Microeconomic Theory
Exam Answer Key
Course Introduction
Microeconomic Theory delves into the foundational principles governing individual and firm decision-making processes in various market environments. This course covers topics such as consumer behavior, production and cost analysis, market structures (perfect competition, monopoly, oligopoly), and theories of market failure and welfare economics. Students will engage with models to analyze how prices are determined, resources are allocated, and how economic agents respond to changes in policy and market conditions, emphasizing both theoretical frameworks and real-world applications.
Recommended Textbook
Microeconomics and Behavior 8th Edition by
Robert H. Frank
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Page 2
Chapter 1: Thinking Like an Economist
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Sample Questions
Q1) If the benefits of X = $50 and the price of X = $50, then
A)$100 is the reservation price
B)You will be indifferent between buying X and keeping your money
C)$0 is the reservation price
D)You should buy X
Answer: B
Q2) You can drive to campus, take a bus, or walk.Driving costs you $1/mile in gas and maintenance, the bus costs $1 for unlimited distance, and walking is free but involves a disutility equivalent to $1/mile.If you live 2 miles from campus, and are a rational decision maker, what is your reservation price for a bus ticket?
A)$0
B)$1
C)$2
D)$4
Answer: C
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Chapter 2: Supply and Demand
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Q1) If an airline overbooks it pays people who volunteer to leave the overbooked flight.This system is better than drawing randomly from a hat the people who should miss the flight because
A)Those with the least to lose are the ones who miss the flight
B)It gives everyone a chance to get money they hadn't counted on
C)It is quicker and helps keep the flight on schedule
D)It is the most equitable way of solving the situation
Answer: A
Q2) A good that is not scarce
A)Would have a vertical supply curve over the relevant range
B)Would have a zero price
C)Is not in demand
D)Would have an infinite price
Answer: B
Q3) The equilibrium price is the price
A)From which there is always a tendency to move away
B)At which quantity supplied equals quantity demanded
C)Where there are surpluses and shortages
D)Suppliers agree to charge
Answer: B
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Chapter 3: Rational Consumer Choice
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Sample Questions
Q1) The marginal rate of substitution is
A)The absolute value of the indifference curve
B)The tradeoff rate between the two goods under consideration at any particular point
C)The total utility derived at any point
D)The rate at which the consumer increases utility
Answer: B
Q2) A student buys only two goods, pizza and books. The price of Pizza is $5 and the price of books is $10. At the student's present level of consumption, her marginal utility of pizza is 4 and her marginal utility of books is 2. Currently, the student is spending all her income.
Answer: a.Is this student currently in consumer equilibrium (maximizing utility)? Explain using a graph.
b.What would this student have to do in order to increase her utility? Use the diagram from part (a) to explain your answer. 11ea72a4_634f_d271_9d1a_6fd9ee317847_TB3720_00_TB3720_00
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Page 5
Chapter 4: Individual and Market Demand
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Sample Questions
Q1) The formula for elasticity is given by
A) \(\triangle Q/ Q / \Delta P /P\)
B)(Q/P)(slope)
C)(P/Q)(slope)
D)(Q/P)(1/slope)
Q2) Which of the following two goods is likely to have a negative cross-price elasticity of demand?
A)Left and right shoes
B)Margarine and butter
C)Coke and Pepsi
D)Peanut butter and tuna fish
Q3) Which of the following is likely to increase the elasticity of demand for a good?
A)A decrease in the availability of close substitutes
B)A longer period of time
C)A smaller share of income designated for the good in question
D)A decrease in the price
Q4) Assume that the price-consumption curve is horizontal.What additional information does that tell you about the demand for good X and the amount people spend on it?
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Chapter 5: Applications of Rational Choice and Demand
Theories
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Q1) A decrease in the interest rate will
A)Produce an increase in current savings
B)Produce an increase in current consumption
C)Produce a decrease in current savings
D)Depend on the particular consumer's preferences
Q2) Show, using a sketch graph, why a consumer prefers a cash gift rather than a larger gift of merchandise.
Q3) If the opportunity cost of a unit of current consumption is exactly 1 unit of future consumption then you must sacrifice $10 of current consumption to finance
A)$9 of future consumption
B)$10 of future consumption
C)$11 of future consumption
D)$1 of future consumption
Q4) Use the following to answer the next two questions.
Q5) Show with a sketch graph on each graph what the market does to correct the disequilibrium.
Q6) Show, using a similar sketch graph, why another consumer chooses the merchandise rather than the cash grant.
Page 7
Q7) Why is the market for loanable funds not in equilibrium?
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Chapter 6: The Economics of Information and Choice
Under Uncertainty
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Q1) The "Lemon's" argument helps to explain why
A)Physical depreciation is the only reason for the sharp price differential between new and used cars
B)Physical depreciation is an insufficient reason for the sharp price differential between new and used cars
C)Used cars fail to satisfy consumer demands for transportation
D)New and used cars sell for more than their intrinsic value would suggest
Q2) In general, a firm sends a signal to consumers that their product is high quality when A)it has high level of fixed costs
B)it has low level fixed costs
C)it spends very little in advertising campaigns
D)it gives huge discounts to large sellers
Q3) When a job applicant discloses information that could be seen as favorable by potential employers, other job candidates:
A)must do the same in order to get hired
B)will be seen as more unfavorable by potential employers
C)will earn less compensation
D)will be seen as more favorable by potential employers
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Chapter 7: Explaining Tastes: The Importance of Altruism and
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Sample Questions
Q1) Use the following to answer the next three questions:
C.The students with the best grades are the ones who stay on in school.From this information answer the following questions.
Q2) Say Anna's utility function was given by UA = MAMM, where MA is Anna's wealth and MM is Marie's wealth. Initially, Anna has 160 units of wealth and Marie has 40. In order to maximize her utility Anna should:
A)transfer all her wealth to Marie
B)transfer 60 units to Marie
C)keep all her wealth for herself.
D)get 40 units from Marie.
Q3) In this chapter, virtue can lead to material gain and therefore is an inevitable part of the social order.Evaluate this view of virtue or moral behavior.Is material gain a sufficient motive for morality? Is moral behavior based on more than the possibility for personal gain?
Q4) If the teacher allows the students to pick their team partners without a grade penalty, what will the population of the class eventually become? Draw a payoff graph again showing this outcome.
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Chapter 8: Cognitive Limitations and Consumer Behavior
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Q1) Which of the following is true?
A)People prefer the toll ways where they throw in some change every dozen miles or so to a toll road that has one payment at the end of the trip
B)Budgeting your income will often result in more total spending
C)High prices and rebates on cars simply irritate the consumer and make him feel treated like a fool
D)People tend to enjoy the process of buying a car more when the process involved difficult choices
Q2) The Kahneman-Tversky value function is
A)Risk-averse in gains, risk-seeking in losses
B)Risk-seeking in gains, risk-averse in losses
C)Risk-averse in gains and losses
D)Risk-neutral in gains and losses
Q3) The Kahneman-Tversky value function shows that a gain of $100
A)Is valued less than two gains of $50
B)Would be offset in one's mind by a loss of less than $100
C)Would be offset in one's mind by a loss of more than $100
D)Would be offset by a gain of $100
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Chapter 9: Production
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Q1) If the owner of an ice-cream stand told a student looking for summer work that he would not hire him even if he worked for nothing, we can infer that
A)The marginal product of the labor is zero or less
B)The average product of labor is rising
C)The marginal product of labor is rising
D)The owner is producing at the lowest cost
Q2) In a typical production function the relevant factors of production are land, labor, capital, and
A)Raw materials
B)Technology
C)Entrepreneurship
D)Resources
Q3) Suppose you are using 10 units of labor in your short-run production process.At this point, the average product of your labor is 10, and the marginal product of the last unit of labor was 14.Given this, we know that the:
A)Average product of labor must be increasing
B)Average product of labor must be decreasing
C)Marginal product of labor must be increasing
D)Marginal product of labor must be decreasing
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Page 11
Chapter 10: Costs
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Q1) A firm that is trying to produce a given level of output Q<sub>0</sub> at the lowest possible cost will
A)Select the input combination at which an isocost line is tangent to the Q<sub>0</sub> isoquant
B)Select the input combination at which an isocost line is above the Q<sub>0</sub> isoquant
C)Select the input combination at which an isocost line is below the Q<sub>0</sub> isoquant
D)Choose to produce at a level where variable costs are less than or equal to fixed costs
Q2) The minimum efficient scale of production is the level of production required for the A)Long run average curve to reach its minimum
B)Variable cost curve to reach its minimum
C)Marginal cost curve to reach its minimum
D)Average cost curve to reach its minimum
Q3) During the last 30 years computers have changed most production processes. Use an Isocost-Isoquant diagram to show the effect the spread of computers have had on labor during the last 30 years.
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Page 12
Chapter 11: Perfect Competition
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Q1) In the graph above at a price of P*, in the above graph, the profit maximizing level of output is
A)Q*
B)Above Q*
C)Below Q* but above zero
D)Zero
Q2) The price of the typical MP3 player (such as the iPod) has been going down in the past 10 years. What could explain this consistent drop in the price of MP3 players? Use the model for the long-run competitive firm to illustrate your answer (hint: you need two diagrams here: one showing the LAC for the typical firm, and another showing the long-run supply curve for the industry.)
Q3) Sketch a perfectly competitive firm operating in short-run equilibrium but making economic losses.Put in all the functions necessary to show that the firm should stay in business in the short-run despite the losses.Shade in the area of loss shown by the drawing.
Q4) How much profit is each firm making if fixed costs are $375 per firm?
Q5) How can a firm stay in business if it makes no economic profit in the long run?
Q6) What is the producer and consumer surplus in the entire market?
Q7) What is the equilibrium price and quantity produced by the industry as a whole?
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Chapter 12: Monopoly
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Q1) Which of the following is not a source of monopoly power?
A)Exclusive control over inputs
B)Economies of scale
C)Patents
D)Rapid low cost technological change in the industry
Q2) A natural monopoly always has
A)A downward sloping long run average cost curve
B)A downward sloping marginal cost curve
C)Its profit maximization point where price = marginal cost
D)Patent rights
Q3) For the output maximizing monopolist whose stockholders demand a normal economic return on equity, economic profit
A)Is positive
B)Is negative
C)Is zero
D)May be positive or zero
Q4) If a monopoly generally brings a loss of economic efficiency and consumer surplus, why would a local government give only one utility company (such as a cable television company) a license to enter its market? Should local governments continue this practice?
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Chapter 13: Imperfect Competition: a Game-Theoretic Approach
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Q1) Derive the reaction curve for a Cournot duopolist where the industry demand curve is as stated above and the MC of production is zero.
Q2) In a prisoner's dilemma game a dominant strategy would mean that one of the players
A)Follows the moves of the opponent no matter what the opponent does
B)Knows the payoff matrix outcomes while the other does not
C)Is sure to come out with the most preferred outcome no matter what the other does
D)Will benefit most from one particular move no matter what the opponent does
Q3) In game theory, a dominant strategy is one
A)In which the firm gains the greatest competitive advantage
B)In which the same strategy is chosen by one firm regardless of the anticipated action
C)of the other firm
D)That produces the greatest comparative advantage
E)That both firms agree on independently
Q4) If the town projected a total population of 180 by the end of the decade, how many restaurants would the city planners project as optimal for the end of the decade?
Q5) What will industry output be at equilibrium in this model?
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Chapter 14: Labor
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Q1) Economic theory supports the view that increasing the minimum wage will
A)Increase the employment of teenagers
B)Decrease the employment of teenagers
C)Decrease the employment of unionized labor
D)Increase the number of monopsony firms
Q2) The market demand for labor is
A)More elastic in the long run than in the short run
B)More elastic in the short run than in the long run
C)Unaffected by time differences
D)Never elastic in the relevant range
Q3) Say a workers sees work and leisure as perfect complements with a ratio of 5 to 1 (requiring 1 hour of leisure for every $5 in income). If this worker earned a wage of $10 her optimal demand for leisure would be:
A)16
B)20
C)24
D)10
Q4) What will the wage rate be for labor in Question 4 above?
Q5) What is an important moral of this story?
Q6) What is the wage rate paid to the laborer in Question 2 above?
Page 16
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Chapter 15: Capital
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Q1) If the going interest rate went up to 10%, how much would you be willing to pay for the machine?
Q2) The quantity of loanable funds supplied by firms is
A)Independent of the interest rate
B)Positively related to the interest rate
C)Inversely related to the interest rate
D)Negatively related to the rate of return
Q3) What is the maximum you should be willing to pay for the machine?
Q4) What is the actual value of an alleged million dollar lottery jackpot, paid at the rate of $100,000 at the end of each year for 10 years, assuming that the interest rate remains are 5% over that period?
Q5) A cash register at a coffee shop should be considered:
A)real capital
B)financial capital
C)either financial or real capital
D)none of the choices are correct
Q6) If the machine cost $12,000 to purchase, should you buy it?
Q7) What is the present value of the income stream from the machine?
Page 17
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Chapter 16: Externalities Property Rights and the Coase
Theorem
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Q1) Define in technical terms the tragedy of the commons.
Q2) If there were no controls over fishing how many vessels would be sent out fishing?
A)0
B)6
C)7
D)8
Q3) How much irritation is the most efficient amount for each person in the town to absorb?
Q4) According to the Coase theorem, when the parties affected by externalities can negotiate costlessly with one another
A)An efficient outcome results if the liability is placed on the party with the lowest cost of prevention
B)An efficient outcome results no matter how the law assigns responsibility
C)Efficiency cannot be reached without government intervention
D)The correct way to deal with an externality is to tax it
Q5) If there are no restrictions of any kind on burning leaves and negotiation costs among citizens are prohibitive, what will happen to the leaves in the town?
Page 18
Q6) What is the marginal cost to society when a bushel of leaves is burned?
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Chapter 17: Explaining Tastes: The Importance of Altruism and
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Q1) According to the negative income tax, the breakeven income level for a program whose tax credit is $3,000 and whose tax rate is 30 percent would be:
A)$10,000
B)$6,000
C)$4,500
D)$9,000
Q2) Draw a graph of the individual demand equations and the total community demand for fireworks.Sketch in the marginal cost function as well.
Q3) Which of the following is the best example of a nonexcludable good?
A)Television broadcast over the air
B)Cable TV
C)National parks
D)Beer
Q4) Handicap access to buildings is becoming very expensive for many operators of public buildings.Are the laws mandating such alterations based on social efficiency or some other criteria?
Q5) What is the total community demand equation for the fireworks display?
Page 19
Q6) If the fireworks show is left to the private marketplace, what is likely to happen?
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Chapter 18: General Equilibrium and Market Efficiency
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Q1) A tax on all goods consumed
A)Would not cause distortions if all consumer goods are taxed at the same rate
B)Would be more efficient than an income tax
C)Would cause distortions between consumer goods and other goods and services
D)Will increase the welfare of all consumers
Q2) According to the second welfare theorem
A)The issues of equity and efficiency are tied together
B)The issues of equity and efficiency are separate
C)Equity is unimportant to economists
D)The market also achieves equity for all participants of the economy
Q3) When the two-good production and trade models are extended from a given country to the entire world
A)The price of the exported good falls for the country going global
B)The cost of producing the exported good rises for the country going global
C)The price of the imported good falls to the country's consumers
D)The price of both goods rises for the country going global
Q4) Describe what happens automatically in markets to solve these allocation problems.Relate your explanation to markets in general and to the graph in Problem 33 above.
Q5) Graph the problem of Question 35 above and show the solution on the graph.
Page 20
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