marginal external benefit curve minus the marginal social benefit curve.
c. demand curve.
d. marginal personal benefit curve.
ANSWER: c

58. How is the marginal social benefit curve positioned on a graph when there are positive externalities?
a. It is above the demand curve and has a negative slope.
b. It is below the demand curve and has a negative slope.
c. It intersects the demand curve and has a positive slope.
d. It intersects the demand curve and has a negative slope.
ANSWER: a

59. The outcome that is most efficient for society as a whole — including the interests of buyers, sellers, and
bystanders — is the _____ outcome.
a. externally optimal
b. social benefit maximizing
c. public optimal
d. socially optimal
ANSWER: d

60. The socially optimal outcome is the outcome that:

a. is most efficient for society as a whole, including for buyers, sellers, and bystanders.
b. benefits the largest number of people.
c. has the most externalities.
d. has the most benefits for society as a whole, regardless of the costs involved.
ANSWER: a

61. The Rational Rule for Society is that society should produce another unit of a good if:
a. the total social benefit exceeds the total social cost.
b. the marginal social benefit exceeds the marginal social cost.
c. the marginal private benefit exceeds the marginal private cost.
d. gains to the producer exceed losses to the producer.
ANSWER: b

62. The idea that society should produce another unit of a product if the marginal social benefit exceeds the
marginal social cost is known as the:
a. Optimizing Social Rule.
b. Public Welfare Guide.

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c. Marginal Gain Rule.

d. Rational Rule for Society.
ANSWER: d

63. The Rational Rule for Society says that more of a good should be produced:
a. if the marginal social cost is greater than the marginal social benefit.
b. as long as the total social benefit exceeds the total social cost to everyone.
c. if the rational external benefit exceeds the rational external cost.
d. as long as its marginal social benefit is at least as large as the marginal social cost.
ANSWER: d

64. The socially optimal outcome occurs where the _____ benefit equals the _____ cost.
a. marginal external; marginal external
b. total external; total external
c. marginal social; marginal social
d. total social; total social
ANSWER: c

65. When externalities are present, the socially optimal outcome occurs where the _____ benefit equals the
_____ cost.
a. marginal external; marginal external
b. marginal social; marginal social
c. total social; total social
d. total external; total external
ANSWER: b

66. Which of the following is NOT part of the three-step recipe used to analyze externalities? (Note: the steps
are not necessarily in order.)
a. Predict the equilibrium.
b. Assess society's preferences.
c. Find the socially optimal outcome.
d. Assess what externalities are involved.
ANSWER: b

67. Which of the following is NOT part of the three-step recipe used to analyze externalities? (Note: the steps
are not necessarily in order.)
a. Assess what externalities are involved.
b. Find the socially optimal outcome.
c. Identify costs and benefits in the public sector.
d. Predict the equilibrium.
ANSWER: c
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68. What step is omitted from the three-step recipe used to analyze externalities in Table 1?

a. Predict the degree of market power.

b. Determine the level of exploitation.
c. Predict the equilibrium outcome.
d. Determine the role of the public sector.
ANSWER: c

69. Which step is omitted from the three-step recipe used to analyze externalities in Table 2? (Note: The steps
are not necessarily in order.)

a. Predict the degree of market power.

b. Find the socially optimal outcome.
c. Determine the level of exploitation.
d. Determine the current role of the public sector.
ANSWER: b

70. What step is omitted from the three-step recipe to analyze externalities in Table 3? (Note: Steps are not
necessarily in order.)

a. Predict the degree of market power.

b. Determine the level of exploitation.
c. Determine the role of the public sector.
d. Assess what externalities are involved.
ANSWER: d

71. (Figure: Market) Use the graph to answer the question.

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The graph shows the marginal social cost, demand, and supply curves in the jigsaw puzzle market. If market
forces prevail, this market will produce and sell _____ units of output at a price of _____.
a. 6; $6
b. 4; $8
c. 6; $8
d. 8; $4
ANSWER: a

72. (Figure: Market) Use the graph to answer the question.

The graph shows the marginal social cost, demand, and supply curves in the jigsaw puzzle market. What are the
socially optimal quantity and price in this market?
a. 6; $6
b. 8; $4
c. 6; $10
d. 4; $8

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ANSWER: d

73. (Figure: Market 2) Use the graph to answer the question.

The graph shows the marginal social cost, demand, and supply curves in the shower gel market. In this market,
the socially optimal output is _____, and the market-determined output is _____.
a. six; four
b. four; six
c. six; eight
d. ten; six
ANSWER: b

74. (Figure: Market 3) Use the graph to answer the question.

The graph shows the marginal social cost, demand, and supply curves in the toothpaste market. If market forces
prevail, this market will produce and sell _____ tubes of toothpaste at a price of _____.
a. eight; $5
b. eight; $4
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c. 12; $3
d. 12; $4
ANSWER: c

75. (Figure: Market 3) Use the graph to answer the question.

The graph shows the marginal social cost, demand, and supply curves in the toothpaste market. What is the
socially optimal quantity and price in this market?
a. eight; $4
b. 12; $3
c. four; $6
d. three; $12
ANSWER: a

76. (Figure: Market 3) Use the graph to answer the question.

The graph shpws the marginal social cost, demand, and supply curves in the salad dressing market. In this
market, the socially optimal output is _____, and the market-determined output is _____.
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a. 12; three
b. four; eight
c. eight; two
d. eight; 12
ANSWER: d

77. By contrast with a market that produces the socially optimal output, a market with negative externalities
will:
a. produce no output.
b. produce the correct output.
c. overproduce.
d. underproduce.
ANSWER: c

78. A market with negative externalities will tend to _____ compared to a market producing the socially optimal
output.
a. underproduce and sell at a higher price
b. overproduce and sell at a higher price
c. underproduce and sell at a lower price
d. overproduce and sell at a lower price
ANSWER: d

79. The socially optimal amount of an externality is:

a. zero.
b. one-half of the amount of the externality that the market would produce.
c. based on cost-benefit analysis.
d. the amount that market forces would produce.
ANSWER: c

80. When the lawn care services market is characterized by positive externalities:
a. too many lawn care services are produced.
b. too few lawn care services are produced.
c. output is too high, and price is too low.
d. output is too low, and price is too high.
ANSWER: b

81. (Figure: Market 4) Use the graph to answer the question.

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The graph shows the marginal social benefit, demand, and supply curves in the milkshake market are in the
graph. What are the socially optimal quantity and price?
a. 12; $3
b. eight; $2
c. 12; $1
d. eight; $4
ANSWER: a

82. (Figure: Market 4) Use the graph to answer the question.

The graph show the marginal social benefit, demand, and supply curves in the milkshake market. Market forces
would yield a quantity of _____ and a price of _____ in the milkshake market.
a. 12; $1
b. 16; $4
c. 12; $3
d. eight; $2
ANSWER: d

83. (Figure: Market 4) Use the graph to answer the question.

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The graph shows the marginal social benefit, demand, and supply curves in the toothbrush market. Market
forces would yield a quantity of _____, whereas the socially optimal quantity is _____.
a. four; six
b. eight; 12
c. two; three
d. 12; three
ANSWER: b

84. (Figure: Market 5) Use the graph to answer the question.

The graph shows the marginal social benefit, demand, and supply curves in the toothbrush market. What are the
socially optimal quantity and price?
a. four; $4
b. eight; $8
c. six; $6
d. four; $8
ANSWER: c

85. (Figure: Market 5) Use the graph to answer the question.

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The graph shows the marginal social benefit, demand, and supply curves in the toothbrush market are in the
graph. Market forces would yield a quantity of _____ and a price of _____.
a. four; $8
b. six; $2
c. six; $6
d. four; $4
ANSWER: d

86. (Figure: Market 5) Use the graph to answer the question.

The graph shows the marginal social benefit, demand, and supply curves in the toothbrush market. Market
forces would yield a quantity of _____, whereas the socially optimal quantity is _____.
a. four; six
b. eight; four
c. six; four
d. four; eight
ANSWER: a

87. (Market 6) Use the graph to answer the question.

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The graph shows the marginal social benefit, marginal private benefit, and marginal private curves in the taco
market. If market forces prevail, output will be _____, and the price will be _____.
a. 6; $9
b. 4; $6
c. 9; $6
d. 6; $4
ANSWER: b

88. (Market 6) Use the graph to answer the question.

The graph shows the marginal social benefit, marginal private benefit, and marginal private curves in the taco
market. The socially optimal quantity is _____, and the price is ______.
a. four; $12
b. nine; $6
c. four; $6
d. six; $9
ANSWER: d

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89. (Market 6) Use the graph to answer the question.

The graph shows the marginal social benefit, marginal private benefit, and marginal private curves in the taco
market. In this market, the socially optimal output would be _____, whereas the market-determined output
would be _____.
a. six; nine
b. six; four
c. 12; six
d. four; six
ANSWER: b

90. All of the solutions to externality problems involve:

a. setting regulations that impose the socially optimal price and quantity in the market.
b. turning private costs and benefits into external costs and benefits.
c. getting buyers and sellers to consider marginal external costs and benefits.
d. converting social costs into private costs.
ANSWER: c

91. Which of the following statements describes the Coase Theorem?

a. If bargaining is costless, and property rights are clearly established and enforced, then externality
problems can be solved through private bargaining.
b. Even if bargaining is not costless, and property rights are unclear, externality problems can be solved
through private bargaining.
c. If the marginal benefit of a good exceeds the good's marginal cost, more of it should be produced.
d. Elimination of an externality is possible only when the marginal benefit of a good is no higher than
its marginal cost.
ANSWER: a

92. A farmer agrees to give a company access to a private road on his property if the company reduces pollution
of the farm's water source. This is an example of reducing an externality through:
a. corrective taxes.
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b. public goods.
c. cap and trade.
d. private bargaining.
ANSWER: d

93. Junko's car dealership has been suffering from dust on the cars in its lot ever since Mak opened his bakery
nearby. The bakery's flour deliveries send waves of dust down the block. Junko offers to cover half of the cost
of Mak adding a shelter for his delivery area to reduce the blowing of flour dust toward the dealership. This is
an example of reducing a negative externality through:
a. rules and regulations.
b. private bargaining.
c. cap and trade.
d. corrective taxes and subsidies.
ANSWER: b

94. What conditions must be met for private bargaining to be effective in resolving an externality?
a. Bargaining costs must be low, and property rights must be clear.
b. Property rights must be clear, and production must begin at a socially optimal level.
c. There must be trade in public goods.
d. Taxes must be low, and regulations must be minimal.
ANSWER: a

95. A tax designed to induce people to take account of the negative externalities that they cause is referred to as
_____ tax.
a. an externality
b. an open offset
c. a corrective
d. a compensatory
ANSWER: c

96. _____ tax is designed to encourage people to take responsibility for the negative externalities they cause.
a. A corrective
b. A compensatory
c. A Coase
d. An externality offset
ANSWER: a

97. A corrective tax leads:

a. to a reduction of external benefits and costs.
b. people to internalize the external costs and benefits of their actions.
c. to a Coase Theorem–based solution that arises from private bargaining.

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d. to a need for offsetting subsidies.

ANSWER: b

98. (Figure: Market 3) Use the graph to answer the question.

The graph shows the marginal social cost, demand, and supply curves in the cinnamon roll market. A corrective
tax of _____ per unit will move the cinnamon roll market to the socially optimal output of _____ units.
a. $3; 12
b. $2; 12
c. $4; 8
d. $2; 8
ANSWER: d

99. (Figure: Market 2) Use the graph to answer the question.

The graph shows the marginal social cost, demand, and supply curves in the cinnamon roll market. A corrective
tax of _____ per unit will move the cinnamon roll market to the socially optimal output of _____ units.
a. $4; 4

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b. $8; 4
c. $6; 6
d. $2; 6
ANSWER: a

100. What happens in a supply and demand diagram of the pesticide market when a corrective tax is used to
solve a negative externality problem?
a. The equilibrium quantity rises as the supply curve shifts left.
b. The tax causes a rightward shift of the supply curve.
c. The marginal social cost curve becomes the supply curve.
d. The marginal external cost curve becomes the supply curve.
ANSWER: c

101. A corrective tax designed to resolve a negative externality problem is typically set at an amount equal to
the _____ cost.
a. marginal social
b. marginal external
c. total externality
d. total social
ANSWER: b

102. Which of the following is the amount of a corrective tax that would resolve a negative externality
problem?
a. The marginal social cost.
b. The total social cost.
c. The total external cost.
d. The marginal external cost.
ANSWER: d

103. A corrective subsidy:

a. removes choice by requiring production to change for goods with externalities.
b. provides more alternatives so that satisfaction rises with few units sold.
c. incentivizes a reduction in the output when negative externalities exist.
d. incentivizes an increase in the output when positive externalities exist.
ANSWER: d

104. Which of the following is NOT an example of a corrective tax or subsidy used to address an externality
problem?
a. The government charges Ku's company a tax equal to the difference between the marginal social cost
and the marginal private cost of emissions.
b. The government discourages the production of paper products in a suburban community by imposing
a unit tax on the production of such products, limiting paper companies' emissions of carcinogenic
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toxins.
c. Marlo's customers have been bothered by the noisy, midday deliveries at the business next door. She
arranges to cover part of the delivery costs in order to have the neighbor's deliveries arrive early in
the morning rather than at midday.
d. The government covers part of the cost of a particular immunization.
ANSWER: c

105. Which of the following is NOT an example of a corrective tax or subsidy used to address an externality
problem?
a. A country charges a set fee to companies that manufacture in the country for every 100 gallons of a
particular chemical that they release into the country's lakes and waterways.
b. The government sets a limit on the quantity of pollution companies can emit by issuing a set number
of pollution permits that companies can trade.
c. An environmental protection organization publishes and publicizes an annual list of companies that
have taken actions to protect the environment as well as a list of companies that it finds are damaging
the environment.
d. A community distributes "I voted" stickers to everyone who votes in an election, hoping that seeing
them on voters will encourage others to vote.
ANSWER: b

106. The production of a particular good generates a negative externality. To reduce the amount of this
externality, the government sets a limit on the quantity of the product that can be produced. This type of action
shows the government ______ to deal with the externality.
a. imposing a tax
b. using private bargains
c. setting a quota
d. using a subsidy
ANSWER: c

107. (Figure: Market 8) Use the graph to answer the question.

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The graph shows the marginal social cost, marginal private cost, and demand curves in the aux cable market. If
the government uses a quota to control an externality in this market, what quantity would be chosen as a limit
on sales?
a. two
b. four
c. six
d. 12
ANSWER: b

108. (Figure: Market 3) Use the graph to answer the question.

The graph shows the marginal social cost, supply, and demand curves in the hand sanitizer market. At what
quantity could the government set a quota to control this externality?
a. 2
b. 4
c. 8
d. 12
ANSWER: c

109. Quotas change _____, and taxes change _____ when they are used to deal with externalities.
a. costs; quantity
b. price; costs
c. price; quantity
d. quantity; price
ANSWER: d

110. What determines whether a corrective tax or quantity regulation is a better choice for controlling an
externality?
a. It depends on whether the externality is positive or negative.
b. It depends on whether more is known about marginal external costs or about the socially optimal
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quantity.
c. It depends on how much damage is being done by the externality.
d. It depends on whether or not the rational rule can be applied.
ANSWER: b

111. When a quota is used to control an externality, the government must determine both _____ and _____.
a. the socially optimal quantity; how to distribute that quantity across suppliers
b. the socially optimal quantity; the socially optimal price
c. how large a tax to use; which external impact to address
d. how to bargain with companies; whether to use a subsidy
ANSWER: a

112. "Cap and trade" means that each business has:

a. the right to emit unlimited pollution.
b. a set level of taxes to pay in order to trade.
c. external costs and private costs and that it faces demand that includes both.
d. permits to emit a certain quantity of pollutants and can trade or sell those permits to other companies.
ANSWER: d

113. Why would the government allow companies to buy and sell permits that allow companies to emit
specified amounts of pollutants?
a. It reduces the externality even more than setting limits without the possibility of trading emissions
permits.
b. It eliminates bias in the allocation of emissions rights.
c. It ensures that emissions reductions are primarily undertaken by firms that can reduce emissions at a
lower cost than others can.
d. It eliminates the costs of any externalities.
ANSWER: c

114. Which of the following is the term for a quantity regulation that is implemented by allocating a fixed
number of permits to producers, which can then be traded?
a. quota market
b. cap and trade
c. private bargaining
d. public goods
ANSWER: b

115. Pedro attends a university that provides antivirus software to all students, faculty, and staff for their
personal computers as well as all university-owned computers. Why would the university pay for the protection
of the personal computers of students, faculty, and staff?
a. Having this extra perk from being associated with the university makes it easier to attract high-
quality students, faculty, and staff.
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b. It reduces the cost of operations for the university because it can thereby buy software in bulk.
c. It reduces the number of viruses on university-owned computers by reducing the probability that
viruses will spread through files transferred from personal computers to university-owned computers
and systems.
d. Reducing the spread of viruses across campus promotes health among students and decreases
absenteeism, which improve educational outcomes on campus.
ANSWER: c

116. An apartment complex imposes a rule prohibiting loud noise from 9 p.m. until 7 a.m. This is an example of
using _____ to reduce externalities from noise.
a. a government regulation
b. a corrective tax
c. cap and trade
d. a company rule
ANSWER: d

117. Which of the following is NOT a problem that occurs when rules and regulations are used to control
externalities?
a. Rules and regulations tend to eliminate rather than reduce externalities when reduction might be the
better option.
b. Rules and regulations may focus on an easy-to-monitor way to achieve a goal rather than the best
way to achieve it.
c. Rules and regulations tend to focus on the most extreme cases of an externality rather than the most
common.
d. Rules and regulations may stifle innovation and discovery of how to achieve the rule's goal.
ANSWER: c

118. A nonexcludable good is a good in which:

a. it is difficult to prevent someone from using or having access to the good.
b. one person consuming or using the good cannot prevent others from using or consuming the same
unit of the good.
c. there is a regulation that the good must be provided to everyone.
d. the good has no cost of production and so is available to consumers at no cost.
ANSWER: a

119. A good is characterized as _____ when one person's use of the good does not reduce another person's
ability to use the same unit of the good.
a. nonexcludable
b. free
c. nonrival
d. shareable
ANSWER: c
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120. When someone can enjoy the benefits of a good without bearing the cost, the good:
a. is subject to the free-rider problem.
b. is excludable and rival.
c. is a nonmarket good.
d. is attractive to manufacturers.
ANSWER: a

121. A good is _____ when it is difficult to prevent someone from using or having access to it.
a. free
b. nonrival
c. shareable
d. nonexcludable
ANSWER: d

122. A nonrival good is a good:

a. that someone cannot be easily excluded from using.
b. where the market has only one producer, so the producer does not face any rival suppliers.
c. where one person's use of the good does not reduce another person's ability to use the same unit of
the good.
d. in which only one version is available, so consumers do not have choices, although there are many
sellers.
ANSWER: c

123. A good has a free-rider problem when:

a. any seller provides it for free as a special promotion.
b. someone can enjoy the benefits of the good without bearing the costs.
c. it can be transported at no cost to the consumer, with sellers bearing all transportation costs.
d. it has no negative externalities but only positive externalities.
ANSWER: b

124. When a good is nonrival and nonexcludable, the good is referred to as:
a. a free-ride benefit good.
b. an external good.
c. a private good.
d. a public good.
ANSWER: d

125. Which of the following would be both nonrival and nonexcludable?

a. a museum
b. a siren tornado warning system

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c. a road
d. an immunization
ANSWER: b

126. Which of the following goods would be nonrival?

a. a candy bar
b. gasoline
c. an online course
d. toothpaste
ANSWER: c

127. When a good is nonrival and nonexcludable, it suffers from the _____ problem.
a. cap and trade
b. Coase Theorem
c. free-rider
d. partial good
ANSWER: c

128. A government uses taxes to build and maintain a museum, and citizens can visit the museum without
paying an admission fee. Which of the following considerations implies that visiting a museum is NOT a public
good?
a. Although admittance is nonexcludable, it is rival because other museums are vying for consumers to
visit them instead.
b. Visiting a museum is both nonexcludable and nonrival, which means it is not a public good.
c. Visiting a museum is both excludable and rival, which means it is not a public good.
d. Although enjoying the exhibits might be nonrival, the experience is excludable because admittance
could easily be limited to those who pay.
ANSWER: d

129. When a good is a rival good:

a. firms vie to gain as much market share as possible.
b. firms compete to gain government permission to be the sole producer.
c. one person's use of it prevents others from using it.
d. there are many versions available, so sellers are rivals.
ANSWER: c

130. In a market system, public goods would:

a. be underproduced.
b. be overproduced.
c. lack demand.
d. have no costs.

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ANSWER: a

131. Which of the following is FALSE regarding public goods?

a. The fact that the government should fund a public good doesn't mean that the government should
produce it.
b. The fact that the government provides it doesn't mean that it is a public good.
c. The fact that something is a public good doesn't mean it is nonrival.
d. The fact that something is a public good doesn't mean that the government should fund it.
ANSWER: c

132. The difference between a club good and a public good is that a club good is _____ and a public good is
_____.
a. nonexcludable and rival; excludable and rival
b. excludable and nonrival; excludable and rival
c. nonexcludable and rival; nonexcludable and nonrival
d. excludable and nonrival; nonexcludable and nonrival
ANSWER: d

133. A good that is excludable but nonrival in consumption is known as a _____ good.
a. public
b. club
c. private
d. proprietary
ANSWER: b

134. A good that is rival and nonexcludable is known as a:

a. public good.
b. club good.
c. common resource.
d. private resource.
ANSWER: c

135. Common resources have:

a. shared gains but private costs.
b. private gains but shared costs.
c. characteristics of being nonrival and nonexclusive.
d. characteristics of being rival and exclusive.
ANSWER: b

136. The tragedy of the commons is the:

a. destruction of rival, excludable goods.

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b. destruction of nonrival, nonexcludable goods.

c. tendency to underconsume common resources.
d. tendency to overconsume common resources.
ANSWER: d

137. How can the tragedy of the commons be averted?

a. The government can assess corrective taxes.
b. Ownership rights can be assigned.
c. The parties involved can engage in public bargaining.
d. The government can implement a cap and trade policy.
ANSWER: b

138. What type of good is rival and nonexcludable?

a. private goods
b. club goods
c. common resources
d. public goods
ANSWER: c

139. What type of good is rival and excludable?

a. private goods
b. club goods
c. common resources
d. public goods
ANSWER: a

140. What type of good is nonrival and excludable?

a. private goods
b. club goods
c. common resources
d. public goods
ANSWER: b

141. What type of good is nonrival and nonexcludable?

a. private goods
b. club goods
c. common resources
d. public goods
ANSWER: d

Essay
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142. Ollie considers the benefits and costs of buying a large motorcycle versus a bicycle or a car. He buys the
motorcycle. What externalities might be associated with Ollie's use of his motorcycle that he might not have
considered when he assessed the benefits and costs of buying a large motorcycle?
ANSWER: Ollie's motorcycle might be noisy enough to bother other people. When it burns gasoline, there may
be fumes that affect other people. If Ollie causes an accident while using his motorcycle, others
could be hurt. All of these are negative externalities.

143. Explain why positive and negative externalities lead to market failure.
ANSWER: Decision makers in markets focus primarily on enhancing their own welfare. Buyers want to gain as
much marginal benefit as they can for the funds they have to spend. Sellers are focused on
determining their best output and price based on their marginal cost. Because the focus is on what is
best for themselves, the buyers' marginal benefit is referred to as marginal private benefit, and the
sellers' marginal cost is referred to as marginal private cost. Neither party tends to pay attention to
the external costs or benefits that might result from their actions. This leads to a market equilibrium
outcome that is good for market participants, but because of the external costs and benefits
experienced by bystanders, the market equilibrium may not be optimal for society. Thus, the
outcome is considered to be a market failure.

144. Describe the three-step recipe for analyzing externalities based on the Rational Rule for Society.
ANSWER: The Rational Rule for Society is that society's welfare will be highest if output increases until
marginal social benefit equals marginal social cost. Analyzing a market with externality problems to
see where it stands in relation to what is best for society involves three steps. First, predict the
market equilibrium that would prevail in the market based on market forces and private costs and
benefits. Second, determine what externalities would result from market activity and what the level
of the external costs and benefits would be. Third, determine the socially optimal outcome based on
marginal social costs and benefits that include both private and external costs and benefits, and then
compare the socially optimal outcome with the forecast of the market outcome.

145. What is meant by the statement "There is a socially optimal amount of water pollution that is not zero"?
ANSWER: The socially optimal outcome in a market with externalities such as water pollution is based on
marginal social cost and marginal social benefit. At the output level where the two measures are
equal, the welfare of society is maximized. Some water pollution will exist at this output level. The
marginal social cost of reducing water pollution further would exceed the marginal social benefit of
having water any cleaner than it is at the output level where marginal social benefit equals marginal
social cost. The goal is not eliminating an externality completely but rather maximizing the welfare
of society.

146. Using rules or regulations as a method to control an externality is often described as a blunt instrument.
What aspects and implications of using rules and regulations to control an externality give it the "blunt
instrument" description?
ANSWER: Many rules (or regulations) do help lessen externality problems. However, rules can be rigid ways
of dealing with externalities. They can lessen the forces of competition, which can lessen the level
of efficiency in the firms and market compared to the use of some other tools for controlling or
offsetting externalities. Sometimes, to be easily enforceable, a rule may need to be written so that it
addresses more than necessary to achieve its goal. Rules that achieve an externality abatement goal
may be written in a way that lessens the incentives for innovation and technical advancement (for
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example, by saying that a certain technology must be used to reduce pollution rather than pollution
must be reduced by X amount).

147. Why would a country choose to use a "cap and trade" policy rather than a quota to control a negative
externality?
ANSWER: Both approaches put a quantity limit on the externality or the externality-creating activity. A quota
simply limits the quantity. The quota rights to produce must be allocated across the producers who
desire to engage in the activity, and the government must come up with a method for allocating the
rights. When a cap and trade approach is used, the government is setting a quota limit; allocating the
quota rights across producers, often equally; but then allowing the producers to trade or sell their
quota rights among themselves. This allows production under quota rights to shift to the most
efficient producers because those are the producers who would be most willing to buy quota rights.
It may be difficult for the government to ascertain who are the most efficient producers to allocate
quota rights more heavily to those producers. Identifying who is most efficient is not needed under
cap and trade because the open trade in quota rights will lead production to the most efficient
producers. The externality problem is resolved, and production efficiency in the market is
maintained.

148. Pedro attends a university that requires all students, faculty, and staff to have antivirus software on their
personal computers and even provides — at no cost to students, faculty, and staff — antivirus software for their
personal computers. Why would the university pay for the protection for the personal computers of students,
faculty, and staff?
ANSWER: This is an example of company rules targeting externalities. If one person (students, faculty, or staff)
gets a virus, that one person a problem that can make the use of his or her private computer more
difficult. However, if one person's computer gets a virus, he or she can inadvertently share the virus
with others whenever he or she has virtual contact with them through the infected computer. This is
a negative externality when it impacts others. When students, faculty, or staff share files, viruses can
be spread. If students, faculty, or staff share files from a home computer or through a home
computer to a campus computer or system, a virus can be spread to the campus system of
computers. For example, a student could upload a file to the university learning management
system, or a faculty member or staff member could reply to a student email from a home computer.
Once the virus is in the university system, it can spread and be difficult for the university to
eradicate. Thus, it is simpler for the university to minimize the risk by paying for all students,
faculty, and staff to have antivirus software on their personal or home computers.

149. What two characteristics are used to classify a good as a "public good," and what implications do these
characteristics have for the good?
ANSWER: A public good has two characteristics — nonrival and nonexcludable. Nonrival means that if the
good is provided to one, it is still available to others. One person consuming or using it does not use
it up. Nonexcludable means that there is no feasible way to prevent nonpayers from having access to
the good; if it is provided to one, it is provided to many. When a good has these two features, then if
it is provided to one consumer, it is provided to all. When this is the case, there is a high risk of free
riders because they cannot be excluded from the good. Because the good is nonrival, it does not
really cost more to provide it to many than it costs to provide it to one. Because nonpayers have
access to the good (nonexcludable), then markets tend to fail because no one wants to pay for the
good. Everyone hopes to be a free rider.

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150. What problem results in markets when the good is a public good, and how can the government solve the
problem?
ANSWER: Underproduction occurs in the market for a public good. This underproduction can be so severe that
the market falls apart and the good is not produced even though it is desired. No one wants to buy
the good because each hopes to be a free rider if someone else buys it. With no one buying, sellers
do not earn the revenue needed to cover their costs. The government can deal with the free-rider
problem by forcing everyone to "buy" the public good by forcing everyone to pay taxes and then
using part of the tax revenue to pay for the public good. The government may produce the public
good or pay a private firm to produce it, but the government pays for it out of tax revenue. The
government may not do this for all public goods but may choose to do this for public goods that it
deems important to the welfare of the population.

151. Why does a common resource lead to the tragedy of the commons?
ANSWER: A common resource is rival and nonexcludable. The nonexcludable characteristic leads to people
feeling free to use the resource as much as they want because they cannot be excluded from it.
However, the rival characteristic means that some of the resource is used up and unavailable to
others every time someone uses some of it. This combination of characteristics leads to overuse
where people who can't be excluded keep using the resource, which leads to less and less of it being
left as available. There is overuse. One reason this happens is that with a common resource,
everyone owns it jointly. This can make it seem like no one owns it because no one has the incentive
to protect it from overuse.

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Multiple Choice

1. The wage in a labor market is determined by the

a. intersection of its labor demand and labor supply curves.
b. difference in the demand for jobs and the supply of jobs.
c. positive slope of the demand curve and the negative slope of the supply curve.
d. length of the labor demand curve and the labor supply curve.
ANSWER: a

2. In the labor market for computer programmers, the labor demand represents
a. the workers looking for a job as a programmer.
b. the employers looking to hire programmers.
c. all the workers looking for a job.
d. all the employers looking to hire.
ANSWER: b

3. In the labor market for computer programmers, the labor supply represents
a. all the workers seeking to sell their labor.
b. all the firms seeking to hire labor.
c. the workers seeking to sell their labor as programmers.
d. the firms seeking to hire programmers.
ANSWER: c

4. The labor demand curve in a labor market

a. is based on the workers demanding jobs in the market.
b. is based on the firms selling jobs in the market.
c. slopes upward.
d. slopes downward.
ANSWER: d

5. The labor supply curve in a labor market

a. is based on the firms demanding labor in the market.
b. is based on the firms selling jobs in the market.
c. slopes upward.
d. slopes downward.
ANSWER: c

6. In a labor market, the wage is

a. the price of labor.
b. the quantity of labor.
c. what workers pay.
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d. what employers receive.

ANSWER: a

7. In a labor market, the quantity is

a. the wage or amount of money paid.
b. the hours of work bought or sold.
c. the different types of skills that are sought.
d. the number of companies hiring.
ANSWER: b

8. In a labor market graph, _____ is measured on the vertical axis, and _____ is measured on the horizontal
axis.
a. product price; number of workers
b. number of workers; product price
c. wage; hours of labor
d. hours of labor; wage
ANSWER: c

9. As wage rises, the opportunity cost principle leads to a _____ in the number of hours supplied and a _____ in
the number of hours demanded in the labor market for marketers.
a. fall; rise
b. fall; fall
c. rise; rise
d. rise; fall
ANSWER: d

10. According to the cost-benefit principle, the number of labor hours demanded will _____, and the number of
labor hours supplied will _____ as the wage decreases.
a. rise; fall
b. fall; fall
c. rise; rise
d. fall; rise
ANSWER: a

11. In a perfectly competitive labor market, employers

a. pay varying wages.
b. pay the market wage.
c. who pay less than the market wage will attract workers.
d. have an incentive to pay more than other employers.
ANSWER: b

12. In a perfectly competitive labor market, employers will not pay less than the market wage because at a wage
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below the equilibrium
a. there would be a surplus of workers.
b. they would be inundated with excess workers.
c. they would not be able to hire anyone.
d. the equilibrium wage would rise.
ANSWER: c

13. In a perfectly competitive labor market, employers will not pay more than the market wage because:
a. there would be a shortage of workers at a wage above equilibrium.
b. good workers would go to other firms.
c. other firms would also pay the higher wage.
d. plenty of good workers are available at the market wage.
ANSWER: d

14. In a perfectly competitive labor market, the manager's hiring decision is about
a. how many workers to hire.
b. what wage to pay.
c. both how many workers and what wage to pay.
d. how to avoid a labor shortage.
ANSWER: a

15. Which of the following is NOT a principle used in determining how many workers a company should hire?
a. The opportunity cost principle
b. The absolute advantage principle
c. The marginal principle
d. The cost-benefit principle
ANSWER: b

16. The extra production that occurs from hiring an extra worker is known as the
a. quantity change.
b. labor productivity.
c. marginal product of labor.
d. marginal labor production.
ANSWER: c

17. The marginal product of labor is the

a. amount of extra worker time it takes to produce one extra unit of output.
b. change in output from the slowest worker to the most productive worker.
c. extra output produced by all the firm's employees.
d. extra production that occurs from hiring an extra worker.
ANSWER: d
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18. The marginal revenue from hiring an additional worker is known as

a. marginal revenue product.
b. labor marginal revenue.
c. marginal worker revenue.
d. labor marginal product.
ANSWER: a

19. Marginal revenue product is the

a. change in revenue from selling an extra item.
b. marginal revenue from hiring an additional worker.
c. extra product produced from spending marginal revenue on inputs.
d. change in revenue from the total production.
ANSWER: b

20. The marginal revenue product is equal to the marginal

a. revenue multiplied by the wage.
b. revenue multiplied by output.
c. product of labor multiplied by the price of that product.
d. product of labor multiplied by the wage.
ANSWER: c

21. The marginal revenue product of labor is equal to:

a. MPL + P.
b. MR × Wage.
c. MR + Wage.
d. MPL × P.
ANSWER: d

22. The marginal cost of an additional worker is the change in

a. the company's total cost when one extra worker is hired.
b. total cost when one more unit of output is produced by an extra worker.
c. revenue minus the change in total cost when an extra worker is hired.
d. costs after adjustment for revenue due to an extra worker.
ANSWER: a

23. An additional worker hired, produces extra output that is sold. The change in total revenue due to this is
a. marginal product revenue.
b. marginal revenue product.
c. worker marginal revenue.
d. worker marginal product.
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ANSWER: b

24. An employer should hire one more worker if

a. the total benefit exceeds the total cost.
b. the marginal cost is falling.
c. the marginal benefit exceeds the marginal cost.
d. demand is rising.
ANSWER: c

25. Employers should hire more workers when the marginal revenue product is greater than (or equal to) the
wage. This rule is known as the
a. Marginal Hiring Rule.
b. Labor Demand Rule.
c. Labor Maximization Guide.
d. Rational Rule for Employers.
ANSWER: d

26. The Rational Rule for Employers says to hire more workers if
a. the marginal revenue product is greater than (or equal to) the wage.
b. the cost of workers is less than the revenue of workers.
c. worker skill exceeds worker wage.
d. output increase is sought and wage is falling.
ANSWER: a

27. Use the data in Table: Pat's Pedicures to answer the question.

If Pat uses the Rational Rule for Employers, how many nail technicians will she hire?
a. one
b. two
c. three
d. four
ANSWER: c

28. Use the data in Table: Larry's Lawn Mowing to answer the question.

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If Larry uses the Rational Rule for Employers, how many workers will he hire?
a. one
b. two
c. three
d. four
ANSWER: b

29. Use the data in Table: Wendy's Windows to answer the question.

If Wendy uses the Rational Rule for Employers, how many workers will she hire?
a. one
b. two
c. three
d. four
ANSWER: c

30. Use the data in Table: Wendy's Windows to answer the question.

What is the marginal revenue product of the second worker?

a. $600
b. $800
c. $1,200
d. $2,400

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ANSWER: b

31. Use the data in Table: Wendy's Windows to answer the question.

What is the marginal revenue product of the fourth worker?

a. $400
b. $600
c. $1,200
d. $2,400
ANSWER: a

32. Alena manages a small theme park. She hires one more custodian at $450 per week, and her park is cleaner
and more attractive. As a result of this improvement, ticket sales rise by 40 tickets per week. Tickets sell for
$12. Use the Rational Rule for Employers to determine if hiring the extra custodian was a good move.
a. Yes, it was a good move because it added more to revenue than to cost.
b. Yes, it was a good move because the ticket sales rose more than price.
c. No, it was a bad move because it added more to cost than revenue.
d. No, it was a bad move because price did not rise as much as ticket sales.
ANSWER: a

33. If an employer follows the Rational Rule for Employers, they will keep hiring additional workers until
a. minimum average cost is achieved.
b. marginal revenue equals zero.
c. revenue equals cost.
d. wage equals marginal revenue product.
ANSWER: d

34. Use the data in Table: Carmin's Cones to answer the question.

Using the Rational Rule for Employers, the maximum profit Carmin could earn is _____. She would employ
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_____ workers to earn this profit.
a. $344; two
b. $1,144; two
c. $352; three
d. $1,552; three
ANSWER: c

35. Use the data in Table: Katia's Car Wash to answer the question.

When four workers are employed, the total revenue equals _____, and total cost equals _____.
a. $3,200; $1,880
b. $1,560; $3,200
c. $320; $1,600
d. $1,880, $1,600
ANSWER: d

36. Use the data in Table: Larry's Lawn Mowing to answer the question.

If three workers are employed, total revenue will equal _____, and total costs will be _____.
a. $1,680; $1,620
b. $420; $540
c. $1,260; $540
d. $1,980; $1,620
ANSWER: a

37. To maximize profits when hiring employees, continue to hire workers until
a. revenue is maximum and costs are minimum.
b. marginal product equal marginal revenue.
c. wage equals marginal product.
d. wage equals marginal revenue product.
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ANSWER: d

38. The Rational Rule for Employers implies that they keep hiring until
a. revenue equals cost.
b. the wage equals marginal product.
c. the wage equals the marginal revenue product of the last worker hired.
d. marginal product equals marginal revenue.
ANSWER: c

39. An employer's labor demand curve is equal to the

a. marginal revenue product curve.
b. marginal product curve.
c. marginal revenue curve.
d. rational product curve.
ANSWER: a

40. The labor demand curve has a _____ slope because of _____.
a. downward; diminishing opportunity cost
b. downward; diminishing marginal product
c. upward; increasing opportunity cost
d. upward; increasing marginal product
ANSWER: b

41. Why does an employer's labor demand curve slope downward?

a. diminishing product demand
b. substitution rule
c. diminishing marginal product
d. marginal cost adjustment
ANSWER: c

42. Which of the following is an example of derived demand?

a. The demand for kitchen renovation affects the demand for carpenters.
b. The demand for nails affects the demand for saws.
c. The demand for accountants affects the demand for accounting services.
d. The demand for workout videos affects the demand for treadmills.
ANSWER: a

43. Alex and Marilyn started Ono Yo, an organic and fresh fruit frozen yogurt truck. As the demand for organic
and healthier desserts rose, demand for Ono Yo's products grew. Because of the growth in demand for Ono Yo's
product, Alex's and Marilyn's
a. supply decreased.

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b. demand for workers increased.

c. equilibrium quantity shifted to the left.
d. employee wages fell.
ANSWER: b

44. If the demand for Ono Yo's organic frozen yogurt increases, then the _____ Ono Yo's workers will _____.
a. wages of; fall
b. demand for; hold steady
c. marginal revenue product of; increase
d. productivity of; rise
ANSWER: c

45. When an increase in demand for stand-up paddleboards rises, then the demand for skilled paddleboard
shapers _____, and their marginal revenue product _____.
a. falls; falls
b. falls; rises
c. rises; falls
d. rises; rises
ANSWER: d

46. Your landscaping company uses labor and shovels. The price of shovels falls, and this _____ your demand
for labor because labor and shovels are _____.
a. raises; complements
b. raises; substitutes
c. lowers; complements
d. lowers; substitutes
ANSWER: a

47. Jenna is a concert pianist. A grand piano is a _____ to her labor in the production of her concerts.
a. derivation
b. substitute
c. complement
d. wage match
ANSWER: c

48. As the price of scanners with high-resolution cameras dropped, Ford began using them instead of human
inspectors to check the quality of the painted surfaces of its cars. What is the relationship between capital and
labor in this example?
a. Labor and capital are substitutes in production.
b. Labor and capital are complements in production.
c. Labor and capital are scalers in production.

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d. Labor and capital are production margins.

ANSWER: a

49. An increase in the price of capital will _____ demand for labor if capital and labor are substitutes, and it will
_____ the demand for labor if the scale effect dominates.
a. increase; decrease
b. increase; increase
c. decrease; decrease
d. decrease; increase
ANSWER: a

50. Carlo implemented some management changes that increased worker productivity in his company. This
increased the _____ and led him to _____ workers.
a. marginal product of labor; lay off some
b. marginal revenue product of labor; hire more
c. product demand; hire more
d. product price; lay off some
ANSWER: b

51. After Giselle increased worker training at her company, the output per worker rose by 5%. What impact
would this have on labor's marginal revenue product and her demand for labor?
a. Marginal revenue product would rise, and demand for labor would decrease.
b. Marginal revenue product would decrease, and demand for labor would increase.
c. Both marginal revenue product and demand for labor would increase.
d. Both marginal revenue product and demand for labor would decrease.
ANSWER: c

52. Nora, the manager of three hospital rehabilitation clinics, has the clinics adopt software that allows better
tracking of supplies. This software adoption also allows therapists to spend less time gathering supplies for
therapy sessions. On average, each therapist can meet with one more patient per day. The marginal revenue
product of the therapists will _____, and the demand for therapists at the clinics will _____.
a. decrease; decrease
b. decrease; increase
c. increase; decrease
d. increase; increase
ANSWER: d

53. If a company incurs expenses to start providing childcare at work so that employees can have lunch with
their preschool children, the company's demand curve for labor will shift to the
a. left because employees are more expensive to the firm.
b. right because employees are more expensive to the firm.
c. left because workers will be more loyal.
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d. right because workers will be more loyal.

ANSWER: a

54. When nonwage worker benefits are increased at a company, the company's demand for labor will _____
because employees are _____ to the company.
a. increase; more costly
b. decrease; more costly
c. increase; more valuable
d. decrease; less valuable
ANSWER: b

55. Which of the following will NOT shift a company's demand curve for labor?
a. Change in the price of capital
b. Better management techniques
c. Change in the wage paid to workers
d. Change in the demand for the company's product
ANSWER: c

56. Over long periods, the price elasticity of demand for labor becomes
a. unit elastic.
b. inelastic.
c. less elastic.
d. more elastic.
ANSWER: d

57. The _____ principle explains why the loss of jobs due to automation in certain industries may create jobs in
other industries.
a. interdependence
b. off-set
c. marginal
d. opportunity
ANSWER: a

58. Who gains the most when robots replace workers?

a. Workers whose jobs were replaced by robots
b. Owners of robots
c. Owners of land
d. Teachers
ANSWER: b

59. The long-run effect of laws that raise the minimum wage is that

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a. any short-run effect disappears and there is no long-run impact.

b. the demand for minimum wage workers rises and more minimum wage workers are hired.
c. labor-saving devices and management practices are slowly adopted.
d. labor-saving devices are quickly adopted to replace labor.
ANSWER: c

60. Consider the labor market, predict which of the following create an incentive for investment in capital?
a. Higher capital prices
b. Lower land prices
c. Lower wages
d. Higher wages
ANSWER: d

61. When technology replaces low-skilled jobs in one industry, in the short-run, there is loss of low-skilled jobs.
The long-run impact is:
a. higher productivity leading to a better standard of living.
b. higher wages in low-skilled jobs.
c. lower productivity leading to a worse standard of living.
d. the loss of jobs in other industries.
ANSWER: a

62. Who gains and who loses when robots replace workers?
a. Displaced workers gain, and robot owners lose.
b. Robot owners gain, and displaced workers lose.
c. Low-wage workers gain, and robot manufacturers lose.
d. Workers gain, and robots lose.
ANSWER: b

63. When robots replace workers in performing a particular task, productivity

a. and total output can fall because machines are not teachable like humans.
b. will rise, but the total output may fall because of tensions between workers and machines.
c. and total output can rise because displaced workers are now free to produce other things.
d. will fall because there is idle labor and reliance on machines.
ANSWER: c

64. Technological change _____ productivity.

a. makes cyclical changes in
b. stabilizes
c. diminishes
d. boosts
ANSWER: d
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65. In a labor market, workers _____ labor, and employers _____ labor.
a. supply; demand
b. demand; supply
c. hire; use
d. use; hire
ANSWER: a

66. An individual's time is divided into the two main categories of

a. work and play.
b. work and leisure.
c. leisure and production.
d. play and production.
ANSWER: b

67. When you are working in the labor market, you are
a. demanding labor.
b. demanding a job.
c. supplying labor.
d. supplying a job.
ANSWER: c

68. The opportunity cost of working is

a. what you can buy because you worked.
b. too high to even consider not working.
c. the wage you earn for the time spent working.
d. what you would have done during the time if you were not working.
ANSWER: d

69. If a worker is deciding how many hours to work by asking, "Should I work one more hour?" then the
worker is using the _____ principle to make the decision.
a. marginal
b. opportunity cost
c. cost-benefit
d. additive
ANSWER: a

70. When deciding on the number of hours to work using the marginal principle, you are asking the question,
a. "How many total hours do I want to work?"
b. "Should I work one more hour?"
c. "How much could I buy if I work?"

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d. "How much do I give up if I work?"

ANSWER: b

71. When making labor supply decisions, your options are

a. working or doing housework.
b. working, shopping, or relaxing.
c. working or leisure.
d. working, sleeping, or leisure.
ANSWER: c

72. What you forgo in order to work is the

a. wage of work.
b. labor supply.
c. marginal cost of working.
d. opportunity cost of working.
ANSWER: d

73. The Rational Rule for Workers is to work

a. one more hour as long as the wage is at least as large as the marginal benefit of another hour of
leisure.
b. as long as there is a desire for more income that exceeds the loss of income from not working.
c. as long as the marginal cost exceeds the marginal benefit.
d. one more hour as long as the wage exceeds the cost of necessities.
ANSWER: a

74. The guideline to work one more hour as long as the wage is at least as large as the marginal benefit of
another hour of leisure is known as the
a. Rational Rule for Employers.
b. Rational Rule for Workers.
c. Work-Leisure Principle.
d. Time Allocation Principle.
ANSWER: b

75. The Rational Rule for Workers is based on the _____ principle.
a. opportunity-cost
b. labor demand
c. cost-benefit
d. transfer
ANSWER: c

76. The benefit of working one more hour is

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a. what you produce during the hour.

b. the leisure time you gain.
c. the experience you gain.
d. the wage you will earn during the hour.
ANSWER: d

77. The cost of working one more hour is

a. the hour of leisure that is given up.
b. the wage earned.
c. the lost output due to inefficiency.
ANSWER: a

78. If Bella uses the Rational Rule for Workers, she will keep choosing more work and less leisure until the
a. value of her production equals her wage.
b. marginal benefit of one more hour of leisure is equal to the wage.
c. marginal cost of her work equals the value of her production.
d. marginal benefit of one more hour of leisure is equal to the value of her production.
ANSWER: b

79. When wages increase, the substitution effect makes work

a. more productive.
b. less productive.
c. more attractive.
d. less attractive.
ANSWER: c

80. The substitution effect of a higher wage measures

a. the trade-off between production and inputs.
b. how people choose one of many possible occupations.
c. the trade-off between relative quantities.
d. how people respond to a change in relative prices.
ANSWER: d

81. The _________________ measures how people respond to a change in relative prices when the wage rises.
a. substitution effect
b. income effect
c. opportunity cost
d. marginal benefit
ANSWER: a

82. The income effect measures

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a. the impact of change in relative prices.

b. how people's choices change when they have more income.
c. the change in welfare when income rises.
d. how people's choices change when they have to work more.
ANSWER: b

83. In labor supply, the change in people's choices when they have more income is called the _____ effect.
a. marginal
b. opportunity cost
c. income
d. substitution
ANSWER: c

84. What is the impact of higher wages on labor supply according to the income effect?
a. Workers are more productive.
b. Workers are less productive.
c. Work is more attractive.
d. Leisure is more attractive.
ANSWER: d

85. Damon's wage rises. The substitution effect would cause him to _____ his work hours, and the income
effect would cause him to _____ his work hours.
a. increase; decrease
b. increase; increase
c. decrease; decrease
d. decrease; increase
ANSWER: a

86. Damon's wage falls. The substitution effect would cause him to _____ his work hours, and the income effect
would cause him to _____ his work hours.
a. increase; decrease
b. increase; increase
c. decrease; decrease
d. decrease; increase
ANSWER: d

87. When the substitution effect dominates, a person's labor supply curve
a. slopes upward.
b. slopes downward.
c. is horizontal.
d. is vertical.
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ANSWER: a

88. When the income effect dominates, an individual's labor supply curve
a. slopes upward.
b. slopes downward.
c. is horizontal.
d. is vertical.
ANSWER: b

89. Most economist agree that individual labor supply between $40 and $80 and hour is
a. cyclical.
b. fixed in place.
c. inelastic.
d. elastic.
ANSWER: c

90. Which graph shows the scenario where the substitution effect dominates labor supply decisions?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

91. Which graph shows the scenario where the income effect dominates labor supply decisions only at high
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wages?

a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

92. The _____ margin deals with how many hours each worker supplies to the labor market supply, and the
_____ margin deals with how many people are in the workforce.
a. substitution; income
b. income; substitution
c. extensive; intensive
d. intensive; extensive
ANSWER: d

93. The decision about whether to work depends on the _____ principle, and the decision about how many
hours to work depends on the _____ principle.
a. cost-benefit; marginal
b. substitution; cost-benefit
c. marginal; substitution
d. marginal; cost-benefit
ANSWER: a

94. The costs of working do NOT include what

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a. could have been done during the time spent at work.

b. could have been bought with the income earned.
c. could have been done with the time spent commuting.
d. it would cost to buy a professional wardrobe if needed for the job.
ANSWER: b

95. A worker's benefits from working do NOT include

a. nonwage benefits.
b. wage.
c. output.
d. gaining experience and skills.
ANSWER: c

96. Higher wages lead to

a. a leftward shift in the labor demand curve.
b. a leftward shift in the labor supply curve.
c. fewer people supplying their labor to a labor market.
d. more people supplying their labor to a labor market.
ANSWER: d

97. The extensive margin deals with a person's decision regarding

a. whether or not to work.
b. how many hours to work.
c. what occupation to choose.
d. what wage to seek.
ANSWER: a

98. The intensive margin deals with a person's decision regarding

a. whether or not to work.
b. how many hours to work.
c. what occupation to choose.
d. what wage to seek.
ANSWER: b

99. Consideration of the benefits of choosing an occupation should NOT include

a. salary or wage.
b. the amount you love the work.
c. if you find it easy.
d. the trajectory of income over a career.
ANSWER: c

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100. When considering the costs of different occupations, _____ is/are NOT a cost.
a. the volatility of income and work in the field
b. the work hours
c. the risks and odds of success
d. your comparative advantage
ANSWER: d

101. The three key labor market decisions that you make do NOT include
a. how many workers to hire.
b. what kind of work to do.
c. whether to work.
d. how many hours to work.
ANSWER: a

102. When you love your job, the opportunity cost of working is _____ the opportunity cost if you dislike your
job.
a. higher than
b. lower than
c. the same as
d. not related to
ANSWER: b

103. You are likely to succeed in a career for which you

a. have multiple opportunities for raises.
b. work long hours.
c. have a comparative advantage.
d. have generous nonwage benefits.
ANSWER: c

104. Costly or negative factors to consider that vary across occupations include
a. income trajectory and starting salary.
b. nonwage benefits and comparative advantage.
c. salary and future opportunities.
d. the probability of success and volatility in earnings.
ANSWER: d

105. Average annual earnings _____ across occupations.

a. vary widely
b. vary within a narrow range
c. are equal
d. are set by the government
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ANSWER: a

106. The factors that cause a labor market supply curve to be upward sloping do NOT include
a. which occupations people choose.
b. how many employers there are.
c. how many people decide to work.
d. how many hours existing workers put in.
ANSWER: b

107. Higher wages for accountants will cause

a. the demand for accountants to increase.
b. existing accountants to work fewer hours.
c. some people to switch jobs to become accountants.
d. fewer people to seek jobs as accountants.
ANSWER: c

108. Higher wages for data analysts would NOT cause

a. some people to switch jobs to become data analysts.
b. existing data analysts to work longer hours.
c. some people to enter the workforce as data analysts.
d. the supply curve for data analysts to shift.
ANSWER: d

109. When the wage for public school teachers rises by 15% in a state, the number of people seeking jobs as
teachers
a. increases.
b. decreases.
c. remains the same.
d. fluctuates up and down quickly.
ANSWER: a

110. The slope of a labor market supply curve depends on each of the following factors EXCEPT the
a. number of people who decide to work.
b. wage.
c. number of hours each worker works.
d. occupation each person chooses.
ANSWER: b

111. Which of the following will NOT happen when the wage for pharmacists drops?
a. People will choose other occupations instead of becoming a pharmacist.
b. Fewer people will enter the workforce to become pharmacists.

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c. The supply curve for pharmacists shifts to the left.

d. Existing pharmacists will want to work fewer hours.
ANSWER: c

112. People will be induced to enter the workforce when:

a. wages in other occupations fall.
b. nonwage benefits are reduced.
c. wages fall.
d. wages rise.
ANSWER: d

113. The labor supply curve for social workers will shift to the right when:
a. nonwage benefits increase for social workers.
b. the wages of all workers rise.
c. the government increases benefits for those who are not working.
d. wages in other occupations rise.
ANSWER: a

114. If wages rise for accountants but not for financial analysts, there will be _____ in the market for
accountants and _____ in the market for financial analysts.
a. a rightward shift of labor supply; a decrease in quantity supplied
b. an increase in quantity supplied; a leftward shift of labor supply
c. a leftward shift of labor supply; an increase in quantity supplied
d. a decrease in quantity supplied; a rightward shift of labor supply
ANSWER: b

115. If wages fall for surgeons but not for family practice doctors, there will be _____ in the market for
surgeons and _____ in the market for family practice doctors.
a. an increase in quantity supplied; a leftward shift of labor supply
b. a leftward shift of labor supply; an increase in quantity supplied
c. a decrease in quantity supplied; a rightward shift of labor supply
d. a rightward shift of labor supply; a decrease in quantity supplied
ANSWER: c

116. What happens in the labor market for biologists when wages in other occupations fall?
a. There is movement along the supply curve to a larger quantity.
b. There is movement along the supply curve to a smaller quantity.
c. There is a leftward shift of the supply curve.
d. There is a rightward shift of the supply curve.
ANSWER: d

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117. What happens in the labor market for custodians in Indonesia when the population of Indonesia grows?
a. The custodian labor supply curve shifts rightward.
b. The custodian labor supply curve shifts leftward.
c. There is a movement to a larger quantity on the custodian labor supply curve.
d. There is a movement to a smaller quantity on the custodian labor supply curve.
ANSWER: a

118. The population of Japan is declining. What impact will this have on the labor market for optometrists in
Japan?
a. The optometrist labor supply curve shifts rightward.
b. The optometrist labor supply curve shifts leftward.
c. There is a movement to a larger quantity on the optometrist labor supply curve.
d. There is a movement to a smaller quantity on the optometrist labor supply curve.
ANSWER: b

119. How would U.S. labor markets be impacted if the U.S. government reduces Social Security benefits by
20%?
a. The labor demand would decrease.
b. The labor demand would increase.
c. The labor supply would increase.
d. The labor supply would decrease.
ANSWER: c

120. If a government increases subsidies for childcare, there will be a _____ in the country's labor market.
a. move to a different point on the labor supply curve with a smaller quantity
b. move to a different point on the labor supply curve with a larger quantity
c. leftward shift of the labor supply curve
d. rightward shift of the labor supply curve
ANSWER: d

121. What will happen in the labor market if income tax rates rise?
a. There will be a move to a different point on the labor supply curve with a smaller quantity.
b. There will be a move to a different point on the labor supply curve with a larger quantity.
c. There will be a leftward shift of the labor supply curve.
d. There will be a rightward shift of the labor supply curve.
ANSWER: c

122. What will happen in the labor market if employers increase the amount of paid vacation days each year?
a. There will be a move to a different point on the labor supply curve with a smaller quantity.
b. There will be a move to a different point on the labor supply curve with a larger quantity.
c. There will be a leftward shift of the labor supply curve.
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d. There will be a rightward shift of the labor supply curve.

ANSWER: d

123. In labor markets, the wages in each occupation are determined by

a. the intersection of the labor demand curve and the labor supply curve.
b. government regulation.
c. the intersection of its job demand curve and job supply curve.
d. workers who demand jobs and firms that supply jobs.
ANSWER: a

124. Which of the following is NOT one of the three steps for forecasting changes in wages and employment
opportunities in labor markets? (Note: Steps are not necessarily listed in order.)
a. Is that shift an increase or a decrease?
b. How many people are available to work?
c. How will wages and the number of jobs change in the new equilibrium?
d. Is the labor demand or labor supply curve shifting?
ANSWER: b

125. Labor demand is based on _____, and labor supply is based on _____.
a. marginal revenue product; opportunity costs
b. opportunity costs; marginal revenue product
c. price; quantity
d. quantity; price
ANSWER: a

126. Which of the following would shift the labor supply curve?
a. Technological advancement increases worker productivity.
b. Demand increases for the output produced by workers.
c. There is more effective management at companies.
d. The government increases its provision of childcare services.
ANSWER: d

127. Which of the following would shift both the labor supply curve and the labor demand curve?
a. There is an increase in the proportion of the population that is of working age.
b. Employers begin covering the cost of better health insurance for all employees.
c. There is more effective management at companies.
d. Technological advancement increases worker productivity.
ANSWER: b

128. What will happen in the market for nurses in the United States if capital equipment replaces nurse labor to
monitor vital statistics on patients in hospitals?

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a. Labor demand will decrease, resulting in lower wages and fewer hours of employment for nurses.
b. Labor demand will increase, resulting in higher wages and more hours of employment for nurses.
c. Labor supply will decrease, resulting in higher wages and fewer hours of employment for nurses.
d. Labor supply will increase, resulting in lower wages and more hours of employment for nurses.
ANSWER: a

129. Better management increases worker productivity in the labor market for factory production line workers.
What will happen in the labor market for production line workers?
a. Labor demand will decrease, resulting in lower wages and fewer hours of employment for the
workers.
b. Labor demand will increase, resulting in higher wages and more hours of employment for the
workers.
c. Labor supply will decrease, resulting in higher wages and fewer hours of employment for the
workers.
d. Labor supply will increase, resulting in lower wages and more hours of employment for the workers.
ANSWER: b

130. Salaries for physical therapists rise more than salaries for athletic trainers. What will happen in the labor
market for athletic trainers?
a. Labor demand will decrease, resulting in lower wages and fewer hours of employment for the
trainers.
b. Labor demand will increase, resulting in higher wages and more hours of employment for the
trainers.
c. Labor supply will decrease, resulting in higher wages and fewer hours of employment for the
trainers.
d. Labor supply will increase, resulting in lower wages and more hours of employment for the trainers.
ANSWER: c

131. Inputs are also called:

a. services.
b. products.
c. means to output.
d. factors of production.
ANSWER: d

132. Supermarkets need to hire fewer cashiers, due to self-checkout counters. Which graph shows what happens
to the labor market for cashiers?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: b

133. New startups allow professionals to work from home and this makes working with startups more attractive.
Which graph shows what happens to the labor market for professionals who want to work with startups?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: d

134. Demand for in-home health workers is increasing as the baby boomers are retiring. Which graph shows
what happens to the labor market for in-home health workers?

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a. Graph A
b. Graph B
c. Graph C
d. Graph D
ANSWER: a

Essay

135. Rasa completed her credentials as a speech therapist. She is entering the labor market for speech therapists
along with 500 other licensed speech therapists in her state. How will the entry of 501 new speech therapists
affect the labor market for speech therapists in her state?
ANSWER: Rasa and the other new speech therapists are entering the labor market as additional suppliers of
labor because they are selling their services as speech therapists. This will increase the market
supply of labor. An increase in labor supply will cause the equilibrium price (the wage for speech
therapists) to decrease and the equilibrium quantity (the hours of work available for speech
therapists) to increase.

136. Use the interdependence principle to explain how self-checkout lines — where customers scan the
products they buy themselves-- at Sam's Club reduces the need for workers at cash registers and creates jobs in
other industries.
ANSWER: Sam's Club will adopt the self-check-out lines if this equipment allows Sam's to meet customer
needs at a lower cost. If Sam's has lower costs, it can pass on the savings to its customers. This
means customer income can buy more, either at Sam's Club or at other places. If more goods and
services are purchased, then more workers will be needed to produce the extra things consumers are
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buying.

137. Why will all employers pay the market wage in a perfectly competitive labor market?
ANSWER: In a perfectly competitive labor market, many companies need workers and many workers are
available who have the desired skills. In this situation, the employers end up paying the market
equilibrium wage. If they try to pay less, the workers will go to the other companies. They have no
incentive to pay more because plenty of workers with the needed skills are available at the market
wage.

138. How does an increase in the use of technology that increases worker productivity impact the demand for
labor? Include the chain of events in your description.
ANSWER: A company implements an advance in technology that increases worker productivity, which causes
each worker's marginal product to rise. The rise in marginal product increases the marginal revenue
product of labor because it equals marginal product multiplied by product price. When the marginal
revenue product of labor rises, the company finds it profitable to hire more workers until marginal
revenue product equals wage.

139. Why does the marginal revenue product of a worker rise as the demand for the product produced by the
worker rises?
ANSWER: The marginal revenue product of a worker is equal to the worker's marginal product multiplied by
the product price. As the demand for the product rises, the equilibrium price of the product will
increase, leading to an increase in the worker's marginal revenue product even though the worker's
productivity has not changed.

140. What costs and benefits should be considered in choosing an occupation?

ANSWER: There are multiple costs and benefits that should be taken into account when choosing an
occupation. It's important you find a job that you love, that interests you and you are good at it. The
benefits the employer offers like health and vacation should be considered, as well as the future
prospects for growth in the occupation.

The costs to be considered include what your chances are of success in an occupation. The volatility
in compensation and the hours you might need to work.

141. What is the difference between the intensive margin and the extensive margin with regard to labor supply?
What principles are the basis for the intensive margin and extensive margin labor supply decisions.
ANSWER: When people decide about supplying their labor, they decide whether to work or not, and if they
decide to work, they must decide how many hours to work. The decision about whether to work is
an either/or decision that is considered to be the extensive margin decision. This decision is based
on an overall cost-benefit analysis. The decision about how many hours to work is a marginal
decision because hours can be added one at a time. This is considered an intensive margin decision
and is based on the rational rule for workers, which suggests to work one more hour as long as the
wage is at least as large as another hour of leisure.

142. Increase in the use of e-books has reduced the demand for physical books. How has this impacted the labor
market for bookstore managers? Explain the change in the market.
ANSWER: A reduction in the demand for physical books means that there will be reduced use of bookstores
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and reduced demand for bookstore managers. As the demand for bookstore managers decreases, the
equilibrium price for them (their wage) would decrease, and the equilibrium quantity (the number of
hours of bookstore manager time) would decrease. There will be fewer opportunities to work as
bookstore managers.

143. Forecast what will occur in the labor market for dental hygienists if a powerful new mouthwash rinse is
developed that reduces the need for professional teeth cleanings. Describe how you arrive at the forecast.
ANSWER: If a powerful new mouthwash rinse is developed that reduces the need for professional teeth
cleanings, then the demand for professional teeth cleanings will decrease. When the demand for a
product decreases, the demand for the inputs used to produce the product will also decrease. The
labor market demand for dental hygienists will decrease and the curve will shift to the left. This will
result in a decrease in the equilibrium wage for hygienists and a decrease in the quantity of hours of
work available to hygienists.

144. Summarize the three-step recipe for forecasting changes in wages and employment opportunities in a labor
market.
ANSWER: Market forces of supply and demand interact to reach equilibrium in labor markets. The equilibrium
price is the wage. The equilibrium quantity relates to the number of hours of work or the number of
jobs. When either the demand curve or the supply curve shift (or both shift), the equilibrium wage
and quantity will change. There is a three-step process for analyzing this: first, identify whether the
demand curve or the supply curve is shifting (or both are shifting). Second, identify whether the
shift in the demand curve or the supply curve is an increase or a decrease (or both are increases or
decreases). Third, see how much the equilibrium price (wage) and quantity (number of work hours
or jobs) change.

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Multiple Choice

1. Human capital is:

a. capital equipment made by hand.
b. accumulated knowledge and skills that make a worker more productive.
c. capital equipment that must be operated by humans.
d. human labor used in place of machines.
ANSWER: b

2. The accumulated knowledge and skills that make a worker more productive are known as:
a. human capital.
b. labor enhancement.
c. labor factoring.
d. efficiency investment.
ANSWER: a

3. To accumulate human capital, you can:

a. buy shares of human capital in a stock market.
b. buy capital equipment and hire workers to operate it.
c. obtain it through education, training, and experience.
d. save money by using your own labor to do things for yourself rather than purchasing services.
ANSWER: c

4. Education level positively correlates with:

a. reliance on transfer payments.
b. custodial work.
c. job loss.
d. average annual income.
ANSWER: d

5. Higher education tends to lead to higher salaries because education:

a. increases productivity.
b. enables graduates to repay loans.
c. confers on one a higher social status.
d. requires time to acquire.
ANSWER: a

6. When education functions as a signal to an employer, it:

a. indicates a certain level of training.
b. conveys information about a job applicant's intelligence and tenacity.
c. matches job applicants to employer needs.
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d. overstates ability.
ANSWER: b

7. When education level is used to convey information to an employer, it serves as a:

a. gateway.
b. capital complement.
c. signal.
d. radio.
ANSWER: c

8. _____ credibly conveys information that is hard for someone else to verify.
a. A proxy
b. A monitor
c. An opportunity cost
d. A signal
ANSWER: d

9. A signal is:
a. an action taken to credibly convey information that is hard for someone else to verify.
b. advance notice of an action that will be taken in the future.
c. a price tag.
d. an indicator of the equilibrium wage and quantity in a market.
ANSWER: a

10. When your education level is used to signal an employer, it conveys that you:
a. studied a field of knowledge.
b. can work hard and persistently to complete a large task.
c. value working at that company.
d. are in debt and need a job.
ANSWER: b

11. Employers use educational background and degrees obtained to indicate an applicant's:
a. salary expectations and productivity.
b. amount of debt.
c. productivity and certain traits.
d. debt level and salary expectations.
ANSWER: c

12. A higher wage paid to encourage greater worker productivity is:

a. an incentive wage.
b. a motivational factor system.
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c. a factor incentive system.

d. an efficiency wage.
ANSWER: d

13. An efficiency wage is a:

a. higher wage paid to encourage greater worker productivity.
b. higher wage paid to reward workers who show greater productivity.
c. system of tying wage rates to overall factory efficiency rather than personal productivity.
d. wage that rises when workers invest in their human capital.
ANSWER: a

14. An efficiency wage is NOT _____ but rather _____.

a. a variable wage; a reward
b. a reward; an incentive
c. an incentive; a fixed wage
d. a fixed wage; a variable wage
ANSWER: b

15. The logic of efficiency wages is that if an employer pays a high wage:
a. workers will invest in additional skill development.
b. the firm thereby shares profits with workers.
c. an employee will be motivated to work hard.
d. low-skilled workers will be unlikely to apply for work with that employer.
ANSWER: c

16. Which of the following is NOT part of the rationale for efficiency wages?
a. An efficiency wage encourages workers to work harder to avoid risking losing their jobs.
b. An efficiency wage helps workers feel valued.
c. An efficiency wage raises the gain to workers for working more.
d. An efficiency wage rewards worker productivity with higher pay.
ANSWER: d

17. An efficiency wage improves efficiency when:

a. the increase in worker effort and reduced turnover cover the cost of the higher wage.
b. it is structured so that only the most productive workers receive a higher wage.
c. capital costs are reduced enough to cover wage costs.
d. improved technology accompanies the worker training.
ANSWER: a

18. When it is hard to monitor worker productivity, employers often pay:

a. a lower wage.
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b. a higher wage.
c. a random wage.
d. a wage based on worker qualifications.
ANSWER: b

19. Employers often pay a higher wage:

a. when it is easy to verify worker qualifications.
b. in a lower-skilled labor market.
c. when it is hard to monitor worker productivity.
d. in a labor market with excess workers.
ANSWER: c

20. Forbes magazine (October 16, 2016) reports that Walmart pays its workers an efficiency wage. This means
that Walmart:
a. rewards workers for being more productive than coworkers.
b. pays bonuses when overall productivity rises.
c. pays higher wages when workers generate new ideas that improve productivity.
d. pays above the going rate for workers in similar jobs at other companies.
ANSWER: d

21. Which of the following principles does NOT support the notion of efficiency wages?
a. the diminishing marginal utility principle
b. the marginal principle
c. the opportunity cost principle
d. the cost-benefit principle
ANSWER: a

22. What impact has technology had on the difference between the income of the best engineers and that of
good engineers?
a. It has had little impact on the gap in income.
b. It has increased the gap in income significantly.
c. It has decreased some of the gap in income.
d. It has eliminated the large gap that once existed.
ANSWER: b

23. When technology enables the best service provider in a field to supply a huge number of buyers instead of
being limited to a small market, the larger market may become:
a. highly competitive.
b. characterized by losses on average.
c. dominated by one "superstar" provider.
d. an efficiency market.
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ANSWER: c

24. The average income of actresses may not be indicative of an aspiring actress's expected earnings because:
a. there is a very narrow range of incomes among actresses.
b. only a few actresses have much talent.
c. the few actresses who do not succeed skew the average income much lower than would be expected
of most actresses.
d. a few superstars with extremely high earnings may skew the average income much higher than all
but a few can hope to earn.
ANSWER: d

25. Star actors in live theater typically do not earn as much as star actors in movies. A key reason for this is that:
a. technology allows many more people to view movies than plays.
b. plays do not require as much acting skill as movies.
c. there are more substitutes for movie actors than for theater actors.
d. government regulations set the pay scales in each of these industries.
ANSWER: a

26. Which of the following is a valid explanation of why a star movie actor earns many times more than a star
Broadway actor?
a. Government regulations specify how much each type of actor earns.
b. In one evening, many more people can view a movie than can see a Broadway play.
c. There is discrimination against Broadway actors but not against movie actors.
d. Broadway actors are far less skilled than movie actors.
ANSWER: b

27. A major factor behind the exceptionally high salaries of superstars is:
a. a huge market supply, owing to the star status of such individuals.
b. limited demand, which results in a very high equilibrium price.
c. technological advance, which has expanded the market for superstar talent.
d. that stars receive large compensating differentials.
ANSWER: c

28. A difference in wages required to offset the desirable or undesirable aspects of a job is:
a. a workplace offset.
b. a stress adjustment.
c. an offset adjustment.
d. a compensating differential.
ANSWER: d

29. When earnings reflect compensating differentials, workers with _____ human capital earn _____ salaries
because _____.
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a. similar; different; their jobs differ in things like risk or enjoyment

b. different; the same; they show different work effort
c. similar; the same; adjustments are made to equalize the salaries
d. different; different; salaries are based on individual productivity
ANSWER: a

30. Compensating differentials lead to:

a. equal salaries for equal levels of human capital.
b. higher salaries for more unpleasant jobs.
c. lower salaries for more unpleasant jobs.
d. incomes based solely on productivity.
ANSWER: b

31. Workers on the night shift at a factory earn more per hour than workers on the day shift, although their
human capital and productivity are the same. This is an example of:
a. discrimination based on time preferences.
b. irrational decision making by an employer.
c. a compensating differential.
d. an efficiency wage.
ANSWER: c

32. Which of the following is an example of a labor market characterized by compensating differentials?
a. A nursery school teacher earns less than a university professor.
b. Two real estate agents paid on commission earn different salaries due to different listings and sales
volumes.
c. Adjustments are made to the salaries of teachers in different states to equalize the purchasing power
of income.
d. Outside window washers of skyscrapers earn higher salaries than outside window washers of single
family homes.
ANSWER: d

33. When would you see the greatest gain if there is a compensating differential built into your salary?
a. The differential is for a negative risk that you care about more than most people do.
b. The differential is for a large negative risk that you don't care about as much as most people do.
c. The differential is for a positive job aspect that you don't care about as much as most people do.
d. The differential is for a slightly positive job aspect that you care about more than most people do.
ANSWER: b

34. When would you see the greatest gain if a compensating differential is built into your salary?
a. The differential is for a large negative risk that you care about more than most people do.
b. The differential is for a slightly negative risk that you don't care about as much as most people do.

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c. The differential is for a large positive job aspect that you care about more than most people do.
d. The differential is for a slightly positive job aspect that you don't care about as much as most people
do.
ANSWER: c

35. Kaila wants her employer to pay her 20% more for making night deliveries in a high-crime neighborhood
than the day delivery people receive. Most of the delivery people are willing to make night deliveries in the
neighborhood for only a 10% differential. Kaila is seeking:
a. a compensating differential based on her individual concerns about the risks.
b. a compensating differential because others are undervaluing her concerns.
c. less than a compensating differential because she is asking for more than others are.
d. more than a compensating differential because she has greater concerns than most workers.
ANSWER: d

36. When a compensating differential is paid, then:

a. all workers who do the same job for the employer receive the same differential.
b. jobs with negative attributes pay less.
c. jobs with positive attributes pay more.
d. each worker individually negotiates a differential based on personal preferences and dislikes.
ANSWER: a

37. A compensating differential is an:

a. adjustment to wages that compensates for lost work due to the use of robotics.
b. adjustment to work hours that allows low-wage employees to earn more.
c. difference in wages that offsets the desirable or undesirable aspects of a job.
d. difference in wages that adjusts for differences in worker productivity.
ANSWER: c

38. How is the labor market for estheticians affected if the government requires estheticians to have licenses to
work in the field?
a. Market demand decreases, leading to a lower equilibrium wage and a lower quantity of labor.
b. Market demand increases, leading to a higher equilibrium wage and a higher quantity of labor.
c. Market supply increases, leading to a lower equilibrium wage and a higher quantity of labor.
d. Market supply decreases, leading to a higher equilibrium wage and a lower quantity of labor.
ANSWER: d

39. When the government requires that a person have a license to work in a particular occupation, then in the
labor market for that occupation:
a. supply decreases.
b. supply increases.
c. demand decreases.
d. demand increases.
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ANSWER: a

40. What happens in the labor market for public school teachers when a state government raises the minimum
educational standards for certification as a public school teacher?
a. The demand for teachers decreases, resulting in a lower wage and lower quantity of labor.
b. The supply of teachers decreases, resulting in a higher wage and lower quantity of labor.
c. The demand for teachers increases, resulting in a higher wage and higher quantity of labor.
d. The supply of teachers increases, resulting in a lower wage and higher quantity of labor.
ANSWER: b

41. The government increases the training requirements to obtain an electrician's license. What impact will this
have in the labor market for electricians?
a. The demand for electricians will decrease, resulting in a lower wage and lower quantity of labor.
b. The demand for electricians will increase, resulting in a higher wage and higher quantity of labor.
c. The supply of electricians will decrease, resulting in a higher wage and lower quantity of labor.
d. The supply of electricians will increase, resulting in a lower wage and higher quantity of labor.
ANSWER: c

42. What will happen in the labor market if the government requires that employers pay employees a higher
wage for overtime hours than for regular work hours?
a. Labor demand will decrease because workers will cut back on work effort.
b. More workers will demand jobs, raising labor demand.
c. With extra pay, workers will not need extra hours.
d. Workers will be more willing to work additional hours.
ANSWER: d

43. What will happen in the labor market for commercial truck drivers if the government raises the requirements
needed to obtain a commercial driver's license?
a. The supply of truck drivers will decrease, resulting in a higher wage and lower quantity of labor.
b. The supply of truck drivers will increase, resulting in a lower wage and higher quantity of labor.
c. The demand for truck drivers will decrease, resulting in a lower wage and lower quantity of labor.
d. The demand for truck drivers will increase, resulting in a higher wage and higher quantity of labor.
ANSWER: a

44. What will happen in the labor market for aestheticians if the government deregulates the industry and no
longer requires individuals to obtain a license to work as aestheticians?
a. The supply of workers will decrease, resulting in a higher wage and lower quantity of labor.
b. The supply of workers will increase, resulting in a lower wage and higher quantity of labor.
c. The demand for workers will decrease, resulting in a lower wage and lower quantity of labor.
d. The demand for workers will increase, resulting in a higher wage and higher quantity of labor.
ANSWER: b

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45. Economic theory implies that when a minimum wage is set above the equilibrium wage, _____ will result.
a. lower wages
b. a shortage
c. unemployment
d. more jobs
ANSWER: c

46. Economic theory implies that if a minimum wage is set above the equilibrium wage, there will _____
workers, and _____ will result.
a. not be enough; overemployment
b. be too many; underemployment
c. not be enough; unemployment
d. be too many; unemployment
ANSWER: d

47. Studies of the minimum wage indicate that minimum wage laws _____ employment opportunities for low-
skilled workers, but there is less agreement regarding _____.
a. reduce; the amount of the reduction
b. reduce; whether wages rise or fall
c. increase; the amount of the increase
d. increase; whether wages rise or fall
ANSWER: a

48. Arguments in favor of minimum wage laws do NOT include that they:
a. reduce poverty.
b. increase unemployment.
c. compensate for a lack of bargaining power among low-skilled workers.
d. provide higher wages to those willing to work.
ANSWER: b

49. The extent to which minimum wage laws cause unemployment depends on how far _____ equilibrium the
wage is set and on _____.
a. above; whether the slope of the labor demand curve is positive
b. below; the degree of worker commitment
c. above; the elasticity of labor demand
d. below; the number of workers in the market
ANSWER: c

50. The more _____ is the demand for low-skilled workers, the _____ is the impact of minimum wage laws on
the number of jobs available for low-skilled workers.
a. elastic; more constant
b. inelastic; more variable
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c. elastic; smaller
d. inelastic; smaller
ANSWER: d

51. Unions are organizations that:

a. jointly represent a group of workers in negotiating with employers.
b. enable groups of workers to start their own companies.
c. represent employers in negotiating with employees.
d. local governments sponsor to set work safety standards for employers.
ANSWER: a

52. Organizations that jointly represent a group of workers in negotiating with employers are called:
a. clubs.
b. unions.
c. cartels.
d. sponsors.
ANSWER: b

53. Unions try to _____ union members by _____.

a. ensure more jobs for; reducing wages
b. ensure more jobs for; raising wages
c. raise wages of; shifting the labor supply curve to the left
d. raise wages of; shifting the labor supply curve to the right
ANSWER: c

54. How does the pay of unionized workers compare with that of nonunionized workers in similar jobs, on
average?
a. The average incomes are the same, but unionized workers' incomes vary far less.
b. Unionized workers earn the same.
c. Unionized workers earn less.
d. Unionized workers earn more.
ANSWER: d

55. Unions both _____ and _____.

a. boost company productivity; increase the wages of union members
b. alter regulations; reduce the wages of union members
c. increase the wages of union members; reduce company costs
d. reduce company productivity; reduce company costs
ANSWER: a

56. What changes in a labor market graph if the workers of a company form a union?
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a. The labor market supply curve shifts to the right.

b. The labor market supply curve shifts to the left.
c. The labor market demand curve shifts to the right.
d. The labor market demand curve shifts to the left.
ANSWER: b

57. If workers in a labor market form a union, wages should _____, and the quantity of labor employed should
_____.
a. decrease; decrease
b. increase; increase
c. increase; decrease
d. increase; increase
ANSWER: c

58. How might the formation of a union impact the productivity of a company?
a. Unions reduce productivity by raising costs.
b. Unions reduce productivity by raising worker confidence and morale.
c. Unions increase productivity by ensuring that there are more workers on the payroll.
d. Unions increase productivity by improving communication between workers and management.
ANSWER: d

59. When an employer negotiates with an effective union, the wages of union members _____, and the number
of jobs _____.
a. increase; decreases
b. increase; increases
c. decrease; decreases
d. decrease; increases
ANSWER: a

60. Monopsony power exists in a labor market when there:

a. is a major seller of labor who can exert influence to sell at higher prices.
b. is a major buyer of labor who can exert influence to pay lower prices.
c. are many sellers of labor who each have little power but can still impact price.
d. are many buyers of labor who each have little power but can still impact price.
ANSWER: b

61. A business using its bargaining power as a major buyer of labor to pay lower prices, including lower wages,
is exerting _____ power.
a. compensating
b. union
c. monopsony
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d. monopoly
ANSWER: c

62. When an employer exerts monopsony power:

a. product prices will be higher.
b. product prices will be lower.
c. wages will be higher.
d. wages will be lower.
ANSWER: d

63. The _____ wage resulting from an employer with monopsony power can be offset through _____.
a. low; minimum wage laws
b. low; discrimination
c. high; minimum wage laws
d. high; discrimination
ANSWER: a

64. When a minimum wage is imposed in a monopsony labor market, the _____ may not reduce the _____.
a. minimum wage; number of employers
b. minimum wage; number of jobs
c. number of employers; minimum wage
d. number of employers; product price
ANSWER: b

65. In a monopoly, there is one _____; in a monopsony, there is one _____.

a. unit of product; price
b. price; unit of product
c. seller; buyer
d. buyer; seller
ANSWER: c

66. If one company provides 70% of the jobs in a town, the company could exert _____ power in its labor
market.
a. differential
b. compensating
c. monopoly
d. monopsony
ANSWER: d

67. Why can a company with monopsony power in its labor market succeed in paying low wages?
a. Workers don't have other employment options.

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b. The employer doesn't have other options for employees.

c. There is a very limited supply of workers.
d. It must charge a low product price, so it cannot afford to pay a high wage.
ANSWER: a

68. Monopsony power is held by a _____, and monopoly power is held by a _____.
a. seller; buyer
b. buyer; seller
c. producer; regulator
d. regulator; producer
ANSWER: b

69. In a monopsony labor market:

a. employees bargain with market power through a union.
b. employees have an advantage, due to their human capital.
c. the employer pays a low wage.
d. the employer uses an attractive benefit package to attract good employees.
ANSWER: c

70. Treating people differently based on characteristics such as gender, race, ethnicity, sexual orientation,
religion, disability, social class, or other factors is:
a. union bias.
b. monopsony capital.
c. compensating differentials.
d. discrimination.
ANSWER: d

71. Which of the following is NOT true regarding discrimination in labor markets?
a. Any differences in wages between members of different racial or age groups is due to discrimination.
b. Groups may differ in wages, due to differences in human capital or the types of jobs held.
c. Differences in effort or bargaining power across groups can lead to differences in wages across
groups.
d. Discrimination may result in some workers being underpaid.
ANSWER: a

72. Unobserved influences on wages do NOT include:

a. ability.
b. education level.
c. effort.
d. bargaining power.
ANSWER: b
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73. If there is discrimination against people of a particular race in labor markets, and workers of that race
constitute the majority of workers in a particular occupation, all workers in that occupation may end up:
a. underworked.
b. overworked.
c. underpaid.
d. overpaid.
ANSWER: c

74. Which of the following statements is true regarding discrimination in labor markets?
a. When discrimination occurs, all workers are treated equally.
b. If two workers in the same job have different salaries, one is a victim of discrimination.
c. If average income differs across groups of workers, there is discrimination.
d. Discrimination accounts for only part of the differences in wages across groups of workers.
ANSWER: d

75. There is evidence that, despite antidiscrimination laws, discrimination _____ in labor markets.
a. impacts wages
b. exists but has no impact
c. benefits groups that are discriminated against
d. accounts for all differences in wages across groups of workers
ANSWER: a

76. Discrimination refers to:

a. the identification of differences among people that could affect their performance and preferences.
b. the identification of influences on people that lead them to adopt different attitudes and beliefs.
c. treating people differently based on such characteristics as gender, race, ethnicity, sexual orientation,
religion, disability, social class, or other factors.
d. treating people differently based on their productivity.
ANSWER: c

77. Which of the following factors would not lead to differences in average wages across racial groups?
a. the average human capital level among members of each racial group
b. types of jobs held by people in each racial group
c. the average family size in each racial group
d. the amount of bargaining power held by workers of each racial group
ANSWER: c

78. The three sources of discrimination do NOT include:

a. statistical discrimination.
b. implicit bias.

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c. prejudice.
d. malevolent bias.
ANSWER: d

79. Prejudice is:

a. a preconceived bias, not based on reason or experience, against a group.
b. the use of observations about the average characteristics of a group to make inferences about an
individual member of that group.
c. judgments shaped by the unconscious attribution of particular qualities to specific groups.
d. a feeling of inferiority, believing that everyone else is better and more skilled.
ANSWER: a

80. A preconceived bias against a group that's not based on reason or experience is known as:
a. implicit bias.
b. prejudice.
c. statistical discrimination.
d. compensatory bias.
ANSWER: b

81. A judgment shaped by the unconscious attribution of particular qualities to specific groups is known as:
a. statistical discrimination.
b. compensatory bias.
c. implicit bias.
d. prejudice.
ANSWER: c

82. Statistical discrimination is:

a. the use of observations about the average characteristics of a group to make inferences about an
individual member of the group.
b. a feeling of inferiority arising from membership in a small group.
c. a preconceived bias, not based on reason or experience, against a group.
d. judgments shaped by the unconscious attribution of particular qualities to specific groups.
ANSWER: a

83. When an employer makes decisions based on statistical discrimination, it is:

a. relying on a preconceived bias against a group that's not based on reason or experience.
b. making judgments shaped by the unconscious attribution of particular qualities to specific groups.
c. experiencing a feeling of inferiority arising from membership in a small group.
d. using observations about the average characteristics of a group to make inferences about an
individual.
ANSWER: d
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84. Using observations about the average characteristics of a group to make inferences about an individual
member of the group is known as:
a. differential bias.
b. statistical discrimination.
c. prejudice.
d. implicit bias.
ANSWER: b

85. An employer who discriminates in hiring based on prejudice is likely to have higher costs than necessary
because:
a. all inputs will have higher prices as others shun the party who discriminates.
b. the employer pays a higher wage to the group of workers discriminated against.
c. more productive workers may be forgone in order to hire less productive workers who have preferred
characteristics.
d. less productive workers may be forgone in order to hire more productive workers who have preferred
characteristics.
ANSWER: c

86. Discrimination based on prejudice can sometimes lead to:

a. expanded employment opportunities.
b. higher average wages.
c. compensatory differentials.
d. segregation.
ANSWER: d

87. An employer who discriminates in hiring based on prejudice may end up _____.
a. paying a higher wage for a less productive employee
b. paying a lower wage for a more productive employee
c. hiring more workers than needed at a lower wage
d. hiring fewer workers than needed at a higher wage
ANSWER: a

88. As an employer, you can minimize discrimination based on implicit bias when hiring employees if you base
your hiring decisions on:
a. gut feelings about the likely productivity of individual job applicants.
b. carefully structured assessments of individual candidates rather than gut feelings.
c. the track records of similar applicants in the past rather than full assessments of individual applicants.
d. a conscious effort to hire members of a group that is discriminated against.
ANSWER: b

89. Which of the following is an example of statistical discrimination?

a. No companies will hire Marcella because they do not want to hire women.
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b. Arturo is unaware that he avoids hiring Asians.

c. An employer relies on stereotypes in making hiring decisions.
d. Ingrid refuses to hire people who do not have at least five years of experience in their previous jobs.
ANSWER: c

90. Sources of discrimination do NOT include:

a. employers.
b. co-workers.
c. customers.
d. job applicants.
ANSWER: d

91. There is evidence that differences in wages may stem from differences in:
a. labor demand, product preferences, discrimination, and family support.
b. human capital, regulation, environmental conditions, and theory.
c. product preferences, population, family support, and banking systems.
d. labor demand, labor supply, institutions, and discrimination.
ANSWER: d

92. Skills that are useful to many employers are classified as _____ skills.
a. general
b. low-level
c. job-specific
d. rudimentary
ANSWER: a

93. In personnel terminology, "general skills" refers to skills that:

a. are used at the military rank of general.
b. are useful to many employers.
c. all employees of a company acquire during orientation training.
d. are specific to an occupation.
ANSWER: b

94. Skills only useful in a job with one employer are classified as _____ skills.
a. general
b. high-level
c. job-specific
d. artisan
ANSWER: c

95. A risk of investing in the general skills of workers at your firm is that your workers:
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a. will be more productive after training.

b. may not actually gain the skills taught to them.
c. may not apply the skills in their work.
d. will be better prepared for jobs at many other firms.
ANSWER: d

96. Callie's firm uses a proprietary and complicated production process to ensure product quality. Her workers
are carefully trained in this process as soon as they are hired. Callie thereby:
a. prevents employees from leaving the firm.
b. raises production costs.
c. invests in job-specific skills.
d. ensures that all workers have the needed general skills.
ANSWER: c

97. Chandra owns a paddleboard company. If she invests in job-specific skills for her employees, she _____ and
_____.
a. hires only those who already have the needed skills; pays them a high salary to foster loyalty
b. hires separately for each labor task; focuses her hiring on specific skills needed
c. trains workers as needed; thereby ensures that all have general skills
d. provides training internally; does not impart skills that her workers could use to find jobs elsewhere
ANSWER: d

98. Investing in the _____ skills of your workers makes them more marketable, and investing in their _____
skills enables your firm to become more productive.
a. general; job-specific
b. job-specific; general
c. job; higher-level
d. higher-level; job
ANSWER: a

99. Pay-for-performance:
a. creates incentives for employers to focus on nonwork tasks.
b. links the incomes your workers earn to their performance.
c. links an employer's goals to the goals of its customers.
d. gets customers to buy more in exchange for discounts.
ANSWER: b

100. Linking your workers' earnings to their performance is called:

a. productivity bracketing.
b. differential performance.
c. pay-for-performance.
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d. incentivizing profit.
ANSWER: c

101. Which of the following is NOT an example of compensating workers through a pay-for-performance
program?
a. piece rates
b. bonuses
c. commissions
d. weekly rates
ANSWER: d

102. The manager of a research project finds that the productivity of survey data collectors increases
significantly when their pay is changed from an hourly rate to a fee per completed questionnaire. This is an
example of a _____ incentive.
a. pay-for-performance
b. job-specific
c. common-motive
d. joint complementary
ANSWER: a

103. The Tangerine Hair Salon classifies its stylists in terms of four levels: protégé, studio, senior, and master.
At each level, customers pay different prices, and the stylists earn different wages. Stylists must meet particular
criteria to advance from one level to the next level. This is an example of:
a. pay-for-performance based on piece rate.
b. pay-for-performance based on promotion.
c. job-specific incentives based on human capital.
d. job-specific incentives based on promotion.
ANSWER: b

104. Which of the following is NOT a problem that can arise from motivating workers through incentives?
a. The rewarded action may not further all the goals of the company.
b. Workers may have an incentive to cheat to appear productive.
c. Most workers are not motivated by incentives.
d. "Stick" motivations may cause some good workers to leave the company to avoid the risk of penalty.
ANSWER: c

105. Chau owns a small garment factory. What two things happen when she changes her pay structure from an
hourly rate to a piece rate?
a. Worker productivity varies more, and her costs rise.
b. Worker productivity varies more, and she has a harder time hiring workers.
c. Worker productivity rises, and her most productive workers quit.
d. Worker productivity rises, and the quality of the finished garments decreases.
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ANSWER: d

106. Extrinsic motivation is the:

a. desire to do something for its external rewards.
b. desire to do something for the enjoyment of the activity itself.
c. incentive to improve and be better at a task than a set standard.
d. incentive to improve to exceed another person in a competitive sense.
ANSWER: a

107. The desire to do something for its external rewards is known as:
a. exterior stimulus.
b. extrinsic motivation.
c. outside impetus.
d. nonlocal stimulus.
ANSWER: b

108. Intrinsic motivation is the:

a. inner drive to exceed the achievement of others.
b. motivation to use inside information to succeed.
c. desire to do something for the enjoyment of the activity itself.
d. desire to meet imposed expectations for praise.
ANSWER: c

109. The desire to do something for the enjoyment of the activity itself is known as:
a. pleasure-seeking.
b. passive self-actualization.
c. internal maximization.
d. intrinsic motivation.
ANSWER: d

110. A school principal strives to motivate teachers to work hard and be effective by stressing to them the
satisfaction they can gain from knowing that they can have an impact for good on the next generation. The
principal is using _____ to get teachers to provide students with a high-quality education.
a. intrinsic motivation
b. extrinsic motivation
c. carrots and sticks
d. rewarding good decisions
ANSWER: a

111. A corporate culture that makes workers feel that their treatment is _____ may lead them to slack off.
a. reciprocal

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b. unfair
c. valued
d. transparent
ANSWER: b

112. Employees will be motivated to work hard and try to help their employer succeed if the company:
a. uses carrots and sticks.
b. focuses on extrinsic rewards.
c. lives up to a core set of ideals that workers identify with.
d. provides compensating differentials.
ANSWER: c

113. The owner of a small biotechnology company motivates employees _____ by reminding them of the
satisfaction they will gain from helping to reduce hunger through hybrid crops with higher yields that they are
developing. The owner motivates them _____ by providing a bonus to each research team when patents are
gained for new developments.
a. financially; differentially
b. differentially; financially
c. extrinsically; intrinsically
d. intrinsically; extrinsically
ANSWER: d

114. A free way to appeal to workers' intrinsic motivation is to _____ by _____.

a. help them feel valued; praising them
b. provide bonuses; establishing a reward system
c. stress reciprocity; rewarding them when they contribute significantly to the company's bottom line
d. invest in workers; paying for training
ANSWER: a

115. Workers consider a company's _____ and not just the _____.
a. annual salary; entire compensation package
b. entire compensation package; annual salary
c. disincentives; incentives
d. incentives; disincentives
ANSWER: b

116. Which of the following is NOT a reason that it is advantageous for employers to offer benefits rather than
extra salary?
a. Employers can buy in bulk, often at lower prices than employees can.
b. Employers can offer complements to hard work.
c. Employers can offer substitutes for hard work.

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d. Some compensation packages provide tax benefits.

ANSWER: c

117. In deciding what benefits to offer employees, the manager of a company should consider that complements
to hard work can _____ the company and that substitutes for hard work can _____ the company.
a. reduce profits for; cost
b. cost; reduce profits for
c. hurt; help
d. help; hurt
ANSWER: d

118. One university offers its employees the opportunity to purchase cell phones and cellular service at
discounted prices through the university purchasing department. The university can offer this benefit to
employees easily because:
a. the university has greater negotiating power than individual employees have with a cellular service
provider.
b. employees' use of cell phones is a substitute for work, which helps the university function better.
c. cell phone ownership provides employees with intrinsic motivation.
d. cellular service equips employees with the right human capital.
ANSWER: a

119. Which of the following employee benefits would you want to avoid as an employer because it is a
substitute for rather than a complement of hard work?
a. coffee at the workplace
b. lunch vouchers for restaurants near the workplace
c. laptop computers
d. flu shots
ANSWER: b

120. Which of the following employee benefits would you want to avoid as an employer because it is a
substitute for rather than a complement of employees working productively?
a. laptop computers
b. coffee
c. a foosball table in the break room
d. preventive health care
ANSWER: c

121. Which of the following is likely to attract the most productive workers to a company?
a. 20 days of paid vacation per year
b. health insurance
c. a fun work environment
d. pay based on a piece rate
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ANSWER: d

122. Which of the following employee benefits or policies would NOT attract good workers?
a. an employee lounge
b. preventive health care
c. piece rate pay
d. training
ANSWER: a

123. Which of the following policies or benefits would be particularly effective in attracting highly productive
employees?
a. gym memberships
b. merit-based pay raises
c. partial employer match to retirement savings
d. discounts on cell phone service plans
ANSWER: b

124. Which of the following personnel policies would help your company's hiring manager attract the best
workers?
a. Provide benefits that are a substitute for work.
b. Provide general skills training.
c. Comply with regulations.
d. Reward productivity.
ANSWER: d

125. How can a company's hiring manager attract workers who are motivated to advance in their field?
a. Offer gym memberships.
b. Provide a retirement savings plan.
c. Avoid discrimination.
d. Provide training.
ANSWER: d

126. Company owners want their company to be known as a family-friendly place to work to attract employees
who are stable and require a steady income. Which of the following personnel policies would be most
conducive to achieving this goal?
a. flexibility to work from home
b. gym membership
c. retirement savings
d. training
ANSWER: a

127. Which of the following is NOT among the main factors affecting wages?
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a. discrimination
b. regulation and institutional factors
c. labor demand
d. complements
ANSWER: d

Essay

128. Explain the role of education in labor markets.

ANSWER: Education plays two key roles in labor markets. First, it builds human capital in individuals, making
them more productive. Beyond general education knowledge, studying in a particular field provides
some expertise or advanced skills that may be highly desirable to particular employers. Second,
education level is used as a signal of characteristics such as persistence and effort because these
characteristics are needed to complete a course of study.

129. Explain the logic of efficiency wages.

ANSWER: An efficiency wage is paid when an employer pays a wage that is higher than the going rate for an
occupation in the hope that it provides workers with an incentive to work hard and be more
productive. Workers would be attracted to the employer who pays a higher-than-normal wage. The
larger labor supply of applicants would allow the firm to choose employees who may have better
credentials or a higher likelihood of being productive. The higher wage gives them an incentive to
want to keep the job rather than risk losing it and needing to work for less pay elsewhere. This gives
them an incentive to work hard and be productive. Evidence shows that this indeed occurs in many
cases.

130. Scarlett Johansson was the world's highest paid actress in 2018, earning $40.5 million (according to Forbes
magazine). The average actor/actress salary in that year was $50,175 plus bonuses, profit sharing, and
commissions. What allows Scarlett Johansson to earn over 380 times the average earnings of others in her
profession?
ANSWER: There have been professional actors and actresses throughout history, and some have been highly
compensated. However, it is only in the past century that superstar actresses and actors have existed,
earning many times the average salary. The key development in the market for acting services that
has contributed to superstar status and income is the advancement of technology (particularly film)
that has allowed an actress to provide entertainment to a much wider audience than can be housed in
a single theater for a live performance. Buyers of entertainment do not need to vie for a very limited
number of tickets for a live performance. All customers who can pay a movie theater ticket price can
choose exactly which actor or actress they wish to see on screen. This allows any (or every) person
to choose to see the "best" actress, leading to their superstar status and income.

131. What determines the size of a compensating differential? Use market equilibriums in your explanation.
ANSWER: A compensating differential exists in labor markets when the wage differs for jobs that require
similar human capital and productivity. The compensating differential is an adjustment for aspects
of the jobs that make them more attractive or less attractive for workers. A job might be less
attractive because it is riskier (risk of physical harm or lower job security), is more stressful, or has
inconvenient work hours. Workers would avoid such a job, resulting in a low supply of workers to

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that labor market and a higher equilibrium salary. If a job with similar human capital needs and
productivity expectations has positive attributes that workers value, then many workers will be
willing to supply their services to that labor market, resulting in a lower equilibrium salary. The
difference between these two equilibrium salaries is the compensating differential.

132. How can unions improve business productivity?

ANSWER: Unions negotiate with employers on behalf of the workers who belong to the union. This gives the
workers a greater voice in communicating and negotiating with their employer. Having a greater
voice can boost worker morale, which would have a positive rather than negative impact on the
workers. If they can communicate more effectively with their employer through the union, many
worker issues might be resolvable, creating a work environment that they find more satisfactory.
This can lead to greater loyalty and work effort. Workers will feel more a part of the company and
may try to find solutions to productivity issues.

133. The Oyu Tolgoi copper mine is the largest mine in Mongolia, producing 30% of Mongolia's GDP and 80%
of Mongolia's exports, by some estimates. About 66% of the mine is owned by Turquoise Hill Resources, a
subsidiary of Rio Tinto, with the remaining ownership held by the Mongolian government. Describe the
implications for workers in the geographic area of the mine if Turquoise Hill Resources exerted monopsony
power in the local labor market.
ANSWER: The significant role of the mine in Mongolia's economy would lend support to the idea that
Turquoise Hill Resources must be a major employer in the locality of the mine. Those workers with
skills relevant to mining would likely have few other places to work. This would give Turquoise
Hill Resources monopsony power. When employers exert monopsony power in a labor market,
wages are lower than they would have been otherwise because the labor market buyer (employer)
has more power in the market than the sellers (workers).

134. Explain why it can be difficult to isolate the impact of discrimination in labor markets.
ANSWER: Differences in wages and employment rates across discriminatory factors are often used to illustrate
the impact of discrimination. However, differences in wages and employment rates across groups
can be affected by many factors besides discrimination. For example, there could be differences in
education levels across groups that feed into different wage rates. People in one group may choose
to apply for certain types of jobs more often than people in another group, resulting in different
wage rates. There could be differences in factors such as cultural differences that impact how
assertive people are in bargaining, which may play into wages. Identifying exactly how much of a
wage differential is due to discrimination is not simple because these other influences must be
accounted for.

135. Explain how discrimination based on prejudice in a labor market can cause an employer to have higher
costs than necessary.
ANSWER: When an employer discriminates based on prejudice in the hiring process, the employer is reluctant
to hire workers who have the particular characteristic against which the employer is prejudiced
(such as workers of a particular race, age group, or gender). If the employer refuses to hire workers
of one race, then those who are of that race are excluded from consideration for employment, and
the employer considers only a smaller pool of potential employees (those who are not of that race).
A smaller effective supply of workers would result in a higher equilibrium wage. The employer
could have hired a sufficient number of employees at a lower wage if the full or larger labor supply
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was considered. Furthermore, if the group subject to discrimination happens to include more skilled
workers than other groups include, the employer may be forgoing more skilled workers in favor of
less skilled workers, resulting in a less productive workforce and further adding to the employer's
costs.

136. How can an employer motivate employees with incentives in ways that help the company operate more
productively in achieving its goals?
ANSWER: Motivating workers through incentives is common, but not all incentives are equally effective in
helping a company achieve its goals. Offering better pay for better performance through
commissions, bonuses, or piece-rate pay is a very common approach, but it may not further all
objectives that a company is trying to achieve. Rewarding good decisions rather than just hard work
or long hours is another way to create incentives, particularly when the worker must make hard
choices. A third approach is to use sticks rather than carrots, with workers striving to avoid being
fired or some other negative penalty. Appealing to intrinsic motivation rather than solely extrinsic
motivation is important and can be a unifying factor among employees. One of the difficulties with
incentives is that it is difficult to design incentives to cover all aspects of what a firm hopes to
achieve. Whatever outcome is rewarded will get the most attention from workers, and other desired
outcomes may be compromised.

137. Generally speaking, workers prefer extra wages to extra benefits, yet most employers provide several
benefits to employees. Why does it make sense for an employer to offer benefits rather than extra wages?
ANSWER: There are several good reasons for employers to offer employees benefits rather than extra wages.
Sometimes, the employer can offer a benefit to employees at a lower cost than that at which the
employees could provide the benefit to themselves. One reason for this is that some benefits have
tax advantages. A second reason is that employers that buy in bulk may be able to get a better price
on a benefit item than an individual employee can. A third reason for an employer to offer a benefit
is that some benefits help employees be more productive. These benefits complement the work
employees do.

138. List and describe the main factors impacting an individual's wage.
ANSWER: Four key factors impact wages—labor demand, labor supply, regulations and institutional factors,
and discrimination. Employers' willingness to hire and pay wages is tied to worker productivity.
Human capital and worker effort play big roles in productivity. Labor supply concerns workers'
willingness to supply their efforts in the labor market. Job characteristics and work environment
affect the attractiveness of different occupations. The benefit packages and employee policies
offered by employers affect the attractiveness of working for particular companies. Labor markets
are subject to numerous regulations, such as wage laws and occupational licensing, and institutions,
such as unions. Finally, discrimination affects the wage and employment prospects of people who
are part of a group that is subject to discrimination.

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Multiple Choice

1. In the text, the population is divided into _____ groups based on income, and each group is called _____
when data on the distribution of income in a country are presented.
a. four; a quarter
b. five; a quintile
c. six; a section
d. three; an income bracket
ANSWER: b

2. Assume that a country with total income of $160,000 has a population of 10 households whose incomes are
listed in Table: Income of Households.

What percentage of income is earned by the top quintile of the population?

a. 110%
b. 94%
c. 69%
d. 6%
ANSWER: c

3. Assume that a country with total income of $160,000 has a population of 10 households whose incomes are
listed in Table: Income of Households.

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What percentage of income is earned by the bottom quintile of the population?

a. 8%
b. 4%
c. 3%
d. 2%
ANSWER: d

4. Table: Income Distribution in Four Countries provides recent data from the World Bank on the distribution of
income in four countries.

Based on the data, the country with the most unequal distribution of income is:
a. Bangladesh.
b. El Salvador.
c. Mexico.
d. Costa Rica.
ANSWER: d

5. Table: Income Distribution in Four Countries provides recent data from the World Bank on the distribution of
income in four countries.

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Based on the data, the country with the distribution of income that is closest to equal is:
a. Bangladesh.
b. El Salvador.
c. Mexico.
d. Costa Rica.
ANSWER: a

6. Data on the distribution of income for the United States show that from 1970 through 2014, the share of
income earned by the top quintile _____, and the share earned by the bottom quintile _____.
a. rose; rose
b. rose; fell
c. fell; rose
d. fell; fell
ANSWER: b

7. Data from the World Bank for the top and bottom quintiles of the distribution of income in Costa Rica for
two years are presented in Table: Costa Rica Income Distribution, Top and Bottom Quintiles.

Which of the following statements is correct for the time period based on the data in the table?
a. The incomes of those in the top quintile decreased.
b. The incomes of those in the bottom quintile increased.
c. The distribution of income has become more equal in the country.
d. The distribution of income has become more unequal in the country.
ANSWER: d

8. Data from the World Bank for the top and bottom quintiles of the distribution of income in Costa Rica for
two years are presented in Table: Costa Rica Income Distribution, Top and Bottom Quintiles.

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Which of the following claims CANNOT be made conclusively for the time period based on the data in the
table?
a. Costa Rica's distribution of income became more unequal.
b. The top quintile percentage of total income became a larger multiple of the bottom quintile
percentage of total income between 1986 and 2016.
c. Average income in the bottom quintile was lower in 2016 than it was in 1986.
d. The top quintile earned a higher share of total income in 2016 than in 1986.
ANSWER: c

9. Recent data from the World Bank for the distribution of income and average income in Sri Lanka and
Mongolia are presented in Table: Distribution of Income and Average Income for Sri Lanka and Mongolia.

Based on the data in the table, which of the following statements is correct?
a. Average household income varies more in Mongolia than in Sri Lanka.
b. The rich tend to be richer in Mongolia than in Sri Lanka.
c. Average income in the top quintile is lower in Sri Lanka than in Mongolia.
d. Average income in the bottom quintile is lower in Sri Lanka than in Mongolia.
ANSWER: d

10. Table: Average Income and Distribution of Income Data provides recent data from the World Bank on
average income and the distribution of income in four countries.

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Based on the data in the table, those in the bottom quintile have the lowest average income in which country?
a. Bangladesh
b. Uganda
c. Sri Lanka
d. Mongolia
ANSWER: b

11. Table: Average Income and Distribution of Income Data provides recent data from the World Bank on
average income and the distribution of income in four countries.

Based on the data in the table, those in the top quintile have the highest average income in which country?
a. Bangladesh
b. Uganda
c. Sri Lanka
d. Mongolia
ANSWER: c

12. Table: Average Income and Distribution of Income Data provides data on average income and the
distribution of income in four countries.

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According to the data in the table, which country has the largest dollar gap between the average income of those
in the top and bottom quintiles?
a. country A
b. country B
c. country C
d. country D
ANSWER: d

13. Table: Average Income and Distribution of Income Data provides recent data from the World Bank on
average income and the distribution of income in four countries.

According to the data in the table, which statement is correct regarding the situations of Sri Lanka and
Mongolia?
a. The average household is more prosperous in Mongolia than in Sri Lanka.
b. Average income in the top quintile is higher in Mongolia than in Sri Lanka.
c. Average income in the bottom quintile is higher in Mongolia than in Sri Lanka.
d. There is a bigger gap in average income between the top and bottom quintiles in Mongolia than in Sri
Lanka.
ANSWER: c

14. Use the World Bank data in Table: Costa Rica Distribution of Income, 1986 and 2016 to determine what
happened to the distribution of income in Costa Rica over the time period 1986 to 2016.

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a. It remained the same.

b. It became more unequal.
c. It moved closer to equality.
d. It became more equal at the top and bottom and less equal in the middle.
ANSWER: b

15. Hedra is a legislator who is concerned about income inequality in her country. She has data on the
distribution of income over time that show that the distribution is becoming more unequal. Which important
step should she take next in order to make credible arguments in the legislature that income inequality is an
issue that needs attention?
a. Examine current data on the issue.
b. Check to see if data related to the issue have changed over time.
c. Determine if the outcome is fair.
d. Determine if her conclusions are consistent across alternative ways of conceptualizing and measuring
the issue.
ANSWER: d

16. Jose has spent most of his life in the top two quintiles of income distribution, although he did spend a year
without earned income when he lost his job during a recession. Which of the following ways of thinking about
inequality explains why someone might make the observation that Jose's living standard did not vary as much as
his income varied?
a. permanent income
b. consumption and inequality of living standards
c. wealth and inequality of purchasing power
d. intergenerational mobility
ANSWER: a

17. In the field of economics, the observation that the living standard of a household is more stable than its
income, because people think in terms of their long-term earnings as they spend, is known as:
a. permanent income versus current income.
b. consumption and inequality of living standards.
c. wealth and inequality of purchasing power.
d. intergenerational mobility and inequality of opportunity.
ANSWER: a

18. Focusing on differences in the amount people actually spend on goods and services as a measure of their
material well-being rather than comparing their current incomes leads to a focus on _____ in discussions of the
level of economic inequality across households.
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a. permanent income
b. consumption
c. wealth
d. intergenerational mobility
ANSWER: b

19. _____ is a stock that is more unequal across households than income, which is a flow.
a. Wealth
b. Age
c. Permanent income
d. Consumption
ANSWER: a

20. Economists believe that average lifetime income is a better predictor of a person's current living standard
than current income because:
a. wealth from assets allows increasing consumption as a person gets older.
b. people can save and borrow to average out consumption over their lifetimes.
c. income levels in a person's childhood home are a strong predictor of adult income.
d. the distribution of income is fixed over a person's lifetime.
ANSWER: b

21. _____ is often used as a measure of the equality or inequality of opportunity rather than using equality or
inequality of outcomes.
a. Childhood household income
b. Permanent income
c. Intergenerational mobility
d. Wealth
ANSWER: c

22. Intergenerational mobility is the extent to which:

a. children own more personal transportation vehicles (such as cars and motorcycles) than their parents
did.
b. the geographic dispersion of families occurs as children pursue economic opportunities.
c. the income of children in a given family varies across the children.
d. the economic status of children is independent of the economic status of their parents.
ANSWER: d

23. How do people's beliefs about the distribution of wealth in the United States compare to the actual
distribution of wealth in the country?
a. People have an accurate view of the distribution of wealth.
b. People believe the distribution of wealth is more equal than it actually is.

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c. People believe the distribution of wealth is more unequal than it actually is.
d. People believe the distribution of wealth is changing rapidly and becoming more equal.
ANSWER: b

24. How do American's beliefs about the ideal distribution of wealth compare to their perception of the
distribution of wealth in the United States?
a. The ideal distribution of wealth is more equal than the perceived distribution of wealth.
b. The ideal distribution of wealth is less equal than the perceived distribution of wealth.
c. The ideal distribution of wealth is the same as the perceived distribution of wealth.
d. Views of the ideal distribution are becoming more unequal, and the perception of the distribution of
wealth is becoming more equal.
ANSWER: a

25. Permanent income is a person's:

a. average income over the past 10 years.
b. fixed income in retirement.
c. average income over their lifetime.
d. estimate of future income based on education and skills.
ANSWER: c

26. Differences in consumer spending tend to vary _____ differences in income.

a. in proportion to
b. more than
c. less than
d. not at all compared to
ANSWER: c

27. The distribution of wealth is _____ the distribution of income.

a. the same as
b. more unequal than
c. less unequal than
d. unrelated to
ANSWER: b

28. Juan is 80 years old. Over Juan's adult lifetime, he accumulated savings for several decades and is using that
savings to cover his expenses in retirement. Early in life when his income was low, he borrowed funds several
times to cover his expenses, paying back the loans over the next few years. Juan's consumption pattern over his
lifetime was influenced heavily by his:
a. permanent income.
b. annual income.
c. wealth.
d. intergenerational mobility.
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ANSWER: a

29. How has the U.S. poverty rate varied over the past 40 years?
a. The rate has had an upward trend.
b. The rate has had a downward trend.
c. The rate has been relatively stable.
d. The rate rose for 20 years and then fell for 20 years.
ANSWER: c

30. An income level below which a family is defined to be in poverty is known as the:
a. poverty line.
b. bottom quintile.
c. relative poverty measure.
d. needs-based indicator.
ANSWER: a

31. The poverty line is:

a. a measure that is used to define relative poverty and is based on housing and food costs.
b. an estimate of the minimum income needed to provide a comfortable standard of living.
c. an income level determined by the government, below which a family is defined to be in poverty.
d. an income level set by the poor to identify the income needed to cover their basic needs.
ANSWER: c

32. The poverty rate is the:

a. portion of the population who cannot afford to pay rent.
b. percent of people whose family income is below the poverty line.
c. income level below which a household cannot provide itself with necessities.
d. income level based on three times the cost of basic food.
ANSWER: b

33. The percent of the population whose household income falls below the poverty line is known as the:
a. poverty line proportion.
b. needs rate.
c. poverty prevalence.
d. poverty rate.
ANSWER: d

34. The poverty line in the United States is based on an estimate of:
a. the cost of basic food, housing, medical care, and transportation.
b. minimum wage income.
c. three times the value of low-cost food for the household.
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d. the income level that separates the bottom and second quintiles of the population.
ANSWER: c

35. In the United States, the poverty line income:

a. is based on estimated medical care costs.
b. excludes medical care costs.
c. is the same for all households.
d. is adjusted based on family size.
ANSWER: d

36. What is the basis for the income level that the U.S. government uses as the poverty line?
a. the value of low-cost rent, food, transportation, and medical care annually for the family size
b. the income line that separates the bottom quintile from the second quintile of earners
c. the average household income of the lowest-paid 15% of households
d. the value of a low-cost food plan multiplied by three, updated annually for inflation
ANSWER: d

37. When a poverty line is based on relative poverty, a household is poor if its income is less than:
a. one-half the median household income in the country.
b. three times the cost of a low-cost food plan for the household.
c. twice the rent on a low-cost two-bedroom apartment.
d. $3 per day per person in the household.
ANSWER: a

38. Which of the following statements describes a poverty line based on absolute poverty?
a. It is the income level that separates the bottom and second quintiles in the distribution of income.
b. Household assets are worth less than a third of the average household assets in the nation.
c. Income is below $5 per day per person in the household.
d. It is an income that provides less than the average household is able to buy.
ANSWER: c

39. The United Nations and the World Bank use poverty lines that are based on:
a. an absolute poverty measure.
b. a relative poverty measure.
c. a higher standard of living than what is represented by the U.S. poverty line.
d. the same standard of living as the U.S. poverty line.
ANSWER: a

40. When the definition of poverty focuses on relative poverty, a person is in poverty if the household income
is:
a. in the bottom 10% of household incomes in the nation.

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b. insufficient to provide basic food, shelter, medical care, and transportation.

c. is less than three times the cost of a basic food plan.
d. below $3.10 per day.
ANSWER: a

41. Yifen lives in a very prosperous nation. Her household income is high enough to allow her family to take a
vacation to the mountains each year and pay for piano lessons for her daughter after covering food, shelter,
medical care, transportation, and clothing. It exceeds the official poverty line. However, because her household
income is in the bottom 10% of households in her nation, Yifen often claims that she is poor. Yifen is claiming:
a. absolute poverty because her income is below an officially set minimum standard of living.
b. absolute poverty because she has less income than most others in her society.
c. relative poverty because her income is below an officially set minimum standard of living.
d. relative poverty because she has less income than most others in her society.
ANSWER: d

42. Malia and Asi have a household income that is insufficient to pay for both food and shelter, with no funds
available for other types of expenses. However, their household income is higher than 75% of the households in
their developing nation. Malia feels that they are poor, and Asi feels that they are prosperous. Their feelings are
consistent with which views of poverty?
a. Malia focuses on relative poverty, and Asi focuses on extreme poverty.
b. Malia focuses on extreme poverty, and Asi focuses on absolute poverty.
c. Malia focuses on absolute poverty, and Asi focuses on relative poverty.
d. Malia focuses on relative poverty, and Asi focuses on absolute poverty.
ANSWER: c

43. Otto and Marta live in a nation with a 15% poverty rate. Their household income is sufficient to pay for
food, shelter, and basic needs with some funds available for other things their family wants. However, their
household income is lower than 75% of the households in their nation. Otto believes that they are prosperous
and not poor, but Marta believes that they are poor. Otto is defining poverty in _____ terms, and Marta is
defining poverty in _____ terms.
a. absolute; relative
b. relative; absolute
c. relative, relative
d. relative; extreme
ANSWER: a

44. Olya and her husband share an apartment. He feels prosperous because they have enough income to cover
food, shelter, and other basic needs without going into debt. She feels poor because she has less than her sister's
family and the families of some of her friends. Olya is defining poverty in _____ terms, while her husband is
defining poverty in _____ terms.
a. absolute; extreme
b. relative; absolute
c. extreme, relative
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d. relative; extreme
ANSWER: b

45. Which of the following poverty standards uses a measure of relative poverty?
a. annual income below $8,000 per person in the household
b. the minimum income level that covers basic food, shelter, transportation, and medical care
c. the bottom 10% of household incomes
d. income of $3.10 or less per day
ANSWER: c

46. If a poverty line is set at a third of the median household income in a country, the poverty line is based on a
_____ poverty standard.
a. fixed
b. absolute
c. relative
d. extreme
ANSWER: c

47. Rachelle is considered poor because her income is in the bottom quintile of the population. Marcella is
considered poor because her income is below a long-standing poverty line of $10,000. Rachelle is considered to
be in poverty under _____ poverty standard, and Marcella is considered to be in poverty under _____ poverty
standard.
a. an absolute; an absolute
b. an absolute; a relative
c. a relative; an absolute
d. a relative; a relative
ANSWER: c

48. The global extreme poverty line of $1.90 per day is:
a. the same as the U.S. poverty line.
b. lower than the U.S. poverty line.
c. higher than the U.S. poverty line.
d. the same as the U.S. poverty line but adjusted for local price levels.
ANSWER: b

49. Which of the following is NOT true of the incidence of poverty in the United States?
a. People of color are more likely than others to experience poverty.
b. Elderly people are more likely than other age groups to be in poverty.
c. Children and single moms are most likely to be in poverty.
d. Most people in poverty will spend much of their lives in poverty, but most people will spend some
time in poverty during their lifetime.
ANSWER: b
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50. Which of the following statements is NOT correct for the United States?
a. Most people who are in poverty will spend much of their lives in poverty.
b. Most people will spend some time in poverty in their lifetime.
c. Children and single moms are the most likely to be in poverty.
d. People of color are less likely than others to experience poverty.
ANSWER: d

51. When there is a high level of intergenerational mobility among the poor in a nation:
a. most of the individuals who are poor remain poor.
b. most of the poor have incomes that are barely below the poverty line.
c. the age distribution among the poor is the same as the age distribution in the total population.
d. children of poor parents do not remain in poverty when they are adults.
ANSWER: d

52. In which of the following situations would 100 people in poverty in a country be LEAST worrisome to
policy makers?
a. There is a low level of intergenerational mobility among the poor.
b. Most of the poor have incomes just barely below the poverty line.
c. The poor remain poor for long periods of time.
d. There is little turnover among the poor. The same people stay in poverty.
ANSWER: b

53. Data for the United States show that poverty is not evenly distributed across groups in the population.
Which of the following groups has the LOWEST poverty rate?
a. single fathers
b. married couples
c. children
d. single mothers
ANSWER: b

54. Certain events can trigger a spell of poverty. Which of the following is NOT among the events that normally
can trigger a spell of poverty?
a. retirement
b. divorce or separation in a marriage
c. the birth of a child
d. the loss of a job
ANSWER: a

55. Which of the following statements is NOT correct regarding the incidence of poverty in the United States?
a. People in long-term poverty are both a small proportion of those who enter poverty and a large share
of the poor at a point in time.
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b. Poverty is often recurrent, with over half of all people who escape poverty returning within five
years.
c. Over half of all spells of poverty last no more than three months.
d. Long-term poverty is an important problem.
ANSWER: c

56. Across demographic groups in the U.S. population, the poverty rate:
a. tends to be equal.
b. varies by race/ethnicity and employment but not by family structure.
c. varies by employment and family structure but not by race/ethnicity.
d. varies by race/ethnicity, family structure, and employment.
ANSWER: d

57. How common is it for Americans to have a spell of poverty during their lifetime?
a. Less than 10% will experience poverty.
b. Approximately 25% will have a spell of poverty.
c. No more than 35% will have a spell of poverty.
d. Over 50% will have a spell of poverty.
ANSWER: d

58. The cash-assistance, goods, and services provided by the government to better the lives of those at the
bottom of the income distribution are known as the:
a. progressive tax system.
b. offset tax system.
c. social insurance.
d. social safety net.
ANSWER: d

59. What is social insurance?

a. It is the cash-assistance, goods, and services provided by the government to better the lives of those
at the bottom of the income distribution.
b. It is government-provided financial funding to households to compensate for bad outcomes such as
unemployment, illness, disability, or outliving their savings.
c. It is the government assignment of jobs to individuals based on household need and employee
education and skills.
d. It is a system where those with more income tend to pay a higher share of their income in taxes than
those with lower incomes.
ANSWER: b

60. What is a social safety net?

a. It is the cash-assistance, goods, and services provided by the government to better the lives of those
at the bottom of the income distribution.
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b. It is government-provided financial funding to people to compensate for bad outcomes such as

unemployment, illness, disability, or outliving their savings.
c. It is the government assignment of jobs to individuals based on household need and employee
education and skills.
d. It is a system where those with more income tend to pay a higher share of their income in taxes than
those with lower incomes.
ANSWER: a

61. What is a progressive tax system?

a. It is the cash assistance, goods, and services provided by the government to better the lives of those
at the bottom of the income distribution.
b. It is government-provided financial funding to people to compensate for bad outcomes such as
unemployment, illness, disability, or outliving their savings.
c. It is the government assignment of jobs to individuals based on household need and employee
education and skills.
d. It is a system where those with more income pay a higher share of their income in taxes than those
with lower incomes.
ANSWER: d

62. Government-provided financial funding to households to compensate for bad outcomes such as
unemployment, illness, disability, or outliving your savings is known as a:
a. progressive tax system.
b. social safety net.
c. social insurance system.
d. disaster relief program.
ANSWER: c

63. A system where high-income households pay a higher share of their income in taxes than those with lower
incomes is known as a:
a. social safety net.
b. regressive tax system.
c. social insurance program.
d. progressive tax system.
ANSWER: d

64. Social safety nets, social insurance programs, and progressive tax systems are all types of income _____
programs that have the impact of moving income distribution _____ equality.
a. redistribution; closer to
b. replacement; further from
c. redistribution; further from
d. replacement; closer to
ANSWER: a
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65. Which of the following is NOT a means-tested social safety net program in the United States?
a. Medicaid
b. Social Security
c. housing assistance
d. earned income tax credit
ANSWER: b

66. A government program provides needed medical care to households whose income falls below the poverty
line. The program is funded through the general tax revenues in the country. This program would be classified
as:
a. an income redistribution program in the social safety net.
b. an income maintenance program as a type of social insurance.
c. a progressive tax inversion in the social safety net.
d. a social insurance program to enhance poverty levels.
ANSWER: a

67. Which of the following is a mean-tested social safety net program in the United States?
a. Social Security
b. worker's compensation
c. Medicare
d. earned income tax credit
ANSWER: d

68. In the United States, the social insurance programs do NOT meet which of the following criteria?
a. They provide benefits to everyone, both rich and poor.
b. The benefits are based on certain bad outcomes.
c. People pay into social insurance programs.
d. They are means-tested.
ANSWER: d

69. Government programs that are "means-tested" require:

a. all citizens to be eligible for benefits regardless of income.
b. the program to verify that it accomplishes its purposes through its activities.
c. recipients to be examined to verify health status.
d. eligibility to be based on income and sometimes on wealth.
ANSWER: d

70. When eligibility for a government program is based on income and sometimes on wealth, the program is
classified as _____ program.
a. an income-limited
b. a means-tested
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c. a poverty-tested
d. a social insurance
ANSWER: b

71. Which of the following statements describes a means-tested government program?

a. All persons are able to receive benefits after they reach 66 years of age.
b. Zain is eligible to receive benefits because he is disabled.
c. Hua Xing can receive benefits if she is too young to be head of a household.
d. Holly is eligible for benefits only if her household income is below $10,000 per year.
ANSWER: d

72. Which of the following is an example of an in-kind transfer?

a. Junko receives an old-age pension from her former employer.
b. Tomasi is eligible for an income supplement because he lost his job.
c. Ellen is eligible for income because she had a type of accident that qualifies.
d. Martin receives housing from the government due to his low income.
ANSWER: d

73. Some safety net programs provide specific goods rather than income or tax breaks. This type of program
benefit is known as:
a. an in-kind transfer.
b. an income-substitute transfer.
c. a product-specific transfer.
d. an alternative need transfer.
ANSWER: a

74. Which of the following is NOT one of the four key reasons that the government provides in-kind benefits
rather than cash benefits?
a. Giving goods rather than cash prevents recipients from making bad choices.
b. An in-kind benefit like child care is a complement to work, which provides some incentive for
recipients to provide for themselves rather than rely on the safety net.
c. In-kind benefits give the recipient the greatest flexibility to choose what matters most.
d. Taxpayers may care more about reducing homelessness or hunger than what will make the recipient
happiest.
ANSWER: c

75. Which of the following gifts is most like an income transfer rather than an in-kind transfer?
a. membership in a gym for a year
b. an antique book
c. a custom-tailored suit with the recipient choosing fabric and style
d. a gift card branded through one of the main credit card companies

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ANSWER: d

76. Benefits from social safety net programs may come in the forms of:
a. cash assistance, expense reimbursements, or in-kind transfers.
b. expense reimbursements, tax breaks, or cash assistance.
c. cash assistance, tax breaks, or in-kind transfers.
d. tax breaks, in-kind transfers, or expense reimbursements.
ANSWER: c

77. Which of the following is a social insurance program in the United States?
a. Medicaid
b. Social Security
c. housing assistance
d. earned income tax credit
ANSWER: b

78. Which of the following is NOT a social insurance program in the United States?
a. housing assistance
b. Social Security
c. worker's compensation
d. Medicare
ANSWER: a

79. Which of the following is NOT a characteristic of social insurance programs?

a. Benefits are based on past earnings.
b. Employers and workers pay for social insurance programs.
c. Benefit eligibility is based on experiencing specified bad outcomes.
d. Benefits are available only to the poor.
ANSWER: d

80. A difference between a means-tested government social safety net program and a government social
insurance program is that means-tested social safety net benefits are available based on _____ while social
insurance benefits are available to those who _____.
a. low income; experience specified negative outcomes
b. experiencing specified negative outcomes; have low incomes
c. regressive taxes; pay progressive taxes
d. progressive taxes; pay regressive taxes
ANSWER: a

81. _____ program benefits are available only to those whose incomes meet a poverty standard, and _____
program benefits are available to anyone who experiences specified negative outcomes.
a. Absolute poverty; relative poverty
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b. Relative poverty; absolute poverty

c. Social insurance; means-tested social safety net
d. Means-tested social safety net; social insurance
ANSWER: d

82. Government social insurance programs are funded by:

a. progressive taxes on income.
b. taxes and fees that are assessed on workers and employers specifically for each program.
c. a pay-back system where beneficiaries repay benefits over a 10-year period.
d. a premium paid by those who choose to participate in the insurance programs.
ANSWER: b

83. Social insurance programs do NOT:

a. set individual benefits based on past income.
b. obtain revenue through program-specific taxes and fees.
c. cover both rich and poor.
d. use a means test to qualify people for benefits.
ANSWER: d

84. Most social insurance programs pay benefits that are based on:
a. the severity of the negative outcome.
b. the premium paid for the insurance.
c. past earnings.
d. family size.
ANSWER: c

85. What is the name of a tax system that is designed so that the higher a person's income, the higher the tax rate
the person pays on each additional dollar earned?
a. income-based tax system
b. progressive tax system
c. in-kind tax system
d. ladder tax system
ANSWER: b

86. A progressive tax system is designed so that:

a. a person pays the same tax rate, regardless of income.
b. as a person progresses from one tax rate to another, the after-tax income falls.
c. as a person's income rises, a lower tax rate is paid on the extra dollars that are earned.
d. as a person's income rises, a higher tax rate is paid on the extra dollars that are earned.
ANSWER: d

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87. Which of the following is NOT a reason that the impact of the U.S. federal tax system is less progressive
than the income tax rate schedule implies?
a. Some investment gains are excluded from the income tax.
b. The poor pay a higher tax rate than those with higher incomes.
c. Some other types of federal taxes are regressive.
d. Higher-income people often have higher tax breaks.
ANSWER: b

88. A regressive tax is a tax where:

a. additional income earned is taxed at lower rates as additional income is earned.
b. additional income earned is taxed at higher rates as additional income is earned.
c. the tax rate remains stable as income rises.
d. the total tax bill remains stable as income rises.
ANSWER: a

89. Which of the following taxes is regressive? Raj pays a 10% tax on the first $10,000 he earns plus a _____
tax on any additional income.
a. 15%
b. 5%
c. 10%
d. 25%
ANSWER: b

90. Which of the following tax systems is progressive? Corinne pays a 10% tax on the first $10,000 she earns
plus _____ tax on any additional income.
a. no
b. a 5%
c. a 10%
d. a 25%
ANSWER: d

91. In the United States, most social insurance programs are funded by taxes that are:
a. progressive.
b. NOT progressive.
c. paid by the government.
d. paid by those with no income.
ANSWER: b

92. Which tax is regressive? Arturo pays an 8% tax on the first $9,000 he earns plus _____ tax on any
additional income.
a. a 5%
b. an 8%
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c. a 10%
d. a 25%
ANSWER: a

93. The tax system is used to reduce income inequality through the use of _____ taxes.
a. regressive
b. proportional
c. efficiency offset
d. progressive
ANSWER: d

94. Survey data for Americans are illustrated in a graph with the average level of well-being reported (on the
vertical axis) at each level of income (on the horizontal axis). The slope of this curve indicates the relationship
between well-being and income is consistent with _____ marginal benefit for additional income.
a. a diminishing
b. a consistent level of
c. an increasing
d. an unpredictable
ANSWER: a

95. How does the law of diminishing marginal utility relate to changing income?
a. The marginal benefit of an extra dollar of income rises as income rises.
b. The marginal benefit of an extra dollar of income falls as income rises.
c. The total utility gained from a small income is higher than the total utility gained from a high
income.
d. The total utility gained from a high income is lower than the total utility gained from a low income.
ANSWER: b

96. The concept of diminishing marginal utility means that an additional dollar of income will yield _____
marginal benefit compared to the previous dollar of extra income.
a. more
b. less
c. the same
d. an unpredictable amount of
ANSWER: b

97. According to diminishing marginal utility, which of the following people would gain the highest marginal
benefit from an extra $100 of income?
a. Jokum, a professional football star with an annual household income of $1 million
b. Julia, a single mother of three young children with an annual household income of $18,000
c. Clive, head of a three-person household with an annual household income of $100,000
d. Clara, a single person with an annual household income of $20,000
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ANSWER: b

98. According to diminishing marginal utility, which of the following people would gain the lowest marginal
benefit from an extra $100 of income?
a. Ariana, an actress with an annual household income of $1,500,000
b. Shawna, a single mother of three young children with an annual household income of $19,000
c. Devin, head of a three-person household with an annual household income of $120,000
d. Chin, a single person with an annual household income of $20,000
ANSWER: a

99. According to diminishing marginal utility, which of the following people would gain the highest marginal
benefit from an extra $100 of income?
a. Geoff, a rugby star with an annual household income of $1,200,000
b. Artem, head of a three-person household with an annual household income of $90,000
c. Paco, a single person with an annual household income of $21,000
d. Seru, a single father of three young children with an annual household income of $19,000
ANSWER: d

100. Junko is a single mother who earns $17,000 per year. She receives $3,000 per year in in-kind transfers and
a $1,000 earned income tax credit. If her earned income rises to $22,000, she will lose the tax credit and $500 of
her in-kind transfer benefits. What is Junko's effective marginal tax?
a. 6.8%
b. 8.8%
c. 30.0%
d. 37.5%
ANSWER: c

101. The logic of income redistribution by the government is that it:

a. reduces total utility in the population but creates opportunities for increasing utility for all persons.
b. maintains total utility in the population but equals out the level of utility across people.
c. increases total utility in the population by creating more equal incomes with enhanced work
incentives.
d. increases total utility in the population by placing income where it yields the highest marginal
benefit.
ANSWER: d

102. The political philosophy that government should try to maximize total utility in society is known by the
term:
a. welfare maximization.
b. equal benefit and fairness-for-all.
c. utilitarianism.
d. redistributive justice.
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ANSWER: c

103. Data comparing people's reported level of well-being to their income in the United States show:
a. a negative or inverse relationship between well-being and income.
b. a positive or direct relationship between well-being and income.
c. a U-shaped relationship between well-being and income, positive at first and then negative.
d. no relationship between well-being and income.
ANSWER: b

104. The well-being score for Marcella (income $22,000) is 6.5, and the well-being score for Mariko (income
$180,000) is 10.2. Across the two of them, total well-being is 16.7. The change in well-being for a $5,000
change in income for Marcella is .5 and for Mariko is .2. What net change in total well-being will occur if
$5,000 of Mariko's income is taken as tax and transferred to Marcella through an income transfer?
a. Total well-being will fall to 16.4 for a net loss of .3.
b. Total well-being will remain constant at 16.7, but how it is distributed across Marcella and Mariko
will change.
c. Total well-being will rise to 17.4 for a net gain of .7.
d. Total well-being will rise to 17 for a net gain of .3.
ANSWER: d

105. The well-being score for Mario (income $20,000) is 5.6, and the well-being score for Lance (income
$150,000) is 9.2. Across the two of them, total well-being is 14.8. The change in well-being for a $5,000 change
in income for Mario is .4 and for Lance is .1. What net change in total well-being will occur if $5,000 of Lance's
income is taken as tax and transferred to Mario through an income transfer?
a. Total well-being will fall to 14.5 for a net loss of .3.
b. Total well-being will remain constant at 14.8, but how it is distributed across Mario and Lance will
change.
c. Total well-being will rise to 15.1 for a net gain of .3.
d. Total well-being will rise to 15.3 for a net gain of .5.
ANSWER: c

106. The overall well-being score for Yulhee (income $25,000) is 4.6, and the well-being score for Pancho
(income $120,000) is 8.2. Across the two of them, total well-being is 12.8. The change in well-being for a
$5,000 change in income for Yulhee is .4 and for Pancho is .2. What net change in total well-being will occur if
$5,000 of Pancho's income is taken as tax and transferred to Yulhee through an income transfer?
a. Total well-being will fall to 12.6 for a net loss of .2.
b. Total well-being will remain constant at 12.8, but how it is distributed across Yulhee and Pancho will
change.
c. Total well-being will rise to 13.0 for a net gain of .2.
d. Total well-being will rise to 13.2 for a net gain of .6.
ANSWER: c

107. What relationship exists between income and well-being in the well-being curve found in the figure?
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a. a negative relationship with increasing marginal gains in well-being as income rises

b. a negative relationship with decreasing marginal gains in well-being as income rises
c. a positive relationship with increasing marginal gains in well-being as income rises
d. a positive relationship with decreasing marginal gains in well-being as income rises
ANSWER: d

108. Which of the following is NOT a cost of the redistribution of income?

a. reduced marginal benefits to extra income
b. reduced incentive to work and earn
c. tax avoidance and fraud
d. administrative costs
ANSWER: a

109. The costs of the redistribution of income include each of the following EXCEPT:
a. administrative costs.
b. higher taxes reduce work effort.
c. higher prices for goods and services.
d. tax avoidance and fraud.
ANSWER: c

110. The percent of each extra dollar of earned income that an income transfer recipient loses to higher taxes
and lower government benefits is called the recipient's:
a. benefit-reduction adjustment rate.

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b. effective marginal tax rate.

c. transfer adjustment tax rate.
d. leak transfer tax rate.
ANSWER: b

111. Meredith is a single mother who earns $20,000 per year. She receives $3,600 per year in in-kind transfers
and a $600 earned income tax credit. If her earned income rises to $25,000, she will lose the tax credit and
$1,900 of her in-kind transfer benefits. What is Meredith's effective marginal tax?
a. 10.0%
b. 12.5%
c. 50.0%
d. 59.5%
ANSWER: c

112. Pedro is a single father who earns $18,000 per year. He receives $3,600 per year in in-kind transfers and a
$1,200 earned income tax credit. If his earned income rises to $24,000, he will lose the tax credit and $800 of
his in-kind transfer benefits. What is Pedro's effective marginal tax rate?
a. 8.3%
b. 11.1%
c. 33.0%
d. 41.7%
ANSWER: c

113. Which of the following statements summarizes the equity-efficiency tradeoff in relation to income
redistribution programs?
a. The more equal the incomes, the greater the efficiency gains.
b. When efficiency grows, the income distribution narrows.
c. When incomes equalize, average incomes rise.
d. More equal incomes may come at the cost of lower average incomes.
ANSWER: d

114. Which of the following is NOT a correct rationale about why income redistribution programs do not
always reduce efficiency?
a. Fewer resources may need to be devoted to dealing with crime when incomes are more equal.
b. Less concentrated political power may exist when incomes are more equal.
c. When incomes are more equal, work incentive grows.
d. Worker productivity grows when educational opportunities are widespread.
ANSWER: c

115. With regard to income redistribution, what is the trade-off between efficiency and equality?
a. Increasing equality of incomes is associated with greater efficiency in production but greater worker
dissatisfaction.
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b. Redistributing incomes reduces work incentives, leading to lower average income and other costs
associated with redistribution.
c. Efficiency and equality move in opposite directions only when average incomes rise.
d. When incomes are equal, efficiency is at its highest level.
ANSWER: b

116. The relationship between efficiency and equality is _____ when incomes are redistributed.
a. positive
b. negative
c. direct
d. vertical
ANSWER: b

117. When incomes are redistributed toward equality, efficiency tends to _____, and average income tends to
_____.
a. rise; rise
b. rise; fall
c. fall; rise
d. fall; fall
ANSWER: d

118. Which of the following is a negative result of redistributing income toward equality?
a. Average income rises.
b. The poor have a higher standard of living.
c. Work incentives are reduced.
d. Government expenses fall, and tax revenues rise.
ANSWER: c

119. Which of the following statements is true regarding views of what is "fair"?
a. Everyone tends to agree that things should be fair, but everyone does not agree on exactly what is
fair.
b. Everyone tends to agree that things should be fair, and everyone tends to agree on what is fair.
c. Few believe that things should be fair, and everyone does not agree on exactly what is fair.
d. Few believe that things should be fair, but everyone tends to agree on what is fair.
ANSWER: a

120. The views of fairness discussed in the chapter do NOT include:

a. equal innate abilities.
b. fair processes.
c. equality of outcomes.
d. equality of opportunities.
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ANSWER: a

121. Which of the following is consistent with the view that "fairness" means equality of outcomes?
a. equal access to education
b. equal incomes
c. nondiscrimination in hiring processes
d. equal productivity that yields equal pay
ANSWER: b

122. The view that a fair income stems from a person's contribution or productivity is at odds with the idea that
_____ seems to play a significant role in the incomes of many people.
a. hard work
b. individual output
c. education level
d. luck
ANSWER: d

123. Which of the following is NOT one of the three questions that should guide discussions and policies
related to the redistribution of income that were presented in the chapter?
a. How fair is this redistribution?
b. How large are the benefits of redistributing income to those who most benefit from it?
c. How long will it take to redistribute income?
d. How large are the costs of redistribution of income?
ANSWER: c

Essay

124. Between 1970 and 2014, the share of income earned by the bottom quintile in the United States fell from
5.4% to 3.6%. However, this does not mean that the incomes of those in the bottom quintile fell. Explain how
people in the bottom quintile could earn a lower percentage of total income and yet not have lower incomes.
ANSWER: If the total income earned in the country rises significantly, then a smaller percentage of the total
income could be a higher dollar amount. For example, if total income in the country was $100 in
1970, the bottom quintile would have earned $5.40 of the $100. If total income doubled by 2014 to
$200, then the bottom quintile would have earned 3.6% of $200, or $7.20, which is a 36% increase
in income. If the population growth was less than 36%, then the average household income in the
bottom quintile would have risen, even though that quintile had a lower percentage of total income
than it had in 1970. The distribution of income became more unequal even though there were rising
incomes overall.

125. Assume there are two countries with populations of the same size, equal average incomes, and equal price
levels. Use the concept of distribution of income to explain how one country could have more people in
absolute poverty than the other country.
ANSWER: Distribution of income conveys understanding of how equally or unequally income is spread across
the households in a country. For example, imagine two countries with equal populations, equal
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average real incomes, and the same poverty line (which provides a measure of an absolute poverty
level). Imagine that one country has a distribution of income with 50% of income earned by the top
quintile and 4% of income earned by the bottom quintile. Imagine that in the other country, the top
quintile earns 30% of income, and the bottom quintile earns 12% of income. Income in the second
country is much closer to equality than in the first country. The first country will have more
households with incomes below the poverty line than the second country. In assessing the extent of
poverty in a country, the distribution of income in combination with the average income level
provides important insights.

126. Explain why some economists favor the use of permanent income rather than annual income of a
household when examining income inequality in a country.
ANSWER: Household annual income is the current income each year for the household. It may vary
considerably over a household's lifespan. For example, it might be very low while a spouse is
attending graduate school, but that education might enable the income to be quite high for many
working years. The permanent income of a household is the household's average income over its
lifespan. Permanent income varies much less than annual income. In the example above, permanent
income would average across the low- and high-income years to provide a steady permanent
income. Because households can borrow and save, there is logic to assuming that households might
use these tools to adjust consumer spending to be more even than income over a lifetime. Many
economists believe that permanent income might be a better measure of the standard of living of a
household than its current annual income and thus might be an appropriate basis for classifying a
household as poor or nonpoor.

127. Intergenerational mobility is viewed as a measure of inequality of opportunity rather than outcomes when
looking at the issue of income inequality. Define intergenerational mobility, and describe how intergenerational
mobility conveys understanding on income inequality.
ANSWER: Intergenerational mobility is the extent to which the economic status of children is independent of
the economic status of their parents. If children cannot break away from the economic status of their
parents, then poverty can be persistent throughout generations with the same people remaining poor
on a consistent basis. If there is intergenerational mobility, then "who" is poor is constantly
changing, and a child born into poverty is not destined to remain poor throughout life. When
intergenerational mobility is high, then children have the opportunities needed to change their
economic status to be different than that of their childhood. If two countries both have the same
poverty rate but one has a higher level of intergenerational mobility than the other, poverty would be
considered a less severe problem in the country with high intergenerational mobility because "who"
is poor is constantly changing.

128. What is the difference between absolute poverty and relative poverty?
ANSWER: Absolute poverty is based on a household's ability to provide itself with a set minimum standard of
living. Relative poverty is based on a household having a lower standard of living or less income
than other households. Having less makes a household poor relative to other households.

129. How could a completely equal distribution of income in a country eliminate relative but not absolute
poverty?
ANSWER: Relative poverty is having less income or goods than others in society. If there is an equal
distribution of income, then everyone has the same income, and no one would be considered poor
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relative to others. Everyone's income would be the average income.

Absolute poverty is based on whether a household has a set minimum living standard that is
determined by the government as the poverty line. If incomes are inequal, typically some
households have income above the poverty line, and others have income below the line. If incomes
were completely equal across all households, then either all households would be poor, or all would
be nonpoor, depending on how the average income compared to the absolute poverty standard (the
poverty line).
If a country has an average income below the poverty line and an equal distribution of income, then
that country has eliminated relative poverty but not absolute poverty.

130. How could a country have no absolute poverty and yet still have relative poverty?
ANSWER: Relative poverty is having less income or fewer goods than others in society. If there is an equal
distribution of income, then everyone has the same income, and no one would be considered poor
relative to others. Everyone's income would be the average income. If there is an unequal
distribution of income, then the households in the lower quintiles would be considered poor relative
to others.
Absolute poverty is based on whether a household has a set minimum living standard that is
determined by the government as the poverty line. If incomes are unequal, typically some
households have income above the poverty line, and others have income below the line. However, if
incomes are high enough, there can be income inequality, and yet no households might be poor in an
absolute sense (a poverty rate of zero). If incomes are completely equal across all households, then
either all households would be poor, or all would be nonpoor, depending on how the average income
compared to the absolute poverty standard (the poverty line).
If a country has an unequal distribution of income and a high level of prosperity, it is possible that a
country could have relative poverty at the same time that no household would meet the standard for
absolute poverty (income below the poverty line). This seems more hypothetical than real.

131. Describe the types of life events that can trigger or cause a spell of poverty for a household.
ANSWER: Several types of life events can put a household at increased risk for a spell of poverty. Perhaps the
most obvious is unemployment: when a household member loses a job, household income drops.
Another type of event is when the household size increases, perhaps due to a birth, and even though
income is stable, the household moves into poverty status. Another situation when persons may
move into poverty is when one household divides into two (through divorce or separation). Even
though members of the original household may have unchanged incomes, the division of income
over the two smaller households could put one or both of them into poverty status. Another type of
household split occurs when young adults move out of their parents' household to set up their own
household. The new young adult household may be categorized as poor if income is low enough,
even though the young adults might not have been categorized as poor when they were part of their
parents' household.

132. What is the main conceptual difference between a social insurance program and a means-tested program
that is part of a social safety net?
ANSWER: A means-test program provides benefits only to the poor, with eligibility based on income. A social
insurance program provides benefits to anyone, rich or poor, based on the recipient's experience of
specified bad outcomes such as unemployment, old age, or disability.

133. The three main approaches that governments use to reduce inequality and poverty are providing a social
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safety net, proving social insurance programs, and designing tax systems. Briefly explain how each can be used
to reduce inequality and poverty.
ANSWER: Social safety net programs provide income or in-kind transfers to households when the household
income falls below a set poverty line. These programs alone do not typically provide enough to
move a household out of poverty, but they provide some funds to help provide some essentials to
households with low incomes, reducing the likelihood of poverty. These are means-tested programs
that are funded through tax revenues.
Social insurance programs are not means-tested but are available to all. These government
insurance-type programs provide funding to households that experience specified negative events,
such as unemployment, disability, or old age. The programs are funded through program-specific
taxes and fees/premiums that are assessed to workers and employers. The payments from these
programs prevent households that experience the specified negative events from being completely
destitute, thus reducing the likelihood of poverty.
Tax systems are often designed to reduce inequality and poverty through the implementation of
progressive taxes and tax credits. Progressive taxes have rates that rise on additional income with
the overall effect that those with high incomes pay higher average tax rates than those with low
incomes. This places a higher proportionate tax burden on those with high incomes and provides tax
revenue funds that can be used for the transfer payments in the social safety net. Also, tax systems
are sometimes designed to include tax credits for those with low incomes, which provides them with
a reduction in taxes owed or even cash payments. Both progressive taxes and tax credits tend to
move incomes closer to equality. Tax credits, but not progressive taxes, lift the after-tax income of
the poor, potentially moving some households out of poverty.

134. What does it mean for a government program to be means-tested?

ANSWER: A means-tested program is one where people's eligibility to receive benefits is based on their income
being below a set threshold (typically an established poverty line). Means-tested programs are
designed to help the poor as part of a social safety net.

135. What is the difference between the definitions of progressive tax and regressive tax?
ANSWER: A progressive tax takes an increasing percentage of additional income as income rises so that high-
income households end up paying a larger percentage of income in tax than low-income households.
A regressive tax is the opposite. With a regressive tax, the percentage of additional income paid as
tax falls as income rises, leading to an outcome where high-income households pay a smaller
percentage of income in tax than low-income households pay.

136. Use the principle of diminishing marginal utility to explain the logic of government income redistribution
programs.
ANSWER: Income redistribution programs take income from some households (usually through taxes) and
transfer income to other households (typically through income transfers, in-kind transfers, or tax
credits), with a goal of making the resulting income distribution less unequal. The rationale for such
programs is that the total level of well-being or utility in the population is increased through
redistribution because of the principle of diminishing marginal utility. This principle states that
additional units of a good (or of money) provide less additional benefit than previous units. For
example, an extra dollar of income provides less extra utility to someone with an income of $1
million than it would provide to someone with an income of $10,000. Thus, if a dollar of income
were taken from the $1 million income and transferred to the household with the $10,000 income,

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then the high-income household would lose less utility than the low-income household would gain,
yielding an increase in total utility across the two households.

137. There are many costs of the redistribution of income that reduce the efficiency gains of such programs.
Summarize at least four costs associated with the redistribution of income.
ANSWER: The goals of redistribution of income programs are the reduction of poverty and enhancement of
overall well-being in society. However, there are costs associated with such programs that reduce
their effectiveness in achieving these goals. Some of the costs, with brief descriptions, include the
following:
Administrative costs are incurred to collect the tax revenues and provide benefits. Part of the tax
revenues must be used to cover these administrative costs, reducing the amount of funds that can be
used toward benefits.
Raising taxes on higher-income households to cover benefits to lower-income households will
reduce the work incentives of both high- and low-income households. High-income households will
have a lower after-tax reward to their work efforts. Low-income households will see lower benefits
to working because there are enhanced benefits to having low earned income due to the transfers.
The higher taxes on higher incomes will create greater incentives to avoid taxes through financial
planning for deductions and selective investments, through tax evasion and fraud. This could lead to
inadequate tax revenues to cover promised benefits and thus the need for even higher tax rates.
Expenses for lobbying may be incurred on behalf on both high-income tax payers and low-income
benefit recipients. These efforts use resources that could have generated greater well-being benefits
if put to alternative uses.

138. Explain how income redistribution programs reduce the work incentive of both high-income tax payers and
low-income benefit recipients.
ANSWER: The work incentive of individuals is tied to their net gain from working. In everyday thinking, that
gain is viewed in terms of dollars of take-home income. The essence of an income redistribution
program is that income is taken from high-income households through taxes to fund transfers of
income (or in-kind benefits) to low-income households with an overall effect of moving after-tax,
after-transfer income closer to equality. When taxes are increased on high-income households, their
after-tax income falls, reducing the reward for their work effort. When transfer payments are means-
tested, low-income households receive transfer payments and would receive reduced benefits if they
increased their work efforts to earn more income. This means that their increased work efforts
would yield little added benefit to the household, providing a low incentive to work.

139. What is meant by the trade-off between efficiency and equality in discussions of reducing poverty and
income inequality?
ANSWER: Suggested Answer:
The trade-off between efficiency and equality is the reality that efforts to equalize incomes have
costs that reduce efficiency. The costs fall into two main categories — administrative expenses and
reduced incentives for productivity. Administrative expenses use funds, reducing the amount of
funds available for transfer to the poor. If taxes are raised on the nonpoor to cover these expenses,
they have a reduced reward for their productive efforts and lose incentive to be as productive. Even
if taxes were not raised, the existence of transfer payments to the poor can reduce work incentives
among both the poor and nonpoor because they realize that they would not be destitute even if they
were without earned income. The overall impact of these costs and negative incentives is that efforts

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to equalize income tend to be paired with reduced average incomes—a trade-off between equality
and efficiency.

140. One view of fair incomes ties a fair income to the hard work and productivity of the individual. Explain
how the concept of "luck" creates complications in achieving a "fair income based on work productivity."
ANSWER: The idea that a fair income is tied to a person's hard work and productivity is logical to many. If one
person chooses to work hard and become skilled and highly productive, then it makes sense for that
person's income to be higher than someone who is far less diligent and productive. However,
sometimes there are factors that seem to occur by chance that unequally impact the incomes of
equally productive individuals. For example, some people may have the "luck" of meeting and
making connections with someone who can help them get a particularly good job that pays more
than what is earned by another equally productive worker who worked just as hard on networking.
Some people may have the "luck" to be born with certain innate aptitudes that allow them to develop
higher skill levels than others who study and train just as hard and long. It is difficult, if not
impossible, to find ways of adjusting for all the possible ways in which "luck," or just life, can
create situations in which equal effort might not yield equal productivity and in which equal
productivity might not be equally rewarded.

141. Describe the difference between equality of opportunity and equality of outcomes with respect to income
distribution.
ANSWER: Equality of outcomes with respect to income distribution would mean that there is an equal
distribution of income across households: every household has the same income (perhaps adjusted
for family size). Government policy involvement to achieve such an outcome typically requires
income redistribution policies of tax and transfer payments. When equality is defined in terms of
opportunity rather than outcome, then every household has the opportunities it takes to earn
equivalent incomes, but it is up to the household members whether or not to take advantage of the
opportunities. The result could conceivably be equal incomes but is much more likely to result in
differing incomes across households. However, the differing incomes primarily would be the result
of choices made and effort put forth by household members with regard to pursuit of opportunities.
Government policies to ensure equality of opportunities might entail things like equal access to
education and policies requiring no discrimination in the workplace.

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Chapter 14: Market Structure and Market Power

Multiple Choice

1. A firm's ability to raise its product price without losing many customers to competing businesses is known as
a. market power.
b. competitive power.
c. marginal revenue.
d. revenue dependability.
ANSWER: a

2. The market power of a firm is its

a. ranking based on units sold compared to other firms selling the same product.
b. ability to cause other firms in its market to drop out of the market.
c. ability to raise its price without losing many of its customers to competing businesses.
d. market share based on the percentage of total market revenue.
ANSWER: c

3. What is the relationship between a company's market power and the price that the company's owner can
charge for its product?
a. The lower the market power, the lower the price the firm can charge before losing customers.
b. The lower the market power, the higher the price the firm can charge without losing many customers.
c. The greater the market power, the higher the price the firm can charge without losing many
customers.
d. The greater the market power, the lower the price the firm must charge to avoid losing many
customers.
ANSWER: c

4. What type of relationship exists between the level of a company's market power and the price that its owner
is able to charge for its product?
a. circular
b. positive
c. negative
d. opposing
ANSWER: b

5. In which of the following situations would Max's Doughnut Shop have the greatest market power?
a. Within three miles, there are five other doughnut shops and three bakeries that sell breakfast pastries.
b. There are two rival doughnut shops within three miles but no other bakeries.
c. The closest doughnut shop is 10 miles away, but there is a bakery with breakfast pastries two miles
away.
d. The closest doughnut shop or bakery is 25 miles away from Max's shop.
ANSWER: d

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6. In which of the following situations would Maria's Doughnut Shop have the LEAST market power?
a. Within three miles, there are five other doughnut shops and three bakeries that sell breakfast pastries.
b. There are two rival doughnut shops within three miles but no other bakeries.
c. The closest doughnut shop is 10 miles away, but there is a bakery with breakfast pastries two miles
away.
d. The closest doughnut shop or bakery is 25 miles away from Maria's shop.
ANSWER: a

7. Which of the following conditions is NOT present in perfect competition?

a. All companies in the market sell identical goods.
b. All companies in the market sell a small share of the total market output.
c. There are many buyers and sellers in the market.
d. The product price varies across the companies in the market.
ANSWER: d

8. Which of the following conditions is present for all sellers in a perfectly competitive market?
a. All sellers have an equal and high level of market power.
b. The product price varies across the sellers.
c. The number of sellers is small.
d. All sellers are selling identical products.
ANSWER: d

9. A price-taker is a seller that:

a. keeps taking an increasing share of market sales in its market.
b. sets its price based on the cost of inputs plus an allowance for profit.
c. takes all available information into consideration in deciding how much to charge above or below the
current market price.
d. charges the current market price for its product.
ANSWER: d

10. What level of market power exists for sellers in a perfectly competitive market?
a. The level of market power varies widely across the sellers in the market.
b. All sellers have an equal and high level of market power.
c. All sellers lack market power.
d. The largest seller in the market holds all market power.
ANSWER: c

11. Which of the following markets is an example of a perfectly competitive market?

a. Fast-food hamburgers
b. Shares of McDonald's stock
c. Dining chairs
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d. Apple computers
ANSWER: b

12. The market structure of _____ is rare because _____ and _____.
a. monopoly; most goods are not identical; most markets have some dominant firms
b. monopoly; most firms advertise; most markets have many firms
c. perfect competition; most goods are not identical; most markets have some dominant firms
d. perfect competition; most firms advertise; most markets have many firms
ANSWER: c

13. Perfectly competitive markets are rare because most

a. firms advertise and most markets have many firms.
b. goods are not identical and most markets have many firms.
c. firms advertise and most markets have many buyers.
d. goods are not identical and most markets have some dominant firms.
ANSWER: d

14. A product market has many buyers and many sellers, and its largest company produces 1% of the market
output. In addition, all sellers produce identical goods. What market structure is consistent with this description?
a. Perfect competition
b. Monopoly
c. Monopolistic competition
d. Oligopoly
ANSWER: a

15. When a company has market power, it is _____ in its market.

a. one of many small companies
b. not a price-taker
c. a producer of nondifferentiated products
d. not able to impact the market equilibrium price
ANSWER: b

16. Which of the following is a characteristic of a perfectly competitive market?

a. Sellers are price-takers.
b. There are some dominant sellers.
c. There are only a few sellers in the market.
d. The product varies across the sellers.
ANSWER: a

17. Which of the following is NOT a characteristic of perfectly competitive markets?

a. There are many sellers.

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b. No seller has a significant market share.

c. The products sold by all sellers are identical.
d. Each seller sets its own price.
ANSWER: d

18. Which of the following statements about market power is TRUE?

a. All sellers that have market power will have equal market power.
b. Markets can have power, but sellers cannot have market power.
c. The extent of market power held by a seller can vary along a spectrum from none to a high level.
d. There are two types of sellers, those with no market power and those with complete market power.
ANSWER: c

19. An intense struggle to gain market share is a distinguishing characteristic of what type of market?
a. Perfect competition
b. Monopoly
c. Oligopoly
d. Monopolistic competition
ANSWER: c

20. Which of the following is a characteristic of monopoly that is not present in other market structures?
a. There are many buyers.
b. The product is identical across all sellers.
c. Sellers are price-takers.
d. There is only one seller.
ANSWER: d

21. A product market has only one seller, and that seller has a high level of market power. There are no close
substitutes for the product. What type of market is this?
a. Perfect competition
b. Monopoly
c. Oligopoly
d. Monopolistic competition
ANSWER: b

22. A company is the only one producing its type of product. The company's owner is able to set price at the
most profitable level. This company is in what type of market?
a. Oligopoly
b. Monopolistic competition
c. Monopoly
d. Perfect competition
ANSWER: c
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23. When a seller has a high level of market power, the seller
a. produces a product that is identical to the output of other companies in the market.
b. is in a market with growing demand.
c. is one of many sellers selling in its market.
d. can raise its price without losing many customers.
ANSWER: d

24. A characteristic of monopoly that is not present in any other market structure is that
a. no firm in the market has a high level of market power.
b. each firm strives to differentiate its product from others in the market.
c. there is only one seller.
d. the product is identical across the many firms selling in the market.
ANSWER: c

25. A characteristic of oligopoly that is not present in any other market structure is that there
a. is only one seller and that seller has a high level of market power.
b. are many sellers and each produces its own version of the product.
c. are a small number of sellers with considerable market power.
d. are many sellers that produce identical products.
ANSWER: c

26. A certain city has four hospitals, and there are no other hospitals within 200 miles. Two of the hospitals are
more specialized than the other two because one has a large cardiac unit and the other has a specialized cancer-
treatment center. The local market for hospital services is what type of market?
a. Monopoly
b. Oligopoly
c. Perfect competition
d. Monopolistic competition
ANSWER: b

27. In which market structure do the actions of a rival have a significant impact on your operations?
a. Monopoly
b. Monopolistic competition
c. Oligopoly
d. Perfect competition
ANSWER: c

28. A characteristic of oligopoly that is not present in other market structures is that there
a. is only one seller and that seller holds a high level of market power.
b. are many sellers and each produces a differentiated version of the product.

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c. are a small number of sellers and they have market power.

d. are many sellers that produce identical products.
ANSWER: c

29. A characteristic of monopolistic competition that is not present in any other market structure is that there
a. is only one seller and that seller holds a high level of market power.
b. are many sellers and each produces its own version of the product.
c. are a small number of sellers who have market power.
d. are many sellers that produce identical products.
ANSWER: b

30. A characteristic of perfect competition that is not present in any other market structure is that there
a. is only one seller and that seller holds a high level of market power.
b. are many sellers and each produces its own version of the product.
c. are a small number of sellers and at least a few of them have market power.
d. are many sellers that produce identical products.
ANSWER: d

31. In an oligopolistic market, the impact on a seller of the _____ is greater than in other types of market
structures.
a. actions of other market sellers
b. total number of buyers in the market
c. fact that all sellers produce identical products
d. lack of rival sellers
ANSWER: a

32. A market with a large number of sellers and a high level of product differentiation is known as
a. a perfectly competitive market.
b. a monopoly.
c. an oligopoly.
d. a monopolistically competitive market.
ANSWER: d

33. In a market, when a company's owner tries to make its product slightly different from the output of other
companies so that it is more attractive to buyers, the company is engaged in
a. market fixation.
b. product differentiation.
c. dominant rivalry.
d. rational competition.
ANSWER: b

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34. Monopolistic competition is a market characterized by
a. one seller that competes against itself.
b. many sellers that produce identical products.
c. a few sellers that can impact the other sellers through their actions.
d. many sellers that produce different versions of the same product.
ANSWER: d

35. Most U.S. grocery stores sell a variety of boxed breakfast cereals. This observation indicates that the boxed
breakfast cereal market is
a. a perfectly competitive market.
b. a monopoly.
c. an oligopoly.
d. a monopolistically competitive market.
ANSWER: d

36. Walmart has a large aisle that displays many different types of shampoos. This observation indicates that the
shampoo market is
a. a perfectly competitive market.
b. a monopoly.
c. an oligopoly.
d. a monopolistically competitive market.
ANSWER: d

37. Walmart has a large aisle that displays many different kinds of toothpastes. This observation indicates that
the toothpaste market is
a. a perfectly competitive market.
b. a monopolistically competitive market.
c. an oligopoly.
d. a monopoly.
ANSWER: b

38. With a _____ number of sellers in a market, _____ market power tends to exist in the market.
a. smaller; more
b. smaller; less consistent
c. greater; more
d. greater; less consistent
ANSWER: a

39. When a seller is able to differentiate its product successfully, the seller
a. has a reduction in costs of production.
b. takes its market closer to perfect competition.

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c. loses market share.

d. gains market power.
ANSWER: d

40. Which of the following statements about the prevalence of different types of market structures is TRUE?
a. Monopolistic competition and monopoly are more common than oligopoly and perfect competition.
b. Oligopoly and perfect competition are more common than monopolistic competition and monopoly.
c. Oligopoly and monopolistic competition are more common than monopoly and perfect competition.
d. Monopoly and perfect competition are more common than oligopoly and monopolistic competition.
ANSWER: c

41. Which of the following two market structures are LESS common?
a. Monopoly and perfect competition
b. Perfect competition and oligopoly
c. Oligopoly and monopolistic competition
d. Monopolistic competition and monopoly
ANSWER: a

42. The most common market structures are

a. monopoly and oligopoly.
b. monopoly and monopolistic competition.
c. monopolistic competition and oligopoly.
d. monopolistic competition and perfect competition.
ANSWER: c

43. Imperfect competition stems from _____ and whether or not the product is _____.
a. the product price; produced by all firms in the market
b. the costs of production; identical across firms
c. market power; a good or a service
d. the number of sellers; differentiated
ANSWER: d

44. Which of the following is NOT true about imperfect competition?

a. Greater product differentiation decreases market power.
b. A smaller number of sellers in a market increases market power.
c. Imperfect competition among buyers gives them bargaining power.
d. Sellers with market power can use independent pricing strategies.
ANSWER: a

45. Which of the following statements is an accepted insight into imperfect competition?
a. The higher the number of competitors, the greater the market power of firms.
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b. Market power leads to all sellers accepting the market equilibrium price.
c. A seller's best choice depends on the actions that other businesses take.
d. Market power grows when the product is standardized and identical across sellers.
ANSWER: c

46. What "balancing act" do imperfect competitors face as they set their product price?
a. If the price is too high, profit will be large as you sell a large quantity.
b. If the price is too high, profit will be small as you sell a small quantity.
c. If the price is too high, few firms produce and costs rise.
d. If the price is too high, many firms produce and costs rise.
ANSWER: b

47. In a product market, why would a company owner prefer to face fewer competitors rather than more?
a. Costs of production will be lower when there are fewer companies.
b. With fewer competitors, companies have more market power.
c. With fewer competitors, companies have less market power.
d. Per-unit costs of production rise when the number of companies falls.
ANSWER: b

48. When buyers in a market have market power, then the

a. product price is higher.
b. product price is lower.
c. number of sellers rises.
d. number of sellers falls.
ANSWER: b

49. When interdependence exists between sellers in a market, then

a. each seller relies on another seller in the market to supply its inputs.
b. all sellers produce an identical product.
c. each seller's best choice depends on what the other sellers choose to do.
d. there must be a rising market demand for any seller to increase its sales.
ANSWER: c

50. Market power determines the shape of a firm's

a. market equilibrium.
b. marginal revenue curve.
c. supply curve.
d. demand curve.
ANSWER: d

51. A seller's incentive to increase production is reflected in its

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a. marginal revenue curve.

b. demand curve.
c. market equilibrium price.
d. market share.
ANSWER: a

52. A seller's demand curve summarizes its _____, and its marginal revenue curve measures its _____.
a. incentive to increase production; costs of production
b. market share; market power
c. customer power; costs of production
d. market power; incentive to increase production
ANSWER: d

53. The degree of a seller's market power has an impact on the

a. market demand curve for the seller's market.
b. seller's demand curve.
c. demand curves for individual customers of the seller.
d. seller's cost curves.
ANSWER: b

54. What happens to a seller's demand curve as the seller gains market power?
a. The curve becomes horizontal.
b. The curve shifts to the left.
c. The slope of the curve becomes steeper.
d. The slope of the curve becomes less steep.
ANSWER: c

55. When a seller has no market power, its demand curve

a. is horizontal.
b. is vertical.
c. has a negative slope.
d. has a positive slope.
ANSWER: a

56. A seller's demand curve will have a steep negative slope when the seller
a. has a low level of market power.
b. has a high level of market power.
c. is in perfect competition.
d. does not have a differentiated product.
ANSWER: b

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57. The _____ a seller's market power is, the _____ the price elasticity of its demand curve.
a. more variable; greater
b. greater; lower
c. lower; more variable
d. lower; lower
ANSWER: b

58. (Figure: Market Power) Based on the demand curves for four sellers, which of the following sellers has the
most market power?

a. Firm A
b. Firm B
c. Firm C
d. Firm D
ANSWER: c

59. (Figure: Market Power) Based on the demand curves for four sellers, which of the following firms has the
least market power?

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a. Firm A
b. Firm B
c. Firm C
d. Firm D
ANSWER: a

60. How does a business owner discover the business's demand curve?
a. The owner watches its competitors.
b. The owner tries out different versions of a product.
c. The demand curve is found by determining the market equilibrium price.
d. The owner experiments with different prices for its product.
ANSWER: d

61. The change in total revenue from selling one additional unit of output is the
a. market power.
b. profit.
c. marginal revenue.
d. collusive reward.
ANSWER: c

62. Marginal revenue is the

a. profit a company earns from selling an additional unit of output.
b. change in revenue from selling an additional unit of output.
c. rise in costs when an additional unit of output is produced.
d. revenue obtained from giving discounts to customers to manipulate sales.
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ANSWER: b

63. (Figure: Marginal Revenue) What is the marginal revenue of the fourth unit in the following example?

a. $20
b. $5
c. $2
d. $1
ANSWER: c

64. (Figure: Marginal Revenue) What is the marginal revenue of the fifth unit in the following example?

a. $20
b. $5
c. $4
d. $0
ANSWER: d

65. Marginal revenue reflects the _____ effect and the _____ effect.
a. cost; revenue
b. output; discount
c. discount; cost
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d. revenue; sales
ANSWER: b

66. Your company sells 19 units at a price of $10 and must change price to $9.90 in order to sell 20 units. What
is the marginal revenue of the twentieth unit?
a. –$.10
b. $8.00
c. $9.90
d. $198.00
ANSWER: b

67. For a seller with market power, as the number of units sold increases, marginal revenue
a. falls further and further below the price.
b. rises further and further above the price.
c. remains constant and unchanging.
d. remains equal to the price needed to sell the output.
ANSWER: a

68. How does marginal revenue compare to price for a seller with market power?
a. Marginal revenue is equal to price.
b. Marginal revenue is always higher than price.
c. Beyond the first unit sold, marginal revenue is below price.
d. Beyond the first unit sold, marginal revenue is above price.
ANSWER: c

69. Marginal revenue is the difference between output effect or price and the _____ effect for a given quantity.
a. output
b. profit
c. sales
d. discount
ANSWER: d

70. As the quantity sold rises, how does marginal revenue compare to price for a company with market power?
a. Marginal revenue falls further and further below price.
b. Marginal revenue rises further and further below price.
c. Marginal revenue remains constant regardless of the price level.
d. Marginal revenue maintains a constant difference from price.
ANSWER: a

71. The Rational Rule for Sellers is that sellers should choose the quantity _____ and choose the price _____.
a. that is associated with a minimum average total cost; that is on the seller's demand curve for the

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quantity
b. that is associated with a minimum average total cost; with maximum marginal revenue
c. where marginal revenue equals marginal cost; that is on the seller's demand curve for that quantity
d. where marginal revenue equals marginal cost; with maximum marginal revenue
ANSWER: c

72. According to the Rational Rule for Sellers, a seller should choose the output level where _____ and the
price level _____.
a. marginal cost equals marginal revenue; that is on the seller's demand curve at that output level
b. maximum revenue is obtained; that is on the seller's demand curve for that output
c. average total cost is minimum; that is associated with maximum revenue
d. sales are maximum; where revenue is maximum
ANSWER: a

73. (Figure: Output Level) According to the rational rule, what output and price should the firm in the following
example choose?

a. quantity = 6; price = $6.00

b. quantity = 4; price = $4.00
c. quantity = 8; price = $9.00
d. quantity = 4; price = $7.00
ANSWER: d

74. (Figure: Output Level 2) What price and output should the firm in the following example choose according
to the Rational Rule for Sellers if MC = $4?

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a. output = six; price = $6.00

b. output = five; price = $4.00
c. output = six; price = $4.00
d. output = six; price = $5.00
ANSWER: a

75. According to the Rational Rule for Sellers, this company should produce ____ of output and charge a price
of _____.

a. one unit; $300

b. two units; $200
c. three units; $200
d. four units; $150
ANSWER: c

76. According to the Rational Rule for Sellers, the manager of this company should choose to produce _____ of
output and charge a price of _____.

a. one unit; $400

b. two units; $450
c. three units; $400
d. four units; $350

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ANSWER: b

77. Why would the owner of the following company decide NOT to produce and sell the fourth unit, even
though it adds less to costs than the price he could get for it?

a. It would add no additional revenue even though it sells for $150.

b. It has a price that is less than cost per unit of output.
c. It has marginal cost that is less than its marginal revenue.
d. It is associated with an increase in cost per unit.
ANSWER: a

78. The basic logic behind the Rational Rule for Sellers is that a company owner should increase output as long
as the extra output
a. moves the company toward maximum total revenue.
b. leads to a larger gap between price and average total costs.
c. leads the company toward minimum average total costs.
d. adds more to revenue than it adds to costs.
ANSWER: d

79. In a perfectly competitive market, a company's marginal revenue equals _____. For a company with market
power, marginal revenue is _____.
a. price; less than price
b. price; greater than price
c. marginal cost; greater than marginal cost
d. marginal cost; less than marginal cost
ANSWER: a

80. Based on the Rational Rule for Sellers, how does a manager set price and quantity? If the company has no
market power, the marginal cost _____ price. If the company has market power, the marginal cost is _____ than
price.
a. is less than; greater
b. is greater than; less
c. equals; less
d. equals; greater
ANSWER: c

81. How is the result of the Rational Rule for Sellers different for companies with market power versus
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companies with no market power?
a. The price is lower for companies with market power.
b. The price is higher for companies with market power.
c. The demand is lower for companies with market power.
d. The demand is higher for companies with market power.
ANSWER: b

82. Companies with market power face a trade-off between

a. gaining market share and reducing costs.
b. having a higher marginal cost and a reduction in output.
c. reducing costs and increasing profit.
d. having a higher profit margin and selling a larger quantity.
ANSWER: d

83. Following the Rational Rule for Sellers, how does output for a seller who has market power compare to
output for a seller who does not have market power?
a. Output is the same in both situations.
b. Output is higher with market power than without market power.
c. Output is higher without market power than with market power.
d. The level of market power has no impact on output.
ANSWER: c

84. The higher the level of market power among the sellers in a market, the _____ when the Rational Rule for
Sellers is applied.
a. lower the market output
b. higher the marginal cost
c. closer marginal revenue is to price
d. lower the market demand
ANSWER: a

85. The negative outcomes of market power do NOT include

a. higher prices.
b. smaller demand.
c. larger economic profits.
d. higher costs.
ANSWER: b

86. The negative outcomes of market power include all of the following EXCEPT
a. smaller quantity.
b. higher costs.
c. larger profits.
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d. lower prices.
ANSWER: d

87. Which of the following is NOT an outcome of a market where sellers have market power?
a. Larger economic profits
b. Higher prices
c. Lower costs
d. An inefficiently small output
ANSWER: c

88. Which of the following is a negative outcome of markets where sellers have market power?
a. Higher prices
b. An inefficiently large output
c. Smaller economic profits
d. Lower costs
ANSWER: a

89. The output in a market with market power is

a. efficient because marginal cost is equal to marginal revenue.
b. higher than the output in a market without market power.
c. inefficient because the marginal benefit to society of extra output exceeds the marginal cost.
d. more predictable than the output in a market without market power due to product differentiation.
ANSWER: c

90. Which of the following is correct about the discount effect facing companies in perfectly and imperfectly
competitive markets? Companies in perfect competition _____ it. Companies in imperfect competition _____ it.
a. face; face
b. face; do not face
c. do not face; face
d. do not face; do not face
ANSWER: c

91. What effect do patents have on competition?

a. They increase competition by putting downward pressure on price.
b. They increase competition by encouraging new companies to enter a market.
c. They reduce competition by fixing the price of the product so it cannot fall.
d. They reduce competition by creating a barrier to new companies entering a market.
ANSWER: d

92. What effect does increasing competition have on price for firms with market power?
a. It inspires product differentiation and higher prices.

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b. It drives the price down to the level of costs.

c. It pushes the price up above marginal revenue.
d. Price enters a cycle of ups and downs.
ANSWER: b

93. One of the market failures caused by market power is

a. reduced demand.
b. high costs.
c. high price.
d. underproduction.
ANSWER: d

94. Market power results in companies that _____ and that have _____ compared to perfect competition.
a. produce less; higher price
b. have higher costs; lower revenue
c. have more elastic demand curves; less variation in costs
d. have lower revenue; more elastic demand curves
ANSWER: a

95. Patents have a positive impact of _____ and the negative impact of _____.
a. reducing price; increasing costs
b. creating more competition; reducing demand
c. encouraging research; creating a monopoly
d. reducing costs; reducing competition
ANSWER: c

96. What would happen in the renewable energy markets if patents were banned?
a. Research into new energy technologies would fall, and new companies would enter renewable
energy sectors which they can emulate.
b. Renewable energy markets would shrink, and energy prices would rise.
c. Renewable energy prices would fall, and research into new energy technologies would increase.
d. Current renewable energy companies would suffer, but new companies would benefit.
ANSWER: a

97. Patents on drugs to treat AIDS were removed in South Africa. How would the market for these drugs have
been different if there had never been patents on drugs?
a. The drug prices would have been lower from the start.
b. The drug prices would have been even higher.
c. The drugs would not have been developed.
d. Larger quantities of the drugs would have been produced.
ANSWER: c
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98. To maximize social benefits from markets, governments regulate markets using what two basic approaches?
a. They restrict prices and reduce costs.
b. They encourage market power and foster research.
c. They reduce competition and encourage market power.
d. They encourage competition and minimize harm from market power.
ANSWER: d

99. Which of the following is NOT an example of a type of law that tries to foster competition?
a. Anti-collusion laws
b. Laws that encourage international trade
c. Patents
d. Laws that restrict mergers
ANSWER: c

100. What is collusion?

a. Cooperation between sellers to increase the level of competition
b. Regulatory restrictions on the entry of new sellers into an industry
c. A merger of two sellers
d. Agreements between sellers to increase their market power
ANSWER: d

101. Which of the following is NOT an example of illegal collusion in a market?

a. Sellers agree to restrict the quantity produced.
b. Sellers include complete and accurate lists of ingredients on all products.
c. All sellers agree to charge a higher price.
d. Sellers divide up the market share to restrict competition.
ANSWER: b

102. An agreement among sellers in a market that limits competition is called:

a. patent.
b. collusion.
c. covert manipulation.
d. power promotion.
ANSWER: b

103. When collusion occurs, sellers in a market

a. legally join together to become one seller.
b. collide by trying to serve the same segment of the market.
c. act like a monopolist to increase profits.
d. strive to increase the level of competition in the market.
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ANSWER: c

104. What are the main positive and negative impacts of mergers?
a. Lower costs and increased market power
b. Increased competition and higher costs
c. Lower prices and more companies
d. Decreased market power and higher prices
ANSWER: a

105. A market has 10 sellers. The fifth and seventh in size merge, becoming the largest seller in the market.
How can this merger support competition in the market?
a. If the merger increases the level of market power in the market.
b. If the newly merged seller becomes more efficient and offers lower prices.
c. If the least efficient of the eight sellers that did not merge goes bankrupt, further reducing the number
of market sellers.
d. If average prices in the market rise after the merger.
ANSWER: b

106. A merger benefits society when it results in

a. increased market power.
b. a larger number of sellers in the market.
c. cost savings.
d. decreased market demand.
ANSWER: c

107. Mergers harm society when they lead to

a. price reductions.
b. cost savings.
c. a higher number of companies.
d. increased market power.
ANSWER: d

108. Which of the following is consistent with current U.S. law on monopolies?
a. Being a monopoly is illegal.
b. Gaining monopoly or market power through specified exclusionary business practices is illegal.
c. Monopolizing is legal.
d. Companies can act to reduce the number of competitors but cannot discourage new entrants.
ANSWER: b

109. _____ using specific business practices that increase a seller's market power and excludes other sellers is
illegal under U.S. law.
a. Differentiating
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b. Rationalizing
c. Monopolizing
d. Powering
ANSWER: c

110. Monopolizing is when a company gains market share by

a. being able to charge a lower price than rivals because the company is more efficient in production.
b. pushing suppliers not to sell inputs to rival companies.
c. providing better customer service than rival companies.
d. producing a version of the product that is preferred by customers.
ANSWER: b

111. When a country is open to international trade, the product markets in the country become
a. less competitive because each seller has fewer customers as foreign sellers attract some customers.
b. more competitive because there are more suppliers (both domestic and international sellers) selling in
the product markets.
c. less competitive because foreign buyers will attract some of the country's sellers.
d. more competitive because total costs will rise.
ANSWER: b

112. Being open to international trade helps a country foster competition for all the following reasons EXCEPT
that there will be
a. more sellers in the country's product markets.
b. more buyers for the country's output.
c. increased pressure for efficient production methods.
d. more bias toward domestic production.
ANSWER: d

113. Price ceilings tend to create shortages when used to

a. bring down price in a competitive market.
b. create a price above equilibrium.
c. reduce exploitative use of market power.
d. bring down price to the level of marginal cost.
ANSWER: a

114. The list of problems that can be triggered by price ceilings does NOT include
a. shortages.
b. reduced incentive for efficient production.
c. less incentive for maintaining product quality.
d. reduced demand.
ANSWER: d
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115. In a _____ monopoly, the marginal cost falls as production increases. Only one company can survive in the
market as new entrants will always be at a cost disadvantage.
a. exploitative
b. cost-based
c. natural
d. strategic
ANSWER: c

116. A natural monopoly exists when

a. the good produced by a monopoly is classified as a natural product.
b. the monopoly-level of market power develops naturally due to the company's high product quality.
c. producing a large output has significantly lower marginal cost than producing a small output.
d. exploitative business tactics are used to force other companies out of the market illegally.
ANSWER: c

117. The basic idea of a natural monopoly is that there is one producer, and new sellers are discouraged from
entering the market because
a. they would have significantly higher marginal costs than the existing seller in the market.
b. there would be legal barriers against entering the market.
c. the current producer has a patent on its product.
d. the current producer is facing a rise in costs due to natural increases in the prices of inputs.
ANSWER: a

118. When a single business can service the entire market demand at a lower cost than several smaller
businesses, the market is
a. an oligopoly.
b. a marginal monopoly.
c. a rational rule monopoly.
d. a natural monopoly.
ANSWER: d

119. In a natural monopoly, what deters new sellers from entering the market?
a. The existing seller has higher costs and profits than what the new entrant will face.
b. Marginal revenue will be higher for new entrants, making profits less probable.
c. The new seller would have much higher costs than the existing large seller in the market.
d. The existing monopolist has long-term contracts with buyers.
ANSWER: c

120. What challenge does a government face when regulating price in a natural monopoly?
a. Natural monopoly prices are not public, and so the government does not know the current price.
b. Costs will fall if the price is reduced, allowing the monopolist to maintain high profits.
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c. There is a net loss in social welfare when a competitive price is imposed on a natural monopoly.
d. Setting a price ceiling at the marginal cost of the last unit sold may cause the seller to have losses.
ANSWER: d

121. If setting the price of a natural monopoly at the socially optimal level would cause the seller to have losses,
the government often ends up
a. not regulating the natural monopoly, allowing it to charge the profit maximizing price.
b. being the provider of the good or service and covering any losses with tax revenue.
c. subsidizing new entrants to create competition that will bring down the price.
d. funding research to bring down the cost of production.
ANSWER: b

122. Market power leads to markets that do NOT have socially optimal results. The _____ is higher and the
_____ is lower than the socially optimal result in perfect competition.
a. total cost; price
b. output; demand
c. price; output
d. demand; total cost
ANSWER: c

123. To avoid harm to society, the government often becomes the supplier of a good or service when the
respective market
a. has high profit, and the government can use those to replace tax revenue.
b. has been engaging in illegal activities that the government seeks to eliminate.
c. would be competitive enough to cause surpluses to develop.
d. would be a natural monopoly, and the good or service is considered essential.
ANSWER: d

124. Sellers who are in _____ markets face a less extreme trade-off between higher prices and higher quantity
than sellers in perfect competition. As a result of this, they can _____.
a. perfectly competitive; increase demand
b. imperfectly competitive; earn higher profits
c. perfectly competitive; gain market power
d. imperfectly competitive; reduce costs
ANSWER: b

125. Imperfectly competitive sellers can earn higher profits because they
a. face a less extreme trade-off between higher prices and higher quantity.
b. tend to have lower cost curves than perfectly competitive sellers.
c. face demand curves that are more elastic.
d. are subject to less government regulation than perfectly competitive sellers.

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ANSWER: a

126. A common strategy for a seller to increase its market power is to

a. raise price.
b. reduce price.
c. differentiate its product.
d. increase output.
ANSWER: c

127. The degree to which a market provides socially optimal outcomes depends on the degree to which it
a. engages in research to develop products to meet needs of customers.
b. differentiates products to satisfy different consumer preferences.
c. focuses on low prices rather than high output.
d. is closer to the competition outcome than market power outcomes.
ANSWER: d

128. How would the discount effect on marginal revenue differ for a seller increasing sales from 100 units to
101 units compared to an increase in sales from 1,000 units to 1,001 units?
a. The discount effect would be the same in both situations and would be less than price.
b. The discount effect would be the same in both situations and would be larger than price.
c. The discount effect would be smaller for a change from 100 to 101 units than 1,000 to 1,001 units.
d. The discount effect would be larger for a change from 100 to 101 units than 1,000 to 1,001 units.
ANSWER: c

129. As the quantity sold rises for a seller in imperfect competition, what happens to the difference between
price and marginal revenue?
a. It remains constant and is equal in size to price.
b. It remains constant and is smaller than price.
c. It gets smaller and smaller.
d. It gets larger and larger.
ANSWER: d

130. How does the slope and placement of the marginal revenue curve compare to the demand curve in
imperfectly competitive markets?
a. The marginal revenue curve is parallel to and above the demand curve.
b. The marginal revenue curve is parallel to and below the demand curve.
c. The marginal revenue curve has a steeper negative slope and is above the demand curve.
d. The marginal revenue curve has a steeper negative slope and is below the demand curve.
ANSWER: d

Essay

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131. How does product differentiation allow a seller to avoid being a price-taker?
ANSWER: Sellers in a perfectly competitive market are price-takers because they all produce the same product.
There is no variation in the product from seller to seller. Because of this, sellers charge the market
equilibrium price and consumers pay the lowest price possible. If the seller tries to charge more than
the going market price, the buyers will purchase from other sellers. In this case, the sellers are
referred to as price-takers because they take, or accept, the going market price.
If a seller were to differentiate his product by varying its features or customer service in ways that
are attractive to consumers, then some buyers might be willing to pay more. The extent to which a
seller can charge a higher price without losing customers is the seller's market power or his ability to
avoid being a price-taker.

132. Describe the two main sources of market power.

ANSWER: The two sources that determine market power are the number of competitors and the degree to
which a product is differentiated. If a market has a large number of sellers, then the degree of market
power is limited. No seller is large enough to influence the market price. When there are few sellers
in a market, some of them will produce a significant share of the output. In this case, if a seller
reduces output he can charge a higher price and exercise market power.
Product differentiation is the other main source of market power. When identical products are
sold, the sellers charge the market price or lose all the customers. Successful differentiation allows a
seller to charge a higher price without losing customers because some customers prefer the
differentiated product. The extent to which the seller can differentiate his product and sell for a
higher price determines the seller's market power.

133. Why are most markets considered to be imperfectly competitive markets?

ANSWER: Imperfectly competitive markets have two defining characteristics — more than one seller and
product differentiation. A monopoly is rare because significant profits would attract new entrants
into the industry that would erode the profits. Furthermore, advances in technology and the
development of new products change barriers to entry for a monopoly market as well. Thus few
monopoly markets exist for long.
In any market with more than one seller, there is an incentive for the sellers to differentiate their
products. This is the key to each seller's ability to reduce the elasticity of demand for their product
and charge a higher price without losing customers many customers. Sellers in a perfectly
competitive market cannot make profits. Their key to changing that is to successfully differentiate
the product. Most markets have differentiated products and more than one seller and are considered
imperfectly competitive.

134. Imperfect competition puts company owners in a position to accomplish different outcomes than perfect
competition. Identify five insights about companies operating in imperfectly competitive markets.
ANSWER: Operating a company under imperfect competition is different than operating under perfect
competition or monopoly. Five key insights into these differences are:
- Market power allows a company to choose the price that will be best for that company. It does not
need to accept the market price.
- The greater the number of competitors, the less the market power.
- Successful product differentiation leads to market power.
- Buyers can also have market power. Imperfect competition among buyers provides them with
bargaining power.

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- A company's best choice depends on the actions that other businesses take. The smaller the number
of companies, the more pronounced this dependency becomes.

135. What impact does the extent of a seller's market power have on the seller's demand curve?
ANSWER: The greater a seller's market power, the less impact a price increase has on the quantity demanded
by buyers. This means that the demand is less elastic. The slope of the demand curve will have a
steeper negative slope as a seller's market power increases.

136. Why does marginal revenue differ from price in imperfectly competitive markets?
ANSWER: Marginal revenue is the change in total revenue that a firm has from selling one additional unit of
output. Firms in imperfectly competitive markets face downward-sloping demand curves. They
must lower price to sell additional units of their product. Thus, when they sell an additional unit of
output, they have extra revenue from selling a larger quantity, but they must lower the price of their
output to attract the extra buyer. Marginal revenue ends up being less than price because of this. The
change in revenue stems from the output effect (the price of the extra item sold) minus the discount
effect (the price cut on all the units sold). The discount effect is what causes marginal revenue to be
less than the price.

137. As a company sells more and more, what happens to the balance between the discount effect and the
output effect in determining marginal revenue?
ANSWER: Both the discount effect and the output effect deal with the change in total revenue from selling one
more unit (marginal revenue). The discount effect is the impact on revenue due to the fact that price
must be lowered to attract an additional buyer. The price is lowered for all units sold, not just the
additional unit. The output effect is the extra revenue from the price obtained from selling a higher
quantity (the extra unit). As the quantity sold rises, the output effect reflects the price of one more
unit with each additional unit sold. The discount effect intensifies as the quantity sold rises because
the price reduction applies to a larger and larger total quantity being sold. For example, if price must
be reduced by $1 to sell an additional unit, then when the fifth unit is sold, the discount effect would
be a negative $5 (stemming from a $1 price reduction on five units), but for the tenth unit sold, the
discount effect would be a negative $10 (stemming from a $1 price reduction on 10 units).

138. What is the Rational Rule for Sellers, and how does it help sellers earn as much profit as possible?
ANSWER: The Rational Rule for Sellers is to sell one more item if the marginal cost is less than (or equal to)
marginal revenue. If producing and selling one more unit adds more to revenue than it adds to costs,
and the profit will increase. If producing and selling one more unit were to add more to costs than to
revenues, the seller will lose. If sellers use the rational rule, they would produce and sell every unit
that adds more to revenue than to costs, meaning they would produce those units that add to profits.
The marginal revenue curve is based on the demand curve. While, the rational rule determines the
output based on marginal cost and marginal revenue, but that specific marginal revenue is based on
the firm charging the price on the demand curve for that output.

139. Describe the negative impacts of market power.

ANSWER: Firms with downward-sloping demand curves have varying degrees of market power. When sellers
maximize profits, the results in these markets are not socially optimal. The degree of market power
affects the level of these negative outcomes, which include higher prices, an inefficiently small
output, larger economic profits, and higher costs. With higher prices and larger profits, buyers lose.
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Costs are higher costs as sellers differentiate products. The pressure to keep costs down is low since
the price is higher than the marginal cost. The smaller output is inefficient because the price does
not equal the marginal cost. This means that the marginal benefit to the last consumer (which is the
price paid) is greater than the extra cost that would be incurred to produce an additional unit.

140. Why is the output in a market where sellers have market power considered to be an inefficient output?
ANSWER: In a market where sellers have market power, the sellers face downward-sloping demand curves
with the marginal revenue below price. Sellers choose the output level where marginal revenue
equals marginal cost and then choose the price on the demand curve for that output. This means that
price is greater than marginal cost. The price on the demand curve conveys the marginal benefit to
the last buyer who purchases the product at that price. When price is above marginal cost, the
marginal benefit to buyers overall exceeds the marginal cost of producing an additional unit of the
product, indicating that additional production would be an efficient use of resources. However,
company owners will not produce this additional output because marginal cost would exceed their
marginal revenue. Thus, from a consumer or societal perspective, the output is inefficiently small
and some net gain to buyers is missed.

141. What is the difference between being a monopoly and monopolizing? Why is one legal and the other
illegal?
ANSWER: A monopoly exists when there is only one supplier in a market who has a lot of market power.
Monopolizing is the process of gaining market power or becoming a monopoly through the use of
business practices that are unfair and illegal because they exclude other sellers or prey on them.
Thus, being a monopoly is legal, but monopolizing is illegal. A seller could become a monopoly
legally if it gains its market power through legal practices such as producing a product that is
preferred by customers. However, if it engages in monopolization practices, it is breaking U.S. law.

142. What policy approaches are used by governments to encourage competition?

ANSWER: Suggested Answer:
feedbackGovernments want to ensure that competition flourishes as it provides an efficient outcome
compared to other market structures. However, free markets typically develop to be imperfectly
competitive, and so governments often adopt policies to encourage competition. Four main policy
approaches are used to do this:
· Laws to ban collusion: Collusion refers to agreements made between companies to act
collectively in an attempt to earn monopoly profits.
· Laws to prevent mergers that threaten competition: When a merger occurs, a market ends up
with one less seller. If this significantly increases market power, the merger would reduce
competition.
· Laws to ban abusive use of market power: Sometimes sellers try to gain advantages over other
sellers or push other sellers out of a market through practices that are considered unfair or
exploitative. Gaining market power through these practices is illegal in many countries.
· Encouraging international trade: When a country is engaged in international trade, the number
of sellers and consumers in its product markets is not limited to only domestic producers and
consumers. There are more sellers and more consumers, which creates a more competitive
environment.

143. How can international trade increase the level of competition in a product market in a country when there
are only three producers of the product in that country?
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ANSWER: If a country does not engage in international trade, product markets consist of only domestic
consumers and producers. In this example, with only three domestic producers, the market would be
an oligopoly, and the three producers would have significant market power. Prices would be high
than in a more competitive market.
If this country opens its borders to international trade, foreign producers will sell the product at
lower prices. Consumers can buy from both domestic and foreign producers. Domestic producers
will feel the pressure to match the lower price offerings, cutting into their market power. Domestic
producers can sell their products abroad if they can offer it at prices attractive to foreign buyers.
With more sellers and potentially more buyers, the market will be more competitive.

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Multiple Choice

1. Total revenue minus expenses paid equals:

a. economic profit.
b. cost-adjusted revenue.
c. accounting profit.
d. financial revenue.
ANSWER: c

2. Max earns a yearly salary of $120,000 per year from his job and $1,000 per year in interest on his savings.
After he quits his job to start a company, he uses all his savings to purchase manufacturing equipment for his
company. Given the above information and the data summarizing his first year in business in the table, how
much economic profit or loss does Max earn?

a. $4,000
b. $5,000
c. $125,000
d. $126,000
ANSWER: a

3. Malia earns a yearly salary of $130,000 in her job and earns $1,000 per year in interest on her savings. After
she quits her job to start a company, she uses all her savings to purchase manufacturing equipment for her
company. Given the above information and the data summarizing her first year in business in the table, how
much economic profit or loss does Malia earn?

a. $19,000
b. $21,000
c. $219,000
d. $171,000
ANSWER: a

4. Juan earns a yearly salary of $120,000 in his job and $1,000 per year in interest on his savings. After he quits
his job to start a company, he uses all his savings to purchase manufacturing equipment for his company. Given
the above information and the data summarizing his first year in business in the table, how much accounting
profit or loss does Juan earn?

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a. $4,000
b. $5,000
c. $125,000
d. $126,000
ANSWER: c

5. Junko earns a yearly salary of $130,000 in her job and $1,000 per year in interest on her savings. After she
quits her job to start a company, she uses all her savings to purchase manufacturing equipment for her company.
Given the above information and the data summarizing her first year in business in the table, how much
accounting profit or loss does Junko earn?

a. $19,000
b. $21,000
c. $150,000
d. $171,000
ANSWER: c

6. The formula for calculating accounting profit is total revenue minus _____ costs.
a. explicit financial
b. total
c. opportunity
d. explicit financial costs minus implicit opportunity
ANSWER: a

7. Implicit opportunity costs of running a business include:

a. bills that a company pays.
b. debt that a company has accumulated during the year.
c. earnings that are given up in order for the owner to start or run a business.
d. the imagined costs of inputs that a company buys at a discount.
ANSWER: c

8. The two main types of implicit opportunity costs are:

a. bills paid and revenue forgone.
b. bills paid and forgone wages.
c. earned wages and earned interest.

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d. forgone wages and forgone interest.

ANSWER: d

9. Corinne is offered a job with a salary of $70,000, which she turns down to start her own business. She uses
$20,000 of her own savings to help start the business, savings that had been providing her a return of $1,000 per
year. Over her first year in business, Corinne collects total revenue of $180,000 and must cover explicit costs of
$105,000. During her first year in business, Corinne's accounting profit is _____, and her economic profit is
_____.
a. $110,000; $4,000
b. $75,000; $4,000
c. $75,000; –$16,000
d. $110,000; –$16,000
ANSWER: b

10. What is the difference between accounting profit and economic profit?
a. fixed costs
b. marginal costs
c. explicit financial costs
d. implicit opportunity costs
ANSWER: d

11. How do a company's accounting profit and economic profit compare in size?
a. Accounting profit is larger than economic profit, if there are implicit costs.
b. Economic profit is larger than accounting profit, if there are implicit costs.
c. They are equal in size, regardless of whether there are implicit costs.
d. Economic profit is larger when the firm has losses, and accounting is larger when there are profits.
ANSWER: a

12. Which of the following statements is true?

a. A firm with accounting profits will also have economic profits.
b. A firm with economic losses will also have accounting losses.
c. A firm with economic profits will also have accounting profits.
d. A firm with accounting losses can also have economic profits.
ANSWER: c

13. Amal gives up a salary of $80,000 per year to start his company. He invests $50,000 of his savings in his
company, savings that had been earning him $4,000 per year in interest. During Amal's first year in business,
total revenue is $300,000, and his explicit financial costs are $225,000. What is Amal's economic profit from
his first year in business?
a. –$59.000
b. –$9,000
c. $71,000
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d. $75,000
ANSWER: b

14. Luana gives up a salary of $80,000 per year to start her company. She invests $50,000 of her savings in her
company, savings that had been earning her $4,000 per year in interest. During Luana's first year in business,
total revenue is $300,000, and her explicit financial costs are $225,000. What is Luana's accounting profit from
her first year in business?
a. –$59.000
b. –$9,000
c. $71,000
d. $75,000
ANSWER: d

15. If a business owner is maximizing their economic profit, the owner:

a. might be suffering accounting losses.
b. cannot have any implicit opportunity costs.
c. is better off financially than with any other use of the resources used in the business.
d. has implicit opportunity costs that are larger than the direct financial costs.
ANSWER: c

16. Because _____ profit is calculated based on _____ costs, it allows firm owners to make better decisions
about _____.
a. economic; total; entering and exiting a market
b. accounting; total; increasing or decreasing output
c. economic; implicit opportunity; increasing or decreasing output
d. accounting; implicit opportunity; entering and exiting a market
ANSWER: a

17. John is thinking of opening a florist shop. He forecasts revenues of $200,000 per year and explicit financial
costs of $140,000 per year. He can pursue this opportunity only if he quits his current job as a driver, where he
earns $45,000 per year. He would also need to invest $110,000 of his savings to set up the shop—funds on
which he would otherwise be earning a 6% return. Based on this information, how much economic profit or loss
would John earn in his first year in business?
a. a loss of $50,000
b. a loss of $5,400
c. a profit of $8,400
d. a profit of $60,000
ANSWER: c

18. Maia is thinking of opening a restaurant. She forecasts revenues of $200,000 per year and explicit financial
costs of $140,000 per year. She can pursue this opportunity only if she quits her current job as a hair stylist,
where she earns $45,000 per year. She would also need to invest $110,000 of her savings to set up the
restaurant—funds on which she would otherwise be earning a 6% return. Based on this information, what are
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Maia's implicit opportunity costs?
a. $6,600
b. $51,600
c. $155,000
d. $161,600
ANSWER: b

19. Neville is a lawyer at a large law firm where he earns a salary of $170,000 per year. He is thinking of
leaving the firm to set up his own law office. To do this, he would need to invest $140,000 of his savings, which
currently earns 5% in interest each year. He estimates that if he starts a law office, his annual revenue will be
$510,000, and his explicit financial costs will be $300,000. How much would Neville earn in economic profits
or losses if he starts his own law office?
a. –$100,000
b. $33,000
c. $203,000
d. $210,000
ANSWER: b

20. Portia is graduating from dental school and has a job offer with a salary of $140,000 from a chain of dental
clinics. However, she wants to set up her own dental practice instead. To do this, she would need to invest her
own funds in new equipment that would cost $80,000—funds that have been earning her a return of 10% per
year. Portia estimates that her practice would have revenue of $470,000 per year and annual explicit financial
costs of $330,000. What would Portia's economic profit or loss be if she sets up her own practice?
a. a loss of $80,000
b. a loss of $8,000
c. a profit of $132,000
d. a profit of $322,000
ANSWER: b

21. How does a business owner know if it is financially worthwhile to open a business?
a. The implicit opportunity costs are less than revenue.
b. There are no implicit opportunity costs.
c. The business earns accounting profits.
d. The business earns economic profits.
ANSWER: d

22. Mario's company definitely has economic losses in which of the following situations?
a. Total costs exceed total revenue.
b. Implicit opportunity costs exceed direct financial costs.
c. Total revenue exceeds direct financial costs.
d. Total revenue exceeds implicit opportunity costs.
ANSWER: a
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23. Marta's company definitely has economic profits in which of the following situations?
a. Implicit opportunity costs are less than direct financial costs.
b. Total revenue is less than direct financial costs.
c. Total costs are less than total revenue.
d. Total revenue exceeds implicit opportunity costs.
ANSWER: c

24. Total revenue divided by the quantity sold equals:

a. marginal revenue.
b. price.
c. medium revenue.
d. profit.
ANSWER: b

25. Price is equal to:

a. marginal revenue divided by the quantity sold.
b. total revenue divided by average revenue.
c. total revenue divided by the quantity sold.
d. the quantity sold divided by total revenue.
ANSWER: c

26. Total revenue divided by quantity is called _____ or _____.

a. average revenue; profit
b. price; marginal revenue
c. price; profit
d. average revenue; price
ANSWER: d

27. A firm's average revenue curve is:

a. horizontal.
b. above the firm's demand curve.
c. below the firm's demand curve.
d. the same as the firm's demand curve.
ANSWER: d

28. Average cost equals:

a. price.
b. the cost of producing one additional unit.
c. total cost divided by output.
d. total revenue divided by quantity.
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ANSWER: c

29. Samuel's company is in the following situation:

What is the price at Samuel's company?

a. $14.37
b. $5.63
c. $34.37
d. $20.00
ANSWER: d

30. Samuel's company is in the following situation:

What is the average cost at Samuel's company?

a. $14.37
b. $5.63
c. $34.37
d. $20.00
ANSWER: a

31. Which of the following statements is FALSE regarding total costs?

a. Total costs are equal to fixed costs plus variable costs.
b. Total costs are equal to direct financial costs plus implicit opportunity costs.
c. Total costs minus fixed costs equals average cost.
d. Total costs divided by output equals average cost.
ANSWER: c

32. (Figure: Average Cost Curve) Which curve below has the most common shape of an average cost curve?

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a. Curve A
b. Curve B
c. Curve C
d. Curve D
ANSWER: b

33. What happens to average fixed costs as output rises?

a. They follow an unpredictable pattern.
b. They hold steady.
c. They rise.
d. They diminish.
ANSWER: d

34. As output increases, fixed costs:

a. rise.
b. fall.
c. remain constant.
d. fall and then rise.
ANSWER: c

35. As output rises, average fixed costs:

a. rise.
b. fall.
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c. remain constant.
d. fall and then rise.
ANSWER: b

36. Beginning at an output of one, as output increases, average variable costs:

a. rise.
b. fall.
c. remain constant.
d. fall and then rise.
ANSWER: d

37. Why do average variable costs eventually rise if a company's output increases enough?
a. The diminishing marginal revenue triggers increased use of resources.
b. The reduction in average fixed costs must be offset by increasing variable costs.
c. Diminishing marginal product occurs, causing average variable costs to rise.
d. The price paid for each unit of input keeps rising.
ANSWER: c

38. A company's profit margin per unit sold equals:

a. total cost minus total revenue.
b. total revenue minus total cost.
c. average cost minus price.
d. price minus average cost.
ANSWER: d

39. A company's profit margin is calculated as:

a. price minus total cost.
b. average revenue minus average cost.
c. price minus average direct financial costs.
d. average revenue minus total cost.
ANSWER: b

40. The table provides daily data on Marla's Smoothie Shop. Use these data to answer the question.

What is Marla's profit margin?

a. $5.00
b. $4.50

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c. $3.50
d. $2.50
ANSWER: d

41. The table provides daily data on Artem's Sandwich Shop. Use these data to answer the question.

What is Artem's profit margin?

a. $1
b. $2
c. $7
d. $8
ANSWER: a

42. If your company has losses, then its:

a. average revenue exceeds its costs.
b. profit margin is positive.
c. average cost falls short of price.
d. profit margin is negative.
ANSWER: d

43. Total profit equals:

a. price multiplied by quantity.
b. total cost minus total revenue.
c. the profit margin multiplied by quantity.
d. marginal revenue minus total cost.
ANSWER: c

44. On a graph of a company's cost, revenue, and demand curves, the company's profit margin can be identified
as the gap between _____ and _____ for a given quantity.
a. price; marginal revenue
b. price; average cost
c. marginal revenue; marginal cost
d. marginal revenue; average cost
ANSWER: b

45. (Figure: Profit Margin) What is the profit margin for this firm if it produces a quantity of six?

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a. $7 – $4 = $3
b. $5 – $4 = $1
c. $7 – $2 = $5
d. $5 – $2 = $3
ANSWER: a

46. (Figure: Profit Margin 2) What is the profit margin for this firm at a quantity of eight?

a. $6.00 – $3.00 = $3.00

b. $6.00 – $3.50 = $2.50
c. $3.50 – $3.00 = $.50

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d. $3.50 – $6.00 = $2.50

ANSWER: b

47. (Figure: Profit Margin 3) JoJo's company data is in the graph below. JoJo would earn a profit:

a. only at an output of nine.

b. at all output levels.
c. at any output between eight and 18.
d. at any output between three and 14.
ANSWER: d

48. Candice's stand-up paddleboard company will earn profits producing and selling at any output level where
the company's:
a. marginal cost curve is above its demand curve.
b. average cost curve is above its marginal revenue curve.
c. demand curve is above its average cost curve.
d. marginal revenue curve is below its average cost curve.
ANSWER: c

49. In the short run, companies face _____, and in the long run, _____.
a. a changing number of competitors; the number of competitors is fixed
b. a fixed set of competitors; the number of competitors can change
c. variation in all costs; all costs are fixed
d. only fixed costs; all costs vary
ANSWER: b

50. How long does it take for a company to be in the long run?
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a. It takes as long as is needed for the number of sellers in the company's market to increase or
decrease.
b. It is any time period longer than one year.
c. It takes as long as is needed for the prices of inputs to vary.
d. It is any time period longer than two years.
ANSWER: a

51. What attracts new sellers into a market?

a. A large number of sellers already in the market.
b. A market that has not changed in several years.
c. Fewer sellers in the market than a year previously.
d. Existing sellers in the market earning economic profits.
ANSWER: d

52. When sellers in a market earn economic profits:

a. average costs must be falling.
b. marginal revenue is above price.
c. new sellers will be attracted into the market.
d. marginal cost is above average revenue.
ANSWER: c

53. The Rational Rule for Entry says that a seller should enter a market when:
a. price exceeds average cost.
b. the number of sellers in the market is falling.
c. marginal revenue is below average cost.
d. average cost exceeds average revenue.
ANSWER: a

54. Marcella is deciding whether to start a bakery in her hometown. She should start it if she expects that:
a. her marginal revenue will be below her marginal cost.
b. her average revenue will exceed her average cost.
c. the average cost curve will shift downward.
d. the number of bakeries will soon decrease.
ANSWER: b

55. Adhika is deciding whether to open a company to produce step stools. He should start the company if he
expects that:
a. the number of step stool manufacturers will soon decrease.
b. the average cost curve will shift downward.
c. his price will exceed his average cost.
d. his marginal revenue will be below his average cost.
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ANSWER: c

56. Almira is a chocolatier with a small chocolate shop. There are three other chocolatiers in her city. Almira
should be concerned that new companies will enter her city's chocolate market and take away some of her
customers if the average chocolatier in her city:
a. has average revenue that is below average cost.
b. has marginal revenue that is below price.
c. is facing rising costs.
d. is earning economic profits.
ANSWER: d

57. Carlos owns one of the 30 lawn mowing businesses in his city. What will happen to his business if there are
new entrants into his city's lawn mowing market?
a. Carlos's marginal cost will fall.
b. Carlos's marginal cost will rise.
c. The demand for Carlos's services will rise.
d. The demand for Carlos's services will fall.
ANSWER: d

58. If a new company enters a product market, what will happen to the existing companies in the market?
a. Their average cost curves will shift up.
b. Their marginal revenue curves will shift to the right.
c. Their demand curves will shift to the left.
d. Their demand curves will shift to the right.
ANSWER: c

59. Sellers in a market will become less profitable when:

a. new sellers enter the market.
b. marginal cost falls.
c. average revenue rises.
d. market demand rises.
ANSWER: a

60. When there are new entrants into a market, an existing seller will NOT face:
a. decreased demand.
b. lower profits.
c. upwardly shifting cost curves.
d. customers with more choices.
ANSWER: c

61. When new sellers enter a market, existing sellers will:

a. have less market power.
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b. face reductions in average cost.

c. see average revenue rise.
d. face upward shifts in their average cost curves.
ANSWER: a

62. Ari owns a hair salon in a small city. Which of the following is NOT an effect that the opening of new hair
salons in her city will have on her salon?
a. Its profit will decrease.
b. It will have less market power.
c. The quantity it sells will decrease.
d. Its cost curves will shift upward.
ANSWER: d

63. When sellers exit a market in which the average seller has losses, what results?
a. The sellers that exit avoid the losses that the remaining market sellers continue to suffer.
b. The losses shrink or disappear as the market demand is spread over a smaller number of sellers.
c. The market demand shrinks as consumers avoid struggling sellers.
d. The remaining sellers have higher demand but also face cost curves that shift upward.
ANSWER: b

64. Victor owns a shoe store that is losing money, and several other shoe stores in his market are also losing
money. Which of the following guidelines will help him decide whether to remain in business or exit the
market?
a. Remain in the market only if average costs are greater than average revenue.
b. Remain in the market only if average costs exceed marginal revenue.
c. Exit the market if price is expected to be less than average costs.
d. Exit the market if price is less than average revenue.
ANSWER: c

65. Which of the following does NOT occur in a market when one or more sellers exits the market?
a. The remaining sellers' demand curves shift to the right.
b. The remaining sellers have more market power.
c. The market demand rises.
d. The market price rises.
ANSWER: c

66. Jane is one of 10 chiropractors in her city. Demand for chiropractic services is low enough that all
chiropractors in the city are suffering losses. After three chiropractors close their practices, which of the
following changes does Jane's practice NOT experience?
a. Its price falls.
b. It loses market power.
c. Its demand curve shifts to the right.
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d. It sells more chiropractic services.

ANSWER: b

67. When sellers exit a market due to losses, the:

a. remaining sellers face reduced demand.
b. amount of market power in the market rises.
c. market demand holds steady.
d. market price falls.
ANSWER: b

68. When sellers exit a market in which the average seller has losses, the remaining sellers will each experience:
a. a rising price, higher sales, and increased market power.
b. a rising price, lower sales, and increased market power.
c. a steady price, higher sales, and decreased market power.
d. a steady price, lower sales, and decreased market power.
ANSWER: a

69. Which of the following is FALSE?

a. If an industry is profitable, new entrants will be attracted to it.
b. If an industry has losses, competition will decline as sellers exit.
c. When sellers exit an industry, market power will fall for the remaining sellers.
d. When sellers enter an industry, market price will fall.
ANSWER: c

70. When a market has free entry and exit, in the long run, sellers:
a. tend to leave the market.
b. suffer economic losses.
c. have positive profits.
d. have zero economic profits.
ANSWER: d

71. When firms in a market with free entry and exit have economic profits, then:
a. some companies will exit the market, reducing average company profits.
b. new companies will enter the market, reducing average company profits.
c. some companies will exit the market, raising average company profits.
d. new companies will enter the market, raising average company profits.
ANSWER: b

72. When firms in a market with free entry and exit experience economic losses, then:
a. some sellers will exit the market, reducing average seller losses.
b. new sellers will enter the market, reducing average seller losses.
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c. some sellers will exit the market, raising average seller losses.
d. new sellers will enter the market, raising average seller losses.
ANSWER: a

73. When there is free entry and exit of sellers in an industry, in the long run, sellers will have:
a. positive economic profits.
b. economic losses.
c. zero economic profits.
d. enhanced market power.
ANSWER: c

74. Free entry into a market tends to cause _____ to disappear.

a. desirable opportunities
b. low prices
c. product quality
d. freedom
ANSWER: a

75. Free entry and exit means that in the long run, price will:
a. trend upward.
b. trend downward.
c. equal average cost.
d. allow all firms to earn economic profit.
ANSWER: c

76. Assume that there is free entry and exit in the management consulting market. How profitable can Mario
expect his new consulting business to be in the long run?
a. It will experience continually rising economic profits.
b. It will suffer economic losses.
c. It will earn positive economic profits.
d. It will experience zero economic profits.
ANSWER: d

77. When there is free entry and exit in a market, in the long run, price will:
a. keep rising.
b. keep falling.
c. never change.
d. equal average cost.
ANSWER: d

78. When the typical seller in a market suffers economic losses, then:
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a. new sellers will enter the market.

b. some sellers will exit the market.
c. the number of sellers will remain steady.
d. the market will disappear.
ANSWER: b

79. When the typical seller in a market has economic profits, then:
a. new sellers will enter the market.
b. some sellers will exit the market.
c. the number of sellers will remain steady.
d. the market will disappear.
ANSWER: a

80. What is the dominant factor determining market price in the long run?
a. average costs
b. the profit level
c. the prices of inputs
d. the number of sellers in the market
ANSWER: a

81. When free entry and free exit exist in a market, then in the long run, a seller's demand curve will:
a. barely touch its average cost curve.
b. be below its average cost curve.
c. be above its average cost curve.
d. cross its average cost curve.
ANSWER: a

82. (Figure: Demand and Average Cost Curves) Which of the following diagrams represents the demand and
average cost curves of a firm in the long run, given free entry and exit?

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a. Firm A
b. Firm B
c. Firm C
d. Firm D
ANSWER: d

83. In the long run, a company's ability to maintain profits depends on:
a. low costs.
b. high demand.
c. barriers to entry.
d. marginal costs.
ANSWER: c

84. In the long run, a company can remain profitable only if:
a. it has a higher company demand than the market demand.
b. it has lower costs than the average company in the market.
c. the market demand is rising.
d. barriers to entry are present.
ANSWER: d

85. _____ allow a profitable company to maintain profits over time.

a. Barriers to entry
b. Cost-saving initiatives
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c. Free entry and exit conditions

d. Reverse profit margins
ANSWER: a

86. Creating _____ to _____ is key to a company's ability to earn profits in the long run.
a. network effects; reduce costs
b. marginal revenue; increase demand
c. barriers to entry; deter new entrants
d. reduced barriers to entry; raise profit margins
ANSWER: c

87. A company produces a particular cell phone that requires accessories (such as chargers, cases, and ear
plugs) that are specific to that phone and cannot be used with phones manufactured by other companies. The
company that produces this cell phone is using what strategy to create a barrier to entry?
a. Creating cost advantages.
b. Controlling the markets for key inputs needed by all firms in the product market.
c. Intimidating rivals.
d. Increasing switching costs to ensure demand for its product.
ANSWER: d

88. Which of the following is NOT a strategy used by a company to "lock-in" customers to ensure demand for
its product?
a. Increasing switching costs.
b. Generating positive network effects.
c. Pressuring the government to require a license for entry into the market
d. Building goodwill and loyalty among customers.
ANSWER: c

89. Why are reputation and customer loyalty important to a company?

a. They raise the market demand for a product.
b. They raise the cost to customers if they switch to another provider.
c. They render the company less likely to lose customers to new firms entering the market.
d. They encourage excellence in the industry, raising customer satisfaction across companies.
ANSWER: c

90. When a product is characterized by network effects, then the product _____ when more customers use the
product.
a. becomes more valuable to each customer
b. is compatible with more and more other products
c. drops in price
d. is sold to other companies or organizations that have a group of customers.

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ANSWER: a

91. A cable TV company gives current customers a year-long discount for each new customer they bring to the
cable company. Jose, a current customer, gets five of his friends to sign up for cable TV service with his
provider so that he can receive discounts on his cable bill. The cable TV company is using a _____ strategy to
create a barrier to entry.
a. free exit
b. reputation and goodwill
c. switching cost
d. network effect
ANSWER: d

92. Sellers try to avoid the entry of new rivals through the use of demand-side strategies. These demand-side
strategies do NOT include:
a. raising the market demand for the product.
b. raising the cost that customers face when they switch to a new seller of the product.
c. generating network effects.
d. building a good reputation with customers who are loyal.
ANSWER: a

93. When a seller raises the switching costs of its customers:

a. the seller's costs of production switch between custom production and mass production as the
number of customer changes.
b. customers are discouraged from using the company's product because the company keeps creating
new versions of the product.
c. it attracts customers by having a low initial price, but then customers must pay extra when they
actually switch the product on to use it.
d. its customers find it difficult or costly to switch to a different seller of the product.
ANSWER: d

94. When a seller uses a demand-side strategy to create barriers to entry, the seller is trying to:
a. increase market demand so that there are extra customers for the new entrants.
b. ensure that new entrants face higher cost curves.
c. encourage the government to use regulations to discourage new entrants.
d. prevent new entrants from attracting any of the seller's customers.
ANSWER: d

95. If a seller can create switching costs for its product, then:
a. it is difficult or costly for the seller to switch to producing a different product.
b. it is difficult or costly for customers to switch to another seller of the product.
c. customers will find it more costly to stay with the company than to switch to another seller.
d. it increases its costs by producing several versions of the product so customers can switch between
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versions.
ANSWER: b

96. A seller strives to achieve consistently high quality in all its output so that customers can trust that they will
be pleased with the product. Building a reputation for high quality is consistent with a seller trying to _____
through _____ strategy.
a. build a network; an entry deterrence
b. proliferate brands; a supply-side
c. raise switching costs; an entrepreneurial
d. create customer lock-in; a demand-side
ANSWER: d

97. Where there are short-run profits, new competitors will enter the market until:
a. the minimum average cost is achieved.
b. demand increases.
c. economic profits are zero.
d. losses are incurred.
ANSWER: c

98. When the average across all sellers in a market is zero economic profit, the profit level of each seller:
a. will be zero economic profit.
b. may vary some across the sellers, with some earning profits and others experiencing losses.
c. may vary across sellers, with some earning profits but none suffering losses.
d. may vary across sellers, with some earning zero profits or losses but none earning profits.
ANSWER: b

99. If a seller can develop large enough _____ compared to other sellers in the market, this will deter the entry
of new sellers.
a. cost advantages
b. marginal costs
c. competitive forces
d. costs
ANSWER: a

100. In which of the following situations would a seller be better able to survive a price war than other sellers in
a given market?
a. The seller has lower marginal revenue than other sellers in the market.
b. The seller has lower switching costs than other sellers in the market.
c. The seller has lower demand than other sellers in the market.
d. The seller has cost curves that are lower than those of other sellers in the market.
ANSWER: d

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101. If Elise's company is achieving cost advantages over rivals, it can maintain these advantages only if:
a. they are unique and cannot be copied by other companies.
b. they relate to marginal costs rather than average costs.
c. the company is producing an identical product rather than a differentiated product.
d. the company faces a steady demand.
ANSWER: a

102. Ever since Giselle's company developed its new product ten years ago, Giselle has managed its production
with little turnover in workers. During that time, the company's average cost has fallen by 30%, due to the
refinement of its production methods, thereby achieving greater efficiency. Other rival companies have not
achieved such low costs. The cost advantage that Giselle's company now has over rivals is referred to as _____
achieved through _____.
a. marginal cost reduction; long-term production
b. a key input price reduction; unique cost advantages
c. a unique cost advantage; learning by doing
d. mass production; key input price reduction
ANSWER: c

103. "Learning by doing" can result in _____ for a company.

a. unique cost advantages
b. increased product demand
c. higher switching costs
d. lobbying gains
ANSWER: a

104. Over time, Paco's Pie Shop has developed a pie crust that cooks more rapidly than the crusts of other
bakers and a filling that uses less costly inputs while maintaining comparable customer appeal. Other bakers
have tried but failed to duplicate Paco's two cost advantages. Knowing that they will need to compete against
Paco's Pie Shop, potential new entrants will:
a. cut corners on pie quality to reduce demand.
b. have less potential demand because of increased costs.
c. be discouraged from entering, owing to the advantages Paco's has achieved.
d. have free entry into but not free exit from the market.
ANSWER: c

105. Mass production typically creates:

a. higher demand.
b. cost disadvantages.
c. lower demand.
d. cost advantages.
ANSWER: d

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106. Which of the following is NOT one of the ways companies create barriers to entry through unique cost
advantages?
a. advantageous relationships with suppliers
b. mass production
c. regulations
d. learning by doing
ANSWER: c

107. When market leaders produce on a mass scale, new entrants:

a. can easily compete.
b. have a hard time competing.
c. have higher switching costs.
d. have lower switching costs.
ANSWER: b

108. Which of the following strategies would allow a seller to develop unique cost advantages to create a barrier
to new sellers entering its market?
a. Gain market power as a buyer in a critical input market.
b. Convince the government to require licenses to enter the market.
c. Add switching costs to lock in customers.
d. Use brand proliferation to cover all market niches.
ANSWER: a

109. How can a company's research and development expenditures create a barrier to entry into its market?
a. It increases switching costs, which means companies cannot change production techniques.
b. It generates larger network effects for the product.
c. It prevents learning by doing, which keeps consumers from learning about new options.
d. It can result in new production technologies that reduce the cost of production.
ANSWER: d

110. If a company gains market power as an input buyer, then:

a. the company may be able to purchase inputs at lower prices than other companies who use the same
inputs can.
b. the company can set its product price without losing customers.
c. new entry into the industry will be more likely because inputs are available.
d. network effects will result, discouraging new entry into the market.
ANSWER: a

111. Michelle owns the largest florist shop in her town. Each week, she orders a truckload of flowers from the
flower wholesaler. The other two florists in town order only one-third as many flowers. Because Michelle's
order fills the delivery truck, the wholesaler sells flowers to her at a lower price than the other florists must pay.
How will this situation impact potential new entrants?
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a. New florists will be encouraged to enter because they will be energized by the challenge to succeed.
b. The cost differential can easily be offset by creating a demand differential, so it will have little
impact.
c. New florists will not be affected because input prices are minor factors in markets.
d. New florists will be discouraged from entering the market because of the difficulty of competing on
cost.
ANSWER: d

112. A government may want to create barriers to sellers entering a given market for all of the following
reasons EXCEPT:
a. encouraging research and development by offering patents on new inventions and technologies.
b. ensuring that sellers provide products and services that are safe for consumers.
c. increasing the market demand for a product so that all sellers enjoy higher demand.
d. keeping average cost low when there is a natural monopoly.
ANSWER: c

113. Many governments require companies that produce drugs to obtain government approval before selling a
new drug. This is done to _____, and it leads to _____ in the market for the new drug.
a. ensure public safety; a barrier to entry
b. create network effects; a barrier to exit
c. reduce production costs; a lower equilibrium price
d. meet consumer needs; greater drug availability
ANSWER: a

114. When the government requires a license or government approval for a company to produce and sell a
product, then in the market for that product:
a. the price will be lower.
b. demand must be strong.
c. companies are using a supply-side strategy.
d. there will be fewer sellers.
ANSWER: d

115. When a government is concerned about the safety of the product for sale in a given market, often the
government:
a. taxes producers.
b. creates networks of consumers.
c. imposes regulations on the product or providers.
d. raises the switching costs for consumers of the product.
ANSWER: c

116. All of the following government policies would create a barrier to entry in a market EXCEPT:
a. a requirement that only companies with a license to produce the specific product can sell it.
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b. a requirement that all versions of the product for sale are subject to extensive safety testing.
c. a requirement that there can be no switching costs for consumers.
d. the granting of a patent to the developer of the product.
ANSWER: c

117. Which of the following government policies would create a direct barrier to entry for new sellers in a
market?
a. taxing business profits with a progressive tax
b. banning switching costs to protect consumers
c. ensuring that all sellers have equal access to inputs
d. granting a patent to the developer of a new product
ANSWER: d

118. Which of the following is NOT a government action that results in a barrier to entry in a product market?
a. granting a patent on a product
b. requiring that advertising not make false claims
c. imposing regulations that increase start-up costs for new companies
d. issuing compulsory licenses to produce the product
ANSWER: b

119. When government regulations are influenced by lobbyists for the producers in a market, the regulations
often:
a. make it more difficult for new producers to enter the market.
b. reduce costs of production, increasing competitive pressures.
c. are biased in favor of consumer safety.
d. raise market demand.
ANSWER: a

120. When developing laws and regulations, elected government leaders are often biased in favor of the
interests of established companies over those of new entrants because:
a. new entrants have clear reasons for being biased in their proposals, and established companies do
not.
b. change has uncertain effects and is therefore avoided.
c. established companies and their employees are voters who have clear interests in preserving the
success of established companies.
d. profits are important to tax revenues.
ANSWER: c

121. Effective entrance deterrent strategies are based on:

a. rising costs.
b. decreasing market demand.
c. enacted regulations.
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d. credible threats.
ANSWER: d

122. Which of the following is NOT an entry deterrence strategy that a seller would use?
a. brand proliferation to cover all product niches
b. a market demand growth strategy
c. maintaining cash balances
d. building excess production capacity
ANSWER: b

123. When one company produces several different versions of a product, the company is using _____ to
_____.
a. brand proliferation; discourage new companies from entering the market
b. product differentiation; increase freedom of entry
c. product switching; confuse potential new entrants
d. demand satisfaction; make the market more competitive
ANSWER: a

124. The toothpaste aisle at a large store that sells personal care products contains many versions of toothpaste
produced by a small number of sellers. This indicates that toothpaste producers are engaging in _____ to _____.
a. product differentiation; reduce costs
b. regulatory policy; limit competition
c. cost-switching; stimulate demand
d. brand proliferation; deter new entrants
ANSWER: d

125. The shampoo aisle at a large store that sells personal care products contains many versions of shampoo
produced by a small number of companies. This indicates that shampoo producers are engaging in _____ to
_____.
a. product differentiation; stimulate market demand
b. brand proliferation; deter new entrants
c. cost-switching; limit market supply
d. government policy support; create cost advantages
ANSWER: b

126. A company engaged in brand proliferation is _____ to _____.

a. encouraging product differentiation across producers; encourage the market to satisfy as many
customer desires as possible
b. encouraging market entry; give customers maximum choice
c. producing many versions of its product; reduce profitable opportunities for new entrants
d. changing the company name; make customers think the product is different
ANSWER: c
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127. In what two ways can a company's reputation be a barrier to other companies entering its market?
a. It can keep customers loyal and reduce the cost of production.
b. It can create network effects and enhance efficiency gains.
c. It can keep customers loyal and intimidate rivals with the threat of being crushed.
d. It can enhance efficiency gains and trigger research and development.
ANSWER: c

128. Strategies used by entrepreneurs to overcome barriers to entry do NOT include:

a. finding ways to reduce costs.
b. using regulatory strategies to the entrepreneur's advantage.
c. duplicating the product of the industry leader.
d. combatting customer lock-in.
ANSWER: c

129. Which of the following is an example of a strategy that an entrepreneur might use to overcome barriers to
entry to an established product market?
a. Duplicate the product of the most successful seller in the market.
b. Push for strict licensing requirements for all sellers in the market.
c. Maintain minimal cash reserves to keep costs low.
d. Differentiate the product in ways that make it attractive to the goals of government regulators.
ANSWER: d

130. The cost advantages of established, large-scale producers in a market might be overcome by a new entrant
who can:
a. increase market demand.
b. push the market price down.
c. convince the government to stop issuing new patents.
d. develop a new, low-cost, small-scale production technology.
ANSWER: d

131. In the short run, a seller _____, but in the long run, _____.
a. cannot differentiate its product; all sellers differentiate their products
b. can vary all its costs; the seller faces only fixed costs
c. faces a fixed number of rivals; the number of rivals can vary
d. faces no barriers to entry and exit; there are barriers to entry and exit
ANSWER: c

132. The strong incentive of sellers to deter the entry of new sellers is a major reason that:
a. average costs are higher than necessary in the long run.
b. product differentiation is rare.

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c. deterrence strategies are rarely used.

d. most markets are imperfectly competitive.
ANSWER: d

Essay

133. What is the difference between explicit financial costs and implicit opportunity costs?
ANSWER: Total costs include both explicit financial costs and implicit opportunity costs. Explicit financial
costs are what most people think of when the word costs is used. These are the direct payments that
a company makes to purchase inputs. Examples of explicit financial costs include prices paid for
inputs like raw materials, wages for labor, and payments for electricity. Implicit opportunity costs
are the forgone earnings on inputs for which direct payments are not made. Examples of implicit
opportunity costs include the salary an entrepreneur foregoes to start a company and forgone
earnings on funds that the entrepreneur invests in the company.

134. Explain the difference between accounting profit and economic profit. Why do economists prefer to use
economic profit when analyzing the profitability of firms?
ANSWER: Profit is defined as revenue minus costs. Both accounting profit and economic profit are consistent
with this basic concept. However, they are not the same because accountants and economists
measure cost differently.
Accounting profit is computed as total revenue minus explicit financial costs, where explicit
financial costs are direct payments for inputs. There is an outflow of funds from the company for
these costs.
Economic profit is computed as total revenue minus total costs, where total costs include both
explicit financial costs and implicit opportunity costs. Implicit opportunity costs are the opportunity
costs of inputs for which explicit or direct payments are not made. For example, the forgone income
the company owner could earn in a salaried job instead of starting and running the company would
be the opportunity cost of his or her time.
If a company has an accounting profit, it is operating "in the black" and can pay all its bills.
However, owners could still be worse off financially than if they had not started the business if
accounting profit is less than the opportunity cost of the inputs not directly paid for. If a company
has an economic profit, the owners are better off than they would have been in the next best use of
their inputs. This is why economists consider economic profit is a preferable measure.

135. Hua Xing forgoes a job with an annual salary of $80,000 to start her own interior design company. She
invests $30,000 of her own savings in the company, which means forgoing the $3,000 per year that she has been
earning on those savings. During her first year in business, Hua Xing's firm collects revenue of $250,000 and
pays out $160,000 in expenses. What is Hua Xing's economic profit or loss situation at the end of her first year
in business? Provide the specific amount of economic profit or loss, and explain how you arrived at that
conclusion.
ANSWER: Economic profit equals total revenue minus total costs, where total costs include both direct
financial costs and implicit opportunity costs. Hua Xing's total revenue is given as $250,000, and
her direct financial costs are given as $160,000. Hua Xing's implicit opportunity costs total to
$83,000. This is the total of her forgone earnings of $80,000, which is the opportunity cost of her
time, plus the $3,000 of forgone earnings on her savings that she invested in her company. Hua
Xing's total costs were $243,000, which is the total of the explicit costs ($160,000) plus her implicit
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costs ($83,000). This means that Hua Xing had economic profits of $7,000, based on revenue minus
total costs, or $250,000 minus $243,000.

136. Why is the average cost curve typically a U-shaped curve?

ANSWER: Average cost can be computed by dividing total cost by output or by adding together average fixed
cost and average variable cost. It is easiest to understand the U-shape of average cost curve by
focusing on what happens to average fixed cost and average variable cost as output increases. The
average fixed cost curve is downward-sloping, since as output expands, the set fixed cost is divided
by a larger and larger output. The average variable cost curve, by contrast, is typically U-shaped.
This is because at low levels of output, as variable inputs are added to fixed inputs, efficiency
increases, whereas at higher levels of output, diminishing marginal returns set in, so that more and
more variable inputs are needed to produce each additional unit of output. Since at low levels of
output, fixed costs dominate variable costs, the decline in average fixed cost initially pulls the
average total cost down as output expands. This causes the average cost curve to slope downward in
this range of output. At high levels of output, however, variable costs dominate fixed costs, pulling
the average total cost upward. Thus, the average total cost curve slopes upward in this range.

137. Why will an industry naturally move to zero economic profits in the long run if it has free entry and exit of
firms?
ANSWER: The presence of profits in a market will attract new entrants into the market. The presence of losses
in a market will cause some sellers to exit the market. When there is free entry and exit, new sellers
can easily enter a market, and existing sellers can easily exit the market. Sellers will therefore enter
a market when the average seller is profitable and exit a market when the average seller has losses.
When sellers enter a market, the market supply gradually increases, leading to a reduction in the
market equilibrium price. This causes the profits of sellers to fall. As long as the average seller has
profits, new sellers will enter the market, causing the market price to fall. Once price falls to the
point that the average seller has zero economic profits, there is no incentive for additional sellers to
enter the market.
If the average seller incurs economic losses, some sellers will exit the market. This reduces the
market supply, causing the market price to rise. Sellers will continue to exit the market until the
market price has risen enough to cover average costs. Thus, sellers will cease exiting the market
once price has risen to the point that economic profits are zero.
The market settles at zero economic profits. If price is higher, new sellers enter, pushing price down.
If price is lower, sellers exit, pushing price up.

138. In the long run, what is the main determinant of price when a market has free entry and exit? Explain why
this occurs.
ANSWER: Given free entry and exit, average cost is the main determinant of price in the long run. If profits are
present in the market, then new firms will enter. This reduces the demand facing each firm, as the
market demand is spread over a larger number of companies. Profits disappear as the market price
falls due to the increase in market supply. If there are economic losses in a market, then some firms
will exit the market, reducing the market supply and causing the equilibrium price to rise. The
number of firms in the market will stabilize when price equals average cost, and profit equals zero.
In the long run, price equals average cost, since only at a price equal to average cost is there no
longer an incentive for firms to enter or exit the market.

139. Explain how the entry of new sellers into a market decreases the demand faced by incumbent sellers in the
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market.
ANSWER: When new sellers enter a market, the existing market demand will be spread across a larger number
of sellers. As some customers of incumbent sellers will buy from new sellers, the average incumbent
seller will face reduced demand. Exactly how much demand declines for a given seller will vary
across sellers and depend on how loyal customers are.

140. Describe four strategies firms may use to deter new companies from entering a market.
ANSWER: Discouraging the entry of new firms into a market is key to existing companies' ability to maintain
profits. Strategies employed to discourage new entry fall into four main categories. First, a company
can try to instill loyalty in its existing customer base. Second, a company can seek a cost advantage
not available to other companies. Third, a company can appeal to the government to impose
regulations that create entry barriers. Fourth, a firm can try to convince potential entrants that they
have little chance of success.

141. How can government regulations that focus on ensuring the health and safety of the public effectively
create barriers to entry in markets?
ANSWER: Regulations ostensibly designed to protect health and safety can effectively create barriers to entry
in a market for several reasons. First, the regulation could make it more costly for a new entrant to
start operations. For example, if the government requires extra testing on more expensive equipment
before giving its approval, incumbent companies may be in a better position to cover the added
costs. Second, incumbent companies may lobby for regulations that are consistent with health and
safety goals but biased in favor of established firms. Third, the government could issue licenses to
enter an industry to ensure the knowledge and skill of providers. This would make it harder for new
entrants to enter a market.

142. How does brand proliferation create a barrier to entry in a market?

ANSWER: Brand proliferation occurs when an existing company produces multiple versions of a product to
appeal to differing consumer preferences. When companies do this, a new company may be
discouraged from entering a market, since it is then more difficult for the new company to
differentiate its product from the many versions that are already available.

143. What is the difference between brand proliferation and product differentiation?
ANSWER: Brand proliferation and product differentiation are similar in certain ways but are different concepts.
Product differentiation refers to efforts by a company to make its version of a product appear
different and more attractive to consumers than versions produced by other companies. To the
extent that a company can make its version appear different in attractive ways, the company can
gain market power. In markets with high levels of product differentiation, many versions of a
product will be available. Typically, these versions come from many companies, each producing one
or just a few versions.
Brand proliferation occurs when a company produces multiple versions of its product to gain market
share and deter potential entrants into the market by ensuring that all niches in the market are
already filled. In markets with high levels of brand proliferation, consumers can choose from many
versions of a product. Although from a consumer's perspective, this may seem like product
differentiation, in the case of brand proliferation, many versions may be produced by just a few
companies.

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Multiple Choice

1. Which of the following is NOT one of the five forces that determine the structure of competition in a market?
a. the bargaining power of buyers
b. the existing market price
c. competition from existing competitors
d. potential competitors
ANSWER: b

2. The five forces that determine the structure of competition in a market do NOT include:
a. existing competitors.
b. bargaining power of buyers.
c. bargaining power of suppliers.
d. potential regulation.
ANSWER: d

3. The competitive forces in a market largely determine the _____ of the companies in the market.
a. demand
b. short-term vision
c. long-term profitability
d. product
ANSWER: c

4. Which of the following is one of the five forces that determine the long-term profitability of a company in a
market?
a. potential competitors
b. size and prominence of the company
c. talent of the company's staff
d. quality of the company's product
ANSWER: a

5. The five forces that determine the long-term profitability of a company in a market include the:
a. quality of the company's product.
b. talent of the company's staff.
c. size of the company.
d. bargaining power of suppliers.
ANSWER: d

6. The Five Forces framework focuses on competitive forces. Which of the following is NOT one of the five
forces?
a. suppliers
b. substitute products
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c. prices
d. existing competitors
ANSWER: c

7. Under the Five Forces framework, how can the market power of customers impact a seller's profitability?
a. The market power increases the total number of customers, raising market demand.
b. The market power reduces the total number of customers, raising market demand.
c. They can raise the selling price sellers charge.
d. Customers with market power can use their leverage to lower the selling price that sellers charge.
ANSWER: d

8. According to the Five Forces framework, how do suppliers with market power impact a company's
profitability?
a. Suppliers with market power can charge higher prices on inputs the company needs to purchase,
reducing the company's profits.
b. Suppliers with market power can charge higher prices on output the company needs to sell, raising
the company's profits.
c. Suppliers with market power charge lower prices on inputs the company needs to purchase, raising
the company's profits.
d. Suppliers with market power charge lower prices on output the company needs to sell, reducing the
company's profits.
ANSWER: a

9. According to the Five Forces framework, how can producers of potential substitute goods impact a
company's profits?
a. The producers of potential substitute goods may exit the market, signaling that the market demand is
weak and profits are low.
b. The producers of potential substitute goods may become actual competitors, causing the market
demand to be spread across a larger number of companies and thereby reducing the profits of the
original companies.
c. The producers of potential substitute goods indicate that the market supply is shrinking, leading to
higher company profits.
d. The producers of potential substitute goods indicate that the market demand is weak, leading to lower
company profits.
ANSWER: b

10. According to the Five Forces framework, a seller's existing competitors determine the _____ and _____ of
existing competition.
a. level; price
b. market supply; market demand
c. type; intensity
d. seller demand; market demand

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ANSWER: c

11. _____ the long-term profitability of a company.

a. Product type determines
b. The seven forces determine
c. Market demand determines
d. Market structure determines
ANSWER: d

12. Market structure has significant impact on:

a. the long-term profitability of sellers in a market.
b. the market demand in the market.
c. whether the product in a market is a good or a service.
d. whether the product is worth purchasing.
ANSWER: a

13. According to the Five Forces framework, the _____ the degree of rivalry in an industry, the _____ the
average profits will be in the industry.
a. lower; lower
b. more variable; greater
c. lower; more variable
d. greater; lower
ANSWER: d

14. According to the Five Forces framework, the greater the _____ in an industry, the lower the _____ in the
industry will be.
a. degree of rivalry; average profits
b. product variation; average company profits
c. average company profits; average price
d. rivalry; number of companies
ANSWER: a

15. The degree of rivalry in a market moves from high to low in the following order:
a. monopoly, imperfect competition, and perfect competition.
b. perfect competition, imperfect competition, and monopoly.
c. imperfect competition, monopoly, and perfect competition.
d. monopoly, perfect competition, and imperfect competition.
ANSWER: b

16. In which of the following situations would the level of competition be most intense?
a. Price is higher.

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b. Product characteristics vary less across producers.

c. Demand is growing faster.
d. More firms are in the market.
ANSWER: d

17. Marcella is a tomato farmer. Under which of the following conditions would she face the most intense
competition?
a. Each tomato farmer in the market produces its own hybrid variety of tomato.
b. Marcella is one of 1,200 tomato farmers who sell in the same tomato market.
c. There are six suppliers in the market for the main input used by firms in the tomato market.
d. There is little threat of new entrants into the market.
ANSWER: b

18. Leonardo owns a semiconductor factory. Under which of the following conditions would he face the most
intense level of competition in his semiconductor market?
a. There are 12 sellers in the market, each producing its own type of semiconductor.
b. There are 12 sellers in the market, each producing identical semiconductors.
c. There are 1,400 sellers in the market, each producing its own type of semiconductor.
d. There are 1,400 sellers in the market, each producing identical semiconductors.
ANSWER: d

19. Which of the following sellers faces the least competitive pressure?
a. an oligopolist with a few direct rivals
b. one of 800 sellers in a market, each producing identical products
c. a monopolist with no direct rivals
d. one of 800 sellers in a market, each producing a differentiated product
ANSWER: c

20. What is price competition?

a. Sellers compete with each other by charging as high a price as possible.
b. Sellers force competitors to lower their prices until the competitors have losses.
c. Sellers try to win customers through charging as low a price as possible.
d. Sellers differentiate products so they can charge a higher price.
ANSWER: c

21. Price competition is most likely to occur in each of the following situations EXCEPT when:
a. all sellers in the market sell identical products.
b. market demand is rising.
c. switching costs are low.
d. the prices charged by sellers are easy to observe.
ANSWER: b
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22. When price competition occurs:

a. product differentiation rises, and price rises.
b. profits rise, and the number of sellers rises.
c. price rises as competitive pressures increase.
d. price is pushed down, reducing profits.
ANSWER: d

23. Customers would be less loyal and more price sensitive in which of the following situations?
a. The switching costs are low.
b. There is only one seller in the market.
c. The market's companies sell differentiated products.
d. Customers are aware of the prices of all sellers.
ANSWER: a

24. In which of the following situations would a company have a lower chance of losing customers when it
raises the price of its product?
a. There are low switching costs.
b. Customers have many sellers to choose from.
c. Companies advertise their prices.
d. The product is differentiated across companies.
ANSWER: d

25. Lena owns a cookie bakery in a small city. There are six other bakeries that offer cookies in the city. Which
of the following is NOT an example of the threat of entry that Lena faces in her local baked goods market?
a. A cookie bakery in another city might add a new location by opening a cookie bakery in Lena's city.
b. One of the six bakeries that offer cookies in the city may decide to cease cookie production in order
to focus on cakes.
c. A doughnut shop in Lena's city might expand its product lines to include cookies.
d. A skilled baker who just finished culinary training might open a new cookie bakery in the city.
ANSWER: b

26. The threat of entry includes the:

a. expansion of existing businesses into the market, the creation of a new product market, and new
entrants.
b. addition of new distribution channels by existing businesses, the expansion of existing businesses
into the market, and the creation of a new product market.
c. creation of a new product market, the addition of new inputs, and the expansion of an existing
business into new distribution channels.
d. expansion of existing businesses into the market, the addition of new distribution channels by
existing businesses, and new entrants.
ANSWER: d
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27. What protects a business from the threat of entry by potential competitors?
a. low price
b. barriers to entry
c. potential substitutes
d. high costs
ANSWER: b

28. Heri owns one of three shoe repair shops in his city. Then he loses some of his customers when a luggage
repair shop expands its services to include shoe repair as well as luggage repair. Which of the five forces in the
Five Force framework is Heri facing when the luggage shop expands its services?
a. bargaining power of buyers
b. threat of existing competitors
c. threat of potential substitutes
d. threat of entry
ANSWER: d

29. Malia's auto repair shop faces the threat of entry. This intensifies _____ in her market and pushes _____
prices and pushes _____ profits.
a. competition; down; down
b. competition; down; up
c. production; up down
d. production; up; up
ANSWER: a

30. Barriers to entry _____ existing businesses _____.

a. protect; from price wars
b. expose; to limited pools of customers
c. protect; from competition by new entrants
d. expose; to competitive pressures
ANSWER: c

31. In the long run, the strength of the barriers to entry in a market have an impact on the _____ and the _____
in the market.
a. number of customers; number of sellers
b. number of sellers; profit level
c. fixed costs; number of substitute products
d. profit level; number of substitute products
ANSWER: b

32. In the long run, the number of sellers and the level of profit in a market are both affected heavily by the
_____ in the market.
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a. type of product
b. level of variable costs
c. strength of the barriers to entry
d. income tax levels
ANSWER: c

33. If more acceptable substitutes are available for a product, the market for the product will:
a. be more profitable.
b. be less profitable.
c. face higher costs.
d. face lower costs.
ANSWER: b

34. Jorge is considering what to give his wife for their wedding anniversary. He is choosing between flowers,
dinner at a restaurant, a weekend at a resort hotel, skydiving together, or a visit to her favorite museum. Based
on Jorge's consideration of these options for a gift, Jorge considers them to be:
a. complements.
b. the same product.
c. substitute products.
d. potential new entrants.
ANSWER: c

35. When a seller considers the threat of potential substitutes, what is a substitute product?
a. It is anything that a company could produce using the same inputs as needed to produce its current
product.
b. It is a new company that enters the market by producing a product identical to other companies.
c. It is what is made when a company can use more labor and less capital or less labor and more capital
to produce its product.
d. It is anything that could be consumed in place of a given product to satisfy the need or want of the
consumer for the given product.
ANSWER: d

36. How does the threat of potential substitutes lessen the market power of a business? If the substitute becomes
available, then the:
a. business may gain customers from the substitute market, adding to its profits.
b. business may reduce its costs by substituting one input for another input.
c. business may lose customers to the substitute good's market unless it lowers price.
d. addition of new substitutes will raise the level of customer satisfaction, allowing higher prices to be
charged.
ANSWER: c

37. Potential substitutes for a given product:

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a. are always similar to the given product.

b. are produced using the same mix of inputs.
c. must be used in the same way as the given product.
d. may be quite different from the given product.
ANSWER: d

38. The threat of potential substitutes is larger when:

a. the product market is differentiated.
b. the substitutes are more expensive.
c. switching costs are low.
d. barriers to entry are high.
ANSWER: c

39. The threat of potential substitutes is high when the substitutes:

a. offer greater value for their price than the original product.
b. face high barriers to enter the market.
c. have higher production costs than the original product.
d. cause customers to incur high switching costs.
ANSWER: a

40. When the emergence of new substitutes reduces the demand for a given product, the product's producer may
benefit from:
a. raising product price.
b. reducing the switching cost for its product.
c. reducing barriers to entry into the market.
d. pursuing new complement opportunities.
ANSWER: d

41. A strategy to reduce the threat posed by substitutes is to:

a. raise price.
b. increase supply.
c. make it more difficult for substitutes to enter the broad market.
d. help customers understand that they have numerous options.
ANSWER: c

42. Which of the following strategies would NOT reduce the threat posed by substitutes?
a. Lobby for government policies that reduce the attractiveness of substitutes.
b. Raise barriers to entry into the relevant market or markets.
c. Raise switching costs to retain current customers.
d. Raise price to show that product demand is strong.
ANSWER: d
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43. In which of the following situations would the supplier have the greatest power to hurt a business that is its
customer?
a. The supplier rents building space to a bakery in a real estate market with a vacancy rate of less than
.5%.
b. The supplier is one of 100 companies selling the input needed by the business.
c. The business could use an alternative input mix that uses significantly less of the supplier's product.
d. The cost for the business to switch to a different supplier is low.
ANSWER: a

44. In which of the following situations would the supplier of an input to Andrea's Herbal Supplement Products
have the greatest market power to hurt Andrea's Herbal Supplement Products?
a. The supplier is one of 200 sellers of the input in the input market.
b. Andrea's company can easily change the mix of inputs used to produce its product.
c. The supplier is the only available provider of a critical input.
d. The switching costs for Andrea's company to change input suppliers are low.
ANSWER: c

45. When an input seller has market power in the input market, its customers:
a. have the ability to charge a higher price for their products.
b. may earn higher profits.
c. gain market power in their product markets.
d. may end up paying a higher price for inputs.
ANSWER: d

46. In which of the following cases would a company's profits be threatened?

a. The threat of potential substitutes for its product diminishes.
b. Barriers to entry into its industry rise.
c. Its customers face higher switching costs.
d. One of its key input providers gains market power in the input market.
ANSWER: d

47. When there is only one buyer in a product market, a seller in the market:
a. has great market power in the monopoly market.
b. has no opportunities in substitute markets.
c. may be pressured to sell at a lower price than if there were many buyers.
d. is able to sell at a higher price than if there were many buyers.
ANSWER: c

48. Clarice's factory has invested in expensive equipment to produce a specialized weapon for her government's
military. There are no other buyers of this type of weapon, and the equipment is not useful for the production of
other goods. Which of the following statements describes Clarice's vulnerability based on the Five Forces
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framework?
a. Clarice is vulnerable because the number of existing competitors is high.
b. Clarice is vulnerable because barriers to entry into her market are low.
c. Clarice is vulnerable because her customer can choose from many products.
d. Clarice is vulnerable because her customer has market power.
ANSWER: d

49. When the demand side of a market holds a high level of market power, then the sellers _____ than they
would otherwise.
a. are likely to sell at a lower price
b. are likely to sell at a higher price
c. will face higher switching costs
d. will face lower switching costs
ANSWER: a

50. The two dimensions of the rivalry between current competitors in a product market are _____ and _____.
a. barriers to entry; switching costs
b. price competition; non-price competition
c. market power; switching costs
d. non-price competition; barriers to entry
ANSWER: b

51. A key thing for managers to remember regarding product differentiation is that:
a. differences across the products of different companies are innate to the products.
b. if the producer views its product as different, customers will view it as different.
c. consumers don't really care if a product is differentiated.
d. differentiation stems from choices made by the company.
ANSWER: d

52. When a product is NOT differentiated and price competition prevails, then:
a. the sellers are not likely to earn economic profits.
b. barriers to entry will rise.
c. barriers to entry will fall.
d. the sellers are likely to earn high economic profits.
ANSWER: a

53. In the absence of product differentiation, _____ to prevail, leading to _____ profits.
a. barriers to entry tend; high
b. barriers to entry tend; low
c. price competition tends; low
d. price competition tends; high
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ANSWER: c

54. Price competition with a product that is identical across sellers leads to an outcome of:
a. positive economic profits for the sellers.
b. zero economic profits for the sellers.
c. rising barriers to entry in the market.
d. falling barriers to entry in the market.
ANSWER: b

55. Price competition with identical products across producers leads to _____ because _____.
a. a high price; sellers are competing to sell at a high price
b. high profits; more consumers enter the market
c. a low price; consumers choose a seller based on price
d. low profits; more consumers enter the market
ANSWER: c

56. Market power can be gained through:

a. increased product differentiation.
b. decreased barriers to entry.
c. higher price competition.
d. increased entry of substitute products.
ANSWER: a

57. Without product differentiation, the presence of _____ can lead to _____ economic profits.
a. one or more rivals; zero
b. barriers to entry; zero
c. no switching costs; high
d. suppliers with market power; high
ANSWER: a

58. Another name for product differentiation is:

a. product rivalry.
b. variation barriers.
c. non-price competition.
d. price differentiation.
ANSWER: c

59. When Joe's Manufacturing Company successfully differentiates its product, then from the perspective of
consumers:
a. the product may be different, but price remains the key factor in purchase decisions.
b. there are different prices charged by different sellers, but the product is the same.

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c. rival sellers produce different but equally desirable products.

d. the output of rival sellers is not a good substitute for Joe's output.
ANSWER: d

60. Med-Ready Supplies produces and sells thermometers that are basically identical to those sold by other
companies in the market. However, Med-Ready thermometers sell for twice the price of the other thermometers.
Why can Med-Ready charge higher prices than other sellers yet still maintain customers?
a. Med-Ready must have lower production costs than other producers.
b. Med-Ready has successfully used barriers to entry to maintain its dominance.
c. Consumers are not interested in price but only in getting a thermometer that works.
d. In the minds of customers, Med-Ready must have successfully differentiated its thermometers from
the others.
ANSWER: d

61. Ways to differentiate a product do NOT include:

a. adding features to a company's product.
b. changing the quality of the company's product.
c. providing different types of customer service for a product.
d. charging a lower price than other companies for a given product.
ANSWER: d

62. Which of the following statements about product differentiation is FALSE?

a. It can be achieved even when the product is identical to that for sale by other firms.
b. It is charging a lower price than other sellers.
c. It is a key way for a seller to maintain long-term profits.
d. It can be achieved through customer service.
ANSWER: b

63. Product differentiation can be achieved through all of the following EXCEPT differences in:
a. product price.
b. product features.
c. advertising.
d. service.
ANSWER: a

64. The basis of product differentiation is to convince your customers that your product _____ so that customers
will _____ for your firm's product.
a. is different from the output of other sellers; have a more elastic demand
b. will more completely satisfy their wants; pay a higher price
c. is the best version; be more price sensitive
d. is as good as any other version; pay an equal price

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ANSWER: b

65. One negative aspect of product differentiation is that it:

a. reduces market demand.
b. makes demand more elastic.
c. reduces consumer choice.
d. adds to costs.
ANSWER: d

66. In differentiating a product, the demand-side consideration is to _____ as possible.

a. be as attractive to buyers
b. raise market demand as much
c. increase demand elasticity as much
d. sell as much
ANSWER: a

67. In differentiating a product, the supply-side consideration is to _____ as possible.

a. be as different from competitors
b. create as many barriers to entry
c. increase the number of competitors as much
d. cut price as much
ANSWER: a

68. A company will be subject to price competition if:

a. other producers are selling in the product market.
b. there is successful product differentiation in the product market.
c. customers view its product as the same as or very similar to the products of rival companies.
d. barriers to entry reduce the number of firms participating in the product market.
ANSWER: c

69. To gain as many customers as possible through product differentiation, a producer must consider _____ as
the producer makes decisions about how to distinguish its product.
a. how rivals are positioning their products
b. what the desired product price should be
c. how to decrease market demand
d. how to increase demand elasticity
ANSWER: a

70. When differentiating its product, a company should strive to:

a. increase the demand elasticity for its product.
b. supply the underserved part of its market.

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c. change the market demand for its product.

d. duplicate the features of rivals.
ANSWER: b

71. A new vendor wants to position his cart on a beach where another seller is already selling from a cart. To
attract as many customers are possible, the new vendor should choose:
a. the spot as far from the current seller as possible.
b. the middle spot on the beach.
c. the side of the beach with the most customers and as close to the current seller as possible.
d. a location with as many customers between the two vendors as possible.
ANSWER: c

72. To reduce price competition as much as possible, a seller should:

a. position its product to be as similar to those of rivals as possible.
b. position its product to be as different from those of rivals as possible.
c. strive to increase product demand as much as possible.
d. strive to keep product demand as steady as possible.
ANSWER: b

73. To gain as many customers as possible, a seller should position its product to serve _____ while also being
as _____ rival products as possible.
a. the average preferences; similar to
b. the average preferences; different from
c. an underserved segment of customers; similar to
d. an underserved segment of customers; different from
ANSWER: c

74. As a general rule, the more similar a firm's product is to those of its rivals, the more intense _____ will be,
and the _____ likely customers will be to switch between sellers.
a. non-price competition; less
b. price competition; less
c. non-price competition; more
d. price competition; more
ANSWER: d

75. If you want to reduce the incentive of rivals to undercut your company's product price, your company needs
to _____ as much as possible.
a. differentiate its product
b. increase substitution
c. enhance bargaining power of suppliers
d. lower switching costs

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ANSWER: a

76. Your company should position its product _____ its rival to attract as many customers as possible and
_____ its rivals to reduce price competition.
a. far from; close to
b. far from; far from
c. close to; close to
d. close to; far from
ANSWER: d

77. Positioning your product closer to those produced by rivals will increase your company's _____, but
positioning it further from those produced by rivals will increase its _____.
a. barriers to entry; switching costs
b. switching costs; barriers to entry
c. quantity sold; profit margin
d. profit margin; quantity sold
ANSWER: c

78. As a basic rule of thumb, when price competition is intense, business owners should try to:
a. differentiate their products as much as possible.
b. charge as low a price as possible.
c. charge as high a price as possible.
d. produce a product as similar to rivals as possible.
ANSWER: a

79. As a basic rule of thumb, business owners should differentiate their products as much as possible when:
a. costs are high.
b. costs are low.
c. price competition is subdued.
d. price competition is intense.
ANSWER: d

80. As a basic rule of thumb, when price competition is subdued, a company owner should:
a. minimize product differentiation.
b. emphasize product differentiation.
c. reduce switching costs.
d. reduce barriers to entry.
ANSWER: a

81. As a basic rule of thumb, a company owner should minimize product differentiation when:
a. there are many sellers.

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b. there are only a few sellers.

c. price competition is minimal.
d. price competition is intense.
ANSWER: c

82. Advertising has goals of affecting demand for a company's product in what two ways?
a. by shifting the company's demand curve to the right and making the curve's slope more horizontal
b. by shifting the company's demand curve to the right and making the curve's slope steeper
c. by shifting the company's demand curve to the left and making the curve's slope more horizontal
d. by shifting the company's demand curve to the left and making the curve's slope steeper
ANSWER: b

83. A business owner spends on advertising with the intent that it will affect the demand for the company's
product in what two ways?
a. by decreasing the company's demand and making its demand more elastic
b. by decreasing the company's demand and making its demand more inelastic
c. by increasing the company's demand and making its demand more elastic
d. by increasing the company's demand and making its demand more inelastic
ANSWER: d

84. When advertising increases brand loyalty for your company's brand, then the company's demand curve
becomes:
a. more elastic.
b. more inelastic.
c. more unstable.
d. horizontal.
ANSWER: b

85. Two ways that effective advertising affects a company's demand are by _____ the demand for the
company's product and the _____ of that product.
a. increasing; inelasticity
b. increasing; elasticity
c. decreasing; inelasticity
d. decreasing; elasticity
ANSWER: a

86. When your company's advertising is effective, the demand curve for your company's product will shift to
the _____ and rotate to a _____ slope.
a. left; steeper
b. left; more shallow
c. right; steeper

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d. right; more shallow

ANSWER: c

87. (Figure: Demand After Advertising) Which of the following diagrams shows what would happen to a
company's demand curve after an effective advertising campaign? Old demand is demand before advertising,

and New demand is demand after advertising.

a. A
b. B
c. C
d. D
ANSWER: b

88. Which of the following statements regarding advertising is correct? Advertising by a _____ seller affects
primarily _____.
a. perfectly competitive; demand for the seller's product and not market demand
b. imperfectly competitive; demand for the seller's product more than market demand
c. monopoly; market demand but not demand for the seller's product
d. monopoly; demand for the seller's product but not market demand
ANSWER: b

89. In which of the following types of market structure is advertising used more intensively to increase demand
for a company's product rather than market demand?
a. perfect competition
b. monopoly
c. imperfect competition
d. both perfect and imperfect competition
ANSWER: c

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90. When a market is perfectly competitive, advertising typically is done _____ because _____.
a. for the entire industry; it affects market demand more effectively than some individual company
demands
b. by individual companies; it effectively differentiates each company's product
c. for the entire industry; with only one company, the market demand is the company demand
d. by individual companies; it helps the advertising company stand out from the others
ANSWER: a

91. When a monopoly advertises, the goal is to _____ because _____.

a. increase its demand as a share of market demand; the monopoly faces a small portion of market
demand
b. increase its demand as a share of market demand; the monopoly faces a significant portion of market
demand
c. increase market demand; the monopoly produces a product that is identical to the output of all other
sellers in the market
d. increase market demand; the monopoly faces the entire market demand
ANSWER: d

92. Chantelle is a monopolist with a patent on her product. There is no close substitute. What would be her goal
in advertising?
a. to increase demand in her market
b. to increase brand recognition
c. to reduce switching
d. to raise her share of the market demand
ANSWER: a

93. Advertising by companies is most intense in which of the following types of market structure?
a. perfect competition
b. monopoly
c. imperfect competition
d. industry associations
ANSWER: c

94. A search good is a product that:

a. is difficult to locate, so it takes time to find it.
b. can easily be evaluated before purchase.
c. is not yet available, but consumer desires for it are known.
d. is produced with rare or hard-to-find inputs.
ANSWER: b

95. Informative advertising is particularly appropriate for:

a. search goods.
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b. tangible products.
c. services.
d. books.
ANSWER: a

96. The characteristics of search goods make _____ advertising particularly effective.
a. virtual
b. branding
c. persuasive
d. informative
ANSWER: d

97. When it is difficult for customers to assess quality prior to consuming a product, they tend to rely on _____
as an indicator of quality.
a. informative advertising
b. brand reputation
c. persuasive advertising
d. new experiences
ANSWER: b

98. What distinguishes persuasive advertising from informative advertising?

a. Persuasive advertising relies on statistics summarizing customer reviews.
b. Persuasive advertising uses facts about the product to convey its excellence.
c. Persuasive advertising focuses on emotions and provides few facts about the product.
d. Persuasive advertising focuses on brand reputation by frequent reminders of awards won by brand.
ANSWER: c

99. When advertising is used to gain customers from rivals rather than to increase the market demand, the term
_____ effect is used to describe the impact of the advertising.
a. zero-sum
b. business-stealing
c. brand enhancement
d. rival
ANSWER: b

100. Which of the following is an example of the business-stealing effect in advertising? Jo Bakery's advertising
campaign:
a. increases the demand for baked goods in the city.
b. raises Jo's sales at the expense of sales by rival bakeries.
c. raises Jo's costs more than it increases Jo's sales.
d. creates a trade-off between quantity sold and price.
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ANSWER: b

101. The pressure to advertise to avoid losing market share to rivals can:
a. help increase understanding about a product and facilitate consumer choice.
b. increase customer satisfaction and increase efficiency.
c. raise costs and be considered wasteful.
d. raise consumer satisfaction and reduce rivalry.
ANSWER: c

102. Advertising does not:

a. raise the cost of production.
b. influence market or firm demand.
c. influence consumers.
d. make markets more efficient.
ANSWER: d

103. Bargaining power is a buyer's or seller's ability to:

a. increase market demand.
b. reduce market supply to raise price.
c. negotiate a deal to its own benefit.
d. get a lower price as a seller or higher price as a buyer.
ANSWER: c

104. The ability to negotiate a higher price as a seller or a lower price as a buyer is known as:
a. advertising.
b. bargaining power.
c. dominant extension.
d. market incursion.
ANSWER: b

105. Dinesh owns a restaurant. He is able to negotiate lower prices than other restaurants pay with his supplier
because he buys in volume and threatens to buy from another supplier. Dinesh is:
a. trying to gain market share in the input market.
b. operating in a highly competitive market.
c. operating at a disadvantage compared to other restaurants.
d. exercising bargaining power.
ANSWER: d

106. What determines a negotiator's bargaining power?

a. the negotiator's market share
b. the market equilibrium price

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c. the number of rivals

d. the negotiator's next best alternative
ANSWER: d

107. Which of the following principles is critical to understanding how a company owner negotiates a deal to its
greatest advantage?
a. market equilibrium
b. opportunity cost
c. accounting profits
d. fixed costs
ANSWER: b

108. A company's _____ determines its bargaining power. More bargaining power is held when _____.
a. opportunity cost; its next best alternative is better than its rival's
b. current situation; market demand is growing
c. market equilibrium; price is higher than quantity
d. profit margin; the firm is more profitable than rivals
ANSWER: a

109. A seller bargains to sell _____, and a buyer bargains to buy _____.
a. the highest possible quantity; the lowest quantity
b. more than any rival; the desired quantity
c. a quantity that disadvantages rivals; to put the seller at a loss
d. at a higher price; at a lower price
ANSWER: d

110. The better a company's _____, the greater its _____.

a. next best alternative; bargaining power
b. profit margin; total profits
c. sales; bargaining power
d. opportunity cost; market share
ANSWER: a

111. A company's owner can improve its bargaining power by _____ and _____.
a. cutting costs; reflecting rival situations
b. improving its next best alternative; making the other party aware of it
c. raising market demand; maintaining market share
d. keeping secrets from competition; not sharing information with the other party
ANSWER: b

112. When would an improved next best alternative NOT yield results for a company owner that is negotiating?
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a. The market demand is falling.

b. The rival companies are experiencing more change than the company that is negotiating.
c. The company makes the other party aware of its improved next best alternative.
d. The company does not make the other party aware of its improved next best alternative.
ANSWER: d

113. Relationship-specific investments are investments that:

a. increase your bargaining power.
b. contractually obligate a business partner to continue working with the investor.
c. are worth more in the context of a specific business relationship.
d. create seller-to-seller training programs.
ANSWER: c

114. Investments that are worth more if the current business relationship continues are known as _____
investments.
a. relationship-specific
b. human capital
c. context-based
d. interdependent
ANSWER: a

115. A hold-up problem can occur whenever _____ have been made.
a. contractual obligations
b. switching costs
c. relationship-specific investments
d. entry barriers
ANSWER: c

116. Amal invests in equipment that allows him to win a contract to supply inputs to an interior designer. When
the contract is up for renewal, the interior designer insists on no increases in the price she pays. This disappoints
Amal, who wanted a price increase because some of his costs have risen, but he needs the sales to keep up with
payments for the equipment. Amal is experiencing:
a. a hold-up problem.
b. switching costs.
c. investor's remorse.
d. specific-partner disadvantage.
ANSWER: a

117. Which of the following is NOT an example of a relationship-specific investment that could result in a
hold-up problem?
a. organizing the layout of a factory for the most efficient flow of the production line
b. buying customized equipment to produce output to the specifications of a major customer
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c. training employees in the same computer system and programming used by customers to simplify
transfer of data
d. locating a factory near a major supplier of inputs
ANSWER: a

118. Avoiding the possibility of hold-up problems can lead to the problem of:
a. relationship-specific contracts.
b. low switching costs.
c. high switching costs.
d. underinvestment.
ANSWER: d

119. Making relationship-specific investments can _____ bargaining power because they can _____.
a. strengthen; worsen the company's next-best alternative
b. strengthen; strengthen the other party's profit margin
c. weaken; worsen the company's next-best alternative
d. weaken; strengthen the other party's profit margin
ANSWER: c

120. Which of the following is NOT a solution to the hold-up problem?

a. reputation and trust
b. relationship-specific investments
c. long-term contracts
d. vertical integration
ANSWER: b

121. Long-term contracts can overcome the _____ that sometimes stems from relationship-specific investments,
but only if _____.
a. negative profit margin; demand increases
b. lack of competition; barriers to entry are reduced
c. lack of market power; market concentration rises
d. hold-up problem; the contract terms are complete
ANSWER: d

122. Which of the following can reduce the incentive of business partners to hold up a company when the
company has made relationship-specific investments?
a. The greater the level of relationship-specific investments, the lower the incentive for the partners to
hold-up.
b. The more the company relies on the business partner, the lower the incentive for the partners to hold-
up.
c. A high level of market power is held by the business partners.
d. A long-term relationship based on trust exists between the partners and the company.
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ANSWER: d

123. Vertical integration occurs in a merger when the companies that merge:
a. had a buyer-seller relationship prior to the merger, with each covering a different stage in a
production chain.
b. are different sizes, with one being significantly larger than the other.
c. produce different types of products, such as one producing a service and the other a tangible good.
d. each produce different products whose productions are unrelated but are consumed together.
ANSWER: a

124. Which of the following mergers between two companies would be considered to be a vertical merger?
a. A dressmaker merges with a doughnut shop.
b. An auto repair shop merges with a boat repair shop.
c. A fabric mill merges with a pants factory.
d. A hair salon merges with a dry cleaner.
ANSWER: c

125. Which of the following is NOT one of the benefits that result when a company produces at several stages
in a production chain rather than specializing in just one stage?
a. It eliminates the hold-up problem.
b. It increases within-brand competition.
c. It reduces transaction costs.
d. It eliminates supplier market power.
ANSWER: b

126. One of the benefits of a company producing at multiple stages in a production chain rather than
specializing in just one stage is:
a. increased within-brand competition.
b. increased transaction costs.
c. increased market power of the supplier.
d. elimination of the hold-up problem.
ANSWER: d

127. The costs of vertical integration include:

a. increased risk of the hold-up problem.
b. increased within-brand competition.
c. reduced incentive for innovation.
d. higher transaction costs.
ANSWER: c

128. The costs of vertical integration do NOT include reduced:

a. within-brand competition.
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b. efficiency.
c. individual profit motive.
d. innovation.
ANSWER: a

129. A company's decision regarding the degree to which it should vertically integrate or be more specialized is
basically a trade-off between _____ and _____.
a. reduced costs of production; increased sales
b. greater efficiency in market power; reduced incentives for innovation
c. pushing hold-up problems onto rivals; reducing incentives for growth over time
d. eliminating the bargaining power of customers and suppliers; providing incentives for efficiency and
profit
ANSWER: d

130. A company is able to maintain dominance in a product market by:

a. keeping its costs lower than other companies.
b. raising market demand.
c. successfully differentiating its product.
d. relying on relationship-specific investments.
ANSWER: c

131. Which of the following is a supply-side strategy that a company owner could use to maintain its
dominance as a seller in its product market?
a. The company could differentiate its product.
b. The company could deter the entry of new firms into its market.
c. The company could promote buyer power in its market.
d. The company could advertise to consumers.
ANSWER: b

132. A company can reduce the chance that new sellers will enter the market with different versions of the
market's product by:
a. engaging in relationship-specific investments.
b. ensuring that input markets remain highly competitive.
c. avoiding dominance in the product market.
d. selling a wide variety of versions of the product.
ANSWER: d

133. Marta wants to open a shop specializing in gourmet candies and is having a difficult time finding space to
rent in a location where many potential customers will pass by each day. There are only two possible locations
that meet Marta's criteria, and several other types of businesses are vying to rent each location. This leads to
high rents. What challenge to profitability is Marta facing as she starts her business?
a. the threat of potential entrants
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b. the threat of competition from existing competitors

c. suppliers with bargaining power
d. customers with bargaining power
ANSWER: c

134. In which of the following situations would a business's profits be most threatened by the bargaining power
of customers?
a. There are many customers, who each makes individual purchase decisions for small purchases.
b. There are many customers, but they are affiliated into several groups. Each group decides which
seller to buy from.
c. There are only a few customers, but each buys a large volume.
d. There is only one customer, who represents the entire market demand.
ANSWER: d

Essay

135. Briefly describe how each of the five forces in the Five Forces framework impacts the profitability of
companies in a market.
ANSWER: The five forces in the framework are (1) existing competitors, (2) potential competitors, (3)
competitors in substitute markets, (4) supplier bargaining power, and (5) buyer bargaining power.
First, when there are many competitors, it is difficult for a company to charge a high price because
its customers have many other companies from which to purchase. Each company tries to gain or
maintain customers by charging a lower price, driving down price and erasing profits.
Second, sometimes it is not just the presence of existing competitors that drives down price.
Sometimes the possibility that new companies will enter the market can keep existing companies
from charging high prices. Those starting new companies are attracted to markets where the average
company has profits. To avoid attracting new entrants, existing companies may charge lower prices
than they would charge otherwise.
Third, the threat of competitors extends beyond a company's market. There may be other types of
products that could be used as a substitute for a given company's product. If the given company's
price is high enough, its customers will switch to substitute products. Thus, the company may
charge a lower price and accept lower profits in order to avoid losing customers to substitutes.
The fourth force, supplier bargaining power, affects a company's profits by impacting cost of
production rather than revenue. If the company must purchase inputs in an input market where the
sellers have bargaining power, the sellers will be able to extract higher input prices from the
company, raising its cost of production and reducing its profits.
Fifth, in the company's product market, if there are buyers with market power or bargaining power,
they will be able to push down price to lower levels, reducing the company's profits. All five of
these forces will impact the profit level of a company.

136. What is the product positioning trade-off that a company owner faces when differentiating the company's
product compared to the output of rival sellers? How can a company owner decide where to position her
company in this trade-off?
ANSWER: The product positioning trade-off is sometimes portrayed as a demand-side versus supply-side trade-
off. On the demand-side, if a company wants to gain the most customers, then it should position its
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product close to those of rival companies but slightly toward the underserved segment of customers.
On the supply-side, if a company wishes to reduce price competition (be able to charge a higher
price without losing customers), then it should differentiate its product from those of rivals as much
as possible. Where to produce along this trade-off continuum is an important decision for a company
owner. Looking at the level of price competition that currently exists in the market can be a helpful
guide. If price competition is strong in the market, then the owner may gain more by emphasizing
product differentiation in order to be able to charge a higher price. If price competition is not strong,
then minimizing the differences across sellers may allow the owner to gain as many customers are
possible.

137. Zara has a food truck that sells soft pretzels. Thus far, she has relied on word-of-mouth rather than
advertising to build her customer base, but she is considering a local advertising campaign. What two goals
would Zara have for her demand curve from an advertising campaign?
ANSWER: A business such as Zara's is willing to spend on advertising to achieve the goals of increasing
demand for its product (shifting its demand curve to the right) and decreasing the elasticity of
demand for its product (rotating the demand curve to a steeper slope). If Zara's demand curve shifts
to the right, then she could charge a higher price without losing customers or could charge the same
price while selling a greater quantity. If her demand curve rotates to a steeper slope, then her
quantity sold will vary less when she changes price. Having a strong, growing, and inelastic demand
can be important in positioning Zara to earn a profit and be able to survive if new competitors enter
her market.

138. Why can expenditures on advertising be important to a company's owner when customers are uncertain
about product quality?
ANSWER: Advertising has goals of increasing firm demand and reducing the elasticity of demand for the
company's product, both of which can allow the company to charge a higher price. When potential
customers are unsure of product quality, they may be hesitant to buy, causing weak demand for the
product. Thus, advertising can be important to developing a strong product demand for the
company. If the uncertainty about product quality stems from a lack of information, then
informative advertising may give potential customers enough information to make them feel
confident purchasing the product. If the product is not a search good, then persuasive advertising
and advertising that builds the brand's reputation may be more appropriate for encouraging
customers to buy from the company.

139. What are the pros and cons of vertical integration for a company?
ANSWER: When a company integrates vertically, it begins to take on more of the production processes in the
chain of production processes that goes from raw resources to final customer. Vertically integrating
can have some cost advantages for a company because it may reduce transaction costs, eliminate
loss due to supplier bargaining power, eliminate hold-up problems from relationship-specific
investments it has made, and reduce advertising and customer service costs by reducing within-
brand competition. However, there are some potential negative impacts from vertical integration. By
becoming a less specialized producer, the firm loses some of the efficiencies of specialization. The
broader focus can reduce sharp focus on profit and efficiency across the workers.

140. Marcella builds a building for her bakery at a specific location so that she can be near the two restaurants
that are her main customers. What term is used for this type of investment, and what risks does Marcella now
face because of this type of investment?
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ANSWER: Marcella has made a relationship-specific investment because her decision on location is based on
her relationship with some of her key customers. Her decision on location will benefit her as long as
she maintains her sales to the two restaurants. However, the location also makes her more
vulnerable because the restaurants probably realize this. They will have more bargaining power now
because they know her return on investing in that specific location will drop if she loses their
business. They may be able to negotiate a lower price because of that. This is referred to as a hold-
up problem. Hold-up problems can lead to unproductive investments (if the restaurants fail to buy
from Marcella) or underinvestment. (if fear of being "held up" caused Marcella not to build her
factory there or at all).

141. Stephan owns a small specialty cheese factory in Switzerland. For many years, he has purchased milk from
the same dairy farmer and sold his cheese to a few cheese shops in a large nearby city. The dairy farmer now
wants to retire and is going to sell the farm. Stephan must decide whether he should buy the dairy farm to
ensure a continued supply of milk, try to negotiate with whoever buys the farm, or find a new milk supplier.
Stephan also is considering a plan to add online cheese sales through a website for his factory. Describe the
risks and benefits Stephan faces as he decides whether to expand his business vertically.
ANSWER: When a business integrates vertically, it takes on more of the production processes in the production
chain between raw resources and the final consumer. If Stephan adds dairy farming (milk
production) and retail sales to his company, he will need a wider range of expertise on his staff.
Right now, he knows that he gets quality (or at least satisfactory) milk from the dairy farmer. It is
one thing to recognize good milk when making a purchase decision and quite another thing to know
how to produce the milk to meet his specifications. It is one thing to have working relationships with
wholesale customers (the cheese stores) and another thing to have the knowledge to set up a retail
sales website and market the cheese to final consumers.
Stephan has specialized in cheese production. If he expands vertically, he will need greater
expertise. On the one hand, some of the incentives for efficiency and profit can be reduced in the
broader focus on a wider array of issues. On the other hand, there is a potential for greater profits
through the vertical expansion of his business. He could bring in-house the profits of the dairy
farmer and the cheese retailers if he produces his own milk and sells his cheese at retail prices rather
than wholesale prices. He would not be subject to any bargaining power held by his current
suppliers or wholesale customers if he takes on those vertically connected tasks.

142. What determines the range of outcomes when two sides are negotiating a purchase or sale?
ANSWER: When two sides are negotiating a purchase or sale, the range of outcomes in negotiations to buy or
sell are limited by the opportunity costs, or next best alternatives, of the buyer and seller. The range
for negotiations is that the seller must receive a price at least as high as (and preferably higher than)
his next best alternative and the buyer must pay a price no higher than (and preferably lower than)
her next best alternative.

143. Explain how a negotiator (buyer or seller) can improve its bargaining power in negotiations to buy or sell.
ANSWER: A negotiating party's bargaining power is based on its next best alternative, or rather, its opportunity
cost. To improve a party's bargaining power, that party must improve its next best alternative and
make sure that the other party in negotiations is aware of this. For example, if a business owner is
negotiating to sell its product for $10 each but the buyer is aware that the seller's only other
alternative is to sell to someone else for $7, then the buyer has no incentive to agree to a price of
$10. But if the seller can get an offer from a different buyer for $9.90, then the buyer will be much

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more likely to agree to $10 because the buyer will realize that the offer of $9.90 must be matched or
beaten to gain the purchase.

144. How can advertising affect a company owner's bargaining power?

ANSWER: Advertising seeks to increase a company's demand curve and to make the demand less elastic (or
more inelastic). Both of these would improve the company's next best alternative when the company
owner is negotiating to sell its product. A company's bargaining power in negotiations is based on
its next best alternative. Advertising is an extra expense for a company, and this can impact its
profitability. Effective advertising that impacts the company's next best alternative can give it
greater bargaining power.

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Multiple Choice

1. Price discrimination occurs when a company

a. refuses to sell its product to certain customers based on some distinguishing factor such as race or
religion.
b. produces different versions of its product.
c. buys a given input from several sellers and pays a different price to each seller.
d. charges different prices to different customers who are all buying the same product.
ANSWER: d

2. When a company sells its product to different customers for different prices, the company is practicing
a. revenue extortion.
b. price differentiation.
c. price discrimination.
d. revenue differentiation.
ANSWER: c

3. Selling the same good at different prices to different buyers is

a. price differentiation.
b. price discrimination.
c. revenue differentiation
d. alternative revenue collection.
ANSWER: b

4. Which of the following is an example of a company practicing price discrimination?

a. A restaurant charges different prices for fountain drinks based on their size.
b. Johann's bakery charges $2 for a cookie, and Bella's bakery charges $3 for an identical cookie.
c. The average price of a haircut is $20 in Dayton and $30 in Cincinnati.
d. Most passengers traveling on an airplane pay different prices for their tickets.
ANSWER: d

5. A reservation price is
a. the price you pay a producer to guarantee that a unit of a product will be available when you need it.
b. a lower than normal price that a seller "reserves" for (or makes available to) his best customers.
c. the lowest price at which a seller is willing to make a sale.
d. the highest price that a customer is willing to pay for a product.
ANSWER: d

6. The highest price that a customer is willing and able to pay for a product is the customer's
a. trigger price.
b. market equilibrium price.

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c. reservation price.
d. perfect price.
ANSWER: c

7. The goal of price discrimination is to increase

a. profit by charging each customer the highest price he is willing to pay.
b. profits by raising the demand to sell at higher prices.
c. sales by advertising to gain more customers who are willing to pay more.
d. sales by attracting new groups of customers who are willing to pay more for the product.
ANSWER: a

8. If a company engages in perfect price discrimination, it is attempting to

a. attract more customers by charging lower prices to groups of new customers.
b. try different prices until it finds the exact market equilibrium price.
c. charge each customer the lowest price they would be willing to pay.
d. charge each customer their reservation price.
ANSWER: d

9. The highest price that a buyer would be willing to pay for a product is
a. the market equilibrium price.
b. based on their income.
c. the value of the marginal benefit they would receive from the product.
d. above their reservation price, which is the lowest price the seller might charge.
ANSWER: c

10. A buyer's reservation price for a product is equal to the _____ and the _____.
a. market equilibrium price; perfect discrimination price
b. product's marginal benefit to the buyer; maximum price the buyer would pay for the product
c. maximum price the customer would pay for the product; market equilibrium price
d. perfect discrimination price; the minimum price a customer would pay for the product
ANSWER: b

11. Perfect price discrimination consists of

a. charging each customer their reservation price.
b. charging each customer based on the marginal cost.
c. basing price on the highest marginal cost the customer is willing to pay.
d. charging each customer the lowest price they are willing to pay.
ANSWER: a

12. Ariel owns an automobile dealership that sells several car models. Ariel negotiates the price with each
customer so that they are willing to pay the highest price possible. This results in customers paying different
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prices for the same model. Ariel is
a. exploiting customers.
b. giving customers a bargain by selling at prices below the demand curve.
c. practicing perfect price discrimination.
d. seeking to sell at market equilibrium.
ANSWER: c

13. How does the price customers pay under price discrimination compare to the price with no price
discrimination or the one that is set according to the marginal cost = marginal benefit?
a. There is no difference in the prices.
b. Under price discrimination, the price is higher.
c. Under price discrimination, the price is lower.
d. Under price discrimination, some customers pay a higher price, and some pay a lower price.
ANSWER: d

14. When price discrimination is practiced, a company sells _____ and charges _____ compared to what it
would do without practicing price discrimination.
a. a larger output; a greater range of prices
b. the same output; a greater range of prices
c. a smaller output; higher prices
d. a higher output; higher prices
ANSWER: a

15. Two objectives a company owner tries to achieve through price discrimination are to _____ and to _____.
a. charge each person the highest possible price; sell to the maximum number of customers
b. charge each person the highest possible price; reduce the marginal cost
c. sell to every customer whose marginal benefit exceeds the firm's marginal cost; charge each person
the highest possible price
d. sell to every customer whose marginal benefit exceeds the firm's marginal cost; sell to the maximum
number of customers
ANSWER: c

16. Which of the following is NOT something companies try to achieve through price discrimination?
a. Charge each customer the highest price they are willing to pay.
b. Create barriers to entry.
c. Sell to every customer whose marginal benefit exceeds the firm's marginal cost.
d. To increase profits.
ANSWER: b

17. When a price-discriminating company charges some customers a higher price than it would have charged
without price discrimination, total economic surplus
a. stays the same, but there is a transfer from buyers to sellers.
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b. rises, with the seller receiving the increase.

c. stays the same, but there is a transfer from sellers to buyers.
d. rises with the gain shared by sellers and buyers.
ANSWER: a

18. A price-discriminating company can attract more customers by _____ price, as long as _____.
a. reducing; the price is above marginal benefit and below marginal cost
b. reducing; the price is above its marginal cost
c. raising; the price is above marginal benefit and below marginal cost
d. raising; new customers are convinced to pay the price
ANSWER: b

19. When a price-discriminating company lowers price for potential new customers who wouldn't buy
otherwise, total economic surplus
a. stays the same, but there is a transfer from buyers to sellers.
b. rises, with the buyers receiving all the increase.
c. stays the same, but there is a transfer from sellers to buyers.
d. rises with the gain shared by sellers and buyers.
ANSWER: d

20. A price-discriminating company can attract additional customers by _____, this will add to its profits if the
_____.
a. shifting the company's demand curve to the left; price is above the customer's marginal benefit
b. shifting the company's demand curve to the left; price is below the company's marginal cost
c. reducing price; price is above the company's marginal benefit
d. reducing price; price is above the company's marginal cost
ANSWER: d

21. When price discriminating, a company owner should set price _____ for each customer.
a. equal to marginal cost
b. at the competitive market equilibrium
c. no higher than marginal cost
d. at or just below the marginal benefit
ANSWER: d

22. When a company price discriminates, it ends up selling

a. in a different product market.
b. at a consistent price across all customers.
c. more than it would sell otherwise.
d. less than it would sell otherwise.
ANSWER: c
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23. Compared to charging the same price to all customers, the quantity that a price-discriminating company
sells is _____ as some customers pay _____ prices.
a. higher; lower
b. higher; higher
c. lower; lower
d. lower; higher
ANSWER: a

24. What impact does price discrimination have on the quantity a company sells?
a. The quantity increases.
b. The quantity decreases.
c. The quantity remains the same.
d. The quantity increases and then decreases.
ANSWER: a

25. In a market without price discrimination

a. when the firm lowers price to attract new customers, all customers pay the lower price.
b. any change in price will raise profits.
c. total revenue will fall.
d. businesses do not experience economic surplus.
ANSWER: a

26. When a company owner practices price discrimination, the marginal revenue of an extra unit sold
a. is greater than its price.
b. is less than its price.
c. equals its price.
d. is less than marginal cost.
ANSWER: c

27. When a company practices price discrimination, it will keep adding customers until the point where the
a. last customer's marginal benefit equals the marginal quantity.
b. last customer's marginal benefit exceeds the company's marginal cost.
c. company's marginal cost exceeds the last customer's marginal benefit.
d. company's marginal cost equals the last customer's marginal benefit.
ANSWER: d

28. The efficient quantity of output occurs where the

a. company's marginal cost equals the last customer's marginal benefit.
b. company's marginal benefit equals the last customer's marginal cost.
c. price exceeds the marginal benefit.

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d. price is just less than marginal benefit.

ANSWER: a

29. With price discrimination, a company ends up selling

a. less but earning more profits.
b. less but at an efficient level.
c. more but at an efficient output level.
d. more but earning less in profits.
ANSWER: c

30. How does price discrimination move a market that is not perfectly competitive to an efficient output level?
a. Price discrimination causes businesses to charge the price where marginal cost equals marginal
benefit for all customers.
b. Price discrimination gives businesses the incentive to increase output to the level where their
marginal cost equals the marginal benefit of their last customer.
c. Price discrimination causes a business to raise its output to the level where the average cost is at its
minimum.
d. Price discrimination gives businesses the incentive to move revenue to its highest possible level.
ANSWER: b

31. Price discrimination leads businesses to _____ than they would under a single-price model.
a. sell a larger quantity
b. sell a smaller quantity
c. produce a smaller quantity at a lower price
d. produce a bigger quantity to sell at a higher price
ANSWER: a

32. Price discrimination leads to _____ than a one-price system.

a. a lower average price
b. fewer buyers
c. a lower average cost
d. a more efficient output
ANSWER: d

33. What problem does price discrimination resolve that occurs when businesses exploit market power?
a. High price
b. High costs
c. Underproduction
d. Overproduction
ANSWER: c

34. _____ is a problem in markets where companies exercise market power and it is resolved when companies
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practice price discrimination.
a. Overproduction
b. Underproduction
c. Excess profits
d. Excess costs
ANSWER: b

35. When companies exercise market power, _____ occurs. _____ can solve this problem.
a. overproduction; Price competition
b. underproduction; Price discrimination
c. high costs; Price competition
d. high levels of competition; Price discrimination
ANSWER: b

36. Price discrimination _____ the quantity that a company sells and _____ its efficiency.
a. raises; improves
b. reduces; improves
c. raises; reduces
d. reduces; reduces
ANSWER: a

37. (Figure: Price Discrimination) A business that price discriminates will produce at what output level?

a. Quantity 1
b. Quantity 2
c. Quantity 3
d. Quantity 4
ANSWER: c

38. (Figure: Price Discrimination 2) The following figure shows a business that price discriminates. The
business will produce at output level C. What range of buyers will be given a discount so that they are induced
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to buy the good?

a. Between A and B
b. Between B and C
c. Between C and D
d. Between A and C
ANSWER: b

39. (Figure: Price Discrimination 2) The following figure shows a business that price discriminates. The
business will produce at output level C. What range of buyers will pay a higher price to the seller to buy the
good?

a. Between A and B
b. Between B and C
c. Between C and D
d. Between A and C
ANSWER: a

40. How can price discrimination improve efficiency in a market compared to a single-price situation?
a. The price is pushed down to the level of average costs.
b. The average cost ends up at the level of minimum average costs.
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c. The company's output is where marginal cost equals the last customer's marginal benefit.
d. Everyone willing and able to pay for the product gets the same low price.
ANSWER: c

41. Why is an expert hairstylist more likely to price discriminate than an expert jam maker?
a. A hairstylist has no market power, but a jam maker can have market power.
b. A haircut cannot be resold, but a jar of jam can be resold.
c. There are many substitutes for a hairstyle but few substitutes for a particular jam.
d. The stylist uses fewer inputs than the jam maker.
ANSWER: b

42. Price discrimination can be successful only if

a. the market is highly competitive.
b. the product cannot be resold.
c. there are many sellers.
d. the company lacks market power.
ANSWER: b

43. As a company manager, what do you need to know about your customers before you can successfully price
discriminate?
a. You need to know your own costs.
b. You need to know that the product is a tangible good rather than a service.
c. You need to know how long each customer has been buying the product.
d. You need to know each customer's reservation price.
ANSWER: d

44. What three conditions must be present before a company can price discriminate?
a. The company has market power; the product is homogeneous; the demand is elastic.
b. The product cannot be resold; consumers have differing willingness to pay; there are many sellers.
c. The company can identify how much each customer is willing to pay; the product cannot be resold;
the company has market power.
d. Product demand is highly elastic; the company can identify how much each customer is willing to
pay; the company is seeking market power.
ANSWER: c

45. Price discrimination is feasible only when certain conditions are present for the company in the market.
Which of the following is NOT one of these necessary conditions?
a. The company has market power.
b. The market is overproducing.
c. The company can identify customers' reservation prices.
d. The product cannot be resold.

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ANSWER: b

46. Which of the following is NOT one of the conditions a business must meet to price discriminate?
a. The product is identical across all producers.
b. The product cannot be resold.
c. The company knows how much different customers value the product.
d. The company has market power.
ANSWER: a

47. Inez owns a technology company. Which of the following conditions would make it difficult for her to price
discriminate?
a. Her market is highly competitive.
b. Her product cannot be resold.
c. She is aware of how much each customer is willing to pay.
d. She is eager to increase her profits.
ANSWER: a

48. Arlo owns a barbershop. What condition would make it difficult for him to price discriminate?
a. His product cannot be resold by customers.
b. He is aware of how much each customer is willing to pay.
c. He seeks to earn a profit.
d. He lacks market power.
ANSWER: d

49. Why is market power necessary for price discrimination?

a. Market power increases competitive pressures, which facilitates discriminatory pricing.
b. When a seller has market power, his product cannot be resold.
c. Market power allows a seller to control the market demand, and that allows him to set price.
d. Without market power, a seller would lose customers if he tried to charge a higher price.
ANSWER: d

50. Marta owns a food truck. Which of the following would limit Marta's ability to price discriminate?
a. Marta's product is good only if it is consumed immediately, making it difficult to store for resale.
b. Marta has considerable market power because she is the only seller in town of of that kind of food.
c. Marta has little understanding of how much each customer values her product.
d. Marta is facing rising costs.
ANSWER: c

51. Which of the following is NOT a condition needed for price discrimination?
a. The company faces a flat demand curve.
b. The company knows how much different customers are willing to pay for the product.

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c. The company has market power in its product market.

d. The company can keep customers from reselling the product after they have purchased it.
ANSWER: a

52. Price discrimination by charging different prices to different groups of people is called
a. group discrimination.
b. price partitioning.
c. segmentation.
d. group pricing.
ANSWER: d

53. Sellers that use group pricing can avoid resentment towards those who pay less by publicizing a pricing
structure where certain groups _____ rather than where other groups _____.
a. receive a discount off the normal price; pay a premium above the normal price
b. earn a lower price; are forced to subsidize others.
c. are penalized with a higher than normal price; qualify for a discounted price.
d. pay less than their marginal benefit; pay more than their marginal benefit.
ANSWER: a

54. When a seller uses group pricing, members of the same group pay
a. a price equal to that buyer's marginal benefit.
b. an individually negotiated price.
c. the same price for the product.
d. an escalating price.
ANSWER: c

55. When using group pricing, each group's price should be set by what two steps?
a. Identify the group's average income or ability to pay, and multiply this by the average share of
income spent on this product.
b. Identify the quantity where the marginal cost equals marginal revenue for each group, and then find
the price for that quantity on each group's demand curve.
c. Divide the demand by the number of segments, and choose the price on the marginal revenue curve
associated with each segment's quantity.
d. Choose the profit-maximizing price according to the rational rule for sellers, and then adjust the price
up or down based on the number of segments.
ANSWER: b

56. Which of the following is NOT done when setting group prices?
a. Consider each group as a separate market.
b. Produce at the quantity where marginal revenue equals marginal cost.
c. Charge the price on the demand curve for the chosen quantity.
d. Assume that group demand equals market demand.
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ANSWER: d

57. (Figure: Group Pricing) The diagram represents the demand and costs facing BJ's Smoothies for two
different groups of consumers. What price and quantity should BJ choose for each group?

a. Group A: P = $5; Q = 200; Group B: P = $5, Q = 50

b. Group A: P = $10, Q = 200; Group B: P = $5, Q = 100
c. Group A: P = $9, Q = 50; Group B: P = $10, Q = 100
d. Group A: P = $10, Q = 100; Group B: P = $9, Q = 50
ANSWER: d

58. When setting prices for different groups of customers, a manager should charge higher prices for groups that
a. have a lower demand.
b. have a more elastic demand.
c. value the product more.
d. have lower marginal benefit.
ANSWER: c

59. When setting prices for different groups of customers, a manager should charge lower prices to groups that
a. value the product more.
b. have a more elastic demand.
c. have a higher demand.
d. have a more inelastic demand.
ANSWER: b

60. A useful rule of thumb is that the higher the marginal benefit a consumer gains from a product, the
a. more the consumer will seek substitutes for the product.
b. lower the consumer's demand for the product will be.
c. more price-sensitive the consumer will be.
d. higher the buyers' reservation price will be.
ANSWER: d

61. A useful rule of thumb is that the lower the marginal benefit a consumer gains from a product, the
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a. lower the consumer's reservation price will be.

b. less price-sensitive the consumer will be.
c. higher the consumer's demand for the product will be.
d. higher the price that the seller can charge.
ANSWER: a

62. When a group of buyers is price-sensitive, then the

a. group's marginal benefit is high.
b. group has a high reservation price.
c. group's demand is inelastic.
d. group will not buy at higher prices.
ANSWER: d

63. When setting prices for different groups of customers, a manager should charge higher prices to groups that
have _____ and lower prices to groups that have _____.
a. higher marginal benefit; lower reservation prices
b. more elastic demand; more inelastic demand
c. higher reservation prices; more inelastic demand
d. lower reservation prices; lower marginal benefit
ANSWER: a

64. (Figure: Group Pricing 2) Artem's Day Spa sells facials at different prices to different groups of customers.
The demand that the owner faces from each of two groups is depicted below. What price should he charge, and
how many facials should he plan to provide for each group?

a. Group A: P = $130, Q = 90; Group B: P = $100, Q = 50

b. Group A: P = $60, Q = 40; Group B: P = $60, Q =25
c. Group A: P = $130, Q = 40; Group B: P = $100, Q = 25
d. Group A: P = $60, Q = 90; Group B: P = $60, Q =90
ANSWER: c

65. Which of the following statements is FALSE about group pricing?

a. The higher the reservation price of a group, the higher its marginal benefit from the product.
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b. The higher the reservation price of a group, the more inelastic the group's demand for the product.
c. The higher the reservation price of a group, the more the group members value the product.
d. The higher the reservation price of a group, the more sensitive the group is to price changes.
ANSWER: d

66. Which of the following statements is FALSE about group pricing?

a. The lower the reservation price of a group, the more price-sensitive the group is.
b. The lower the reservation price of a group, the less the group members value the product.
c. The lower the reservation price of a group, the more inelastic the group's demand for the product.
d. The lower the reservation price of a group, the lower the marginal benefit from the product.
ANSWER: c

67. Pak has divided his customers into two groups so that he can charge a higher price to one group than the
other. Which of the following should be TRUE about the group that pays a higher price?
a. This group gains a higher marginal benefit from the product than the group paying a lower price.
b. This group has a lower reservation price than the group paying a lower price.
c. This group has less market power than the group paying a lower price.
d. This group has a more elastic demand than the group paying a lower price.
ANSWER: a

68. Hendra has divided her customers into two groups so that she can charge a higher price to one group than
the other. Which of the following is TRUE about the group paying the lower price?
a. This group gains a higher marginal benefit from the product than the group paying the higher price.
b. This group has a lower reservation price than the group paying the higher price.
c. This group has more market power than the group paying the higher price.
d. This group has a more inelastic demand than the group paying the higher price.
ANSWER: b

69. Marcella owns a sandwich shop. She targets one group of potential customers by giving them a discount
coupon and the other group no coupons. Which of the following would be a characteristic of the group that
receives the discount coupon? They _____ than other potential customers.
a. have a higher reservation price
b. must be more price-sensitive
c. have a more inelastic demand
d. receive more marginal benefit from the product
ANSWER: b

70. Kate owns a food truck. She divides her potential customers into two groups and gives discount coupons to
the one she thinks are especially price sensitive. How should she set the price for each group? Kate should
consider the _____ for each group separately and then choose each group's price _____.
a. marginal benefit; so that it is equal to marginal cost where it intersects with marginal benefit
b. marginal benefit; at the point on the marginal benefit curve where the average cost is minimum
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c. demand curve; at the point on marginal cost curve where marginal cost equals marginal revenue
d. demand curve; on its demand curve based on the quantity where marginal cost equals marginal
revenue
ANSWER: d

71. Hassan is a student who received a coupon to buy pizza from Pizza House at $4 off the regular price.
Students at Hassan's school seem to receive the coupons frequently. Which of the following is an assumption
that the owners of Pizza House are making about students at Hassan's school?
a. Their demand for pizza is highly inelastic.
b. They have a high reservation price for pizza.
c. Their marginal benefit from pizza is very high.
d. They are price-sensitive.
ANSWER: d

72. The two rules to use in setting group prices are to charge higher prices to those _____ and charge lower
prices to those _____.
a. with lower marginal benefit; with higher marginal benefit
b. who value the product more; who are especially price-sensitive
c. with low reservation prices; with higher reservation prices
d. with elastic demand; with unit elastic demand
ANSWER: b

73. Which of the following is NOT one of the three steps to take in segmenting customers into groups?
a. Divide the consumers into groups whose demand differs.
b. Charge higher prices to groups with more elastic demand.
c. Give discounts to chosen groups based on identifiable characteristics.
d. Base discounts on characteristics that are hard to change.
ANSWER: b

74. When segmenting your market demand into groups, base them on _____ and _____ characteristics.
a. income; preference
b. equal; unifying
c. easy-to-observe; demand-unifying
d. verifiable; difficult-to-change
ANSWER: d

75. To practice group pricing, you would segment your market so as to identify groups that
a. differ in the reservation price.
b. have an inelastic demand.
c. represent average demographic characteristics.
d. are based on difficult-to-identify characteristics.

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ANSWER: a

76. What factor determines how many segments to divide your demand in for group pricing?
a. Whether the product is a tangible good or an intangible service.
b. The similarity of demand across segments.
c. The ability of the company to identify segments with similar reservation price.
d. The amount of consumer information available to the company.
ANSWER: d

77. In deciding how many segments to divide its market into, a company should look for ways to identify clear
segments that have _____ demand.
a. distinctly different
b. equal reservation
c. mirror image
d. overlapping
ANSWER: a

78. The factors to use for easily separating customers into market segments are a proxy for the differing _____
of the customers.
a. reservation prices
b. average costs
c. minimum prices
d. marginal costs
ANSWER: a

79. Which of the following correctly summarizes the process of segmenting a market into groups? The
decision-maker should ensure that
a. there are differences in elasticities and costs of production across groups.
b. demand differs across groups and that consumers are separated based on easily verifiable and hard-
to-change characteristics.
c. demand is equal and reservation prices are different across groups.
d. marginal benefit and group sizes vary across groups, and that demand curves are elastic.
ANSWER: b

80. To prevent people from pretending to qualify for the market segment with the lowest price, a company
manager that engages in group pricing needs to make sure that
a. segmentation is on a detailed set of qualifications.
b. each consumer has no way of knowing the range of prices paid by other consumers.
c. there are equivalent prices paid by consumers in each segment.
d. there is a simple way to verify the segment in which a consumer qualifies.
ANSWER: d

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81. Which criteria for market segmentation would be easiest to use for an online retailer?
a. Customer height
b. Student or nonstudent status
c. Income
d. Account address
ANSWER: d

82. Martin is a piano teacher who wishes to price discriminate across his students based on their household
income. What would be a simple, verifiable characteristic for him to use as a proxy measure of income?
a. Hair color
b. Parents' musical background
c. Age
d. Address
ANSWER: d

83. Corinne gives private art lessons to children. She wants to price discriminate based on the household income
of her students. She does not know the exact household income of her students but wants to estimate it, to put
them into different price segments. What easily verifiable measure of income could she use?
a. Household income taxes
b. Public or private school attendance
c. Child's participation in sports
d. Year in school
ANSWER: b

84. Arturo makes and sells organic frozen yogurt with fresh fruit toppings. He wants to price discriminate
according to a preference for organic food so that those with the most inelastic demand for organic food pay the
highest price. To accomplish this, to which group should he give discount coupons for his yogurt?
a. Members of the local organic food co-op
b. People who come to the community's weekly farmer's market
c. Customers of the local fast-food restaurant
d. Students at the local art school
ANSWER: c

85. For effective segmentation of market demand, the basis for putting each customer into a given price
segment requires criteria that are _____ and _____.
a. consistent across consumers; hard-to-change
b. verifiable; at each consumer's discretion
c. easy to check; hard to change
d. based on preferences; easy to change
ANSWER: c

86. Which of the following bases for segmenting people would make it most difficult for people to manipulate
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the situation by switching segments to get a lower price?
a. Households with a subscription to a newspaper
b. The number of TVs in the household
c. Preferences
d. Customer height
ANSWER: d

87. Why would it be a bad idea for a retailer to use "wearing nail polish" as the basis for segmenting customers
into groups for price discrimination?
a. A retailer can easily verify whether a customer is wearing nail polish.
b. Preference for nail polish seems to be closely tied to a preference for the retailer's product.
c. There are big differences in customers who wear nail polish compared to those who do not.
d. People can easily switch from wearing nail polish to not wearing it.
ANSWER: d

88. When a retailer engages in price discrimination through group pricing, the variation in price is described as
some consumers paying _____ rather than some consumers paying _____.
a. a premium added to price; a discounted price
b. a discounted price; a premium added to the price
c. a cost-based price; a demand-based price
d. a demand-based price; a cost-based price
ANSWER: b

89. Price discrimination through group pricing works when the basis for segmenting the consumers is _____, is
_____, and separates consumers based on their _____.
a. secret; hard to change; costs
b. verifiable; hard to change; reservation price for the product
c. open; easy to change; marginal costs
d. verifiable; easy to change; flexibility in demand for the product
ANSWER: b

90. When you are a seller who offers lower prices only to people who are willing to overcome some obstacle to
get the lower price, you are using _____ to get consumers to reveal their reservation price.
a. impediment pricing
b. segment blocking
c. incentive revelation
d. the hurdle method
ANSWER: d

91. When a seller offers lower prices to those buyers who are willing to overcome some obstacle to get it, the
seller is using _____ to get buyers to reveal their _____.
a. segment blocking; marginal benefit
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b. the hurdle method; reservation price

c. impediment pricing; marginal benefit
d. the hurdle method; marginal cost
ANSWER: b

92. Vickie, owner of a day spa, would use the hurdle method to price discriminate because she
a. does not have a good way to identify the reservation prices of buyers.
b. knows there is no variation in reservation price across buyers.
c. does not feel there is a strong demand for the product and buyers need incentives.
d. knows that buyers have an inelastic demand for the product.
ANSWER: a

93. When the hurdle method is used to price a product across buyers,
a. only those buyers who want it can buy the product.
b. they can buy different versions of the product with more advanced versions costing more.
c. the seller prices the product based on the amount of difficulty faced in producing it.
d. only those who overcome the obstacle that the seller specifies will get a lower price.
ANSWER: d

94. When the hurdle method is used to price discriminate, buyers

a. are put into a price group based on an observable, personal characteristic.
b. are unaware that they are paying a different price than some of the other buyers.
c. sort themselves into reservation price groups based on their willingness to overcome the hurdle.
d. face insurmountable obstacles to accessing the product.
ANSWER: c

95. Selling alternative versions of a product at different prices is a way to identify the _____ of customers and
charge them different prices.
a. reservation price
b. marginal cost
c. size of the population
d. observable differences
ANSWER: a

96. Charging more for fast shipping than for slower shipping is an example of a retailer using _____ to create
_____.
a. timing; growth in demand
b. alternate versions; hurdles
c. timing; lower average costs
d. alternative versions; higher average costs
ANSWER: b
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97. The early bird specials at many restaurants are an example of using _____ to create _____.
a. alternate versions; marginal benefit
b. difficult-to-change characteristics; a hurdle
c. alternate versions; lower marginal costs
d. timing; a hurdle
ANSWER: d

98. A certain shampoo is on sale twice a year, every year. This is an example of a seller using _____ as a form
of _____ to achieve price discrimination.
a. alternate versions; the hurdle method
b. price fluctuation; group pricing
c. price fluctuation; the hurdle method
d. alternate versions; group pricing
ANSWER: c

99. An appliance store holds a week-long sale on refrigerators every summer, and on stoves every fall. This is
an example of a seller using _____ to achieve price discrimination through _____.
a. price fluctuation; the hurdle method.
b. group pricing; marginal benefit fluctuation
c. haggling; group pricing
d. alternative versions; delayed gratification
ANSWER: a

100. Pancho owns a small grocery store. Even though Pancho's costs do not vary much from month to month,
he puts most of his merchandise on sale a few times a year. He rotates the items which are on sale each month.
He is using the strategy of _____ to create _____ for customers who _____.
a. shopping around; group pricing; have inelastic demand
b. rebates; hurdles; have high reservation prices
c. group pricing; inelastic demand; have low reservation prices
d. price fluctuation; hurdles; are price sensitive
ANSWER: d

101. When a retailer varies price on items in ways that require buyers to spend extra time or effort to get a lower
price, the retailer is using which of the following strategies to price discriminate?
a. Shopping around
b. Bad service
c. Quantity discounts
d. Alternate versions
ANSWER: a

102. Marcella spends an hour each week going through the weekly grocery store advertisements and then shops
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at four or five stores to get the best deals. Her friend Hua Xing shops at the same store each week and never
looks at the advertisements. The grocery stores are practicing price discrimination through the _____ method
because _____ has a lower reservation price.
a. segmentation; Marcella
b. hurdle; Marcella
c. segmentation; Hua Xing
d. hurdle; Hua Xing
ANSWER: b

103. A large department store advertises time-of-day discounts for particular items on a special sale day. The
store is using _____ to create a _____ for the most price-sensitive customers to gain low prices.
a. bundling; segmentation
b. alternate versions; group pricing
c. fluctuating prices; hurdle
d. haggling; segmentation
ANSWER: c

104. A furniture store owner allows its salespersons to lower a price by up to ten percent to gain a sale if the
buyer appears price sensitive. The owner also instructs salespersons to confer with management about the
possibility of higher discounts if needed to make a sale. This example of individually negotiated prices is a form
of price discrimination known as
a. alternate versions.
b. haggling.
c. bundling.
d. bad service.
ANSWER: b

105. Which of the following is an example of price discrimination through haggling?

a. Ajri sells five veggie burgers to five people at different prices based on the time of day of the sale.
b. Max sells three TVs to three customers at two different prices based on how many TVs he had
already sold that day.
c. Pule sells three muffins to three customers at two different prices depending on when he baked them.
d. Arturo sells five identical shovels to five people at different prices at his yard sale based on
negotiations with them.
ANSWER: d

106. In the hurdle method of price discrimination, a seller gives a lower price only to those who are price
sensitive by
a. identifying a characteristic of those who are price sensitive and giving that group discounts.
b. requiring price-sensitive buyers to do something extra to get a lower price.
c. identifying those who are price sensitive by the goods they buy and then discounting those goods
only.
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d. choosing a discount pattern so that every fifth or 100th (or whatever chosen frequency) customer
receives a discount.
ANSWER: b

107. Lena likes to buy vegetables at a farmer's market. Each week, she walks through the market to see what's
available and compares prices offered by different sellers. She makes sure each seller knows that she is
comparing prices and then buys from the one who gives her the best deal. Lena is practicing:
a. segmentation.
b. haggling.
c. bad service.
d. alternate versions.
ANSWER: b

108. Mario's Bed & Breakfast is willing to offer discounts to customers, but it does not advertise discounts.
Discounts are given only to customers who ask if any discounts are available or who seem very indecisive when
inquiring rates. As a result of this practice, some customers pay full price, and others pay lower prices. Mario is
practicing _____ through _____.
a. segmentation; group pricing
b. price discrimination; quantity discounts
c. hurdle method; segmentation
d. price discrimination; the hurdle method
ANSWER: d

109. Which of the following is NOT an example of the hurdle method of price discrimination?
a. Offering different versions of a product that sell for different prices.
b. Bundling to get a second good at a lower price.
c. Segmenting the market into identifiable groups with different prices.
d. Making customers put extra effort to get a lower price on a product.
ANSWER: c

110. Why would a seller choose the hurdle method instead of group pricing to price discriminate?
a. The seller wishes to make it more difficult for customers to deal with the seller's company.
b. The seller realizes that those who are willing to go over a hurdle to get a product are willing to pay
more for it.
c. The seller knows that hurdles increase customer interest in the product.
d. The seller cannot find a verifiable, hard-to-change characteristic on which to base the group
segmentation.
ANSWER: d

111. Which of the following is NOT an example of the hurdle method of price discrimination?
a. Making slightly different product versions available at different times at different prices.
b. Fluctuating the product's price over time.
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c. Providing group discounts to price-sensitive consumers based on an identifiable characteristic.

d. Distributing discount coupons that can be turned in to get a lower price.
ANSWER: c

112. Which of the following is NOT an example of price discrimination through the hurdle method?
a. All senior citizens are eligible to receive a 10% discount.
b. Those who use a manufacturer coupon receive $5 off the price.
c. Those who are willing to wait for periodic sales get a lower price.
d. Slightly different product versions are available at different prices.
ANSWER: a

113. An airline charges its customers a $10 fee for purchasing a flight ticket by talking on the phone to a
reservation specialist who can search available flight options. The airline does not charge a fee for purchasing a
flight ticket on the airline's website. On the website, customers find it confusing to identify all options and make
a reservation. This airline is practicing price discrimination through
a. creating group pricing through the mode of purchase choice by consumers.
b. segmenting consumers based on the timing of their purchase.
c. creating a hurdle through quantity discounts.
d. creating a hurdle of worse service.
ANSWER: d

114. Coupons and rebates provide discounts to the especially price-sensitive consumers even though they are
available to all consumers. Why do only price-sensitive consumers avail these discounts? Price-Sensitive
consumers
a. are the only ones who receive the coupons and rebate forms.
b. have the identifying characteristic that the seller uses to segment the customers.
c. are more willing to take the time to locate and use the coupons and rebate forms.
d. want to buy at full price in order to appear prosperous.
ANSWER: c

115. All of the following are commonly used to create a hurdle for price-sensitive consumers to overcome in
order to get a lower price EXCEPT
a. group pricing.
b. coupons.
c. bundling.
d. haggling.
ANSWER: a

116. Sergio sells identical shirts under two brand names — Rags and Bees. The shirts with the Rags label sell
for $70, and the shirts with the Bees label sell for $40. The Rags shirts hang wrinkle-free on a hanger, and the
Bees shirts are folded and have some wrinkles. This is an example of price discrimination through
a. using an imperfect product to create a hurdle.
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b. using shopping around to create a hurdle.

c. assuming that customers are unaware of quality.
d. segmenting into groups based on customer income.
ANSWER: a

117. Malia sells headbands that are identical except that some do not have a small embroidered logo. Those
with the logo sell for $10, and those without the logo sell for $5. Malia is using the price discrimination strategy
of _____ through _____ to increase her revenue.
a. group pricing; alternate versions
b. the hurdle method; imperfect goods
c. segmentation; shopping around
d. the hurdle method; fluctuating prices
ANSWER: b

118. Which of the following is NOT a way of creating a hurdle that will cause price-sensitive buyers to self-
identify?
a. Offer coupons to redeem for discounts that inconvenience price-sensitive buyers.
b. Make a lower-price version that is available only after the product has been available for some time
at a higher price.
c. Make a less appealing version of the product that is available at a lower price.
d. Find a verifiable, hard-to-change characteristic to group customers based on price-sensitivity.
ANSWER: d

119. Bayside Shoe Shop offers a BOGO (buy one, get one) special where customers can buy one pair at full
price and get another pair at half-price. This form of price discrimination is referred to as
a. group pricing.
b. bad service.
c. quantity discount.
d. fluctuating prices.
ANSWER: c

120. Kroger offers a discounted price on bottles of soda if customers buy four or more bottles. What kind of
price discrimination strategy is this?
a. Segmentation
b. Group pricing
c. The hurdle method
d. Verifiable purchase
ANSWER: c

121. The Clean Company sells a bottle of bathroom cleaner for $4 and a grout brush for $3. It offers a special
deal for a package containing both the bathroom cleaner and the grout brush for $5. This type of quantity
discount is known as
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a. imperfect goods.
b. bundling.
c. group pricing.
d. shopping around.
ANSWER: b

122. Which of the following describes bundling as a form of price discrimination?

a. Customers with similar demographic characteristics are grouped together.
b. Customers with similar preferences are put in groups, each with a set price.
c. Different products are sold together at a cheaper total price than if sold separately.
d. A product is sold at a lower per-unit price if several units are bought together.
ANSWER: c

123. Jordan's food truck sells tacos and burritos. Her most popular items are chicken tacos and beef tacos. Bean
burritos are the least popular item on her menu, although some buyers like the burrito's large size compared to
the tacos. The tacos and the burritos both sell for $4. Jordan offers a special deal of a taco and a bean burrito for
$7. How is this a form of price discrimination?
a. Buyers are grouped according to preferences for tacos or burritos. Those who prefer tacos pay a
lower price for the taco in the bundle.
b. Buyers are grouped according to preferences for tacos or burritos. Those who prefer burritos pay a
lower price for the burrito in the bundle.
c. Buyers who buy the bundle are getting less satisfaction per dollar spent because they are getting a
less preferred item instead of two of their more preferred items.
d. Those who prefer tacos and those who prefer burritos are induced to get a unit of their less preferred
product because they can buy it at a discounted price of $3 by buying a bundle.
ANSWER: d

124. Sun Do sells key chains with leather fobs for $12 and $9. The key chains are very similar and have
identical manufacturing costs. The difference is that the stitching on the leather fob is in a less precise pattern on
the $9 key chain than it is on the $12 key chains. What approach to price discrimination is Sun Do using?
a. Shopping around as a form of group pricing.
b. Segmenting the market through bad service.
c. Offering imperfect goods as part of the hurdle method.
d. Offering alternate versions through timing as part of the hurdle method.
ANSWER: c

125. Zephyr Appliances sells the same stove to customers at two different prices. The higher price is for buyers
who get top-notch customer service. The lower price is for those who forgo customer service. This is an
example of what kind of price discrimination?
a. The hurdle method
b. Group pricing
c. Segmentation valuation
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d. Quantity discounts
ANSWER: a

126. What current development is making it possible for businesses to use more sophisticated price
discrimination strategies than they were able to use before this century?
a. Sellers now produce more advanced versions of products.
b. Communication is moving away from the use of land-line phones.
c. Sellers now have access to massive amounts of digital data on individual customers.
d. Large numbers of people have moved out of extreme poverty in countries like China.
ANSWER: c

127. Two issues that cause company managers to be cautious in their use of the massive amounts of customer
information available digitally are
a. profits and ethics.
b. fairness and ethics.
c. fairness and communication.
d. honesty and profits.
ANSWER: b

128. The massive amount of individual consumer data available digitally could lead to which of the following
levels of price discrimination?
a. Group pricing
b. Bi-level pricing
c. Individual pricing
d. Segmentation fluctuation
ANSWER: c

129. Perfect price discrimination could be referred to as

a. group pricing.
b. segmentation.
c. hurdle pricing.
d. individual pricing.
ANSWER: d

130. Individual pricing is a way to describe

a. segmentation pricing.
b. hurdle pricing.
c. perfect price discrimination.
d. reservation discrimination.
ANSWER: c

131. Consumer backlash against price discrimination often focuses on the issue of
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a. profit.
b. consumers' needs versus their wants.
c. honesty.
d. fairness.
ANSWER: d

Essay

132. How does price discrimination increase efficiency in a market?

ANSWER: Price discrimination occurs in imperfect markets. In general, imperfectly competitive markets are
inefficient as their output is lower than a perfectly competitive market. Businesses in imperfect
markets set output where marginal cost equals the marginal benefit. As demand is downward
sloping, marginal revenue for the last unit is less than the price. When businesses price discriminate,
they are willing to increase output to the level, where marginal cost equals the marginal benefit of
the last consumer as they can charge different buyers different prices. The result is a larger and more
efficient quantity sold than would exist if the imperfectly competitive company did not price
discrimina

133. Why is market power necessary for a business owner to price discriminate successfully?
ANSWER: When a company has market power, it will not lose all its customers when they raise the price and
can charge different buyers different prices. If a company has no market power. such as the case of
perfect competition, charging customers different prices won't work because customers will buy
from somewhere else. Market power is required for a business to price discriminate.

134. What three conditions must be present for a company owner to price discriminate successfully?
ANSWER: The first condition that must hold for a company to price discriminate is to have market power.
Without market power, the company will fail to charge some customers a higher price than others.
Second, the product must be one that cannot be resold. If the product can be resold, those eligible to
buy at a low price will buy more than they need and resell it to others at higher prices. Third, the
business should be able to identify which customers are willing to pay higher prices and which are
price sensitive.

135. How do the prices that prevail during price discrimination compare to the price that would exist if the
market were charging just one price across all buyers?
ANSWER: Price discrimination leads to higher prices for some and lower prices for others. A manager with
market power first chooses their quantity at the point where marginal revenue equals marginal cost,
then chooses the price by looking up to the demand curve. With no price discrimination, everyone
pays the same price. With price discrimination, you can charge or negotiate a higher price to those
customers who have a higher marginal benefit because these customers have a higher reservation
price. While you give discounts to potential customers who have a lower reservation price and are
not willing to buy the product.

136. What is a consumer's reservation price? How does a consumer's reservation price relate to price
discrimination?
ANSWER: A consumer's reservation price is the highest price he is willing to pay for a product. It represents
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the marginal benefit that the consumer would receive from the product. Through price
discrimination, a manager wants to charge each customer a price at or close to his/her reservation
price to maximize revenue. However, the manager will not reduce the price below his marginal cost
for the last consumer.

137. What three steps should a company owner take to segment its market successfully?
ANSWER: To segment market demand, the first criteria is that different groups should have different demand.
In other words, the elasticity of demand from group to group should vary. Second, the groups should
have verifiable characteristics, that are easy to notice and confirm. Furthermore, this characteristic
should be different across the groups so that a manager can use it to segment market demand. Third,
the identifying characteristic should be difficult to change. Otherwise, customers will adopt that
characteristic to get the lower price.

138. When group pricing is used, what should determine which group is charged a high price and which group
is charged a lower price?
ANSWER: Each group's price should be according to the reservation price of those who are in the group.
Groups whose members receive greater benefit from the product or value it more should be charged
more. The groups with lower reservation prices should be charged less because the group members
do not value the product as much. They will buy only if the price is low.

139. Under what conditions will group pricing NOT work as a means for price discrimination?
ANSWER: Group pricing is a simple way for a company's management to capture extra profits, but it is not
feasible in all situations. Demand should differ across buyers for the product so that they can be put
in groups and offered specific group pricing. An easily verifiable and hard-to-change characteristic
needs to be present that will help divide buyers into groups. If these conditions don't hold, group
pricing will not work.

140. Why would a seller use the hurdle method to price discriminate rather than group pricing?
ANSWER: Group pricing is a type of price discrimination that works by charging different prices to different
groups of people. Forming groups require buyers should have differing demand, easily verifiable
and difficult-to-change characteristics. If this information about buyers is not available then group
pricing is not possible, and sellers can use the hurdle method. The hurdle method requires buyers to
overcome some type of obstacle to qualify for a lower price. Those who are more price sensitive (or
have a lower reservation price) will be more willing to overcome the hurdle to get the lower price.

141. Some retailers practice price discrimination through the hurdle method. Describe at least four ways that a
seller could create a hurdle that a consumer must overcome in order to pay a lower price for a product.
ANSWER: There are numerous ways that a retailer can limit access to low prices to only those who are
especially price sensitive. Some of these methods include quantity discounts, alternative versions
based on timing, shopping around, differing levels of service, imperfect goods, and extra hassle.
With quantity discounts, consumers get a lower price only if they buy multiple units, either of the
same goods or a bundle of different goods. Alternative versions based on timing occur when
consumers pay a high price to buy immediately and a lower price to buy later or to buy at
inconvenient times. Retailers may eat up customer time through shopping around to get a lower
price so that only those who are willing to give up time get a discount. Shopping around could be
achieved through tactics like periodic price fluctuations or haggling. An example of requiring
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customers to deal with hassle would be something like the need to clip and turn in coupons to get a
low price. Different prices for different levels of customer service are also used. Another way to
target customers with differing reservation prices is selling slightly different versions of a product,
with one version viewed as inferior to the other, at different prices.

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Multiple Choice

1. An interaction between two or more persons is considered a strategic interaction when:

a. all people involved are working together to achieve a common goal best achieved through joint
action.
b. all people involved have a clear path or action that will give them optimal results regardless of what
any other person chooses.
c. there is no optimum result possible for anyone in the group, so each person tries to avoid a worst-
case scenario.
d. an individual's best choice may depend on what the others choose, and others' best choice may
depend on what the individual chooses.
ANSWER: d

2. Which of the following terms denotes a situation in which an individual's best choice may depend on what
others choose, and others' best choice may depend on what the individual chooses?
a. comparative advantage
b. strategic interaction
c. coordination interaction
d. partial equilibrium
ANSWER: b

3. The science of making good decisions in situations involving strategic interactions is called:
a. game theory.
b. interaction analysis.
c. focal point analysis.
d. strategic interdependency.
ANSWER: a

4. Game theory is:

a. a view on the development of children's games and toys.
b. the analysis of market forces when there is role reversal for buyers and sellers.
c. the science of making good decisions in situations involving strategic interactions.
d. a view on decision making when clear paths to optimum outcomes are known.
ANSWER: c

5. When an individual's best choice may depend on what other people choose and other people's best choices
may depend on what the individual chooses, then _____ is the science that is useful to help the decision makers
analyze their options.
a. strategic interaction theory
b. game theory
c. analytical strategy
d. partial equilibrium analysis
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ANSWER: b

6. Game theory is helpful in analyzing situations in which there is _____ the decision makers.
a. dominance by one of
b. independence across all
c. unequal information across
d. interdependence between
ANSWER: d

7. "Playing games" is another term for engaging in:

a. strategic interactions.
b. independent actions.
c. rivalry investments.
d. alternative theory.
ANSWER: a

8. How common are strategic interactions and games in people's lives?

a. They are rare, occurring only a few times in a lifetime.
b. They occur occasionally, perhaps every few years.
c. They are somewhat frequent, occurring perhaps every six to 12 months.
d. They are a pervasive part of life that occur daily or weekly.
ANSWER: d

9. A basic logic that applies to all strategic interactions is:

a. making a good choice requires that you anticipate what others will do.
b. action should not be taken until there is a clear best choice.
c. risk must be eliminated.
d. games should be avoided, so that decisions can be based on facts.
ANSWER: a

10. Which of the following is NOT one of the four steps for making good strategic decisions?
a. Consider all the possible outcomes.
b. Consider all the possible "what ifs" simultaneously.
c. Play your best response.
d. Put yourself in other people's shoes.
ANSWER: b

11. Which of the following is NOT one of the four steps for making good strategic decisions?
a. Consider only the most favorable outcomes.
b. Think about the "what ifs" separately.
c. Play your best response.
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d. Put yourself in other people's shoes.

ANSWER: a

12. Which of the following is NOT one of the four steps for making good strategic decisions?
a. Consider all the possible outcomes.
b. Think about the "what ifs" separately.
c. Do what others don't expect you to do.
d. Put yourself in other people's shoes.
ANSWER: c

13. Which of the following is NOT one of the four steps for making good strategic decisions?
a. Consider all the possible outcomes.
b. Think about the "what ifs" separately.
c. Play your best response.
d. Assume that others will defer to your action.
ANSWER: d

14. A payoff table lists all possible _____, with a row for each _____ and a column for _____.
a. outcomes; of one player's possible outcomes; each of the other player's possible outcomes
b. costs; fixed cost; each variable cost
c. rivals; possible rival; each outcome resulting from competing against each rival
d. outcomes; possible negative outcome; each possible positive outcome
ANSWER: a

15. Two people have an interactive relationship. A table that has a row for each possible outcome for one
person and a column for each possible outcome for the other person is called:
a. an outcome matrix.
b. an interaction table.
c. a game matrix.
d. a payoff table.
ANSWER: d

16. Use the table about Hikaru and his parents to answer the question.

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What is this kind of table called?

a. an outcome matrix
b. an interaction table
c. a payoff table
d. a game matrix
ANSWER: c

17. Use the table about Hikaru and his parents to answer the question.

Hikaru wants to graduate from college as soon as possible after high school and begin his career with his
personal finances as sound and debt-free as possible. Hikaru's best option to achieve this goal is _____ work
part-time in high school if his parents pay his tuition and _____ work part-time in high school if his parents do
not pay his tuition.
a. to; not to
b. to; to
c. not to; not to
d. not to; to
ANSWER: b

18. When looking at a payoff table, what does it mean to "Put yourself in someone else's shoes"?
a. Look at the other party's options to see if those options are better than yours.
b. Negotiate with the other party to switch places with that party.
c. Try to take on the roles of both parties to determine which choices lead to the best of all possible
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outcomes.
d. Figure out what decision the other party is likely to make, given the other party's incentives.
ANSWER: d

19. Use the table with data for Maria and Jose to answer the question.

If Maria charges $8, then Jose's best option would be to charge_____ in order to earn _____.
a. $4; $280
b. $4; $180
c. $8; $180
d. $8; $40
ANSWER: a

20. Use the table with data for Maria and Jose to answer the question.

If Jose charges $8, then Maria's best price would be _____, and she would earn _____
a. $8; $200
b. $8; $50
c. $4; $300
d. $4; $180
ANSWER: c

21. Use the table with data for Maria and Jose to answer the question.

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If Maria charges $4, then Jose's best option would be to charge _____ in order to earn _____.
a. $8; $180
b. $8; $280
c. $4; $40
d. $4; $150
ANSWER: d

22. Use the table with data for Maria and Jose to answer the question.

If Jose charges $4, then Maria's best option would be to charge _____ in order to earn _____.
a. $8; $200
b. $8; $50
c. $4; $300
d. $4; $180
ANSWER: d

23. Use the table with data for Maria and Jose to answer the question.

If Jose charges $8, Maria should charge _____. If Jose charges $4, Maria should charge _____.
a. $8; $8
b. $8; $4
c. $4; $8
d. $4; $4
ANSWER: d

24. Use the table with data for Maria and Jose to answer the question.

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If Maria charges $8, the Jose should charge _____. If Maria charges $4, then Jose should charge _____.
a. $4; $4
b. $4; $8
c. $8; $4
d. $8; $8
ANSWER: a

25. Use the table with data for Maria and Jose to answer the question.

Maria is most likely to charge a price of _____, and Jose is most likely to charge a price of _____.
a. $4; $4
b. $4; $8
c. $8; $4
d. $8; $8
ANSWER: a

26. Use the table with data for Vlad and Assad to answer the question.

If Assad charges $1, then Vlad should charge _____. If Assad charges $3, then Vlad should charge _____.
a. $3; $3
b. $3; $1
c. $1; $3
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d. $1; $1
ANSWER: d

27. Use the table with data for Vlad and Assad to answer the question.

With no cooperation, the most likely outcome is that Vlad will charge _____, and Assad will charge _____.
a. $1; $1
b. $1; $3
c. $3; $1
d. $3; $3
ANSWER: a

28. Use the table with data for Vlad and Assad to answer the question.

If Vlad charges $1, then Assad should charge _____. If Vlad charges $3, then Assad should charge _____.
a. $1, $1
b. $1; $3
c. $3; $1
d. $3; $3
ANSWER: a

29. Use the table with data for Tasha and Hui Er to answer the question.

Tasha tries to put herself in Hui Er's shoes. Tasha concludes that if she (Tasha) charges $5, then Hui Er will
charge _____ to earn a profit of _____.
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a. $5; $3,000
b. $5; $700
c. $9; $6,000
d. $9; $5,000
ANSWER: a

30. Use the table with data for Tasha and Hui Er to answer the question.

Tasha tries to put herself in Hui Er's place. Tasha concludes that if she (Tasha), charges $9, then Hui Er will
charge _____ to earn a profit of _____.
a. $9; $3,000
b. $9; $700
c. $5; $6,000
d. $5; $5,000
ANSWER: c

31. Use the table with data for Tasha and Hui Er to answer the question.

With no cooperation, the most likely outcome is that Tasha will charge _____, and Hui Er will charge _____.
a. $5; $5
b. $5; $9
c. $9; $5
d. $9; $9
ANSWER: a

32. Use the table with data for Gizelle and Devin to answer the question.

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Gizelle tries to put herself in Devin's place. If she (Gizelle) charges a price of $7, then she thinks that Devin will
charge ____ to earn a profit of _____.
a. $6; $2,500
b. $6; $5,000
c. $8; $1,000
d. $8; $4,000
ANSWER: a

33. Use the table with data for Gizelle and Devin to answer the question.

Gizelle tries to put herself in Devin's place. If she (Gizelle) charges a price of $9, then she thinks that Devin will
charge ____ to earn a profit of _____.
a. $6; $2,500
b. $6; $5,000
c. $8; $1,000
d. $8; $4,000
ANSWER: b

34. Use the table with data for Gizelle and Devin to answer the question.

With no cooperation, the most likely outcome is that Gizelle will charge _____ and Devin will charge _____.
a. $9; $8
b. $9; $6
c. $7; $8
d. $7; $6
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ANSWER: d

35. Use the table with data for Gizelle and Devin to answer the question.

Devin tries to put himself in Gizelle's place. He concludes that if he (Devin) charges $8, then Gizelle will
charge _____ to earn a profit of _____.
a. $6; $3,000
b. $7; $6,000
c. $8; $4,000
d. $9; $5,000
ANSWER: b

36. An equilibrium in which the choice that each player makes is a best response to the choices other players are
making is the definition of a:
a. strategic equilibrium.
b. Coase theorem solution.
c. Nash equilibrium.
d. game-played solution.
ANSWER: c

37. A Nash equilibrium is an equilibrium in which:

a. no trade-offs are made by buyers and sellers.
b. the choice that each player makes is a best response to the choices other players are making.
c. maximum profits are earned by each player, due to cooperative decision making.
d. cooperation between market participants leads to self-serving but nonoptimum results.
ANSWER: b

38. If a check mark is put next to each player's best response in a payoff table, then an outcome cell with a
check mark from each player is called:
a. a Coase payoff solution.
b. an interaction equilibrium.
c. a game-based solution.
d. a Nash equilibrium.
ANSWER: d

39. A Nash equilibrium can be identified on a payoff table when:

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a. a check mark is put next to each player's best response, and there is a cell with a check mark for each
player.
b. a check mark is put next to each player's best response, and there is a cell with no check marks in it.
c. one cell contains the highest gain for each player, although it may not be the player's best response.
d. each player has an equilibrium that is opposite that of the other player, so they are not in conflict.
ANSWER: a

40. Why is a "Nash equilibrium" called an equilibrium?

a. The market is at maximum profits, with quantity demanded equal to supply.
b. No players can do better by changing his or her own choice alone, so the situation is relatively stable.
c. It overcomes market failure to provide the optimum social welfare outcome.
d. Costs are minimized, and profits are maximized.
ANSWER: b

41. Use the table, with data for Gizelle and Devin, to answer the question

Use the check mark method to determine which cell, if any, has a Nash equilibrium, and then choose the correct
description.
a. The Nash equilibrium is Gizelle earning profit of $5,000 and Devin earning profit of $4,000.
b. The Nash equilibrium is Gizelle earning profit of $1,000 and Devin earning profit of $5,000.
c. The Nash equilibrium is Gizelle earning profit of $6,000 and Devin earning profit of $1,000.
d. The Nash equilibrium is Gizelle earning profit of $3,000 and Devin earning profit of $2,500.
ANSWER: d

42. Use the table, with data for Vlad and Assad, to answer the question.

Use the check mark method to determine which cell has a Nash equilibrium. When there is a Nash equilibrium,
Vlad earns profits of _____, and Assad earns profits of _____.
a. $3,000; $3,000
b. $3,500; $500

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c. $500; $3,500
d. $2,000; $2,000
ANSWER: d

43. Use the table, with data for Tasha and Hui Er, to answer the question.

Use the check mark method to determine which cell contains a Nash equilibrium. Under a Nash equilibrium,
Hui Er earns profits of _____, and Tasha earns profits of _____.
a. $6,000; $700
b. $3,000; $3,000
c. $700; $6,000
d. $5,000; $5,000
ANSWER: b

44. Which of the following statements is FALSE regarding a Nash equilibrium?

a. Each player's expectation of the other player's strategy is correct.
b. Cooperation between the players could not improve the outcome.
c. All players choose their best response to the strategy they expect the other player will choose.
d. No player can do better by unilaterally changing his or her choice.
ANSWER: b

45. Which of the following statements regarding a Nash equilibrium is TRUE?

a. Cooperation between players could not improve the outcome.
b. All players choose their overall best response without regard to the other player's likely choice.
c. No player can do better by unilaterally changing his or her choice.
d. Each player's expectation of the other player's choice is often incorrect.
ANSWER: c

46. Agreements to cooperate among players in a game are:

a. expected.
b. common.
c. not credible.
d. reliable.
ANSWER: c

47. The Prisoner's Dilemma shows how markets:

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a. deliver the best possible outcomes.

b. are based on collusive agreements in most cases.
c. can deliver bad outcomes.
d. minimize costs.
ANSWER: c

48. Markets under _____ deliver efficient outcomes; markets with _____ deliver inefficient outcomes.
a. perfect competition; strategic interactions
b. strategic interactions; perfect competition
c. limited rivalry; strong rivalry
d. strong rivalry; limited rivalry
ANSWER: a

49. While _____ markets do not necessarily lead to efficient outcomes, _____ markets tend to yield efficient
outcomes.
a. Strategic; prisoner-based
b. Prisoner-based; strategic
c. Competitive; strategic interactions in
d. Strategic interactions in; competitive
ANSWER: d

50. Why are cooperative agreements rare in markets with strategic interactions?
a. Players have incentives to disregard such agreements.
b. It is too hard to predict what other players will do.
c. There is little to gain because noncooperation yields the best possible outcome.
d. Cooperation entails higher costs.
ANSWER: a

51. Use the table with data for Bella and Martin to answer the question.

With no cooperation, the Nash equilibrium yields Bella a profit of _____ and Martin a profit of _____.
a. $6,000; $1,000
b. $4,000; $3,500
c. $5,000; $5,000
d. $1,000; $5,500
ANSWER: b
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52. Use the table, with data for Bella and Martin, to answer the question.

If Bella and Martin successfully cooperate, then Bella's profit will be _____, and Martin's profit will be _____.
a. $6,000; $1,000
b. $4,000; $3,500
c. $5,000; $5,000
d. $1,000; $5,500
ANSWER: c

53. Use the table, with data for Bella and Martin, to answer the question.

If Bella and Martin cooperate, Bella would earn _____ more and Martin _____ more than they would without
cooperation.
a. $3,000; $2,000
b. $5,000; $4,500
c. $5,000; $5,000
d. $1,000; $1,500
ANSWER: d

54. Use the table, with data for Bishan and Amara, to answer the question.

If Bishan and Amara cooperate, Bishan would earn _____ more and Amara would earn _____ more than they
would without cooperation.
a. $100; $20

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b. $1,700; $2,000
c. $300; $400
d. $1,000; $1,200
ANSWER: c

55. When resources are shared or owned in common, the Nash equilibrium leads to:
a. underuse of resources.
b. overuse of resources.
c. higher profits than with unshared resources.
d. lower profits than with unshared resources.
ANSWER: b

56. The Nash equilibrium leads to the overuse of resources when:

a. competition is intense.
b. profit is not the main goal.
c. resources are privately owned.
d. resources are shared.
ANSWER: d

57. The tragedy of commons is due to:

a. excessive cooperation to extract maximum group profits.
b. a failure to cooperate so that all players take only their fair share.
c. a failure to reach a Nash equilibrium.
d. demand exceeding supply when payoffs are considered.
ANSWER: b

58. Peter and Olga live near a lake with open fishing, and both have fishing boats there. They are the only two
providers of fish to their local fish market. What is likely to happen if the local fish market maintains a Nash
equilibrium?
a. Peter and Olga will obtain the maximum possible profits.
b. Fish prices will fall due to competitive pressures.
c. The supply of fish will flourish due to underfishing.
d. The supply of fish will dwindle due to overfishing.
ANSWER: d

59. When a market uses a resource owned in common, then in the Nash equilibrium in that market,:
a. producers will continue to have an incentive to enter, causing the equilibrium to constantly change.
b. the resource will be overused.
c. producers will have higher costs than if all resources were private.
d. less will be produced than is in the public's best interest.
ANSWER: b
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60. The tragedy of commons leads to a Nash equilibrium with shared resources that are:
a. turned into privately owned resources.
b. excluded from production.
c. underused.
d. overused.
ANSWER: d

61. Use the table, with data for Peter and Olga, to answer the question.

Peter and Olga live near a lake with open fishing, and both have fishing boats there. They are the only two
sellers in their local fish market. What is likely to be the result in a Nash equilibrium?
a. Both Olga and Peter have smaller and smaller catches over time.
b. Peter catches and sells more fish than Olga.
c. Olga catches and sells more fish than Peter.
d. Both Olga and Peter continue to have large catches on each fishing trip.
ANSWER: a

62. Cooperation requires:

a. common goals and methods.
b. coordination regarding who does what.
c. no more than one player.
d. interaction but not coordination.
ANSWER: b

63. Multiple equilibria exist when:

a. there are many different product markets, each with its own equilibrium.
b. a market splits in two, so that there are two markets, each with its own equilibrium.
c. there are multiple products but one market with one equilibrium for these products.
d. there is more than one equilibrium.
ANSWER: d

64. A situation with more than one equilibrium is called:

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a. partial equilibrium.
b. multiple equilibria.
c. excess balance points.
d. varied settlements.
ANSWER: b

65. A coordination game exists when:

a. the product or issue of the game concerns communication, such as phones or media.
b. coordination is costless and easy, regardless of whether it is harmful.
c. all players have a common interest in coordinating their choices.
d. collusion created the market or situation from the start.
ANSWER: c

66. When all players have a common interest in coordinating their choices, there is:
a. a coordination game.
b. a systemization game.
c. an interaction game.
d. an intermeshing organization.
ANSWER: a

67. What problem arises in coordination games with multiple equilibria?

a. Players have no incentive to coordinate.
b. The multiple equilibria mean that coordination yields no possible gain.
c. The equilibria make all players worse off.
d. It is difficult to achieve the commonly desired outcome.
ANSWER: d

68. When players will be better off if they coordinate their choices, there is a:
a. back-hand game.
b. collusion game.
c. coordination game.
d. multiple incentive.
ANSWER: c

69. How can multiple equilibria be identified, using the check mark method on a payoff table?
a. More than one cell has two checks, and those cells represent equilibria.
b. There is a check in more than one cell, each check indicating an equilibrium.
c. Multiple cells have no checks, and those cells are the equilibria.
d. A check is put in a cell if both players have agreed to take that action.
ANSWER: a

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70. Which of the following is NOT an example of a coordination game?
a. interpersonal relationships
b. coordination with customers
c. deciding whether to grow tomatoes or flowers
d. deciding whether to use the same technology as others you are connected to
ANSWER: c

71. Use the table, with data for Rocky and Tina, to answer the question.

Both Tina and Rocky are ready to buy new phones. The accessories are things like cables. What is the term for
the type of game Tina and Rocky are playing?
a. an anti-coordination game
b. a one-shot game
c. a single equilibrium game
d. a coordination game
ANSWER: d

72. Use the table, with data for a company and available workers, to answer the question.

A company wants certified workers for its production and is trying to decide whether to hire only workers who
already have certifications or to hire untrained workers and provide on-the-job certification training. Those
entering the workforce are trying to decide whether to seek certification training in order to get a stable job.
What type of game is represented in this payoff table?
a. a coordination game with multiple equilibria
b. a prisoner's game with Coase equilibria
c. a coordination game with a single equilibrium
d. an anti-coordination game with a single equilibrium

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ANSWER: a

73. Use the table with data for an election to answer the question.

Tori is running for a government office in an election. Merced and many others want Tori to win and are
deciding whether to campaign for Tori. The amount of campaigning will have a significant impact on the
outcome of the election. What type of game is being played in Table 11?
a. a coordination game with a single equilibrium
b. a coordination game with multiple equilibria
c. a prisoner's game with a dilemma equilibrium
d. an anti-coordination game with multiple equilibria
ANSWER: b

74. Which of the following is NOT an example of a coordination game with multiple equilibria?
a. Two people decide whether to remain friends or pursue a romantic relationship with each other.
b. Two sellers are in a market where their best option is the same regardless of what the other firm does.
c. Potential protesters decide whether to participate in protests to try to overthrow a government.
d. A company decides in which hours to operate for the convenience of its customers and suppliers.
ANSWER: b

75. When a player's best response is to take a different (but complementary) action to the other player, then both
participants are playing _____ game.
a. a coordination
b. an anti-coordination
c. a Coase equilibrium
d. a strategic dilemma
ANSWER: b

76. An anti-coordination game is a game where:

a. both players have the same best response, regardless of what one player does.
b. both players will gain from coordination but will resist initiating it.
c. a player's best response goes against the welfare of the other player without complementarity.
d. a player's best response is to take a different (but complementary) action to the other player.
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ANSWER: d

77. Which of the following is NOT an example of an anti-coordination game?

a. Drivers try to choose the route with the least traffic.
b. Two opposing negotiators decide whether to argue aggressively or passively.
c. A market has multiple suppliers and common, rival resources.
d. Multiple firms decide whether to enter a market that can support only one more firm.
ANSWER: c

78. There are two popular hiking trails between the bottom parking lot and the top of a mountain. Both trails are
similar in length and difficulty. If Markus and Jarrah want to hike on the less crowded trail, they are facing what
type of game?
a. a coordination game
b. an anti-coordination game
c. a Coase equilibrium game
d. a single issue game
ANSWER: b

79. Which is an example of an anti-coordination game?

a. Sela is trying to decide where to locate her new factory in relation to her suppliers and customers.
b. Mara and her international suppliers and customers are deciding what language to use in contracts.
c. Atith must decide whether to pursue a romantic relationship with his friend Charaya.
d. Chan wants to hike on the less crowded of the two popular hiking trails that go around the mountain.
ANSWER: d

80. Which of the following is an example of an anti-coordination game?

a. Jamal owns one of several fishing boats that catch fish on a public lake with no restrictions on
fishing.
b. A market has enough growth in demand to support only one more firm, and Asad wants that firm to
be his.
c. Sharna wants the dictator in her country to be overthrown and must decide whether to protest against
him.
d. Matt is deciding whether to use Flash or html5 for his website.
ANSWER: b

81. Which of the following is an example of an anti-coordination game?

a. Jade is trying to decide where to locate her new store in relation to her suppliers and customers.
b. Dina and her international suppliers are deciding what currency to use in contracts.
c. Farid must decide whether to be aggressive or passive in negotiating the price of a new car.
d. Sam wants the dictator in his country to be overthrown and must decide whether to protest against
her.
ANSWER: c
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82. An equilibrium:
a. is a positive outcome.
b. is a negative outcome.
c. can be a positive outcome or a negative outcome.
d. cannot have two winners.
ANSWER: c

83. Use the table, with data for workers and businesses, to answer the question. The payoff cells are labeled A,
B, C, and D.

The equilibria are cells _____. A high-income country would settle in _____, and a low-income country would
settles in _____.
a. A and B; B; A
b. A and D; D; A
c. B and C; B; C
d. C and D; D; C
ANSWER: b

84. Which of the following is NOT consistent with the idea that an economy's booms and busts can be self-
fulfilling prophecies?
a. A boom is a good equilibrium, and a bust is a bad equilibrium.
b. When households spend a lot, firms tend to produce a lot.
c. An equilibrium occurs when workers underspend and firms overproduce.
d. If households believe firms will cut back on hiring, households cut back on spending.
ANSWER: c

85. When using coordination games to look at the issue of bank runs, the best outcome occurs when:
a. people do not use the banking system.
b. some people, but not all, keep their money in the bank.
c. people run to withdraw their money from the bank.
d. all people keep their money in the bank.
ANSWER: d

86. Use the table, with data for workers and firms, to answer the question. The payoff cells are labeled A, B, C,
and D.
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The equilibria are cells _____. The boom is cell _____, and the bust is cell _____.
a. B and C; B; C
b. B and C; C; D
c. A and D; D; A
d. A and D; A; D
ANSWER: d

87. One problem associated with a situation that has good and bad equilibria is that:
a. someone always benefits from the bad equilibrium.
b. it can be difficult to prevent the bad equilibrium from occurring.
c. the good equilibrium benefits everyone.
d. it is unlikely that the situation will end in an equilibrium.
ANSWER: b

88. Three ways to solve coordination problems include:

a. focal points, first moves, and regulation.
b. regulations, focal points, and communication.
c. communication, check marks, and first moves.
d. regulations, check marks, and reversals.
ANSWER: b

89. Coordination problems can be solved through each of the following approaches EXCEPT:
a. backward reasoning.
b. laws and regulations.
c. communication.
d. focal points, culture, and norms.
ANSWER: a

90. Use the table, with data for workers and businesses, to answer the question. The payoff cells are labeled A,
B, C, and D.

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Which of the following would help lead to D, the best outcome?

a. Businesses continue to assume that workers will not get training, since that's been the pattern in the
past.
b. The government enacts a program that provides unskilled workers with supplemental income.
c. The company announces in advance that it will hire only skilled workers.
d. Resource ownership becomes common ownership.
ANSWER: c

91. Use the table, with data for workers and businesses, to answer the question. The payoff cells are labeled A,
B, C, and D.

If payoffs in cells A or D are equally likely, which of the following approaches would help solve the problem
and lead to D?
a. Workers continue to avoid training, as they have been accustomed to doing in the past.
b. Businesses announce that they will work with whatever skill level exists in the workforce.
c. All firms move to common resource ownership.
d. The government adds workforce skill training to compulsory education requirements.
ANSWER: d

92. Use the table, with data for workers and firms, to answer the question. The payoff cells are labeled A, B, C,
and D.

There are multiple equilibria in the table. The desired outcome is cell A, but there is an equal chance of an
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equilibrium outcome in cell D. Which of the following is an appropriate approach to resolving the problem
through communication, so that the outcome in cell A is likely?
a. The government decrees that firms cannot reduce employment.
b. The government conducts an advertising campaign that urges households to increase their saving.
c. Workers expect that their jobs are just as secure as their parents' jobs were.
d. Firms announce that they will not cut production or jobs as long as consumer spending does not fall.
ANSWER: d

93. Three basic approaches to solving coordination problems are:

a. focal points and norms, laws and regulations, and check marks.
b. communication, focal points and norms, and revolution.
c. revolution, laws and regulations, and communication.
d. laws and regulations, communication, and focal points and norms.
ANSWER: d

94. A first-mover advantage is the:

a. strategic gain from an anticipatory action that can force a rival to respond less aggressively.
b. reduced costs that are associated with being the first to produce a product.
c. disincentive imposed on other players when a player takes action.
d. profits that go to the player who gets a patent on a product.
ANSWER: a

95. The strategic gain from an anticipatory action that can force a rival to respond less aggressively is the
definition of:
a. a second-mover advantage.
b. an anticipatory response advantage.
c. a first-mover advantage.
d. leading triggers.
ANSWER: c

96. A simultaneous game is one in which:

a. the alternative outcomes all occur on the same time line.
b. regardless of which choices are made, the resulting outcome occurs at the same time.
c. each player learns of the other's intention at the same time, before the final choices are made.
d. each player must choose without knowing the other player's choice.
ANSWER: d

97. When can making the first move NOT create an advantage?
a. The move is made before other players are aware.
b. Other players are making concurrent moves.
c. The move is not viewed as a credible commitment.
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d. Other players are harmed by the move.

ANSWER: c

98. What type of game is played when each player must choose without knowing the other player's choice?
a. an anti-coordination game
b. a forced-ignorance game
c. a simultaneous game
d. a one-shot game
ANSWER: c

99. The table lists the profits of two different spa chains, Elite and Supreme. The profits depend on the number
of locations each chain has in a certain city.

Each chain has one location, and both owners are considering expansion. If you were the owner of Elite Day
Spas, what would you do if you want to gain a first-mover advantage?
a. Announce expansion plans while you begin to search for a new location.
b. Quickly and quietly open a second location before Supreme has time to act.
c. Quickly and aggressively open two more locations before Supreme has time to act.
d. Coordinate with the Supreme owner to decide jointly about expansion for both firms.
ANSWER: b

100. When playing a simultaneous game, one way to get ahead is to:
a. communicate with the other player to make sure no one loses.
b. push for protective government regulations.
c. rely on focal points, culture, and norms as guides for decisions.
d. make a credible first move before the other player can act.
ANSWER: d

101. Once an original decision has been made, what happens on a game tree with each additional decision made
by a player?
a. A new branch is formed.
b. A root sprouts downward.
c. A new tree is created.
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d. A merger occurs between two branches.

ANSWER: a

102. Which of the following formats shows how a game plays out over time, with the first move forming the
trunk, each subsequent choice creating a new branch, and the final leaves showing all possible outcomes?
a. game tree
b. bush growth chart
c. tree matrix
d. game growth chart
ANSWER: a

103. What is a game tree?

a. a model that shows the path of growth of a firm from its roots to its final height (or profits)
b. a chart that illustrates the impact of solutions to coordination problems, with a branch for each
solution
c. a diagram that shows how a game plays out over time, with the first move forming the trunk,
subsequent choices adding branches, and the final leaves showing all possible outcomes
d. a chart that starts with the goal sought and that branches out to show what could happen after the
original goal is achieved
ANSWER: c

104. What is true about game trees and payoff tables?

a. A tree conveys less information than a payoff table.
b. They cannot be used to portray the same types of games.
c. They can convey the same information.
d. A payoff table shows chains of events better than a game tree.
ANSWER: c

105. What advantage does a game tree have over a payoff table in presenting data for players in a game that
plays out over time?
a. The game tree allows a player to see all options rather than just current options.
b. The game tree shows only the options generating gain rather than all options.
c. The game tree focuses on what the other player is most likely to do rather than on all options.
d. The game tree allows a player to look forward and reason backward.
ANSWER: d

106. In games that play out over time, the phrase "look forward" means to:
a. have hope and a positive attitude about possibilities.
b. anticipate the likely consequences of choices.
c. make sure all of other players options are considered.
d. recognize that options can change over time.
ANSWER: b
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107. Choose the term that is used for analyzing by this process: "Start by analyzing the last period of the game.
Use this to figure what will happen in the second-to-last period, and keep reasoning backward until you can see
all the consequences that follow from today's decision."
a. reasoning forward
b. chain-based analytics
c. reverse sequencing
d. reasoning backward
ANSWER: d

108. When a game player "looks forward," she:

a. is living in the future rather than the present, which can lead to decisions based on hopes rather than
facts.
b. accounts for the ways in which today's choices will shape future choices, all the way through to the
consequences in the final period.
c. starts at the end goal and reasons from that forward date back to the present to identify a path.
d. simplifies analysis by eliminating any options that lead to losses to create a path for gain.
ANSWER: b

109. What is the "prune the tree method" for solving a game tree?
a. The player will remove any branches that are associated with losses for the player so that they are not
considered.
b. The player looks to the possible end results, chooses the desired result, works backward to where the
player is, and eliminates all other cells.
c. The player looks forward to the final period, highlights out her rival's best responses, then removes
the options the rival would not choose.
d. The player starts at the beginning and eliminates all branches that do not take her in a desired
direction.
ANSWER: c

110. When using the "prune the tree" method on a game tree, the branches and leaves that are removed are the
ones that:
a. are bad for the player doing the analysis.
b. the player doing analysis dreads the most.
c. show losses for either player.
d. the other player will never choose.
ANSWER: d

111. Which of the following describes when a first-mover advantage can happen?
a. It occurs when a player chooses an option that the other player would not expect, taking the second
player by surprise.
b. It occurs when a player makes the move that the other player had announced intentions to make.

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c. It occurs when a player preemptively commits to an aggressive position, and the other player's best
response will be less aggressive.
d. It occurs when a player chooses their best response before the other player chooses, regardless of
how this impacts the other player's options.
ANSWER: c

112. The strategic advantage that can follow from taking an action that adapts to your rival's choice is a:
a. reflex gain.
b. second-mover advantage.
c. reaction advantage.
d. lagged gain.
ANSWER: b

113. A second-mover advantage is the:

a. strategic advantage that can follow from taking an action that adapts to your rival's choice.
b. change in options that occurs after one player has made a choice.
c. second player's offsetting of any gains to the first mover by pruning.
d. reduced set of options that must be considered in making a choice.
ANSWER: a

114. What advantage might a second-mover gain?

a. the flexibility to adapt a strategy based on what the first mover did
b. the time to consider options more thoroughly
c. the avoidance of failure if the first mover fails
d. the assurance of a better result
ANSWER: a

115. What determines whether it is more advantageous to be the first mover or the second mover?
a. whether profit or growth is more important to the player
b. whether the other player is bigger or smaller than the player making the first decision
c. whether the unique equilibrium benefits everyone
d. whether commitment or flexibility is more important in the situation
ANSWER: d

116. When players in a game collude, they:

a. choose to avoid any outcomes that harm their rival.
b. make agreements not to compete with each other and, typically, to charge high prices.
c. act independently to try to eliminate other players from the game.
d. change their products, so that they are in different markets and not competing with each other.
ANSWER: b

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117. Use the table, with data for Bishan and Amara, to answer the question.

If Bishan and Amara collude, then Bishan will charge _____, and Amara will charge _____.
a. $35; $30
b. $35; $45
c. $50; $30
d. $50; $45
ANSWER: d

118. Use the table, with data for Bella and Martin, to answer the question.

If Bella and Martin collude, then Bella's price will be _____, and Martin's price will be _____.
a. $55; $50
b. $55; $35
c. $40; $50
d. $40; $35
ANSWER: a

119. A strategic interaction that occurs only once is called a _____ game.
a. single-round
b. one-shot
c. only-move
d. mono
ANSWER: b

120. A one-shot game is a:

a. strategic interaction where a player faces only one option in each round.
b. game where each player faces identical options.
c. strategic interaction that occurs only once.
d. game where there is only one player.
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ANSWER: c

121. When a game player faces the same strategic interaction with the same rivals and the same payoffs in
successive periods, then the game is called a _____ game.
a. repeated
b. single-shot
c. succession
d. finite-shot
ANSWER: a

122. A repeated game is a game where a player:

a. faces the remaining options over and over, even though the player has already chosen an option.
b. cannot progress in profit or size but will remain in the same situation regardless of the player's
choices.
c. faces the same options regardless of changing rivals.
d. faces the same strategic interaction with the same rivals and the same payoffs in successive periods.
ANSWER: d

123. When a player faces the same strategic interaction a fixed number of times, the player is engaged in _____
game.
a. a limited repetition
b. a finitely repeated
c. an internally repeated
d. a temporarily constant
ANSWER: b

124. In a finitely repeated game, each player:

a. faces repetition in only some of the player's options.
b. cannot change its choice for a set number of games.
c. faces the same strategic interaction a fixed number of times.
d. can achieve the same outcome regardless of choice for a set number of rounds.
ANSWER: c

125. How can a finitely repeated game be solved?

a. The player can coordinate with the other player.
b. The player can choose to be the second mover.
c. The player can look forward and reason backward.
d. The player can always charge a low price.
ANSWER: c

126. Which of the following situations do players face in the last round of a finitely repeated game?
a. an anti-coordination game
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b. a one-shot Prisoner's Dilemma

c. a coordination game
d. an indefinitely repeated game
ANSWER: b

127. In a finitely repeated game, both players have an incentive to _____ during the last round.
a. cooperate
b. defect
c. collude
d. maintain past behavior
ANSWER: b

128. Players face the same strategic interaction an unknown number of times in _____ game.
a. a forward release
b. a one-shot
c. a finitely repeated
d. an indefinitely repeated
ANSWER: d

129. In an indefinitely repeated game, the players face:

a. the same strategic interaction an unknown number of times.
b. uncertainty about how many other players there are in each round.
c. unclear options with each round of the game.
d. the same options in each round but different players.
ANSWER: a

130. A list of instructions that describe exactly how to respond in any possible situation is a:
a. check list.
b. payoff chart.
c. strategic plan.
d. game tree.
ANSWER: c

131. A strategic plan is a:

a. map of alternative actions and their potential payoffs.
b. list of instructions that describe exactly how to respond in any possible situation.
c. list of goals to be achieved.
d. payoff chart or game tree.
ANSWER: b

132. Under what type of strategy will a player cooperate if other players have cooperated in all previous rounds
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but defect if any player ever defects?
a. a Grim Trigger strategy
b. a loyalty enforcement strategy
c. an all-or-nothing strategy
d. a Defect Trigger strategy
ANSWER: a

133. If a player has a Grim Trigger strategy, that player:

a. becomes pessimistic if any other player gains an advantage that the player does not share in.
b. becomes hostile if she is the only player left in the game.
c. is serious and firm in her quest to do whatever it takes to succeed, particularly if opposition from
other players rises.
d. cooperates if other players have cooperated in all previous rounds but defects if any player ever
defects.
ANSWER: d

134. A Grim Trigger strategy is to:

a. take extreme actions whenever profits fall.
b. defect on all agreements.
c. aggressively announce actions in advance.
d. punish rivals who do not cooperate.
ANSWER: d

135. When all players follow a Grim Trigger strategy, the result is:
a. the highest possible profits for all players.
b. a loss as all players punish each other.
c. a Nash equilibrium.
d. a finitely repeated game.
ANSWER: c

Essay

136. Summarize the four steps for making good strategic decisions.
ANSWER: Following four basic steps can help decision makers to make good strategic decisions. First, identify
all the possible outcomes. Second, think about the "what-ifs" separately. Third, the player should act
based on what is best for the player. Fourth, think what the other player is likely to do.

137. What is a Nash equilibrium, and how is one identified in a payoff table?
ANSWER: A Nash equilibrium exists when each player in a game makes a choice that is a best response to the
choices of the other players. A Nash equilibrium can be identified in a two-by-two (two player)
payoff table by placing a check mark in each cell that represents a player's best response to each
potential action by the other player. If a cell ends up with two check marks in it (one for each
player), then that cell represents a Nash equilibrium—the best response of each player, given the
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choice that the other player is making. Play will tend to move to that result. It is an equilibrium
because no player can do better by unilaterally changing his or her action.

138. How does the Prisoner's Dilemma show that markets can deliver bad outcomes?
ANSWER: The analysis of perfect competition shows that outcomes tend to be efficient when market
participants are so small that their decisions have no effect on the payoffs of other players. The
Prisoner's Dilemma, by contrast, shows that when outcomes arise from strategic interactions—
choices that impact the outcomes of others—outcomes may be inefficient. Thus, in a world in which
strategic interactions are common, there's no reason to suppose that free markets always yield good
outcomes.

139. How can the Prisoner's Dilemma illustrate the tragedy of the commons?
ANSWER: A payoff table illustrating the Prisoner's Dilemma can be used to show why the Tragedy of the
Commons will occur when resources are owned in common. Assuming that two producers use the
same commonly-owned resource in production, the payoff table would look like this:

If Producer 1 uses the common resource two times per week, Producer 2 will prefer to use the
resource daily. If Producer 1 uses the common resource daily, Producer 2 will prefer to use the
resource daily. The same would apply if the roles were reversed. The Nash equilibrium is thus for
both producers to use the common resource daily, leading to overuse of it and more limited future
production potential. Neither producer would want to cut back to two times per week for fear that
the other would not. The result is that the common resource is overused—the Tragedy of the
Commons.

140. Explain the difference between a coordination game and an anti-coordination game.
ANSWER: A coordination game is one in which there are multiple equilibria, and the players have a common
interest in coordinating their choices to ensure that all make the same choice. An anti-coordination
game is one in which players must make different but complementary choices to achieve the best
outcome.

141. How can a coordination game with multiple equilibria help explain the difference between wages in less
developed countries and wages in more highly developed countries?
ANSWER: A payoff table for good jobs (skilled jobs) and bad jobs (unskilled jobs) can be used to show how
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there are two equilibria—one with high-paying jobs and one with low-paying jobs. A country could
"settle" into either equilibrium.

The two equilibria are "Low-skilled, low-paying jobs prevail" and "High-skilled, high-paying jobs
prevail." More highly developed countries will tend to end up in the "High-skilled, high-paying jobs
prevail" cell. Less developed countries will tend to end up in the "Low-skilled, low-paying jobs
prevail" cell.

142. Summarize three solutions to coordination problems.

ANSWER: Three solutions to coordination problems are communication, focal points or norms, and laws and
regulations. Through communication, players can inform one another of their intended actions.
Since players all want the same thing, there is no incentive for one player to deviate from one's
communicated intention. Alternatively, if players have not communicated their intended actions
beforehand, they might rely on their best guesses of other players' behavior. The latter could be
based on norms or culture or focal points that have served to coordinate behavior in the past. And if
no obvious focal points or customs exist, a third solution is for the government to mandate certain
behaviors through laws and regulations.

143. Explain when it is better to be a first mover and when it is better to be a second mover.
ANSWER: Whether to be a first mover or second mover becomes an issue in markets that play out over time, as
in a sequential game, rather than all at once, as in a simultaneous game. A first mover advantage
arises when a player can credibly commit to an aggressive action that forces the other player to
respond less aggressively. For example, a company that moves first to manufacture a product may
develop economies of scale that act as a barrier to entry to would-be second movers. A second
mover advantage arises when a player can benefit from flexibly responding to an action of a first
mover. For example, a company may wait to develop a product until a first mover has established a
market for that product. The second mover might then benefit by observing the successes and
failures of the first mover. When to be a first mover and when to be a second mover depends on the
situation. If you can force a rival to act in a less aggressive way by credibly committing to an action,
then it may better to be a first mover. If you can best advance your interest by basing your action on
the prior action of your rival, then it may be better to be a second mover.

144. How is being a player in an indefinitely repeated game different from being a player in a finitely repeated
game?
ANSWER: A player's solution in a finitely repeated game is to look forward to the final interaction and then
reason backward. The last interaction is like a one-shot Prisoner's Dilemma where both players
choose to defect. Knowledge of this eliminates any incentive players may have to cooperate in
earlier stages.
When a game is repeated an indefinite number of times, the players do not know when the final
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round will occur, so they do not have the same incentive to defect. In such a game, it is important
for players to have a strategic plan to guide their responses in different possible scenarios. One such
strategy is a Grim Trigger strategy that punishes the other player indefinitely if that player ever fails
to cooperate.

145. How does collusion create a Prisoner's Dilemma game? Use a payoff table in your response.
ANSWER: Collusion is a form of high-level cooperation in which rivals agree not to compete but to charge
high prices instead. The fact that the payoff to unilateral defection typically exceeds that of mutual
cooperation renders collusive arrangements vulnerable to collapse. In other words, collusion is an
example of the Prisoner's Dilemma, as illustrated in the following payoff table:

In the game's Nash equilibrium, both players defect and end up with no gains.

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Multiple Choice

1. People face risk whenever:

a. there are several certain outcomes, but a choice must be made.
b. there is a lack of uncertainty about a situation or choice.
c. they do not know with certainty what the outcome of a situation or choice will be.
d. there is more than one option.
ANSWER: c

2. The two essential elements of risk are _____ and _____.

a. choices; consequences
b. consequences; hedging
c. payoffs; hedging
d. probabilities; payoffs
ANSWER: d

3. A fair bet is a:
a. wager entered into with honesty and concern for the welfare of the other party.
b. wager entered into when the rules are clear to all participants.
c. gamble that, on average, will leave a person with the same amount of money.
d. gamble that provides net gains to all participants so there is no loser.
ANSWER: c

4. A gamble that, on average, will leave a person with the same amount of money is known as:
a. a zero gain bet.
b. a fair bet.
c. an equal option.
d. an equity wager.
ANSWER: b

5. Marta is considering the purchase of a condominium. Which of the following would be a gamble that is a fair
bet?
a. The condo has a 10% probability of rising in value by 20% and a 10% probability of falling in value
by 30%.
b. The condo has a 10% probability of rising in value by 30% and a 30% probability of falling value by
5%.
c. The condo has a 10% probability of rising in value by 15% and a 15% probability of falling in value
by 10%.
d. The condo has a 10% probability of rising in value by 30% and a 15% probability of falling value by
30%.
ANSWER: c

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6. Merced is considering an investment that has a 50% probability of rising in value by 60% and a 50%
probability of falling value by 40%. Is this a fair bet?
a. Yes, the odds are that Merced will gain a positive return.
b. Yes, the odds are that Merced will break even.
c. No, the odds are that Merced will gain a positive return.
d. No, the odds are that Merced will have a negative return.
ANSWER: c

7. A risk-averse person is someone who:

a. changes direction when there is risk.
b. seeks risk in order to gain return.
c. keeps returning to higher risk.
d. dislikes uncertainty.
ANSWER: d

8. What is true about risk-averse people and fair bets?

a. Risk-averse people will accept a fair bet.
b. Risk-averse people will reject a fair bet.
c. Risk-averse people will renegotiate an unfair bet to make it fair before accepting it.
d. Risk-averse people will not accept any uncertainty, even if the bet is fair.
ANSWER: b

9. Bishan is risk averse. This means he would consider only one of the following options, immediately rejecting
all of the others. Which one would Bishan consider?
a. a 50% chance of a 20% return and a 50% chance of a 30% loss
b. a 50% chance of a 20% return and a 50% chance of a 20% loss
c. a 40% chance of a 20% return and a 60% chance of a 15% loss
d. a 40% chance of a 20% return and a 60% chance of a 10% loss
ANSWER: d

10. Mathematically, a fair bet has an expected return of:

a. anything above zero.
b. the current interest rate or higher.
c. zero.
d. anything from negative to positive, but the exact return is known in advance with certainty.
ANSWER: c

11. If an investment has a 40% probability of a 20% return and a 60% probability of a 10% loss, then the
expected return would be:
a. an 8% gain.
b. a 6% loss.

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c. a 2% loss.
d. a 2% gain.
ANSWER: d

12. In a fair bet, the:

a. outcome is known in advance so there is no uncertainty.
b. expected return is high enough to induce risk-averse people to accept the risk.
c. expected winnings exactly offset the expected losses.
d. expected winnings are greater than the expected losses.
ANSWER: c

13. A person who dislikes uncertainty is known as a _____ person.

a. fair bet
b. risk-averse
c. payoff
d. negative
ANSWER: b

14. A person's utility level is his or her:

a. level of health.
b. usefulness.
c. overall degree of risk aversion.
d. overall level of well-being.
ANSWER: d

15. Which of the following statements about the marginal utility of wealth is accurate?
a. Marginal utility of wealth is high when a person is poor and diminishes as wealth increases.
b. Marginal utility of wealth is low when a person is poor and rises as wealth increases.
c. Marginal utility of wealth holds steady as wealth changes, but total utility changes as wealth changes.
d. Marginal utility of wealth is the total utility gained from a person's wealth.
ANSWER: a

16. The marginal utility of an extra dollar is:

a. the change in usefulness that comes from extra income.
b. determined by the source of the dollar.
c. the change in economic status that comes from an overall level of wealth.
d. the extra satisfaction you would get from having one more dollar.
ANSWER: d

17. The slope of a utility function is:

a. positive and increasing.
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b. positive and diminishing.

c. negative and increasing.
d. negative and diminishing.
ANSWER: b

18. The utility function for wealth indicates that:

a. there is a negative relationship between wealth and total utility.
b. total utility falls as wealth rises.
c. marginal utility falls as wealth rises.
d. marginal utility rises as wealth rises.
ANSWER: c

19. What principle explains why the utility function gets flatter as wealth rises?
a. the law of demand
b. cost analysis
c. the risk-reward trade-off
d. diminishing marginal utility
ANSWER: d

20. Your marginal utility would be highest at which of the following wealth levels?
a. $10,000
b. $50,000
c. $100,000
d. $500,000
ANSWER: a

21. Diminishing marginal utility makes people:

a. wealthy.
b. risk averse.
c. less prosperous.
d. risk neutral.
ANSWER: b

22. How does a gain of $1,000 versus a loss of $1,000 impact a person's utility?
a. The gain and loss have equal impact on utility but in opposite directions.
b. The gain would have greater impact on utility than the loss.
c. The loss would have greater impact on utility than the gain.
d. Gaining or losing money has no impact on utility.
ANSWER: c

23. Shantelle faces a risk where she has equal chance of either gaining $2,000 or losing $2,000. Which of the
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following statements describes her view of the risk if she is risk averse?
a. Losing $2,000 would diminish her well-being more than gaining $2,000 would raise it.
b. Losing $2,000 would diminish her well-being less than gaining $2,000 would raise it.
c. Losing $2,000 would diminisher her well-being just as much as gaining $2,000 would raise it.
d. Both options would have the same impact on her well-being so she is indifferent.
ANSWER: a

24. When considering diminishing marginal utility, how do the costs compare to the benefits of a fair bet?
a. The costs and benefits are equal in size and in the same direction.
b. The costs and benefits are equal in size but in opposite directions.
c. The drop in utility due to losses exceeds the increase in utility due to gains.
d. The drop in utility due to losses is less than the increase in utility due to gains.
ANSWER: c

25. Which income change would cause Martin's utility level to change by the largest absolute amount?
a. $2,000 gain
b. $1,000 gain
c. $1,000 loss
d. $2,000 loss
ANSWER: d

26. When looking at utility rather than money, what does the outcome of a fair bet look like?
a. The potential drop in utility is greater than the potential increase in utility.
b. The potential drop in utility is smaller than the potential increase in utility.
c. The potential drop in utility is equal to the potential increase in utility.
d. There is no expected change in utility.
ANSWER: a

27. What of the following principles explains why a fair bet would, on average, cause a drop in well-being for a
risk-averse individual?
a. diversification
b. hedging
c. diminishing marginal utility
d. demand and supply
ANSWER: c

28. Cost-benefit analysis indicates that a person should make an investment if the:
a. utility value of its average exceeds its average returns.
b. utility value of its average returns exceeds its average losses.
c. monetary value of its returns exceeds its losses.
d. monetary value of its losses exceeds its returns.
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ANSWER: b

29. There is a trade-off between _____ and _____.

a. money; benefits
b. money; utility
c. decisions; certainty
d. risk; return
ANSWER: d

30. (Figure: Utility Function) Use the utility function graph to answer the question.

Jo has income of $40,000. She is faced with an opportunity that has an equal chance of resulting in an additional
$10,000 in income or a loss of $10,000 in income. Using expected utility as the deciding factor, should Jo
pursue the opportunity?
a. Yes, the potential increase in utility is larger than the potential decrease in utility.
b. No, the potential increase in utility is less than the potential decrease in utility.
c. It is a toss-up because her expected rise in utility exactly offsets her expected loss in utility.
d. She can expect her utility to remain unchanged regardless of what she does.
ANSWER: b

31. (Figure: Utility Function) Use the utility function graph to answer the question.

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Olga has income of $30,000. She has an opportunity that has a 50% chance of increasing her income by
$20,000 and a 50% chance of decreasing her income by $10,000. Which of the following is true regarding this
opportunity and her utility?
a. The potential loss in utility exceeds the potential gain in utility.
b. The potential loss in utility is less than the potential gain in utility.
c. The potential change in utility is the same, just in opposite directions.
d. Her utility is unaffected by changes in income.
ANSWER: b

32. Chin is extremely risk averse. This means that his utility function will have a _____ slope that _____
becomes more horizontal as his wealth rises.
a. negative; slowly
b. negative; rapidly
c. positive; slowly
d. positive; rapidly
ANSWER: d

33. Hua Xing is mildly risk averse. This means that her utility function will have a _____ slope that _____
becomes more horizontal as her wealth rises.
a. negative; slowly
b. negative; rapidly
c. positive; slowly
d. positive; rapidly
ANSWER: c

34. (Figure: Utility Functions) Which utility function represents the most risk-averse person?

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a. Utility function A
b. Utility function B
c. Utility function C
d. Utility function D
ANSWER: c

35. (Figure: Utility Functions) Which curve is a utility function for a slightly risk-averse person?

a. Utility function A
b. Utility function B
c. Utility function C
d. Utility function D
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ANSWER: d

36. The more risk averse a person is, the:

a. more willing they are to suffer a loss.
b. less willing they are to suffer a loss.
c. more eager they are to have a gain.
d. more indifferent they feel about investment decisions.
ANSWER: b

37. The more risk averse people are, the:

a. less they try to gain.
b. less they try to avoid loss.
c. more they try to gain.
d. more they try to avoid loss.
ANSWER: d

38. If a person is highly risk averse, the _____ marginal utility associated with a negative outcome outweighs
the _____ marginal utility from a positive outcome.
a. lower; higher
b. higher; lower
c. lower; lower
d. higher; higher
ANSWER: b

39. Risk aversion is evident in what types of decisions?

a. financial and occupational but not relationships or health
b. relationships and health but not financial or occupational
c. financial but not occupational, relationships, or health
d. financial, occupational, relationships, and health
ANSWER: d

40. A person's willingness to accept a given risk-reward combination reflects his or her level of _____, which
depends on the person's _____ and _____.
a. utility; income; goals
b. risk aversion; goals; temperament
c. utility; goals; occupation
d. risk aversion; temperament; life situation
ANSWER: d

41. When deciding whether to take a risk, Janelle's decision should depend on what three factors?
a. Janelle's income, level of risk aversion, and needs

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b. Janelle's income, her level of reward, and whether the stakes are high or low
c. Janelle's level of risk aversion, the risk-reward ratio, and whether the stakes are high or low
d. Janelle's income, level of risk aversion, and wants
ANSWER: c

42. Which of the following is NOT one of the three factors that you should consider in deciding whether to take
a risk?
a. whether the stakes are high or low
b. your degree of risk aversion
c. the size of the risk relative to the reward
d. the level of wealth
ANSWER: d

43. If Kono makes a particular choice, his utility, on average, is his:

a. total well-being.
b. normal well-being.
c. middle utility.
d. expected utility.
ANSWER: d

44. Expected utility is:

a. the utility level a person hopes to achieve if all goes as expected.
b. a person's utility, on average, if he or she makes a particular choice.
c. the average level of utility across a population.
d. the standard level of utility used to determine if a person is happier or less happy than anticipated.
ANSWER: b

45. The expected utility of a choice is calculated as:

a. the anticipated level of utility of the choice based on the spread between the best and worst possible
outcomes.
b. the change in utility that will occur based on the difference between the pre-choice and post-choice
utility levels.
c. a weighted average of the different utility levels associated with each possible outcome, weighted by
the probability that outcome occurs.
d. the total of all possible utility levels resulting from the choice divided by the number of possible
utility levels.
ANSWER: c

46. When a choice is being considered, the _____ of that choice is the weighted average of the different utility
levels associated with each possible outcome, weighted by the probability that outcome occurs.
a. expected utility
b. anticipated utility
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c. marginal well-being result

d. normed utility result
ANSWER: a

47. A choice with two possible outcomes is being considered. The expected utility of that choice is equal to:
a. (Utility of outcome 1 + Utility of outcome 2) / 2.
b. ((Probability of outcome 1) × (Utility of outcome 1)) + ((Probability of outcome 2) × (Utility of
outcome 2)).
c. ((Probability of outcome 1) – (Utility of outcome 1)) + ((Probability of outcome 2) – (Utility of
outcome 2)).
d. (Utility of outcome 1 / Probability of outcome 1) + (Utility of outcome 2 / Probability of outcome 2).
ANSWER: b

48. Lela must decide whether to go on a winter trip to Norway with the hope of seeing the Northern Lights.
Seeing the lights would yield a utility level of 2,000, but she has only a 50% chance that they will show during
the days of her trip. Making the trip without seeing the lights would yield a utility level of 100, and there is 50%
chance of this happening. What is Lela's expected utility if she goes on the trip?
a. 2,100
b. 42
c. 950
d. 1,050
ANSWER: d

49. Sven is considering a fishing trip. If there is good weather, his utility gained from the trip will be worth
$900. If the weather is bad, his utility from the trip will be worth –$300. There is a 60% chance of bad weather
and a 40% chance of good weather. What is Sven's expected utility for the fishing trip?
a. $240
b. –$180
c. $180
d. $360
ANSWER: c

50. Lek is deciding whether to enter a contest. If she wins, her rise in utility will be worth $10,000. If she loses,
her change in utility would be worth –$500. She has a 5% chance of winning and a 95% chance of losing. What
is Lek's expected utility if she participates in the contest?
a. –$475
b. $25
c. $500
d. $525
ANSWER: b

51. Assad has an opportunity to enter a contest. If he wins the contest, the value of his increase in utility will be
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$6,000. If he loses the contest, the value of his decrease in utility will be -$300. His probability of winning is
4%. His probability of losing is 96%. What is Assad's expected utility if he enters the contest?
a. $192
b. $240
c. $288
d. –$48
ANSWER: d

52. Why do people gamble?

a. They have a greater chance of winning money than losing it.
b. They are willing to pay for the entertainment value of the experience.
c. They are risk averse.
d. The expected earnings provide a positive return.
ANSWER: b

53. Markus is considering an investment that has a 30% chance of providing a value in utility worth $20,000
and a 70% chance of incurring a loss of utility worth $7,000. What is Markus's expected utility from this
investment?
a. $4,900
b. $1,100
c. $10,900
d. $6,000
ANSWER: b

54. Anneke is considering a hiking vacation in the mountains. If the weather is good, she will gain utility valued
at $3,000 from the trip. If the weather is bad, she will lose utility valued at $2,000. The weather has a 40%
chance of being good and a 60% chance of being bad. What is Anneke's expected utility if she goes on the trip?
a. $0
b. $2,500
c. $1,200
d. $2,400
ANSWER: a

55. Anna is considering an investment that has a 50% chance of providing a positive return of utility worth
$5,000 and a 50% chance of a loss of utility worth $5,000. When the probability of a positive return rises to
60% and a negative return falls to 40%, her expected utility rises from _____ to _____.
a. $1,000; $3,000
b. $0; $2,500
c. $2,500; $3,000
d. $0; $1,000
ANSWER: d

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56. Which of the following is NOT a strategy for reducing risk?
a. hedging
b. gathering information
c. specialization
d. risk spreading
ANSWER: c

57. Which of the following is NOT a strategy that you could use to reduce risk?
a. diversification
b. dominance
c. insurance
d. risk spreading
ANSWER: b

58. Which of the following is NOT a strategy that Jolene could use to reduce her risk?
a. insurance
b. gathering information
c. verification
d. hedging
ANSWER: c

59. Each of the following is a strategy for reducing risk EXCEPT:

a. hedging.
b. gathering information.
c. insurance.
d. magnification.
ANSWER: d

60. Risk spreading is:

a. making a deep risk appear thinner.
b. creating a broader set of potential losers.
c. reducing the number of potential winners.
d. transforming big risks into small risks to be spread over many people.
ANSWER: d

61. Splitting up big risks into many small risks is called:

a. diminishing risk.
b. risk spreading.
c. risk break-up.
d. risk minimizing.
ANSWER: b
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62. Breaking a big risk into many smaller risks so that it can be spread over many people is known as:
a. risk dilution.
b. risk spreading.
c. risk division.
d. horizontal risk division.
ANSWER: b

63. Marta has an idea for a new product that could earn $1 million if successful. It would cost $600,000 to bring
it to market, and that is the potential loss if it fails. Marta estimates that it has a 60% chance of success and 40%
chance of failure. Marta is not willing to accept the risk of failure. She enlists 1,000 investors to each put in
$600 toward the cost with a promise that they will share proportionately in the profits. What risk reduction
strategy is Marta using?
a. hedging
b. diversification
c. risk spreading
d. insurance
ANSWER: c

64. Why are people less willing to make a large investment than a small investment when both investments
carry the same probabilities of success versus failure as well as the same rates of return?
a. The risk level is positively related to the number of investors.
b. If a large investment is broken into smaller parts, the return rates grow.
c. The potential positive impact on wealth and utility is much greater with a large investment.
d. The potential negative impact on wealth and utility is much greater with a large investment.
ANSWER: d

65. People tend to make _____ choices when the stakes are large and _____ choices when the stakes are small.
a. risk-loving; risk-neutral
b. risk-averse; nearly risk-neutral
c. risk-averse; risk-loving
d. nearly risk-neutral; risk-averse
ANSWER: b

66. How is Jamal's wealth affected by an investment when the stakes are small?
a. It is impacted by a great deal in either a positive or a negative direction.
b. It is affected more if the probability is great than if the probability is small.
c. It is affected by a small amount in either a positive or a negative direction.
d. It is impacted more if the return is positive than if it is negative.
ANSWER: c

67. JoJo is risk neutral when she:

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a. faces an opportunity with equal probabilities of success and failure.

b. faces an opportunity with equal expected negative and positive changes in utility.
c. has no sense of positive or negative utility.
d. is indifferent to uncertainty.
ANSWER: d

68. If you are indifferent to uncertainty, you are referred to as:

a. uncommitted.
b. risk neutral.
c. an impartial utilitarian.
d. not risk averse.
ANSWER: b

69. What is the deciding factor in an investment decision when the investor is risk neutral?
a. whether the average financial returns on the investment are positive
b. whether the rate of return is greater than the probability of a positive outcome
c. whether the outcome is positive or negative
d. whether the expected utility of the investment is greater than the financial return
ANSWER: a

70. It is appropriate to take any risk that is better than a fair bet when:
a. risk aversion is high.
b. risk is high.
c. the stakes are small enough.
d. the stakes are large.
ANSWER: c

71. Risk spreading explains why most large companies have:

a. low profit rates.
b. high profit rates.
c. few shareholders.
d. many shareholders.
ANSWER: d

72. Reducing risk by combining a large number of small risks whose outcomes are not closely related is called:
a. risk-spreading.
b. hedging.
c. gambling.
d. diversification.
ANSWER: d

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73. Diversification is:
a. breaking a big risk into many smaller risks so that it can be spread over many people.
b. reducing risk by combining a large number of small risks whose outcomes are not closely related.
c. a gamble that, on average, allows the risk to be spread out into small parts to make it smaller.
d. a reduction in risk that comes from changing the nature of risk into something else that is less risky.
ANSWER: b

74. What impact does diversification have on the risk Andrew faces?
a. Each new option has less risk, but the combined total risk may be greater.
b. Risk rises, falls, and then returns to its original level.
c. Risk is reduced.
d. Risk is increased.
ANSWER: c

75. Maria is a senior at a university and wants to have a job lined up to begin working the month after she
graduates. She has identified three companies that have openings that she describes as her "dream job" and
many companies that offer career-track positions in her field. Which of the following actions would give her the
lowest risk of not having a job arranged to begin a month after graduation?
a. She should apply only at the companies that offer her "dream job."
b. She should apply at the companies offering her "dream job" and three other companies with job
openings in her field.
c. She should apply at the companies offering her "dream job" and 50 other companies with job
openings in her field.
d. She should apply at 50 companies with job openings in her field.
ANSWER: c

76. Chantelle has $20,000 to invest in stocks. She wants to diversify her investments to reduce her risk as much
as possible. Which mix of investments would give her the most diverse portfolio?
a. She should put all $20,000 into a chosen company.
b. She should invest in the leading five companies in a chosen industry.
c. She should invest in the leading company in five different industries.
d. She should invest in carefully selected companies in 10 different industries.
ANSWER: d

77. A key issue in reducing risk through diversification is to make sure that the risks:
a. all carry a low return.
b. all are as high as possible.
c. that are being combined are different.
d. that are being combined are similar.
ANSWER: c

78. An investment that automatically invests in a predefined portfolio of stocks is known as _____ fund.
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a. an index
b. a set-mix
c. a definition
d. a grouped
ANSWER: a

79. Risks that are common across the whole economy are known as:
a. common risks.
b. integrated risks.
c. wide-deep risks
d. systematic risks.
ANSWER: d

80. A systematic risk is a risk that:

a. affects the decision maker's most vulnerable assets.
b. is common across the whole economy.
c. would change the relationships between factors.
d. intensely focuses on one relationship.
ANSWER: b

81. Which of the following statements is true about diversification and systematic risk?
a. Diversification has no impact on systematic risk.
b. Diversification eliminates systematic risk.
c. Systematic risk increases diversification.
d. Systematic risk reduces diversification.
ANSWER: a

82. Which of the following is NOT an example of a systematic risk?

a. financial crisis
b. price change of a product
c. natural disaster
d. recession
ANSWER: b

83. The price of insurance is:

a. based on diversification.
b. equal to the expected utility.
c. the total value of loss.
d. a premium.
ANSWER: d

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84. A premium is:
a. what is gained beyond expected utility.
b. the cost of risk spreading.
c. the price of insurance.
d. what is paid to gain expected utility.
ANSWER: c

85. Insurance is:

a. a promise of compensation if a specified bad thing happens.
b. a promise that a specified bad thing will be avoided.
c. the removal of the risk of bad events.
d. compensation that is given in return for risk.
ANSWER: a

86. A promise of compensation if a specified bad thing happens is the definition of:
a. hedging.
b. insurance.
c. risk spreading.
d. diversification.
ANSWER: b

87. An insurance policy is actuarially fair if:

a. the average premium is equal to the total losses of those who have policies.
b. the premium charged to each policy holder is equal.
c. there are no losses suffered by policy holders.
d. on average, it is expected to pay out as much in compensation as it receives in premiums.
ANSWER: d

88. An insurance policy that, on average, is expected to pay out as much in compensation as it receives in
premiums is:
a. nonexploitative.
b. actuarially fair.
c. equitably reserved.
d. nonhedged.
ANSWER: b

89. Actuarially fair insurance is equivalent to:

a. diversification.
b. raising the expected utility.
c. a fair bet.
d. a skewed risk-reward trade-off.
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ANSWER: c

90. Most insurance:

a. is designed to earn a profit for the insurance company.
b. does not charge a premium.
c. is actuarially fair.
d. does not actually reduce risk for the buyers.
ANSWER: a

91. Which of the following is NOT a factor that makes insurance more worthwhile to an individual?
a. The individual is more risk averse.
b. The stakes are larger.
c. The insurance is closer to being actuarially fair.
d. The risk factor of the situation is lower.
ANSWER: d

92. Which of the following is not equivalent to insurance?

a. Medicare
b. progressive taxes and earned income tax credits
c. savings
d. family
ANSWER: c

93. To hedge is to:

a. acquire an offsetting risk.
b. prevent loss from happening.
c. build a barrier against a risk.
d. transform a big risk into small risks.
ANSWER: a

94. When you acquire an offsetting risk, you are engaged in:
a. gathering information.
b. risk spreading.
c. diversification.
d. hedging.
ANSWER: d

95. Which of the following is NOT an example of hedging?

a. Employees buy stock in the company that employs them in case dividends are needed.
b. People gain computer skills in case robots replace workers.
c. College seniors apply to graduate school in case they don't find a job.
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d. People stock up on nonperishables in case inflation occurs.

ANSWER: a

96. Which of the following is an example of hedging?

a. Mario stocks ice cream and hot chocolate in his shop so there will be sales in hot or cold weather.
b. Sissy eats vegetables and proteins to enhance her health.
c. Juan buys professional equipment to help ensure his success as a barber.
d. Gizelle buys stock in a tree farm to help provide clean air.
ANSWER: a

97. Which of the following would NOT reduce Leah's risk of being too cold or hot when outside for a picnic?
a. checking the weather forecast and dressing according to it
b. arranging an alternate date for the picnic should the weather be unfavorable
c. wearing several layers that can be removed or added back as needed
d. making sure the food is so good it will distract from the weather
ANSWER: d

98. _____ reduces risk.

a. Wealth
b. Time
c. Information
d. Uncertainty
ANSWER: c

99. The more _____ you have about something, the less _____ you have about that something.
a. information; uncertainty
b. information; certainty
c. expected utility; certainty
d. expected utility; uncertainty
ANSWER: a

100. Many risks are due to:

a. too much diversification.
b. spreading the risk.
c. hedging.
d. insufficient information.
ANSWER: d

101. Why do people make decisions with incomplete information?

a. They prefer risk.
b. Information is costly to obtain.
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c. Information does not help them make good decisions.

d. Information causes problems.
ANSWER: b

102. The _____ information that you have that is relevant to a decision, the _____ risk that is associated with
the decision.
a. more; less
b. more; more
c. less; less stable the
d. more; more stable the
ANSWER: a

103. The value of information is greater the:

a. more information there is, and the lower the stakes involved in the decision.
b. higher the stakes involved in the decision, and the lower the number of options there are.
c. more information there is, and the lower the number of options there are.
d. more it reduces uncertainty, and the higher the stakes involved in the decision.
ANSWER: d

104. Coco is getting ready to buy a car. She knows how much she can spend but is concerned about getting a
reliable, comfortable car with good gas mileage. How can Coco reduce her risk of buying an unsatisfactory car?
a. She can diversify by making friends with a mechanic in case the car she buys has problems.
b. She can increase her need for a car so that getting the right car becomes more important to her.
c. She should gather all the information she can about the cars that are available in her price range.
d. She should hedge her bet by getting a motorcycle and bicycle as well as a car to make sure she has
transportation.
ANSWER: c

105. Sadie is going to buy a guitar for the first time. There are many options, and she wants to choose a guitar
that she will enjoy using for many years. Which of the following is an example of gathering information as a
strategy to reduce risk?
a. She can learn all she can about the guitars that are available and try out as many as possible.
b. She can pay a little more to buy from a store with a trade-in policy as a protection against being
displeased long-term.
c. She can ask her family for contributions toward purchasing the guitar instead of birthday gifts.
d. She can learn to play other instruments as well as the guitar.
ANSWER: a

106. Sadie is going to buy a guitar for the first time. There are many options, and she wants to choose a guitar
that she will enjoy using for many years. Which of the following is an example of insurance as a strategy to
reduce risk?
a. She can learn all she can about the guitars that are available and try out as many as possible.
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b. She can pay a little more to buy from a store with a trade-in policy as a protection against being
displeased long-term.
c. She can ask for contributions toward the guitar from family instead of birthday gifts.
d. She can learn to play other instruments as well as the guitar.
ANSWER: b

107. Economic analysis that includes psychological factors in assessing how people make economic decisions is
known as:
a. psychonomics.
b. behavioral economics.
c. econology.
d. economic psychology.
ANSWER: b

108. Behavioral economics is economic analysis that:

a. uses principles of animal behavioral training to train human behavior.
b. explains human behavior by tying it to economic principles.
c. includes psychological factors in assessing how people make economic decisions.
d. replaces emotion with factual analysis.
ANSWER: c

109. Using Kahneman's terminology, psychologists distinguish between what two styles of thinking?
a. thinking broadly and thinking narrowly
b. thinking deeply and shallow thinking
c. thinking linearly and thinking circularly
d. thinking fast and thinking slow
ANSWER: d

110. The tendency to overrate the accuracy of your forecasts is known as:
a. exaggeration.
b. excessive ego.
c. overconfidence.
d. irrational exuberance.
ANSWER: c

111. Overconfidence is the:

a. tendency to overrate the accuracy of your forecasts.
b. basic optimism that comes with hoping for the best.
c. initial belief that risks are greater than they are.
d. rare belief that mistakes are not possible.
ANSWER: a
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112. People who are overconfident are likely to:

a. overestimate risks and make bad decisions.
b. underestimate risks and make bad decisions.
c. overestimate risks leading to good decisions.
d. underestimate risks leading to good decisions.
ANSWER: b

113. Overconfident people tend to _____ risks and make _____ decisions.
a. overestimate; positive
b. overestimate; bad
c. underestimate; good
d. underestimate; bad
ANSWER: d

114. The pitfalls of overconfidence include all of the following EXCEPT:

a. underestimating the risks of a situation.
b. not paying attention to good advice that others offer.
c. overestimating uncertainty.
d. thinking that one's own assessment is better than others.
ANSWER: c

115. Which of the following offers a way to minimize overconfidence?

a. "thinking fast"
b. "thinking slow"
c. diversification
d. hedging
ANSWER: b

116. Thinking slow is a way to reduce the chance that uncertainty will be understated due to:
a. hedging.
b. diversification.
c. overconfidence.
d. risk spreading.
ANSWER: c

117. In assessing probability, the cost-benefit principle implies that you:

a. should think harder only if the extra mental exertion will yield a sufficiently better estimate.
b. need the best possible estimate of the probability in order to make the best possible decision.
c. tend to overestimate costs and underestimate benefits.
d. focus only on what is known for sure and disregard what is uncertain.
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ANSWER: a

118. The tendency to overestimate the frequency of events that are easily recalled and to underestimate the
frequency of less memorable events is known as:
a. estimation irrationality.
b. availability bias.
c. range bias.
d. memory skew.
ANSWER: b

119. Availability bias is the tendency to:

a. assume that outcomes that are visible are more likely to occur than outcomes that must be imagined.
b. assume that outcomes that are currently available are more positive than outcomes that are possible
but not seen.
c. overestimate the positivity of outcomes that occur quickly and underestimate the positivity of
outcomes that occur slowly over time.
d. overestimate the frequency of events that are easily recalled and to underestimate the frequency of
less memorable events.
ANSWER: d

120. If attention-grabbing events distort your probability assessments, the solution is:
a. fast thinking to avoid overthinking the situation.
b. diversification to reduce risk.
c. slow thinking and looking up reliable statistics.
d. hedging to spread the risk.
ANSWER: c

121. Anchoring bias is the tendency to:

a. focus on the end result, using it as an anchor and assuming that nothing will change in the future.
b. focus on the desired result and form all other expectations in relation to it.
c. begin with an anchor, or starting point, and insufficiently adjust from there.
d. skew probability toward a vivid, easily recalled event.
ANSWER: c

122. The tendency to begin with a starting point and insufficiently adjust from there is known as:
a. anchoring bias.
b. availability bias.
c. initial skew.
d. overconfidence.
ANSWER: a

123. Which of the following statements is consistent with anchoring bias?

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a. All is well that ends well.

b. Easy come, easy go.
c. First impressions matter.
d. A stitch in time saves nine.
ANSWER: c

124. Anchoring bias leads to _____ of success and _____ of failure.

a. overestimation; overestimation
b. overestimation; underestimation
c. underestimation; overestimation
d. underestimation; underestimation
ANSWER: b

125. The tendency to assess the likelihood that something belongs in a category by judging how similar it is to
that category is known as:
a. similarity bias.
b. comparability skew.
c. anchoring bias.
d. representativeness bias.
ANSWER: d

126. Representativeness bias is the tendency to:

a. begin with an anchor, or starting point, and insufficiently adjust from there.
b. assess the likelihood that something belongs in a category by judging how similar it is to that
category.
c. assess how well an outcome matches up with the desired outcome.
d. begin with a starting point and insufficiently adjust from there.
ANSWER: b

127. The tendency to mispredict your utility by focusing on a few factors at the expense of others is known as:
a. a narrow skew.
b. a telescopic skew
c. compulsive bias.
d. focusing illusion.
ANSWER: d

128. Focusing illusion is the tendency to:

a. assess how well an outcome matches up with the desired outcome.
b. mispredict your utility by focusing on a few factors at the expense of others.
c. assess the likelihood that an outcome belongs in a category by judging how similar it is to that
category.
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d. skew probability toward a vivid, easily recalled event.

ANSWER: b

129. If Pattica is suffering from focusing illusion as he chooses a major, then he is likely to:
a. be happier with his choice than he anticipated.
b. be less happy with his choice than he anticipated.
c. overestimate the probability of a choice.
d. underestimate the probability of a choice.
ANSWER: b

130. Evaluating your payoffs as gains or losses relative to an arbitrary baseline distorts your decisions and is a
problem associated with:
a. loss aversion.
b. anchoring bias.
c. representativeness bias.
d. overconfidence.
ANSWER: a

Essay

131. What is meant by the statement "Risk is a set of probabilities and payoffs"?
ANSWER: Risk exists when there is uncertainty about an outcome or situation. There is more than one
possibility, and exactly which will occur is not known for sure. Some possible outcomes may be
more desirable than others, and some may be negative. How risky a situation is depends on how
likely it is that an undesirable outcome will occur and how undesirable that outcome is or on how
likely it is that a desirable outcome will occur. This leads to the statement that "Risk is a set of
probabilities and payoffs." Probability deals with how likely it is that a particular outcome will
occur. The payoff is the outcome, and the possible outcomes can range from very positive or
desirable to highly undesirable.

132. What insight does diminishing marginal utility add to cost-benefit analysis by a risk-averse person facing a
fair bet?
ANSWER: Diminishing marginal utility is the principle that each additional unit consumed of something adds
less to total utility or well-being than the previous unit. A fair bet is one in which, financially, the
expected loss exactly offsets the expected gain. For example, a 50% chance of losing $1,000 and a
50% chance of gaining $1,000 would be a fair bet. On the surface, it might seem that cost-benefit
analysis would indicate that this situation would, on average, have costs that offset the benefits
exactly. However, in terms of utility, this situation would have an expected loss because the $1,000
gain would have less positive impact on utility than the $1,000 loss would have in negative impact
on utility. This is because diminishing marginal utility indicates that $1 more has less impact on
utility than $1 lost.

133. Why are people more hesitant to make risky choices when the stakes are large than when the stakes are
small?
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ANSWER: When the stakes are large, the potential loss is much greater than when the stakes are small, even if
the probability of each is the same. A large loss would have a greater impact on wealth than a small
loss would. Diminishing marginal utility indicates that the extra dollars lost in a large loss are
associated with greater per dollar losses in utility than in a small loss. For example, if there were a
$100 loss or a $1,000 loss, the loss of $100 would have the same impact on utility in both cases, the
extra $900 of loss in the second case would decrease utility by more than nine times the $100 loss.

134. Why is most insurance NOT actuarially fair?

ANSWER: An actuarially fair insurance policy pays out, on average, as much in compensation as it receives in
premiums. There are two main reasons that most insurance is not actuarially fair. First, the provider
of the insurance (usually a company but sometimes a government or other entity) incurs
administrative expenses in providing the insurance service to clients. These costs must be covered if
the insurance program is to continue to be available. Second, if a company is the provider, typically
there is a profit motive. Owners of the company want to earn a return. Thus, the premiums on
insurance policies typically cover the expected compensation to policy holders plus an allowance
toward the firm's administrative expenses and profits. This means that premiums are higher than the
average compensation.

135. What is the difference between risk spreading and diversification as strategies for reducing risk?
ANSWER: Risk spreading and diversification are both strategies for reducing risk. However, they are different.
Recall that risk is a set of probabilities and payoffs. With risk spreading, a big risk is broken into
smaller risks so that multiple people can each take on a small chunk of risk. Small chunks of risk are
more palatable to risk-averse individuals because the potential downside impact on wealth is much
smaller. The probability of loss is unchanged, but the size of the gain or loss is much smaller. An
example of risk spreading is selling shares of stock in a company to raise funds for an investment.
Instead of one owner taking on all the risk and potential reward, the risk is broken up and taken on
by many shareholders. While the probabilities are the same, the size of the risk is more palatable.
With diversification, instead of taking on one large risk (for example, one investment), the decision
maker takes on a large number of small risks (for example, multiple smaller investments). The total
value of the group of small investments may be the same as the value of the large investment option.
The difference is that with diversification, there is less risk of loss because it is unlikely that all the
small investments will turn out badly at the same time. The more unsimilar the small investments
are, the less likely it is that all will swing in the same ways. However, diversification does not
reduce systemic risk.

136. What is the role of information in determining and reducing risk?

ANSWER: Gathering information reduces risk because the more that someone knows and understands about a
situation and the options available, the more accurate the person's assessments of probabilities and
payoffs can be. The risk is based on the probabilities and payoffs associated with the situation or
opportunities. The more a decision maker knows because of accurate information, the more accurate
assessments of probabilities and payoffs will be because there will be less uncertainty. This reduces
risk.

137. What is the difference between availability bias and anchoring bias?
ANSWER: Availability bias and anchoring bias lead to inaccurate assessments of probability by individuals.
When decision makers suffer from availability bias, they tend to think that vivid and easily recalled
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outcomes have higher probability than warranted and then underestimate the probability of less
memorable or dramatic outcomes. Buying earthquake insurance right after an earthquake is an
example of availability bias. The recent memory causes you to overestimate the probability of a
future earthquake, when that probability is most likely a lot lower. Decision makers with anchoring
bias tend to overestimate the probability of outcomes close to some initial estimate or starting point
and assign an underestimation of probability to outcomes far from the initial estimate. Basically,
those with anchoring bias overestimate the probability of the initial situation and then do not make
the fully warranted adjustment in probability to outcomes far from the initial anchor point. Many
people tend to overestimate probabilities of failure when the probability of a first event succeeding
is high. People also tend to cling to first impressions and fail to readjust their assessments, even if
initial impressions are a small sample size and poor overall representation. Both are examples of
anchoring bias.
Both availability bias and anchoring bias lead to poor estimates of probability. The difference is in
what is given undue focus in assigning probability estimates. With availability bias, the estimate of
probability is skewed in favor of dramatic, memorable outcomes. With anchoring bias, the estimate
of probability is skewed toward the initial starting point or anchor.

138. Provide a description of a hypothetical example of the impact of loss aversion in evaluating payoffs.
ANSWER: Loss aversion refers to people being more sensitive to a loss than a gain of the same size, even if the
gain and loss are the same funds being gained and then lost. For example, a company might be
prepared to pay a reward of $1,000 per new client up to a total of 10 clients per worker over the
year. How the system is set up could have a big impact on worker satisfaction and motivation.
Option 1 might be that at year's end a worker will get a $1,000 bonus for every new client (up to 10)
that is enrolled during the year. Option 2 might be that each worker is told that there is $10,000 in a
bonus payment account set up for workers and payable at year's end, as long as they have enrolled
10 new clients. For every client short of 10 that is enrolled by year's end, $1,000 will be deducted
from the account.
From the company's perspective, the two options will cost the same, and the amount employees
receive at year's end (their payoff) is the same with both options. However, Option 2 taps into the
loss aversion of employees because they will dislike the thought of losing any funds from their
accounts. Trying to avert loss may be a bigger motivation than accruing benefits.

139. How does loss aversion differ from risk aversion?

ANSWER: Risk aversion is disliking uncertainty and is explained by the principle of diminishing marginal
utility of wealth. Loss aversion is being more sensitive to losses than to gains. For example, if
someone receives $1,000 and then loses it, according to diminishing marginal utility, the person's
utility level should end up right where it started. But with loss aversion, there is a greater reduction
in utility from the loss than there was an increase in utility from the gain, leaving such a person with
a lower level of utility than the starting point. People usually dislike loss.

140. Behavioral economics offers insights into mistakes people make in evaluating risk and into ways to
minimize these problems. Explain the problem that overconfidence creates and ways to minimize the problem.
ANSWER: Overconfidence is the tendency of people to overrate the accuracy of their own forecasts and
assessments. This leads to bad decisions because risks are not properly assessed but rather are
underestimated. Overconfidence leads people to a failure to seek information and a failure to
consider advice that may be valuable. If a decision maker knows that people have a tendency toward

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overconfidence, then that awareness may help the decision maker temper his or her quick and overly
confident assessments in order to take the time to seek information and carefully evaluate options.
"Slow thinking" rather than "fast thinking" can help overcome the issue of overconfidence.

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Multiple Choice

1. When one party to a transaction knows something the other doesn't, there is
a. private information.
b. collusion.
c. exploitation.
d. side information.
ANSWER: a

2. Private information exists when

a. there are secrets known only by all the buyers and sellers in a market.
b. one party to a transaction knows something the other doesn't.
c. information is being bought and sold.
d. the information is useful to certain individuals but not to the population as a group.
ANSWER: b

3. Another name for private information is _____ information.

a. collusive
b. personal
c. asymmetric
d. nonpublic
ANSWER: c

4. Private information creates _____ between parties involved in a transaction.

a. balance
b. cohesiveness
c. division
d. asymmetry
ANSWER: d

5. When buyers cannot tell whether a product is high or low quality before making the purchase
a. both high-quality and low-quality units of the product will sell for the same price.
b. high-quality and low-quality units of the product will sell at different prices.
c. sellers must let the buyers know the quality of each unit of the product.
d. buyers must let sellers know the quality of the unit that they desire to buy.
ANSWER: a

6. When buyers cannot tell whether a product is high or low quality before making the purchase, high-quality
items end up selling for _____, and low-quality items end up selling for _____ than if the buyer knew the
quality before purchase.
a. more; less
b. less; more
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c. the same; more

d. less; the same
ANSWER: b

7. Sellers may choose not to sell a high-quality item when buyers are _____ to tell the quality in advance, and
so the buyers _____.
a. not able; pay a high price hoping for high quality
b. not able; are not willing to pay the price of a high-quality product
c. able; pay a high price regardless of quality
d. able; pay a low price
ANSWER: b

8. A product that has more problems or inferior quality than the average unit available is known as
a. a pickle.
b. an adverse unit.
c. a lemon.
d. a bump unit.
ANSWER: c

9. When buyers cannot assess the quality of a product before buying, owners of _____ units are more likely to
choose to sell their units, and owners of _____ units are less likely to choose to sell their units.
a. moderate-quality; low-quality
b. high-quality; moderate-quality
c. high-quality; low-quality
d. low-quality; high-quality
ANSWER: d

10. Owners of _____ goods are more likely to sell their units than owners of other types of goods when buyers
cannot observe quality before they buy.
a. low-quality
b. high-quality
c. moderate-quality
d. diminishing-quality
ANSWER: a

11. When buyers cannot judge the quality of a good before buying, the market tends to be skewed toward
a. high prices.
b. lower-quality units.
c. average prices.
d. higher-quality units.
ANSWER: b
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12. Adverse selection of sellers means that each of the following occurs EXCEPT
a. the market price falls when low-quality goods become common.
b. low-quality goods are a large share of what is for sale.
c. the low market price causes sellers of high-quality goods to leave the market.
d. high-quality goods sell at higher prices.
ANSWER: d

13. More low-quality goods are a large share of the market when buyers cannot observe quality. This is known
as
a. adverse selection of sellers.
b. lemon bias.
c. selection quandary of buyers.
d. market quality bias.
ANSWER: a

14. The adverse selection of sellers is the

a. tendency for buyers to choose to buy from sellers who are not trustworthy even when product quality
is high.
b. tendency for the mix of goods to be skewed toward more low-quality goods when buyers can't
observe quality.
c. skew in markets when sellers cannot observe quality that leads to lower prices.
d. skew in markets toward buyers who pay less when sellers cannot tell a buyer's willingness to pay.
ANSWER: b

15. Inga wants to buy a used computer but is nervous about the risk of buying one that could be a lemon. What
will induce Inga to buy?
a. She will buy if the seller tells her it is a high-quality computer.
b. She will buy if the computer is only slightly used.
c. She will buy if the price is the price of a low-quality used computer.
d. She will buy if there is another buyer in the market.
ANSWER: c

16. Benjamin sells used cell phones, and buyers find it difficult to assess the quality of this product before
buying. Which of the following statements is NOT consistent with the situation in Benjamin's market?
a. Benjamin may end up selling low-quality used cell phones.
b. Customers will pay only a low price, even if the phone quality is high.
c. Adverse selection of buyers will be present.
d. The market will skew toward low quality.
ANSWER: c

17. Assume that the value of a high-quality used phone of a particular model is $200. The value of a low-quality
model of the same used phone is $100. Assume that 15% are low-quality models and 85% of them are high
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quality. What will be the case in the market for used phones of that model?
a. Fewer than 15% of the buyers will expect low quality.
b. Fewer than 15% of the sellers will charge low price.
c. Fewer than 15% of the phones sold will be low quality.
d. More than 15% of the phones sold will be low quality.
ANSWER: d

18. When sellers have private information, _____ can result.

a. adverse selection
b. a skew toward high-quality
c. disequilibrium
d. risk-seeking
ANSWER: a

19. Which of the following statements is correct when sellers know more about quality than buyers?
a. High price indicates high quality, but the low price does not imply low quality.
b. Low price indicates low quality, but the high price does not imply high quality.
c. There is a positive relationship between price and product quality.
d. Price is not a reliable indicator of product quality.
ANSWER: d

20. When quality is not observable by buyers, it is difficult for buyers to purchase
a. at a low price.
b. because they have an advantage over sellers.
c. high-quality products.
d. because of their overconfidence.
ANSWER: c

21. Adverse selection leads to a market that

a. is efficient.
b. is inefficient.
c. maximizes benefits.
d. maximizes harm.
ANSWER: b

22. A market will move toward buying and selling low-quality products when
a. sellers have less information than buyers.
b. costs are rising.
c. there is an adverse selection problem due to private information.
d. sellers have no understanding of product quality.
ANSWER: c
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23. Mariko wants to buy a hand-knotted rug made without child labor. What challenge does she face in making
this purchase?
a. The marginal benefit curve has a positive slope.
b. The markets for hand-knotted rugs do not function at equilibrium.
c. Most suppliers have no way of knowing whether child labor was used in production.
d. It will be difficult for her to verify seller claims about the use of child labor.
ANSWER: d

24. Jo wants to buy organic strawberries. Several sellers in her town claim to sell organic strawberries, and their
prices range from $2 to $4 per pound. Strawberries that are not labeled as organic sell for $1.50 to $2.50 per
pound. What is FALSE about the situation Jo faces in the organic strawberry market?
a. It is not easy for her to verify if the strawberries are organic.
b. Price is not a reliable indicator of whether the strawberries are organic.
c. Sellers have little incentive to sell at a low price.
d. Sellers know more than buyers about whether the strawberries are organic.
ANSWER: c

25. Which of the following statements is consistent with markets where it is difficult for buyers to assess the
quality before purchase?
a. Sellers have incentives to sell high-quality goods at high prices.
b. Price is not a reliable indicator of quality.
c. Sellers need to be skeptical of buyer intent.
d. In spite of the difficulty, the market result will be efficient.
ANSWER: b

26. When a market is subject to severe adverse selection due to seller private information
a. the market skews toward higher quality.
b. the market skews toward higher prices.
c. all suppliers end up selling low-quality products.
d. buyers have more information than sellers.
ANSWER: c

27. Pak is one of many sellers of green beans in local farmer's markets where consumers are willing to pay more
for organically grown green beans than regular green beans. However, the buyers have no way to verify
whether any of the green beans for sale are grown organically. As a result of this
a. the market price tends to be high because all sellers claim to sell organic green beans.
b. green beans are not sold because there is no trust in the market.
c. most of the green beans sold will be organic because sellers want to cater to customers.
d. green beans end up selling at low prices because buyers are skeptical.
ANSWER: d

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28. When a market has an adverse selection problem due to seller's having private information, then
a. buyers have a hard time finding high-quality products to buy.
b. sellers have a hard time producing high-quality products to sell.
c. average price will rise to the level of high-quality products.
d. sellers of low-quality products will leave the market.
ANSWER: a

29. Sellers of high-quality products tend to leave a market when the

a. buyers have more information than the sellers have.
b. market is subject to adverse selection due to seller's having private information.
c. price is rising.
d. marginal benefit is rising as sales increase.
ANSWER: b

30. What causes adverse selection problems?

a. Buyers have unrealistic expectations.
b. Sellers have private information.
c. Sellers are not interested in profit.
d. Buyers are not interested in low prices.
ANSWER: b

31. What are buyers unsure about when a market has an adverse selection problem due to seller's having private
information?
a. The number of sellers that are in the market.
b. The level of quality that is desired in the product.
c. The price that each seller is charging.
d. The quality level of the units that are for sale.
ANSWER: d

32. What condition does NOT need to be present for adverse selection to be a problem?
a. There is variation in quality of the products in the market.
b. Buyers who are unsure of quality will pay a low price for the product.
c. Consumers have a hard time assessing quality prior to purchase.
d. Sellers who are unsure of quality will sell the product at a low price.
ANSWER: d

33. Which of the following is NOT a solution to an adverse selection problem due to seller's having private
information?
a. The government can provide information or weed out low-quality goods.
b. Buyers can produce the good for themselves.
c. Sellers can signal quality.
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d. Third-party verifiers can provide information to buyers.

ANSWER: b

34. All of the following statements are solutions to an adverse selection problem caused by seller's having
private information EXCEPT
a. sellers can signal quality.
b. third-party verifiers can provide information to buyers.
c. the government can provide information or weed out low-quality goods.
d. buyers can signal quality.
ANSWER: d

35. Which of the following is NOT an example of a solution to an adverse selection problem that is caused by
the seller's having private information?
a. The government bans the sale of air conditioners with energy efficiency below a certain standard.
b. A buyer's organization makes a verified list of product characteristics demanded by buyers.
c. An independent organization verifies organic production and publishes a list of certified organic
farmers.
d. A producer of a weight loss supplement offers a money-back guarantee that its product works.
ANSWER: b

36. Which of the following is NOT an example of a solution to an adverse selection problem caused by the
seller's having private information?
a. A list of award winners and top-tier producers is published by the organization of experts that judges
an annual chocolate bar quality competition.
b. A hairstylist offers a free brief follow-up appointment within a week of a haircut to adjust anything
the customer does not like about a cut.
c. A government requires miles-per-gallon labeling on all automobiles sold in the country.
d. A company makes sure that all its employees enter positive product reviews on an online website that
reports product reviews.
ANSWER: d

37. Which of the following is an example of a credible third-party verifier providing helpful information to
buyers when it is difficult for them to judge the quality of a health supplement in advance?
a. A product review website allows anyone, including buyers and sellers, to post reviews of a health
supplement.
b. Producers provide detailed descriptions of the supplement's features.
c. A research lab publishes a comparative study of the effectiveness of the versions of the supplement
produced by 10 companies.
d. The association of all producers of the supplement makes a list of suggested standards for the
supplement.
ANSWER: c

38. Which of the following is NOT an example of a credible third-party verifier providing buyers information
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that could solve an adverse selection problem due to seller's having private information?
a. Brianna relies on washing machine ratings in a well-regarded consumer magazine that tests and rates
products.
b. Mia insists on seeing at least three projects of a given tile layer's work along with getting references
from former customers before she will consider hiring him for a bathroom renovation.
c. Martin's car repair company guarantees repair work for 60 days after a repair.
d. Pierre pays a certified home inspector to examine a home he is considering for purchase.
ANSWER: c

39. Which of the following would NOT be a credible third-party verifier of information on a product?
a. A research laboratory whose research is funded by the company producing the product.
b. A panel of experts on the product that are not employed or funded by producers.
c. An independent organization funded by subscribers to its magazine that is dedicated to verifying
product quality claims.
d. A certified home inspector who will inspect homes for a set fee and provide a report on its condition.
ANSWER: a

40. In which of the following would a third-party verifier not be helpful for shoppers to gain information about
a product?
a. A verifying organization can test the product or hire experts to test the product to verify its quality or
claims.
b. A verifying organization can provide information on the experiences of past users of the product,
verifying that the experiences are from actual users of the product who are not tied to the producer.
c. A consumer can send questions about the product quality to the producer to learn more about the
production.
d. A consumer could hire a trusted expert to examine a particular unit of the product that he wants.
ANSWER: c

41. When producers signal customers, they are

a. advertising the product's price using mass media.
b. using a banner or sound to attract attention to their product.
c. using a third-party to convince customers to buy.
d. taking action to convey private information credibly.
ANSWER: d

42. An action taken to convey private information credibly is known as

a. an advertisement.
b. collusion.
c. a signal.
d. a memo.
ANSWER: c

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43. Natalia is graduating from university and seeking her first full-time job. She wants the employers to know
that she is a hard worker who pursues excellence in her work. What sort of signal could she use to convey this?
a. The prospective employers ask for letters of recommendation from professors who can verify her
work as a student.
b. In her cover letter for a job application, Natalia notes that she was student worker of the year twice
during her four years of part-time work at the university.
c. At a job interview, the employer asks her if she is a hard worker.
d. She works hard at her current student part-time job.
ANSWER: b

44. Which one of the following is NOT an example of a seller offering signals of quality?
a. Chau asks customers to write reviews of her manicures on a website for local businesses.
b. Hui Er proofreads her job application and cover letter four times to make sure it shows that she is
careful about details.
c. Mak offers a money-back guarantee on his product.
d. Ian's Auto Body Shop offers a warranty on its work.
ANSWER: a

45. A seller's signal about product quality is useful to potential customers when it
a. makes it more difficult for the customer to learn about the products of other producers.
b. reduces the profit margin so that customers don't feel exploited.
c. gives customers verification about things they already know.
d. helps them differentiate between high- and low-quality versions of the product.
ANSWER: d

46. A seller's signal to potential buyers can work well for the seller only when it is
a. focused on reinforcing the idea that there are lemons for sale in the market.
b. focused on reinforcing the idea that there are no lemons for sale in the market.
c. substantially costlier for sellers of high-quality products to send the signal than for sellers of low-
quality goods to do so.
d. substantially costlier for sellers of low-quality products to send the signal than for sellers of high-
quality goods to do so.
ANSWER: d

47. When a signal from sellers to buyers is effective, then sellers

a. of high-quality products can charge a higher price than sellers of low-quality products.
b. of low-quality products can charge the same price as sellers of high-quality products.
c. know which buyers are willing to pay a high price.
d. know which buyers are not interested in quality.
ANSWER: a

48. The three ways that government policy can solve an adverse selection problem do NOT include
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a. regulating quality.
b. requiring that buyers purchase a particular product.
c. providing information to buyers.
d. giving sellers an incentive to reveal truthful information.
ANSWER: b

49. The three ways that government policy can solve an adverse selection problem do NOT include
a. limiting the number of sellers.
b. providing information directly to buyers.
c. regulating quality.
d. giving sellers an incentive to reveal truthful information.
ANSWER: a

50. Which of the following is an example of a government reducing adverse selection by eliminating the lowest-
quality products in a market?
a. Requiring that sellers reveal to buyers any known flaws in the product.
b. Requiring a skill or knowledge-based license to offer the product or service.
c. Offering accurate information to buyers.
d. Allowing firms to go out of business if they have insufficient customers.
ANSWER: b

51. If low-quality goods are not allowed to be sold, then the problem of adverse selection due to seller's having
private information will
a. grow.
b. not be affected.
c. lessen slightly.
d. disappear.
ANSWER: d

52. If sellers charge only one price in a market where buyers have private information, then sellers
a. end up with a mix of customers skewed toward expensive customers.
b. end up with a mix of customers skewed toward less expensive customers.
c. can avoid adverse selection.
d. will flourish as much as possible.
ANSWER: a

53. When buyers know more than sellers about how costly the buyers are likely to be to the sellers, then
a. sellers are likely to charge a price that drives the most expensive customers out of the market.
b. buyers will exert pressure on sellers to charge a price based on the least expensive customers.
c. buyers will exert pressure on sellers to charge a price based on the most expensive customers.
d. sellers are likely to charge a price that drives the least expensive customers out of the market.
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ANSWER: d

54. When buyers have private information, the risk to sellers is that they will
a. end up with disproportionately high-cost customers.
b. end up with disproportionately low-cost customers.
c. have an advantage over buyers.
d. be more influential than buyers.
ANSWER: a

55. The tendency for the mix of buyers to be skewed toward more high-cost buyers when sellers don't know
buyers' type is known as
a. adverse buyer bias.
b. high-cost discrimination bias.
c. adverse selection of buyers.
d. private information bias.
ANSWER: c

56. The adverse selection of buyers is the tendency

a. of buyers to make purchases that are not in their best interests.
b. of sellers to target advertising toward individuals who are unlikely to buy.
c. for the sellers to be skewed to high prices when buyers want low prices.
d. for the mix of buyers to be skewed toward more high-cost buyers when sellers don't know buyers'
types.
ANSWER: d

57. When buyers have private information, they

a. know more about how costly they will be to sellers than the sellers know.
b. have access to information about the sellers that sellers prefer to keep private.
c. tend to favor more specialized versions of products.
d. are at a disadvantage in making purchases.
ANSWER: a

58. When buyers have private information and sellers charge a single price based on the average cost of buyers,
then
a. the mix of buyers will be skewed toward those who are less costly for sellers.
b. the mix of buyers will be skewed toward those who are more costly for sellers.
c. buyers who would be lower-cost buyers will be more likely to buy.
d. buyers who would be higher-cost buyers will be less likely to buy.
ANSWER: b

59. A dental insurance company charges premiums higher than average dental costs across a population and
loses money. When it keeps raising the premiums on its policies, its losses keep rising. The dental insurance
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company is facing
a. the challenge of having private information not known by the buyers.
b. sellers with diminishing market power.
c. an adverse selection death spiral.
d. the challenge of high growth of demand.
ANSWER: c

60. When buyers have private information, which group of buyers will have the most difficult time making a
purchase at a price no higher than their costs?
a. Extremely high-cost buyers
b. High-cost buyers
c. Average-cost buyers
d. Low-cost buyers
ANSWER: d

61. Which of the following worsens adverse selection due to buyers having private information?
a. Buyers have the choice to buy or not buy whenever they want to.
b. Buyers have constraints on their ability to buy or not buy whenever they want to.
c. Sellers have very limited ability to change price.
d. Sellers have flexibility to lower price but not to raise price.
ANSWER: a

62. When people are risk averse, the price they are willing to pay for insurance _____ the actuarially fair price.
a. must be lower than
b. may be higher than
c. must be equal to
d. may be equal to or lower than but not higher than
ANSWER: b

63. How do risk-averse buyers affect adverse selection in a market where buyers have private information?
a. Risk-averse buyers reverse the adverse selection problem from a seller problem to a buyer problem.
b. Risk-averse buyers reverse the adverse selection problem from a buyer problem to a seller problem.
c. Risk aversion in buyers will reduce adverse selection.
d. Risk aversion in buyers will increase adverse selection.
ANSWER: c

64. Which seller is most likely to face adverse selection problems due to buyers having private information?
a. A lawyer gives clients a choice of paying $500 per hour or paying a flat fee of $6,000 for up to 12
hours of work plus $500 per hour for any work beyond 12 hours.
b. An accountant prices his services for completing tax returns individually, with each person's price
based on the number of schedules and forms that need to be used to complete each return.

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c. A toy store offers a special sale of "buy one, get one free" on puzzles.
d. A clothing store advertises free hemming alterations on pants and then adjusts its price on pants to
add in the average cost of hemming based on the proportion of the population that is taller or shorter
than average.
ANSWER: d

65. Which pricing approach for a restaurant would have the greatest risk of adverse selection due to buyers
having private information?
a. Offering a set price all-you-can-eat buffet.
b. Offering small- and large-plate versions of each entrée with different prices.
c. Pricing each menu item based on its cost of production.
d. Charging a price per ounce and weighing each plate.
ANSWER: a

66. The owner of an apartment building is deciding what rent to charge and how to cover any damages. A lease
with a monthly rent of $1,000 would cover expenses, including normal wear and tear but no additional damage.
Which of the following lease options would create an adverse selection of buyers due to private information?
a. Rent of $1,000 plus a one-time, nonrefundable cleaning fee of $300.
b. Rent of $1,100 plus a security and cleaning deposit of $500 that will be refunded less any damage
repairs or cleaning.
c. Rent of $1,000 plus a security and cleaning deposit of $1,500 that will be refunded less any damage
repairs or cleaning.
d. Rent of $1,300.
ANSWER: a

67. Ari had gastric by-pass surgery for weight loss and can eat very little at a meal. Which of the following
restaurants will she be most likely to buy from if she wants to pay only for food that she eats?
a. An all-you-can-eat-buffet with a set price.
b. Each plate (entrée with two sides) is priced based on the cost of production.
c. All entrees and all sides are priced based on the cost of production.
d. A discount is given if a dessert is ordered with a dinner plate.
ANSWER: c

68. Zhang Wei is opening an auto repair shop. Which of the following pricing approaches might
disproportionately attract buyers who have cars in worse-than-average condition?
a. Three-tier pricing for repairs based on an initial assessment of repair needs — low-cost, average-cost,
and high-cost repairs.
b. An hourly charge for time spent on repair plus cost of parts.
c. An hourly charge so the price is based on how long it takes to complete the repair.
d. A flat fee based on average costs for all repairs, with a 30-day guarantee.
ANSWER: d

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69. Merced (5 feet tall) and Tina (6 feet tall) are the shortest and tallest members of a women's choir who need
to have matching floor-length outfits made. Each wants to pay as little as possible for her outfit. Which tailor
would Merced prefer?
a. Each choir member pays $120 for eight hours of sewing and $100 for five yards of fabric, which are
the average sewing and fabric costs.
b. Each choir member pays $15 per hour for sewing and $80 to $120 for fabric based on the actual
amount needed for that member's garment.
c. There is two-tier pricing based on height, with choir members paying either $210 or $230.
d. Each choir member pays $15 per hour for sewing and $100 for five yards of fabric.
ANSWER: b

70. Merced (5 feet tall) and Tina (6 feet tall) are the shortest and tallest members of a women's choir who need
to have matching floor-length outfits made. Each wants to pay as little as possible for her outfit. Which tailor
would Tina prefer?
a. Each choir member pays $120 for eight hours of sewing and $100 for five yards of fabric, which are
the average sewing and fabric costs.
b. Each choir member pays $15 per hour for sewing and $80 to $120 for fabric based on the actual
amount needed for that member's garment.
c. There is two-tier pricing based on height, with choir members paying either $210 or $230.
d. Each choir member pays $15 per hour for sewing and $100 for five yards of fabric.
ANSWER: a

71. In an insurance market, what may help ease the problems of adverse selection due to buyers having private
information?
a. Utility maximization
b. Risk aversion
c. Hidden-customer quality
d. Third-party verifiers of product quality
ANSWER: b

72. What worsens adverse selection in a dental insurance market where buyers have private information?
a. Selling only to risk-averse buyers.
b. Grouping buyers by a risk factor and charging a premium based on risk.
c. Requiring that each buyer's premium be based on that specific buyer's costs.
d. Allowing buyers to opt-in and opt-out of the market at any time they desire.
ANSWER: d

73. Which of the following is NOT a solution to adverse selection when buyers have private information?
a. The government can increase information, offer subsidies, enforce mandates, or provide insurance.
b. Sellers can offer different contracts so that buyers separate themselves.
c. Sellers can use information that is related to buyers' likely costs.
d. Sellers can simplify by charging a single average price.
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ANSWER: d

74. Which of the following is NOT a solution to adverse selection when buyers have private information?
a. Sellers can use information that is related to buyers' likely costs.
b. The penalty for being a high-cost customer is reduced.
c. The government can increase information, offer subsidies, enforce mandates, or provide insurance.
d. Sellers can offer different contracts so that buyers separate themselves.
ANSWER: b

75. The solutions to adverse selection in a market where buyers have private information focus on
a. reducing buyer choice so that customers are forced into purchasing the product whether they need it
or not.
b. raising market price so that sellers can cover costs of all customers, including high-cost customers.
c. helping sellers get more information about their customers so they can distinguish between high- and
low-cost customers.
d. reducing seller costs so that price will cover costs.
ANSWER: c

76. Which of the following factors can health insurers NOT use as a basis for different premiums on health
insurance policies?
a. age
b. smoker or nonsmoker
c. regular exerciser or not
d. sex
ANSWER: d

77. The government can help solve a market problem with adverse selection in each of the following ways
EXCEPT
a. providing insurance.
b. requiring that everyone buy insurance.
c. reducing the need for insurance.
d. providing incentives for buyers to reveal private information.
ANSWER: c

78. To reduce their disadvantage due to buyers having private information, auto insurers try to
a. raise the price of all policies.
b. collect information from customers that relate to how costly the customer will be to the insurer.
c. create incentives for buyers to be high-cost buyers so that they will pay more for insurance.
d. reduce the costs of providing insurance.
ANSWER: b

79. An automobile insurance agency offers two policy options — one with a deductible of $400 and a premium
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of $1,900 and another with a deductible of $900 and a premium of $1,500. What is the auto insurer trying to
achieve by offering these two options?
a. Charging a high deductible to low-cost customers will reduce their incentive to buy insurance.
b. Charging a high deductible to high-cost customers will induce them to buy insurance.
c. Low-cost customers will buy the $1,900 one, and high-cost customers will buy the $1,500 one.
d. Low-cost customers will buy the $1,500 one, and high-cost customers will buy the $1,900 one.
ANSWER: d

80. Which of the following is NOT a method used by a government to reduce adverse selection due to buyers'
private information in a product market?
a. The government imposes laws with penalties for insurance fraud.
b. The government provides insurance to all and pays for it with tax revenue.
c. The government helps the population become less risk-averse.
d. The government subsidizes the cost of insurance so that more people buy it.
ANSWER: c

81. The government could reduce adverse selection due to buyer-held private information by
a. requiring that insurance companies publicize their profit rates.
b. regulating the premium that insurance companies charge.
c. reducing the level of risk aversion in the population.
d. requiring everyone to buy insurance.
ANSWER: d

82. When the government subsidizes the cost of health insurance

a. the cost of insurance rises for all people in the country's population.
b. the cost of insurance rises for high-cost people in the country's population.
c. fewer people will buy insurance, decreasing adverse selection.
d. more people will buy insurance, decreasing adverse selection.
ANSWER: d

83. Who is least likely to buy health insurance when individuals have private information about their health and
health insurance is optional?
a. A person who has a family history of cancer
b. An obese person
c. A young adult in good health
d. A person who is 60 years old and in good health
ANSWER: c

84. What can an insurance company do to reduce adverse selection due to buyers holding private information?
a. Gather information on buyers that is related to their cost to the insurance company and can be used to
set premiums.
b. Offer a single option insurance plan to buyers rather than several options of different premiums with
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differing deductibles.
c. Make sure that buyers have the option to buy and opt-out of insurance at any time.
d. Reduce the level of risk aversion among buyers so that more people will buy insurance.
ANSWER: a

85. You are a government policymaker with the responsibility to propose a policy that will reduce adverse
selection in the health insurance market. Which of the following policies would achieve that goal?
a. The government will protect the people's right to keep their personal information private.
b. The government will subsidize the cost of health insurance.
c. The government will ensure that people can opt-in and opt-out of health insurance at any time.
d. The government will fund a public information campaign to reduce risk aversion.
ANSWER: b

86. Which of the following is NOT used by auto insurers to assess your cost to them as a policyholder?
a. Your age
b. The type of vehicle
c. Your driving record
d. Your height
ANSWER: d

87. If you think you're a low-cost customer who is unlikely to need to file a claim, you'll often get a much better
deal if you choose the insurance plan that
a. has a single option for all buyers.
b. allows buyers to opt-in and opt-out at any time.
c. has a high deductible.
d. reduces risk aversion.
ANSWER: c

88. How is health insurance usually paid for when the government provides it?
a. Individual premiums based on each person's health costs
b. Health care provider fees
c. Taxes
d. Rebates
ANSWER: c

89. Which of the following does NOT cause adverse selection?

a. Sellers having private information
b. Buyers having private information
c. Unobservable actions
d. Price-related private information
ANSWER: d
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90. The actions you take because your actions are not fully observable and you are partially insulated from their
consequences are referred to as
a. a hidden risk.
b. moral hazard.
c. adverse selection.
d. a bounded risk.
ANSWER: b

91. Moral hazard refers to the

a. actions you take because they are not fully observable and you are partially insulated from their
consequences.
b. risks that result from doing what is morally right.
c. result of moral behavior in a society that is immoral.
d. increased risks that result from acting based on communal rather than personal interests.
ANSWER: a

92. Jane builds her home in an area that is at high risk for flooding, instead of on higher ground. She does so
because the low-lying area has a better view and she can get flood insurance. This is an example of
a. adverse selection due to seller private information.
b. adverse selection due to market-based private information.
c. moral hazard.
d. incentive neglect.
ANSWER: c

93. Which of the following is an example of moral hazard?

a. Mario opens a smoothie shop rather than a hamburger joint because he only wants to offer vegan
options at his establishment.
b. Jenesse buys a bigger size coat than she needs so that she can still wear it if she gains weight in the
future.
c. Arturo buys life insurance as he wants to make sure his family will be provided for, even though he
is healthy and takes care of himself.
d. Jane builds her home on a piece of property with a great view but that is at high risk for flooding
because she can get flood insurance on the low-lying land.
ANSWER: d

94. Moral hazard is consistent with the idea that when people have health insurance that protects against high
medical expenses, they tend to
a. seek more medical care.
b. seek less medical care.
c. get sick less often.
d. get sick more often.
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ANSWER: a

95. _____ is consistent with the idea that people with health insurance that protects against high medical
expenses will seek more medical care than those without health insurance.
a. Adverse selection
b. Moral hazard
c. Seller-held private information
d. Market disequilibrium
ANSWER: b

96. Which of the following statements is consistent with moral hazard?

a. The more coverage a health insurance policy provides, the more often medical care will be sought.
b. The more coverage a health insurance policy provides, the less often medical care will be sought.
c. The more coverage a health insurance policy provides, the more often the policyholder will get sick.
d. The more coverage a health insurance policy provides, the less often the policyholder will get sick.
ANSWER: a

97. Moral hazard becomes a greater problem to an insurer when customers

a. act in full view of the insurer.
b. can take actions that are not observable by the insurer.
c. get advance approval from the insurer for all actions.
d. have higher deductibles.
ANSWER: b

98. Which of the following is an example of moral hazard?

a. Asad gets a life insurance policy to protect his family if he dies.
b. Chantelle works hard to improve her health, so she does not need to go to the doctor as often.
c. Jose goes to the doctor more often after he gets health insurance.
d. Bella gets an insurance policy with a higher deductible to save money.
ANSWER: c

99. When you have health insurance, your marginal benefit of a visit to the doctor's office is _____, and your
marginal cost is _____.
a. higher; higher
b. unchanged; higher
c. higher; lower
d. unchanged; lower
ANSWER: d

100. When you have health insurance, you tend to seek medical care more often because
a. your need for medical care rises as you get sick more often.

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b. cost-benefit analysis shows a net gain more often.

c. the marginal benefit of seeking medical care rises.
d. the marginal benefit rises faster than the marginal cost rises.
ANSWER: b

101. Per person, health care costs tend to be _____ when _____.
a. higher; everyone has health insurance
b. lower; the level of health care is advanced
c. higher; individuals can opt-in and opt-out of health insurance
d. lower; fewer health care providers are present
ANSWER: a

102. The cost-benefit principle leads you to _____ when you are insured.
a. become more risk-averse
b. respond less to incentives
c. take fewer precautions
d. remain consistent in behavior
ANSWER: c

103. Hidden actions are a type of _____ that creates moral hazard.
a. risk aversion
b. complement
c. monitoring
d. private information
ANSWER: d

104. The problem that moral hazard poses in insurance markets is that once you insure against a bad thing,
a. the bad thing becomes more likely to happen.
b. the benefits of having insurance are reduced.
c. individual incentives to avoid the bad thing rise.
d. the need for insurance is reduced.
ANSWER: a

105. The problems that arise when a principal hires an agent to do something on their behalf but the principal
cannot perfectly observe the agent's actions is known as _____ problem.
a. an adverse selection
b. a principal-agent
c. a risk-averse
d. a fundamental agency
ANSWER: b

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106. A principal-agent problem can arise when
a. a principal hires an agent to do something on their behalf, but the principal cannot perfectly observe
the agent's actions.
b. an agent hires a principal to do something on their behalf, and the agent can observe the principal's
actions.
c. an insurance agent sells a policy to a buyer who uses it as an incentive to behave badly.
d. a principal uses an agent to accomplish a task the principal wants credit for completing.
ANSWER: a

107. According to the principal-agent problem, when the principal hires the agent to complete a task but is
unable to watch the agent complete it, the agent has an incentive to
a. do the opposite of what is asked.
b. do exactly what is requested.
c. underdeliver.
d. overdeliver.
ANSWER: c

108. Workers often slack off on a job when pay is not tied to output due to the _____ problem.
a. risk-aversion
b. lemon
c. buyer private information
d. principal-agent
ANSWER: d

109. The principal-agent problem can lead to

a. market failure.
b. unacceptably low price.
c. overdelivering on contract requirements.
d. excessive purchases.
ANSWER: a

110. Hui Er hires a contractor to remodel her kitchen while she is gone on vacation. In spite of the contractor's
promise to do high-quality work, she later discovers that he did not. Hui Er is experiencing a
a. problem due to buyer-held private information.
b. principal-agent problem.
c. lemon problem.
d. risk-aversion problem.
ANSWER: b

111. Which of the following is an example of a principal-agent problem?

a. Jordan buys a new car that seems to have more flaws than the average new car.
b. Jeff, a CEO, puts pressure on his staff to increase productivity.
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c. Maria slacks off at work when her boss is on vacation.

d. Ingrid is highly risk-averse and tends to over-insure against loss.
ANSWER: c

112. Nguyen's team of salespersons is not very productive in making sales. They claim to work in the field all
day, but the product sales have been minimal. Nguyen is experiencing a _____ problem.
a. lemon
b. risk-aversion
c. moral-aversion
d. principal-agent
ANSWER: d

113. When a principal-agent problem occurs, the agent engages in actions that
a. the principal can't observe, and they are not in the principal's best interest.
b. are impulsive rather than planned and that end up working against the agent's best interest.
c. are based on risk aversion rather than the principal's best interest.
d. result in lemons that harm the agent rather than the principal.
ANSWER: a

114. Which of the following is an example of a principal-agent problem?

a. A firm fails to earn profits because a manager mismanages the employees.
b. Workers are motivated to do their best on the job regardless of compensation.
c. Buyers opt to buy the low-cost, low-quality version of a product even though they say their primary
goal is high quality.
d. Shareholders hire a CEO to increase profits, and the CEO remodels the office with expensive artwork
and furnishings.
ANSWER: d

115. Moral hazard problems are likely to develop under what conditions?
a. They develop when you must depend on the hidden actions of others.
b. They occur when costs are rising.
c. They develop when risk aversion leads to irrational behavior.
d. They occur when private information is stolen by the other party.
ANSWER: a

116. Which of the following is NOT a solution to a moral hazard problem?

a. Pick the right kind of agents.
b. Give the actor "skin in the game," or a stake in the outcome.
c. Ensure that the principal has clear expectations.
d. Reward things that go along with the actions you want.
ANSWER: c
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117. Which of the following is NOT a solution to a moral hazard problem?
a. Government rules and social norms can help align incentives.
b. Make hidden actions observable by monitoring.
c. Pick the right kind of agents.
d. Give the principal stronger incentives.
ANSWER: d

118. The Thompsons use video surveillance to ensure that the lawn care company they employ applies the lawn
fertilizer and weed controller they paid for. This is an example of solving
a. a principal-agent problem through monitoring.
b. a lemon's problem through quality control.
c. an adverse selection problem due to buyer-held private information.
d. a risk-aversion problem due to insufficient seller information.
ANSWER: a

119. A health insurance company offers a discount on the annual premium to policy holders who complete four
specific health screenings each year. This is an example of
a. giving agents "skin in the game" to reduce a risk-aversion problem.
b. rewarding desired behavior to reduce a principal-agent problem.
c. creating incentives to reduce a lemons problem.
d. making hidden actions observable to reduce moral hazard.
ANSWER: b

120. Linking the income your workers earn to measures of their performance is called
a. incentivized employment.
b. monitoring.
c. pay-for-performance.
d. social norms.
ANSWER: c

121. Pay-for-performance is
a. hiring workers to complete a task.
b. withholding all pay until a job has been completed.
c. allowing employees to come up with new ways to produce and rewarding the best ideas.
d. linking the income your workers earn to measures of their performance.
ANSWER: d

122. Which of the following is an example of solving moral hazard by giving others a stake in the outcome?
a. Worker pay is based on productivity.
b. Video surveillance monitors worker actions.
c. Additional hiring screenings ensure that hard-working persons are hired.
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Chapter 20: Decisions with Private Information

d. Laws against theft and fraud reduce those problems in workplaces.

ANSWER: a

123. Which of the following is an example of solving moral hazard by making hidden actions observable?
a. Worker pay is based on productivity.
b. Video surveillance monitors worker actions.
c. Additional hiring screenings ensure that hard-working persons are hired.
d. Laws against theft and fraud reduce those problems in workplaces.
ANSWER: b

124. Which is an example of solving moral hazard by finding the right kind of agents?
a. Worker pay is based on productivity.
b. Video surveillance monitors worker actions.
c. Additional screenings ensure that hard-working persons are hired.
d. Laws against theft and fraud reduce those problems in workplaces.
ANSWER: c

125. Ku owns a company and wants sales to increase. She implements a bonus pay system for the sales team at
her company where workers receive extra compensation for sales beyond a set minimum expectation. This is an
example of solving a moral hazard problem by
a. providing complements to support the actions you want.
b. making hidden activities observable.
c. using social norms to align incentives.
d. giving people a stake in the outcome.
ANSWER: d

126. A community teaches children that hard work and doing your best at tasks are virtues. This is an example
of
a. reducing moral hazard through social norms.
b. resolving risk aversion through social norms.
c. reducing moral hazard through complements to actions you want.
d. resolving risk aversion through complements to actions you want.
ANSWER: a

127. Which of the following is an example of resolving moral hazard by picking the right kind of agent?
a. Marla decides that she will work only for a boss who is known for honesty.
b. When traveling in developing countries, Evan eats at international chain restaurants rather than try
local foods.
c. Hua Xing makes a complete survey of all sellers to make sure she buys from the one with the lowest
price.
d. Jose's government requires truthful advertising, which gives him confidence in making purchases
based on advertised claims.
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ANSWER: b

128. Private information is an obstacle to

a. company profitability.
b. efficient functioning of markets.
c. moral hazard.
d. risk aversion.
ANSWER: b

129. Market forces work more efficiently when

a. adverse selection is offset by moral hazard.
b. price is fixed rather than flexible.
c. buyers and sellers are altruistic.
d. there is an absence of private information.
ANSWER: d

Essay

130. Explain why markets fail when sellers know more than buyers and quality is hard for buyers to observe
before purchase.
ANSWER: When sellers know more about product quality than buyers, they tend to supply low-quality
products. Buyers are hesitant to pay a high price because they can't tell if the product is of high
quality. As price falls, more sellers of high-quality products leave the market. The result in the
market is that many people cannot buy or sell high-quality products even when the marginal benefit
to buyers would exceed the marginal cost to sellers of high-quality products. The market outcome is
inefficient.

131. Describe the chain of events that occurs when products considered to be lemons enter a market and leads to
adverse selection of sellers.
ANSWER: Lemons are units of a product that have multiple flaws or problems. When increasing numbers of
buyers discover that they have lemons and others hear this, buyers start to assume that all units are
lemons, and they are not willing to pay much for the product. As the price falls, sellers offer lower-
quality units for sale, and the higher-quality units begin to disappear. This result is called the
adverse selection of sellers.

132. How can adverse selection problems due to seller-held private information be solved?
ANSWER: There are three main approaches to solving adverse selection problems that occur because sellers
hold private information. When sellers hold private information, buyers are at risk of making a bad
purchase decision. Solutions to this problem focus on buyers obtaining insight into the private
information or having greater assurance that they are not at risk of a poor decision. One approach for
resolving the problem is for buyers to gain insight into the sellers' private information from third-
party verifiers who might test or confirm the claims sellers have made about the product. Another
approach is for sellers to send a credible signal about their product's quality, such as offering a
warranty. A third approach is for the government to either provide information or use regulation to

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eliminate low-quality items from sales.

133. Describe the impact of risk aversion on a market with adverse selection due to buyers holding private
information.
ANSWER: When buyers hold private information, the sellers in a market have a difficult time distinguishing
between high-cost buyers and low-cost buyers. The result is that low-cost buyers are not willing to
pay a high price or even an average price, and they opt-out of buying the insurance. Mostly, high-
cost buyers make purchases which result in insurance companies charging higher and higher prices.
However, if low-cost buyers who are risk-averse want insurance they may be willing to pay a price
that exceeds their expected cost in return for lower risk. Buyers who want to avoid unexpected
medical bills will be willing to pay a premium higher than their average medical costs in return for
reduced risk. Therefore, the impact of risk aversion is that if low-cost buyers remain in the market,
then premiums can stay close to the average cost of medical care.

134. What is meant by the terms high-cost customer and low-cost customer?
ANSWER: The terms high-cost customer and low-cost customer are for how costly it is for a seller to serve a
customer. A high-cost customer creates extra costs for a seller, such as an auto insurance
policyholder who has many car accidents in a year. A low-cost customer, such as an auto insurance
policyholder who makes no claims during a policy year, does not create any extra costs for the
seller.

135. An automobile insurance agency offers buyers two policy options — one with a deductible of $300 and
premium of $1,800 and the other with deductible of $800 and premium of $1,400. How will this reduce adverse
selection due to buyers holding private information?
ANSWER: Insurance buyers who don't expect to make a claim will be drawn to the cheaper policy with the
$1,400 annual premium and a higher deductible. While the high-risk insurance buyers who foresee
making frequent claims will prefer buying the more expensive policy with the $1,800 annual
premium that has a lower deductible. If the company offered only one type of policy, those who
don't expect to make a claim would be reluctant to buy insurance because they would be subsidizing
those who make more claims. By offering two options, the insurance company gives an incentive
for high-cost drivers to pay more than they would pay otherwise, and low-cost drivers have a greater
incentive to maintain coverage.

136. Summarize the three solutions to adverse selection when buyers know more than sellers.
ANSWER: The solutions to adverse selection when buyers know more than sellers, deal with ways that help the
sellers can gain some of the private information held by buyers. Sellers can try to get buyers to
reveal information through questionnaires that allow them to better assess how costly the buyer will
be. Sellers can offer different contracts that are designed in a way that leads buyers to separate
themselves based on how costly they will be. Finally, the government can take actions like
increasing the availability of information, offering subsidies or providing insurance in ways that
reduce adverse selection.

137. Why can moral hazard cause an insurance market to collapse?

ANSWER: Moral hazard occurs when insurance buyers take hidden actions that are not fully observable and
they are partially insulated from the consequences of those actions. For example, when people have
health insurance, it is less costly for them to go to the doctor, and so they go more often. This makes
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coverage more expensive for the health insurance company to provide. If the insurance company
raises rates to cover its added costs, then customers will be unhappy, and some will drop out of the
insurance market. If moral hazard is great enough, the policies can become so expensive that the
health insurance market collapses due to lack of customers and high costs associated with the
customers.

138. How can moral hazard cause an insurance market to collapse?

ANSWER: The problem that moral hazard poses in insurance markets is that once you insure against a bad
thing, that bad thing becomes more likely to happen. Once you're insured, you will take more
unobservable or hidden actions that raise your risk, and fewer unobservable precautions that reduce
your risk. By contrast, you're more careful when you're uninsured because you bear all the costs of
things going wrong. The problem is that you don't have the incentive to be as careful when you are
insured. For example, when people have health insurance, it is less costly for them to go to the
doctor, and so they go more often. This makes coverage more expensive for the health insurance
company to provide. If the insurance company raises rates to cover its added costs, then customers
will be unhappy, and some will drop out of the insurance market. If moral hazard is great enough,
the policies can become so expensive that the health insurance market collapses due to lack of
customers and high costs associated with the customers.

139. Summarize five solutions to moral hazard.

ANSWER: Moral hazard problems can be solved in five ways. First, the principal can find ways to make hidden
actions observable. This makes the agent accountable for the actions. Second, the principal can
create rewards for the desired actions. This gives agents an incentive to act based on the principal's
desires. Third, the principal can find a way to make the agent's welfare tied to the desired outcome
by giving agents a stake in the game. Fourth, social norms or the government can create pressures
that align actions and incentives. Fifth, principals can find ways to choose agents that will be true to
the principal's best interest.

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