Econ Final Review

Front 1

The difference between the short-run and the long-run production function is:

the time it takes for firms to change all production inputs.

Back 1

A) three months or one business quarter.
B) the time it takes for firms to change all production inputs.
C) the time it takes for firms to change only their variable inputs.
D) More information is required to answer this question.

Front 2

A firm using two inputs, X and Y, is using them in the most efficient manner when:

MPX/MPY = PX/PY

Back 2

A) MPX = MPY.
B) PX = PY and MPX = MPY.
C) MPX/PY = MPY/PX.
D) MPX/MPY = PX/PY.

Front 3

Which of the following is not true about the law of diminishing returns?

It divides Stage I and II of the production process

Back 3

A) It is a short-run phenomenon.
B) It refers to diminishing marginal product.
C) It will have an impact on the firm's marginal cost.
D) It divides Stage I and II of the production process.
E) All of the above are true.

Front 4

Which of the following indicates when Stage II ends and Stage III begins in the short-run production function?

when MP = 0

Back 4

A) when AP = 0
B) when MP = 0
C) when MP = AP
D) when MP starts to diminish

Front 5

Assume a firm employs 10 workers and pays each $15 per hour. Further assume that the MP of the 10th worker is 5 units of output and that the price of the output is $4. According to economic theory, in the short run:

the firm should hire additional workers

Back 5

A) the firm should hire additional workers.
B) the firm should reduce the number of workers employed.
C) the firm should continue to employ 10 workers.
D) More information is required to answer this question.

Front 6

Decreasing returns to scale:


None of the above is true

Back 6

A) indicates that an increase in all inputs by some proportion will result in a decrease in output.
B) must always occur at some point in the production process.
C) is directly related to the law of diminishing returns.
D) All of the above are true.
E) None of the above is true.

Front 7

A firm that operates in Stage III of the short-run production function:

has too little fixed capacity relative to its variable inputs

Back 7

A) has too much fixed capacity relative to its variable inputs.
B) has too little fixed capacity relative to its variable inputs.
C) has greatly overestimated the demand for its output.
D) should try to increase the amount of variable input used.

Front 8

In the short run, finding the optimal amount of variable input involves which relationship?

MRP = MFC

Back 8

A) MP = MC
B) AP = MP
C) MP = 0
D) MRP = MFC

Front 9

If a firm finds itself operating in Stage I, it implies that:

it overinvested in fixed capacity

Back 9

A) variable inputs are extremely expensive.
B) it overinvested in fixed capacity.
C) it underinvested in fixed capacity.
D) fixed inputs are extremely expensive.

Front 10

If MRP > MLC, it means that a firm should:

use more labor

Back 10

A) use less labor.
B) use more labor.
C) increase its fixed capacity.
D) decrease its fixed capacity.

Front 11

In the long run, a firm is said to be experiencing decreasing returns to scale if a 10 percent increase in inputs results in:

an increase in output from 100 to 105

Back 11

A) an increase in output from 100 to 110.
B) a decrease in output from 100 to 90.
C) an increase in output from 100 to 105.
D) a decrease in output from 100 to 85.

Front 12

When the law of diminishing returns takes effect:

firms must add increasingly more input if they are to maintain the same extra amount of output

Back 12

A) firms must add increasingly more input if they are to maintain the same extra amount of output.
B) firms must add decreasingly more input if they are to maintain the same extra amount of output.
C) more input must be added in order to increase its output.
D) a firm must always try to add the same amount of input to the production process.

Front 13

Output (Total Product) is maximized when:

input marginal productivity is zero

Back 13

A) input average productivity is at its maximum.
B) the "law of diminishing returns" sets in.
C) input marginal productivity is zero.
D) input marginal productivity is at its maximum.

Front 14

The law of diminishing returns begins first to affect a firm's short-run cost structure when:

marginal cost begins to increase

Back 14

A) average variable cost begins to increase.
B) marginal cost begins to increase.
C) average cost begins to increase.
D) average fixed cost begins to decrease.

Front 15

Which of the following statements best represents a difference between short-run and long-run cost?

There are no fixed costs in the long run

Back 15

A) Less than one year is considered the short run; more than one year the long run.
B) There are no fixed costs in the long run.
C) In the short-run labor must always be considered the variable input and capital the fixed input.
D) All of the above are true.

Front 16

The relationship between MC and AC can best be described as follows:

when MC exceeds AC, AC starts to increase

Back 16

A) when AC increases, MC starts to increase.
B) when MC increases, AC starts to increase.
C) when MC decreases, AC decreases.
D) when MC exceeds AC, AC starts to increase

Front 17

Average fixed cost is:

AC minus AVC

Back 17

A) AC minus AVC.
B) TC divided by Q.
C) AVC minus MC.
D) TC minus TVC.

Front 18

Which of the following cost relationships is not true?

AFC = AC - MC

Back 18

A) AFC = AC - MC
B) TVC = TC - TFC
C) The change in TVC/the change in Q = MC.
D) The change in TC/ the change in Q = MC.

Front 19

Economists consider which of the following costs to be irrelevant to a short-run business decision?

historical cost

Back 19

A) opportunity cost
B) out-of-pocket cost
C) historical cost
D) replacement cost

Front 20

Which of the following is a relevant cost?

replacement cost

Back 20

A) replacement cost
B) sunk cost
C) historical cost
D) fixed cost
E) All of the above are relevant.

Front 21

Which of the following is a reason for economies of scale?

Input productivity increases as a result of greater specialization

Back 21

A) Fixed costs are spread out as volume increases.
B) The law of diminishing returns does not take effect.
C) Input productivity increases as a result of greater specialization.
D) There is greater savings in transportation costs.

Front 22

When a firm's MC curve shifts to the right, it implies that:

labor productivity is increasing

Back 22

A) new firms are entering the market.
B) labor productivity is decreasing.
C) labor productivity is increasing.
D) the firm's overhead costs are decreasing

Front 23

The marginal cost will intersect the average variable cost curve:

at the minimum point of the average variable cost curve

Back 23

A) when the average variable cost curve is rising.
B) where average variable cost curve equals price.
C) at the minimum point of the average variable cost curve.
D) the two will never intersect.

Front 24

Which of the following is not characteristic of perfect competition?

a differentiated product

Back 24

A) a differentiated product
B) no barriers to entry or exit
C) large number of buyers
D) complete knowledge of market price

Front 25

Which of the following conditions would definitely cause a perfectly competitive company to shut down in the short run?

P < AVC

Back 25

A) P < MC
B) P = MC < AC
C) P < AVC
D) P = MR

Front 26

In economic analysis, any amount of profit earned above zero is considered "above normal" because:

this would indicate that the firm's revenue exceeded both its accounting and opportunity cost

Back 26

A) normally firms are supposed to earn zero profit.
B) this would indicate that the firm's revenue exceeded both its accounting and opportunity cost.
C) this would indicate that the firm was at least earning a profit equal to its opportunity cost.
D) this would indicate that the firm's revenue exceeded its accounting cost.

Front 27

At the point at which P=MC, suppose that a perfectly competitive firm's MC = $100, its AVC = $80 and its AC = $110. This firm should:

continue operating in the short run

Back 27

A) shut down immediately.
B) continue operating in the short run.
C) try to take advantage of economies of scale.
D) try to increase its advertising and promotion.

Front 28

When a firm has the power to establish its price,

P > MR

Back 28

A) P = MR.
B) P = MC.
C) P > MR.
D) P < MR.

Front 29

When MR = MC,

total profit is maximized

Back 29

A) marginal profit is maximized.
B) total profit is maximized.
C) marginal profit is positive.
D) total profit is zero.

Front 30

In the short run, which of the following would indicate that a perfectly competitive firm is producing an output for which it is receiving a normal profit?

P = AC

Back 30

A) P > AC
B) AVC < P < AC
C) P = AC
D) P = AVC

Front 31

A firm that seeks to maximize its revenue is most likely to adhere to which of the following?

MR =0

Back 31

A) MR = MC
B) MR =0
C) MR =P
D) MR < MC

Front 32

Which of the following is true for a monopoly?

P > MR

Back 32

A) P = MC
B) P = MR
C) P > MR
D) P < MR

Front 33

Suppose a firm is currently maximizing its profits (i.e., following the MR=MC rule). Assuming that it wants to continue maximizing its profits, if its fixed costs increase, it should:

Back 33

A) maintain the same price.
B) raise its price.
C) lower its price.
D) Not enough information to answer this question.

Front 34

Suppose a firm is currently maximizing its profits (i.e., following the MR=MC rule). Assuming it wants to continue maximizing its profits, if its variable costs decrease, it should:

Back 34

A) lower its price in response to the lower costs.
B) raise its price in order to earn more profits.
C) maintain the same price.
D) Not enough information to answer this question.

Front 35

Monopoly is characterized by:

All of the above

Back 35

A) unique products.
B) market entry and exit difficult or impossible.
C) nonprice competition not necessary.
D) All of the above.

Front 36

In the short run a firm should shut down if it cannot:

cover its variable costs

Back 36

A) make normal profits.
B) make economic profits.
C) cover its variable costs.
D) cover its fixed costs.

Front 37

Firms are 'price makers" if they:

have sufficient market power to set their product price

Back 37

A) have sufficient market power to set their product price.
B) make the market price their product price.
C) make their product price competitive.
D) None of the above.

Front 38

The Herfindahl-Hirschman (HH) Index is used to:

measure the degree of market concentration in an industry.

Back 38

A) measure the degree of nonprice competition.
B) measure the degree of market concentration in an industry.
C) measure the extent of price leadership.
D) None of the above.

Front 39

If firms are earning economic profit in a monopolistically competitive market, which of the following is most likely to happen in the long run?

New firms will enter the market, thereby eliminating the economic profit

Back 39

A) Some firms will leave the market.
B) Firms will join together to keep others from entering.
C) New firms will enter the market, thereby eliminating the economic profit.
D) Firms will continue to earn economic profit.

Front 40

Mutual interdependence means that:

each firm sets its own price based on its anticipated reaction by its competitors

Back 40

A) all firms are price takers.
B) each firm sets its own price based on its anticipated reaction by its competitors.
C) all firms collaborate to establish one price.
D) all firms are free to enter or leave the market.

Front 41

The main difference between perfect competition and monopolistic competition is:

the degree of product differentiation

Back 41

A) the number of sellers in the market.
B) the ease of exit from the market.
C) the degree of information about market price.
D) the degree of product differentiation.

Front 42

The demand curve, which assumes that competitors will follow price decreases but not price increases, is called:

a kinked demand curve.

Back 42

A) an industry demand curve.
B) an inelastic demand curve.
C) a kinked demand curve.
D) a competitive demand curve.

Front 43

The existence of a kinked demand curve under oligopoly conditions may result in:

price rigidity

Back 43

A) price flexibility.
B) price rigidity.
C) competitive pricing.
D) None of the above.

Front 44

All of the following are conditions which are favorable to the formation of cartels, except:

easy entry into the industry

Back 44

A) the existence of a small number of firms.
B) geographic proximity of firms.
C) homogeneity of the product.
D) easy entry into the industry.

Front 45

A cartel price will be established at the quantity where:

the sum of the members' marginal costs equals industry marginal revenue

Back 45

A) total cost equals the industry total revenue.
B) average cost equals the industry revenue.
C) the sum of the members' marginal costs equals industry marginal revenue.
D) marginal cost equals industry price.

Front 46

In the Baumol model (revenue maximizing model), the total quantity sold will usually be larger than:

if profit were maximized

Back 46

A) if perfect competition prevailed.
B) if total costs were minimized.
C) if profit were maximized.
D) if companies were interdependent.

Front 47

In order that price discrimination can exist,

Both A and C

Back 47

A) markets must be capable of being separated.
B) markets must be interdependent.
C) different demand price elasticities must exist in different markets.
D) demand price elasticities must be identical in all markets.
E) Both A and C.

Front 48

Third-degree price discrimination exists when:

when the seller can separate markets by geography, income, age, etc., and charge different prices to these different groups

Back 48

A) the seller knows exactly how much each potential customer is willing to pay and will charge accordingly.
B) different prices are charged by blocks of services.
C) when the seller can separate markets by geography, income, age, etc., and charge different prices to these different groups.
D) when the seller will bargain with buyers in each of the markets to obtain the best possible price.

Front 49

The result for the seller of being able to practice price discrimination will be:

higher profits

Back 49

A) higher profits.
B) lower demand elasticity.
C) lower quantity sold.
D) cost minimization

Front 50

Revenue maximization occurs when a firm sells at a price:

where its marginal revenue is zero

Back 50

A) that is equal to its minimum average variable cost.
B) where its marginal revenue is equal to its marginal cost.
C) where its marginal revenue is zero.
D) None of the above

Front 51

A firm has two plants, one in the United States and one in Mexico, and it cannot change the size of the plants or the amount of capital equipment. The wage in Mexico is $5. The wage in the U.S. is $20. Given current employment, the marginal product of the last worker in Mexico is 100, and the marginal product of the last worker in the U.S. is 500.

A) Is the firm maximizing output relative to its labor cost? Show how you know.
B) If it is not, what should the firm do?

Back 51

Answer:
A. Maximizing output between plants requires that (MPL/w)U.S. = (MPL/w)MEX.
Since 100/5 (=20) is not equal to 500/20 (=25), the firm is not maximizing output relative to its labor cost.
B. The firm should hire more U.S. workers and fewer Mexican workers, all other things being equal.

Front 52

A firm is making a long-run planning decision. It wants to decide on the optimal size of plant and labor force. It is considering building a medium-sized plant and hiring 100 workers. Engineering estimates suggest that at those levels, the marginal product of capital will be 100 and the marginal product of labor will be 75. If the wage rate is $5 and the rental rate on capital is $10, is the firm making the right decision? Support your answer.

Back 52

Answer:
No, the firm is not making the right decision. Minimizing cost (maximizing output) requires that (MPL/w) = (MPK/r). 100/10 < 75/5, so the firm should plan to build a smaller plant and employ more workers, all other things equal.

Front 53

If the price of capital (K) is $24, the price of labor (L) is $15, and the marginal product of capital is 16, the least costly combination of capital and labor requires that the marginal product of labor be ________.

Back 53

Answer:
MPK / MPL = Price of capital/Price of Labor, or marginal product of labor = 10.

Front 54

Fred's Widget Company has purchased $500,000 in equipment, which can be sold for a salvage value of $300,000 at any time. The best interest rate on alternative investments is 5%. What is the cost of using this machinery for one year? How would your answer be different if the machinery had not yet been purchased?

Back 54

Answer:
Short-run cost = $15,000
Cost if the machinery was not purchased = $200,000 + $25,000 = $225,000
Explanation: The short-run cost is just the forgone interest. The short-run depreciation is sunk, and the salvage value doesn't change. The long-run cost (if the machine has not been purchased is the depreciation cost plus the foregone interest on the whole $500,000.

Front 55

How would each of the following affect the firm's marginal, average, and average variable cost curves?

A) An increase in wages
B) A decrease in material costs
C) The government imposes a fixed amount of tax.
D) The rent that the firm pays on the building that it leases decreases.

Back 55

Answer:
A. Wages are a variable cost, so MC, AVC, and ATC increase.
B. Materials are a variable cost, so MC, AVC, and ATC decrease.
C. A fixed or lump-sum tax increases ATC but not MC or AVC.
D. Rent is generally viewed as a fixed cost, so ATC decreases, but MC and AVC are unchanged.

Front 56

Carefully explain the difference between diseconomies of scale and diminishing returns.

Back 56

Answer:
Diseconomies of scale means that, in the long run, average costs are rising, usually due to coordination problems or decreasing returns to scale. Diminishing returns means that, in the short run, marginal product is falling (or marginal cost is rising) because each worker is producing less than the one before him, due to the fact that capital (or some other factor of production) is fixed. There is no connection between these things.

Front 57

Why would a firm choose to remain in an industry in which it makes an economic profit of zero?

Back 57

Answer: Making an economic profit of zero does not mean that the firm is not making any money. It means that it is covering all its costs, including opportunity costs. This means that all resources employed are earning just as much as they would in their next-best use, and thus that there is no gain from moving them to their next -best use.

Front 58

Describe the difference in market structure between Monopoly and Oligopoly.

Back 58

Answer: Oligopoly is a market structure containing a small number of relatively large firms that often produce slightly differentiated output and with significant barriers to entry. Monopoly is a market structure containing a single firm that produces a good with no close substitutes and with significant barriers to entry. The primary difference between oligopoly and monopoly is that monopoly contains a single seller, whereas oligopoly has two or more sellers. Such a difference might seem to provide a clear separation. But not necessarily.

Front 59

Explain the difference between Economic and Normal profits.

Back 59

Answer: Normal profit is the amount of profit necessary to insure that a firm continues to operate in the long run, and it is based on the profit that could be earned in its next best alternative activity. It is equal to the sum of its accounting cost and opportunity cost. Economic profit is the amount of profit above normal profit: profit in excess of what could be earned in its next best alternative activity.

Front 60

How is a monopolistically competitive industry like perfect competition? How is it like monopoly?

Back 60

Answer: Monopolistic competition is very much like perfect competition in the large number of firms and the absence of barriers to entry. But the perfectly competitive firm has a flat demand curve because it produces the same product as other firms; thus, any change in price will cause households to buy from another firm. Monopoly?

Front 61

When one automaker begins offering low cost financing or rebates, others tend to do the same. What two oligopoly models might offer an explanation of this behavior?

Back 61

Answer: (1) Kinked demand curve: the assumption behind the kinked demand curve model is that rivals follow price decreases but not price increases. One automaker offering rebates, etc., is essentially a price cut, and so others will follow. (2) Price leadership: This could also be viewed as a price leader setting a new price and others following.

Front 62

Why do cartels tend to break up?

Back 62

Answer: Cartels tend to break apart because each firm wants to produce more output than what is best collectively. Other examples that break up cartels are:
Price wars
Cheating
Economic recession
High economic volatility
New entrants

Front 63

McDonald's charges a higher price for a Big Mac in New York City than it does in a small town in Ohio. Is this an example of third degree price discrimination? Explain.

Back 63

Answer: No, or not necessarily. Costs differ between the two markets, because land is more expensive in New York City. Thus the higher price reflects that.

Front 64

Some charge that third degree price discrimination is unfair or that it reduces social welfare. Why does charging one group a lower price hurt anyone?

Back 64

Answer:

Front 65

Would it ever make sense for a firm to charge a price at or below the cost of the product?

Back 65

Answer: This might be an example of penetration pricing in which the firm is trying to gain market share. (Two other reasons not discussed in the text: limit pricing to prevent entry, and predatory pricing to drive out rivals.)

Front 66

Define:

Asymmetric information

Back 66

Answer: Asymmetric information is a market situation in which one party in a transaction has more information than another party.

Front 67

Define:

Moral hazard

Back 67

Answer: Moral hazard is the risk that the behavior of one party may change to the detriment of another after a contract has been agreed upon.

Front 68

Define:

Adverse selection

Back 68

Answer: Adverse selection is a situation resulting from asymmetric information in which parties may not come to an agreement on a transaction because of distrust on the part of the other party with incomplete market information about such factors as the quality or reliability of a product that is being offered in the market.

Front 69

In game theory, what is a “dominant strategy”?

Back 69

Answer: A strategy that would be the best one for a player in a non-cooperative game no matter what strategies are adopted by the other players in the game.