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Practice exam BUSS 1040 - Answers

1. The Reserve Bank of Australia is responsible for:

*a. monetary policy, issuing Australia’s banknotes and maintaining the stability of the financial
sector

b. monetary policy only

c. the Federal government’s fiscal policy

d. maintaining Australia’s fixed exchange rate

e. none of the above

2. Which statement is true?

a. GDP measures the total quantity of goods and services produced in an economy in a given period.

b. GDP measures the market value of all goods and services produced in an economy in a given
period.

*c. GDP measures the sum of the value added of all goods and services produced in an economy
over a given period of time.

d. GDP measures the total quantity of final goods and services produced in an economy in a given
period.

e. None of the above.

GDP is the value of all final goods and services (not the number, not all goods etc)

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3. Consider the following table.

Steel firm Car company

Revenue 100 Revenue 210

Costs 80 Costs

wages 80 wages 70

steel 100

Profits 20 Profits 40

What is GDP in this economy

a. 200

*b. 210

c. 220

d. 230

e. 240

Add all wages and profits

4. Long-run growth in standard of living depends on

a. increasing population

b. increasing nominal GDP

*c. increasing technology and human capital

d. increases in the GDP deflator

e. increasing the total inputs used in the production process.

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Long-run increases in the standard of living depend on increasing output per person – which really
depends on making better use of our resources

5. Which statement is true?

a. Unemployment can fall during a recession.

b. Participation rates can fall in a recession.

c. Unemployment can rise during an expansionary period of economic activity.

*d. All of the above.

e. None of the above

Note the definition of Unemployment rate depends on U/LF, so can be affected by changes in the
participation rate as well as the number of unemployed

6. The price of beer increases. As a result total revenue in the market rises from $100 million to $120
million. In this case demand is:

a. Elastic

*b. Inelastic

c. Unit elastic

d. A constant-elasticity

e. It is not possible to assess.

For the revenue to rise the percentage quantity increase in price must be larger than the percentage
decrease in quantity – hence the price elasticity of demand in that range must be inelastic.

7. A party has the comparative disadvantage of producing a good if:

a. they have the lowest opportunity cost

b. they use the least amount of resources

*c. they have the highest opportunity cost

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d. they have the highest opportunity costs and use the most resources

e. they have a lowest opportunity cost but use the most amount of resources

Opposite to definition of comparative advantage.

8. Which statement is true?

a. A tax that raises no revenue causes no deadweight loss

b. A tax that has no deadweight loss cannot raise any revenue

*c. Tax revenue may increase or decrease as the per-unit tax rate on a good rises.

d. Market output is too low compared with the socially optimal level when there is a negative
production externality.

e. None of the above

C follows from the fact that revenue can go up or down depending on whether the price elasticity of
demand is inelastic or elastic.

9. Consider the markets for corn chips and potato chips, two substitutes. We observe the following
facts:

The price rises and the quantity demanded falls in the corn chip market

The price rises and the quantity demanded rises in the market for potato chips

Which of the following could explain these observations?

a. Dry conditions in potato growing areas hinder the cultivation of potato crops.

*b. Frost in corn growing areas hinder the growing of corn

c. Good rains assist potato cultivation

d. Damp conditions and warm weather assist corn production

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e. None of the above

Set up two demand and supply diagrams and follow the changes through. The frost in the corn
growing area shifts the supply curve of corn chips to the left (higher marginal cost of production),
raising the price and decreasing the quantity demand of corn chips; in the other related market the
demand curve for potato chips increases (a substitute product for corn chips)

10. Which statement is true?

a. To realise the gains from trade, parties specialize in producing the good in which they have an
absolute advantage.

b. To realise the gains from trade, parties specialize in producing the good in which they are more
productive.

c. To realise the gains from trade, parties can specialize in producing either the good

d. To realise the gains from trade, the more productive party should specialise in producing the more
costly good and the less productive party should specialize in the other good.

*e. None of the above (that is, all the other statements are false)

To realise the gains from trade, parties specialise in producing goods that they have a comparative
advantage in.

11. Which statement is true?

*a. The cross-price elasticity for complementary goods is negative.

b. The party with the lowest opportunity cost has the comparative disadvantage in producing a
good.

c. The price elasticity of demand is constant along a linear demand curve.

d. A non-binding price ceiling results in excess demand.

e. None of the above (that is all the statements are false).

For complementary products, if the price of one good rises, the quantity demanded for the other
good will fall – giving a negative cross-price elasticity.

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12. This table shows the units of output a worker can produce per month in United States and Korea.

Sugar (tonnes) Steel (tonnes)

United States 9 3

Korea 8 2

The opportunity cost of 1 tonne of steel in United States is:

a. 9 tonnes of sugar

b. 1 tonnes of sugar

c. 1/3 tonnes of sugar

d. 6 tonnes of sugar

*e. None of the above

The opp cost in the US of 1 tonne of steel is 3 tonnes of sugar.

13. This table shows the units of output a worker can produce per month in United States and Korea.

Sugar (tonnes) Steel (tonnes)

United States 9 3

Korea 8 2

The opportunity cost of 1 tonne of steel in Korea is

a. 2 tonnes of sugar

b. ½ a tonne of sugar

*c. 4 tonnes of sugar

d. ¼ tonnes of sugar

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e. None of the above

In Korea to make a tonne of steel you give up making 4 tonnes of sugar.

14. What is the range of prices for a tonne of steel that allows both countries to gain from trade?

a. The price must be greater than 3 tonnes of sugar but less than a 9 of a tonne of sugar.

b. The price must be greater than 2 tonnes of sugar but less than 8 tonnes of sugar.

c. The price must be greater than 1/3 tonnes of sugar but less than 3 tonnes of sugar

*d. The price must be greater than 3 tonnes of sugar but less than 4 tonnes of sugar.

e. None of the above.

The price must be between what the two countries could ‘buy’ the products of themselves for – that
is their respective opportunity costs. The price for a tonne of steel must be between 3 and 4 tonnes
of sugar.

15. For good Y, when the price is P1 = $60 the quantity demanded is q1 = 10 units. When the price
falls to P2 = $40 it is determined formula that the elasticity is 3 (in absolute terms) according to the
initial point elasticity method. What is the quantity demanded, q2, when the price is $40.

a. q2 = 0

*b. q2 = 20

c. q2 = 30

d. q2 = 40

e. None of the above

Use the formula e = (q2 – q1)/q1/(p2 – p1)/p1. In the formula you know everything except for q2.

16. The short-run marginal and average variable cost curves for a competitive firm are given by MC =
8+ 8Q and AVC = 8 + 4Q, respectively. The profit maximizing level of output (Q) is 2 and the total
fixed cost (TFC) is $64. Which of the following must be true about the firm?

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a. The firm is charging a price of $40 and covering its average variable cost, hence it should continue
operating in the short-run.

b. The firm is charging a price of $40 and making a short-run loss, and hence the firm must shut
down immediately.

c. The firm is charging a price of $24 and making a zero profit, and hence the firm should shut down
eventually.

*d. The firm is charging a price of $24, covering its average variable costs, but in the long run at this
price the should exit in the long-run.

e. None of the above.

This is a difficult question. Substitute in for Q into MC. MC = 24 which must equal price for a
competitive firm. Now work out AVC = 16. Thus the firm will produce in the Short Run. However,
note the FC = $64. Compared with revenue of just 48 the firm will exit in the LR.

17. The government issues tradeable pollution permits to deal with an externality. With tradeable
pollution permits:

*a. The cost of reducing pollution is minimised, regardless of their initial distribution amongst
polluting firms.

b. The firms that are allocated permits will continue to emit more pollution than firms with fewer, or
zero, permits.

c. Although the price of permits reflects the opportunity cost of polluting, this only applies to firms
without permits.

d. The firms that are allocated permits will trade all their permits to other firms, and keep the
money.

e. The cost of reducing pollution is minimised, although firms receiving permits will emit more
pollution than other firms.

See the lecture notes – creating a market for permits should see their value maximised (as in a
normal market), regardless as to who has the permits initially.

18. Which statement is true?

a. Marginal cost intersects average fixed cost when average fixed cost is at its minimum.

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b. In the short run, a perfectly competitive profit maximising firm that has not shut down is not
operating on the upward-sloping portion of its AVC

c. A perfectly competitive profit maximizing firm whose long run economic profit is exactly zero
should expand production to try to earn a positive profit

d. It is possible for average variable cost to be greater than average total cost at high levels of
output.

*e. None of the above.

Draw the diagram of a competitive firm’s cost curve. All of the statements are false.

19. Consider a market in which there is a demand curve of qd = 10 - P, where qd is the quantity
demanded and P is the price. The market supply curve is given by qs = P, where qs is the quantity
supplied. There is, however, a negative production externality of $2 per unit produced. What is the
deadweight loss (the loss of surplus) in the market outcome?

*a. $1

b. $2

c. $3

d. $4

e. It is not possible to ascertain with the information provided

The true marginal cost from the firm’s MC and the externality is given by the curve SMC = qs + 2. To
work out the efficient quantity q* equate the SMC curve with the PMB curve (the demand curve).

The market output is 5, the efficient output q* is 4, resulting in a DWL of $1. See the lecture notes
for the correct DWL triangle.

20. Which of the following is true?

a. A profit-maximising monopoly with a straight-line demand will always produce where demand is
inelastic because higher prices raise total revenue.

b. A profit-maximising monopoly with a straight-line demand will always produce where demand is
unit elastic because raising prices further would reduce total revenue.

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c. A profit-maximising monopoly with a straight-line demand will never produce where demand is
elastic because cutting prices would increase total revenue.

d. All of the above are true.

*e. All of the above are false.

A monopolist with a positive marginal cost of production will produce on the elastic part of the a
linear demand curve

21. In monopoly and monopolistic competition, price is greater than marginal cost. This tells us that

a. both make economic profits in the long run.

b. marginal costs must be very low in both types of industry.

c. there are barriers to entry in both types of industry.

*d. both result in deadweight loss.

e. None of the above.

The diagram is essential the same – as P > MC = MR there must be a DWL

22. You are a monopolist in a market with a market demand curve q = 10 – P, where q is the quantity
demanded and P is the price (in dollars). You also have no costs of production.

At what price do you sell the good in order to maximise your profit and what is your total profit?

a. a price of $2; total profit is $16

*b. a price of $5; $25

c. a price of $10; $30

d. None of the above.

With this demand curve MR = 10 – 2q. Equate MR = MC = 0 to get q = 5, and so on. Also note, when
MC = 0 the monopolist produces in the middle of a linear demand curve (where e = -1).

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23. What of the following is a characteristic of a monopoly?

*a. Price-maker

b. Homogenous product offering compared to its rivals

c. Free entry

d. None of the above

Price maker – not a price taker. It sets a price (or quantity). It does not have a supply curve.

24. What of the following is a characteristic of a monopoly?

a. Price-taker

b. Same product offering as its rivals

c. Free entry

*d. None of the above

Same question

25. What of the following is a characteristic of a monopolistic competitive industry?

a. Profits are zero in the long run

b. Product differentiation by firms

c. Free entry

*d. All of the above

See the definition of the monopolistically competitive firm

26. What is the monopolist’s profit under the following conditions? The profit-maximising price
charged for goods produced is $16. The intersection of the marginal revenue and marginal cost
curves occurs where output is 10 units and average total cost is $8.

a. Not enough information is given to answer this question.

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b. $8

c. $16

*d. $80

Profit = 16x10 – 10x8 = 80

27. Consider a monopolist that can practice first degree price discrimination. Assume that marginal
costs are constant and equal to 20, and that the demand curve faced by the monopolist is given by
the following: p=100-Q. What is the monopolist’s profit maximizing level of output?

a. 20

b. 40

*c. 80

d. Not enough information is given to answer the question

With first-degree PD, the monopolist will produce up to where MC = MB; ie when 20 = 100 – q, or
where q = 80

28. Which of the following is an example of second degree price discrimination?

a. a theatre that offers lower prices for children

*b. a computer firm that offer a computer and a printer in a package at a lower price than it would
cost to purchase both separately

c. City rail offering lower priced tickets to students.

d. all of the above

2nd degree PD is where the consumer’s type is hidden information and the monopolist uses different
product packages/bundles to get the consumer to reveal their true valuation for the product.
Answer (b) fits this definition best.

29. Which of the following is an example of third degree price discrimination?

a. a theatre that offers lower prices for children

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b. a computer firm that offer a computer and a printer in a package at a special price to students
from the University of Sydney compared to non student buyers

c. City rail offering lower priced tickets to students.

*d. all of the above

3rd-degree PD is where the consumer types are known by the monopolist, who can discriminate
between consumer types (but now within consumer groups). All are examples of 3rd-degree PD.

30. Consider the following model. Firm 1 and 2 are producing the same good and are rivals. Both
simultaneously decide on their price. There are two choices - they can either price High or Low. If
both price High, the profits are $4 to each firm. If Firm 1 prices Low and Firm 2 prices High, Firm 1
makes $5 and Firm 2 makes $1. If Firm 1 prices High and Firm 2 Low, the firms make $1 and $5 to
Firms 1 and 2 respectively. Finally, if both firms price Low they each make $3. What is the Nash
equilibrium of the game?

a. (High, Low) where the first strategy is for Firm 1 and the second strategy is Firm 2’s.

b. (High, Low) and (Low, High)

c. (High, High)

d. (Low, High)

*e. (Low, Low)

Draw the game and work through the boxes.

31. The entry and exit of firms in a monopolistically competitive market guarantees that:

*a. economic profits and economic losses disappear in the long run.

b. economic profits can survive in the long run, but not economic losses.

c. economic losses will exist in the long run, but not economic profits.

d. both economic profits and economic losses will exist in the long run.

There is free entry and exit in the long run pusing profits back to zero.

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32. A market formed by many buyers and a first degree price discriminating monopolist

a. achieves full efficiency

b. gets to an equilibrium quantity equal to the equilibrium quantity in perfect competition

c. achieves a total surplus equal to the total surplus in perfect competition

*d. all of the above

As the MC for the last unit sold equals its MB, the quantity sold by a perfectly price discriminating
monopolist is efficient.

33. Consider a monopolist producing a good with zero marginal costs and $20 fixed costs. There are
two consumers in the market. Consumer 1 has a demand curve q1 = 10 – P, where q1 is the quantity
demanded and P is the per-unit price. Consumer 2 has a demand curve q2 = 15 – P, where q2 is the
quantity demanded by consumer 2. If the monopolist perfectly price discriminates between two
consumers using a two-part tariff.

a. The monopolist will charge a fixed fee of $100 to consumer 1 and a per unit fee of $0; and the
fixed fee of $225 to consumer 2 and a per-unit fee of $0.

b. The monopolist will charge a fixed fee of $12.5 to consumer 1 and a per unit fee of $5; and a fixed
fee of $25 to consumer 2 and a per-unit fee of $5.

c. The monopolist will not produce as it makes negative profits if it does.

*d. None of the above.

e. This is a ridiculous question.

Draw the diagram. The monopolist charges a fixed fee equal to each consumer’s total surplus. The
per-unit fee charged is equal to MC = $0. The fixed fee is then 15x15/2=112.5 for consumer 2 and
10x10/2 = 50 for consumer 1.

34. Consider a monopolist with a MC curve of MC = q, where q is the quantity produced. The
demand curve in the market is given by qd = 20 - 2P, where P is the market price. If the monopolist
charges a linear price (that is, does not engage in price discrimination and just charges the same
price to everyone), what is the deadweight loss?

a. 2.5

b. 5

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*c. 2.083

d. 7.5

e. 10

Draw the diagram. The efficient quantity is where P = MC. The monopoly quantity is where MR =
MC. Here MR = 10 – qd. Equate MR = MC to get qM = 5. The efficient quantity is q* = 20/3. Draw the
diagram. The DWL triangle is where MB > MC. I calculate this to be 2.083.

35. A Nash equilibrium is when

a. Total surplus is maximised

*b. each player is doing the best they can given what the other players are doing.

c. each player always plays their dominant strategy

d. all of the above

e. none of the above

See the lecture notes – follows from the definition. You will need to remember this definition and be
able to apply it in the exam.

36. A prisoners’ dilemma is when:

a. Each player has a dominant strategy

b. There is a unique Nash equilibrium

c. In the Nash equilibrium surplus is not maximized

*d. All of the above

e. None of the above

True by definition

37. Consider the following game. Amazon can choose to either Enter of Not Enter into the market for
e-books. If Amazon chooses Not Enter then the payoffs are $1 to Amazon and $6 to Apple. If Amazon

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chooses to Enter then Apple observes this and chooses to either Punish or Accommodate. If Apple
chooses to Punish the payoffs are $1 to Apple and -$1 to Amazon. If Apple Accommodates the
payoffs are $2 to each party.

What are all of the Nash equilibria in this game?

a. (Enter, Accommodate)

b. (Not Enter, Punish)

c. (Enter, Punish)

*d. (Not Enter, Punish) and (Enter, Accommodate)

e. (Not Enter, Punish), (Not Enter, Punish) and (Enter, Accommodate)

Draw the game and solve for all Nash equilibria. In both proposed outcomes neither party has an
incentive to deviate.

38. Consider the following game. Amazon can choose to either Enter of Not Enter into the market for
e-books. If Amazon chooses Not Enter then the payoffs are $1 to Amazon and $6 to Apple. If Amazon
chooses to Enter then Apple observes this and chooses to either Punish or Accommodate. If Apple
chooses to Punish the payoffs are $1 to Apple and -$1 to Amazon. If Apple Accommodates the
payoffs are $2 to each party.

Eliminating any equilibria that rely on incredible threats, what are all the possible credible equilibria?
(That is, using backwards induction what are the subgame perfect equilibria?)

*a. (Enter, Accommodate)

b. (Not Enter, Punish)

c. (Enter, Punish)

d. (Not Enter, Punish) and (Enter, Accommodate)

e. (Not Enter, Punish), (Not Enter, Punish) and (Enter, Accommodate)

See the lecture notes – draw the game tree and solve the game backwards. In the SPE all incredible
threats are eliminated.

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39. There are 5 identical consumers in a market, each with a demand curve of P = 100 – 5q. The
market demand curve is:

*a. P = 100 - Q

b. P = 500 – 5Q

c. P = 20 – 5Q

d. P = 20 - Q

e. None of the above.

40. Consider a public good that has a marginal benefit for consumer 1 of MB = 20 – q and a marginal
benefit for consumer 2 of MB = 30 – 3/2.q. If the marginal cost of provision is $10 per unit, what is
the socially optimal level of output?

a.4 units

b. 20 units

c. 8 units

d. 10 units

*e. 16 units

41. In this unit I will get a:

a. High Distinction

b. Distinction.

c. Credit

d. All of the above

Short answer questions

1. Consider a monopolist selling into a market with a demand curve of P = 100 – q. The monopolist
has a marginal cost of $20 per unit and a fixed cost of $100.

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a. If the monopolist charges a linear or single price, what are its price, quantity and profit? What is
the resulting DWL? Show on a diagram.

b. What if the monopolist gets taxed by the government at a per unit rate of $20. Now what are the
monopolist’s price, quantity and profit? What is the resulting DWL? Explain your answer.

c. Now assume that instead of the per-unit tax, the government imposes a profits tax at a rate of
50%. What is the outcome in this case? Explain.

a. q = 40, p = 60, Profit = $1500, DWL = $800

b. Now, q = 30, P (to consumers) = 70, profit = 800 and DWL = 1250.

c. The output, price and DWL are the same as in part (a). The firm’s profits are $750.

2. Consider the market for guns in Australia. Assume that because some of these guns fall into the
hands of criminals, there is a negative consumption externality. Illustrate this market on a diagram,
and explain the resulting DWL from the market outcome. What is a possible government
intervention from the government? Under what circumstances would the optimal level of guns
traded be zero? Explain.

See lecture notes on negative consumption externalities. For zero trade to be optimal the negative
consumption externality at q = 0 needs to be at least as large as the gap between the PMB curve and
the PMC curve.

3. Define Nash equilibrium. Give an example of a prisoners’ dilemma in a business context. Explain
why your game is a prisoners dilemma.

Nash equilibrium – every player has adopted their best response to the strategies of all the other
players in the game.

Prisoners’ dilemma – every player has a strictly dominant strategy; there is a unique nash
equilibrium; in the NE total surplus is not maximised.

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