Chapter Three
Microeconomics with Strategy Emphasis
9. (c) is the correct answer. The market clearing quantity is the quantity purchased which leaves no frustrated consumers. If the increase in both demand and supply were equal, that increase in supply would be purchased and there would be no frustrated consumers. Thus, the quantity purchased would increase. Answer (a) is not correct because it is not likely that the price would increase because the supply increased. Answer (b) is not correct because it is not likely that the price would decrease because the demand increased. Answer (d) is not correct because both demand and supply increase equally.
10. (c) is the correct answer. A perfectly inelastic supply curve is a vertical line; and it implies that a change in price will not impact the quantity offered in the market. That would be the case where firms cannot vary input usage.
Answer (a) is not correct because an equilibrium price of zero would mean that it is a free good. Answer (b) is not correct because a horizontal supply curve is used to represent a perfectly elastic supply curve, not an inelastic one.
Answer (d) is not correct because a perfectly inelastic supply curve is more likely to occur in the short run, than in the long run. In the long run, producers may be able to adjust to lower or higher demand for the product.
11. (c) is the correct answer. If the maximum price is set below the equilibrium price, the supply will not be sufficient to meet the demand. Thus, there will be a shortage of the product. Answer (a) is not correct because demand is independent of supply. Answer (b) is not correct because supply will not increase if the market-clearing price cannot be realized. Answer (d) is not correct because regulations that set minimum prices are likely to have an impact on the market in most situations.
12. (d) is the correct answer. In a competitive market, the forces of demand and supply will, in the long run, cause price to equal marginal cost. If price is higher than marginal cost, additional production will be forthcoming. If price is lower than marginal cost, producers will quit producing. Answer (a) is not correct because a competitive market cannot assure a fair price that all consumers can afford. The disposable income of the consumers dictates whether or not they can afford the product at the equilibrium price. Some will be able to afford it and some will not. Answer (b) is not correct because a price set equal to the total cost of production fails to recognize that the total cost should be divided by the number of units produced. Answer (c) is not correct because a price set equal to the total fixed cost of production fails to recognize that the total fixed cost should be divided by the total number of units produced. Even then, the variable costs per unit would be ignored.
13. (b) is the correct answer. The principle of diminishing marginal utility states that additional utility declines as quantity consumed increases. Answer (a) is not correct because the principle of diminishing marginal utility states just the opposite is true. One tires of something the more he or she has of it. Answer (c) is not correct because a vertical demand curve implies that the demand remains unchanged as price changes. That is contrary to the principle of diminishing marginal utility. Answer (d) is not correct because it implies that marginal utility increases as supply increases. Utility is independent of supply.
14. (b) is the correct answer. In the short run the addition of variable inputs to fixed resources yields additional output; but the amount of additional output diminishes as more variable inputs are used. Thus, as price increases, the amount of product supplied will increase until the marginal cost is equal to the marginal revenue. Answer (a) is not correct because a higher price does not usually cause an increase in demand. The increase in demand is what would likely cause a higher price. Answer (c) is not correct because as the size of the business firm increases, the price must fall if the demand remains unchanged. Answer (d) is not correct because increases in supply do not always imply a shift in consumer preference; it could be caused by the entry of a new producer in pursuit of excess profits.
15. (c) is the correct answer. Economies of scale are declines in long-run average costs that are caused by increased plant size. Answers (a) and (b) are not correct because they describe the law of diminishing returns. Answer (d) is not correct because increasing the size of the factory might lower average costs, but it will not lower total costs.
16. (a) is the correct answer. Monopolistic competition is characterized by a market in which a large number of firms sell differentiated products. Answer (b) is not correct because firms in a market characterized by monopolistic competition are faced with economies and dis-economies of scale. Answer (c) is not correct because the monopolistic competition market is characterized by a set of goods that are differentiated but have a large number of close substitutes. Answer (d) is not correct because the monopolistic competition market is faced with a downward sloping demand curve. As the price of the product declines, more will be demanded.
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17. (b) is the correct answer. In a purely competitive market, in the long run, an increase in market demand will cause the price to rise. Economic profit will result, and new firms will enter the industry in response to this profit.
As new firms enter, the market supply increases causing price to fall to the point at which all firms are earning zero economic profit. Answer (a) is not correct because consumers will be able to buy the product at the same price from several sources. Answer (c) is not correct because informational advertising plays a limited role in perfectly competitive markets because there is little opportunity for product differentiation. Answer (d) is not correct because there is no such thing as overproduction because all of the production will be cleared at the market price.
18. (d) is the correct answer. Cartels control price by restricting output. The oil cartel is an example. The OPEC countries restrict output to increase price. Answer (a) is not correct because cartels do not seek to decrease demand.
Answer (b) is not correct because advertising is not likely to influence demand for the homogeneous product that the cartel produces. Answer (c) is not correct because there is no evidence that cartels encourage the introduction of higher-priced substitute products. The effect of a cartel might be the introduction of lower-priced substitute products, e.g., natural gas substituted for oil.
19. (a) is the correct answer. If supply remains unchanged and there is a concerted effort to increase price, demand will fall and unemployment will increase. This is one of the arguments against the minimum wage. Answer (b) is not correct because it is possible that there is no additional labor supply available to respond to the increased wage.
Answer (c) is not correct because there is no economic law that says that the government must interfere. Answer (d) is not correct because the firms may choose to substitute capital for labor in order to maintain production.
20. (d) is the correct answer. In the long run, the firm has the opportunity to change the factors of production. The firm can expand or contract in response to changes in consumer demand. Thus, in the long run all inputs are variable. Answer (a) is not correct because in the long run the demand factors play a role in determining price and output. Answer (b) is not correct because supply factors play a role in determining price and output. Answer (c) is not correct because in the long run firms are assumed to enter and exit the industry.
21. (a) is the correct answer. A business that has the ability to control the price of the product it sells is a monopolistic firm. In such a situation the firm faces the market demand curve because the firm is the single seller in the market. Market demand curves have a negative slope (downward sloping). Answer (b) is not correct because such a firm is monopolistic; and industries in which monopolism exists have barriers to entry and exit. Answer (c) is not correct because in the case of a monopolist, one cannot predict the supply curve without knowing the demand curve. In a sense a monopolist has no supply curve. Answer (d) is not correct because in a monopolistic industry, the firm faces the market demand curve and market demand curves have negative slopes (downward sloping
22. (d) is the correct answer. A minimum price above the equilibrium price will cause more to be produced than can be cleared by the price. This excess uncleared production is a surplus. Answer (a) is not correct because a maximum price above the equilibrium price means that the price will be set by the market at the equilibrium price. At the equilibrium price there will be no surplus. Answer (b) is not correct because the minimum price below the equilibrium price means that the price will be set by the market at the equilibrium price. At the equilibrium price there will be no surplus. Answer (c) is not correct because if there is technological improvement in the means of production the average cost would decrease and a new supply curve would result. Given no change in the demand curve, the equilibrium price would be adjusted downward; but there would be no surplus.
23. (b) is the correct answer. A boycott would decrease the demand at all price levels and result in a shift in the demand curve to the left. Answer (a) is not correct because a lower quantity would be sold at the same price. Answer (c) is not correct because there would be no increase in availability. The supply curve would be dictated by the cost of production, not by the demand curve. Answer (d) is not correct because the quantity demanded would be lower at every price level with no change in the cost of production. Thus, profits would decline.
24. (b) is the correct answer. The monopolist produces a small output and charges a higher price than a perfectly competitive firm. The monopolist is encouraged to stop production when the marginal cost equals marginal revenue.
Answer (a) is not correct because the firm in a perfectly competitive market will produce an output where price equals marginal cost and marginal cost and average cost will be equal. Answer (c) is not correct because the maximization of total revenue does not pay proper attention to the role that cost plays in influencing supply. Answer (d) is not correct because the firm in a perfectly competitive market will produce an output where price equals
25. (b) is the correct answer. Given an unchanging supply, the price of a product in a competitive market will decline as there is a decline in the demand for the product. Answer (a) is not correct because an increase in the demand for the product will cause a higher price. Answer (c) is not correct because when there is a decline in the available labor, the costs go up and the price is likely to rise. Answer (d) is not correct because as the interest rates increase, the costs will increase and the price is likely to rise.
26. (a) is the correct answer. Product demand elasticity refers to the extent to which demand will change in response to changes in price. If there are substitute products, the demand will be more elastic than if there were no substitute products. With substitute products, if the price goes up, the consumer will merely shift demand to the substitute products. Answer (b) is not correct because when the consumer has greater income, there is decreasing marginal utility. The decreasing marginal utility causes the consumer to be less likely to reduce demand as the price increases.
Thus, increased income would result in less elasticity of demand. Answer (c) is not correct because the elasticity of supply is independent of the elasticity of demand. Answer (d) is not the correct answer because higher input costs might influence the price, but it will not influence the elasticity of demand.
27. (d) is the correct answer. Because the product's demand is elastic, the revenue effect of the increase in quantity is greater than the revenue effect of the decrease in price. The result is a net increase in total revenue. Answer (a) is not correct because when the product's demand is elastic, the revenue effect of the increase in quantity is greater than the revenue effect of the decrease in price. Thus, the total revenue would not decrease. Answer (b) is not correct because when the product's demand is elastic, the revenue effect of the increase in quantity is greater than the revenue effect of the decrease in price. Thus, the total revenue would not stay the same. Answer (c) is not correct because elasticity of demand refers to changes in the quantity demanded as price changes. It does not refer to shifts in the demand curve.
28. (c) is the correct answer. This highlights an important distinction between a change in the quantity demanded and a shift in the demand curve. When the change is along a specific demand curve, as it is in this question, it is referred to as a change in the quantity demanded. In contrast, if the demand curve itself changes, that is referred to as a shift in the demand curve. Answer (a) is not correct because a change in demand would imply a shift in the demand curve, not movement along the existing demand curve. Answer (b) is not correct because a shift in the demand curve means a movement of the demand curve in response to a change in the demand. Answer (d) is not correct because an increase in demand would imply a shift in the demand curve, not movement along the existing demand curve.
29. (b) is the correct answer. A product that is a necessity is often characterized by inelastic demand. Thus, the quantity demanded does not change much in response to a change in the price of the product. Answer (a) is not correct because the term "perfectly elastic" implies that there would be a major change in the quantity demanded for any small change in the price. Answer (c) is not correct because the term "elastic" implies that there would be a significant change in the quantity demanded for any small change in the price. Answer (d) is not correct because of the phrase in the question which states "no matter what cost." That phrase suggests that this answer, although a good answer, may not be the best answer.
30. (a) is the correct answer. Monopolistic competition is the situation in which there are a large number of sellers who can, for a short period of time, create a monopoly by differentiating their product. Answer (b) is not correct because monopolistic competition is not characterized by a relatively small number of sellers. An oligopoly has a small number of sellers. Answer (c) is not correct because that choice describes a monopoly or an oligopoly. Answer (d) is not correct because that choice describes perfect competition.
31. (c) is the correct answer. A price elasticity of 2.0 suggests that the percentage change in quantity will be twice the percentage change in price. Such a change is not perfectly elastic; but it is elastic. Answer (a) is not correct because perfectly elastic demand would have a price elasticity of demand of infinity. Answer (b) is not correct because perfectly inelastic demand would have a price elasticity of demand of zero. Answer (d) is not correct because a price elasticity of less than 1 is characteristic of inelastic demand.
32. (c) is the correct answer. If there are few substitutes and the product is considered a necessity, then any increase in price will not have much of an impact on demand. Answer (a) is not correct because luxury items are items for which there are a significant number of substitutes. Thus, if the price goes up, the demand for the item might be
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significantly reduced. Answer (b) is not correct because complements are products that are sold in conjunction with the main product. The fact that there is a complement for the product has no real impact on the elasticity of demand for the primary product. Answer (d) is not correct because such a generalization is not warranted. This is true because some people spend a large portion of their income on necessities and some people spend a large portion of their income on luxuries. The statement may be more true for those who spend a large portion of their income on necessities.
33. (d) is the correct answer. If a firm in a perfectly competitive industry were to price its product above the industry price, the firm would sell nothing. This is true because the consumer could buy an identical product at a lower price just down the street. Answer (a) is not correct because it is a choice that describes a characteristic of perfect competition. Answer (b) is not correct because it is a choice that describes a characteristic of perfect competition.
Answer (c) is not correct because it is a choice that describes a characteristic of perfect competition.
34. (c) is the correct answer. Monopolistic competition is characterized by many firms in a situation in which there can be product differentiation for a short period of time. An example is the fast food industry. One fast food chain will develop a new concept; and the others will soon be copying that concept. Answer (a) is not correct because a monopoly usually has only one firm. Answer (b) is not correct because a natural monopoly is a monopoly which is created because the economies of scale restrict competitors. An example would be power generation. Answer (d) is not correct because an oligopoly usually has only a few firms.
35. (c) is the correct answer. Complementary products are products that are sold in conjunction with the primary product. If the primary product is a razor, then the complementary product would be razor blades. Answer (a) is not correct because a rise in the price of a substitute product would cause the demand curve for this product to shift to the right. This would indicate a larger quantity demanded at all price levels. Answer (b) is not correct because a rise in the average household income would tend to shift the demand curve to the right indicating a larger quantity demanded at all price levels. Answer (d) is not correct because a rise in population would tend to shift the demand curve to the right indicating a larger quantity demanded at all price levels.
36. (b) is the correct answer. The supply curve would shift to the right and the demand curve would remain unchanged. Thus, there would be a decline in the price and an increase in the quantity demanded. Answer (a) is not correct because the supply curve would shift to the right and the demand curve would remain unchanged. Thus, there would be an increase in the quantity demanded. Answer (c) is not correct because the supply curve would shift to the right and the demand curve would remain unchanged. There would be no impact on the demand curve.
However, there would be a larger quantity demanded as the price falls. Answer (d) is not correct because the supply curve would shift to the right and the demand curve would remain unchanged. The result should be a decrease in the price of pork as the demand shifts from pork (a substitute for beef) to beef because of the lower price of beef.
37. (a) is the correct answer. Marginal utility will decline as a consumer acquires additional units of a specific product. As we consume more, the utility of the last unit consumed is less than the utility of the previous unit consumed. Answer (b) is not correct because even though marginal utility will decline, total utility will continue to increase until marginal utility becomes zero or negative. Answer (c) is not correct because consumers' wants may not diminish with the passage of time. Further, the law of diminishing utility deals with a finite time period. Answer (d) is not correct because as the marginal utility diminishes, the relationship between supply and demand as reflected in the demand curve will change; however, the price of a specific product may only be assessed in terms of its relationship with quantity demanded. That relationship is reflected in the demand curve.
38. (a) Substitute goods are goods that are regarded as substitutes for each other. One purchases either one or the other. Answer (b) is not correct because there is no economic term such as "superior good." There is a distinction between a normal good and an inferior good. A normal good is one for which demand increases as income increases.
An inferior good is one for which demand falls as income increases. Answer (c) is not correct because complementary goods are goods that are often acquired together. An example is razors and razor blades. Answer (d) is not correct because public goods are goods that are nonrival in consumption and not subject to exclusion.
Nonrival means the good is not used up through consumption. Exclusion means that non-payers can be prevented from consuming the good. An example of a public good might be sunshine.