Economics CFA Level 1 Flashcards
Reading 13 Demand and Supply Analysis: Introduction
3.1
Question 1: In a demand function, if the price of a complement to Good J decreases, the quantity demanded of Good J:
A. increases.
B. decreases.
C. may increase or decrease.
Answer = A
The price coefficient of a complement in a demand function is negative. This means a decrease in the price of a complement to a good will increase the quantity demanded of that good.
Reading 13 Demand and Supply Analysis: Introduction
3.1
Question 2: Monthly demand for gasoline at a particular location, as a function of the price of gasoline and the price of bus travel, is given (in hundreds of gallons) as QD = 300 - 15 Pgas + 2 Pbug. The slope of the demand curve for gasoline is closest to:
A. -0.07.
B. -0.13.
C. -15.00.
Answer = A
The demand curve (price as a function of QD) is found by inverting the demand function:
Pgas = 20 + 2/15 Pbus — 1 /1 5QD
The slope of this function (for any positive value of Pbus) is —1/15, or —0.0667.
Reading 13 Demand and Supply Analysis: Introduction
3.4
Question 1: A decrease in the price of a good will most likely be reflected in a:
change in the slope of the supply curve.
change in the intercept of the supply curve.
downward movement along the supply curve.
Answer = C
A decrease in the price of a good will cause suppliers to supply less of a good and be reflected in a downward movement along the supply curve.
Reading 13 Demand and Supply Analysis: Introduction
3.4
Question 2: An increase in the supply of cars is most likely to be caused by a(n):
A. increase in wages.
B. decrease in price of steel.
C. decrease in the price of cars.
Answer = B
Decreasing costs of factors of production cause a supply curve to increase (shift to the right). An increase in wages would shift the supply curve to the left. A decrease in the price of cars is represented as movement along the supply curve to a lower quantity supplied.
Reading 13 Demand and Supply Analysis: Introduction
3.6
Question 1: Assume the following:
An individual consumer’s demand for tea Qdt = 1,800 – 40Pt + 0.5I + 150Pc
Seller’s supply of tea Qst = –516 + 350Pt – 120W
Legend and Initial Values Assumed Values Qdt Quantity of tea Pt Price of tea per 100 grams I Household income £2,400 W Hourly wage rate for labor Pc Price of coffee per 100 grams £22.4 Equilibrium price of tea £30.6
If the household income increases by 2.5% while Pc and W do not change, the new equilibrium quantity will be closest to:
5,166.
5,163.
5,136.
Answer = B
Qdt = 1,800 – 40Pt + 0.5I + 150Pc
= 1,800 – 40 × 30.6 + (0.5 × 2400) + (150 × 22.4) = 5,136 = Qst (equilibrium)
Qst = –516 + 350Pt – 120W = 5,136
Solve for W = [5,136 + 516 – (350 × 30.6)]/(–120) = 42.15
I increased by 2.5%; I = 2,400 × 1.025 = 2,460.
Set Qdt = Qst and solve for new Pt:
Pt = [1,800 + (0.5 × 2,460) + (150 × 22.4) + 516 + (120 × 42.15)]/390 = 30.68
Qd = 1,800 – (40 × 30.68) + (0.5 × 2,460) +(150 × 22.4) = 5,162.8
Reading 13 Demand and Supply Analysis: Introduction
3.6
Question 2: Consider a market where quantity supplied = 1,500 - 3 x price, and quantity demanded = 2,000 - 5 x price. With respect to equilibrium price and quantity, there is:
A. no market equilibrium.
B. a stable market equilibrium.
C. an unstable market equilibrium.
Answer = B
There is a market equilibrium at a price of 250, where = 750 and QD = 750. Although the supply curve is downward sloping, the equilibrium is stable because the supply curve intersects the demand curve from above—the slope of the supply curve (-1/3) is steeper than the slope of the demand curve (—1/5).
Reading 13 Demand and Supply Analysis: Introduction
3.6
Question 3: At the equilibrium levels of output and price in a competitive industry without taxes:
A. consumer and producer surplus are equal.
B. both consumer and producer surplus are maximized.
C. the sum of producer and consumer surplus is maximized.
Answer = C
At competitive equilibrium, the sum of consumer and producer surplus is at its maximum level. Neither consumer nor producer surplus is necessarily at a maximum at the equilibrium output and price. Which surplus is larger or smaller depends on the elasticities of supply and demand.
Reading 13 Demand and Supply Analysis: Introduction
3.6
Question 4: If a market has a supply curve that intersects the demand curve from above, a price below equilibrium will lead to:
A. excess supply that will tend to decrease the price.
B. excess demand that will tend to increase the price.
C. excess demand that will tend to decrease the price.
Answer = B
Even if a supply curve is downward sloping, it still results in a stable equilibrium if it intersects the demand curve from above (i.e., if the supply curve is more steeply sloped than the demand curve). An equilibrium is stable if a price below equilibrium leads to excess demand that will tend to increase the price. An unstable equilibrium results when a downward sloping supply curve intersects the demand curve from below.
Reading 13 Demand and Supply Analysis: Introduction
3.6
Question 5: Consider a market where quantity demanded = 1,500 - 3 x price, and quantity supplied = 2,000 - 5 x price. With respect to equilibrium price and quantity, there is:
A. no market equilibrium.
B. a stable market equilibrium.
C. an unstable market equilibrium.
Answer = C
There is a market equilibrium at a price of 250 and quantity of 750. The supply curve is downward sloping and intersects the demand curve from below; that is, the downward slope of the supply curve (—1/5) is less than the slope of the demand curve (—1/3). The equilibrium is unstable because there is excess demand above the equilibrium price and excess supply below the equilibrium price, either of which forces the price away from equilibrium rather than toward it.
Reading 13 Demand and Supply Analysis: Introduction
3.7
Question 1: In an unstable equilibrium, both demand and supply are negatively sloped but the slope of the demand curve is steeper than that of the supply curve. In such a scenario, if the market price P is higher than the equilibrium price P*, the market mechanism will most likely dictate that price will:
fall.
move to equilibrium.
rise.
Answer = C
There’s excess demand.
Draw the picture.
(Note, too: if the price is higher than the equilibrium price and market mechanisms would make the price fall, the equilibrium would be stable, not unstable.)
Reading 13 Demand and Supply Analysis: Introduction
3.7
Question 2: The market supply and demand curves for a good are P = 0.05QS + 0.84 and P = 180 - 0.25QD. At a market price of 30, the market excess demand is closest to:
A. 9 units.
B. 17 units.
C. 32 units.
Answer = B
To get the inverse supply and demand functions, we must invert each function to get:
QS = P/0.05 - 0.84/0.05 = 20P - 16.8
Qd = 180(4) - (4)P = 720-4P
At a price of 30, QS = 583.2, QD = 600, and excess demand is approximately 17 units.
Reading 13 Demand and Supply Analysis: Introduction
3.7
Question 3: The market supply function for a good is Qs = -120 + 5P and the market demand function for the good is QD = 440 - 9P. If the price of the good is 45, competitive forces will:
A. increase the price and increase the quantity supplied.
B. increase the price and decrease the quantity demanded.
C. decrease the price and increase the quantity demanded.
Answer = C
The equilibrium price is 40:
-120 + 5P = 440 - 9P; 14P = 560; P = 40
At a price of 45, which is above the equilibrium price, quantity supplied is greater than the quantity demanded. Sellers will compete to offer the excess supply at lower prices until the price has decreased to its equilibrium level, reducing the quantity supplied and increasing the quantity demanded.
Reading 13 Demand and Supply Analysis: Introduction
3.8
Question 1: The following bids are observed in a single-price Dutch auction to sell $100 billion in T-bills, with $25 billion in non-competitive bids.
Discount Rate Bid (%) Competitive Bids
($ billions)
0.1205 35
0.1210 40
0.1215 30
0.1220 25
The winning bid for this auction is closest to:
- 1210.
- 1215.
- 1205.
Answer = A
The winning bid is the highest bid at which all offered securities can be sold, including the non-competitive bids.
Discount Rate Bid (%) Competitive Bids ($ billions) Non-Competitive Bids
($ billions) Total Cumulative Bids
0.1205 35 25 60
0.1210 40 25 100
0.1215 30 25 130
0.1220 25 25 155
The supply will be fully absorbed at the bid of 0.1210.
Reading 13 Demand and Supply Analysis: Introduction
3.8
Question 2: A government is auctioning 500 newly issued bonds and receives the following bids: Bidder Yield Number of Bonds Bidder 1 5.25% 200 Bidder 2 5.30% 100 Bidder 3 5.40% 300 Bidder 4 5.45% 400
Bidder 3 receives 200 bonds at a yield of 5.40%. This auction is best described as a(n):
A. second price auction.
B. ascending price auction.
C. descending price auction.
Answer = C
In a descending price or Dutch auction, the government will sell bonds to the bidders who bid the lowest yields (highest prices) until all the bonds are sold. Bidder 1 receives 200 bonds at a yield of 5.25%, Bidder 2 receives 100 bonds at a yield of 5.30%, and Bidder 3 receives the remaining 200 bonds at a yield of 5.40%.
Reading 13 Demand and Supply Analysis: Introduction
3.9
Question 1: The monthly demand curve for playing tennis at a particular club is given by the following equation: . The club currently charges members $4.00 to play a match. The consumer surplus at this price is closest to:
$40.00.
$62.50.
$162.50.
Answer = B
P = 0 => Q = 45 Q = 0 => P = 9
=> The demand function is: P = 9 - 0.2Q
or Q = 45 - 5P
The number of matches played per month at $4.00/match = 45 - 5 x 4 = 25
=> The consumer surplus = 1/2 x 25 x (9 - 4) = 62.5
Reading 13 Demand and Supply Analysis: Introduction
3.10
Question 1: The supply function for a good is: quantity supplied = -170 + 10 x price. If the market price is 25, the value of producer surplus is:
A. 320.
B. 640.
C. 2,000.
Answer = A
Quantity supplied is zero at P = 17, and quantity supplied at P = 25 is 80. The area of the producer surplus triangle is 1/2 x (25 - 17) x 80 = 320.
Reading 13 Demand and Supply Analysis: Introduction
3.13
Main key words: “imposition”
Question 1: The most likely effects of the imposition of an effective increase in the minimum wage include:
A. an increase in the real wage, gains in efficiency, and a decrease in inflation.
B. increased unemployment, an excess supply of labor at the new wage rate, and a decrease in economic efficiency.
C. a reduction in non-monetary labor benefits, excess demand for labor, and a shortage of highly skilled workers.
Answer = B
At a minimum wage above the equilibrium wage, there will be an excess supply of workers. Firms substitute other productive resources for labor and use more than the economically efficient amount of capital. The result is increased unemployment and a decrease in economic efficiency. Firms may decrease the quality or quantity of the non-monetary benefits they previously offered to workers.
Note: A good example of a price floor is the imposition of a legal minimum wage in the United States, the United Kingdom, and many other countries. Although controversy remains among some economists on the empirical effects of the minimum wage, most economists continue to believe that a minimum wage can reduce employment. Although some workers will benefit, because they continue to work at the higher wage, others will be harmed because they will no longer be working at the increased wage rate.
Reading 13 Demand and Supply Analysis: Introduction
3.13
Question 2: Assume that the supply of ethanol is relatively more elastic than the demand for ethanol. Compared to an initial competitive equilibrium in the market for ethanol, the imposition of a per-gallon tax on producers of ethanol will most likely decrease:
A. producer surplus by the total amount of tax collected.
B. producer surplus by less than it reduces consumer surplus.
C. the sum of consumer and producer surplus by the amount of tax collected.
Answer = B
Regardless of whether a tax is imposed on suppliers or consumers, the relative burden of the tax to each depends on the relative elasticities of supply and demand. Since demand is relatively less elastic than supply, the burden of the tax will be greater on consumers than on producers. These burdens are equivalent to decreases in producer and consumer surpluses. Total consumer and producer surpluses will be reduced by the amount of the resulting deadweight loss in addition to the total amount of tax collected.
Reading 13 Demand and Supply Analysis: Introduction
3.13
Question 3: If a minimum wage is set above the equilibrium wage in the labor market, what is the most likely effect?
A. The minimum wage will have no effect on the quantity of labor employed.
B. Firms will use less than the economically efficient amount of capital.
C. There will be excess supply of labor, and unemployment will increase.
Answer = C
At a minimum wage above the equilibrium wage, there will be an excess supply of workers, since firms will not employ all the workers who want to work at the minimum wage. Firms will substitute other productive inputs for labor and use more than the economically efficient amount of capital. The result is increased unemployment because even though there are workers willing to work for less than the minimum wage, firms cannot legally hire them.
Reading 13 Demand and Supply Analysis: Introduction
3.13
Question 4: A loss of economic efficiency from price regulation is least likely to result from a:
A. rent ceiling that effectively increases renters’ search times for available units.
B. minimum wage that is greater than the equilibrium wage for unskilled workers.
C. maximum price for electricity set at a price level at which the quantity of electricity supplied is greater than the quantity demanded.
Answer = C
If the quantity supplied at a given price is greater than the quantity demanded, then that price is greater than the equilibrium price. A price ceiling on electricity set above the equilibrium price will have no effect because the quantity supplied equals the quantity demanded at a price less than this legal maximum. A minimum wage causes a loss of efficiency (quantity of labor supplied is greater than the quantity demanded) when it is set above the equilibrium wage for unskilled workers. Increased search time is an example of an inefficiency that results from a rent ceiling below the equilibrium rent level.
Reading 13 Demand and Supply Analysis: Introduction
3.13
Question 5: Which of the following statements about elasticity is least accurate?
A. Both demand and supply are more elastic in the long run than in the short run.
B. When demand is inelastic, an increase in price will cause a decrease in the total expenditure on a good.
C. When the price of a product increases, consumers will reduce their consumption by a larger amount in the long run than in the short run.
Answer = B
If demand is inelastic, the percentage change in quantity demanded is smaller than the percentage change in price; quantity demanded is relatively unresponsive to price changes. A price increase increases total expenditures on a good.
Reading 13 Demand and Supply Analysis: Introduction
3.13
Question 6: Setting a minimum wage above the equilibrium wage:
A. results in increased unemployment, and setting a minimum wage below the equilibrium wage has no effect on unemployment.
B. has no effect on unemployment, and setting a minimum wage below the equilibrium wage results in increased unemployment.
C. results in increased unemployment, and setting a minimum wage below the equilibrium minimum wage results in decreased unemployment.
Answer = A
If the minimum wage rate is set above the equilibrium wage rate, it results in excess supply of labor at that wage level and therefore increases unemployment. If the minimum wage is set below the equilibrium wage, then the minimum wage has no effect.
Reading 13 Demand and Supply Analysis: Introduction
3.13
Question 7: The government of Wallvania is evaluating the impact of a new tax on automobiles that will be levied on manufacturers. Research on the auto market in Wallvania shows that supply is more elastic than demand. Which of the following statements is most accurate?
A. Auto manufacturers will bear the entire tax burden.
B. Consumers will bear a greater portion of the tax burden.
C. Auto manufacturers will bear a greater portion of the tax burden.
Answer = B
If the demand curve is less elastic than the supply curve, consumers will bear a higher portion of the tax burden. Suppliers will bear a greater portion of the tax burden if demand is more elastic than supply. Consumers and suppliers will share in the tax burden equally if the elasticity of supply equals the elasticity of demand.
Reading 13 Demand and Supply Analysis: Introduction
3.13
Question 8: As a result of a decline in cucumber production by small-scale growers, the U.S. government has decided to provide assistance to cucumber growers by paying them $0.05 per pound produced. Which of the following is the most likely result of this policy?
A. The marginal benefit of cucumbers will exceed the marginal cost, causing a deadweight loss.
B. The marginal cost of cucumbers will exceed the marginal benefit, causing a deadweight loss.
C. The marginal cost of cucumbers will exceed the marginal benefit, and a shortage of cucumbers will emerge.
Answer = B
When a market is subsidized by a government, the supply curve (marginal cost curve) shifts to the right while the demand curve (marginal benefit curve) stays constant. Producers in the market end up receiving more than the equilibrium price for their product and consumers in the market end up paying less than the equilibrium price for the product. In addition, the quantity produced and consumed is greater than the equilibrium quantity that would prevail without the subsidy. In this situation, the marginal cost of the product is greater than the marginal benefit, resulting in a deadweight loss due to overproduction and a surplus of the commodity.
Reading 13 Demand and Supply Analysis: Introduction
3.13
Question 9: The actual incidence of a tax imposed on producers of a good will be borne by:
A. producers more than consumers if demand for the good is less price elastic than supply.
B. consumers more than producers if the supply of the good is more price elastic than demand.
C. consumers and producers equally because the actual incidence of a tax is unaffected by price elasticity.
Answer = B
If price elasticity of supply is greater than price elasticity of demand, the impact on the price (net of tax) received by producers will be less than the impact on the price paid by consumers. As a result, consumers will pay a larger share of the tax. The actual incidence of a tax is unaffected by its statutory incidence, but it is affected by the relative elasticity of supply and demand for the good being taxed.
Reading 13 Demand and Supply Analysis: Introduction
4
Question 1: If a price cut of a product increases total revenue, demand is best described as:
unit elastic.
elastic.
inelastic.
Answer = B
A product’s demand is elastic if demand increases by a greater percentage than the percentage price cut when prices are cut. For example, if a 1% price cut increases the quantity sold by more than 1%, total revenue increases and demand is said to be elastic.
Reading 13 Demand and Supply Analysis: Introduction
4
Question 2: Demand for gasoline (in hundreds of liters) at a particular station, as a function of the price of gasoline and the price of bus travel, is QD = 300 - 14 Pgas + 2Pbus. If the price of gasoline per liter (Pgas) is 1.50 euros, and the price of a standardized unit of bus travel (Pbus) is 12 euros, the cross price elasticity of gasoline demand with respect to the price of bus travel is closest to:
A. 0.01.
B. 0.08.
C. 2.00.
Answer = B
To calculate the cross price elasticity of the quantity demanded of gasoline with respect to the price of bus travel, we must first calculate the quantity of gas demanded:
300- 14(1.5) + 2(12) = 303
The cross elasticity is:
(ΔQD / ΔPbus) x (Pbus / QD) = 2 x 12 / 303 = 0.0792 or 0.08
Reading 13 Demand and Supply Analysis: Introduction
4
Question 3: The price of milk in a country increases from €1.00 per liter to €1.10 per liter, and the quantity supplied does not change. This suggests the elasticity of the short-run supply of milk in this country is equal to:
A. infinity, and supply is perfectly elastic.
B. zero, and supply is perfectly inelastic.
C. infinity, and supply is perfectly inelastic.
Answer = B
If quantity supplied does not respond to a change in price, supply is perfectly inelastic. For perfectly inelastic supply, elasticity equals zero.
Reading 13 Demand and Supply Analysis: Introduction
4
Question 4: When two goods are complements, the cross elasticity of demand is:
A. positive, and for substitutes the cross price elasticity of demand is negative.
B. negative, and for substitutes the cross price elasticity of demand is negative.
C. negative, and for substitutes the cross price elasticity of demand is positive.
Answer = C
The cross elasticity of demand for goods that are complements is negative because an increase in the price of one would tend to decrease the quantity demanded of the other. The cross elasticity of demand for substitute goods is positive because an increase in the price of one would tend to increase the quantity demanded of the other.
Reading 14 Demand and Supply Analysis: Consumer Demand
4.1
Question 1: A consumer’s budget constraint is drawn with Good X on the horizontal axis and Good Y on the vertical axis. If the price of Good X decreases from €8 to €6, and the price of Good Y decreases from €20 to €14, the absolute value of the slope of the consumer’s budget constraint:
A. increases.
B. decreases.
C. remains the same.
Answer = A
The slope of a consumer’s budget constraint is equal to — Px/ Py. The original slope is —8 / 20 = —0.4, and the slope after the price decreases is —6 / 14 = —0.429. The absolute value of the slope increases (i.e., the budget constraint becomes more steeply sloped).
Reading 14 Demand and Supply Analysis: Consumer Demand
5.1
Question 1: If MRSXY= 0.6 and PX/PY= 0.7, where MRSXY is the marginal rate of substitution of X for Y, and PX and PY are the price per unit of goods X and Y, respectively, the consumer will most likely prefer purchasing:
only Y, because it is preferred to X.
a small additional amount of Y in place of X.
a large additional amount of Y in place of X.
Answer = B
The consumer maximizes utility when MRSXY equals PX/PY. MRSXY is the rate at which the consumer is willing to give up Y for additional X, while the price ratio, PX/PY, is the rate at which the consumer must give up Y to gain additional X. With the values as stated, the price to consume more X exceeds the consumer’s willingness to pay. So, moving toward the consumer’s equilibrium would require spending a little more on good Y and a little less on good X.
Reading 14 Demand and Supply Analysis: Consumer Demand
5.1
Question 2: In utility analysis, a consumer’s optimal bundle of goods lies on an indifference curve that is:
A. most preferred by the consumer.
B. tangent to the consumer’s budget line.
C. contained within the consumer’s opportunity set.
Answer = B
Based on utility analysis, the optimum bundle of goods lies on the consumer’s highest attainable indifference curve, at the point where this indifference curve is tangent to the consumer’s budget line. The point of tangency is the only point at which this indifference curve intersects the consumer’s opportunity set of attainable bundles. The consumer would prefer bundles that lie on higher indifference curves, but those bundles are unaffordable given the consumer’s budget constraint.
Reading 14 Demand and Supply Analysis: Consumer Demand
6
Question 1: An individual sees her income rise from $80,000 to $88,000, and along with it, her consumption of Good X has decreased from eight dozen packages per year to six dozen packages per year. Good X should be classified as a(n):
A. normal good.
B. Veblen good.
C. inferior good.
Answer = C
An inferior good is one that experiences a decline in demand when income rises.
Reading 14 Demand and Supply Analysis: Consumer Demand
6
Question 2: With respect to a decrease in the price of a normal good, the income effect:
A. and substitution effect both tend to increase consumption of the good.
B. is to decrease consumption of the good, and the substitution effect is to increase consumption of the good.
C. is to increase consumption of the good, and the substitution effect is to decrease consumption of the good.
Answer = A
For a normal good, both the income and substitution effects are positive (i.e., they tend to increase consumption of the good).
Reading 15 Demand and Supply Analysis: The Firm
2.1
Question 1: Under conditions of perfect competition, in the long run companies will most likely earn:
zero accounting profit and positive economic profit.
positive accounting profit and negative economic profit.
normal profit and zero economic profit.
Answer = C
In highly competitive market situations, companies tend to earn the normal profit level over time because the ease of market entry allows for other competing companies to compete away any economic profit over the long run. When accounting profit equals normal profit, economic profit is zero.
CFA Level I
“Demand and Supply Analysis: The Firm,” by Gary L. Arbogastand Richard V. Eastin
Sections 2.1.1–2.1.2
Reading 15 Demand and Supply Analysis: The Firm
2.1
Question 2: Accounting profit is often an unsatisfactory performance measure from an economic point of view because it:
A. does not consider depreciation.
B. considers marginal costs rather than average costs.
C. does not consider the opportunity costs of equity capital.
Answer = C
Accounting profit is often an unsatisfactory performance measure from an economic point of view because accounting costs generally do not include the opportunity costs of equity capital. Accounting costs do reflect the cost of depreciation.
Reading 15 Demand and Supply Analysis: The Firm
2.1
Question 3: A profit-maximizing firm in short-run equilibrium sells 300 units, has total revenue of 12,000, and marginal revenue of 25. It is most likely that this firm:
A. earns an economic profit.
B. faces a perfectly elastic demand curve.
C. should invest in productive capacity to increase profits.
Answer = A
Because a profit-maximizing firm produces the quantity for which marginal cost equals marginal revenue, marginal cost must equal 25. Average revenue (i.e., price) of 12,000 / 300 = 40 is greater than marginal revenue, therefore the firm earns an economic profit. Because marginal cost is less than price the firm must face a downward sloping demand curve. We cannot conclude that an increase in productive capacity will increase profits.
Reading 15 Demand and Supply Analysis: The Firm
3.1
Question 1: Under imperfect competition, maximum profit is best described as occurring at the output level at which:
marginal revenue equals marginal cost.
total revenue equals total costs.
the difference between total revenue and total costs is greatest.
Answer = C
Maximum profit occurs at the output level at which the difference between total revenue and total costs is greatest.
Reading 15 Demand and Supply Analysis: The Firm
3.1
Question 2: A firm faces a downward sloping demand curve, QD = 500 - 20P. The marginal revenue if the price were decreased from $18.00 to $17.95 is closest to:
A. $11.
B. $13.
C. $15.
Answer = A
Marginal revenue is the change in total revenue per additional unit produced and sold. At a price of 18, quantity demanded is equal to 500 - 20(18) = 140, and total revenue is 140 x 18 = $2,520. At a price of 17.95, quantity demanded is equal to 500 - 20(17.95) = 141, and total revenue is 141 x 17.95 = $2,530.95. Marginal revenue for the 141st unit is 2,530.95 - 2,520 = $10.95.
Reading 15 Demand and Supply Analysis: The Firm
3.1
Question 3: A manufacturing plant exhibits diseconomies of scale if long-run average cost (LRAC) is:
A. decreasing as output increases, and the plant is at its minimum efficient scale if LRAC is at its lowest level.
B. decreasing as output increases, and the plant is at its minimum efficient scale if LRAC is decreasing over the entire range of output.
C. increasing as output increases, and the plant is at its minimum efficient scale if LRAC is at its lowest level.
Answer = C
Diseconomies of scale are present when long-run average cost increases as output increases. The minimum efficient scale is the plant size that produces the quantity of output for which LRAC is at a minimum.
Reading 15 Demand and Supply Analysis: The Firm
3.1.2
Question 1: The law of diminishing marginal returns explains:
A. the shape of the long-run average cost curve.
B. the upward sloping portion of the short-run marginal cost curve.
C. the upward sloping portion of the long-run marginal cost curve.
Key words: “diminishing marginal returns”
Answer = B
The law of diminishing returns states that at some point, as more of a resource is used in a production process, holding other inputs constant, output increases at a decreasing rate. This accounts for the upward slope of the SRMC curve beyond that point. Returns to scale determine the shape of the long-run cost curves.
Reading 15 Demand and Supply Analysis: The Firm
3.1.3
Question 1: With respect to the relationship between output and costs in the short run, a decline in the marginal cost per unit most likely occurs at what level of production?
Profit-maximizing output
Low output
High output
Answer = B
Marginal cost per unit, in the short run, decreases at low levels of output as a result of economies from greater specialization. At higher levels of output, however, it eventually increases because of the law of diminishing returns.
Reading 15 Demand and Supply Analysis: The Firm
3.1.3
Question 2: Pauker Company is producing at minimum short-run marginal cost. Pauker is most likely also producing:
A. maximum profits.
B. at maximum marginal product.
C. at minimum average variable cost.
Answer = B
The quantity of output at which short-run marginal cost of production is minimized is the same quantity at which the marginal product of inputs (e.g., labor) is maximized. Profit is maximized by producing the output quantity at which marginal revenue equals marginal cost, which is not typically the same quantity at which marginal cost is minimized. The minimum average variable cost is at the output quantity at which it equals marginal cost, but this is also not typically the quantity with minimum marginal cost.
Reading 15 Demand and Supply Analysis: The Firm
3.1.3
Question 3: At the quantities where the marginal cost curve intersects the average variable cost (AVC) curve and the average total cost (ATC) curve, respectively:
A. AVC and ATC are at their minimum points.
B. AVC is at its minimum point and ATC is increasing.
C. ATC is at its minimum point and AVC is decreasing.
Answer = A
The marginal cost curve intersects both the AVC and ATC curves at their minimum points. If the cost of producing the next unit of output (marginal cost) is less than the average cost (variable or total) of the units already produced, producing the next unit will decrease the average cost. If the marginal cost is greater than the average cost of units already produced, then producing another unit will increase the average cost.
Reading 15 Demand and Supply Analysis: The Firm
3.1.3
Question 4: Average total costs for Dunhill Corporation’s turbine plant are minimized when production is 100,000 units per year. Justin Collins states that (1) average variable cost is minimized at this same level of production, and that (2) profit is maximized at this level of production. Are Collins’ statements accurate?
A. Both statements are accurate.
B. Neither statement is accurate.
C. Only one of the statements is accurate.
Answer = B
Neither statement is accurate. The minimum average variable cost will occur at a lower production level than the minimum average total cost. Profit is maximized where marginal revenue equals marginal cost, not where average total cost is minimized.
Reading 15 Demand and Supply Analysis: The Firm
3.1.5
Question 1: Which of the following factors is most likely to lead to economies of scale?
Supply constraints
Duplication of product lines
Specialization by workers
Answer = C
Specialization by workers can increase their proficiency, leading to lower average costs when the firm is large enough to allow specialization.
Reading 15 Demand and Supply Analysis: The Firm
3.1.5
Question 2: Hanover Industrial operates a factory in Paris, which produces goods at a marginal cost above marginal revenue, and a factory in Munich, which products identical goods at a marginal cost less than marginal revenue. To maximize profits, Hanover should most likely.
A. decrease output at both factories.
B. decrease output at the Paris factory and increase output at the Munich factory.
C. increase output at the Paris factory and decrease output at the Munich factory.
Answer = B
Since the Munich plant is generating revenues greater than costs and the Paris plant is not, Hanover should increase output at the Munich plant and reduce output at the Paris plant.
Reading 15 Demand and Supply Analysis: The Firm
3.1.5
Question 3: Tetra Corporation holds the exclusive production rights to a wireless cellular phone technology. Tetra’s production rights will remain exclusive for 15 years, effectively eliminating any competition while the technology is viable. If their marginal revenue, marginal cost, and average total cost are $50, $43, and $57, respectively, Tetra Corporation can maximize profits by:
A. expanding output until marginal revenue equals marginal cost.
B. reducing output until marginal revenue equals average total cost.
C. expanding output until marginal revenue equals average total cost.
Answer = A
For all firms, profit is maximized at the output where the incremental revenue from selling an additional unit (marginal revenue) is equal to the incremental cost of producing it (marginal cost). Since marginal revenue is still higher than marginal cost, Tetra can expand output.
Reading 15 Demand and Supply Analysis: The Firm
3.1.6
Question 1: The long-run production decision differs from the short-run production decision in that:
A. fixed costs can be changed in the long run but not the short run.
B. variable costs can be changed in the long run but not the short run.
C. variable costs can be changed in the short run but not the long run.
Answer = A
The long-run production decision differs from the short-run production decision in that fixed costs can be changed in the long run but not the short run. Thus, short-run cost curves apply for a given size of a plant, and long-run cost curves can show costs for different size plants.
Reading 15 Demand and Supply Analysis: The Firm
3.1.6
Question 2: The short run, as an economic decision-making time frame, is best described as:
A. one year or the length of the firm’s production cycle.
B. the period during which the firm’s plant size and production methods are fixed.
C. the period in which the firm cannot change its input quantities of labor and materials.
Answer = B
The economic short run is the period in which a firm’s plant size and technology are fixed. All factors of production can be changed in the long run. Input quantities of labor and raw materials can be changed in the short run. One year or the firm’s operating cycle, whichever is longer, is the time frame typically used to distinguish between current and long-lived assets or liabilities on a balance sheet.
Reading 15 Demand and Supply Analysis: The Firm
3.1.7
Question 1: In a decreasing-cost industry, the long-run supply curve will most likely be:
negatively sloped.
a horizontal line.
positively sloped.
Answer = A
In a decreasing-cost industry, the long-run supply curve will have a negative slope.
Reading 15 Demand and Supply Analysis: The Firm
3.1.7
Question 2: Over the long term, in an increasing-cost industry, market prices will most likely:
remain the same as a result of competitive forces.
fall in response to technological advances.
rise in response to higher resource costs over time.
Answer = C
In an increasing-cost industry, as resource costs increase over time, market prices must increase to cover these higher costs.
Reading 15 Demand and Supply Analysis: The Firm
3.1.7
Question 3: As output quantities expand in an industry with a downward-sloping long- run industry supply curve, what is the most likely long-run effect on the equilibrium selling price per unit of the industry’s output?
A. Increase, because of upward pressure on input prices.
B. Decrease, because of lower input costs per unit of output.
C. No effect, because selling price is only affected in the short run.
Answer = B
An industry with a downward-sloping long-run industry supply curve is a decreasing-cost industry. In such an industry, input costs decrease as output quantities increase. In the short run, this causes firms to earn economic profits. In the long run, these economic profits attract new entrants to the industry, which reduces the equilibrium selling price of the industry’s output.
Reading 15 Demand and Supply Analysis: The Firm
3.2.1
Question 1: In the short run, the average product of labor:
A. is increasing when the total product of labor is increasing.
B. is at a maximum where it intersects the marginal product of labor curve.
C. is upward-sloping if the firm is experiencing diminishing marginal returns to labor.
Answer = B
In the short run, the average product of labor curve is first increasing and then decreasing as diminishing marginal returns to that factor take effect. In the short run, the marginal product of labor is first increasing and then decreasing when diminishing marginal returns take effect. The marginal product of labor curve will be above the average product of labor curve initially, and, at some point, will intersect the average product curve at its maximum. When the total product of labor begins to increase at a decreasing rate, the average product of labor will be decreasing.
Reading 15 Demand and Supply Analysis: The Firm
3.2.2
Question 1: A company uses three types of labor—unskilled, semiskilled, and skilled—in the production of electronic components. The company’s production plan allows for the substitution of one type of labor for another. The marginal product and compensation in U.S. dollars is as follows:
Type of Labor Marginal Product per Day Compensation per Day (US$)
Unskilled 200 units 105
Semiskilled 300 units 160
Skilled 500 units 270
Assuming that the compensation of the unskilled labor increases by 4%, what labor type should the company most likely hire when expanding output?
Semiskilled
Skilled
Unskilled
Answer = A
The company should maximize output per monetary unit of input cost. So, it should look for the labor type that has the highest ratio of marginal product to compensation cost (MPinput/Pinput)) .
Type of Labor Marginal Product (MP) per Day Compensation per Day MPinput/Pinput
Unskilled 200 units 105 × 1.04 = 109.2 200/109.2 = 1.83
Semiskilled 300 units 160 300/160 = 1.88
Skilled 500 units 270 500/270 = 1.85
The company minimizes costs and enhances profitability by adding semiskilled labor rather than the other two types because it has the highest ratio of MP to input price.
Reading 16 The Firm and Market Structures
2.2
Question 1: A market structure characterized by homogeneous/standardized product differentiation is best described as:
monopolistic competition.
monopoly.
perfect competition and oligopoly.
Answer = C
Perfect competition and oligopoly are characterized by homogeneous/standardized product differentiation.
Market Structure Degree of Product Differentiation
Perfect competition Homogeneous/ standardized
Monopolistic competition Differentiated
Oligopoly Homogeneous/ standardized
Monopoly Unique product
Reading 16 The Firm and Market Structures
2.2
Question 2: Which of the following is most likely a characteristic of monopolistic competition?
A. Producer decisions are interdependent.
B. Each producer offers a differentiated product.
C. Producers face horizontal demand curves.
Answer = B
Differentiated products are a feature of monopolistic competition markets. Interdependence is a characteristic of oligopoly markets. Horizontal demand curves facing producers are a feature of perfect competition.
Reading 16 The Firm and Market Structures
2.2
Question 3: A natural monopoly is most likely to exist when:
A. economies of scale are great.
B. average total cost increases as output increases.
C. a single firm owns essentially all of a productive resource.
Answer = A
A natural monopoly may exist when economies of scale are great. The large economies of scale mean that a single producer results in the lowest production costs.
Reading 16 The Firm and Market Structures
2.2
Question 4: Which of the following most likely describes a loss that consumers suffer under an unregulated monopoly compared to a competitive market?
A. Monopolies produce less goods than a competitive market would.
B. Costs of production are higher with monopolies.
C. Monopolists charge the maximum price.
Answer = A
A reduction in output and increase in price under monopoly decrease consumer surplus and welfare compared to perfect competition. A natural monopoly may have lower costs than several competitive suppliers. Monopolists charge the profit maximizing price, not the “maximum price.”
Reading 16 The Firm and Market Structures
2.2
Question 5: The kinked demand curve oligopoly model is based on a belief that:
A. competing firms that collude to restrict output each have an incentive to cheat.
B. a firm’s competitors will follow a price decrease but will not follow a price increase.
C. a firm can increase profits by charging different prices to distinct groups of consumers.
Answer = B
In the kinked demand curve oligopoly model, the demand curve facing each firm is more elastic above the current price and less elastic below the current price, because the other firms in the industry will likely match a price decrease by one firm but will not match a price increase.
The incentive to cheat on price collusion agreements is illustrated by the Prisoner’s Dilemma game theory. Price discrimination is the method by which a price seeking firm can increase profits by charging different prices to consumers in distinct groups with differing price elasticity of demand.
Reading 16 The Firm and Market Structures
2.2
Question 6: A firm operating in an industry characterized by monopolistic competition will least likely:
A. earn positive economic profits in the short run.
B. maximize economic profits by colluding with the other firms and operating as a single seller.
C. differentiate its product based on price or quality.
Answer = B
Successful collusion is unlikely in a market that can be characterized as monopolistic competition because low entry barriers would allow new competitors to emerge. Firms in such an industry can earn short-run economic profits and often differentiate their products on quality or price.
Reading 16 The Firm and Market Structures
2.2
Question 7: An economist finds the following characteristics for the market for two products, S and T:
Product Firms Pricing Power Concentration Ratio
S Considerable High
T Some Low
Based on the above characteristics, the economist could conclude that the industry for Product S is:
A. an oligopoly and the industry for Product T is also an oligopoly.
B. an oligopoly and the industry for Product T is monopolistic competition.
C. monopolistic competition and the industry for product T is an oligopoly.
Answer = B
Greater pricing power for the individual firm and a high concentration ratio suggest Product S is produced in an oligopolistic industry. Product T, with less pricing power for firms and a lower concentration ratio, is most likely producted by an industry characterized by monopolistic competition.
Reading 16 The Firm and Market Structures
2.2
Question 8: Wilmer Jones owns several restaurants in different cities. His restaurants compete on quality of food and service, price, and marketing. Competitors can enter and exit his markets, and there are usually several competitors in each market. His market structure can best be characterized as:
A. perfect competition.
B. monopolistic competition.
C. oligopoly.
Answer = B
This is an example of monopolistic competition, because this market has low barriers to entry and exit, and features product differentiation.
Reading 16 The Firm and Market Structures
2.2
Question 9: Which of the following arguments about the efficiency of monopolistic competition in allocating resources is most accurate?
A. Since economic profits in the long run are positive for firms in monopolistic competition, there are efficiency losses.
B. Product differentiation under monopolistic competition offers benefits that tend to offset inefficiency from the reduction in output compared to perfect competition.
C. Advertising expenditures under monopolistic competition represent a deadweight loss to society.
Answer = B
Economic profits are zero in the long run under monopolistic competition, but since average cost includes the costs of product differentiation and advertising (branding), there is disagreement over the efficiency of long-run output. Both advertising and product differentiation can create value as consumers prefer more choices and use the advertising and branding information to make purchase decisions. Whether there is an efficient amount of product differentiation or not, the benefits of product differentiation do tend to offset its costs. Whether the benefits of differentiated products totally offset the costs compared to a competitive market with a single (undifferentiated) product is open to debate.
Reading 16 The Firm and Market Structures
3
(15.g, 16.d)
Question 1: Notasled, Inc., a producer of cafeteria trays, operates in a perfectly competitive market. If the market price of a cafeteria tray is $3.25, Notasled will increase production so long as:
A. marginal revenue is positive.
B. marginal cost is less than $3.25.
C. marginal revenue is greater than $3.25.
Answer = B
A firm will increase production if its marginal revenue is greater than its marginal cost, until it reaches the profit-maximizing output level at which marginal revenue equals marginal cost. Under perfect competition, marginal revenue equals price.
Reading 16 The Firm and Market Structures
3
Question 2: A firm in a perfectly competitive market will tend to expand its output as long as:
A. its marginal revenue is positive.
B. the market price is greater than the marginal cost.
C. its marginal revenue is greater than the market price.
Answer = B
Under perfect competition, each firm faces a flat demand curve. This means the price is constant and the marginal revenue line is flat. A company will continue to produce as long as MR > MC, so the competitive company will produce as long as P > MC. It will stop when MC = MR = P.
Reading 16 The Firm and Market Structures
3
Question 3: The short-run supply curve for a firm under perfect competition is the firm’s:
A. marginal cost curve above average total cost.
B. marginal cost curve above average variable cost.
C. average variable cost curve above marginal revenue.
Answer = B
The supply curve for a firm under perfect competition is its marginal cost curve above average variable cost. As long as price exceeds AVC, the firm will produce up to the quantity where MC = Price, which is also MR in this case.
Reading 16 The Firm and Market Structures
3
Question 4: Under which market structure is the profit maximizing strategy to produce the quantity of output for which the price is equal to marginal cost?
A. Monopoly.
B. Perfect competition.
C. Monopolistic competition.
Answer = B
Firms’ demand curves are perfectly elastic (horizontal) in a market characterized as perfect competition, so that marginal revenue is equal to price and a firm maximizes profit by producing the output quantity at which marginal cost equals price. In monopoly markets or under monopolistic competition, firm demand curves are downward sloping so that marginal revenue is less than price.
Reading 16 The Firm and Market Structures
3
Question 5: In the short run, a perfectly competitive firm’s supply curve is:
A. upward sloping and its demand curve is perfectly elastic.
B. upward sloping and its demand curve is downward sloping.
C. perfectly inelastic and its demand curve is perfectly elastic.
Answer = A
In the short run, a perfectly competitive firm’s supply curve is upward sloping, because if the price increases, firms will increase their quantity supplied. The demand curve for a perfectly competitive firm is horizontal. Each firm in a competitive market is a price taker and has no influence on the price of the product.
Reading 16 The Firm and Market Structures
5
Question 1: Oligopolists have an incentive to cheat on collusive agreements in order to:
A. avoid competitive practices.
B. increase their individual share of the joint profit.
C. restrict output and put upward pressure on price.
Answer = B
Colluding restricts output and puts upward pressure on price, but cheating actually increases output and ultimately, if enough cheating occurs, puts downward pressure on the price. Colluders cheat to increase their share of the profits.
Reading 16 The Firm and Market Structures
5
Question 2: Assume a cartel is organized among the producers of a commodity and begins practicing collusion. The most likely effects on price and output are that:
A. both will increase.
B. price will increase and output will decrease.
C. price will decrease and output will increase.
Answer = B
Collusion is an agreement among firms to avoid various competitive practices. The cartel practicing collusion will be similar to a monopoly, causing prices to increase and output to decrease compared to a competitive market.
Reading 16 The Firm and Market Structures
5
Question 3: Oil Tool Inc. and Jones International Co. are manufacturers in an oligopolistic industry. Oil Tool and Jones enter a covert pricing agreement in which neither will reduce its prices to gain market share. Using the Nash equilibrium model, which outcome is most likelyl
A. Both firms will cheat on this agreement.
B. Neither firm will cheat on this agreement.
C. Only one of the firms will cheat on this agreement.
Answer = A
Applying the Nash equilibrium model, Oil Tool will make the best possible decision based on Jones’s potential decisions and Jones will make the best possible decision based on Oil Tool’s potential decisions. If Oil Tool complies, then it must depend on Jones to comply, but complying is not in the interest of Jones. If Jones were to comply, then it must depend on Oil Tool to comply, but complying is also not in the best interest of Oil Tool. Both Oil Tool and Jones will conclude that the best course of action is to cheat on the pricing agreement.
Reading 16 The Firm and Market Structures
6
Question 1: To benefit from price discrimination, a monopolist least likely needs to have:
A. a higher-quality product at a premium price and a lower-quality alternative.
B. a way to prevent reselling between types of consumers.
C. two identifiable groups of consumers with different price elasticities of demand for the product.
Answer = A
Price discrimination involves a single product, not two alternatives. As long as the company faces a downward-sloping demand curve, can identify at least two groups of customers with different price elasticities of demand, and can prevent reselling between groups, the company can profit from price discrimination.
Reading 16 The Firm and Market Structures
6
Question 2: Which of the following statements about a monopolist is most accurate? A monopolist will:
A. maximize the average profit per unit sold.
B. charge the highest price for which it can sell its product.
C. produce where marginal revenue equals marginal cost.
Answer = C
Like all price searchers, monopolists will expand output until marginal revenue equals marginal cost. Monopolists do not charge the highest possible price which would be the price resulting in only one sale. A monopolist seeks to maximize profit, not price.
Reading 16 The Firm and Market Structures
6
Question 3: If the government regulates a natural monopoly and enforces an average cost pricing, what are the effects on output quantity and price compared to an unregulated natural monopoly?
A. Both are lower under average cost pricing.
B. Both are higher under average cost pricing.
C. One is higher and one is lower under average cost pricing.
Answer = C
Average cost pricing is meant to force a natural monopolist to reduce price to where the firm’s average total cost intersects the market demand curve. This results in higher output and a lower price than would prevail for an unregulated natural monopoly.
Reading 16 The Firm and Market Structures
6
Question 4: Which of the following statements about a monopolist is least accurate’?
A. The monopolist faces a downward sloping demand curve.
B. Unlike an oligopolist, a monopolist will always be able to earn economic profit.
C. A profit-maximizing monopolist will expand output until marginal revenue equals marginal cost.
Answer = B
In some cases, a monopolist may be unable to sell for a profit. Price may be insufficient to cover the per-unit cost of the monopolist, even when operating at the MR = MC rate of output. The monopolist faces a downward-sloping demand curve.
Reading 16 The Firm and Market Structures
6
Question 5: Which of the following statements about monopolists is most accurate?
A. Monopolists have imperfect information about demand.
B. Without government intervention, monopolists will always earn economic profits.
C. A monopolist maximizes total revenue where marginal revenue equals marginal cost.
Answer = A
Demand curves are not observable so a monopolist must search for the profit maximizing price. Because demand information is not perfect, a monopolist is a price searcher. The other statements are false. Although a monopolist can earn positive economic profits in the long run, they are not guaranteed profit. If average total costs exceed price, the monopolist will lose money. A monopolist maximizes profit where marginal revenue equals marginal cost.
Reading 16 The Firm and Market Structures
6
Question 6: Compared to a competitive market result, a single-price monopolist will most likely:
A. adopt a marginal cost pricing strategy, which will decrease consumer surplus.
B. increase price, decrease consumer surplus, and increase producer surplus.
C. reduce output, create a deadweight loss, and decrease both producer and consumer surplus.
Answer = B
A firm in a monopoly position will reduce output to where MC = MR, which will increase price, decrease consumer surplus, and increase producer surplus. A marginal cost pricing strategy refers to regulation which requires a firm to set price equal to marginal cost.
Reading 16 The Firm and Market Structures
6
Question 7: The difference in production outcomes between monopolistic firms and purely competitive firms is best explained by the fact that:
A. the profit maximizing output level for monopolists occurs at lower levels of production than for purely competitive firms.
B. monopolists maximize profits by setting output such that marginal revenue exceeds marginal cost.
C. monopolists maximize profits by setting output such that marginal revenue is maximized.
Answer = A
All firms maximize profits at the point where marginal revenue equal marginal cost. For a monopolist, this occurs at a lower output level than for a purely competitive firm, because the monopolist has a marginal revenue curve that falls below the demand curve, while the purely competitive firm has a marginal revenue curve that lies along the demand curve.
Reading 16 The Firm and Market Structures
6
Question 8: A business believes a price discrimination strategy will increase both its output and profits. For this to occur, the firm must have:
A. customers who cannot resell the product and whose price elasticities of demand are in a limited range.
B. distinct groups of customers with different price elasticities of demand who are able to resell the product.
C. distinct groups of customers with different price elasticities of demand who cannot resell the product.
Answer = C
For a price searcher firm, price discrimination can increase profits if the firm has two or more identifiable customer groups with different price elasticities of demand, and if customers who buy the product at a lower price cannot resell it to other customers.
Reading 16 The Firm and Market Structures
7
Question 1: A market has the following characteristics: a large number of independent sellers, each producing a differentiated product; low barriers to entry; producers facing downward sloping demand curves; and demand that is highly elastic. This description most closely describes:
A. an oligopoly.
B. pure competition.
C. monopolistic competition.
Answer = C
These conditions characterize monopolistic competition. By contrast, monopolies and oligopolies have high barriers to entry and involve either a single seller (monopoly) or a small number of interdependent sellers (oligopoly). Similar to monopolistic competition, pure competition involves a large number of independent sellers. With pure competition, products are homogeneous (not differentiated), no barriers to entry exist (not low barriers to entry), and the demand schedule is horizontal (not downward sloping) and perfectly elastic (not highly elastic).
Reading 17 Aggregate Output, Prices, and Economic Growth
2.1.2
Question 1: Assume that an economy is composed of two products, X and Y, with the following details:
Product Quantity Produced in 2012 Quantity Produced in 2013 Product Unit Prices in 2012 Product Unit Prices in 2013
X 351.0 352.0 13.3 13.8
Y 179.0 182.5 unknown 11.1
Assuming 2012 is the base year for measuring GDP and the GDP deflator for the economy in 2013 is 102.4, the unit price of Y in 2012 is closest to:
- 8.
- 5.
- 2.
Answer = C
Product
Quantity Produced in 2012 (1)
Quantity Produced in 2013 (2)
Product Unit Prices in 2012 (3)
Product Unit Prices in 2013 (4)
(5) = (2) × (4)
X 351.0 352.0 13.3 13.8 4,857.6
Y 179.0 182.5 N/A 11.1 2,025.8
Nominal GDP in 2013 equals the sum of the last column: 6,883.4
Real GDP 2013 = Nominal GDP 2013 x 100 / GDP deflator
= 6,883.4 x 100 / 102.4 = 6,722.1
Real GDP 2013 = P(x)2012 x Q(x)2013 + P(y)2012 x Q(y)2013
6,722.1 = (13.3 x 352.0) + P(y)2012 x 182.5
P(y)2012 = 11.2
Reading 17 Aggregate Output, Prices, and Economic Growth
2.1.2
Question 2: Which of the following statements about methods of calculating gross domestic product is most accurate?
A. Except for a statistical discrepancy, the income and expenditure approaches to calculating GDP should result in the same value for economic output.
B. Because it includes activity at all stages of production, the sum- of-value-added method results in a better estimate of GDP than the value-of-final-output method.
C. Value-of-final-output is used to calculate GDP under the expenditure approach, while sum-of-value-added is used to calculate GDP under the income approach.
Answer = A
Because aggregate income is the same as aggregate output, measuring GDP by summing incomes or expenditures should produce the same value, except for a statistical discrepancy that results from using different data sources. The sum-of-value-added method of calculating GDP records the sum of the increases in value of goods and services at each stage of their production and distribution. The resulting total for GDP is the same as that reached by the value-of-final-output method because the sum of value added to a good at all stages of processing is equal to its selling price. Both methods calculate GDP based on expenditures.
Reading 17 Aggregate Output, Prices, and Economic Growth
2.1.2
Question 3: A country’s statistical bureau reports a GDP deflator of 106.5. An analyst should interpret this statistic to mean that:
A. the annual inflation rate is 6.5%.
B. nominal GDP is 6.5% greater than real GDP.
C. nominal GDP has increased at a 6.5% annual rate.
Answer = B
If the GDP deflator is 106.5, the price level has increased 6.5% since the base period and nominal GDP is 6.5% greater than real GDP. Because the base period is not necessarily the previous year, we cannot conclude that 6.5% is the annual inflation rate.
Reading 17 Aggregate Output, Prices, and Economic Growth
2.3
Question 1: Which of the following amounts is least likely to be subtracted from gross domestic product in order to calculate national income?
A. Statistical discrepancy.
B. Indirect business taxes.
C. Capital consumption allowance.
Answer = B
Indirect business taxes are not subtracted because they are included in national income.
Reading 17 Aggregate Output, Prices, and Economic Growth
3.1
Question 1: With respect to the IS-LM model, in an LM curve the real interest rate is:
A. positively related to real income, holding the real money supply constant.
B. held constant, resulting in excess savings being positively related to real income.
C. negatively related to real income, holding the marginal propensity to save constant.
Answer = A
The LM curve illustrates a positive relationship between real income and the real interest rate, holding the real money supply constant. The IS curve illustrates a negative relationship between real income and the real interest rate, holding the marginal propensity to save constant.
Reading 17 Aggregate Output, Prices, and Economic Growth
3.1
Question 2: With respect to the IS-LM model, which of the following factors is held constant when combining the IS and LM curves to generate the aggregate demand curve?
A. Price level.
B. Real money supply.
C. Nominal money supply.
Answer = C
Because the real money supply is held constant in constructing each LM curve, holding the nominal money supply constant and changing the price level results in a new LM curve with a different real money supply. The intersections of the IS curve with LM curves at each price level illustrate a negative relationship between the price level and real income, i.e., the aggregate demand curve.
Reading 17 Aggregate Output, Prices, and Economic Growth
3.3
Question 1: Which of the following events is most likely to increase short-run aggregate supply (shift the curve to the right)?
A. Inflation that results in an increase in goods prices.
B. High unemployment puts downward pressure on money wages.
C. An increase in government spending intended to increase real output.
Answer = B
Falling money wages would cause businesses to increase (profit-maximizing) output levels at each price level for final goods and services. Changes in the price level of goods and services are represented by a movement along a short-run aggregate supply curve, not a shift in the curve. A rise in resource prices will decrease aggregate supply.
An increase in government spending will shift the aggregate demand curve but not the aggregate supply curve.
Reading 17 Aggregate Output, Prices, and Economic Growth
3.3
Question 2: What are the most likely effects on aggregate demand in the current period of an increase in expected future incomes and of an increase in the money supply?
A. Both increase aggregate demand.
B. Both decrease aggregate demand.
C. One increases aggregate demand and one decreases aggregate demand.
Answer = A
An increase in expected future incomes will cause consumers to increase current expenditures (reduce current savings) in anticipation of the higher future incomes. An increase in the money supply will tend to decrease interest rates which will lead to increased consumer spending on durable goods and increased investment by businesses. Both effects increase aggregate demand.
Reading 17 Aggregate Output, Prices, and Economic Growth
3.3
Question 3: Other things equal, aggregate demand is most likely to decrease as a result of a decrease in:
A. taxes.
B. the money supply.
C. the foreign exchange value of the domestic currency.
Answer = B
A decrease in the money supply will cause short-term interest rates to increase, decreasing investment and consumption spending and thereby decreasing AD. A decrease in taxes will increase disposable incomes, consumption spending, and AD. If the foreign exchange value of the domestic currency decreases, the country’s products become relatively less expensive to foreign buyers, while foreign goods become relatively more expensive to domestic buyers. As a result, net exports increase, which increases AD.
