PRACTICE EXAM 1, 2015

PRINCIPLES OF ECONOMICS

PART ONE: MULTIPLE-CHOICE QUESTIONS

Answer all 20 questions using the multiple-choice answer sheet provided.

Choose the best response to each question.
This Part is worth 20 marks.
Each question is worth 1 mark.

1. Which of the following is a normative statement?

A. The inflation rate is at a historically high level.
B. The economic growth rate is presently 6.3%.
C. Market analysts expect the natural rate of unemployment to fall.
D. An unemployment rate of 15% is morally disgusting and anyone who thinks
otherwise should be burnt at the stake.
E. The unemployment rate on Alderaan has risen rapidly.

2. Which of the following is a macroeconomic variable?

A. The unemployment rate.
B. The inflation rate.
C. The economy’s growth rate.
D. The price of broad swords.
E. A, B and C.

3. The slope of a production possibility frontier for goods X and Y indicates:

A. The opportunity cost of producing an additional unit of X.
B. The marginal cost of producing an increment of X in terms of an increment
of Y.
C. The rate at which X and Y can be produced.
D. The speed at which X can be produced relative to Y.
E. Both A and B.

4. If the production possibility frontier were to shift outwards from the origin, this would
indicate that:
A. Technological innovation had occurred.
B. Unemployment had increased.
C. Underemployment had fallen.
D. A war with ISIS had destroyed the Kingdom of Saudi Arabia.
E. Labour force productivity had declined.

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5. If the price of oil decreases, other things being equal, price for petrol will:
A. Not change. Only the quantity demanded will change.
B. Increase, because the goods are substitutes.
C. Decrease because the goods are substitutes.
D. Decrease, because the goods are complements.
E. Decrease, because oil is an input in petrol production.

6. An increase in the demand for hamburgers, an inferior good, can be caused by:
A. A decrease in consumer income
B. An increase in the price of steak
C. An increase in the price of fries
D. An increase in consumer income
E. An increase in the number of songs plagiarized by Pharrell Williams.

7. Suppose the government sets a price ceiling on petrol. Which of the following will most
likely be the result (ceteris paribus)?
A. The quantity of petrol demanded will be greater than quantity supplied.
B. There will be a shortage of petrol.
C. There will be a surplus of petrol.
D. The quantity of petrol supplied will be equal to quantity demanded.
E. The profits of oil refining companies will increase.

8. If the equilibrium price of good X is $15 and a price floor is imposed at $14, the result
will be:
A. Equality of quantity demanded and quantity supplied.
B. Impossible to determine.
C. An over-supply of good X.
D. A shortage of good X.
E. A decrease in the production of Wild Fire.

9. Suppose the price of pizzas rises 5% and the number of pizzas sold falls by 1%. The
demand for pizza is:
A. Price elastic.
B. Unit price elastic.
C. Perfectly price elastic.
D. Price inelastic.
E. An illusion manufactured by the Big Pizza Illuminati.

10. If the price of tennis racquets rises from $100 per racquet to $110, and as a result, the
number of tennis racquets sold falls from 1 million to 900,000, then the price
elasticity of demand is:
A. Perfectly price elastic.
B. Perfectly price inelastic.
C. Unit price elastic.
D. Price elastic.
E. Price inelastic.

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11. The law of diminishing marginal returns to labour over the short run:
A. Accounts for the falling average fixed cost curve.
B. Explains why the short run marginal cost curve eventually slopes upwards.
C. Shows that at some point each additional worker is less competent than
the previous worker.
D. Says that after some point, the probability of Sean Bean’s character
surviving in a movie diminishes.
E. Is a well-established, universally applicable empirical fact.

12. If a firm has total revenue of $300 million, explicit costs of $200 million and implicit
costs of $100 million, its economic profit is:
A. $0.
B. $100 million.
C. $200 million.
D. $300 million.
E. $500 million.

13. If in the long run, a competitive firm’s average cost equals the price it charges for its
output, it is:
A. Making a profit.
B. Making a loss.
C. Making a milkshake.
D. Breaking even.
E. Underperforming.

14. Under monopoly:

A. Consumer surplus is always larger than the producer surplus.
B. There is a deadweight loss of economic welfare.
C. The government legally restricts entry into the market on behalf of the
company owners.
D. Can choose from a variety of slightly heterogeneous substitutes offered by
a few suppliers.
E. There are no barriers to entry.

15. A monopoly can result because of:

A. The exclusive ownership of a vital resource.
B. A legal patent over a good is shared with another large firm.
C. Government regulations preventing new competitors entering the market.
D. Substantial economies of scale.
E. A, B, C and D.

16.A natural monopoly is due to:

A. Economies of scale and relatively limited demand.
B. Diseconomies of scale preventing new firms from entering the market.
C. Pharrell Williams claiming ownership over everything made by everyone
else.
D. High company taxes.
E. Legal barriers to entry.

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 17. Substantial economies of scale are graphically represented by:
A. An upward sloping (left to right) marginal cost curve.
B. A U-shaped average cost curve.
C. A downward sloping (left to right) average cost curve.
D. An upward sloping (left to right) average fixed cost curve.
E. Pharrell Williams plagiarizing Marvin Gaye.

18. Assume the existence of a monopoly, which faces a constant marginal cost of $10 at
all levels of output. Assume the monopolist faces a downward-sloping straight-line
demand curve: at the price of $20, quantity demanded is zero; and at the price of $0,
the quantity demanded is 20. What is the optimal output for the monopolist to
produce?
A. 5.
B. 10.
C. 15.
D. 20.
E. 25.

19. Refer to Figure 1. In the long run, the price-quantity combination of this
monopolistically competitive firm will tend to towards:
A. DE
B. CG
C. BF
D. AH
E. How would I know?

20. A rational firm maximizes short-run profit by following which of the following rules?
A. Produce output which that MC = AR.
B. Produce output which that MC = P.
C. Produce output which that MC = MR.
D. Produce output which that MC > MR.
E. Produce output which that CSI > NCIS.
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 PART TWO: SHORT-ANSWER QUESTIONS

Attempt all 5 questions in this part in the Answer Booklet provided.

This Part is worth 35 marks.
Each question is worth 7 marks.

Question 1

1.1. If a price floor were imposed on a competitive market, what would be the
effect on the producer surplus and total economic surplus areas? (Use a typical
demand-supply curve diagram in your answer.)
1.2. Explain why the slope of the demand curve is important to determining the
effect of the price floor on the change in the size of consumer surplus area. (You can
use a diagram if you wish.)
1.3. Describe a situation where you think the imposition of a price floor would be
acceptable.

Question 2

2.1. Using average and marginal cost curves show a firm in a perfectly competitive
market in long run equilibrium. (Draw a diagram and explain it.)
2.2. Using average and marginal cost curves show a firm in a monopolistically
competitive market in long run equilibrium. (Draw a diagram and explain it.)
2.3. Use Payoff Matrix 1 to explain why it would be rational for each firm to charge
the low price, even though both of them could make more profit if they both chose to
charge to the high price.

Payoff Matrix 1
Firm Y: high price Firm Y: low price
Firm X: high price $5m, $5m $0, $18
Firm X: low price $18m, $0 $1, $1

Question 3

3.1. Define "recession". When was Australia’s last recession?

3.2. If annual real GDP growth is 8% and the annual inflation rate at 2%, what was
the nominal GDP growth rate?
3.3. Is continuous economic growth desirable? Why or why not?

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Question 4

4.1. What are the main components of aggregate expenditure used to calculate
nominal GDP? What are the main income categories used to calculate nominal
GDP?
4.2. What is the link between cyclical unemployment, wage growth and the
inflation rate?
4.3. What is price deflation? Is it desirable?

Question 5

5.1. How can the government stimulate the economy in the short run?
5.2. What tends to happen to tax revenue and social security payments over the
course of a business cycle?
5.3. Draw the Keynesian income-expenditure model of the economy showing the
equilibrium level of real GDP below the full employment level of output. How could
the RBA eliminate the cyclical unemployment? Show the effect diagrammatically.