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READING 13: ELASTICITY

1. When the demand curve is represented by a horizontal straight line, price elasticity of demand is said to be: A. Perfectly elastic B. Relatively inelastic C. Unit elastic 2. When the price elasticity of demand lies between zero and 1, demand is said to be: A. Relatively inelastic B. Relatively elastic C. Perfectly elastic 3. Consider the following statements: Statement A: If close substitutes are easily available for a particular good, price elasticity of demand for the good will be relatively elastic. Statement B: If a relatively large proportion of a persons income is spent on a particular good, price elasticity of demand for that good is most likely relatively high. Which is the following is most likely: A. Both statements are incorrect B. Both statements are correct C. Only one statement is correct 4. A high positive value for the cross elasticity of demand most likely indicates that: A. The two goods are very close substitutes B. The two goods are relatively weak substitutes C. The two goods are complements 5. If consumption of two goods is completely unrelated, which of the following is most likely to equal zero? A. Price elasticity of demand B. Cross elasticity of demand C. Income elasticity of demand 6. Consider the following statements: Statement A: For a normal good income elasticity of demand is always positive. Statement B: For an inferior good, income elasticity of demand is always negative.

Which is the following is most likely: A. Both statement are incorrect B. Both statements are correct C. Only one statement is correct. 7. For which of the following goods will a decrease in income most likely lead to a consumer spending a lower proportion of her income on the good? A. A good for which income elasticity of demand equals +1.5 B. A good for which income elasticity of demand equals -1.5 C. A good for which income elasticity of demand equals +0.5 8. Consider the following statements: Statement A: If price elasticity of demand for a good equals 1.25, an increase in price will decrease total revenue. Statement B: If a decrease in price leads to a decrease in total revenue, demand for the good is price elastic Which is the following is most likely: A. Only Statement A is incorrect B. Only Statement B is incorrect C. Both Statements are incorrect. 9. In response to an increase in price from $3.50 to $4.20, the quantity demanded for a product falls from 120 to 90 units. Which of the following is most likely regarding the value and interpretation of price elasticity of demand for the good? Value Interpretation A. -1.57 Inelastic. B. -1.25 Elastic. C. -1.57 Elastic. 10. If the price elasticity of demand for a good equals 2.5, a 15% increase in its price would most likely result in a: A. 37.5% increase in the quantity demanded. B. 6% decrease in the quantity demanded. C. 37.5% decrease in the quantity demanded. 11. Income elasticity of demand is defined as the change in: A. Income in response to a change in the quantity demanded. B. Quantity demanded in response to a change in market price. C. Quantity demanded in response to a change in income.

12. The percentage change in demand for a good divided by the percentage change in the price of another good is known as the: A. Cross elasticity of demand. B. Income elasticity of demand. C. Price elasticity of demand. 13. When household incomes fall and the demand for a particular product goes up, the product is most likely a: A. Necessity. B. Normal good. C. Inferior good. 14. Price elasticity is defined as the: A. Change in quantity demanded divided by the change in income. B. Percentage change in quantity demanded divided by the percentage change in price C. Percentage change in price divided by the percentage change in quantity demanded. 15. If the demand curve for a given product is a downward-sloping straight line: A. Demand is less elastic at higher prices. B. Demand is more elastic at higher prices. C. Elasticity is constant along the demand curve. 16. For a linear demand curve, at the price where elasticity equals 2.5, decreasing prices will most likely: A. Increase total revenue. B. Have no effect on total revenue. C. Decrease total revenue. 17. Which of the following most accurately describes elasticity of supply? Elasticity of supply is the percentage change in the quantity supplied divided by the percentage change in: A. Price and it equals zero when supply is perfectly elastic. B. Price and it equals zero when supply is perfectly inelastic. C. Quantity demanded and it equals infinity when supply is perfectly inelastic. 18. Which of the following is least likely to affect the elasticity of supply for a good? A. The relative amount of income spent on the good. B. The uniqueness of production inputs. C. The time frame for making the supply decision. 19. Which of the following is most likely to affect the elasticity of demand for a good? A. The time elapsed since a price change. B. The time frame for making the supply decision.

C. The availability of raw materials. 20. A good has a price elasticity of demand of 1.2. In response to an increase in price of 30%, quantity demanded will change from 150 units to: A. 104.24 B. 195.76 C. 96

READING 14: EFFICIENCY AND EQUITY

1. When marginal social benefit exceeds marginal social cost, there is most likely: A. An efficient allocation of resources in society B. A surplus and a dead weight loss from overproduction. C. A shortage and a dead weight loss from underproduction. 2. Which of the following obstacles to efficiency is least likely to result in a dead weight loss from overproduction? A. Common resources B. External costs C. Transaction costs 3. Which of the following most accurately describes the utilitarian and symmetry principles? Symmetry Principle Equality of opportunity Equality of wealth Equality of tax burden Utilitarian Principle Equality of wealth Equality of opportunity Equality of wealth

A. B. C.

4. Justine is willing and able to pay $80 for a handbag when the market price equals $55. The $25 difference is most likely: A. Producer surplus B. Producer deficit C. Consumer surplus 5. A system in which the central authority determines resource allocation is referred to as a(n): A. Allocation by force B. Majority rule system C. Command system 6. If the marginal benefit from consuming the fourth unit of a good is $20, and the marginal cost from consuming it equals $25, which of the following statements is least accurate? A. The competitive equilibrium market price is less than $25. B. The competitive equilibrium market price is more than $20. C. Production of the fourth unit will increase efficiency in society. 7. Which of the following most accurately describes efficient resource allocation in an unregulated economy? A. Consumer surplus is maximized. B. Consumer surplus equals producer surplus. C. The sum of producer and consumer surplus is maximized.

8. As the marginal benefit curve becomes more elastic, assuming that equilibrium price and quantity remain unchanged, consumer surplus: A. Increases B. Remains unchanged C. Decreases 9. In a competitive market, the gains to society are maximized under which of the conditions described below? A. MB = $1.50; MC = $1.50; CS = $45; PS = $30. B. MB = $2.50; MC = $2.50; CS = $35; PS = $35. C. MB = $1.25; MC = $1.00; CS = $15; PS = $15.

READING 15: MARKETS IN ACTION

1. When a rent ceiling is imposed below the equilibrium market price, which of the following is most likely? A. Equilibrium price falls while equilibrium quantity increases B. Equilibrium price rises while equilibrium quantity falls C. Equilibrium price and quantity both fall. 2. When a rent ceiling is imposed below the equilibrium market price, which of the following is least likely? A. Consumer surplus increases B. Producer surplus increases C. Consumer surplus decreases 3. When a minimum wage is imposed above the equilibrium market price, which of the following is most likely? A. Equilibrium price falls while equilibrium quantity increases B. Equilibrium price rises while equilibrium quantity falls C. Equilibrium price and quantity both rise. 4. When a minimum wage is imposed below the equilibrium market price, which of the following is most likely? A. Consumer and producer surplus remain unchanged B. Consumer surplus increases C. Consumer surplus decreases 5. Consider the following statements: Statement A: If demand is perfectly inelastic, consumers bear the entire burden of a tax. Statement B: If supply is relatively more elastic than demand, producers bear the greater burden of the tax regardless of who the law levies the tax upon. Which is the following is most likely: A. Both statement are incorrect B. Only Statement A is correct. C. Only Statement B is correct. 6. A subsidy most likely results in: A. A deadweight loss from underproduction B. An increase in consumer and producer surplus

C. An increase in producer surplus but a decrease in consumer surplus 7. A production quota least likely results in: A. An increase in profits for producers. B. A deadweight loss from underproduction C. Lower prices 8. For an illegal good, if the penalty imposed on producers is greater than the penalty imposed on consumers, equilibrium price and output would most likely: A. Both rise B. Both fall C. Price would rise but quantity would fall. 9. A price ceiling set above the equilibrium price will most likely: A. Lead to a deadweight loss due to underproduction B. Have no effect on market activity C. Lead to a deadweight loss due to overproduction 10. An example of a price ceiling is: A. Minimum wage B. Quota C. Rent control 11. Quotas placed above the equilibrium quantity: A. Lead to a deadweight loss due to overproduction B. Have no effect on market activity. C. Lead to a deadweight loss due to underproduction 12. A subsidy most likely: A. Shifts the demand curve to the right B. Leads to a dead weight loss from underproduction C. Leads to a dead weight loss from overproduction 13. A tax on a good or service is least likely to: A. Increase the equilibrium quantity B. Decrease the equilibrium quantity C. Increase the equilibrium price 14. Penalties on the consumption of an illegal good will most likely: A. Shift the demand curve to the right B. Decrease the equilibrium quantity of output C. Increase equilibrium price

15. If a minimum wage is set above the equilibrium wage rate, it will most likely result in: A. A shortage of workers. B. An increase in unemployment. C. An increase in consumer surplus. 16. Two analysts are discussing how the efficient quantity of output for a good is determined. They make the following statements: Statement 1: The equilibrium quantity of output for a good can be considered efficient as long as its marginal social benefit is greater than its marginal social cost. Statement 2: Subsidies and quotas typically result in an equilibrium quantity at which the marginal social cost exceeds the marginal social benefit. With respect to these statements: A. Both are correct B. Both are incorrect C. One of them is correct

READING 16: ORGANIZING PRODUCTION

1. Which of the following is least likely an implicit cost of production? A. Normal profit B. Economic depreciation C. Rent on premises 2. Which of the following is most likely an implicit cost of production? A. Staff salaries B. Forgone interest C. Interest on bank overdraft. 3. The positioning of competing products in the industry as lower-priced alternatives is most likely an example of: A. Information constraints B. Technology constraints C. Market constraints 4. Which of the following types of business organizations is least likely to put owners entire wealth at risk? A. Corporation B. Partnership C. Proprietorship 5. A low four-firm concentration ratio (less than 40%) for an industry most likely suggests that the industry : A. Is dominated by a few, large players B. Is relatively competitive C. Has high barriers to entry

6. A high HH Index level (above 1800) for an industry most likely suggests that the industry : A. Is dominated by a few, large players B. Is relatively competitive C. Has high barriers to entry 7. Which of the following is most likely an implicit cost? A. Labor salaries and wages. B. The opportunity cost of the owners time and effort. C. Office rent.

8. Economic profits most likely equal zero when: A. The implied rental rate on capital equals forgone interest. B. Implicit costs equal explicit costs. C. Total revenue equals the sum of all opportunity costs. 9. Assume that a firm generates $125 million in total revenue by using $40 million in labor and materials. The value of the firms buildings fell from $2 million to $1.8 million during the period. Further, the firm forgoes $300,000 in interest and normal profit equals $140,000. The economic profit of this firm is closest to: A. $124,360,000. B. $82,760,000. C. $84,360,000. 10. Which of the following statements most accurately describes technological and economic efficiency? A. For a given level of output, the technologically efficient method of production uses the least number of input units, while the economically efficient method entails the lowest possible cost. B. For a given level of output the technologically efficient method of production uses the least number of labor units, while the economically efficient method uses the least number of capital units. C. A production method cannot be technologically efficient without being economically efficient at the same time. 11. Which of the following is most likely to be used to counter the principal-agent problem in a corporation? A. Incentive-based compensation schemes. B. Short-term employment contracts. C. Flat hourly wages. 12. Which of the following organizational structures most likely has the lowest cost of raising external capital? A. Corporations. B. Partnerships C. Proprietorships. 13. Industry A has a Herfindahl-Hirschman Index (HHI) of 350, while Industry B has a four-firm concentration ratio equal to 50%. Which of the following statements most accurately describes these two industries? A. Industry A is relatively more competitive than Industry B. B. Industry B has a larger number of firms than Industry A. C. Both the industries are relatively uncompetitive. 14. Which of the following statements most accurately describes why firms can usually coordinate economic activity more efficiently than markets? Firms benefit from:

A. A higher number of market transactions. B. Diseconomies of scope. C. Economies of team production. Use the following information regarding Magma Corporation to answer Questions 15 and 16:

Total revenues = $4,200,000 Electricity = $380,000 Wages = $250,000 Interest expense = $170,000 Interest forgone = $38,000 Depreciation (straight line) = $100,000 Market value of assets at the beginning of the year = $780,000 Market value of assets at the end of the year = $700,000 Normal profit = $60,000

15. Magma Corporations accounting profit is closest to?

A. $3,320,000 B. $3,262,000 C. $3,300,000

16. Magma Corporations economic profit is closest to?

A. $3,222,000 B. $3,122,000 C. $3,282,000

17. Which of the following production methods is least likely technologically efficient?

Method

Quantities of inputs Labor Capital 80 180 180

A B C

200 200 100

18. Which of the following production methods is most likely economically efficient? Each of them produces 10,000 units per day.

Method

Quantities of Inputs Labor Capital 100 200 300

Cost per Unit of Input Labor ($) 5 10 15 Capital ($) 15,000 10,000 5,000

A B C

20,000 15,000 10,000

READING 17: OUTPUT AND COSTS

1. If total product (TP) is increasing at an increasing rate, which of the following is most likely? A. AP and MP must be increasing as well. B. MP must be increasing, but AP could be increasing or decreasing C. AP must be increasing, but MP could be increasing or decreasing. 2. If total product (TP) is increasing at a decreasing rate, which of the following is most likely? A. AP and MP must be increasing as well. B. MP must be decreasing, but AP could be increasing or decreasing C. AP must be increasing, but MP could be increasing or decreasing. 3. All points on which of the following curves most likely indicate technologically efficient levels of output? A. Total product B. Average product C. Marginal product 4. Which of the following cost curves is least likely U-shaped? A. Short run average fixed cost B. Long run total cost C. Short run average variable cost 5. Which of the following is most likely to be falling as MP increases? A. Total product B. Average product C. Marginal cost 6. Which of the following is most likely to be rising as AP falls? A. Average variable cost B. Marginal product C. Average total cost. 7. Which of the following cost curves is least likely to shift if there is an increase in the firms fixed costs? A. TC B. MC C. AFC 8. Which of the following factors of production is most likely to be variable in the short run?

A. Labor. B. Technology. C. Plant size. 9. The short run is most likely defined as: A. The period for which the quantities of all factors of production are fixed. B. The period for which the quantity of at least one factor of production is fixed. C. The time frame within which working capital decisions cannot be altered. 10. If employment of the last unit of labor increases total product, it implies that the marginal product of that unit of labor is: A. Falling. B. Increasing. C. Positive. 11. When marginal product (MP) is at its maximum, it is most likely that: A. Average product intersects it from above. B. Average variable cost is at its minimum. C. Marginal cost is at its minimum. 12. Which of the following most accurately describes the relationship between marginal product (MP) and average product (AP)? As the quantity of labor increases: A. Initially MP exceeds AP, and later AP exceeds MP. B. Initially AP exceeds MP, and later MP exceeds AP. C. MP interests AP from above through its minimum point. 13. When average product is at its maximum, it is most likely that: A. Average variable cost is at its minimum. B. Marginal product is less than AP. C. Marginal cost is at its minimum. 14. Typically, the marginal product of labor: A. Increases proportionately to output. B. Increases initially, then reaches its peak, and later declines. C. Decreases initially, then reaches a minimum, and later rises. 15. When the marginal cost curve lies above the average cost curve, it is most likely that: A. Average cost is rising. B. Average cost is at its minimum. C. Average cost is falling.

16. If output increases at a decreasing rate as more units of capital are added to a given quantity of labor, the firm is most likely suffering from: A. Diminishing marginal returns to capital. B. Diminishing marginal returns to labor. C. Diseconomies of scale. 17. The upward sloping region of a firms planning curve most likely represents the existence of: A. Economies of scale. B. Diseconomies of scale. C. Minimum efficient scale. Use the following information to answer Questions 18 to 22. Assume that labor is the only variable factor of production.

Quantity of Labor 0 2 4 6

Total Product 0 10 24 -

Marginal Product 0 4

Average Product

5 -

18. The marginal product of the 2nd unit of labor is closest to?

A. 10 B. 7 C. 5

19. The marginal product of the 4th unit of labor is closest to?

A. 6 B. 7 C. 14

20. The average product of labor when four units of labor are hired is closest to?

A. 14

B. 12 C. 6

21. Total product when six units of labor are hired is closest to?

A. 32 B. 28 C. 30

22. Average product when six units of labor are hired is closest to?

A. 4.67 B. 5.33 C. 6

Use the following information to answer Questions 23 to 31. Assume that labor is the only variable factor of production.

QL 0 2 4 6 8

TP 0 10 24 -

TFC 200

TVC 0 960

TC 200 440 -

AFC 0 6.25 -

AVC 0 -

ATC 0 28.75 -

MC 0 17.143 60

23. Average fixed cost when two units of labor are hired is closest to?

A. $100 B. $24 C. $20

24. Average variable cost when two units of labor are hired is closest to?

A. $24 B. $20 C. $120

25. Average total cost when two units of labor are hired is closest to?

A. $220 B. $24 C. $44

26. Marginal cost when two units of labor are hired is closest to?

A. $240 B. $24 C. $20

27. Average variable cost when four units of labor are hired is closest to?

A. $20 B. $10 C. $48

28. Average total cost when four units of labor are hired is closest to?

A. $10 B. $28 C. $68

29. Marginal product when six units of labor are hired is closest to?

A. 4 units B. 8 units C. 32 units

30. Marginal cost when six units of labor are hired is closest to?

A. $240 B. $24 C. $30

31. Average total cost when eight units of labor are hired is closest to?

A. $24 B. $32 C. $29

READING 18: PERFECT COMPETITION

1. Which of the following is least likely an assumption of perfect competition? A. There are a large number of buyers and sellers in the market. B. Each producer makes a differentiated product. C. There is perfect information. 2. Which of the following is most likely in the long run in perfect competition? A. Price equals marginal cost B. Price is greater than marginal revenue C. Price is greater than average total cost 3. Compared to a short run scenario where firms are making economic profits, in the long run in a perfectly competitive industry there are most likely: A. Fewer firms with each firm producing a lower output and the industry producing a larger output. B. More firms with each firm producing a lower output and the industry producing a larger output C. More firms with each firm producing a higher output and the industry producing a larger output. 4. In the long run, a permanent decrease in demand in perfect competition most likely leads to: A. A lower number of firms in the industry, lower equilibrium output in the industry, lower prices and normal profits. B. A lower number of firms in the industry, lower equilibrium output in the industry, restoration of original price levels and normal profits. C. A greater number of firms in the industry, higher equilibrium output in the industry, higher prices and normal profits. 5. The long run supply curve is most likely upward sloping for: A. Constant-cost industries B. Decreasing-cost industries C. Increasing-cost industries 6. In the long run, perfect competition most likely achieves: An Efficient Scale of Production Yes No Yes Allocative Efficiency No Yes Yes

A. B. C.

7. The industry demand curve in a perfectly competitive market is most likely:

A. Upward sloping. B. Horizontal (perfectly elastic). C. Downward sloping. 8. In perfect competition, the price of the product is most likely determined by: A. The producers of the product. B. Market supply and demand. C. Consumers. 9. Firms in perfect competition will most likely increase their total output until: A. Marginal cost equals price. B. Marginal revenue equals average total cost. C. Total revenue equals price. 10. Which of the following is most likely regarding the relationship between price (P), marginal cost (MC), and marginal revenue (MR) at the profit maximizing output level for a firm in perfect competition? A. MC < MR < P B. P = MC = MR. C. P > MC = MR.

11. A firm in perfect competition will most likely continue to operate in the short run as long as: A. Marginal revenue exceeds average variable cost. B. Price exceeds average total costs. C. Marginal revenue equals marginal cost. 12. In the long-run, a firm operating in perfect competition will most likely: A. Generate no economic profits. B. Produce a quantity where marginal revenue is greater than marginal cost. C. Face a perfectly inelastic demand curve. 13. Which of the following statements is least likely? A. Firms in perfect competition are price-takers. B. Perfect competition results in an efficient scale of production. C. Constant-cost industries have a perfectly inelastic long run supply curve. 14. Which of the following is least likely as a result of technological advancement in a perfectly competitive industry? A. The costs for individual firms increase. B. Consumers benefit from lower prices.

C. The industry supply curve shifts to the right.

READING 19: MONOPOLY

1. Typically, is a monopoly likely to achieve: An Efficient Scale of Production No No Yes Allocative Efficiency No Yes Yes

A. B. C.

2. Which of the following statements about monopolies is least accurate? A. A monopolys profit maximizing quantity is at the point where marginal revenue equals marginal cost. B. A Monopoly charges the highest possible price. C. A monopoly sells a product for which there are no close substitutes. 3. Which of the following is most likely regarding a monopoly? A. A monopoly only works in the region of the demand curve where it is relatively elastic. B. The MR curve for a single-price monopoly is flatter than the demand curve that it faces. C. A natural monopoly is one whose fixed cost falls as output expands 4. Which of the following is most likely a consequence of perfect price discrimination? A. The output produced by a monopoly that can engage in perfect price discrimination is greater than the output that would be produced were the industry perfectly competitive. B. There is no consumer surplus if a monopoly engages in perfect price discrimination. C. Perfect price discrimination results in a dead weight loss to society. 5. Which of the following most likely describes the price and output produced under perfect competition relative to a single-price monopoly? Price A. Higher B. Lower C. Same Output Lower Higher Same

6. Which of the following most likely describes the price and output produced under perfect competition relative to perfect price discrimination by a monopoly? Price A. Lower B. Lower C. Same Output Same Higher Same

7. Which of the following pricing methods is also known as efficient regulation? A. Profit-maximizing price B. P = MC C. P = AC

8. Which of the following is least likely a potential gain from monopolies? A. Higher investment in R&D B. Economies of scope C. Active pursuit of rent seeking activities 9. Which of the following is least likely to be offered by the government to offset the losses a monopoly makes when it is forced to embrace marginal cost pricing? A. Two-part pricing B. Price discrimination C. Penalties on production

READING 20: MONOPOLISTIC COMPETITION AND OLIGOPOLY

1. Which of the following is least likely a characteristic of monopolistic competition? A. Low barriers to entry. B. Product differentiation C. Small number of firms. 2. Which of the following statements is least likely? A. Firms in monopolistic competition make economic losses when the AC curve lies above the demand curve. B. Firms in monopolistic competition can make economic losses or economic profits in the short run, but earn zero economic profits in the long run. C. Firms in monopolistic competition face relatively inelastic demand for their products. 3. Which of the following is most likely an advantage of monopolistic competition compared to perfect competition? A. More choice B. Excess capacity C. Markup. 4. Which of the following oligopoly models asserts that there is a break in a firms marginal revenue curve? A. Kinked-demand model. B. Dominant firm model. C. Game theory. 5. Which of the following is least likely a characteristic of an oligopoly? A. Firms in the industry are independent. B. Products can either be similar or differentiated. C. There are only a few producers in the industry. 6. In an oligopoly, if one firm cheats and the other respects the terms of a collusion arrangement, which of the following is most likely? A. The price received by the cheating firm will be greater than the price received by the complying firm. B. The output produced by the cheating firm will be the same as the output produced by the complying firm. C. The average cost of the cheating firm will be lower than the average cost of the complying firm. .

READING 21: MARKETS FOR FACTORS OF PRODUCTION

1. Which of the following statements is most likely? A. An increase in MRP of labor results in an increase in supply of labor. B. If the firm is a price-taker, the MRP of the labor it hires equals MP times the price. C. MRP of labor equals the change in total revenue divided by the quantity of labor employed. 2. A firm will most likely reduce the quantity of labor employed if: A. The wage rate equals MRP of labor. B. The wage rate is greater than MRP of labor. C. The wage rate is lower than the MRP of labor. 3. Which of the following least likely influences the demand for labor? A. The price of the firms output B. The prices of other factors of production. C. The size of the adult population in the economy. 4. Which of the following is most likely regarding the elasticity of demand for labor? A. Demand for labor is more elastic in the long run compared to the short run. B. The higher the proportion of labor costs in total production costs, the less elastic the demand for labor. C. The more elastic the demand for the final good, the less elastic the demand for labor. 5. Which of the following statements regarding an individuals labor supply curve is least likely: A. An individuals labor supply curve bends backwards due to the income effect. B. An individuals labor supply curve bends backwards due to the substitution effect. C. The decision to work and supply labor depends on the wage rate. 6. Compared to a competitive labor market, a monopsony in the labor market most likely results in: A. Higher wage rates and high quantities of labor employed. B. Lower wages and lower levels of labor employed. C. Lower wages and higher quantities of labor employed.

7. If a minimum wage is imposed on a monopsony in the labor market, which of the following is most likely? A. Equilibrium wage rates and the equilibrium quantity of labor rise. B. Equilibrium wage rates rise but the equilibrium quantity of labor falls. C. Equilibrium wage rates fall but the equilibrium quantity of labor rises. 8. Which of the following statements is least likely regarding a factors income? A. The more inelastic the supply curve, the greater the share of economic rent in the factors income. B. The more elastic the supply curve, the greater the share of opportunity cost in the factors income. C. The more elastic the demand for a factor of production, the higher its income. 9. Which of the following statements is most likely regarding the market for natural resources? A. The supply of a renewable resource is perfectly elastic. B. The flow supply of a renewable resource is perfectly elastic at the expected price in the next period. C. The flow supply of a non-renewable resource is perfectly elastic at the present value of the price expected in the next period. 10. Which of the following steps is least likely to be taken by a union in order to mitigate the reduction in the quantity of labor employed when wage rates increase? A. Try to make the demand for labor more elastic B. Support minimum wage laws C. Encourage import restrictions 11. The marginal cost of labor curve for a monopsony employer most likely: A. Rises faster than the supply of labor curve B. Rises slower than the supply of labor curve C. Is downward sloping 12. Demand for capital is least likely to be influenced by: A. Marginal revenue product of capital B. Interest rates C. Income

13. When a tax is imposed on a resource whose supply is perfectly elastic, which of the following is most likely? A. The buyer pays the entire tax and entire factor income is composed of opportunity cost. B. The seller pays the entire tax and entire factor income is composed of economic rent. C. The buyer pays the entire tax and entire factor income is composed of economic rent.

READING 22: MONTORING JOBS AND THE PRICE LEVEL

1. Which of the following is least likely a labor market indicator? A. The unemployment rate. B. The employment to population ratio. C. The consumer confidence index. 2. Which of the following statements is least likely? A. The natural rate of unemployment is composed of frictional and cyclical unemployment. B. The natural rate of unemployment is the unemployment rate that exists at full employment output. C. There is zero cyclical unemployment at the full employment level of output. 3. During an expansion: A. Real GDP exceeds potential GDP and unemployment is greater than the natural rate. B. Real GDP exceeds potential GDP and unemployment is lower than the natural rate. C. Real GDP is lower than potential GDP and unemployment is greater than the natural rate. 4. Which of the following is least likely a source of CPI bias: A. Outlet substitution. B. Quality changes. C. Spending pattern bias. 5. Spartica is a developing country in which 13 million are employed and 9 million are unemployed. Further, 5 million people are below the age of 16, while 6 million are older than 16, but not willing to work. The unemployment rate of Spartica is closest to? A. 41% B. 33% C. 23%

Use the following information to answer questions 6& 7: Basilia has 27 million people employed and 12 million people unemployed out of a total working-age population of 44 million. 6. Its labor force participation rate is closest to? A. 61.36% B. 84.38%

C. 88.64% 7. Its employment-to-population ratio is closest to? A. 88.64% B. 69.23% C. 61.36% 8. Which of the following people is least likely classified as unemployed? A. A person who has been temporarily laid off from a job to which she expects to be called back. B. A person who is without work and has not looked for a job for a month. C. A person who will be starting a new job in 20 days.

9. An analyst wants to calculate the CPI in the current period and gathered the following information to do so:

Item Shirts Bread Fuel

Quantity 100 200 150

Base Price ($) 10 5 20

Current Price ($) 15 10 30

The CPI in the current period is closest to? A. 160 B. 157 C. 63 10. An analyst gathered the following yearly information relating to a developing country:

Year

CPI

2007 2008 2009

122 150 174

The inflation rate for 2009 is closest to? A. 14% B. 18% C. 16%

READING 23: AGGREGATE DEMAND AND AGGREGATE SUPPLY

1. Which of the following statements most likely defines the macroeconomic long run and short run? A. Money wages are assumed constant in the long run, while real wages are assumed constant in the short run. B. Money wages and real wages are assumed constant in the long run, while only money wages are assumed constant in the short run. C. Money wages are assumed constant in the short run, while real wages are assumed constant in the long run. 2. Which of the following least likely explains a shift in the SRAS curve? A. Changes in the prices of factors of production. B. Changes in potential GDP. C. Changes in the prices of final goods and services. 3. Which of the following least likely explains why money wages can change? A. Changes in the level of unemployment. B. Changes in expected inflation. C. Past inflation rates. 4. Which of the following is least likely regarding the AD curve? A. An increase in expected future incomes increases AD. B. An increase in taxes increases AD. C. An increase in expected future profits increases AD. 5. Suppose an economy is initially operating at full employment. An increase in aggregate demand that takes short run equilibrium to a point beyond the economys potential output most likely results in: A. An increase in prices in the long run and the short run. B. An increase in prices in the long run, but no change in prices in the short run. C. An increase in prices in the short run, but no change in prices in the long run. 6. Suppose an economy is initially operating at full employment. A decrease in aggregate demand that takes the economy into a deflationary gap most likely results in: A. A decrease in output in the short run and the long run. B. An increase in output in the short run, but a decrease in output in the long run. C. A decrease in output in the short run, but no change in output in the long run. 7. Which of the following theories least likely asserts that wages are downward sticky? A. Keynesian. B. Classical. C. Monetarist.

8. Which of the following is most likely regarding the price level and potential output in response to an increase in imports for an economy? Prices A. Lower B. Higher C. Lower Potential Output Lower Higher Same

9. Which of the following theories most likely asserts that fluctuations in aggregate demand and aggregate supply are driven by technological changes? A. Keynesian. B. Classical. C. Monetarist. 10. According to the Keynesian school of macroeconomic thought, business cycles are most likely caused by: A. Changing expectations B. Inappropriate monetary policy C. Technological changes

11. The following information related to a developing economy: Consumption expenditure = $47 million Government expenditure =$102 million Investment expenditure = $62 million Exports = $77 million Imports = $83 million Taxes = $20 million The countrys aggregate demand is closest to? A. $185 million B. $205 million C. $288 million 12. Based on the following information, exports are closest to? Aggregate demand = $200 million Consumption expenditure = $25 million Government expenditure = $65 million

Investment expenditure = $70 million Imports = 32 million A. $8 million B. $40 million C. $72 million

READING 24: MONEY, THE PRICE LEVEL AND INFLATION

1. Which of the following is most likely considered in measures of money? A. Checks B. Checking account balances. C. Credit cards. 2. Which of the following most likely comprises the largest portion of the Feds liabilities? A. Federal Reserve Notes. B. Banks deposits. C. U.S. Government Securities. 3. The U.S. Federal Reserve bought $20,000,000 worth of U.S. Treasury securities from the open market. The reserve requirement is currently 20%. The effect of the Feds purchase on the U.S. money supply if there were zero excess reserves in the banking system is closest to: A. A $20,000,000 increase B. A $100,000,000 decrease C. A $100,000,000 increase 4. Which of the following factors is least likely to influence the demand for real money? A. Nominal interest rates. B. Real GDP. C. Price level. 5. Which of the following is least accurate regarding the money demand curve? A. A fall in interest rates reduces the opportunity cost of holding money and increases the quantity of money demanded. B. Financial innovation brings about a shift in the money demand curve. C. A change in real GDP causes a movement along the money demand curve. 6. Which of the following statements is least likely? A. Money-market equilibrium determines interest rates in the short run. B. Loanable-funds market equilibrium determines interest rates in the long run. C. Money market equilibrium determines price level in the short run. 7. Which of the following statements about the quantity theory of money is least likely? A. An increase in the quantity of money may cause a proportionate increase in prices. B. The quantity of money multiplied by the velocity equals prices. C. The velocity of money is determined by institutional factors. 8. Which of the following statements is most likely? A. If the required reserve ratio increases, the money multiplier will decrease. B. If the currency drain ratio increases, the money multiplier will increase. C. The currency drain ratio is the ratio of currency held by individuals to the amount of the loan taken.

9. Which of the following is least likely a policy tool available to the Fed to control the quantity of money to conduct monetary policy? A. Income tax rates. B. Open market operations. C. Required reserve ratio. 10. Which of the following statements regarding open market operations conducted by the Fed is least accurate? A. Money supply falls when the Fed purchases securities. B. Open market operations are used by the Fed to directly affect the monetary base. C. The multiplier effect is reduced when there is significant cash drain. 11. An increase in the discount rate will most likely lead to: A. A decrease in money supply B. An increase in money demand C. A decrease in money demand.

12. The Fed purchases $70 million in securities from the open market. Based on the following information, the maximum increase in the money supply that can result from this action is closest to? Required reserve ratio = 20% Desired reserve ratio = 30% Cash drain ratio = 70% A. 1.7 B. 1.89 C. 0.59 13. An analyst gathered the following information: Velocity of circulation = 4 times GDP = $1,600 billion The quantity of money is closest to: A. $400 million B. $6,400 billion C. $400 billion

14. An analyst obtained the following information from the Feds balance sheet: Gold and foreign exchange = $54 billion U.S. government securities = $700 billion Federal Reserve Notes = $760 billion Banks deposits = $32 billion The amount of loans to banks given that the above information reflects all the assets and liabilities of the Fed is closest to? A. $38 billion B. $60 billion C. $22 billion

Use the following information to answer Questions 15 and 16:

$ billions Notes and coins held by individuals and businesses Notes and coins held in banks Currency and checking deposits owned by the U.S. government Travellers checks Credit cards Checking deposits of individuals and businesses Time deposits Saving deposits Money market mutual funds balances 400 370 770 350 280 560 1,250 2,250 620

15. The M1 measure of money is closest to? A. $1,680 billion B. $1,310 billion C. $2,450 billion

16. The M2 measure of money is closest to? A. $5,430 billion

B. $6,570 billion C. $5,800 billion

READING 25: U.S. INFLATION, UNEMPLOYMENT AND BUSINESS CYCLES

1. Which of the following statements is most likely? A. In demand-pull inflation, the economy temporarily operates above potential output with an unemployment rate that is greater than the natural rate. B. In cost-push inflation, the economy temporarily operates below potential output with an unemployment rate that is lower than the natural rate. C. If the inflation rate is correctly forecasted in the long run, the economy will continue to operate at full employment. 2. Which of the following statements relating to cost-push inflation is least likely? A. The combination of rising price levels and decreasing GDP is known as stagflation. B. During a cost-push inflation spiral, the government faces a tradeoff between unemployment and real GDP. C. An economy temporarily operates in a deflationary gap during cost push inflation. 3. Which of the following least likely results in a shift in the short run Phillips curve? A. A change in the natural rate of unemployment. B. A change in the expected inflation rate. C. A change in real GDP. 4. Which of the following most likely causes a shift in the short run and long run Phillips curves? A. A change in the natural rate of unemployment. B. A change in real output. C. A change in the actual inflation rate. 5. As an economy slips into a recession, which of the following is most likely? A. Interest rates are high and there is a decrease in price and output as the economy operates below its potential. B. Interest rates are low and there is a decrease in price and output as the economy operate below its potential. C. Interest rates are low and there is an increase in price and output as the economy operates below its potential. 6. Which of the following statements is least likely regarding the mainstream business cycle theory? A. It assumes that aggregate demand grows at a steady rate, while potential GDP grows at a fluctuating rate. B. It asserts that prolonged business cycles are possible. C. It asserts the productivity shocks are not the main source of business cycles. 7. Which of the following statements is least likely regarding the real business cycle theory? A. It attributes the existence of business cycles to productivity shocks. B. It asserts that an increase in real interest rates in an expansion results in an increase in the supply of labor.

C. The key ripple effect is felt in the loanable funds market. 8. The Phillips Curve most likely illustrates: A. The relationship between inflation and unemployment. B. The relationship between price levels and real GDP. C. The relationship between unemployment and real GDP 9. Which of the following is least likely a criticism of real business cycle theory? A. The money wage rate tends to be sticky. B. The inter-temporal substitution effect tends to be strong C. Productivity shocks can also be caused by changes in aggregate demand.

READING 26: FISCAL POLICY

1. If potential real GDP is greater than the actual real GDP, which of the following statements would be least accurate? A. The economy is said to be undergoing a recession. B. The unemployment rate is above the natural rate of unemployment. C. The unemployment rate is below the natural rate of unemployment. 2. An expansionary fiscal policy is most likely associated with: A. A cyclical budget surplus B. A cyclical budget deficit C. A structural budget deficit 3. If the economy is in the downward sloping region of the Laffer curve, a decrease in income taxes will most likely: A. Increase tax revenue B. Have no effect on tax revenue C. Decrease tax revenue 4. Which of the following is least likely regarding the crowding-out effect? A. A budget deficit reduces real interest rates as the supply of loanable funds decreases. B. Budget deficits slow down the growth rate of real GDP. C. Budget deficits reduce the supply of loanable funds, which results in an increase in real interest rates. 5. The most likely discretionary fiscal policy in a recession is: A. To increase the money supply. B. To reduce government expenditure. C. To reduce taxes. 6. Which of the following is least likely an automatic fiscal policy stabilizer? A. Unemployment compensation B. Income taxes C. Real interest rates

7. Which of the following statements regarding automatic stabilizers is least accurate? A. They tend to take the budget towards a surplus in a recession and a deficit in an expansion. B. There is no administrative lag associated with them. C. They stimulate the economy during a recession and cool it down during an expansion. 8. An income tax cut would least likely lead to: A. An increase in potential output B. An increase in disposable incomes C. A decrease in aggregate demand 9. A decrease in taxes on capital income would most likely lead to: A. A decrease in savings B. An increase in potential output C. An increase in the growth rate of potential GDP 10. Which of the following statements is most accurate regarding the government expenditure multiplier and the tax multiplier? A. The effects of the government expenditure multiplier outweigh those of the tax multiplier, which makes the balanced budget multiplier positive. B. The effects of the government expenditure multiplier are less significant than those of the tax multiplier, which makes the balanced budget multiplier negative. C. The effects of the government expenditure multiplier exactly offset those of the tax multiplier, which makes the balanced budget multiplier equal zero. 11. An economy that has a potential output of $10 trillion and a natural rate of unemployment of 5% currently has a 7% unemployment rate. The economy has a structural budget surplus of $1 trillion. Which of the following is most likely? A. It has a cyclical deficit. B. It has a cyclical surplus C. It has a budget surplus.

READING 27 MONETARY POLICY

1. Which of the following is least likely a goal of the Feds monetary policy? A. Maximum employment B. Stable exchange rate C. Moderate long-term interest rates 2. Which of the following statements about an increase in the Federal Funds Rate (FFR) is most accurate? An increase in FFR: A. Causes an increase in the long-term rates, but the magnitude of the change is usually less than the change in the FFR itself. B. Causes long-term rates to increase by more than the change in FFR. C. Causes the long-term rates to increase by the same amount as the change in the FFR. 3. Which of the following is most likely to occur due to a decrease in FFR? A. The equilibrium quantity of money rises. B. The supply of loanable funds decreases. C. Aggregate demand decreases. 4. Which monetary policy is the Fed least likely to adopt in an expansion? A. Increase taxes. B. Increase FFR. C. Conduct an open market sale. 5. Which of the following problems is least likely associated with changing the FFR to stabilize an economy? A. The FFR change takes a long time to have an effect on inflation. B. Many factors other than real interest rates also affect the components of aggregate demand. C. There is a strong link between long term real interest rates and the FFR. 6. Which of the following monetary policy strategies most directly targets the growth rate in the monetary base? A. Money targeting rule B. McCallum rule C. K-percent rule.

7. A crawling peg is most likely an example of which of the following monetary policy strategies? A. Inflation targeting B. Exchange rate targeting C. Money targeting 8. When the Fed lowers the Fed Funds Rate, the exchange rate and aggregate demand most likely: Exchange Rate Aggregate Demand A. Falls Falls B. Increases Increases C. Falls Increases

READING 13: ELASTICITY

1. When the demand curve is represented by a horizontal straight line, price elasticity of demand is said to be: A. Perfectly elastic B. Relatively inelastic C. Unit elastic Answer: A A horizontal straight line demand curve has a price elasticity of infinity, which implies that demand is perfectly elastic

2. When the price elasticity of demand lies between zero and 1, demand is said to be: A. Relatively inelastic B. Relatively elastic C. Perfectly elastic Answer: A When the price elasticity of demand lies between zero and 1 demand is said to be relatively inelastic.

3. Consider the following statements: Statement A: If close substitutes are easily available for a particular good, price elasticity of demand for the good will be relatively elastic. Statement B: If a relatively large proportion of a persons income is spent on a particular good, price elasticity of demand for that good is most likely relatively high. Which is the following is most likely: A. Both statements are incorrect B. Both statements are correct C. Only one statement is correct Answer: B Both statements are correct.

4. A high positive value for the cross elasticity of demand most likely indicates that:

A. The two goods are very close substitutes B. The two goods are relatively weak substitutes C. The two goods are complements Answer: A A positive value for the cross elasticity of demand indicates that the two products are substitutes. Further, the high value for cross elasticity indicates that they are close substitutes.

5. If consumption of two goods is completely unrelated, which of the following is most likely to equal zero? A. Price elasticity of demand B. Cross elasticity of demand C. Income elasticity of demand Answer: B Cross elasticity of demand equals zero for goods that are unrelated. When the price of one good changes, the quantity demanded of the other remains unchanged.

6. Consider the following statements: Statement A: For a normal good income elasticity of demand is always positive. Statement B: For an inferior good, income elasticity of demand is always negative. Which is the following is most likely: A. Both statement are incorrect B. Both statements are correct C. Only one statement is correct. Answer: B Both statements are correct.

7. For which of the following goods will a decrease in income most likely lead to a consumer spending a lower proportion of her income on the good? A. A good for which income elasticity of demand equals +1.5 B. A good for which income elasticity of demand equals -1.5 C. A good for which income elasticity of demand equals +0.5

Answer: A When income elasticity is greater than +1, demand is said to be income elastic. As income decreases, a consumer spends a lower proportion of her income on the good.

8. Consider the following statements: Statement A: If price elasticity of demand for a good equals 1.25, an increase in price will decrease total revenue. Statement B: If a decrease in price leads to a decrease in total revenue, demand for the good is price elastic Which is the following is most likely: A. Only Statement A is incorrect B. Only Statement B is incorrect C. Both Statements are incorrect. Answer: B Statement A is correct. If a decrease in price leads to a decrease in total revenue, demand for the good is price inelastic.

9. In response to an increase in price from $3.50 to $4.20, the quantity demanded for a product falls from 120 to 90 units. Which of the following is most likely regarding the value and interpretation of price elasticity of demand for the good? Value Interpretation A. -1.57 Inelastic. B. -1.25 Elastic. C. -1.57 Elastic. Answer: C Percentage change in quantity demanded = [(90 - 120)] / [(90 + 120) / 2] = -30 / 105 = 0.2857 = -28.6% Percentage change in price = [(4.20 - 3.50)] / [(4.20 + 3.50) / 2] = 0.70 / 3.85 = 0.1818 = 18.2% -28.6 % / 18.2% = -1.57 Since the absolute value of price elasticity is greater than 1, the demand for the product is relatively elastic.

10. If the price elasticity of demand for a good equals 2.5, a 15% increase in its price would most likely result in a:

A. 37.5% increase in the quantity demanded. B. 6% decrease in the quantity demanded. C. 37.5% decrease in the quantity demanded. Answer: C Given the price elasticity of demand and the percentage change in price, we can solve for the percentage change in quantity demanded. Price elasticity of demand = (% change in Qd / % change in price) -2.5 = x / 15% x = -37.5% If you do not treat the value for elasticity as a negative number in the equation, then infer that since prices are rising, quantity demanded will fall.

11. Income elasticity of demand is defined as the change in: A. Income in response to a change in the quantity demanded. B. Quantity demanded in response to a change in market price. C. Quantity demanded in response to a change in income. Answer: C Income elasticity of demand is defined as the change in quantity demanded in response to a change in income.

12. The percentage change in demand for a good divided by the percentage change in the price of another good is known as the: A. Cross elasticity of demand. B. Income elasticity of demand. C. Price elasticity of demand. Answer: A Cross elasticity of demand is defined as the percentage change in demand for a good divided by the percentage change in the price of another good

13. When household incomes fall and the demand for a particular product goes up, the product is most likely a: A. Necessity. B. Normal good. C. Inferior good.

Answer: C When household incomes go down and the demand for a product rises, the product is an inferior good.

14. Price elasticity is defined as the: A. Change in quantity demanded divided by the change in income. B. Percentage change in quantity demanded divided by the percentage change in price C. Percentage change in price divided by the percentage change in quantity demanded. Answer: B Price elasticity of demand is defined as the percentage change in quantity demanded divided by the percentage change in price.

15. If the demand curve for a given product is a downward-sloping straight line: A. Demand is less elastic at higher prices. B. Demand is more elastic at higher prices. C. Elasticity is constant along the demand curve. Answer: B Elasticity is greater (absolute value) at higher prices along a linear, downward-sloping demand curve.

16. For a linear demand curve, at the price where elasticity equals 2.5, decreasing prices will most likely: A. Increase total revenue. B. Have no effect on total revenue. C. Decrease total revenue. Answer: A If the price elasticity of demand is 2.5, the percentage change in quantity demanded is greater than the percentage change in price. Therefore, a decrease in price will be more than offset by the increase in quantity demanded, and total revenue will increase.

17. Which of the following most accurately describes elasticity of supply? Elasticity of supply is the percentage change in the quantity supplied divided by the percentage change in: A. Price and it equals zero when supply is perfectly elastic.

B. Price and it equals zero when supply is perfectly inelastic. C. Quantity demanded and it equals infinity when supply is perfectly inelastic. Answer: B Elasticity of supply equals zero when the supply curve is a vertical line, which indicates perfectly inelastic supply.

18. Which of the following is least likely to affect the elasticity of supply for a good? A. The relative amount of income spent on the good. B. The uniqueness of production inputs. C. The time frame for making the supply decision. Answer: A Elasticity of supply is influenced by the time frame within which the supply decision is made and the ability to substitute productive resources. The proportion of income spent on the good has an effect on elasticity of demand.

19. Which of the following is most likely to affect the elasticity of demand for a good? A. The time elapsed since a price change. B. The time frame for making the supply decision. C. The availability of raw materials. Answer: A Elasticity of demand is influenced by the time elapsed since a price change. The time frame within which the supply decision is made and the ability to substitute productive resources are factors that influence elasticity of supply.

20. A good has a price elasticity of demand of 1.2. In response to an increase in price of 30%, quantity demanded will change from 150 units to: A. 104.24 B. 195.76 C. 96 Answer: A Price elasticity of demand = % change in Qd / % change in price -1.2 = x / 30%, x = -36% -36% = [(x - 150)] / [(x + 150) /2] x = 104.24

READING 14: EFFICIENCY AND EQUITY

1. When marginal social benefit exceeds marginal social cost, there is most likely: A. An efficient allocation of resources in society B. A surplus and a dead weight loss from overproduction. C. A shortage and a dead weight loss from underproduction. Answer: C When marginal social benefit exceeds marginal social cost, demand is greater than supply, which implies a shortage and a dead weight loss from underproduction.

2. Which of the following obstacles to efficiency is least likely to result in a dead weight loss from overproduction? A. Common resources B. External costs C. Transaction costs Answer: C When transaction costs are high, the market will usually underproduce. Common resources and external costs are examples of situations where dead weight losses arise due to overproduction.

3. Which of the following most accurately describes the utilitarian and symmetry principles?

A. B. C.

Symmetry Principle Equality of opportunity Equality of wealth Equality of tax burden

Utilitarian Principle Equality of wealth Equality of opportunity Equality of wealth

Answer: A The symmetry principle argues for equality of opportunity (its not fair if the rules are not fair), while the utilitarian principle argues for equality of wealth (its not fair if the results are not fair).

4. Justine is willing and able to pay $80 for a handbag when the market price equals $55. The $25 difference is most likely: A. Producer surplus B. Producer deficit

C. Consumer surplus Answer: C Consumer surplus is the difference between the amount a consumer is willing and able to pay for a product and what she actually pays for it (the market price).

5. A system in which the central authority determines resource allocation is referred to as a(n): A. Allocation by force B. Majority rule system C. Command system Answer: C In a command system, a central authority decides on the allocation of scarce resources.

6. If the marginal benefit from consuming the fourth unit of a good is $20, and the marginal cost from consuming it equals $25, which of the following statements is least accurate? A. The competitive equilibrium market price is less than $25. B. The competitive equilibrium market price is more than $20. C. Production of the fourth unit will increase efficiency in society. Answer: C If marginal cost of producing a unit of a good exceeds its marginal benefit, producing and selling the unit will actually result in a dead weight loss from overproduction and reduce efficiency. Choices A and B contain correct statements. The competitive equilibrium market price will lie between $20 and $25.

7. Which of the following most accurately describes efficient resource allocation in an unregulated economy? A. Consumer surplus is maximized. B. Consumer surplus equals producer surplus. C. The sum of producer and consumer surplus is maximized. Answer: C Resources are allocated efficiently when the sum of consumer and producer surplus is maximized.

8. As the marginal benefit curve becomes more elastic, assuming that equilibrium price and quantity remain unchanged, consumer surplus:

A. Increases B. Remains unchanged C. Decreases Answer: C As the marginal benefit curve becomes more elastic (becomes flatter), the area of the triangle between the y-axis, the market price and the demand curve decreases (assuming equilibrium price and quantity remain unchanged).

9. In a competitive market, the gains to society are maximized under which of the conditions described below? A. MB = $1.50; MC = $1.50; CS = $45; PS = $30. B. MB = $2.50; MC = $2.50; CS = $35; PS = $35. C. MB = $1.25; MC = $1.00; CS = $15; PS = $15. Answer: A An efficient allocation of resources occurs at the point where MB equals MC and the sum of producer and consumer surplus is maximized.

READING 15: MARKETS IN ACTION

1. When a rent ceiling is imposed below the equilibrium market price, which of the following is most likely? A. Equilibrium price falls while equilibrium quantity increases B. Equilibrium price rises while equilibrium quantity falls C. Equilibrium price and quantity both fall. Answer: C A rent ceiling that is imposed below the current equilibrium market price results in a reduction in both price and quantity. See analysis on pg 25-26 ESN Vol 2.

2. When a rent ceiling is imposed below the equilibrium market price, which of the following is least likely? A. Consumer surplus increases B. Producer surplus increases C. Consumer surplus decreases Answer: B A rent ceiling that is imposed below the current equilibrium market price results in a reduction in both price and quantity. Producers are adversely affected by both these movements, so producer surplus falls. As far as consumers are concerned, they benefit from lower prices, but suffer from lower quantities, so consumer surplus could increase or decrease depending on the relative change in price and quantity after the imposition of the ceiling.

3. When a minimum wage is imposed above the equilibrium market price, which of the following is most likely? A. Equilibrium price falls while equilibrium quantity increases B. Equilibrium price rises while equilibrium quantity falls C. Equilibrium price and quantity both rise. Answer: B A minimum wage that is imposed above the current equilibrium market wage rate results in an increase in price, but a decrease in equilibrium quantity. See analysis on pg 28-29 ESN Vol 2.

4. When a minimum wage is imposed below the equilibrium market price, which of the following is most likely?

A. Consumer and producer surplus remain unchanged B. Consumer surplus increases C. Consumer surplus decreases Answer: A A minimum wage that is imposed below the current equilibrium market wage rate has no impact on economic activity. Therefore, market equilibrium remains unchanged.

5. Consider the following statements: Statement A: If demand is perfectly inelastic, consumers bear the entire burden of a tax. Statement B: If supply is relatively more elastic than demand, producers bear the greater burden of the tax regardless of who the law levies the tax upon. Which is the following is most likely: A. Both statement are incorrect B. Only Statement A is correct. C. Only Statement B is correct. Answer: B Statement A is correct If supply is relatively more elastic that demand, consumers bear the greater burden of the tax (since demand is relatively more inelastic) regardless of whom the law levies the tax upon.

6. A subsidy most likely results in: A. A deadweight loss from underproduction B. An increase in consumer and producer surplus C. An increase in producer surplus but a decrease in consumer surplus Answer: B Subsidies result in a deadweight loss from overproduction. Even though there is an increase in consumer surplus (lower prices paid by consumer for higher quantities) and an increase in producer surplus (higher realized prices for producers with higher quantities sold) the combined increase in consumer and producer surplus does not offset the expenditure incurred by the government on the subsidy.

7. A production quota least likely results in: A. An increase in profits for producers.

B. A deadweight loss from underproduction C. Lower prices Answer: C A production quote restricts output and leads to higher prices.

8. For an illegal good, if the penalty imposed on producers is greater than the penalty imposed on consumers, equilibrium price and output would most likely: A. Both rise B. Both fall C. Price would rise but quantity would fall. Answer: C If the penalty on suppliers is greater than the penalty on buyers, prices would rise. The imposition of the penalty would reduce output in all cases.

9. A price ceiling set above the equilibrium price will most likely: A. Lead to a deadweight loss due to underproduction B. Have no effect on market activity C. Lead to a deadweight loss due to overproduction Answer: B In order for price ceilings to be effective, they should be set below the equilibrium market price. In that case, they lead to a deadweight loss from underproduction.

10. An example of a price ceiling is: A. Minimum wage B. Quota C. Rent control Answer: C Rent control is an example of price ceilings.

11. Quotas placed above the equilibrium quantity: A. Lead to a deadweight loss due to overproduction B. Have no effect on market activity. C. Lead to a deadweight loss due to underproduction

Answer: B In order for quotas to be effective, they should be set below the equilibrium quantity.

12. A subsidy most likely: A. Shifts the demand curve to the right B. Leads to a dead weight loss from underproduction C. Leads to a dead weight loss from overproduction Answer: C A subsidy shifts the supply curve to the right and results in a deadweight loss due to overproduction.

13. A tax on a good or service is least likely to: A. Increase the equilibrium quantity B. Decrease the equilibrium quantity C. Increase the equilibrium price Answer: A A tax, whether it is levied on consumer or producers, always results in a decrease in the equilibrium quantity of output.

14. Penalties on the consumption of an illegal good will most likely: A. Shift the demand curve to the right B. Decrease the equilibrium quantity of output C. Increase equilibrium price Answer: B Penalties on consumption of an illegal good will reduce demand for the good. This will decrease the equilibrium quantity of output and its price. This question does not mention any penalty on producers of the illegal good.

15. If a minimum wage is set above the equilibrium wage rate, it will most likely result in: A. A shortage of workers. B. An increase in unemployment. C. An increase in consumer surplus. Answer: B

When the minimum wage is set above the equilibrium wage rate, quantity supplied exceeds quantity demanded, resulting in an increase in unemployment. It also results in a reduction in consumer surplus.

16. Two analysts are discussing how the efficient quantity of output for a good is determined. They make the following statements: Statement 1: The equilibrium quantity of output for a good can be considered efficient as long as its marginal social benefit is greater than its marginal social cost. Statement 2: Subsidies and quotas typically result in an equilibrium quantity at which the marginal social cost exceeds the marginal social benefit. With respect to these statements: A. Both are correct B. Both are incorrect C. One of them is correct Answer: B Both statements are incorrect. An efficient quantity of output occurs at the point where MSB equals MSC (demand equals supply) and the sum of consumer and producer surplus is maximized. Quotas result in deadweight losses from underproduction (where MSB exceeds MSC). However, subsidies result in overproduction (where MSC exceeds MSB).

READING 16: ORGANIZING PRODUCTION

1. Which of the following is least likely an implicit cost of production? A. Normal profit B. Economic depreciation C. Rent on premises Answer: C Rent on premises is an explicit cost of production.

2. Which of the following is most likely an implicit cost of production? A. Staff salaries B. Forgone interest C. Interest on bank overdraft. Answer: B Foregone interest is a part of the implicit rental rate of capital, which is a part of implicit costs.

3. The positioning of competing products in the industry as lower-priced alternatives is most likely an example of: A. Information constraints B. Technology constraints C. Market constraints Answer: C The marketing strategy and positioning of competing products are examples of market constraints on a firms profits.

4. Which of the following types of business organizations is least likely to put owners entire wealth at risk? A. Corporation B. Partnership C. Proprietorship Answer: A

Shareholders in a corporation enjoy limited partnership, which means that their legal obligations are limited to the amount of money that they have invested in the company

5. A low four-firm concentration ratio (less than 40%) for an industry most likely suggests that the industry : A. Is dominated by a few, large players B. Is relatively competitive C. Has high barriers to entry Answer: B A low four-firm concentration ratio (less than 40%) for an industry most likely suggests that the industry has a large number of firms operating in it.

6. A high HH Index level (above 1800) for an industry most likely suggests that the industry : A. Is dominated by a few, large players B. Is relatively competitive C. Has high barriers to entry Answer: A A high HH Index level (above 1800) for an industry most likely suggests that the industry is dominated by a few, large firms. It may or may not be the case the industry is also characterized by high barriers to entry (e.g. number of hairdressers in a small town).

7. Which of the following is most likely an implicit cost? A. Labor salaries and wages. B. The opportunity cost of the owners time and effort. C. Office rent. Answer: B Implicit costs include the cost of the owners time, effort and skills (entrepreneurial abilities) that are devoted to organizing and running the business. Office rent and labor wages are examples of explicit costs.

8. Economic profits most likely equal zero when: A. The implied rental rate on capital equals forgone interest. B. Implicit costs equal explicit costs. C. Total revenue equals the sum of all opportunity costs.

Answer: C When total revenue equals opportunity costs (which include all implicit and explicit costs) economic profit equals zero.

9. Assume that a firm generates $125 million in total revenue by using $40 million in labor and materials. The value of the firms buildings fell from $2 million to $1.8 million during the period. Further, the firm forgoes $300,000 in interest and normal profit equals $140,000. The economic profit of this firm is closest to: A. $124,360,000. B. $82,760,000. C. $84,360,000. Answer: C Economic profit = total revenue - opportunity costs = total revenue - (explicit + implicit costs). In this case, the labor and material cost of $40 million is the explicit cost. Implicit costs include the $300,000 in foregone interest, economic depreciation of $200,000, and normal profit of $140,000. Therefore, total implicit costs equal $640,000 = $300,000 + $200,000 + $140,000 and economic profit is $125,000,000 - $40,000,000 - $640,000 = $84,360,000.

10. Which of the following statements most accurately describes technological and economic efficiency? A. For a given level of output, the technologically efficient method of production uses the least number of input units, while the economically efficient method entails the lowest possible cost. B. For a given level of output the technologically efficient method of production uses the least number of labor units, while the economically efficient method uses the least number of capital units. C. A production method cannot be technologically efficient without being economically efficient at the same time. Answer: A Technological efficiency occurs when the least number of input units are used to produce a given level of output. Economic efficiency occurs when a given output is produced at the lowest possible cost. Option C is incorrect. While an economically efficient production method must also be technologically efficient, it is not necessary for a technologically efficient method to be economically efficient.

11. Which of the following is most likely to be used to counter the principal-agent problem in a corporation? A. Incentive-based compensation schemes. B. Short-term employment contracts. C. Flat hourly wages. Answer: A Incentive-based compensation, long-term contracts, and ownership interests are used to align interests of agents with those of principals and reduce the principal-agent problem.

12. Which of the following organizational structures most likely has the lowest cost of raising external capital? A. Corporations. B. Partnerships C. Proprietorships. Answer: A Corporations usually have a lower cost of raising external capital compared to proprietorships and partnerships.

13. Industry A has a Herfindahl-Hirschman Index (HHI) of 350, while Industry B has a four-firm concentration ratio equal to 50%. Which of the following statements most accurately describes these two industries? A. Industry A is relatively more competitive than Industry B. B. Industry B has a larger number of firms than Industry A. C. Both the industries are relatively uncompetitive. Answer: A An HHI ratio of 350 is very low, which indicates a high level of competition in Industry A. A four firm concentration ratio of 50% on the other hand, indicates that a relatively low level of competition exists in Industry B. For both the four-firm ratio and the HHI, the lower (higher) the concentration measure, the greater (lower) the degree of competition, and the greater (lower) the number of firms in the industry

14. Which of the following statements most accurately describes why firms can usually coordinate economic activity more efficiently than markets?

Firms benefit from: A. A higher number of market transactions. B. Diseconomies of scope. C. Economies of team production. Answer: C Firms can coordinate economic activity more efficiently than markets because they usually incur lower transaction costs, and benefit from economies of scale, scope, and team production.

Use the following information regarding Magma Corporation to answer Questions 15 and 16:

Total revenues = $4,200,000 Electricity = $380,000 Wages = $250,000 Interest expense = $170,000 Interest forgone = $38,000 Depreciation (straight line) = $100,000 Market value of assets at the beginning of the year = $780,000 Market value of assets at the end of the year = $700,000 Normal profit = $60,000

15. Magma Corporations accounting profit is closest to?

A. $3,320,000 B. $3,262,000 C. $3,300,000

Answer: C

Accounting profit = 4,200,000 380,000 250,000 170,000 100,000 = $3,300,000

16. Magma Corporations economic profit is closest to?

A. $3,222,000 B. $3,122,000 C. $3,282,000

Answer: A

Economic profit = 4,200,000 380,000 250,000 170,000 38,000 80,000 60,000

Economic profit = $3,222,000

17. Which of the following production methods is least likely technologically efficient?

Method

Quantities of inputs Labor Capital 80 180 180

A B C

200 200 100

Answer: B

Method A is technologically efficient because it uses less capital than Method B. Method C is technologically efficient because it uses less labour than Method B. Method B is technologically inefficient.

18. Which of the following production methods is most likely economically efficient? Each of them produces 10,000 units per day.

Method

Quantities of Inputs Labor Capital 100 200 300

Cost per Unit of Input Labor ($) 5 10 15 Capital ($) 15,000 10,000 5,000

A B C

20,000 15,000 10,000

Answer: A

Total cost of Method A = (20,000 * 5) + (100 * 15,000) = $1,600,000

Total cost of Method B = (15,000 * 10) + (200 * 10,000) = $2,150,000

Total cost of Method C = (10,000 * 15) + (300 * 5,000) = $1,650,000

Since each of the methods produce the same total output, Method A will have the lowest cost per unit, which makes it economically efficient.

READING 17: OUTPUT AND COSTS

1. If total product (TP) is increasing at an increasing rate, which of the following is most likely? A. AP and MP must be increasing as well. B. MP must be increasing, but AP could be increasing or decreasing C. AP must be increasing, but MP could be increasing or decreasing. Answer: A If TP is increasing at an increasing rate, the slope of the TP curve is rising, which implies that MP must be rising as well. If MP is rising, it lies above the AP curve, so AP must be rising as well.

2. If total product (TP) is increasing at a decreasing rate, which of the following is most likely? A. AP and MP must be increasing as well. B. MP must be decreasing, but AP could be increasing or decreasing C. AP must be increasing, but MP could be increasing or decreasing. Answer: B If TP is increasing at a decreasing rate, the slope of the TP curve is falling, which implies that MP must be falling as well. If MP is falling, AP could still rise (if MP lies above AP) or fall (if MP lies below AP).

3. All points on which of the following curves most likely indicate technologically efficient levels of output? A. Total product B. Average product C. Marginal product Answer: A All points on the TP curve are technologically efficient.

4. Which of the following cost curves is least likely U-shaped? A. Short run average fixed cost B. Long run total cost C. Short run average variable cost Answer: A

The short run average fixed cost curve decreases at a decreasing rate as output rises and fixed costs are spread across more and more units of output.

5. Which of the following is most likely to be falling as MP increases? A. Total product B. Average product C. Marginal cost Answer: C A firms MP curve is linked to its MC curve. As MP increases, MC falls.

6. Which of the following is most likely to be rising as AP falls? A. Average variable cost B. Marginal product C. Average total cost. Answer: A A firms AP curve is linked to its AVC curve. As AP falls, AVC rises.

7. Which of the following cost curves is least likely to shift if there is an increase in the firms fixed costs? A. TC B. MC C. AFC Answer: B MC remains unchanged when there is a change in the firms fixed costs of production.

8. Which of the following factors of production is most likely to be variable in the short run? A. Labor. B. Technology. C. Plant size. Answer: A Labor is typically assumed to be variable in the short run.

9. The short run is most likely defined as: A. The period for which the quantities of all factors of production are fixed. B. The period for which the quantity of at least one factor of production is fixed. C. The time frame within which working capital decisions cannot be altered. Answer: B The short run is typically defined as the period for which at least one factor of production is fixed.

10. If employment of the last unit of labor increases total product, it implies that the marginal product of that unit of labor is: A. Falling. B. Increasing. C. Positive. Answer: C As long as marginal product is positive, total product will increase. Based on the given information, we cannot determine whether MP is increasing or decreasing. To make that decision, we would need to know whether TP is increasing at an increasing rate (MP rising) or if it is increasing at a decreasing rate (MP falling).

11. When marginal product (MP) is at its maximum, it is most likely that: A. Average product intersects it from above. B. Average variable cost is at its minimum. C. Marginal cost is at its minimum. Answer: C Marginal product is at its maximum when marginal cost is at its minimum.

12. Which of the following most accurately describes the relationship between marginal product (MP) and average product (AP)? As the quantity of labor increases: A. Initially MP exceeds AP, and later AP exceeds MP. B. Initially AP exceeds MP, and later MP exceeds AP. C. MP interests AP from above through its minimum point. Answer: A

MP intersects the AP curve from above through its maximum point. Initially when MP is greater than AP, AP rises, and at higher levels of output when MP is less than AP, AP falls.

13. When average product is at its maximum, it is most likely that: A. Average variable cost is at its minimum. B. Marginal product is less than AP. C. Marginal cost is at its minimum. Answer: A When average product is at its maximum, average variable cost is at its minimum.

14. Typically, the marginal product of labor: A. Increases proportionately to output. B. Increases initially, then reaches its peak, and later declines. C. Decreases initially, then reaches a minimum, and later rises. Answer: B The marginal product curve increases initially, reaches a peak at some point, and then decreases as additional units of labor are added to fixed quantities of other factors of production.

15. When the marginal cost curve lies above the average cost curve, it is most likely that: A. Average cost is rising. B. Average cost is at its minimum. C. Average cost is falling. Answer: A If marginal cost is greater than average cost, average cost rises.

16. If output increases at a decreasing rate as more units of capital are added to a given quantity of labor, the firm is most likely suffering from: A. Diminishing marginal returns to capital. B. Diminishing marginal returns to labor. C. Diseconomies of scale. Answer: A

Diminishing marginal returns to capital occur when output increases at a decreasing rate as capital is added to a given quantity of labor.

17. The upward sloping region of a firms planning curve most likely represents the existence of: A. Economies of scale. B. Diseconomies of scale. C. Minimum efficient scale. Answer: B A firms planning curve is its long run average cost curve. Diseconomies of scale occur along the upward sloping region of the long-run average total cost curve, where average costs rise as output increases. Use the following information to answer Questions 18 to 22. Assume that labor is the only variable factor of production.

Quantity of Labor 0 2 4 6

Total Product 0 10 24 -

Marginal Product 0 4

Average Product

5 -

18. The marginal product of the 2nd unit of labor is closest to?

A. 10 B. 7 C. 5

Answer: C

Marginal product = Change in total product / Change in quantity of labor

Marginal product = (10 0) / (2 0) = 5

19. The marginal product of the 4th unit of labor is closest to?

A. 6 B. 7 C. 14

Answer: B

Marginal product = Change in total product / Change in quantity of labor

Marginal product = (24 10) / (4 2) = 7

20. The average product of labor when four units of labor are hired is closest to?

A. 14 B. 12 C. 6

Answer: C

Average product = Total product / Quantity of labor

Average product = 24 / 4 = 6

21. Total product when six units of labor are hired is closest to?

A. 32 B. 28 C. 30

Answer: A

Change in total product = Change in quantity of labor * Marginal product

Change in total product = (6 4) * 4 = 8

Therefore, total product = 24 + 8 = 32

22. Average product when six units of labor are hired is closest to?

A. 4.67 B. 5.33 C. 6

Answer: B

Average product = Total product / Quantity of labor

Average product = 32 / 6 = 5.33

Use the following information to answer Questions 23 to 31. Assume that labor is the only variable factor of production.

QL 0 2 4 6 8

TP 0 10 24 -

TFC 200

TVC 0 960

TC 200 440 -

AFC 0 6.25 -

AVC 0 -

ATC 0 28.75 -

MC 0 17.143 60

23. Average fixed cost when two units of labor are hired is closest to?

A. $100 B. $24 C. $20

Answer: C

Average fixed cost = Total fixed cost / Total product

Average fixed cost = 200 / 10 = $20

24. Average variable cost when two units of labor are hired is closest to?

A. $24 B. $20 C. $120

Answer: A

Average variable cost = Total variable cost / Total product

Total variable cost = 440 200 = $240

Average variable cost = 240 / 10 = $24

25. Average total cost when two units of labor are hired is closest to?

A. $220 B. $24 C. $44

Answer: C

Average total cost = Total cost / Total product

Average total cost = 440 / 10 = $44

26. Marginal cost when two units of labor are hired is closest to?

A. $240 B. $24 C. $20

Answer: B

Marginal cost = Change in total cost / Change in total product

Marginal cost = (440 200) / (10 0) = $24

27. Average variable cost when four units of labor are hired is closest to?

A. $20 B. $10 C. $48

Answer: A

Change in total cost = Change in total product * Marginal cost

Change in total cost = (24 10) * 17.143 = $240

Therefore, total cost = 440 + 240 = $680

Total variable cost = 680 200 = $480

Therefore, average variable cost = 480 / 24 = $20

28. Average total cost when four units of labor are hired is closest to?

A. $10 B. $28 C. $68

Answer: B

Average total cost = Total cost / Total product = 680 / 24 = $28.33

29. Marginal product when six units of labor are hired is closest to?

A. 4 units B. 8 units C. 32 units

Answer: A

Total product = Total fixed costs / Average fixed costs

Total product = 200 / 6.25 = 32 units

Marginal product = Change in total product / Change in units of labor employed Marginal product = (32-24) / 2 = 4

30. Marginal cost when six units of labor are hired is closest to?

A. $240 B. $24 C. $30

Answer: C

Total cost = Total product * Average total cost

Total cost = 32 * 28.75 = $920

Marginal cost = Change in total cost / Change in total product

Marginal cost = (920 680) / (32 24) = $30

31. Average total cost when eight units of labor are hired is closest to?

A. $24 B. $32 C. $29

Answer: B

Total cost when eight units of labor are hired = 200 + 960 = $1,160

Change in total cost = 1,160 920 = $240

Change in total product = Change in total cost / Marginal cost

Change in total product = 240 / 60 = 4 units

Therefore, total product = 32 + 4 = 36 units

Average total cost = 1,160 / 36 = $32.22

READING 18: PERFECT COMPETITION

1. Which of the following is least likely an assumption of perfect competition? A. There are a large number of buyers and sellers in the market. B. Each producer makes a differentiated product. C. There is perfect information. Answer: B In perfect competition, each producer makes an identical product.

2. Which of the following is most likely in the long run in perfect competition? A. Price equals marginal cost B. Price is greater than marginal revenue C. Price is greater than average total cost Answer: A In perfect competition, price always equals marginal revenue as the demand curve facing each individual producer is perfectly elastic (each producer is a price-taker). Since each firm aims to maximize its profits, it must produce at the point where MR equals MC, which implies that price must equal marginal cost as well. Price cannot be greater than MR or ATC as this would mean that the firm would make economic profits (which is impossible in perfect competition in the long run).

3. Compared to a short run scenario where firms are making economic profits, in the long run in a perfectly competitive industry there are most likely: A. Fewer firms with each firm producing a lower output and the industry producing a larger output. B. More firms with each firm producing a lower output and the industry producing a larger output C. More firms with each firm producing a higher output and the industry producing a larger output. Answer: B In response to short run economic profits in perfect competition, more firms enter the industry (with low barriers to entry), which raises industry supply and industry equilibrium quantity (output) and lowers prices. Lower prices imply a fall in demand for each producer, which means that the profit maximizing quantity for each producer falls.

4.

In the long run, a permanent decrease in demand in perfect competition most likely leads to: A. A lower number of firms in the industry, lower equilibrium output in the industry, lower prices and normal profits. B. A lower number of firms in the industry, lower equilibrium output in the industry, restoration of original price levels and normal profits. C. A greater number of firms in the industry, higher equilibrium output in the industry, higher prices and normal profits. Answer: B A permanent decrease in demand leads to lower equilibrium quantity and prices initially. However, in the long run, some firms exit the industry. This reduces industry supply and increases prices for each remaining firm. Eventually, original price levels are restored with each firm making normal profits.

5. The long run supply curve is most likely upward sloping for: A. Constant-cost industries B. Decreasing-cost industries C. Increasing-cost industries Answer: C The long run supply curve for increasing-cost industries is upward sloping as the entry of more firms results in an increase in costs for all firms in the industry. 6. In the long run, perfect competition most likely achieves: An Efficient Scale of Production Yes No Yes Allocative Efficiency No Yes Yes

A. B. C.

Answer: C In perfect competition in the long run, allocative efficiency (sum of CS and PS is maximized and MSB equals MSC) and an efficient scale of production (profits are maximized at an output level where AC is minimized) are both achieved.

7. The industry demand curve in a perfectly competitive market is most likely: A. Upward sloping. B. Horizontal (perfectly elastic). C. Downward sloping. Answer: C

In perfect competition, the industry demand curve is downward sloping. The individual firms demand curve is perfectly elastic.

8. In perfect competition, the price of the product is most likely determined by: A. The producers of the product. B. Market supply and demand. C. Consumers. Answer: B Prices are determined at the point where industry demand equals industry supply.

9. Firms in perfect competition will most likely increase their total output until: A. Marginal cost equals price. B. Marginal revenue equals average total cost. C. Total revenue equals price. Answer: A In perfect competition, since the demand curve is horizontal (perfectly elastic), price equals marginal revenue. Therefore, a firm in perfect competition will continue to expand output until MC equals MR (price).

10. Which of the following is most likely regarding the relationship between price (P), marginal cost (MC), and marginal revenue (MR) at the profit maximizing output level for a firm in perfect competition? A. MC < MR < P B. P = MC = MR. C. P > MC = MR. Answer: B In perfect competition, profits are maximized at the output level where MC equals MR. Since demand facing each individual firm is perfectly elastic, MR equals price.

11. A firm in perfect competition will most likely continue to operate in the short run as long as: A. Marginal revenue exceeds average variable cost. B. Price exceeds average total costs. C. Marginal revenue equals marginal cost.

Answer: A As long as the firm covers its variable costs in the short run, it will continue to operate. If the price (which equals MR in perfect competition) exceeds AVC, the firm will choose to remain in production in the short run.

12. In the long-run, a firm operating in perfect competition will most likely: A. Generate no economic profits. B. Produce a quantity where marginal revenue is greater than marginal cost. C. Face a perfectly inelastic demand curve. Answer: A In the long run, firms in perfect competition earn zero economic profits.

13. Which of the following statements is least likely? A. Firms in perfect competition are price-takers. B. Perfect competition results in an efficient scale of production. C. Constant-cost industries have a perfectly inelastic long run supply curve. Answer: C Constant-cost industries have a perfectly elastic (horizontal) long run supply curve.

14. Which of the following is least likely as a result of technological advancement in a perfectly competitive industry? A. The costs for individual firms increase. B. Consumers benefit from lower prices. C. The industry supply curve shifts to the right. Answer: A Improvements in technology result in an increase in supply and lower prices for consumers. Producers see their costs fall.

READING 19: MONOPOLY

1. Typically, is a monopoly likely to achieve: An Efficient Scale of Production No No Yes Allocative Efficiency No Yes Yes

A. B. C.

Answer: A In a monopoly, allocative efficiency is not achieved as the sum of CS and PS is not maximized and MSB does not equal MSC (unless the monopoly successfully engages in perfect price discrimination). The monopolist does not produce at the output level where average cost is minimized so there is an inefficient scale of production as well.

2. Which of the following statements about monopolies is least accurate? A. A monopolys profit maximizing quantity is at the point where marginal revenue equals marginal cost. B. A Monopoly charges the highest possible price. C. A monopoly sells a product for which there are no close substitutes. Answer: B A monopolist does not charge the highest possible price (the price at which only one unit of output will be sold). A profit-maximizing monopoly charges a price that corresponds to the profit maximizing quantity (where MC = MR) on the demand curve.

3. Which of the following is most likely regarding a monopoly? A. A monopoly only works in the region of the demand curve where it is relatively elastic. B. The MR curve for a single-price monopoly is flatter than the demand curve that it faces. C. A natural monopoly is one whose fixed cost falls as output expands Answer: A A monopoly only operates in the region where demand is relatively elastic. The MR curve facing a single-price monopoly is actually steeper (it falls faster) than the demand curve. A natural monopoly sees its average fixed cost decline as output expands.

4. Which of the following is most likely a consequence of perfect price discrimination? A. The output produced by a monopoly that can engage in perfect price discrimination is greater than the output that would be produced were the industry perfectly competitive.

B. There is no consumer surplus if a monopoly engages in perfect price discrimination. C. Perfect price discrimination results in a dead weight loss to society. Answer: B The entire consumer surplus is grabbed by the monopolist (producer) under perfect price discrimination. The output produced under perfect price discrimination is the same as the output level produced were the industry perfectly competitive (allocative efficiency is reached). Strictly speaking, perfect price discrimination is efficient as there is no dead weight loss.

5. Which of the following most likely describes the price and output produced under perfect competition relative to a single-price monopoly? Price A. Higher B. Lower C. Same Answer: B In perfect competition, prices are lower and total output is higher than under a single- price monopoly. Output Lower Higher Same

6. Which of the following most likely describes the price and output produced under perfect competition relative to perfect price discrimination by a monopoly? Price A. Lower B. Lower C. Same Answer: A In perfect competition, prices are lower and total output is the same as in a situation where a monopoly engages in perfect price discrimination. Output Same Higher Same

7. Which of the following pricing methods is also known as efficient regulation? A. Profit-maximizing price B. P = MC C. P = AC Answer: B Marginal cost pricing is known as efficient regulation because it results in an allocatively efficient outcome (MC = MR).

8. Which of the following is least likely a potential gain from monopolies? A. Higher investment in R&D

B. Economies of scope C. Active pursuit of rent seeking activities Answer: C The pursuit of rent-seeking activities, which result in resources being inefficiently utilized in trying to establish a monopoly, is a potential disadvantage of a monopoly.

9. Which of the following is least likely to be offered by the government to offset the losses a monopoly makes when it is forced to embrace marginal cost pricing? A. Two-part pricing B. Price discrimination C. Penalties on production Answer: C A monopoly that is regulated and forced to price its output at its marginal cost of production will make economic losses. In this case the government would have to either offer the monopoly a subsidy or let it price discriminate or charge two-part prices to enable it to cover its losses.

READING 20: MONOPOLISTIC COMPETITION AND OLIGOPOLY

1. Which of the following is least likely a characteristic of monopolistic competition? A. Low barriers to entry. B. Product differentiation C. Small number of firms. Answer: C There are a relatively large number of firms in monopolistic competition.

2. Which of the following statements is least likely? A. Firms in monopolistic competition make economic losses when the AC curve lies above the demand curve. B. Firms in monopolistic competition can make economic losses or economic profits in the short run, but earn zero economic profits in the long run. C. Firms in monopolistic competition face relatively inelastic demand for their products. Answer: C Firms in monopolistic competition face relatively elastic demand due to the existence of several close substitutes.

3. Which of the following is most likely an advantage of monopolistic competition compared to perfect competition? A. More choice B. Excess capacity C. Markup. Answer: A Even though monopolistic competition results in excess capacity (output < efficient scale of production) and mark-up (MB and P > MC), it offers consumers more choice than perfect competition.

4. Which of the following oligopoly models asserts that there is a break in a firms marginal revenue curve? A. Kinked-demand model. B. Dominant firm model. C. Game theory.

Answer: A The kinked demand curve model suggests that there is a break in a firms MR curve due to the kink in the demand curve.

5. Which of the following is least likely a characteristic of an oligopoly? A. Firms in the industry are independent. B. Products can either be similar or differentiated. C. There are only a few producers in the industry. Answer: A Firm in an oligopoly are interdependent as the actions of one firm influence the price, demand and profits of other firms in the industry.

6. In an oligopoly, if one firm cheats and the other respects the terms of a collusion arrangement, which of the following is most likely? A. The price received by the cheating firm will be greater than the price received by the complying firm. B. The output produced by the cheating firm will be the same as the output produced by the complying firm. C. The average cost of the cheating firm will be lower than the average cost of the complying firm. Answer: C The average cost of the cheating firm is lower than the average cost of the complying firm since it produces a higher quantity of output. The price received by both firms is the same.

READING 21: MARKETS FOR FACTORS OF PRODUCTION

1. Which of the following statements is most likely? A. An increase in MRP of labor results in an increase in supply of labor. B. If the firm is a price-taker, the MRP of the labor it hires equals MP times the price. C. MRP of labor equals the change in total revenue divided by the quantity of labor employed. Answer: B If the firm is a price-taker, it can sell as much output as it desires at the current market price. Prices do not have to be brought down to stimulate more sales, so the MRP of labor equals the MP of labor times the price of the firms product. An increase in MRP of labor is equivalent to an increase in labor demand (not supply). MRP equals change in total revenue divided by the change in quantity of labor (not total quantity of labor).

2. A firm will most likely reduce the quantity of labor employed if: A. The wage rate equals MRP of labor. B. The wage rate is greater than MRP of labor. C. The wage rate is lower than the MRP of labor. Answer: B If the wage rate is greater than the MRP of labor, a firm can increase its profits by employing one less unit of labor.

3. Which of the following least likely influences the demand for labor? A. The price of the firms output B. The prices of other factors of production. C. The size of the adult population in the economy. Answer: C The size of the adult population in an economy affects the supply of labor, not the demand for labor.

4. Which of the following is most likely regarding the elasticity of demand for labor? A. Demand for labor is more elastic in the long run compared to the short run.

B. The higher the proportion of labor costs in total production costs, the less elastic the demand for labor. C. The more elastic the demand for the final good, the less elastic the demand for labor. Answer: A Demand for labor is more elastic in the long run. The higher the proportion of labor costs in total production costs, the more elastic the demand for labor. The more elastic the demand for the final good, the more elastic the demand for labor.

5. Which of the following statements regarding an individuals labor supply curve is least likely: A. An individuals labor supply curve bends backwards due to the income effect. B. An individuals labor supply curve bends backwards due to the substitution effect. C. The decision to work and supply labor depends on the wage rate. Answer: B The labor supply curve bends backwards due to the income effect. As real wage rates rise beyond a particular level, workers begin to prioritize leisure and reduce the quantity of labor supplied.

6. Compared to a competitive labor market, a monopsony in the labor market most likely results in: A. Higher wage rates and high quantities of labor employed. B. Lower wages and lower levels of labor employed. C. Lower wages and higher quantities of labor employed. Answer: B A monopsony in the labor market results in lower wage rates and lower employment levels compared to competitive labor market equilibrium.

7. If a minimum wage is imposed on a monopsony in the labor market, which of the following is most likely? A. Equilibrium wage rates and the equilibrium quantity of labor rise. B. Equilibrium wage rates rise but the equilibrium quantity of labor falls. C. Equilibrium wage rates fall but the equilibrium quantity of labor rises. Answer: A

When a minimum wage is imposed on a monopsony employer, wage rates and the quantity of labor employed both rise.

8. Which of the following statements is least likely regarding a factors income? A. The more inelastic the supply curve, the greater the share of economic rent in the factors income. B. The more elastic the supply curve, the greater the share of opportunity cost in the factors income. C. The more elastic the demand for a factor of production, the higher its income. Answer: C Elasticity of demand does not have anything to do with a factors income. The higher the demand (MRP) for a factor of production, the greater its total income.

9. Which of the following statements is most likely regarding the market for natural resources? A. The supply of a renewable resource is perfectly elastic. B. The flow supply of a renewable resource is perfectly elastic at the expected price in the next period. C. The flow supply of a non-renewable resource is perfectly elastic at the present value of the price expected in the next period. Answer: C The flow supply of a non-renewable resource, such as oil, is perfectly elastic at the present value of the price expected in the next period. The supply of a renewable resource is perfectly inelastic.

10. Which of the following steps is least likely to be taken by a union in order to mitigate the reduction in the quantity of labor employed when wage rates increase? A. Try to make the demand for labor more elastic B. Support minimum wage laws C. Encourage import restrictions Answer: A If labor demand is relatively inelastic an increase in wages will reduce labor quantity demanded to a lesser degree than if labor demand were relatively elastic.

11. The marginal cost of labor curve for a monopsony employer most likely: A. Rises faster than the supply of labor curve B. Rises slower than the supply of labor curve

C. Is downward sloping Answer: A For a monopsony employer, the marginal cost of labor curve is not the same as the supply of labor curve. The MC curve rises faster than supply because the higher wage rates must be paid to all existing units of labor as well.

12. Demand for capital is least likely to be influenced by: A. Marginal revenue product of capital B. Interest rates C. Income Answer: C Income affects the supply of capital, not the demand for capital.

13. When a tax is imposed on a resource whose supply is perfectly elastic, which of the following is most likely? A. The buyer pays the entire tax and entire factor income is composed of opportunity cost. B. The seller pays the entire tax and entire factor income is composed of economic rent. C. The buyer pays the entire tax and entire factor income is composed of economic rent. Answer: A When a tax is imposed on a resource whose supply is perfectly elastic the buyer pays the entire tax and entire factor income is composed of opportunity cost. When a tax is imposed on a resource whose supply is perfectly inelastic the supplier pays the entire tax and entire factor income is composed of economic rent.

READING 22: MONTORING JOBS AND THE PRICE LEVEL

1. Which of the following is least likely a labor market indicator? A. The unemployment rate. B. The employment to population ratio. C. The consumer confidence index. Answer: C The consumer confidence index is not a labor market indicator.

2. Which of the following statements is least likely? A. The natural rate of unemployment is composed of frictional and cyclical unemployment. B. The natural rate of unemployment is the unemployment rate that exists at full employment output. C. There is zero cyclical unemployment at the full employment level of output. Answer: A The natural rate of unemployment is composed of structural and frictional unemployment. There is no cyclical unemployment at full employment.

3. During an expansion: A. Real GDP exceeds potential GDP and unemployment is greater than the natural rate. B. Real GDP exceeds potential GDP and unemployment is lower than the natural rate. C. Real GDP is lower than potential GDP and unemployment is greater than the natural rate. Answer: B Real GDP exceeds potential GDP and unemployment is lower than the natural rate during an expansion.

4. Which of the following is least likely a source of CPI bias: A. Outlet substitution. B. Quality changes. C. Spending pattern bias. Answer: C There is no such thing as the spending pattern bias in relation to the calculation of the CPI. 5. Spartica is a developing country in which 13 million are employed and 9 million are unemployed. Further, 5 million people are below the age of 16, while 6 million are older than 16, but not willing to work. The unemployment rate of Spartica is closest to?

A. 41% B. 33% C. 23% Answer: A Unemployment rate = (No. of people unemployed / Labor force) * 100 Labor force = No. of people unemployed + No. of people employed Labor force = 13 + 9 = 22 million Therefore, unemployment rate = (9 / 22) * 100 = 41%

Use the following information to answer questions 6& 7: Basilia has 27 million people employed and 12 million people unemployed out of a total working-age population of 44 million. 6. Its labor force participation rate is closest to? A. 61.36% B. 84.38% C. 88.64% Answer: C Labor force participation rate = (Labor force / Working-age population) * 100 Labor force participation rate = [(27 + 12) / 44] * 100 = 88.64%

7. Its employment-to-population ratio is closest to? A. 88.64% B. 69.23%

C. 61.36% Answer: C Employment-to-population ratio = (No. of people employed / Working-age population) * 100 Employment-to-population ratio = (27 / 44) * 100 = 61.36%

8. Which of the following people is least likely classified as unemployed? A. A person who has been temporarily laid off from a job to which she expects to be called back. B. A person who is without work and has not looked for a job for a month. C. A person who will be starting a new job in 20 days. Answer: B An unemployed person is one who is without work, but has actively searched for employment opportunities in the last 4 weeks.

9. An analyst wants to calculate the CPI in the current period and gathered the following information to do so:

Item Shirts Bread Fuel

Quantity 100 200 150

Base Price ($) 10 5 20

Current Price ($) 15 10 30

The CPI in the current period is closest to? A. 160 B. 157 C. 63 Answer: A

CPI = (Cost of CPI basket at current prices / Cost of CPI basket at base prices) * 100 Base period cost of CPI basket = (100 * 10) + (200 * 5) + (150 * 20) = $5,000 Current period cost of CPI basket = (100 * 15) + (200 * 10) + (150 * 30) = $8,000 CPI (current period) = (8,000 / 5,000) * 100 = 160

10. An analyst gathered the following yearly information relating to a developing country:

Year 2007 2008 2009

CPI 122 150 174

The inflation rate for 2009 is closest to? A. 14% B. 18% C. 16% Answer: C Inflation rate = [(Current CPI Last years CPI) / Last years CPI] * 100 Inflation rate = (174/150 1) = 16%

READING 23: AGGREGATE DEMAND AND AGGREGATE SUPPLY

1. Which of the following statements most likely defines the macroeconomic long run and short run? A. Money wages are assumed constant in the long run, while real wages are assumed constant in the short run. B. Money wages and real wages are assumed constant in the long run, while only money wages are assumed constant in the short run. C. Money wages are assumed constant in the short run, while real wages are assumed constant in the long run. Answer: C The macroeconomic long run is the time frame long enough for money wages to change to restore full employment. Real wages are assumed constant in the long run. In the short run on the other hand, money wages are assumed constant.

2. Which of the following least likely explains a shift in the SRAS curve? A. Changes in the prices of factors of production. B. Changes in potential GDP. C. Changes in the prices of final goods and services. Answer: C Changes in the prices of final goods and services (the price level) explain movements along the SRAS.

3. Which of the following least likely explains why money wages can change? A. Changes in the level of unemployment. B. Changes in expected inflation. C. Past inflation rates. Answer: C Past inflation rates do not result in changes in money wages.

4. Which of the following is least likely regarding the AD curve? A. An increase in expected future incomes increases AD. B. An increase in taxes increases AD. C. An increase in expected future profits increases AD. Answer: B An increase in taxes reduces disposable income and results in a decrease in consumption expenditure.

5. Suppose an economy is initially operating at full employment. An increase in aggregate demand that takes short run equilibrium to a point beyond the economys potential output most likely results in: A. An increase in prices in the long run and the short run. B. An increase in prices in the long run, but no change in prices in the short run. C. An increase in prices in the short run, but no change in prices in the long run. Answer: A Initially, prices rise in the short run as the economy operates in an inflationary gap. Eventually, long run supply falls and takes prices even higher.

6. Suppose an economy is initially operating at full employment. A decrease in aggregate demand that takes the economy into a deflationary gap most likely results in: A. A decrease in output in the short run and the long run. B. An increase in output in the short run, but a decrease in output in the long run. C. A decrease in output in the short run, but no change in output in the long run. Answer: C When the economy falls into a deflationary gap, real output falls in the short run, but eventually an increase in SRAS restores LR equilibrium at potential output. In the long run, the economy always operates at a point on its LRAS curve, or at the full employment level of output.

7. Which of the following theories least likely asserts that wages are downward sticky? A. Keynesian. B. Classical. C. Monetarist. Answer: B Classical economists believe that the economy is self-correcting. The self-adjusting mechanism only works if nominal wages are easy to change in the short run.

8. Which of the following is most likely regarding the price level and potential output in response to an increase in imports for an economy? Prices A. Lower B. Higher C. Lower Answer: C An increase in imports results in a decrease in aggregate demand, which in turn leads to a decrease in the price level and Real GDP. However, potential output remains unchanged. Potential Output Lower Higher Same

9. Which of the following theories most likely asserts that fluctuations in aggregate demand and aggregate supply are driven by technological changes? A. Keynesian. B. Classical. C. Monetarist. Answer: B Classical economists assert that fluctuations in aggregate demand and aggregate supply are driven by technological changes.

10. According to the Keynesian school of macroeconomic thought, business cycles are most likely caused by: A. Changing expectations B. Inappropriate monetary policy C. Technological changes Answer: A According to the Keynesian school of macroeconomic thought, business cycles are caused by changing expectations. 11. The following information related to a developing economy: Consumption expenditure = $47 million Government expenditure =$102 million Investment expenditure = $62 million Exports = $77 million Imports = $83 million Taxes = $20 million The countrys aggregate demand is closest to? A. $185 million B. $205 million C. $288 million Answer: B Aggregate demand = 47 + 102 + 62 + (77 83) = $205 million

12. Based on the following information, exports are closest to? Aggregate demand = $200 million Consumption expenditure = $25 million Government expenditure = $65 million Investment expenditure = $70 million Imports = 32 million A. $8 million B. $40 million C. $72 million Answer: C Exports = 200 25 65 70 + 32 = $72 million

READING 24: MONEY, THE PRICE LEVEL AND INFLATION

1. Which of the following is most likely considered in measures of money? A. Checks B. Checking account balances. C. Credit cards. Answer: B Checking account balances are included in measures of money. Checks only make transfers of money possible and credit cards are like loans. Therefore, they are not included in measures of money.

2. Which of the following most likely comprises the largest portion of the Feds liabilities? A. Federal Reserve Notes. B. Banks deposits. C. U.S. Government Securities. Answer: A Federal Reserve notes represent the largest proportion of the Feds liabilities.

3. The U.S. Federal Reserve bought $20,000,000 worth of U.S. Treasury securities from the open market. The reserve requirement is currently 20%. The effect of the Feds purchase on the U.S. money supply if there were zero excess reserves in the banking system is closest to: A. A $20,000,000 increase B. A $100,000,000 decrease C. A $100,000,000 increase Answer: C The money multiplier equals 1/0.2 = 5 As the Fed has bought securities, it will increase the money supply by: 5 * 20,000,000 = $100,000,000.

4. Which of the following factors is least likely to influence the demand for real money? A. Nominal interest rates. B. Real GDP. C. Price level. Answer: C While the price level does have an effect on the demand for nominal money, it has no effect on the demand for real money.

5. Which of the following is least accurate regarding the money demand curve? A. A fall in interest rates reduces the opportunity cost of holding money and increases the quantity of money demanded. B. Financial innovation brings about a shift in the money demand curve. C. A change in real GDP causes a movement along the money demand curve. Answer: C A change in real GDP causes a shift in the money demand curve. Movements along the money demand curve are caused by changes in interest rates.

6. Which of the following statements is least likely? A. Money-market equilibrium determines interest rates in the short run. B. Loanable-funds market equilibrium determines interest rates in the long run. C. Money market equilibrium determines price level in the short run. Answer: C The loanable funds market determines real interest rates in the long run, while the money market determines equilibrium interest rates in the short run. In the long run, money market equilibrium only has an effect on price levels.

7. Which of the following statements about the quantity theory of money is least likely? A. An increase in the quantity of money may cause a proportionate increase in prices. B. The quantity of money multiplied by the velocity equals prices. C. The velocity of money is determined by institutional factors. Answer: B Money supply multiplied by the velocity equals GDP, which equals price level times real output.

8. Which of the following statements is most likely? A. If the required reserve ratio increases, the money multiplier will decrease. B. If the currency drain ratio increases, the money multiplier will increase. C. The currency drain ratio is the ratio of currency held by individuals to the amount of the loan taken. Answer: A If the required reserve ratio increases, the money multiplier will decrease. If the currency drain ratio increases, the money multiplier will decrease. The currency drain ratio is the ratio of currency held by individuals to funds deposited in the banking system.

9. Which of the following is least likely a policy tool available to the Fed to control the quantity of money to conduct monetary policy? A. Income tax rates. B. Open market operations. C. Required reserve ratio. Answer: A Income tax rates are not one of the policy tools available to the Fed to conduct monetary policy. Tax rates are a tool of fiscal policy, and do not affect the quantity of money in an economy.

10. Which of the following statements regarding open market operations conducted by the Fed is least accurate? A. Money supply falls when the Fed purchases securities. B. Open market operations are used by the Fed to directly affect the monetary base. C. The multiplier effect is reduced when there is significant cash drain. Answer: A In an open market purchase, money supply increases.

11. An increase in the discount rate will most likely lead to: A. A decrease in money supply B. An increase in money demand C. A decrease in money demand. Answer: A An increase in the discount rate leads to a decrease in money supply as the cost of borrowing reserves from the Fed increases.

12. The Fed purchases $70 million in securities from the open market. Based on the following information, the maximum increase in the money supply that can result from this action is closest to? Required reserve ratio = 20% Desired reserve ratio = 30% Cash drain ratio = 70% A. 1.7 B. 1.89 C. 0.59

Answer: A Money multiplier = (1 + c) / (r + c) Money multiplier = (1 + 0.7) / (0.3 + 0.7) = 1.7 Maximum possible increase in money supply = $70m * 1.7 = $119m

13. An analyst gathered the following information: Velocity of circulation = 4 times GDP = $1,600 billion The quantity of money is closest to: A. $400 million B. $6,400 billion C. $400 billion Answer: C Quantity of money = GDP / velocity of circulation = (1,600 / 4) = $400 billion

14. An analyst obtained the following information from the Feds balance sheet: Gold and foreign exchange = $54 billion U.S. government securities = $700 billion Federal Reserve Notes = $760 billion Banks deposits = $32 billion The amount of loans to banks given that the above information reflects all the assets and liabilities of the Fed is closest to? A. $38 billion B. $60 billion C. $22 billion

Answer: A Loans to banks are an asset for the Fed. Liabilities of the Fed = 760 + 32 = $792 billion Therefore, loans to banks = 792 54 700 = $38 billion

Use the following information to answer Questions 15 and 16:

$ billions Notes and coins held by individuals and businesses Notes and coins held in banks Currency and checking deposits owned by the U.S. government Travellers checks Credit cards Checking deposits of individuals and businesses Time deposits Saving deposits Money market mutual funds balances 400 370 770 350 280 560 1,250 2,250 620

15. The M1 measure of money is closest to? A. $1,680 billion B. $1,310 billion C. $2,450 billion Answer: B M1 = Currency + travellers checks + checking deposits of individuals and businesses Note: Currency only includes notes and coins held by individuals and businesses. M1 = 400 + 350 + 560 = $1,310 billion

16. The M2 measure of money is closest to? A. $5,430 billion B. $6,570 billion C. $5,800 billion Answer: A M2 = M1 + Time deposits + saving deposits + money market mutual funds balances M2 = 1,310 + 1,250 + 2,250 + 620 = $5,430 billion

READING 25: U.S. INFLATION, UNEMPLOYMENT AND BUSINESS CYCLES

1. Which of the following statements is most likely? A. In demand-pull inflation, the economy temporarily operates above potential output with an unemployment rate that is greater than the natural rate. B. In cost-push inflation, the economy temporarily operates below potential output with an unemployment rate that is lower than the natural rate. C. If the inflation rate is correctly forecasted in the long run, the economy will continue to operate at full employment. Answer: C If the inflation rate is correctly forecasted in the long run the economy will continue on its long run course, operating at full employment. In demand-pull inflation, the economy temporarily operates above potential output with an unemployment rate that is lower than the natural rate. In cost-push inflation, the economy temporarily operates below potential output with an unemployment rate that is higher than the natural rate.

2. Which of the following statements relating to cost-push inflation is least likely? A. The combination of rising price levels and decreasing GDP is known as stagflation. B. During a cost-push inflation spiral, the government faces a tradeoff between unemployment and real GDP. C. An economy temporarily operates in a deflationary gap during cost push inflation. Answer: B The government faces a tradeoff between unemployment and rising prices (inflation) during cost push inflation.

3. Which of the following least likely results in a shift in the short run Phillips curve? A. A change in the natural rate of unemployment. B. A change in the expected inflation rate. C. A change in real GDP. Answer: C A change in real GDP has no effect on the short run Phillips curve.

4. Which of the following most likely causes a shift in the short run and long run Phillips curves? A. A change in the natural rate of unemployment. B. A change in real output. C. A change in the actual inflation rate.

Answer: A A change in the natural rate of unemployment brings about a change in both, the long run and the short run Phillips curves.

5. As an economy slips into a recession, which of the following is most likely? A. Interest rates are high and there is a decrease in price and output as the economy operates below its potential. B. Interest rates are low and there is a decrease in price and output as the economy operate below its potential. C. Interest rates are low and there is an increase in price and output as the economy operates below its potential. Answer: A In a recessionary phase, interest rates are high and price and output fall as the economy operates below full employment.

6. Which of the following statements is least likely regarding the mainstream business cycle theory? A. It assumes that aggregate demand grows at a steady rate, while potential GDP grows at a fluctuating rate. B. It asserts that prolonged business cycles are possible. C. It asserts the productivity shocks are not the main source of business cycles. Answer: A Mainstream business cycle theory assumes that potential GDP grows at a constant rate, while aggregate demand grows at a fluctuating rate. Prolonged business cycles are possible because wage rates are sticky.

7. Which of the following statements is least likely regarding the real business cycle theory? A. It attributes the existence of business cycles to productivity shocks. B. It asserts that an increase in real interest rates in an expansion results in an increase in the supply of labor. C. The key ripple effect is felt in the loanable funds market. Answer: C The ripple effect is felt in the labor market as initially in an expansion, the quantity of labor increases due to an increase in labor demand (due to business optimism), and the quantity of labor further rises as labor supply increases (due to intertemporal substitution).

8. The Phillips Curve most likely illustrates: A. The relationship between inflation and unemployment. B. The relationship between price levels and real GDP. C. The relationship between unemployment and real GDP

Answer: A The Phillips curve illustrates the relationship between inflation and unemployment.

9. Which of the following is least likely a criticism of real business cycle theory? A. The money wage rate tends to be sticky. B. The inter-temporal substitution effect tends to be strong C. Productivity shocks can also be caused by changes in aggregate demand. Answer: B If the inter-temporal substitution were strong, it would support the assertions of RBC theory.

READING 26: FISCAL POLICY

1. If potential real GDP is greater than the actual real GDP, which of the following statements would be least accurate? A. The economy is said to be undergoing a recession. B. The unemployment rate is above the natural rate of unemployment. C. The unemployment rate is below the natural rate of unemployment. Answer: C If potential real GDP is greater than the actual real GDP, the economy is said to be in a recession and unemployment is above the natural rate of unemployment.

2. An expansionary fiscal policy is most likely associated with: A. A cyclical budget surplus B. A cyclical budget deficit C. A structural budget deficit Answer: B A cyclical budget deficit involves a net excess of government spending over tax revenue when the economy is not working at full-employment level.

3. If the economy is in the downward sloping region of the Laffer curve, a decrease in income taxes will most likely: A. Increase tax revenue B. Have no effect on tax revenue C. Decrease tax revenue Answer: A In the downward sloping region of the Laffer curve, a decrease in tax rates leads to a significant rise in the number of total dollars earned in the economy, which leads to an increase in tax revenues.

4. Which of the following is least likely regarding the crowding-out effect? A. A budget deficit reduces real interest rates as the supply of loanable funds decreases. B. Budget deficits slow down the growth rate of real GDP. C. Budget deficits reduce the supply of loanable funds, which results in an increase in real interest rates.

Answer: A Budget deficits reduce the supply of loanable funds, which increases real interest rates and leads to a decrease in investment expenditure in the economy.

5. The most likely discretionary fiscal policy in a recession is: A. To increase the money supply. B. To reduce government expenditure. C. To reduce taxes. Answer: C Reducing taxes increases aggregate demand as disposable incomes rise. Increasing money supply is a monetary policy tool. A decrease in government expenditure is a contractionary policy.

6. Which of the following is least likely an automatic fiscal policy stabilizer? A. Unemployment compensation B. Income taxes C. Real interest rates Answer: C Real interest rates are not automatic stabilizers embedded in fiscal policy.

7. Which of the following statements regarding automatic stabilizers is least accurate? A. They tend to take the budget towards a surplus in a recession and a deficit in an expansion. B. There is no administrative lag associated with them. C. They stimulate the economy during a recession and cool it down during an expansion. Answer: A Automatic stabilizers take the budget towards a deficit in a recession and towards a surplus in an expansion.

8. An income tax cut would least likely lead to: A. An increase in potential output B. An increase in disposable incomes C. A decrease in aggregate demand Answer: C

A decrease in income taxes would lead to an increase in aggregate demand.

9. A decrease in taxes on capital income would most likely lead to: A. A decrease in savings B. An increase in potential output C. An increase in the growth rate of potential GDP Answer: C A decrease in taxes on capital income would result in an increase in the growth rate of potential GDP and reduce the size of the Lucas wedge.

10. Which of the following statements is most accurate regarding the government expenditure multiplier and the tax multiplier? A. The effects of the government expenditure multiplier outweigh those of the tax multiplier, which makes the balanced budget multiplier positive. B. The effects of the government expenditure multiplier are less significant than those of the tax multiplier, which makes the balanced budget multiplier negative. C. The effects of the government expenditure multiplier exactly offset those of the tax multiplier, which makes the balanced budget multiplier equal zero. Answer: A The effects of the government expenditure multiplier outweigh those of the tax multiplier, which makes the balanced budget multiplier positive.

11. An economy that has a potential output of $10 trillion and a natural rate of unemployment of 5% currently has a 7% unemployment rate. The economy has a structural budget surplus of $1 trillion. Which of the following is most likely? A. It has a cyclical deficit. B. It has a cyclical surplus C. It has a budget surplus. Answer: A Since the economys unemployment rate is greater than its natural rate of unemployment, it must be in a recession. During a recession the budget is in a cyclical deficit. Whether or not the overall budget is in a surplus or deficit depends on the size of the cyclical deficit, which is not provided in the question.

READING 27 MONETARY POLICY

1. Which of the following is least likely a goal of the Feds monetary policy? A. Maximum employment B. Stable exchange rate C. Moderate long-term interest rates Answer: B The Fed does not try to influence the exchange rate. It leaves the exchange rate and the quantity of money to find their own equilibrium.

2. Which of the following statements about an increase in the Federal Funds Rate (FFR) is most accurate? An increase in FFR: A. Causes an increase in the long-term rates, but the magnitude of the change is usually less than the change in the FFR itself. B. Causes long-term rates to increase by more than the change in FFR. C. Causes the long-term rates to increase by the same amount as the change in the FFR. Answer: A The change in long term interest rates is usually less than the change in the FFR. This is because long term interest rates are influenced by current short term rates and expected future short term rates.

3. Which of the following is most likely to occur due to a decrease in FFR? A. The equilibrium quantity of money rises. B. The supply of loanable funds decreases. C. Aggregate demand decreases. Answer: A A decrease in FFR results in an increase in reserve supply, and therefore brings about an increase in the equilibrium quantity of money. The supply of loanable funds and aggregate demand increase when FFR falls.

4. Which monetary policy is the Fed least likely to adopt in an expansion? A. Increase taxes.

B. Increase FFR. C. Conduct an open market sale. Answer: A Increasing taxes is a tool of fiscal policy.

5. Which of the following problems is least likely associated with changing the FFR to stabilize an economy? A. The FFR change takes a long time to have an effect on inflation. B. Many factors other than real interest rates also affect the components of aggregate demand. C. There is a strong link between long term real interest rates and the FFR. Answer: C Empirically, there is only a weak link between long term real interest rate (which influences aggregate demand) and FFR

6. Which of the following monetary policy strategies most directly targets the growth rate in the monetary base? A. Money targeting rule B. McCallum rule C. K-percent rule. Answer: B The monetary base instrument rule (also called the McCallum rule) targets the growth rate in the monetary base directly.

7. A crawling peg is most likely an example of which of the following monetary policy strategies? A. Inflation targeting B. Exchange rate targeting C. Money targeting Answer: B A crawling peg is an example of exchange rate targeting.

8. When the Fed lowers the Fed Funds Rate, the exchange rate and aggregate demand most likely: Exchange Rate Aggregate Demand A. Falls Falls

B. Increases C. Falls Answer: C

Increases Increases

When the Fed lowers the Fed Funds Rate the exchange rate falls (as hot money flows out) and aggregate demand increases (as consumption, investment and net exports rise).