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Answers of Quiz of Economics - Exam held on August 2 & 3, 2009

1. Correct Answer: B

Income elasticity is the sensitivity of demand to changes in consumer income. Income


elasticity for this good = (percent change in quantity demanded) / (percent change in
income) = -20 / -3 = 6.7. Normal goods with high income elasticities (absolute values > 1)
are considered luxury goods, a type of normal good that experiences a greater
percentage increase in demand than the percentage increase in income

2. Correct Answer: A
quantity demanded in response to a change in market price.

3. Correct Answer: C

4. Correct Answer: C

For an individual, consumer surplus is defined as the sum of the differences between
what that individual is willing to pay for each individual unit of a good or service that he
or she purchases (marginal benefit) and the amount that he or she actually pays for
each of these individual units.

5. Correct Answer: B

Public goods can be consumed by every member of a society, regardless of whether


they paid for them or not. In a competitive market for public goods, fewer goods than
the efficient quantity would be produced because it is not in each person’s interest to
pay their share of the cost

6. Correct Answer: B

Price controls and taxes are obstacles to allocative efficiency. Rent controls and
minimum wages are examples of price controls. As opposed to being obstacles to the
efficient allocation of resources, changes in consumer tastes lead to the reallocation of
society’s resources, producing a different mix of goods or services that provide
increased benefits

7. Correct Answer: C

Deadweight loss is the reduction in consumer and producer surplus due to


underproduction or overproduction
8. Correct Answer: C

The symmetry principle holds that people in similar situations should be treated
similarly. It implies that the market allocates resources fairly if the rules of economic
allocation are fair.

9. Correct Answer: C

Product differentiation gives market power to firms under monopolistic competition by


making the firm the sole producer of a slightly differentiated good

10. Correct Answer: B

In an oligopoly, a small number of producers sell products that can be similar or


differentiated. An oligopoly typically features significant barriers to entry including
economies of scale. Pricing and output decisions by each firm directly influence the
decisions of competing firms.

11. Correct Answer: C

Firms can often coordinate economic activity more efficiently than markets because
firms can reduce the costs of market transactions, and they can achieve economies of
scale, scope, and team production.

12. Correct Answer: C

Diseconomies of scale occur along the upward sloping segment of the long-run average
total cost curve where costs rise as output increases. The flat portion at the bottom of
the long-run average total costs curve represents constant returns to scale

13. Correct Answer: B

The game of Prisoners’ Dilemma applies to oligopoly and the solution from Nash
equilibrium is that both prisoners would confess to the crime

14. Correct Answer: C

In the extreme cases of products with perfectly elastic and perfectly inelastic demand,
the sellers and buyers, respectively, pay the entire tax.
15. Correct Answer: A

The consumer surplus is the value of the good minus the price paid for it (10-4) = 6,
summed over the quantity bought. The total consumer surplus is the consumer surplus
on each mango that Reddy buys and added together. It is the area of the right triangle =
(base x height) / 2 as in Figure 3 on p. 40, with base equal to 20 mangoes a week and the
height equal to 6, the consumer surplus on each mango. Thus the total consumer
surplus = (20 x 6) / 2 = Rs.60

16. Correct Answer: B

The relationship between the tax rate and the amount of tax revenue collected is called
the Laffer curve, named after Arthur B. Laffer, a supply-side economist and a member of
President Reagan’s economic policy advisory board. They argued that tax cuts would
increase tax revenues and decrease the budget deficit

17. Correct Answer: A

Opportunity costs= 100,000 + 50,000 + 40,000 = 190,000Economic depreciation=


300,000 – 280,000 = 20,000Economic profit= Total revenue – Opportunity costs –
Economic depreciation 300,000 - 190,000 – 20,000 = 90,000

18. Correct Answer: B

Upon introduction of a subsidy, the equilibrium level of supply increases and the price
falls. In the new equilibrium, marginal cost (on the supply curve) exceeds marginal
benefit (on the demand curve) and a deadweight loss arises due to overproduction

19. Correct Answer: A

A deficit budget leads to an increase in interest rates, a decrease in investment, and an


increase in private saving

20. Correct Answer: C

The Hotelling principle applies to non-renewable natural resources characterized by


perfectly elastic flow supply. According to the Hotelling principle, the price of resource is
expected to rise at a rate equal to the interest rate.

21. Correct Answer: C


When demand is elastic, a decrease in price by 1% increases the quantity sold by more
than 1% and it results in an increase in total revenue. But when demand is inelastic, a
decrease in price by 1% increases the quantity sold by less than 1% and it results in a
decrease in total revenue

22. Correct Answer: B

The three indicators of the state of the labor market that the U.S. Census Bureau
calculates are: the unemployment rate, the labor force participation rate, and the
employment-to-population ratio.

23. Correct Answer: B


Marginal cost decreases at low outputs because of economies from greater
specialization. At higher levels of production, it eventually increases because of the law
of diminishing returns.

24. Correct Answer: C

When a firm is producing a given output at the least possible cost, it is said to be
operating on its long-run average cost curve.

25. Correct Answer: B

Structural unemployment refers to the unemployment due to changes in technology,


changes in skills needed to perform jobs or changes in the location of jobs. Frictional
unemployment, on the other hand, is influenced by unemployment compensation.

26. Correct Answer: B

The quantity of investment that firms plan to undertake depends only on how
productive capital is and what it costs - its real interest rate. Therefore, a tax on interest
income has no effect on investment demand. On the other hand, a tax on interest
income weakens the incentive to save as savers look at the after-tax real interest rate
they receive. The interest rates would rise as a result of the decrease in saving supply

27. Correct Answer: C

When the supply of the factor is perfectly elastic (horizontal supply curve), the factor’s
entire income comprises opportunity cost. When the supply of the factor is perfectly
inelastic (vertical supply curve), the factor’s entire income comprises economic rent.

28. Correct Answer: B


A change in the natural rate of unemployment shifts both short-run and long-run Phillips
curves. Suppose the natural rate of unemployment increases from 6 to 9%, but the
inflation remains constant at 10%. As a result, both short-run and long-run Phillips
curves move outward adjusting to the new, higher level of natural unemployment rate.
The new point of intersection between the two lines would be at 9% unemployment
rate and 10% inflation rate.

29. Correct Answer: C

A change in total revenue that results from one more unit of labor is called the marginal
revenue product of labor. In a perfectly competitive market, profit is maximized when,
at the quantity of labor hired, marginal revenue equals marginal cost and marginal
revenue product equals the wage rate. These two conditions are equivalent and the
quantity of labor that maximizes profit produces the output that maximizes profit.

30. Correct Answer: A

The marginal cost pricing rule is efficient but it leaves the natural monopoly incurring an
economic loss. Therefore, regulators almost never impose marginal cost pricing rule.
Instead, they adopt the average cost pricing rule, which allows the firm to cover its costs
and earn a normal profit.

31. Correct Answer: C

The real interest rate equals the nominal interest rate minus the expected inflation rate,
which is the same as nominal interest rate equals the real interest rate plus the
expected inflation rate.

32. Correct answer: A


An increase in aggregate demand as a result of an increase in government purchases, an
example of demand-pull inflation, leads to an increase in both price level and the real
GDP

33. Correct Answer: B

MRP decreases for a firm in perfect competition, due to a decline in marginal product.

34. Correct Answer: C

The cross elasticity of demand is negative for a complement and positive for a
substitute.

35. Correct Answer: C


The return to entrepreneurial ability is greater than normal in a firm that makes a
positive economic profit.

36. Correct Answer: A


Both Keynesians and monetarists believe that money wage rates are sticky. Classical
macroeconomics does not.

37. Correct Answer: C


A monopoly employs price discrimination to capture consumer surplus and to convert a
consumer surplus to an economic profit

38. Correct Answer: B

Increased material costs cause firms to manufacture less. Less manufacturing decreases
short-run supply making prices rise

39. Correct Answer: B

Adjusting taxation is not a tool available to central banks. Only the government can
adjust taxation as it is a fiscal policy tool.

40. Correct Answer: A

CPI equals 100 times the cost of the CPI basket at current-period prices divided by the
cost of the CPI basket at base-period prices. In this problem the current period cost is
(15 × 1.75 + 5 × 12) = 86.25. The base period cost is (15 × 2 + 5 × 10) = 80.
The CPI is (86.25 / 80) × 100 = 107.81