Chapter 1: Preliminaries
Multiple Choice
Which of the following topics would most likely be studied in a Microeconomics course?
The correct answer: The rate of change in the price of long distance telephone service.
This price is determined by buyers and sellers interacting in a market.
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Which of the following topics would least likely be studied in a Microeconomics class?
The correct answer:: The wages of all workers in the nation.
This is determined by individual agents acting in a single market.
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Which of the following statements is a normative statement?
The correct answer: The minimum wage is too low.
This statement makes no judgement about the minimum wage. The statement is simply a point of fact.
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Which one of the following statements is the result of positive analysis?
The correct answer: Families with high incomes tend to purchase larger homes than families with lower incomes.
The statement describes what the speaker thinks "ought to be."
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Suppose that vendors sell pretzels outside the football stadium for 50 cents each while pretzels sell for $2 each inside the stadium during a game. Arbitrage would involve
The correct answer: buying pretzels outside the stadium and selling them inside the stadium.
Arbitrage would be buying pretzels outside for 50 cents and reselling inside for $2.
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The difference between the market for automobiles and the automobile industry is that the market consists of all buyers and sellers while the industry consists of
The correct answer: only the sellers of automobiles.
The market is where buyers and sellers come together. The industry is the collection of all sellers of a similar product.
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In defining the geographic extent of the local market for home heating oil, economists need to consider all of the following EXCEPT
The correct answer: the price of unrefined crude oil.
This would limit the extent to which a supplier could expand its market.
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If the price of home heating oil is 20 cents per gallon higher in Leesville than in Culpsville for the entire heating season, one can conclude that
The correct answer: the two towns are not part of the same market for home heating oil.
If arbitrage were taking place, the price gap would eventually disappear.
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Pepsi and Coke can be considered to be selling in the same market UNLESS
The correct answer: buyers of one brand would never consider buying the other brand under any circumstances.
The two brands could be in the same market, and yet, due to product differences, they would sell at different prices.
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If the nominal price of gasoline rises more than the nominal prices of all other goods and services, then
The correct answer:: the real price of gasoline definitely increases.
Since the real price is the nominal price divided by the price index, the real price will increase.
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If the nominal price of gasoline rises, then
The correct answer: the change in the real price of gasoline cannot be determined without further information.
Since the real price is the nominal price divided by the price index, we need to know the change in the price index to know the change in the real price.
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If the nominal price of gasoline is unchanged while the nominal prices of all other goods and services fall, then
The correct answer:: the real price of gasoline definitely increases.
Since the real price is the nominal price divided by the price index, the real price will increase.
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If you know that the real price of gasoline fell during a particular time period, then it must be true that
The correct answer: if the nominal price of gasoline rose, the CPI rose by a greater percentage.
Since the real price is the nominal price divided by the price index, if the real price were to fall, then either the nominal price fell while the CPI either rose or fell by a lesser percentage, or the nominal price rose and the CPI rose by a greater percentage.
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The price of basic cable television service increased from $15 per month in 1983 to $35 per month in 1999. During this same time period, the CPI rose 70%. The real price of cable television service
The correct answer:: increased.
The nominal price increased by (35-15)/15 = 133%. Since this increase is greater than the overall increase in prices, the real price of cable TV increased.
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In 1983, Professor James was hired at an annual salary of $25,000. In 1999, his annual salary is $50,000. Based on a 1999 CPI of 170 (1983=100), the professor's real salary has
The correct answer: increased by almost 20%.
His real 1999 income in 1983 $ is $50,000/1.7 = $29,411. This represents a (29,411 – 25000)/25000 = 17% increase.
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In 1996, George earned an hourly wage of $12. In 1999, George earned an hourly wage of $12.91. Based on a CPI of 158 for 1996 and a CPI of 170 for 1999 (1983=100), the change in George's real hourly wage
The correct answer: was zero from 1996 to 1999.
In 1983 $, his 1996 wage was $12/1.58 = 7.59. In 1983 $, his 1999 wage is $12.91/1.70 =7.59. There is no change in his real wage.
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The Clevons Corporation has a goal of setting the nominal price of its product in such a way as to keep the real price the same as it was when the company started in 1970. In 1970, the company charged $1.00 each for its product and the CPI was 38.8 (1983=100). If the CPI in 1999 was 170, then the price of the product in 1999 should have been
The correct answer:: $4.38.
In 1970, the price in 1983 $ was 1/.388 = 2.58. To keep a real price 2.58 in 1999, the price would be 2.58 * 1.7 = 4.38.
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In 1996, George earned an hourly wage of $10. In 1999, George earned an hourly wage of $15. Based on a CPI of 158 for 1996 and a CPI of 170 for 1999 (1983=100), George's real wage in 1999, in 1996 $ is
The correct answer: $13.94.
Since 1996 prices are 1.58 times greater than 1983 prices, first compute the 1999 wage in 1983 $, then multiply it by 1.58. Real wage = (15/1.70) * 1.58=13.94.
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In 1930, Adam would spend 10 cents for a ticket to go to the movies. Today, a ticket to the movies costs $4. Adam feels that he is paying too much at the movies. You could console him that the real price of a movie ticket is not higher now than it was in 1930 as long as
The correct answer: the CPI increased by more than 3,900% since 1930.
The increase in the price of the movie ticket is (4-0.1)/0.1 = 3,900%.
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In 1983, Pete purchased a 13" television set for $150. In 1999, a 13" television set could be purchased for $75. Knowing that the 1999 CPI is greater than 100 and the CPI equals 100 for 1983, one can conclude that the change in the real price of the 13" television is
The correct answer:: negative.
Since the real price is the nominal price divided by the price index, a drop in the nominal price combined with an increase in the CPI means the real price decreases.
Chapter 2: The Basics of Supply and Demand
Multiple Choice
A rightward shift of the demand curve for computer programmers will result in a
The correct answer: movement along the supply curve for computer programmers and a shift in the supply curve for computer programs.
The new equilibrium is at a higher price as one moves up the supply curve. Programmers now receive a higher "price" for their services. Since programmers are inputs into making programs, the supply curve for programs shifts leftward.
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As the price of oranges rises,
The correct answer: the quantity demanded for oranges decreases.
Price and quantity demanded are inversely related. The change in price results in a movement along the curve – not a shift.
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As the price of oranges rises,
The correct answer: the demand curve for grapefruit shifts to the right.
A rise in the price of orange juice causes a decrease in the quantity demanded of orange juice and a rightward shift in the demand curves of substitutes such as grapefruit.
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As the price of oranges rises,
The correct answer: the supply curve for orange juice shifts to the left.
A rise in the price of an input causes a leftward shift in the supply of a good.
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As the price of automobiles rises,
The correct answer: the demand curve for bicycles will shift to the right.
A price increase causes the quantity demanded for a good to decrease, the demand curve for substitutes to shift rightward, and the demand curve for complements to shift leftward.
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If there is a surplus in the market for gasoline, then which of the following statements is most likely to be true?
The correct answer: Gasoline prices will fall.
A surplus means that at the current price, quantity supplied exceeds quantity demanded. If that is the case, then the price must be above equilibrium price. In the absence of any government restrictions, price is expected to fall.
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If the market for bicycles is not in equilibrium, then which of the following statements is definitely true?
The correct answer: The price of bicycles will change, but not enough information is given to determine the direction of the change.
Not being in equilibrium implies that price and quantity will change. However, since one does not know from the statement whether price is above or below equilibrium, the direction of the change is unknown.
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Suppose that the market for luxury automobiles is currently in equilibrium. What effect would a sharp drop in consumers' income have in this market?
The correct answer: Both the equilibrium price and the equilibrium quantity will fall.
The drop in consumers' income will cause the demand curve for luxury automobiles to shift leftward. This will cause both price and quantity to fall.
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Which of the following factors could best explain the recent increase in the price of golf clubs?
The correct answer: The increase in the popularity of golf.
This would cause the supply curve to shift to the right, and the price would fall.
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Suppose the monthly demand for a can of 3 tennis balls at a nearby tennis club can be expressed as Q = 150 – 30P. What is the price elasticity of demand at a price (P) of $3 per can?
The correct answer: -1.5
Elasticity equals (-30)*(3/60) = -1.5.
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If the cross-price elasticity between home personal computers and video game units for TV is positive, one can conclude that
The correct answer: these products are substitutes for one another.
A positive cross-price elasticity means that the two goods are substitutes.
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Suppose that the demand for lawn fertilizer can be expressed as QD = 5000 – 120P and that the supply of lawn fertilizer can be expressed as QS = 1000 + 80P where Q is measured in thousands of tons per year and P is measured in dollars per thousand tons. What is the price elasticity of demand when the market is in equilibrium?
The correct answer: -0.92
To find equilibrium, set 5,000-120P = 1,000 + 80P. This yields P =20. Price elasticity of demand = (-120)*(20/2,600) = 24/26 =.92.
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The demand for gasoline is more price elastic in the long run than in the short run because in the long run,
The correct answer: consumers have greater ability to change the car they drive than they do in the short run.
In the short run, consumers can only change the amount that they drive. In the long run, they can purchase a different car with different fuel efficiency.
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Suppose that the market equilibrium price of corn is $1 per dozen ears and 4,000 dozen ears are sold each week. Assuming a linear demand curve for corn, if the price elasticity of demand for corn is –1, then the demand curve may be written as
The correct answer: Q = 8000 – 4000P.
Since (change in Q/change in P) * (P/Q) = -1, then (change in Q/change in P) = - 4000. Q = a – 4000P, or 4000 = a –4000(1), so a=8000. Thus, the demand curve can be written as Q = 8000 – 4000P.
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Two demand curves have been drawn to represent the demand for coffee. The two curves intersect at the current market price. One curve is steeper than the other curve. It is most likely that
The correct answer: the steeper curve represents the short-run demand for coffee while the flatter curve represents the long-run demand for coffee.
Over the short run, consumers might change their quantity demanded slightly in reaction to a price change. Over the long run, the response to a price change is change is greater as consumers adopt other beverages.
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A sharp and lasting decrease in the demand for ice cream would result in
The correct answer: a greater price decrease in the short run than in the long run.
Since the short-run supply curve is steeper, the price decrease will be greater in the short run. In the long run, producers can reduce the quantity supplied more so than in the short run. As a result, in the long run, there is a price decrease, but it is smaller than the short-run price decrease.
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If government regulators set a price ceiling on a good, the size of the shortage that results will be greatest under which of the following settings?
The correct answer: Demand and supply are both very elastic.
If demand and supply are both very elastic, the difference between quantity supplied and quantity demanded increases.
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Suppose that the demand for lawn fertilizer can be expressed as QD = 5000 – 120P and that the supply of lawn fertilizer can be expressed as QS = 1000 + 80P where Q is measured in tons per year and P is measured in dollars per ton. What is the effect of a government-imposed price ceiling of $10 per ton of fertilizer?
The correct answer: A shortage of 2,000 tons.
Equilibrium price is found by setting 5000 – 120P = 1000 + 80P, or P =$20, so the ceiling is effective. At a price of $10, quantity demanded equals 3,800 thousand tons, while quantity supplied equals 1,800 tons. Thus, a shortage of 2,000 tons is the result.
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Suppose that the demand for lawn fertilizer can be expressed as: QD = 5000 – 120P and that the supply of lawn fertilizer can be expressed as: QS = 1000 + 80P where Q is measured in thousands of tons per year and P is measured in dollars per thousand tons. If demand increases 10%, by how much will price change?
The correct answer: Price increases by $1.23.
The old price is found by setting 5000-120P = 1000 + 80P. Solving yields P =20. The new price is found by first increasing quantity demanded by 10% so that demand can be written as QD = 5500 – 132P. Then, solve 5500-132P = 1000 + 80P. The new price is $21.23.
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Suppose that 1000 gallons of ice cream sold on the boardwalk each day at a price of $1. Suppose a 10% price increase causes the quantity demanded to fall by 5%. The price elasticity of demand is equal to
The correct answer: -0.5
Price elasticity of demand equals percent change in quantity demanded divided by the percent change in price equals (-5%)/(10%) = -.5
Chapter 3: Consumer Behavior
Multiple Choice
The indifference curves for two goods are negatively sloped because of the principle that
The correct answer: more is preferred to less.
Since along a given indifference curve, a given bundle yields just as much utility as any other bundle and more is preferred to less, then bundles with more of both goods than the original bundle cannot be on the same indifference curve as the original bundle. Bundles with less of both goods than the original bundle cannot be on the same indifference curve as the original bundle. The only bundles that can be on the same indifference curve as the original bundle are bundles that have more of one good and less of the other.
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Indifference curves cannot intersect because of the assumption that
The correct answer: preferences are transitive.
While this is true, it does not keep indifference curves from intersecting.
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Indifference curves between nickels and dimes would be
The correct answer: Negatively sloped and straight.
Two nickels are perfect substitutes for one dime. The indifference curves would therefore be straight lines with a constant slope of –2.
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Indifference curves between left shoes and right shoes would be
The correct answer: L-shaped.
These shoes are good only in pairs of one each. Additional left shoes alone do not make the consumer better off, and additional right shoes alone do not make the consumer better off. The indifference curves are therefore L-shaped.
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John derives utility from the consumption of food and clothing. His utility function can be represented as U =F*C. If John currently consumes 10 units of food and 8 units of clothing, how many units of food would John be willing to give up to get one more unit of clothing?
The correct answer: 1.25
MUC = F =10. MUF = C =8. MRS = 10/8 = 1.25.
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Suppose Tim enjoys coffee (C) but is sickened by tea (T). Which of the following utility functions would best represent Tim's utility function for coffee and tea?
The correct answer: U = C / T
For this function, additional units of tea make Tim better off.
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If Leon's marginal rate of substitution of chicken for steak is 2, then we know that
The correct answer: he is willing to give up 2 units of steak to get the next unit of chicken.
Marginal rate of substitution of x for y tells us how much y one is willing to give up to get the next unit of x.
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When Sally had only one gallon of water in the cupboard, she said she was willing to give up a week's worth of television to get another gallon. Now that she has ten gallons of water in the cupboard, she refuses to part with anything when offered another gallon of water. Sally's behavior demonstrates
The correct answer: diminishing marginal rate of substitution.
It is completely rational to have a diminishing marginal rate of substitution.
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The vertical intercept of the budget line represents
The correct answer: the consumer's real income in terms of the good measured on the vertical axis.
The intercept is I/PY which represents the consumer's real income in terms of good Y being measured on the vertical axis.
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Liz has $10 to spend on soda (S) and pretzels (P). Sodas cost $1 each and pretzels cost $0.50 each. Which of the following represents Liz's budget constraint?
The correct answer: P = 20 – 2S
P = (10/0.5) – (1/0.5)S = 20 – 2S.
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Suppose that the quantity of pretzels consumed is measured on the vertical axis and the quantity of soda consumed is measured on the horizontal axis. If the budget line becomes flatter while the vertical intercept is unchanged, then which of the following may have occurred?
The correct answer: The price of soda decreased while other things remained constant.
For the slope to become flatter, either the price of soda fell or the price of pretzels rose. If the price of pretzels rose, then income must have risen.
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If a consumer's budget line for food (F) and clothing (C) can be written as F = 500 – 4C, then we know that
The correct answer: clothing costs 4 times as much as food.
The intercept (500) is nominal income divided by the price of food. The slope (4) is the price of clothing divided by the price food.
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If all prices and income increase by 5%, then what will happen to the budget line?
The correct answer: Nothing.
Since, the budget line for two goods, X and Y, is Y = I/PY – (PX/PY)X, then neither the slope nor the intercept would change. In real terms, the consumer's buying opportunities have not changed.
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By selecting the combination of goods for which MRS = PX/PY, the consumer is saying
The correct answer: "I get the same marginal utility from my last dollar spent on X as I do from my last dollar spent on Y."
This would only be true for certain utility functions but it is not true in general.
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Mary and Sue each consume apples and chocolate. They each pay the same price for each of the two goods, and both women claim to be in equilibrium. It must be true that
The correct answer: Mary and Sue have the same marginal rate of substitution of apples for chocolate.
The utility functions need not be the same for MUX/MUY to be the same.
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Rocky thinks that a sip of Coke and a sip of Pepsi are perfect substitutes. If Coke sells for $4 per case and Pepsi sells for $2 per case, then
The correct answer: Rocky will not buy any Coke.
The slope of the indifference curve is –1. The slope of the budget line is –2. Rocky will reach the highest indifference curve at a corner solution where he spends his entire cola budget on Pepsi and buys no Coke.
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Stefan has $50 to allocate between plays and movies. Plays cost $10 each and movies cost $4 each. Stefan maximizes his utility by buying tickets to 10 movies and 1 play. For his birthday, Stefan receives tickets to 2 plays. Which of the following statements is false?
The correct answer: Stefan is definitely now on a higher indifference curve than he would be if he had just received the $20 cash.
This statement is true. Stefan's budget line has shifted outward.
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If Liz's marginal rate of substitution of apples for chocolate is 3, while the price of chocolate is $6 per unit and the price of apples is $1 per unit, then Liz will
The correct answer: Liz will reduce her chocolate consumption and buy more apples.
Apples yield 3 times the marginal utility of chocolate while costing only 1/6 as much as chocolate. Liz can make herself better off by buying more apples and less chocolate.
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Herbert's utility function for food (F) and clothing (C) can be written as U = F*C. If the price of food is $4 per unit and the price of clothing is $2 per unit, how will Herbert allocate his $40 budget?
The correct answer: 10 units of clothing and 5 units of food
Herbert's MRS of clothing for food equals F/C. Set this equal to the price ratio of 2/4. Rearranging yields C =2F. Substituting this equilibrium condition into the budget equation yields F = 10 –F, or F =5, and therefore C = 10.
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When the price of clothing was $2 per unit and the price of food was $5 per unit, Jill would spend her $100 budget on 25 units of clothing and 10 units of food. When the price of food doubled to $10 per unit, Jill's mother gave her an extra $50 so that Jill could buy the same bundle that she did before the price change. Assuming convex indifference curves, which of the following statements is true?
The correct answer: Jill is actually better off now than she was before.
The new budget will intersect the original equilibrium but with a different slope than the original budget line. Jill can now reach a higher indifference curve.
Chapter 4: Individual and Market Demand
Multiple Choice
Assuming convex indifference curves for two goods, as the price of one good falls, a consumer will always
The correct answer: reach a higher level of utility.
As the price of a good decreases, the budget line rotates outward. In real terms, the consumer is able to purchase more. Therefore, the consumer will reach a higher level of utility. How the consumer allocates her budget depends on the actual shape of the indifference curves.
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A price consumption path is derived by
The correct answer: connecting all of the tangency points as the price of a good changes.
The price consumption path is derived by drawing a line to connect all of the equilibrium points that result from a change in the price of one good, holding income and all other prices constant.
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Along an individual demand curve for food, which one of the following is not held constant?
The correct answer: The consumer's level of utility.
The demand curve for a good is derived by mapping out the equilibrium quantities of that good that result from changing the price of that good, holding income and the price of all other goods constant.
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Suppose that the quantity of food is measured on the horizontal axis and the quantity of clothing is measured on the vertical axis. If the price consumption path for food is vertical then
The correct answer: the demand for food is perfectly inelastic.
A vertical price consumption path implies that the quantity of food demanded is the same at every price.
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Suppose that the quantity of food is measured on the horizontal axis and the quantity of clothing is measured on the vertical axis. As income rises, the consumption of food also rises. Therefore, it must be true that
The correct answer: food is a normal good.
A normal good is defined as a good for which quantity demanded increases as income increases.
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If food is an inferior good, then
The correct answer: its Engel curve will be negatively sloped.
This is only true for a Giffen good.
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Suppose that the quantity of food is measured on the horizontal axis and the quantity of clothing is measured on the vertical axis. When the price of food changes, the substitution effect can be found by comparing the equilibrium quantities of food purchased
The correct answer: on the old budget line and a line parallel to the new budget line tangent to the old indifference curve.
This comparison evaluates the change in quantity demanded allowing real income to change.
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Suppose that the quantity of food is measured on the horizontal axis and the quantity of clothing is measured on the vertical axis. When the price of food changes, the income effect can found by comparing the equilibrium quantities of food purchased
The correct answer: on the new budget line and a line parallel to the new budget line tangent to the old indifference curve.
The income effect is found by comparing the quantity demanded when facing the new price but the old level of real income with the quantity demanded when facing the new price and the new level of real income.
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Suppose that the quantity of food is measured on the horizontal axis and the quantity of clothing is measured on the vertical axis. In the case of convex indifference curves for the two goods, it is always true that
The correct answer: when the price of food declines, the substitution effect leads to an increase in the quantity of food demanded.
The shape of the income consumption path is dependent upon the specific utility function. With convex indifference curves, one can have a positively or negatively sloped income consumption path.
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Suppose that the substitution effect of a decline in the price of food is the same for both Harry and Sally. However, Harry feels that food is an inferior good while Sally feels that food is a normal good. As a result,
The correct answer: Harry's demand curve for food will be steeper than Sally's.
For a given price decrease, both Harry and Sally experience an increase in real income. Since food is an inferior good for Harry, he will not increase his quantity demanded of food as much as Sally will increase hers. Thus, Harry's demand curve is steeper because the income effect is less for Harry than for Sally.
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Edward and Larry have identical preferences; however, due to differences in income, Edward spends a larger share of his income on caviar than Larry does. Which of the following statements is true regarding a decrease in the price of caviar?
The correct answer: Since the budget share of caviar is greater for Edward than for Larry, the income effect will be greater for Edward than for Larry.
The income effect of a price change is weighted by the budget share of the good for which the price has changed. Therefore, the income effect is greater for Edward than for Larry.
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When the price of food increases, Jimmy spends more on food than he did before. It must be true that Jimmy's demand for food
The correct answer: is relatively inelastic.
Total expenditure on a good will increase when the price of a good increases if demand is relatively inelastic.
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The price of grapes is different each week at the supermarket. Yet, Marge spends exactly $10 on grapes each week. It must be true that Marge's demand for grapes
The correct answer: is unit elastic.
Total expenditure on a good will not change when the price of a good changes if demand is unit elastic.
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Martha's demand for spring water has a price elasticity of –3.0. A recent tax that caused the price of spring water to increase by 20% will cause Martha to decrease her quantity demanded for spring water by
The correct answer: 60%.
Since price elasticity of demand is the percent change in quantity divided by the percent change in price, % change in Q /20% = -3. Rearranging yields % change in Q = -60%.
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Greg, Bobby, and Peter are the only consumers of camera film in a certain small town. Greg's demand is Q = 100 – 2P. Bobby's demand is Q = 25 – P. Peter's demand is Q = 75 – 7P. The market demand for film in that town is
The correct answer: Q = 200 – 10P.
QMARKET = QGREG + QBOBBY + QPETER = (100 – 2P) + (25 –P) + (75 – 7P) = 200 – 10P
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The market demand for photo film in a given town is Q = 500 – 10P where Q is measured as rolls of film consumed per week and P is measured as $/roll. If the price of film is $5 per roll, how much is the consumer surplus in the market for film?
The correct answer: $10,125
At that price, 450 rolls will be purchased. The demand intersects the vertical axis at a reservation price of $50. Consumer surplus is the area [($50 - $5) * 450] / 2 = $10,125.
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Sam is willing to part with his old car for no less than $5,000. Bob likes the car and would pay as much as $8,000 for it. After lengthy negotiations, they agree on a price of $7,000. As a result of the deal, Bob will enjoy a consumer surplus equal to
The correct answer: $1,000.
Bob actually pays $7,000 and is willing to pay $8,000. The difference is $1,000.
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Suppose the demand for bridge crossings at a certain remote site is P = 100 – 2Q where Q is measured as crossings per year and P is measured as $ per crossing. What is the value to consumers of building a bridge at that site?
The correct answer: $2,500
The total value to consumers is the area under the demand curve. The demand intersects the horizontal axis at a quantity of 50. Thus the area under the demand curve is (100 * 50) / 2 = $2,500.
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Evidence of the presence of network externalities in the market for electronic fax machines wouldbe that
The correct answer: an increase in the number of fax machines sold increase the individual consumer's benefit of owning a fax machine.
This is true for any good. A network externality exists if a consumer's utility from a good increases as more of other consumers purchase the good.
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Joe can finally afford his dream car – the MBA2000. He has called around to all of the auto service centers within a 250-mile radius of his home. None of them will service the car. It seems that since there are not too many MBA2000's out on the road, no mechanic has taken the time to learn how to service this vehicle. Joe decides to purchase a more conventional automobile. His behavior can best be explained by
The correct answer: a network externality.
A network externality increases the benefit of owning a product when more and more people own it. A snob effect decreases the benefit of owning a product when more and more people own it.
Chapter 5
Multiple-choice test
1. |
| The probability for all possible events
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| Incorrect. The sum of the probability of the possible outcomes must add to 1. | |||||||
2. |
| Objective probability is
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| Incorrect. This is the definition for subjective probability. | |||||||
3. |
| The expected value
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| Correct. | |||||||
4. |
| If the probability of outcome 1 is 0.75 with an expected payoff of $5000, and the probability of outcome 2 is 0.25 with an expected payoff of $20,000, then the expected value of the outcome is
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| Incorrect. The expected value is the sum of the probability of success times the expected payoff for each possibility. | |||||||
5. |
| Variability is defined as
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| Incorrect. Variability is measured using the sum of the squared differences between the expected and possible outcomes, weighted by their probability, or the Standard Deviation. | |||||||
6. |
| The standard deviation is calculated as
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| Incorrect. The standard deviation is the square root of the weighted average of the sum of the squared differences between the expected and possible payoffs or outcomes. | |||||||
7. |
| A risk adverse individual can be defined as someone who
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| Incorrect. This answer is correct, but number 1 is also correct. | |||||||
8. |
| A risk loving individual can be defined as someone who
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| Correct. More is always preferred to less, especially for a risk loving person who can tolerate a higher standard deviation in the outcomes. | |||||||
9. |
| John is evaluating two investment opportunities, one with an expected outcome of a 5% return on investment (standard deviation of 1 percentage point) and one with an expected outcome of 7.5% return on investment (standard deviation of 5 percentage points). John will decide to invest in
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| Correct. | |||||||
10. |
| The risk premium is
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| Incorrect. Persons who avoid taking risk forgo the opportunity for additional income. | |||||||
11. |
| An investor is considering a $100,000 investment in a developing country that has the potential to return $75,000 with a 0.75 probability, but there is a 0.25 probability that a military coup, will result in a return $0. Purchasing political insurance for $18,750 will lead to an expected return of _____________________ with or without insurance, but reduces the standard deviation from _________ to ____________.
| ||||||
| Incorrect. The expected value is 0.75($75,000)+0.25(0)=$56,200 with a standard deviation of $32,476. The $18,750 insurance guarantees the $75,000 return in case of a coup but reduces the net return to $56,250, and variability is reduced to zero. | |||||||
12. |
| The value of complete information is equal to
| ||||||
| Correct. | |||||||
13. |
| There is a 25% chance that a $100,000 investment will yield $25,000 and a 75% chance that the investment will yield $10,000. However, you are confident that if you purchase market research for $5000 you can with certainty invest the $100,000 and earn $20,000. In this case, the value of complete information is
| ||||||
| Incorrect. The expected value of yield on your investment is $13,750 without complete information, and $20,000 with it, so the value of complete information is $6,250. | |||||||
14. |
| The actual rate of return on Treasury bills
| ||||||
| Incorrect. Treasury bills are a risk free form of investment and so the expected rate of return equals the actual rate of return. | |||||||
15. |
| When analyzing the trade off between risk and return on investment, the slope of the budget line
| ||||||
| Incorrect. This answer is correct, but so is no. 3. | |||||||
16. |
| Indifference curves depicting an investor's trade-off between expected return on investment and risk are upward sloping because
| ||||||
| Incorrect. A risk averse investor requires a higher expected rate of return for each level of risk than risk neutral or risk loving investors. | |||||||
17. |
| An indifference curves depicting a slightly risk averse investor's trade-off between expected return on investment and risk would have
| ||||||
| Incorrect. A small increase in the expected return for an increase in risk is illustrated by a flatter slope of the indifference curve. | |||||||
18. |
| Loss aversion is defined as
| ||||||
| Incorrect. Loss aversion refers to a person wanting to avoid realizing a loss to acquiring gains. | |||||||
19. |
| An example of loss aversion would include
| ||||||
| Correct. | |||||||
20. |
| "Rules of thumb" in economic decision making, such as "anchoring" and ignoring seemingly unimportant pieces of information,
| ||||||
| Incorrect. The time saving effect of rule of thumb decision making may offset some of the negative bias. |
Chapter 6: Production
Multiple Choice
In describing a given production technology, the short run is best defined as lasting
The correct answer: as long as at least one input is fixed.
There is no set calendar time for the short run. Its length can vary with technology from firm to firm. As long as at least one input is fixed, the firm is in the short run.
________________________________________
The production function is a relationship between a given combination of inputs and
The correct answer: the highest resulting level of output.
The production function shows the highest level of output produced by a given combination of inputs, with a given technology.
________________________________________
Suppose the short-run production function at Skip's Pottery can be represented as Q = 100L – L2 where Q is clay pots produced per week and L is the number of hours Skip works per week. If Skip works 40 hours per week, what is his marginal product of labor?
The correct answer: 20
MPL = change in Q/change in L = 100 – 2L. When L =40, MPL = 20.
________________________________________
Suppose the short-run production function at Skip's Pottery can be represented as Q = 100L – L2 where Q is clay pots produced per week and L is the number of hours Skip works per week. If Skip works 40 hours per week, what is his average product of labor?
The correct answer: 60
APL = Q/L. When L = 40, Q = 4000 – 1600 =2400. APL = 2400/40 = 60.
________________________________________
Thomas Malthus' prediction would have come true if
The correct answer: technological changes in food production had not taken place.
Malthus' prediction was based on the law of diminshing marginal productivity that states that as labor increases, total output increases at a decreasing rate, all other things constant. Malthus' prediction failed to account for the fact that technological change would increase the marginal product of labor.
________________________________________
If the marginal product of labor is below the average product of labor, it must be true that
Your answer: the marginal product of labor is negative.
The correct answer: the average product of labor is falling.
Incorrect. Marginal product of labor is the extra output produced by the next unit of labor. If the next unit produces at a rate below the average, the average will be pulled down. The marginal product of labor can still be positive even if it is below the average.
________________________________________
The average product of labor is maximized when the marginal product of labor
The correct answer: equals the average product of labor.
At this point, APL is still rising.
________________________________________
As one moves along a convex isoquant, which of the following does not change?
The correct answer: The level output produced.
An isoquant shows the combinations of capital and labor that produce the same level of output. If the isoquant is convex, then the MRTS diminishes as labor increases.
________________________________________
If the isoquants for two different types of inputs are negatively sloped straight lines, then
The correct answer: the two inputs are perfect substitutes for one another.
If the isoquants have a constant slope, then the one input can always be substituted for the other at the same rate no matter how much of each input is used. The two inputs are, therefore, perfect substitutes.
________________________________________
A certain trench-digging company utilizes the following technology: Each man has a shovel and digs. A man without a shovel is useless, and shovels, of course, cannot dig on their own. The isoquants for this company are
The correct answer: L shaped.
From a fixed proportion of one to one, additional shovels have zero marginal product and additional labor has zero marginal product. The isoquants are, therefore, L shaped.
________________________________________
For the production function, Q = L1/3 K1/3, what shape will the isoquants have?
The correct answer: negatively sloped and convex.
MPL = 1/3(L-2/3 K1/3) = 1/3(Q/L). MPK = 1/3(L1/3 K-2/3) = 1/3(Q/K). The slope of the isoquant equals –(MPL/MPK) = -K/L. As L increases and K decreases, the slope becomes smaller (in absolute terms). Thus, the isoquants are negatively sloped and convex.
________________________________________
The production function, Q = L1/3 K1/3, exhibits
The correct answer: decreasing returns to scale at all levels of production.
Suppose initially L = L1 and K = K1 and Q = Q1. Now increase both inputs by the same factor 2. The new level of output equals 2L11/3 2K11/3= 22/3 L11/3 K11/3 = 22/3Q1. Thus, while inputs were doubled, the increase in output is less than double. This is true for all levels of L1 and K1. Thus, there are decreasing returns to scale at all levels of production.
________________________________________
Labor is measured on the horizontal axis, and capital is measured on the vertical axis. If an isoquant is relatively flat at a certain combination of capital and labor, we know that
The correct answer: the marginal product of labor is less than the marginal product of capital.
Since the slope equals –MPL/MPK, a relatively flat isoquant means that MPL is less than MPK.
________________________________________
If decreasing returns to scale are present, then if all inputs are increased by 10%,
The correct answer: output will increase by less than 10%.
Decreasing returns to scale means that a proportionate increase in all inputs results in a less than proportionate increase in output.
________________________________________
With input combinations (L = 25, K =6), Alma harvested 200 bushels of wheat. After one of the machines broke, she hired more labor. As a result, with input combinations (L = 30, K = 5), she still harvested 200 bushels. One can conclude from these results that
The correct answer: the marginal product of labor is less than the marginal product of capital.
Two points do not provide enough evidence to draw a conclusion about the convexity of the isoquant.
________________________________________
The manager at Skip's Pottery knows the marginal product of labor equals 6 and the marginal product of capital equals 30. Skip will be purchasing one more unit of capital. If the firm wishes to keep the level of output unchanged, then the manager must
The correct answer: decrease labor hired by 5 units.
The increase in capital will raise output by 30 units. To reduce output by 30 units, thus leaving output unchanged, labor must decrease 5 units.
________________________________________
A production function can be written as Q = F(L,K). After various combinations of inputs were used, the following results were obtained: 1000 = F(120,6) 2000 = F(200,10) 3000 = F(300,15) 4000 = F(400,20) 5000 = F(500, 25) 6000 = F(700,35). Over which range of output are there constant returns to scale?
The correct answer: 2000 to 5000 units of output only.
From 1000-2000 units of output, it takes a less than doubling of inputs to double output. From 2000-3000 units of output, a 50% increase in inputs yields a 50% increase in output. From 3000-4000, a 33% increase in inputs yields a 33% increase in output. From 4000-5000, a 25% increase in inputs yields a 25% increase in output. From 5000-6000, a 40% increase in inputs yields a 20% increase in output. Thus, constant returns to scale exist only in the range of 2000-5000 units.
________________________________________
A production function can be written as Q = F(L,K). After various combinations of inputs were used, the following results were obtained: 1000 = F(120,6) 2000 = F(200,10) 3000 = F(300,15) 4000 = F(400,20) 5000 = F(500, 25) 6000 = F(700,35). Increasing returns to scale are present over which range of output?
The correct answer: Up to 2000 units of output only.
From 1000-2000 units of output, it takes a less than doubling of inputs to double output. From 2000-3000 units of output, a 50% increase in inputs yields a 50% increase in output. From 3000-4000, a 33% increase in inputs yields a 33% increase in output. From 4000-5000, a 25% increase in inputs yields a 25% increase in output. From 5000-6000, a 40% increase in inputs yields a 20% increase in output. Thus, increasing returns to scale exist only in the range of 1000-2000 units.
________________________________________
The local factory noticed that each of the following combinations of capital and labor produced the same level of output: (L=1, K=20) (L=2, K=15) (L=3, K=11) (L=4, K=8) (L=5, K=6) (L =6, K=5). In going from 5 units of labor to 6 units of labor along the isoquant, this evidence suggests that
The correct answer: the marginal product of labor equals the marginal product of capital.
In this range, the slope of the isoquant equals –1. Thus, MPK = MPL.
________________________________________
The local factory noticed that each of the following combinations of capital and labor produced the same level of output: (L=1, K=20) (L=2, K=15) (L=3, K=11) (L=4, K=8) (L=5, K=6) (L =6, K=5). This evidence suggests that
The correct answer: the isoquant is convex.
By mapping out the isoquant, we can see that the isoquant becomes flatter as L increases and K decreases. Thus, the isoquant is convex.
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