Economics of Markets and Organizations Practice Exam - 2618 Verified Questions

Economics of Markets and Organizations Practice

Exam

Course Introduction

This course explores the fundamental principles underlying the behavior of markets and the internal structures of organizations. Students will examine how markets allocate resources, set prices, and influence organizational strategy through the lens of microeconomic theory. Topics include market efficiency, imperfect competition, transaction costs, principal-agent problems, organizational incentives, and the role of information in shaping both market and organizational outcomes. Real-world case studies and economic models are used to illustrate how firms coordinate and motivate individuals in pursuit of organizational goals, as well as how they interact with other market participants to maximize value.

Recommended Textbook

Intermediate Microeconomics A Modern Approach 8th Edition by Hal R. Varian

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Chapter 1: Budget Constraint

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Q1) Suppose that the price of good x triples and the price of good y doubles while income remains constant. On a graph where the budget line is drawn with x on the horizontal axis and y on the vertical axis, the new budget line

A) is flatter than the old one and lies below it.

B) is flatter than the old one and lies above it.

C) crosses the old budget line.

D) is steeper than the old one and lies below it.

E) is steeper than the old one and lies above it.

Answer: D

Q2) Georgina thrives on two goods: pears and bananas. The cost of pears is 30 pesos each and the cost of bananas is 15 pesos each. If her income is 180 pesos, how many pears can she buy if she spends all of her income on pears?

A) 9

B) 12

C) 4

D) 6

E) None of the above.

Answer: D

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Page 3

Chapter 1: A: Budget Constraint

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Sample Questions

Q1) In Problem 11, ads in the boring business magazine are read by 300 lawyers and 1,000 M.B.A.s. Ads in the consumer publication are read by 250 lawyers and 300 M.B.A.s. If Harry had $3,250 to spend on advertising, if the price of ads in the boring business magazine were $500, and if the price of ads in the consumer magazine were $250, then the combinations of recent M.B.A.s and lawyers with hot tubs whom he could reach with his advertising budget would be represented by the integer values along a line segment that runs between the two points

A) (3, 900, 4, 550) and (1, 950, 7, 800).

B) (3, 900, 0) and (0, 7, 800).

C) (0, 3, 900) and (1, 950, 0).

D) (3, 250, 3, 900) and (1, 950, 6, 500).

E) (2, 600, 0) and (0, 6, 500).

Answer: D

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Chapter 2: Preferences

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Q1) A consumer with convex preferences who is indifferent between the bundles (5, 2) and (11, 6) will like the bundle (8, 4) at least as well as either of the first two bundles.

A)True

B)False

Answer: False

Q2) A person with reflexive preferences is someone who does not shop carefully.

A)True

B)False

Answer: False

Q3) If preferences are convex, then for any commodity bundle x, the set of commodity bundles that are worse than x is a convex set.

A)True

B)False

Answer: False

Q4) Suppose that there are two commodities and a consumer prefers more to less of each good. If the consumer has transitive preferences, can her in difference curves cross? Sketch a brief proof of your answer, and illustrate with a diagram.

Answer: Not Answr

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5

Chapter 2: A: Preferences

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Q1) In Problem 8, Nancy Lerner is taking a course from Professor Goodheart who will count only her best midterm grade and from Professor Stern who will count only her worst midterm grade. In one of her classes, Nancy has scores of 20 on her first midterm and 70 on her second midterm. When the first midterm score is measured on the horizontal axis and her second midterm score on the vertical, her indifference curve has a slope of zero at the point (20, 70). This class could

A) be Professor Stern's but could not be Professor Goodheart's.

B) be Professor Goodheart's but could not be Professor Stern's.

C) not be either Professor Goodheart's or Professor Stern's.

D) be either Professor Goodheart's or Professor Stern's.

E) There is not enough information to tell whose class it could or couldn't be.

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Chapter 3: Utility

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Q1) Fiery Demon is a rotgut whisky made in Kentucky. Smoothy is an unblended malt whisky imported from Scotland. Ed regards these brands as perfect substitutes. When he goes into a bar, he sometimes buys only Fiery Demon. Other times he buys only Smoothy. This shows that Ed has unstable preferences.

A)True

B)False

Q2) Isabella's utility function is U(x, y) = 4min{x, y} + y. If we draw her indifference curves with x on the horizontal axis and y on the vertical axis, these indifference curves are

A) L-shaped with kinks where x = y.

B) made up of two line segments that meet where x = y. One of these line segments is horizontal and the other has slope -4.

C) L-shaped with kinks where x = 5y.

D) made up of two line segments that meet where x = 5y. One of these line segments is vertical and the other has slope -1.

E) V-shaped with kinks where x = 4y.

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Chapter 3: A: Utility

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Q1) Phil Rupp, from Problem 4, has a sister Ethel who has the utility function U(x, y) = min{ 2x + y, 3y}. Where x is measured on the horizontal axis and y on the vertical axis, her indifference curves consist of a

A) vertical line segment and a horizontal line segment that meet in a kink along the line x = 2y.

B) positively sloped line segment and a negatively sloped line segment that meet along the line x = y.

C) horizontal line segment and a negatively sloped line segment that meet in a kink along the line x = y.

D) vertical line segment and a horizontal line segment that meet in a kink along the line y = 2x.

E) horizontal line segment and a positively sloped line segment that meet in a kink along the line x = 2y.

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8

Chapter 4: Choice

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Q1) Elmer's utility function is U(x, y) = min{x, y²}. If the price of x is $10 and the price of y is $15 and if Elmer chooses to consume 4 units of y, what must his income be?

A) $220

B) $100

C) $320

D) $440

E) There is not enough information to determine his income.

Q2) Clara's utility function is U(x, y) = (x + 2)(y + 1). If her marginal rate of substitution is -4 and she is consuming 14 units of good x, how many units of good y must she be consuming?

A) 30

B) 68

C) 18

D) 63

E) 9

Q3) At a boundary optimum, a consumer's indifference curve must be tangent to her budget line.

A)True

B)False

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Chapter 4: A: Choice

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Q1) Charlie's utility function is U(x_A, x_B) = x_Ax_B. If Charlie's income were $40, the price of apples were $2, and the price of bananas were $5, how many apples would there be in the best bundle that Charlie could afford?

A) 20

B) 6

C) 4

D) 5

E) 10

Q2) In Problem 6, Elmer's utility function is U(x, y) = min{x, y²}. If the price of x is $15, the price of y is $30, and Elmer chooses to consume 2 units of y, what must Elmer's income be?

A) $240

B) $90

C) $220

D) $120

E) There is not enough information to tell.

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Chapter 5: Demand

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Q1) If Charlie's utility function were X⁶_AX_B and if apples cost 40 cents each and bananas cost 10 cents each, Charlie's budget line would be tangent to one of his indifference curves whenever

A) 6X_B = 4X_A.

B) X_A = 6X_B.

C) X_B = X_A.

D) X_B = 6X_A.

E) 40X_A + 10X_B = M.

Q2) Prudence was maximizing her utility subject to her budget constraint. Then prices changed. After the price change she was better off. Therefore the new bundle costs more at the old prices than the old bundle did.

A)True

B)False

Q3) A good is a luxury good if the income elasticity of demand for it is greater than 1.

A)True

B)False

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Chapter 5: A: Demand

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Q1) In Problem 1, if Charlie's utility function were X⁵_AX_B, if apples cost 50 cents each, and if bananas cost 10 cents each, Charlie's budget line would be tangent to one of his indifference curves whenever

A) 5X_B = 5X_A.

B) X_B = 5X_A.

C) X_B = X_A.

D) X_A = 5X_B.

E) 50X_A + 10X_B = M.

Q2) In Problem 1, if Charlie's utility function were X³_AX_B, if apples cost 60 cents each, and if bananas cost 10 cents each, Charlie's budget line would be tangent to one of his indifference curves whenever

A) 3X_B = 6X_A.

B) X_B = 3X_A.

C) X_B = X_A.

D) X_A = 3X_B.

E) 60X_A + 10X_B = M.

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Page 12

Chapter 6: Revealed Preference

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Q1) Rudolf Rational obeys the weak axiom of revealed preferences. His preferences don't change over time. One year he could afford bundle x but bought bundle y. If another year he buys bundle x, then he can't afford bundle y.

A)True

B)False

Q2) Jose consumes rare books which cost him 8 pesos each and pieces of antique furniture which cost him 10 pesos each. He spends his entire income to buy 9 rare books and 11 pieces of antique furniture. Nigel has the same preferences as Jose, but faces different prices and has a different income. Nigel has an income of 162 pounds. He buys rare books at a cost of 4 pounds each and pieces of antique furniture at a cost of 11 pounds each.

A) Nigel would prefer Jose's bundle to his own.

B) Jose would prefer Nigel's bundle to his own.

C) Neither would prefer the other's bundle to his own.

D) Each prefers the other's bundle to his own.

E) We can't tell whether either would prefer the other's bundle without knowing what quantities Nigel consumes.

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Page 13

Chapter 6: A: Revealed Preference

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Q1) In Problem 1, if the only information we had about Goldie were that she chooses the bundle (6, 6) when prices are (6, 2) and she chooses the bundle (10, 0) when prices are (3, 5), then we could conclude that

A) neither bundle is revealed preferred to the other.

B) Goldie violates WARP.

C) the bundle (6, 6) is revealed preferred to (10, 0) but there is no evidence that she violates WARP.

D) the bundle (10, 0) is revealed preferred to (6, 6) and she violates WARP.

E) the bundle (10, 0) is revealed preferred to (6, 6) but there is no evidence that she violates WARP.

Q2) In Problem 4, if situation D is p = (3, 1) and x = (5, 10),

A) Ronald's behavior is consistent with both the Weak and the Strong Axioms of Revealed Preference.

B) Ronald's behavior is consistent with the Weak but not the Strong Axiom of Revealed Preference.

C) Ronald's behavior violates both the Weak and the Strong Axioms of Revealed Preference.

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Page 14

Chapter 7: Slutsky Equation

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Sample Questions

Q1) Suppose that bananas are a normal good and Woody is currently consuming 100 bananas at a price of 10 cents each.

A) His Slutsky compensated demand curve going through this point is steeper than his ordinary demand curve.

B) His ordinary demand curve going through this point is steeper than his Slutsky compensated demand curve.

C) His ordinary demand curve is steeper to the left and his Slutsky compensated demand curve is steeper to the right of this point.

D) Whether his ordinary demand curve or his Slutsky compensated demand curve is steeper depends on whether his price elasticity is greater than 1.

E) None of the above.

Q2) If a good is an inferior good, then an increase in its price will increase the demand for it.

A)True

B)False

Q3) What conditions ensure that the quantity of a good demanded increases as its price falls? Explain your answer, using diagrams.

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Page 15

Chapter 7: A: Slutsky Equation

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Q1) In Problem 4, Maude thinks delphiniums and hollyhocks are perfect substitutes, one for one. If delphiniums currently cost $4 per unit and hollyhocks cost $5 per unit and if the price of delphiniums rises to $7 per unit,

A) the entire change in demand for delphiniums will be due to the substitution effect.

B) of the change in demand will be due to the income effect.

C) the income effect of the change in demand for delphiniums will be bigger than the substitution effect.

D) there will be no change in the demand for hollyhocks.

E) of the change in demand will be due to the income effect

Q2) Goods 1 and 2 are perfect complements, and a consumer always consumes them in the ratio of 2 units of good 2 per unit of good 1. If a consumer has an income of $300 and if the price of good 2 changes from $5 to $6, while the price of good 1 stays at $1, then the income effect of the price change

A) is exactly twice as strong as the substitution effect.

B) accounts for the entire change in demand.

C) does not change demand for good 1.

D) is 6 times as strong as the substitution effect.

E) is 5 times as strong as the substitution effect.

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Page 16

Chapter 8: Buying and Selling

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Sample Questions

Q1) Jack earns 5 dollars per hour. He has 100 hours per week which he can use for either labor or leisure. The government institutes a plan in which each worker receives a $100 grant from the government but has to pay 50% of his or her labor income in taxes. If Jack's utility function is U(c, r) = cr, where c is dollars worth of consumption of goods and r is hours of leisure per week, how many hours per week will Jack choose to work?

A) 30

B) 40

C) 26

D) 20

E) None of the above.

Q2) If someone has a Cobb-Douglas utility function and no income from any source other than labor earnings, then an increase in wages will not change the amount that person chooses to work.

A)True

B)False

Q3) Is it ever possible that an increase in the price of a good for which a person is a net seller can make him worse off? Use a diagram to illustrate your answer.

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Page 17

Chapter 8: A: Buying and Selling

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Q1) In Problem 1, if Abishag owned 6 quinces and 5 kumquats and if the price of kumquats is 3 times the price of quinces, how many kumquats could she afford if she spent all of her money on kumquats?

A) 7

B) 14

C) 11

D) 5

E) 4

Q2) Dudley, in Problem 15, has a utility function U(C, R) = C - (12 - R)², where R is leisure and C is consumption per day. He has 16 hours per day to divide between work and leisure. If Dudley has a nonlabor income of $20 per day and is paid a wage of $8 per hour, how many hours of leisure will he choose per day?

A) 7

B) 6

C) 9

D) 5

E) 8

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18

Chapter 9: Intertemporal Choice

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Q1) The intertemporal budget constraint for a consumer can be expressed by setting the present value of her lifetime consumption equal to the future value of her endowment.

A)True

B)False

Q2) If the price level increases by 80% in one year, then for the real rate of interest to be 10%, the nominal rate of interest would have to be

A) 98%.

B) 70%.

C) 18%.

D) 88%.

E) 72%.

Q3) If the real rate of interest is 8% and the nominal rate of interest is 28%, then the rate of inflation must be about

A) 36%.

B) 24.26%.

C) 3.50%.

D) 18.52%.

E) 23%.

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19

Chapter 9: A: Intertemporal Choice

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Q1) If Peregrine in Problem 1 consumes (1, 400, 1, 440) and earns (900, 2, 040) and if the interest rate is 20%, the present value of his endowment is

A) $2,940.

B) $2,600.

C) $5,720.

D) $2,840.

E) $6,620.

Q2) In the village in Problem 10, if the harvest this year is 6,000 bushels of grain and the harvest next year will be 900 bushels and if rats eat 10% of any grain that is stored for a year, how many bushels of grain could the villagers consume next year if they consume 1,000 bushels of grain this year?

A) 6,900

B) 5,400

C) 8,100

D) 4,500

E) 1,000

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Chapter 10: Asset Markets

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Q1) Bank 1 offers a deal on deposits of $1,000 or more. You must leave your money in the bank for three years, but bank 1 will pay you 4% interest for the first year, 4% interest for the second year, and 7% interest for the third year. In response, bank 2 offers a deal that it claims is even better. It also requires you to deposit at least $1,000 and to leave it in the bank for three years, but it will pay 7% interest in the first year and then 4% in the second and third years. After three years, you can take your money out of either bank and do what you want with it. Both banks compound interest annually.

A) Bank 2 offers a better deal than bank 1.

B) Bank 1 offers a better deal than bank 2.

C) The two offers are equally valuable.

D) The offer of bank 2 becomes relatively more attractive as the size of your initial deposit is larger.

E) None of the above.

Q2) A consumer who can borrow and lend at the same interest rate should prefer an endowment with a higher present value to an endowment with a lower present value, no matter how he plans to allocate consumption over the course of his life.

A)True

B)False

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Page 21

Chapter 10: A: Asset Markets

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Q1) The sum of the terms of the infinite geometric series 1, 0.83, 0.83², 0.83³, . . . is closest to

A) infinity.

B) 1.83.

C) 5.88.

D) 0.55.

E) 120.48.

Q2) The price of an antique is expected to rise by 5% during the next year. The interest rate is 10%. You are thinking of buying an antique and selling it a year from now. You would be willing to pay a total of 500 dollars for the pleasure of owning the antique for a year. How much would you be willing to pay to buy this antique? (See Problem 5.)

A) 5,000 dollars

B) 10,000 dollars

C) 10,500 dollars

D) 500 dollars

E) 5,000 dollars.

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Chapter 11: Uncertainty

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Q1) A consumer has a von Neumann-Morgenstern utility function of the form U(c_A, c_B, p_A, p_B) = p_Av(c_A) + p_Bv(c_B), where p_A and p_B are the probabilities of events A and B and where c_A and c_B are consumptions contingent on events A and B respectively. This consumer must be a risk lover if v is an increasing function.

A)True

B)False

Q2) If Paul is risk loving and his basketball team has a probability of .5 of winning, then Paul would rather bet $10 on his team than $100. (When Paul bets X, he wins X if his team wins and loses X if his team loses.)

A)True

B)False

Q3) If the price of insurance goes up, people will become less risk averse.

A)True

B)False

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Chapter 11: A: Uncertainty

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Q1) Sally Kink is an expected utility maximizer with utility function pu(c₁) + (1 - p)u(c₂), where for any x < 1,000, u(x) = 2x, and for x greater than or equal to 1,000, u(x) = 2,000 + x.

A) Sally will be risk averse if her income is less than $1,000 but risk loving if her income is more than $1,000.

B) Sally will never take a bet if there is a chance that it leaves her with wealth less than $2,000.

C) Sally will be risk neutral if her income is less than $1,000 and risk averse if her income is more than $1,000.

D) For bets that involve no chance of her wealth exceeding $1,000, Sally will take any bet that has a positive expected net payoff.

E) None of the above.

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Chapter 12: Risky Assets

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Q1) If the mean is plotted on the horizontal axis, and the variance on the vertical, then indifference curves for a risk averter must slope upward and to the right.

A)True

B)False

Q2) Suppose that Fenner Smith of Workouts Problem 13.2 must divide his portfolio between two assets, one of which gives him an expected rate of return of 15% with zero standard deviation and one of which gives him an expected rate of return of 55% and has a standard deviation of 10%. He can alter the expected rate of return and the variance of his portfolio by changing the proportions in which he holds the two assets. If we draw a "budget line" with expected return on the vertical axis and standard deviation on the horizontal axis, depicting the combinations that Smith can obtain, the slope of this budget line is

A) 2.

B) -4.

C) 4.

D) -2.

E) 6.

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Chapter 12: A: Risky Assets

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Q1) Suppose that Ms. Lynch in Problem 1 can make up her portfolio using a risk-free asset that offers a surefire rate of return of 10% and a risky asset with an expected rate of return of 20%, with standard deviation 5. If she chooses a portfolio with an expected rate of return of 20%, then the standard deviation of her return on this portfolio will be

A) 2.50%.

B) 8%.

C) 5%.

D) 10%.

E) None of the above.

Q2) Suppose that Ms. Lynch in Problem 1 can make up her portfolio using a risk-free asset that offers a surefire rate of return of 5% and a risky asset with an expected rate of return of 10%, with standard deviation 5. If she chooses a portfolio with an expected rate of return of 8.75%, then the standard deviation of her return on this portfolio will be A) 7.50%.

B) 3.75%.

C) 1.88%.

D) 6.75%.

E) None of the above.

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26

Chapter 13: Consumers Surplus

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Q1) Ella's utility function is min{ 5x, y}. If the price of x is $20 and the price of y is $20, how much money would she need to be able to purchase a bundle that she likes as well as the bundle (x, y) = (7, 15)?

A) $440

B) $360

C) $177

D) $372

E) $72

Q2) Bernice has the utility function U(x, y) = min{x, y}. The price of x used to be 3 but rose to 4. The price of y remained at 1. Her income is 12. The price increase was as bad for her as a loss of $3 in income.

A)True

B)False

Q3) Producer's surplus at price p is the vertical distance between the supply curve and the demand curve at price p.

A)True

B)False

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Chapter 13: A: Consumers Surplus

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Q1) If Bernice (whose utility function is min{x, y}, where x is her consumption of earrings and y is money left for other stuff) had an income of $19 and was paying a price of $5 for earrings when the price of earrings went up to $11, then the equivalent variation of the price change was

A) $19.

B) $38.

C) $9.50.

D) $4.75.

E) $14.25.

Q2) Betsy's utility function for BMWs and money is given by 8,000x + y, where x is the number of BMWs she has and y is the amount of money she has. Her income is $22,000. Her reservation price for one BMW is

A) $14,000.

B) $8,000 - y.

C) $8,000 - p.

D) $8,000.

E) $30,000.

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Chapter 14: Market Demand

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Q1) A person with a quasilinear utility function will

A) have a price elasticity of demand equal to zero for some goods. B) have an income elasticity of demand equal to one for some goods.

C) necessarily consume zero quantity of some good.

D) necessarily consume positive amounts of every good.

E) none of the above.

Q2) Using the graph of a demand curve, explain why marginal revenue is less than price.

Q3) An economy has 100 consumers of type 1 and 200 consumers of type 2. If the price of the good is less than $10, then each type 1 consumer demands 10 - p units of the good; otherwise each type 1 demands zero. If the price of the good is less than 8, then each type 2 demands 24 - 3p; otherwise each type 2 demands zero. If the price of the good is 6, then the total amount of the good demanded will be

A) 1,600 units.

B) 1,800 units.

C) 2,000 units.

D) 420 units.

E) 1,200 units.

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Chapter 14: A: Market Demand

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Q1) In Problem 6, the only quantities of good 1 that Barbie can buy are 1 unit or zero units. For x₁ equal to zero or 1 and for all positive values of x₂, suppose that Barbie's preferences were represented by the utility function (x₁ + 10)(x₂ + 12). Then if her income were $4, her reservation price for good 1 would be

A) $2.91.

B) $6.50.

C) $1.45.

D) $.83.

E) $1.10.

Q2) In the same football conference as the university in Problem 9 is another university where the demand for football tickets at each game is 180,000 - 10,000p. If the capacity of the stadium at that university is 100,000 seats, what is the revenue-maximizing price for this university to charge per ticket?

A) $4.50

B) $9

C) $8

D) $18

E) $27

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Page 30

Chapter 15: Equilibrium

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Q1) Use supply and demand analysis to examine the following statement: "The practice of giving food stamps is self-defeating. Food stamps effectively lower the price of food. When food becomes available at lower prices, demand will increase thereby forcing the price up to its initial level." Is this reasoning correct? Draw supply and demand curves to illustrate your answer.

Q2) The demand function for fresh strawberries is q = 200 - 5p and the supply function is q = 60 + 2p. What is the equilibrium price?

A) $10

B) $20

C) $40

D) $50

E) None of the above.

Q3) If the supply curve is vertical, then the amount supplied is independent of price. A)True

B)False

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Chapter 15: A: Equilibrium

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Q1) Suppose that King Kanuta from Problem 11 demands that each of his subjects give him 4 coconuts for every coconut that they consume. The king puts all of the coconuts that he collects in a large pile and burns them. The supply of coconuts is given by S(p_s)= 100p_s, where p_s is the price received by suppliers. The demand for coconuts by the king's subjects is given by D(p_d) = 10,400 - 100p_d, where p_d is the price paid by consumers. In equilibrium, the price received by suppliers will be

A) $20.

B) $52.

C) $30.

D) $260.

E) None of the above.

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Chapter 16: Auctions

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Q1) If a good is sold in a Dutch auction and the bidders bid rationally, the price paid for the good will always be equal to the second-highest willingness to pay of auction participants.

A)True

B)False

Q2) An antique cabinet is being sold by means of an English auction. There are four bidders, Penelope, Marilyn, Irene, and Betsy. These bidders are unacquainted with each other and do not collude. Penelope values the cabinet at $1,600, Marilyn values it at $1,350, Irene values it at $2,100, and Betsy values it at $1,100. If the bidders bid in their rational self-interest, the cabinet will be sold to

A) Irene for about $2,100.

B) either Irene or Penelope for slightly more than $1,600. Which of them actually gets it is randomly determined.

C) Penelope for about $1,600.

D) Irene for slightly more than $1,600.

E) None of the above.

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Page 33

Chapter 16: A: Auctions

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Q1) An antique cabinet is being sold by means of an English auction. There are four bidders, Arabella, Desiree, Gloria, and Flora. These bidders are unacquainted with each other and do not collude. Arabella values the cabinet at $1,100, Desiree values it at $600, Gloria values it at $1,700, and Flora values it at $700. If the bidders bid in their rational self-interest, the cabinet will be sold to

A) Gloria for slightly more than $1,100.

B) either Gloria or Arabella for about $1,100. Which of these two buyers gets it is randomly determined.

C) Arabella for about $1,100.

D) Gloria for about $1,700.

E) either Gloria or Arabella for about $600. Which of these two buyers gets it is randomly determined.

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Chapter 17: Technology

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Q1) The production function Q = 50K^0.25L^0.75 exhibits

A) increasing returns to scale.

B) decreasing returns to scale.

C) constant returns to scale.

D) increasing, then diminishing returns to scale.

E) negative returns to scale.

Q2) For each of the following production functions, draw a diagram showing the general shape of its corresponding isoquant. Comment on the ease at which labor and capital can be substituted for one another relative to the other two production functions.

a. Q = K + L.

b. Q = K^0.5L^0.5.

c. Q = min(K, L).

Q3) If there are constant returns to scale, then doubling the amount of any input will exactly double the amount of output.

A)True

B)False

Q4) The production set of a firm is the set of all products the firm can produce.

A)True

B)False

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Chapter 17: A: Technology

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Q1) A firm has the production function f(x, y) = x^1.20y². This firm has

A) constant returns to scale.

B) decreasing returns to scale and increasing marginal product for factor x.

C) increasing returns to scale and decreasing marginal product for factor x.

D) decreasing returns to scale and diminishing marginal product for factor x.

E) None of the above.

Q2) In Problem 8, if a = 2.10, b = 1.10, and c = 1.20, the marginal products of x₁, x₂, and x₃ (in this order) are

A) all increasing.

B) decreasing, increasing, and decreasing.

C) all decreasing.

D) increasing, decreasing, and constant.

E) all increasing if A > 1.

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Chapter 18: Profit Maximization

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Q1) If a profit-maximizing competitive firm has constant returns to scale, then its long-run profits must be zero.

A)True

B)False

Q2) If the value of the marginal product of factor x increases as the quantity of x increases and the value of the marginal product of x is equal to the wage rate, then the profit-maximizing amount of x is being used.

A)True

B)False

Q3) The weak axiom of profit-maximizing behavior states that in a modern mixed economy, firms have only a weak incentive to maximize profits.

A)True

B)False

Q4) Just as in the theory of utility-maximizing consumers, the theory of profit-maximizing firms allows the possibility of Giffen factors. These are factors for which a fall in price leads to a fall in demand.

A)True

B)False

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Chapter 18: A: Profit Maximization

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Q1) In Problem 12, if the price of the output good is $4, the price of factor 1 is $1, and the price of factor 2 is $3, what is the profit-maximizing amount of factor 1?

A) 8

B) 2

C) 1

D) 0

E) There is not enough information to tell.

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Chapter 19: Cost Minimization

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Q1) Roberta runs a dress factory. She produces 50 dresses per day, using labor and electricity. She uses a combination of labor and electricity that produces 50 dresses per day in the cheapest possible way. She can hire as much labor as she wants at a cost of 20 cents per minute. She can use as much electricity as she wants at a cost of 10 cents per minute. Her production isoquants are smooth curves without kinks and she uses positive amounts of both inputs.

A) The marginal product of a kilowatt-hour of electricity is twice the marginal product of a minute of labor.

B) The marginal product of a minute of labor is twice the marginal product of a kilowatt-hour of electricity.

C) The marginal product of a minute of labor is equal to the marginal product of a kilowatt-hour of electricity.

D) There is not enough information to determine the ratio of marginal products. We'd have to know the production function to know this.

E) The marginal product of a minute of labor plus the marginal product of a kilowatt-hour of labor must equal.

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Page 39

Chapter 19: A: Cost Minimization

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Q1) Suppose that Nadine in Problem 1 has a production function 3x₁ + x₂. If the factor prices are $3 for factor 1 and $3 for factor 2, how much will it cost her to produce 80 units of output?

A) $960

B) $80

C) $240

D) $600

E) $160

Q2) In Problem 2, suppose that a new alloy is invented which uses copper and zinc in fixed proportions where 1 unit of output requires 4 units of copper and 4 units of zinc for each unit of alloy produced. If no other inputs are needed, the price of copper is $5, and the price of zinc is $2, what is the average cost per unit when 2,000 units of the alloy are produced?

A) $14.25

B) $.50

C) $28

D) $500

E) $14,250

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Chapter 20: Cost Curves

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Q1) A firm has the short-run total cost function c(y) = 4y2 +100. At what quantity of output is short-run average cost minimized?

A) 5

B) 2

C) 25

D) 0.40

E) None of the above.

Q2) Mr. Dent Carr's total costs are 2s² + 40s + 40. If he repairs 10 cars, his average variable costs will be

A) $60.

B) $64.

C) $80.

D) $120.

E) $40.

Q3) If the average cost curve is U-shaped, then the marginal cost curve must cross the average cost curve at the bottom of the U.

A)True

B)False

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Chapter 20: A: Cost Curves

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Q1) In Problem 3, Rex Carr could pay $10 for a shovel that lasts one year and pay $5 a car to his brother Scoop to bury the cars, or he could buy a low-quality car smasher that costs $200 a year to own and that smashes cars at a marginal cost of $1 per car. If it is also possible for Rex to buy a high-quality hydraulic car smasher that cost $650 per year to own and if with this smasher he could dispose of cars at a cost of $.75 per car, it would be worthwhile for him to buy this high-quality smasher if he planned to dispose of A) at least 1,800 cars per year.

B) no more than 900 cars per year.

C) at least 1,810 cars per year.

D) no more than 1,800 cars per year.

E) at least 900 cars per year.

Q2) In Problem 2, if Mr. Dent Carr's total costs were 2s² + 20s + 40, then if he repairs 10 cars, his average variable costs will be

A) $44.

B) $80.

C) $40.

D) $60.

E) $30.

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Page 42

Chapter 21: Firm Supply

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Q1) Mr. O. Carr has the cost function c(y) = y2 + 100 if his output, y, is positive and c(0) = 0. If the price of output is 25, Mr. Carr's profit-maximizing output is zero.

A)True

B)False

Q2) A firm with the cost function c(y) = 20y2 + 500 has a U-shaped cost curve.

A)True

B)False

Q3) Suppose that Dent Carr's long-run total cost of repairing s cars per week is c(s) = 3s2 + 12. If the price he receives for repairing a car is $24, then in the long run, how many cars will he fix per week if he maximizes profits?

A) 6

B) 4

C) 0

D) 8

E) 12

Q4) Average fixed costs never increase with output.

A)True

B)False

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43

Chapter 21: A: Firm Supply

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Q1) A firm has a long-run cost function, C(q) = 8q² + 72. In the long run, this firm will supply a positive amount of output, as long as the price is greater than

A) $48.

B) $104.

C) $96.

D) $24.

E) $53.

Q2) Suppose that Dent Carr's long-run total cost of repairing s cars per week is c(s) = 3s² + 108. If the price he receives for repairing a car is $24, then in the long run, how many cars will he fix per week if he maximize profits?

A) 0

B) 4

C) 6

D) 8

E) 12

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Chapter 22: Industry Supply

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Q1) In a competitive market, if both demand and supply curves are linear, then a per-unit tax of $10 will generate exactly the same deadweight loss as a per-unit subsidy of $10.

A)True

B)False

Q2) Suppose that all firms in a given industry have the same supply curve given by S_i(p) = 2p when p is greater than or equal to $2 and S_i(p) = 0 when p is less than $2. Suppose that market demand is given by D(p) = 12 - p. If firms continue to enter the industry so long as they can do so profitably, the equilibrium price must be closest to

A) $5.

B) $4.

C) $2.40.

D) $2.

E) $1.75.

Q3) It is possible to have an industry in which all firms make zero economic profits in long-run equilibrium.

A)True

B)False

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Page 45

Chapter 22: A: Industry Supply

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Q1) In Problem 4, suppose that each firm has the cost function c(y) = y² + 9 for y > 0 and c(0) = 0. With industry demand given by D(p) = 51 - p, the equilibrium price and equilibrium number of firms in the industry (in that order) will be

A) $8 and 11.

B) $3 and 18.

C) $3 and 48.

D) $6 and 15.

E) $6 and 45.

Q2) In Problem 8, if market demand is equal to D(p) = 20 - 3p, the equilibrium price and number of firms operating in the market are (in that order)

A) $3.08 and 7

B) $3.00 and 6

C) $3.00 and 8

D) $3.14 and 3

E) $3.33 and 5

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Chapter 23: Monopoly

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Q1) If he produces anything at all, a profit-maximizing monopolist with some fixed costs and no variable costs will set price and output so as to maximize revenue.

A)True

B)False

Q2) A monopolist faces the inverse demand curve p = 120 - 6q. At what level of output is his total revenue maximized?

A) 20

B) 5

C) 20.

D) 15

E) 10

Q3) A monopolist faces a constant marginal cost of $1 per unit. If at the price he is charging, the price elasticity of demand for the monopolist's output is -0.5, then

A) the price he is charging must be $2.

B) the price he is charging must exceed $2.

C) the price he is charging must be less than $2.

D) the monopolist cannot be maximizing profits.

E) the monopolist must use price discrimination.

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Chapter 23: A: Monopoly

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Q1) In Problem 6, if there are no fixed costs and marginal cost is constant at $48, the price elasticity of demand at the profit-maximizing level of output is closest to

A) -5.69.

B) -0.35.

C) -11.38.

D) -2.85.

E) -0.18.

Q2) The demand for Professor Bongmore's new book is given by the function Q = 5,000100p. If the cost of having the book edited and typeset is $20,000, if the marginal cost of printing an extra copy is $4, and if he has no other costs, then he would maximize his profits by

A) not having it edited and typeset and not selling any copies.

B) having it edited and typeset and selling 2,300 copies.

C) having it edited and typeset and selling 2,500 copies.

D) having it edited and typeset and selling 4,600 copies.

E) having it typeset and selling 1,150 copies.

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Chapter 24: Monopoly Behavior

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Q1) A monopolist sells in two markets. The demand curve for her product is given by p₁ = 165 - 3x₁ in the first market and p₂ = 2334x₂ in the second market, where x_i is the quantity sold in market i and p_i is the price charged in market i. She has a constant marginal cost of production, c = 9, and no fixed costs. She can charge different prices in the two markets. What is the profit-maximizing combination of quantities for this monopolist?

A) x₁ = 26 and x₂ = 28.

B) x₁ = 54 and x₂ = 26.

C) x₁ = 36 and x₂ = 26.

D) x₁ = 52 and x₂ = 30.

E) x₁ = 46 and x₂ = 38.

Q2) A monopolist who is able to practice third-degree price discrimination will make greater profits than a monopolist who is able to practice first-degree price discrimination.

A)True

B)False

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Chapter 24: A: Monopoly Behavior

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Q1) In Problem 1, if demand in the United States is given by Q₁ = 11,200800p₁, where p₁ is the price in the United States, and if the demand in England is given by 1,600 - 200p₂, where p₂ is the price in England, then the difference between the price charged in England and the price charged in the United States will be

A) $8.

B) $3.

C) $6.

D) $0.

E) $9.

Q2) If a monopolist faces an inverse demand curve, p(y) = 100 - 2y and has constant marginal costs of $32 and zero fixed costs and if this monopolist is able to practice perfect price discrimination, its total profits will be A) $1,156.

B) $17.

C) $578.

D) $1,734.

E) $289.

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Chapter 25: Factor Markets

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Q1) Suppose that the demand curve for mineral water is given by p = 40 - 12q, where p is the price per bottle paid by consumers and q is the number of bottles purchased by consumers. Mineral water is supplied to consumers by a monopolistic distributor who buys from a monopolistic producer, who is able to produce mineral water at zero cost. The producer charges the distributor a price of c per bottle. Given his marginal cost of c per unit, the distributor chooses an output to maximize his own profits. Knowing that this is what the distributor will do, the producer sets his price c so as to maximize his revenue. The price paid by consumers under this arrangement is

A) $30.

B) $3.33.

C) $20.

D) $10.

E) $1.67.

Q2) If a monopolist faces a competitive labor market, it will hire labor up to the point where the price of output times the marginal product of labor equals the wage rate.

A)True

B)False

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Chapter 25: A: Factor Markets

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Q1) Suppose that in Problem 2, the demand curve for mineral water is given by p = 7016q, where p is the price per bottle paid by consumers and q is the number of bottles purchased by consumers. Mineral water is supplied to consumers by a monopolistic distributor, who buys from a monopolist producer who is able to produce mineral water at zero cost. The producer charges the distributor a price of c per bottle, that will maximize the producer's total revenue. Given his marginal cost of c, the distributor chooses an output to maximize profits. The price paid by consumers under this arrangement is

A) $52.50.

B) $35.

C) $4.38.

D) $2.19.

E) $17.50.

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Chapter 26: Oligopoly

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Q1) A duopoly faces the demand curve D(p) = 30 - .5p. Both firms in the industry have a total cost function given by C(q) = 4q. Suppose that firm 1 is a Stackelberg leader in choosing its quantity first. Firm 1's profit function can be written as

A) q₁ = 14 - .5q₂.

B) q₂ = 14 - .5q₁.

C) 28_q₁ - q²₁.

D) 56_q₁ - q²₁.

E) 60_q -q².

Q2) An industry has two firms producing at a constant unit cost of $10 per unit. The inverse demand curve for the industry is p = 110 - .5q. Suppose that firm 1 is a Stackelberg leader in choosing its quantity (i.e., firm 1 chooses its quantity first, knowing that firm 2 will observe firm 1's quantity when it chooses its own output.) How much output will firm 2, the follower, produce?

A) 40 units.

B) 15 units.

C) 20 units.

D) 50 units.

E) 30 units.

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Chapter 26: A: Oligopoly

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Q1) In Problem 4, suppose that the market demand curve for bean sprouts is given by P = 1,680 - 2Q, where P is the price and Q is total industry output. Suppose that the industry has two firms, a Stackleberg leader and a follower. Each firm has a constant marginal cost of $80 per unit of output. In equilibrium, total output by the two firms will be

A) 600.

B) 400.

C) 200.

D) 800.

E) 100.

Q2) In Problem 4, suppose that the market demand curve for bean sprouts is given by P = 1,280 - 4Q, where P is the price and Q is total industry output. Suppose that the industry has two firms, a Stackleberg leader and a follower. Each firm has a constant marginal cost of $80 per unit of output. In equilibrium, total output by the two firms will be A) 150.

B) 75.

C) 225.

D) 300.

E) 37.50.

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Chapter 27: Game Theory

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Q1) If a game does not have an equilibrium in pure strategies, then it will not have an equilibrium in mixed strategies either.

A)True

B)False

Q2) While game theory predicts noncooperative behavior for a single play of the prisoner's dilemma, it would predict cooperative tit-for-tat behavior if the same people play prisoner's dilemma together for, say, 20 rounds.

A)True

B)False

Q3) A two-person game in which each person has access to only two possible strategies will have at most one Nash equilibrium.

A)True

B)False

Q4) In Nash equilibrium, each player is making an optimal choice for herself, given the choices of the other players.

A)True

B)False

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55

Chapter 27: A: Game Theory

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Q1) (See Problem 2.) A small community has 40 people, each of whom has a wealth of $16,000. Each individual must choose whether to contribute $100 or $0 to the support of public entertainment for their community. The money value of the benefit that a person gets from this public entertainment is b times the total amount of money contributed by individuals in the community.

A) If 40b > 1, everybody is better off if all contribute to the public entertainment fund than if nobody contributes, but if 40b < 1, everybody is better off if nobody contributes than if all contribute.

B) This game has a dominant strategy equilibrium in which nobody contributes anything for public entertainment.

C) If 40b > 1, there is a dominant strategy equilibrium in which everybody contributes.

D) Everybody is worse off if all contribute than if nobody contributes if b > 1, but if b < 1, everybody is better off if nobody contributes.

E) In order for there to be a dominant strategy equilibrium in which all contribute, it must be that b > 40.

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Chapter 28: Game Applications

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Q1) In the classic 1960s macabre comedy Dr. Strangelove, the Soviet Union constructed a Doomsday Machine which would end all life on earth if ever the Soviet Union were attacked. In the movie, the existence of the Doomsday Machine was kept secret. This would enhance the effectiveness of such a machine.

A)True

B)False

Q2) In the classic 1960s macabre comedy Dr. Strangelove, the Soviet Union constructed a Doomsday Machine which would end all life on earth if ever the Soviet Union were attacked. When playing against a rational opponent, the existence of such a machine would be of great benefit to the Soviets.

A)True

B)False

Q3) An equilibrium in a sequential game is always a Nash equilibrium in a simultaneous game with equivalent payoffs.

A)True

B)False

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Chapter 28: A: Game Applications

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Q1) (See Problem 7.) The old Michigan football coach had only two strategies, Run the Ball to the Left Side of the line, and Run the Ball to the Right Side. The defense can concentrate either on the left side or the right side of Michigan's line. If the opponent concentrates on the wrong side, Michigan is sure to gain at least 5 yards. If the defense defended the left side and Michigan ran left, Michigan would be stopped for no gain. But if the opponent defended the right side when Michigan ran right, Michigan would still gain at least 5 yards with probability .70. It is the last play of the game and Michigan needs to gain 5 yards to win. Both sides choose Nash equilibrium strategies. In Nash equilibrium, Michigan would

A) run to the right side with probability .77.

B) run to the right side with probability .87.

C) run to the two sides with equal probability.

D) be sure to run to the right side.

E) run to the right side with probability .70.

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Chapter 29: Behavioral Economics

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Q1) People who have recently become unemployed often believe the national unemployment rate is higher than it actually is. Behavioral economists would attribute this to

A) the anchoring effect.

B) the law of small numbers.

C) time inconsistency of preferences.

D) fairness norms.

E) hyperbolic discounting.

Q2) According to a recent New York Times article, "Bank of America debit card customers can agree in advance to round up their purchases to the next dollar, putting the extra cents into a savings account." Why might customers want to commit to this mechanism rather than make deposits to their savings accounts on their own?

Q3) According to behavioral economists, rational consumers are able to make decisions when faced with many choices because preferences are complete.

A)True

B)False

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Chapter 30: Exchange

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Q1) Eduardo and Francisca participate in an economy that is in competitive equilibrium. Although they are unacquainted with each other, both purchase strawberries and champagne. Edouardo's utility function is U(s, c) = 2s + c, where s is the number of boxes of strawberries he consumes per month and c is the number of bottles of champagne. Francisca's utility function is U(s, c) = sc.

A) Francisca consumes equal amounts of strawberries and champagne. B) Eduardo consumes more strawberries than champagne.

C) Francisca consumes twice as many bottles of champagne as boxes of strawberries. D) Francisca consumes twice as many boxes of strawberries as bottles of champagne. E) Eduardo consumes more champagne than strawberries.

Q2) If demand varies continuously with price, then even if there are thousands of goods, there will be at least one set of prices such that demand equals supply in every market.

A)True

B)False

Q3) A competitive equilibrium allocation must be a feasible allocation.

A)True

B)False

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Page 60

Chapter 30: A: Exchange

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Q1) In Problem 1, suppose that Morris has the utility function U(b, w) = 5b + 15w and Philip has the utility function U(b, w) = bw. If we draw an Edgeworth box with books on the horizontal axis and wine on the vertical axis and if we measure Morris's consumptions from the lower left corner of the box, then the contract curve contains

A) a straight line with slopepassing through the lower left corner of the box.

B) a straight line with slopepassing through the upper right corner of the box.

C) a straight line running from the upper right corner of the box to the lower left.

D) a curve that gets steeper as you move from left to right.

E) a curve that gets flatter as you move from left to right.

Q2) ...

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Chapter 31: Production

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Q1) Robinson Crusoe spends 4 hours a day catching fish and picking coconuts. He can always catch 2 fish per hour and he can always gather 3 coconuts per hour. His utility function is CF, where C is the number of coconuts he eats per day and F is the number of fish he eats per day. How many fish will he choose to eat per day?

A) 8

B) 6

C) 4

D) 2

E) 1

Q2) The marginal rate of transformation between two goods indicates the rate at which an efficient economy would have to give up one good to obtain more of the other.

A)True

B)False

Q3) There are two people and two goods, person A has comparative advantage in the production of good 1 if and only if it takes person A less time to produce good 1 than it takes person B.

A)True

B)False

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Chapter 31: A: Production

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Q1) (See Problem 2.) Robinson Crusoe has exactly 14 hours per day to spend gathering coconuts or catching fish. He can catch 5 fish per hour or he can pick 20 coconuts per hour. His utility function is U(F, C) = FC, where F is his consumption of fish and C is his consumption of coconuts. If he allocates his time in the best possible way between catching fish and picking coconuts, his consumption will be the same as it would be if he could buy fish and coconuts in a competitive market where the price of coconuts is $1, his income is

A) $280 and the price of fish is $4.

B) $70 and the price of fish is $5.

C) $350 and the price of fish is $5.

D) $280 and the price of fish is $.20.

E) $175 and the price of fish is $.20.

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Chapter 32: Welfare

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Q1) Suppose that Paul and David have utility functions U = 4A P + O P and U = A D + 3O D, respectively, where A P and O P are Paul's consumptions of apples and oranges and A D and O D are David's consumptions of apples and oranges. The total supply of apples and oranges to be divided between them is 18 apples and 18 oranges. The fair allocations consist of all allocations satisfying the following conditions.

A) A_D = A_P and O_D = O_P.

B) 8A_P + 2O_P is at least 90 and 2A_D + 6O_D is at least 72.

C) 4A_P + O_P is at least 90 and 2A_D + 3O_D is at least 72.

D) A_D + O_D is at least 18 and A_S + O_S is at least 18.

E) 4A_P + O_P is at least A_D + 3O_D and A_D + 3O_D is at least 4A_P + O_P.

Q2) The utility possibilities frontier is the boundary of the production possibilities set. A)True B)False

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Page 64

Chapter 32: A: Welfare

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Q1) A Borda count is used to decide an election between three candidates, x, y, and z, where a score of 1 is awarded to a first choice, 2 to a second choice, and 3 to a third choice. There are 25 voters. 3 voters rank the candidates x first, y second, and z third; 10 voters rank the candidates x first, z second, and y third; 6 rank the candidates z first, y second, and x third; and 6 voters rank the candidates y first, z second, and x third. Which candidate wins?

A) Candidate x.

B) Candidate z.

C) There is a tie between x and y, with z coming in third.

D) Candidate y.

E) There is a tie between y and z, with x coming in third.

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65

Chapter 33: Externalities

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Q1) Two stores are located side by side. They attract customers to each other and to themselves by advertising. The profit functions of the two stores are (75 + x₂)x₁ - 2x²₁ for store 1 and (105 + x₁)x₂ - 2x²₂ for store 2, where x₁ and x₂ are total advertising expenditures by stores 1 and 2 respectively. If each store sets its advertising expenditures independently (as in Nash equilibrium), how much would store 1 spend on advertising?

A) $27

B) $29

C) $32

D) $24

E) None of the above.

Q2) The efficient amount of air pollution is in general independent of whether polluters or pollutees pay to reduce pollution.

A)True

B)False

Q3) The only known way to eliminate externalities is through taxes or subsidies.

A)True

B)False

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Page 66

Chapter 33: A: Externalities

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Q1) Suppose that in Horsehead, Massachusetts, the cost of operating a lobster boat is $6,000 per month. Suppose that if x lobster boats operate in the bay, the total monthly revenue from lobster boats in the bay is $1,000(18x - x²). If there are no restrictions on entry and new boats come into the bay until there is no profit to be made by a new entrant, then the number of boats who enter will be X₁. If the number of boats that operate in the bay is regulated to maximize total profits, the number of boats in the bay will be X₂.

A) X₁= 6 and X₂ = 4.

B) X₁= 12 and X₂ = 6.

C) X₁= 16 and X₂ = 10.

D) X₁= 12 and X₂ = 12.

E) None of the above.

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Chapter 34: Information Technology

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Q1) A group of 9 consumers are trying to decide whether to connect to a new communications network. Consumer 1 is of type 1, consumer 2 of type 2, consumer 3 of type 3, and so on. Each consumer's willingness to pay to belong to the network is proportional to the number of consumers who belong. Where k is the number of consumers who belong, the willingness to pay of a type n consumer is equal to k times n. What is the highest price at which 7 consumers could all connect to the network and either make a profit or at least break even?

A) $23

B) $19

C) $18

D) $26

E) $21

Q2) Copyright protection discourages the production of new software.

A)True

B)False

Q3) List three examples of products for which there are significant network externalities. Explain why you believe network externalities are present in each case.

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Chapter 34: A: Information Technology

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Q1) Eleven consumers are trying to decide whether to connect to a new communications network. Consumer 1 is of type 1, consumer 2 is of type 2, consumer 3 is of type 3, and so on. Where k is the number of consumers connected to the network (including oneself), a consumer of type n has a willingness to pay to belong to this network equal to k times n. What is the highest price at which 11 consumers could all connect to the network and either make a profit or at least break even?

A) $12

B) $10

C) $1

D) $0

E) $11

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Chapter 35: Public Goods

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Q1) An otherwise charming island is inhabited by two religious groups who hate each other. The island is presided over by a benevolent monarch who is extremely concerned about envy between groups. He chooses the distribution of income on the island so as to maximize the social welfare function, W(x, y) = min{2x - y,2y - x}, where x is the utility of the average member of group X and y is the utility of the average member of group Y.

a. If the monarch can accomplish any distribution of utility such that x + 3y = 24, diagram the utility possibilities frontier and the monarchs isowelfare lines.

b. What income distribution maximizes W?

c. Show that an equal increase in both groups income will always please the monarch. d. If the initial incomes are equal, when do increases in both groups utility reduce W?

Q2) A Pareto optimal amount of public goods is shown on a graph (with quantities of public goods on the x axis) by the point at which the horizontal sum of the marginal rate of substitution curves meets the marginal cost curve.

A)True

B)False

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Page 70

Chapter 35: A: Public Goods

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Q1) Recall Bob and Ray in Problem 4. They are thinking of buying a sofa. Bob's utility function is U_B(S, M_B) = (1 + S)M_B and Ray's utility function is U_R(S, M_R) = (2 + S)M_R, where S = 0 if they don't get the sofa and S = 1 if they do and where M_B and M_R are the amounts of money they have respectively to spend on their private consumptions. Bob has a total of $2,000 to spend on the sofa and other stuff. Ray has a total of $3,000 to spend on the sofa and other stuff. The maximum amount that they could pay for the sofa and still arrange to both be better off than without it is

A) $3,000.

B) $1,500.

C) $2,000.

D) $1,050.

E) $4,000.

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Chapter 36: Asymmetric Information

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Q1) In Rustbucket, Michigan, there are 200 used cars for sale; half of these cars are good and half of them are lemons. Owners of lemons are willing to sell them for $500. Owners of good used cars are willing to sell them for prices above $1,300 but will keep them if the price is lower than $1,300. There is a large number of potential buyers who are willing to pay $600 for a lemon and $2,300 for a good car. Buyers can't tell good cars from bad, but original owners know.

A) There will be an equilibrium in which lemons sell for $500 and good used cars sell for $1,300.

B) There will be an equilibrium in which all used cars sell for $1,450.

C) The only equilibrium is one in which all used cars on the market are lemons and they sell for $600.

D) There will be an equilibrium in which all used cars sell for $900.

E) There will be an equilibrium in which lemons sell for $600 and good used cars sell for $2,300.

Q2) An insurance company must be concerned about the possibility that someone will buy fire insurance on a building and then set fire to it. This is an example of moral hazard.

A)True

B)False

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Page 72

Chapter 36: A: Asymmetric Information

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Q1) In Rustbucket, Michigan, there are 200 used cars for sale, half of them are good and half of them are lemons. Owners of lemons are willing to sell them for $200. Owners of good used cars are willing to sell them for prices above $1,100 but will keep them if the price is lower than $1,100. There is a large number of potential buyers who are willing to pay $500 for a lemon and $1,500 for a good car. Buyers can't tell good cars from bad, but original owners know.

A) There will be an equilibrium in which all used cars sell for $650.

B) There will be an equilibrium in which lemons sell for $200 and good used cars sell for $1,100.

C) There will be an equilibrium in which all used cars sell for $1,000.

D) The only equilibrium is one in which all used cars on the market are lemons and they sell for $500.

E) There will be an equilibrium in which lemons sell for $500 and good used cars sell for $1,500.

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