1. Which of the following would be a headline about a microeconomic story?
Microeconomics is about the behavior of individual markets while macroeconomics is about the operation of the entire economy - about things like inflation, unemployment, and budget deficits. The only microeconomic title would be the one concerning the ruling on the Microsoft case.
2. A debate has been gaining steam over what to do with Microsoft in the aftermath of the judge's decision. Those who support the position that Microsoft's power is the result of the company's efficiency and would like to see the government stop its case, would be most likely to be classified as:
In this question the key to the answer is the expansion in the scope of government activity. This is what you would expect from a conservative who believes that active government involvement should be minimized and that profits should flow to the most efficient.
3. Congestion on route 95 in Providence is best explained by which of the following:
Congestion is a classic example of externalities - individual decision makers do not account for the impact that they have on others when they are making their choices.
4. Before you graduate you will be asked to work on some group projects, and if the experience of previous students is any guide to what you can expect, it will be a difficult experience. The situation generally goes something like the following: students in a class are assigned to groups to work on a project and one grade will be given for each project and everyone in the group will receive that grade. The problem is that not everyone works hard. This is a problem that is a characteristic of:
The problem experienced by the group is due to the fact that all group members get the good grade even if all do not contribute equally. This is the same problem that we have with national security – a public good problem.
5. Which of the following affects the marginal physical product of labor?
The marginal productivity of workers would depend on all of the factors mentioned above. A more capable worker would be more productive, as would a worker with access to better capita (machinery, equipment). The productivity of a worker could also be increased in an effective organization where the management possesses technical know-how.
6. The Wall Street Journal reported a decrease in the unemployment rate to a thirty year low, but it is no surprise to those who see the "help Wanted" ads and stories about labor shortages. This has meant that many students with just a high school education are getting substantial wage increases. What is the likely impact of this reduction in the unemployment rate on the cost of a college degree for a high school student considering college next year?
The opportunity cost of school is closely related to the earnings that an individual would make if they were not enrolled in school. For the workers who are employed, the cost of school would rise since they would need to give up the higher income to get their degree.
7. Microhard is a company that we looked at in class as an example of production possibility curves. A review of the "books" of Microhard reveals that the company has projected revenues of $3,000,000 and projected costs of $2,250,000. Bob Bevis, looking for a way into the plastics industry, has made an offer of $500,000 to buy Microhard. Based on your knowledge of economics, what would the economic profit of Microhard's continued operation be in the situation where the sale was refused? All the sales and cost figures represent complete future values.
The alternative to running Microhard would be to sell the company. While running the business Microhard makes a profit of $750,000, while the sale of the business would generate an income of $500,000. By staying in business, Microhard earns $250,000 - the difference between the $750,000 and the $500,000.
8. In a traditional demand-side recession you can expect that unemployment will rise as inflation falls. Based on the diagram above, when did the US economy enter a demand-side recession? [The year on the horizontal axis marks the beginning of the year.]
You need to be able to find the time where the inflation rate starts to fall and the unemployment rate begins to rise. This happens in 1996.
9. Which of the following would be a legitimate characterization of the situation in the US in the past twenty years?
One of the dominant features of the last twenty years of the twentieth century was the increasing inequality.
10. The glass ceiling could best be viewed as an example of:
The glass ceiling describes the lack of females in the top levels of corporate America. One argument is that men do not like to work for women so that women's productivity is lower than men's - hence they are not as often promoted to high level jobs.
11. The explosive growth of the internet has had an impact on more traditional media. One of the things that we have found is that there has been an increase in demand for billboard space as internet companies try to get their URL's some visibility. The impact of this on the market for billboards would be best represented by which diagram?
The increase in demand shows up as an outward shift in the demand curve.
12. The impact on the market for automobiles of a substantial wage increase won by the UAW (union representing the auto workers) this fall in their negotiations with GM.
An increase in the wage of workers will increase the cost of production. This will affect the suppliers who will now need to charge higher prices for their cars. We would describe this as a decrease in supply which will shift the supply curve inward.
13. The impact on the market for CD's of the introduction of DAT (digital audio tapes) which are said to give the same sound quality on tapes as is currently available only on CD's
People will not want to buy as many CDs with the arrival of the substitute and the demand will drop - an inward shift in the demand curve.
14. An alternative solution to the drug problem is the legalization of drugs. The experts suggest that this will result in a substantial downward shift in the supply curve of drugs as more firms enter to supply the newly legal product. Others suggest that the legalization will result in an increase in the demand curve. If both of these views are correct then we can expect:
When both supply and demand shift we cannot predict both the price and quantity effects. In this case an increase in demand is pushing price and consumption up while an increase in supply is pushing price down and consumption up. The result is that we cannot predict price, but consumption can be expected to rise.
In the aftermath of the Kosovo crisis much was written about the level of adequacy of the US military. It has also triggered a debate about the proper allocation of federal defense expenses. The choice situation facing the federal government is the proper allocation of spending between people and machines. In the diagram below the (Y) represents the number of people employed in defense and (X) represents the number of machines. [The dashed line represents the new possibility curve].
15. Which diagram describes the situation if the defense department receives a funding increase?
The funding increase is an increase resources which shows up as a parallel shift outward of the curve. This is graph A
16. Which diagram best describes the choice situation if technological improvements in the machines has decreased the unit cost of the machines?
The decrease in the cost of machines means that the feds can get more bang for the buck out of their spending on machines. This is similar to an increase in productivity of money spent on machines - so the curve's X axis moves out. The graph is B
17-21: answer is a
Use the following graphs to answer the next three questions.
22. Why do country's economies grow at different rates? One of the factors that has been identified in some studies is proximity to the equator. The growth rate in a country's economy (Y) tends to increase as distance from the equator (X) increases. If you are to believe the results of the study, which of the diagrams would be the expected result of a study of growth rates and location?
The question here is: what is the nature of the relationship? In this case it is a positive relationship - as distance from the equator increases, so does the growth rate. This is graph B.
23. Let's stick with the economic growth studies for one more question. An additional factor that has been identified as a determinant of growth is rule-of-law. Countries where the government is more corrupt tend to grow slower. Assume that we have collected data on country growth rates (Y) and an index of corruption (X) where the index increases in value as corruption increases? If you are to believe the results of the study, which of the diagrams would be the expected result of a study of growth rates and location?
The question here is: what is the nature of the relationship? In this case it is a negative relationship - as corruption increases, economic growth slows. This is graph A.
24. Which of the following industries has NOT been highly regulated in the US?
Another easy one that you can find in the table describing regulation in the US. All but the auto industry have been highly regulated.
25. On November 5, 1999 Judge Jackson issued his findings of fact in the Microsoft ant trust case. One of the behaviors that he cited was Microsoft's efforts to bundle its internet browser into its operating system. This is an example of:The behavior is a classic example of tying -using its monopoly power in one market to establish dominance in another market.
26. The savings rate is low in the US. Some people attribute the low savings rate to:
The existence of a low savings rate could be attributed to a high rate of time preference - you really do not care about the future. Your savings would also be lower because of the keep-up-with-the-Jones effect. You get caught up in a spending spiral where you are always trying to spend more and get a higher quality product. The goods where this type of behavior exists are called positional goods.
27. Which of the options would a risk averse person prefer:
- A: A sure gain of $250
- B: A 25% chance of getting $1,000 and a 75% chance of getting $0.
A risk averse person is someone who avoids risks. In this case the expected value of the two is identical $250. because of the uncertainty in option B, however, a risk averse person would prefer the certain $250.
28. The Block Island ferry is considered by many to be a natural monopoly. One of the features of the system is that the price for a ride to the island is the same in the winter and in the summer. This is an example of:
The costs per rider of the ferry are higher in the winter months, but the ferry service charges the same fares year-round. It does this by charging a fare that is below costs in the winter and above costs in the summer - a practice known as cross subsidization.
29. Dumping is an international version of what strategic behavior?
Dumping is the international version of predatory pricing – pricing a product at below cost.
30. Rhode Island has a very large tourist business and Newport is a very popular summer tourist area where there are large number of restaurants that specialize in seafood. Which market structure would be most representative of the restaurant industry in Newport?
A large number of restaurants all selling meals that are similar, but not identical, is what we would expect with monopolistic competition.
31. Cartels tend to be rather rare because they tend to be unstable as individual firms always have an incentive to cheat. One of the more successful cartels was OPEC which was very successful in the 1970s in raising the price of oil. eventually, however, the cartel collapsed. Which of the following contributed to the ultimate decline of the OPEC cartel?
The cost of another barrel of oil is low and we saw a decline in world-wide demand that put downward pressure on price which prompted the individual suppliers to cheat. Another problem for the OPEC countries was the appearance of new suppliers of oil.
32. A firm is attempting to come up with a pricing plan that will either raise prices ( option 1), keep prices constant (option 2), or lower prices (option 3). The impact of the decision on firm A's profit is dependent upon the pricing strategy of the rival seller - firm B. Displayed below is the payoff matrix of firm A for three different strategies, A1, A2, A3, and the potential retaliatory responses of firm B (B1, B2, B3).
| B1 raise P | B2 constant P | B3 lower P | |
| A1 raise P | 100 | -20 | -40 |
| A2 constant P | 10 | 0 | -30 |
| A3 lower P | 75 | 50 | -60 |
If you are a consultant to firm A, what strategy would you promote if you were trying to maximize the expected value of firm A's profit and you thought that each response by firm B was equally likely (33% chance)?
The maximum expected profit would be based on the weighted sum of profits where the weights are the chances of this option happening. The calculations of expected profit for the three options are:
E(profit 1) = 1/3*100 -1/3*20 - 1/3*40 = 40/3 = 13.33
E(profit 2) = 1/3*10 + 1/3*0 - 1/3*30 = -20/3 = 6.66
E(profit 1) = 1/3*75 +1/3*50 - 1/3*60 = 65/3 = 21.67
The best strategy is option 1.
Use the following graphs to answer the next 2 questions.
33. The impact on the automobile market of higher labor productivity due to improvements in labor-management relationships and a robust, booming economy.
There are two separate 'shocks' to the market. The first is the improvement of technology which means more output from the same inputs which means an increase in supply. The robust economy, meanwhile, means that consumers will have more income which will translate into more demand. Both curves shift outward.
34. 1999 has been a verrry good year for housing in Rhode Island. A strong economy, which can be seen in the falling unemployment rate, has helped the industry, but there is one concern. The strong performance nationally has driven up the price of lumber and sheetrock. Which graphs best depicts the impact on the housing market of the strong economy and rising construction costs.
The strong economy will be reflected in an outward shift in the demand curve while the rise in construction costs will be reflected in an inward shift in the supply curve.
35. Steve Jobs, the founder of Apple Computer, is back in the spotlight. In the past year he has led the introduction of the new G3s that come in many colors. The good reviews of the machine have had a positive impact on demand. At the same time, the company has been able to lower the costs of production. Which graph best depicts these developments in the market for Apple machines?
The market for Apple machines is experiencing an increase in demand as a result of the good reviews and an increase in supply as a result of the production improvements. The demand and the supply curves both shift outward.
36. Using the diagram above, calculate Tammy's profit if she is a profit maximizing monopolist (approximately).
Per unit profit would be defined as per unit revenue (AR) - per unit cost (AC). At the profit maximizing level of output this would be approximately $80 - $50 = $30. Given that the firm is producing 50 units, total profit should be about $1,500 = 30*50.
37. If Tammy were interested in a break-even situation, what should the level of production be?
Break-even means zero profit. This would happen when AC = AR which would be closest to 80 units of output.
38. If the demand for softballs increases, one could expect the demand for leather to increase. This is due to the
The demand for any input is a ‘derived’ demand – it is derived from the demand for the product that the input produces.
39. What type of market structure is the market that Tammy finds herself in?
Because the firm faces a horizontal demand curve, this is a perfectly competitive industry.
40. Based on your knowledge of firms' behavior, which of the following statements is true?
Because Tammy faces a horizontal demand curve, this is a perfectly competitive industry. Because P < AC, the firm is losing money and firms will leave the industry.
41. Based on your knowledge of firms' behavior, what is the profit maximizing level of output?
The decision rule is MR = MC and this happens when the two curves intersect. This happens at an output level of 40 because MR = P.
42. We hear much about the era of the entrepreneur in the business press. George has been listening to the stories and has decided the time has come to make a career switch. George is going to quit his job as an accountant (he worked for Nick’s Numbers) to become a potter. George gave up his salary ($50,000) and invested his retirement fund of $50,000 (which was earning 10 percent interest) in this potting venture. After all expenses for materials, space, sales help, and George’s $35,000 salary were paid, Nick (who still does George’s books) reported that the net profit from George's pottery store was $25,000. George's economic profits were:
This is a problem that distinguishes between economic profit and accounting profit. The two costs not picked up by the accountant would be the opportunity cost of George’s labor and the opportunity cost of the money. The opportunity cost of George’s labor is what he was making $50,000, and the cost of the money $5,000 (10%*$50,000). The accountant charged $35,000 for George’s labor in the new venture and the reported profit was $25,000, bringing to $60,000 the sum earned by George. The difference between this and what George would have made in his old job is $60,000 - $55,000 = $5,000.
43. If you were considering the move into a competitive market, what would you use as an indicator that the time was right to move in?
The key to the mobility of factors is the existence of economic profit which has little to do with either marginal cost or marginal revenue. economic profit exists if TR > TC or if the per unit revenue (AR) was greater than the per unit cost (AC).
44. What can you forecast for a competitive firm if you find that at the present time a profit maximizing firm would be in a situation where P<AVC?
If the price is below average variable cost for a profit maximizing firm, this means that the firm is losing money and that the revenue from selling the product does not cover the variable costs of production. This means that if we eliminated output this would reduce costs more than it would reduce revenue and thus it would be profitable for the firm to shut down. Stated differently, if the firm shut down and still paid its fixed costs, then the firm would lose less than if it stayed in operation.
45. Which of the following is likely to have a lower price elasticity of demand?
There are three general sets of determinants of elasticity that we discussed. One of the determinants is size of the purchase. Paper clips are a small ticket item and therefore demand for the clips is not likely to be influenced by price - demand will be inelastic.
46. Your boss has just given you a revenue target for the next quarter - you need to raise sales (units of output) by 5%. Based on your knowledge of your product, you think that the price elasticity of demand is -.5. Given this information, what would be your pricing strategy to hit the target sales figure? You would
You need to start by recognizing that we are talking about the relationship between price and quantity demanded - we are talking about own-price elasticity. The formula is: ep = %DQ/%DP. In this problem we have the figure for elasticity (-.5) and for the desired change in Q (5). If you now plug this into the equation you get:
ep = %DQ/%DP
-.5 = 5/(%DP )
where you need to solve for %DP. With the help of some algebra you can get %DP = 5/-.5 = -10. If you are to increase demand by 5 percent, you will need to decrease the price by 10 percent.
47. The world's population recently reached 6 billion, a substantial increase over the population at the beginning of the century. Which of the following would be the best explanation of the increase in the world's population?
The most dramatic changes have been in death
rates - advances in health care have reduced the likelihood of death and
lengthened the lives of people dramatically during the century.
48. The countries of Avelonia and Babylini both produce cloth
and wine. In Avelonia, one worker can produce four yards of cloth or six bottles of
wine in an hour. In Babylini one worker can produce ten yards of cloth in one hour
or eight bottles of wine. If these two countries could begin to trade and trade
would be in the direction expected based on the theory of comparative advantage, what
would you expect the trade pattern to be?
This is a question on comparative advantage - you
need to find the deal. In Avelonia we have cloth being more expensive than wine, while in
Babylini we have wine being more expensive than cloth. You could make a deal to trade at a
price of one-to-one and in this situation Avelonia would specialize in what they produce
most inexpensively - wine. This trade would benefit both countries even though
Babylini is more efficient in the production of both goods.
Use the diagram to answer the next two questions
49. Based on the analysis of choice, an increase in the price of X will show up as a:
The two pieces in the traditional model of choice are the constraints and the preferences. The constraint is shown in the graph by the budget constraint and it is influenced by both prices and income. If you have more income the curve will shift outward letting you reach higher levels of utility. If the price of either X or Y changes then the slope of the curve will shift. An increase in the price of X will give us a smaller X intercept which will result in a steeper budget constraint.
50. Based on the analysis of choice, an increase in income will show up as a:
The two pieces in the traditional model of choice are the constraints and the preferences. The constraint is shown in the graph by the budget constraint and it is influenced by both prices and income. If you have more income the curve will shift outward letting you reach higher levels of utility. If the price of either X or Y changes then the slope of the curve will shift. An increase in the price of X will give us a smaller X intercept which will result in a steeper budget constraint.
51. Consider the following choice that many of you were given this year: You were asked to assume that you were one of the fortunate few to have a ticket to the New York Yankees - Boston Red Sox match up featuring Pedro Martinez and Roger Clemens. The ticket cost you $150 which is the most that you felt a ticket was worth. When you were asked to sell the ticket for the "street" price is $1,500, many of you did not take the offer. This is an example of:
The offer of $1,500 means that the game actually cost you $1,350. You could go to the game at a cost of $150 or you could sell the ticket for $1,500 and walk away with $1,350 extra money. You would never have spent this on the ticket, but you did because you did not fully account for opportunity cost.
52. Which of the following is incorrect?
The option here that makes no sense is the third one. Answer c should be suspect since you are mixing average and marginal concepts which does not work.
Below you will find the production relationship that exists in Tommy's Tutoring, an on-campus tutoring business. You are to use the following information to answer the following questions.
|
Hours |
Grades |
AP |
MP |
|
0 |
0 |
0.0 |
|
|
1 |
17.0 |
17.0 |
|
|
2 |
30 |
15.0 |
13.0 |
|
3 |
40 |
13.3 |
|
|
4 |
48 |
8.0 |
|
|
5 |
6.0 |
53. What is the average
product of when you use a tutor for four hours?
The formula is output/input = grades/hours =
(48/4) = 12 Now that you have
mastered the production aspects of Tommy's Tutoring, it is time to move over to
the cost side of the ledger. Below you will find some cost data that you
should use to answer the following questions.
|
Hours |
Grades |
FC |
VC |
TC |
MC |
|
0 |
0 |
|
$0 |
$100 |
|
|
1 |
17 |
|
$200 |
11.765 |
|
|
2 |
30 |
|
$500 |
15.385 |
|
|
3 |
40 |
|
$700 |
20 |
|
|
4 |
48 |
|
$800 |
$900 |
|
|
5 |
54 |
|
$1,000 |
33.333 |
54. What is the level of variable cost of a grade when you study for three hours with the tutor?
The key to answering this question is recognizing that TC = FC + VC and we know that FC = $100 and TC = $700. VC for three hours of work is therefore $600 [600 + 100 = 700].
55. What is the level of average variable cost of a grade for five hours of studying? Approximately
The key to answering this question is recognizing that AVC = VC/Q and we know that VC = $1000 and thus AVC = 1000/54 = 18.5.
56. Tina's T's is a local T-shirt shop that sells about 20,000 hand-painted shirts annually. If the price of the T-shirts that Tina buys increases by 20 percent, then
All of the cost measures EXCEPT fixed costs will increase. The answer is c.
The following data has been computed from Tommy's Tutoring. You will use this to answer the following questions.
|
Hours |
Grades |
AP |
MP |
MRP |
|
0 |
0 |
|||
|
1 |
17 |
17.0 |
||
|
2 |
15.0 |
13.0 |
||
|
3 |
40 |
10.0 |
||
|
4 |
48 |
12.0 |
40 |
|
|
5 |
54 |
6.0 |
57. If the price received for each point on your grade is worth $5, what is the marginal revenue product of the fourth hour of studying?
The key to answering this question is recognizing that MRP = Price of the output * MP of the input. In this case the marginal product of the fourth hour is 8 - by adding the extra hour the grade increases by 8. If each one of these points is priced at $5, then the revenue generated is $5*8 = $40.
58. If the price received for each point on your grade is worth $5, what is the marginal product of the fourth hour of studying?
The key to answering this question is recognizing that MRP = Price of the output * MP of the input. In this case the marginal revenue product of the fourth hour is $40 - by adding the extra hour the grade revenue increases by $40. If each one of these points is priced at $5, then the grades generated is $40/$5 = 8.
59. Biggy's Burgers is currently producing 100 units of output (burgers) that it sells for $6 per unit and the consultants that it has hired have convinced Biggy that an expansion of output to 150 will lower the sales price of all units to to $5. What is the MR of expanding output above 100 units?
At an output level of 100, revenue = 100*$6 = $600, while at an output level of 150, revenue = 150*$5 = 750. Plugging into the formula for MR = D(revenue)/D(output) = (750-600)/(150-100) = (150/50) = 3
60. A local music store has begun a PR campaign where they offer a volume discount. If you buy five CDs you pay $16 a CD, but if you buy more than five CDs, the price per CD is lowered to $14 for each CD. What is the marginal revenue of the 6th CD?
If you buy five CDs the cost (revenue) is $80 [$5*16]. The total cost (revenue) of six CDs would be $84 [$6*14]. The marginal revenue of the 6th gallon would be D(revenue)/D(output) = ($84-$80)/(6-5) = $4
61. If at an output level of 4,000 cones, Jim & Benny’s Ice Cream Company is making an economic profit and MC = $.08 and MR = $07, the firm should:
As long as marginal profit is greater than zero [MR > MC], the firm will increase profit if it expands output. In this case where MR < MC, the firm will benefit by lowering the level of output.
Let's return to Tina's and add in some revenue data based on the market analysis conduced by Tina's consultants. The consultant is fairly confident that Tina is operating in a very competitive environment, one that could be approximated by the perfect competition model. It is their opinion that Tina can sell the grades at $20 a point. Use this information to answer the following questions
|
Hours |
Grades |
FC |
VC |
TC |
MC |
R | MR | Profit |
|
0 |
0 |
|
$0 |
$100 |
||||
|
1 |
17 |
|
$200 |
11.765 |
||||
|
2 |
30 |
|
$500 |
15.385 |
||||
|
3 |
40 |
$100 |
$700 |
20 |
||||
|
4 |
48 |
|
$800 |
$900 |
||||
|
5 |
54 |
|
$1,000 |
33.333 |
62. What is total revenue if Tina sells 4 hours of tutoring?:
Total revenue = P*Q = price * quantity = $20*48 = $960
63 The entry of new firms into a perfectly competitive industry will very likely:
An increase in number of firms will shift out the industry supply curve, which will lower price in the industry. The lower price will push profits down, at least in the short run.
64 What would happen to demand for an input if there was a decrease in the price of the product produced with that input?
If a factor of production can produce output with a lower price, then the revenue generated from that factor will decrease and this will provide the basis for paying the factor less.
65. When Microsoft got "slammed" in the court case in early November, many looked to see what impact it would have on the market. Many thought that investors would unload their stock because the expected verdict was seen lowering the company's future profit. How would you show this with a supply-demand graph
The bad news can directly affects both the buyers of stock and the sellers. When you talk about unloading the stock you are talking about an increase in sales - an outward shift in the supply curve.
66. Microsoft, in its case presented in court, tried to emphasize the fact that it was not a monopolist. Its executives pointed to the existence of other operating systems such as Linex. How would you demonstrate the impact on the market for Microsoft's operating system of some good reviews of the Linex system?
The appearance of the new competitor directly affects the buyers of Microsoft's operating system which means that it will show up as a shift in the demand curve. Because demand decreases, this will produce an inward shift in the demand curve.
67. A price cut will decrease the revenue a firm receives if the demand for its product is
From our analysis of elasticity we know that revenue moves in the opposite direction of price changes if demand is elastic. When demand is responsive, then the decrease in price will create a larger increase in demand so that the increase in demand puts more upward pressure on revenue than the downward pressure exerted by the price decline.
68. Universities are feeling the financial pinch and some have resorted to tuition increases to solve their problem. A consultant for RIU has estimated that if RIU raises tuition rates from $20,000 to $22,000, applications will decline from 10,000 to 9,000. The approximate price elasticity coefficient is
Elasticity of demand is %change in Q/% change in P. The percentage increase in price is 10 percent [(22-20)/20] and the percentage decrease in demand is 10 percent. Plugging into the formula we get (10/-10 = -1.0)