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Flashcards in Module 4 - Supply Deck (43):
1

Which of the following is correct?

When one good is being produced using the minimum amount of resources

A. economic efficiency will prevail in the economy as a whole.
B. engineering efficiency will prevail in the production of that good.
C. all resources in the economy will be employed.
D. an increase in the production of that good must lead to a reduction in the production of other goods.

The correct answer is B. Engineering efficiency by definition prevails in the production of a good when that good is being produced using the minimum amount of resources. This does not imply that society is producing all goods in such a fashion and producing that set of goods that maximises society’s utility, i.e. the conditions for economic efficiency. Some resources may be unemployed; and if that is true, increased output of other goods could result without decreasing the output of the good being produced in an engineering-efficient manner.

2

The economy is not producing its maximum output of goods if

I. goods are not being produced in an engineering-efficient manner but all resources are employed in production.

II. goods are being produced in an engineering-efficient manner but not all resources are employed in production.

III. goods are not being produced in an engineering-efficient manner and not all resources are employed in production.

Which of the following is correct?  

A. I only.
B. II only.
C. I or II only.
D. I or II or III.

The correct answer is D. To produce the maximum amount of goods in some time period, two conditions must prevail:

(a) each good must be produced in an engineering-efficient manner, i.e. using the least amount of resources; and
(b) all resources must be employed. Thus if the economy is not producing its maximum output, then either condition I
or II or both I and II in the question prevail.

3

Economic efficiency is achieved in an economy when

I. all goods and services are produced using the least possible amount of resources.

II. all resources are employed.

Which of the following is correct?

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

The correct answer is D. Necessary conditions for economic efficiency are:

(a) engineering efficiency – all goods and services must be produced using the least amount of resources; and

(b) all resources must be fully employed.
A necessary and sufficient condition for economic efficiency is

(c) the production of that set of goods and services that satisfies society’s wants as fully as possible.

Since (c) subsumes conditions (a) and (b), conditions (a) and (b) above are not sufficient to guarantee condition (c).

4

If you were to observe a firm supplying none of a particular good at its existing price, it could justifiably be concluded that

I. the good is incapable of making a profit for the firm at any price.
II. the firm expects the price to fall in the future. Which of the following is correct?

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

The correct answer is D. A firm’s typical supply curve is upward sloping, i.e. more is supplied the higher the price. Below some price the firm will not be prepared to supply any quantity, but this does not imply that the traditional supply curve does not exist. A firm might refrain from supplying a good in one time period if it expected the price of the good to rise, but it would not if it expected the price to fall.

5

A firm that produces a range of cosmetics products moves from Britain to Germany. In comparing monthly sales, it discovers that in Germany it supplies a greater proportion of high-cost items than it did in Britain. The factors that could not have caused this
change in the firm’s sales are

I. higher income levels in Germany compared with Britain.

II. the length of the period being compared. III. different relative prices of cosmetic products in the two countries. Which of the following is correct?

A. I only.
B. II only.
C. II and III only.
D. I, II and III.

The correct answer is B. The two factors that could have caused greater sales of high-priced cosmetics in Germany are higher German incomes and/or different relative prices, e.g. luxury cosmetics being twice as expensive as ‘regular’ cosmetics in Germany and three times as expensive in Britain. What could not have caused the difference in the volume of sales is the length of the time period being considered: we are not comparing, for example, annual sales in Germany with monthly sales in Britain; a common time period of a month exists.

6

What is the correct definition of the term ‘short run’ as used in the theory of supply?

A. The time period between the decision to produce a good and its final appearance on the market.

B. A time period of less than one year in which more than one factor of production can be altered.

C. A time period of up to three years in which any factor of production can be altered.

D. The time period in which a firm cannot increase or decrease the quantity it hires of at least one factor of production

The correct answer is D. This is a definitional question. Economists find it convenient for analytical reasons to distinguish the short run – a time period during which at least one factor of production cannot be increased or decreased – from the long run – a time period where no factor of production is fixed. For example, in deciding how large one should make a supermarket when no building has even been begun can be considered a long-run decision. Once the building is up, however, the variables that can be altered are such things as the number of checkout stands and employees – the variable factors of production.

7

In the theory of supply, what does the term ‘long run’ refer to when used in connection with a firm’s decision making?

A. The number of years over which a firm can expect to produce with unaltered factors of production.

B. Any period of time between three and five years in which a firm can increase or decrease all the factors of production it employs.

C. Any period of time over five years in which a firm can increase or decrease all the factors of production it employs.

D. The time period in which a firm can increase or decrease all the factors of production it employs.

The correct answer is D. The answer to this question uses the same rationale as in Question 4.6 above. In the long run, all the variables can be altered.

8

A firm must make maximum profits when

I. it raises the maximum amount of revenue from selling its products. II. its products are produced at the lowest possible costs per unit of output. Which of the following is correct?

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

The correct answer is D. Given that at any given level of output price exceeds average variable costs, a firm will maximise profit or minimise loss by producing that level of output at which marginal revenue equals marginal cost. Maximum revenue would be obtained by a perfectly competitive firm if it were to sell an infinite quantity, and by an imperfectly competitive firm where marginal revenue was zero. Thus I in the question is incorrect. A perfectly competitive firm in equilibrium will produce at a level of output where average total cost is minimum; it is possible for this to occur under monopoly but it is highly unlikely. Thus, there is no guarantee that the output corresponding to minimum average total cost is the profit-maximising output. Thus II is incorrect.

9

Figure 4.26 provides information about

I. engineering-inefficient outputs.
II. economic efficiency, since wheat is always in demand because of world food shortages.

Which of the following is correct?

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

The correct answer is A. All points on the production frontier and all points between the production frontier and the horizontal axis are attainable outputs: they can be produced with the given fixed factor input and different amounts of the variable factor input. However, only points on the frontier in Figure 4.26, e.g. points X, Y and Z are engineering-efficient outputs, i.e. the maximum outputs attainable with the corresponding amounts of the variable input. Points outside the frontier, e.g. point A, could not be achieved without more of the fixed factor, i.e. point A is not attainable in the short run. Figure 4.26 shows the outputs that can be produced, not what should be produced to maximise society’s welfare. No information exists on the economically efficient level of output.

10

From Figure 4.26 it can be concluded that

I. points X, Y and Z are the only attainable outputs.

II. B is an attainable output.

III. A is an unattainable output even in the long run. Which of the following is correct?

A. I only.
B. II only.
C. III only.
D. Not I, nor II nor III.

The correct answer is B. All points on the production frontier and all points between the production frontier and the horizontal axis are attainable outputs: they can be produced with the given fixed factor input and different amounts of the variable factor input. However, only points on the frontier in Figure 4.26, e.g. points X, Y and Z, are engineering-efficient outputs, i.e. the maximum outputs attainable with the corresponding amounts of the variable input. Points outside the frontier, e.g. point A, could not be achieved without more of the fixed factor, i.e. point A is not attainable in the short run – but may be attainable in the long run.

11

Which of the following is correct?

The output of a good (i.e. the quantity produced) divided by the number of units of a variable factor used in the production of that good is a definition of:

A. marginal product of that factor.
B. average product of that factor.
C. total cost of production.
D. variable cost of production.

The correct answer is B. A definitional question. Total output divided by the number of units of a factor of production is the average product of that factor. The marginal product of a factor is the change in output divided by the change in the factor. The total cost of production of a good is the sum of fixed cost and total variable costs; variable cost of production is total cost minus fixed cost.

12

A hop grower in Kent noted that, within limits, the larger the number of workers he hired the greater was the output of hops from his fields. This means that for the number of workers being employed by the grower the marginal product of labour is necessarily

A. higher than the average product of farm labour.
B. lower than the average product of farm labour.
C. greater than zero.
D. less than zero.

The correct answer is C. The fact that total output increases as more workers are hired results from the fact that the marginal product of labour is positive. The marginal product of labour can be greater than, equal to, or less than the average product of labour.

13

Which of the following is correct? For a firm, in the long run

A. fixed costs tend to be greater than variable costs.
B. variable costs tend to be greater than fixed costs.
C. all costs are fixed.
D. all costs are variable costs.

The correct answer is D. The long run is that time period during which all resources are variable. Since there are no fixed factors of production, there are no fixed costs; all costs are variable.

14

If a perfectly competitive firm is maximising profit in the long run, price equals

I. short-run marginal cost.
II. long-run marginal cost.

Which of the following is correct?

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

The correct answer is C. For perfectly competitive firms, price equals marginal revenue (MR). The rule for profit maximisation for all firms is to produce that level of output where MR = marginal cost (MC). For a perfectly competitive firm, this translates to price = MC; and when a perfectly competitive firm is profit- maximising, in the long run price = LMC (long-run marginal cost). But that implies it is also maximising the short-run marginal cost (SMC); if it were not, it would change output level and price would not equal long-run marginal cost.

15

The long-run supply curve of a competitive industry is found by adding

I. the long-run marginal cost curves of all firms in the industry.

II. the long-run marginal cost curves above the average cost curves of all firms in the industry.

III. the long-run average cost curves of all firms in the industry.

Which of the following is correct?

A. I only.
B. II only.
C. III only.
D. None of the above.

The correct answer is D. In the long run, firms move into and out of an industry. If such movements do not affect factor input price, the long-run supply curve will be a horizontal line. The long-run supply curve is therefore unrelated to any of the cost curves of existing firms in the industry.

16

If an increase in the demand for aircraft causes the price of aluminium to rise, how willthis, other things being unchanged, affect the industry that produces aluminium beer cans?

A. Its output will increase.
B. Its long-run supply curve will shift to the right.
C. Its long-run supply curve will shift to the left.
D. Its long-run supply curve will not be affected.

The correct answer is C. The position of an industry’s long-run supply curve is affected by the cost of factor inputs. If the price of factor inputs increases, the curve will shift to the left, and vice versa.

17

If a firm is producing output at a point where diminishing returns have set in, then

I. each additional unit of output will be more expensive to produce. II. each additional unit of output will require increasing amounts of the variable factor of production.
III. the marginal product of the variable factor of production decreases as the quantity used increases.

Which of the following is correct?

A. I only.
B. I and II only.
C. I and III only.
D. I, II and III.

The correct answer is D. Diminishing returns means that as a firm uses more of a variable factor input with a given amount of fixed factors, the marginal productivity of the variable factor decreases. Thus III is correct by definition. It follows that each additional unit of output will require ever increasing amounts of the variable factor input, and consequently each additional unit of output will be more expensive to produce.

18

A recent economics graduate was hired by a highly competitive restaurant and was assigned the task of improving efficiency in the restaurant. It was felt that an inefficient combination of two variable factor inputs was being employed. The economist was able to make the following calculations where each lunch sells for $2.00:

The economist correctly diagnosed the problem and advised the restaurant owner on the appropriate course of action. That course was to:

A. hire more A and more B.
B. hire more A but no more B.
C. hire more B but no more A.
D. hire less B and less A.

The correct answer is A. The value of the marginal product of A is $12, defined by the number of extra lunches times price. The value of the marginal product of factor B is $6 (3 × $2). The marginal cost of factor A is $3 and of factor B is $1. It will always pay a firm to hire more of a resource as long as MR > MC, since the hiring of more of each factor would contribute more to revenue than it would to cost. Thus as $12 > $3 (factor A) and $6 > $1 (factor B), more of both should be hired.

19

The higher the

I. marginal product of a factor input, the lower the marginal cost of output.

II. average product of a factor input, the lower the average cost of output.

III. costs of fixed factor inputs, the lower the marginal cost of output.

Which of the following is correct?

A. I only.
B. III only.
C. I and II only.
D. I, II and III.

The correct answer is C. Suppose the factor input in question is labour, the variable factor input; then, with Q = output and L = units of labour, we have

{image}

where W = wage rates and the other expressions refer to total, fixed and variable costs.

The expression Q/L appears in Equation A2.1 and L/Q appears in Equation A2.3. Thus APL and AC are inversely related. Thus II in the question is correct. ΔQ/ΔL appears in Equation A2.2 and ΔL/ΔQ appears in Equation A2.4. Thus MPL and MC must be inversely related, and so I in the question is correct. ΔFC/ΔQ = 0, and
thus fixed cost and MC must be unrelated. Therefore III in the question is incorrect.

20

For a firm with given plant and equipment, which of the following will always decrease as output increases?

A. Total variable cost.
B. Total fixed cost.
C. Variable cost per unit.
D. Fixed cost per unit.

The correct answer is D. Fixed costs do not vary with output levels and consequently the higher the level the lower must be average fixed costs, i.e. fixed cost per unit of output must decline as output increases.

21

In one of the largest manufacturing firms, an agreement was recently reached between management and unions that wage rates would increase proportionately with average labour productivity (the output per employee). Last year the firm increased its plant and equipment, retained all of its labour force fully employed, and enjoyed a 6 per cent increase in output. The unions have gone on strike because management has refused to pay any wage increase.
According to the agreement, which of the following is correct?

A. The unions should not receive a wage increase because the 6 per cent increase in output is attributable to the increase in plant and equipment.

B. The unions should receive a wage increase because average labour productivity has increased.

C. The unions should receive a wage increase only if the firm increases its plant and equipment by less than 6 per cent.

D. Whether the unions should receive an increase according to the agreement cannot be determined from the given information.

The correct answer is B. Average labour productivity (APL) is calculated by dividing total output by the number of workers. The agreement with the union was that a wage rate increase would equal the increase in APL. Since APL increased by 6 per cent, the wage rate increase should also be 6 per cent, independent of changes in other factor inputs.

22

A family will be away from its house for six months. The monthly mortgage payment on the house is $130. Local utilities, to be paid by the owner, are $30 per month if the house is occupied, otherwise zero. If the family wished to minimise its losses (or
maximise its gains) from the house (assuming wear and tear, etc. to be zero whether or not the house is occupied), it should let for as much as the market will bear as long as monthly rent is above the following:

A. 0.
B. $30.
C. $130.
D. $160.

The correct answer is B. If the house is left unoccupied, the owner does not have to pay local utilities costing $30 per month. Thus, the owner must reclaim at least $30 per month in rent to make renting the house a viable economic activity.

23

The short-run supply curve of an industry would shift to the right as a result of

I. an increase in the number of firms in the industry.
II. an increase in the cost of the variable factor of production.
III. a decrease in the cost of the variable factor of production.

Which of the following is correct?

A. I only.
B. III only.
C. I and II only.
D. I and III only.

The correct answer is B. A firm’s marginal cost will shift to the right if the cost of a variable factor input decreases. Since the industry short-run supply curve is com- posed of the sum of firms’ short-run marginal cost curves, the industry short-run supply curve will shift to the right if the price of a variable factor input decreases. Thus III is correct. It will also shift to the right as the number of firms in the industry increases, but that is a long-run situation. Thus I is incorrect.

24

Any point on the production frontier identifies output

I. produced in a technically efficient manner
II. produced in an economically efficient manner

Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is A. The production frontier identifies for any given variable input level (labour in this case) the maximum possible output; the frontier traces all possible maximum outputs for all possible inputs. Maximum possible output for a given level of inputs constitutes technical or engineering efficiency. Thus I is true. The product in question, however, could be a wheelbarrow with square wheels, a field of cauliflower unpicked because the going price did not cover pickers’ wages. Economic efficiency subsumes engineering efficiency and means also the resources could not have been put to a better use for satisfying society’s wants. Thus II is wrong.

25

Which unit of labour has the highest marginal product (MPL)?

A. 3
B. 5
C. 4
D. 6

Marginal productivity of labour (MPL) is found by dividing the change in output by the change in variable factor input, i.e. △Q/△L for a given level of output. If a fourth worker were hired, Q would increase from 6 to 10 units, so the MPL of the fourth unit of labour is 4/1. If a fifth worker were hired, Q would increase from 10 units to 15 units, so MPL at that point is 5/1. This happens to be a maximum.

26

Consider points
I. 25,8
II. 25,9
III. 25,10
IV. 25,11

Which of the following output/factor combinations is attainable?
A. I only
B. II only
C. II, III and IV only
D. I, II, III and IV

The correct answer is C. Attainable outputs are outputs on, or within, the production frontier. Points 25,9; 25,10 ad 25,11 all lie on the frontier. Point 25,8 however lies beyond the frontier and is not attainable with the current fixed factor inputs.

27

Consider points
I. 25,8
II. 25,9
III. 25,10
IV. 25,11

Which of these points is attainable and engineering efficient?
A. I only
B. II only
C. II, III and IV only
D. I, II, III and IV

The correct answer is B. Point 25,8 lies outwith the production frontier and cannot be attained with the existing resources. Thus A is incorrect. Points 25,9; 25,10 and 25,11 all lie on the production frontier. However the least amount of labour input required to produce 25 units of output is 9 units and thus 25,10 and 25,11 represent engineering inefficient production.

28

Consider points
I. 25,8
II. 25,9
III. 25,10
IV. 25,11

The fixed factor inputs are altered slightly and the production frontier shifts upwards; point 25,8 is on the new frontier.

Which of the following is correct? The engineering efficient outputs now are

A. I only
B. IV only
C. II, III and IV only
D. III only

Question not answered The correct answer is A. Since 25,8 lies on the new frontier any production which requires more than 8 units of labour can not be an engineering efficient output. Thus B, C and D are wrong.

29

What does the area under the curve equal?
A. The marginal product of labour
B. The average product of labour
C. Total product
D. The optimal amount of labour to employ

The correct answer is C. The height of the curve at any given level labour input indicates the contribution to output made by the last unit hired. By summing the additions to output by each unit hired, i.e. by summing the marginal products, total output is reached. Thus the area under the curve between zero and any level of variable factor input yields total output/product.

30

If the going wage rate fell below W1, what would happen to the total wage bill (W) and the total returns to all other factors inputs (R)?

A. W would increase, R would decrease
B. W would increase, R would increase
C. W might increase or decrease, R would increase
D. W might increase or decrease, R would decrease

The correct answer is C. If the going wage rate were to decrease more labour would be hired. Whether W would increase would depend upon whether the proportional increase in labour input were greater than the proportional decrease in wages. Thus W might increase or decrease. The return to all other factors is the area under the curve and above the horizontal wage line W1. Since W1 fell, R had to increase.

31

To earn any profit, assuming a profit is possible, a firm must operate at the level of output at which

I. total revenue minus total cost is maximum
II. marginal revenue equals marginal cost

Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. I and II state the condition for profit maximisation not the conditions for any profit. As long as total revenue exceeds total cost, a profit is made and there may be a range of outputs where this is possible. It follows that there may be a range of outputs where marginal cost is less than, equal to or greater than marginal revenue and a profit is made given that total revenue (average revenue) exceeds total cost (average total cost) in that range.

32

What will cause a firm’s short-run supply curve to shift to the right?

A. A decrease in the cost of fixed factor inputs
B. An increase in the cost of fixed factor inputs
C. A decrease in the cost of variable factor inputs
D. An increase in the cost of variable factor inputs

The correct answer is C. Fixed factor inputs costs do not affect short run supply curves by definition. Thus A and B are wrong. A short run supply curve will shift to the right i.e. a firm would be willing to supply more at each and every price if the costs of production fell; thus it could occur if either there were a movement towards the production frontier, i.e. greater efficiency or the cost of variable factor inputs decreased. Thus C is true and D is wrong.

33

If an industry long run supply curve is infinitely elastic, i.e. a horizontal line, it means that

I. each firm’s long run supply curve is infinitely elastic
II. factor input prices are unaffected by firms entering or leaving the industry

Which of the following is correct?

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is B. The firm in the long run is in the planning stage, deciding on the optimally sized plant; it estimates long run marginal cost and equates this with MR. As soon as the plant is built the firm is back in the short run. A firm’s infinitely elastic long run supply curve has no meaning. Thus I is wrong. For the industry supply curve to be infinitely elastic it means that as new firms enter the cost of inputs do not change, i.e. the industry in question is infinitely small relative to all other industries taken together which are using the same factor inputs. If input prices were to increase as new firms entered, the average total cost curves of all firms would shift upwards, the marginal cost curves (firm’s short run supply curves) shift left and the industry long run supply curve would be upwards sloping. Thus II is true.

34

At what level of output (Q) is average productivity of labour (APL) greatest?

A. 19
B. 22
C. 24
D. 25

Average productivity of labour (APL) is found by dividing total product/output by the number of units of labour input. APL is at a maximum when output = 19, i.e. 19/6 = 3.166. Utilising the figure, if a straight line is drawn from the origin to any point on the frontier the slope of that line will be Q/L, i.e. it will measure APL. The steepest line (maximum APL) from the origin touches, (is tangent to), the frontier at Q = 19, or should, if the figure were accurate.

35

At points 15,5 and 24,8 the

I. average products of labour (APL) are equal.
II. marginal products of labour (MPL) are equal.

Which of the following is correct?
A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

36

The marginal product (MPL) of the third unit of labour is 3, i.e.

△Q/△L = 6-3/1

At what other point of the production frontier does MPL= 3?
A. 10,4
B. 15,5
C. 22,7
D. 19,6

37

Which of the following is correct?

I. When MPL is decreasing, APL is decreasing also
II. When MPL is at a maximum, APL is at a maximum also

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. If MPL is greater than APL , AP must be increasing; i.e. the addition of one unit of labour results in an increase in output which is greater than the existing average product of labour. The addition to the average of a number greater than the average must increase that average. Thus MPL could reach a maximum and start to decline but as long as MPL > APL , APL will increase. Thus both I and II are wrong.

38

Which of the following is correct?

I. If APL > 0,TP > 0
II. If APL > 0, MPL > 0

A. I only
B. II only
C. Both I and II
D. Neither I nor II

39

An inverse relationship exists between certain productivity and cost variables

I. when MPL is minimum, AVC is minimum
II. when APL is maximum, AVC is minimum

Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is B. MPL is inversely related to MC and APL is inversely related to AVC. Thus I is wrong and II is true.

40

As additional units of labour were hired

I. MPL was decreasing but APL was increasing
II. MC was rising but AVC was decreasing

Which of the following is correct?

A. Only I could occur
B. Only II could occur
C. Both I and II could occur
D. Neither I nor II could occur

A decreasing MPL and an increasing APL are possible simultaneously; as long as MPL>APL, APL will increase. When MPLL, APL will decrease. Thus I is true. Since MPL is inversely related to MC and since APL is inversely related to AVC a mirror image of the MPL/APL relationship will be reflected in the MC/AVC relationship. Thus II is true.

41

The correct answer is C. MPL and APL increase initially (as the factor input (labour) increases) reach peaks then decline. TVC always increases as variable factor inputs increase. Thus A, B and D are wrong. AFC decreases as output/factor input increases because a fixed cost is being divided by an ever increasing number and therefore must decrease as output increases.

42

The short run market supply curve would shift to the left if

I. some firms left the industry
II. the cost of fixed factor inputs increased

Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. The question is about the SHORT RUN. In the short run the number of firms is fixed and changes in the prices of fixed factor inputs do not affect short run supply curves. Thus both I and II are wrong.

43

Which of the following identifies the difference between returns to factor inputs (RF) and returns to scale (RC)?

A. RF is a long run phenomenon, RC short run
B. RF refers to varying one factor input only, RC refers to varying all factor inputs
C. RF refers to a firm, RC to an industry
D. RF depends upon RC but RC does not depend upon RF

The correct answer is B. RF refers to a firm varying one factor input holding all others constant and seeing what happens to output. RF can be positive, constant or negative. By holding at least one other factor constant RF is a short run phenomenon. RC refers to a firm altering all factor inputs (a long run issue) and observing the change in output. RC can be positive, constant or negative. Thus A is wrong and B is true. Both RF and RC refer to a firm not an industry, thus C is wrong. RF and RC are independent of each other. Thus D is wrong.