The following duplicates the introduction to the Test 1 Sample Questions page. If you visited that page, there's no need to reread this material.
The following 12 questions cover some of the material that is relevant for the second exam. While these exact questions will not be on the exam, questions that are similar to (at least) some of them will be. Therefore, seeing these questions will help you prepare for the exam.
Answers and explanations for all 12 questions are found at the bottom of this page. The link after each question takes you to the relevant answer. Please note that while checking the answer to question 3 (for example), you may also be able to see the answer to question 4. If you prefer not to see an answer before you've read the corresponding question, you may wish to look over all 12 questions before checking any answers.
Please note that studying for the first exam should entail more than merely reviewing these 12 questions. The exam itself will have 30 questions, and there are topics covered on the exam that do not appear in the sample questions. Also note that you do not receive any direct credit for accessing this page, nor is the page set up to report a score based on your answers.
The questions and answers on this page are also available (on paper) at the Reserve Desk of the main library.
| Quantity | Total Cost |
|---|---|
| 1 | $7 |
| 2 | $12 |
| 3 | $19 |
| 4 | $29 |
| 5 | $40 |
Question 1 answer is: c. supply of ; rise
Explanation: Market outcomes can be affected by a change in either supply or demand. In general, anything that directly affects the producers of the good has an effect on the supply curve, while anything that directly affects consumers has an effect on the demand curve.
In this case, a freeze in Washington and Oregon has no direct effect on people's interest in eating apples -- the freeze doesn't cause them to become any less interested (or any more interested) in buying apples than they were before the flood. [People will end up eating fewer apples, but we'll get to that.] Thus, the demand curve for apples doesn't move.
The direct impact of the freeze is to make it more difficult (or more expensive) for the suppliers of apples to produce their crop. At any given market price for apples, the freeze causes producers to bring fewer apples to market than they would otherwise bring. Thus, the market supply curve for apples shifts. In particular, there is a reduction in the supply of apples -- the supply curve shifts towards lower quantity levels, or (to put it another way) it shifts to the left.
As noted above, the freeze does cause people to consume fewer apples. They do this not because demand shifted, but rather because the leftward shift in supply causes the market price of apples to rise. This price increase causes an upwards movement along a stationary demand curve.
The question didn't ask this, but the situation can be summarized by saying that a decrease in supply caused a rise in the equilibrium market price and a fall in the equilibrium market quantity.
Question 2 answer is: a. A beneficial rain storm caused a shift in supply.
Explanation: The first thing to notice is that a change in weather conditions will affect price by causing the supply curve, rather than the demand curve, to shift.
Supply will shift because either rain or drought can have a direct effect on the costs and productivity of corn growers. In turn, this causes an increase or decrease in the amount of corn supplied at any given market price. This increase or decrease is illustrated by shifting the supply curve.
The demand curve does not shift because nothing about a drought or a rainstorm will cause consumers' fundamental interest in buying corn (or in buying products made from corn) to change. Consumers may indeed alter the amount of corn they buy; this change in behavior is due to a change in the price of corn. Such an effect on behavior is illustrated by moving along a stationary demand curve, and not by shifting the demand curve.
[In general, remember what the previous answer stated: any event that directly affects the producers of a good will shift the supply curve, while any event that directly affects consumers will shift the demand curve.]
The previous paragraphs tells us that this question is asking us to explain a price decrease by using a supply curve shift. The only way to do this is to shift out (to the right) the supply curve. Remember that such a shift represents an increase in supply (an increase since supply is moving towards larger values for quantity).
An increase in supply is caused by something that leads to a rise in the production of the good. Since a drought would decrease corn production, the drop in price must have been caused by a substantial rain that wet the growing fields and increased the corn supply.
Question 3 answer is: c. decrease ; move in an unknown direction
Explanation: There are two events described in this question. The first is the fall in the price of chicken feed. This event affects the producers of eggs, and thus causes the supply curve to shift. In particular, the reduction in the cost of producing eggs causes an increase in the supply of eggs (the change in the price of feed means that at any given price of eggs, egg producers are willing to sell a larger quantity of eggs than were before the change in feed prices). As a result, the supply curve shifts to the right.
The second event is the rise in health concerns about eggs. This change in attitudes causes people to be less interested in buying eggs than they had been previously; in other words, there is a decrease in the demand for eggs (at any given price of eggs, people will buy fewer eggs than did previously). As a result, the demand curve shifts left.
If both supply and demand shift, and if we have no additional information about the sizes of the shifts, there will be some ambiguity about how the market outcome is affected. In this question, we have no way to tell if supply shifts more than demand, or vice versa.
An increase in supply lowers the market equilibrium price and raises the market equilibrium quantity. A decrease in demand lowers both the equilibrium price and the equilibrium quantity. Since both of these effects push the price down, we can conclude that the equilibrium price definitely falls.
For quantity, however, we do not have have information to predict the outcome. If demand decreases a lot, and supply increases only a little, then equilibrium quantity will fall. But, if demand decreases only a little, and supply increases a lot, then quantity will rise. Since we don't have enough information to know which of these outcomes will occur, the only thing we can say is that equilibrium market quantity moves in an unknown direction.
Question 4 answer is: c. 2
Explanation: To determine which events shifted the demand curve, remember that an event affects demand if it directly impacts on buyers, while it affects supply if it directly impacts on sellers. In this case, both the cold weather in Europe and the flooding in the midwest directly affect buyers.
Since propane is used for heat, cold weather makes buyers fundamentally more interested in buying propone. They wish to buy more propane, not because of a price change, but because the product is now more valuable to them. In other words, cold weather shifts the demand for propane to the right (it increases demand).
Similarly, since propane is used to drop crops, flooding also makes buyers fundamentally more interested in buying propone. Again, they wish to buy more propane, not because of a price change, but because the product is now more valuable to them -- flooding also shifts the demand for propane to the right (it increases demand).
In contrast to the above, the fire directly affects sellers; in fact it eliminates one seller. At any given market price, less propane will be supplied because there is one less plant producing it. In other words, the fire shifts the supply for propane to the left (it decreases supply).
Note that all three of the events listed in the question will increase the price of propane -- two of the events do it by increasing demand and one does it by decreasing supply.
Question 5 answer is: b. maximum price law ; shortage
Explanation: The question describes a situation in which the quantity demanded by consumers exceeds the quantity supplied by producers. Drawing a standard supply-and-demand diagram makes clear that the price set by the law must be below the price at which the supply and demand curves cross. It is only when the price is below the intersection of supply and demand that quantity demanded exceeds quantity supplied.
Thus, the law described in the question is one that prevents the selling price of the good from rising to its market equilibrium level. A law that places an upper limit on a selling price is a "maximum price law." [Note that a "minimum price law" prevents a price from falling to the level it would be in the absence of the law.]
Finally, any situation in which quantity demanded exceeds quantity supplied is called a "shortage." In such a case, some consumers who would like to buy the good at its legal selling price face a shortage of the good -- they are unable to buy it because firms produce fewer units than consumers wish to buy.
Question 6 answer is: c. less than 30 ; would not be
Explanation: The question describes a situation in which a law is keeping the selling price of a product below the price at which it would sell in the absence of the law. In particular, the product would otherwise sell at a price of $15, but now can only sell at a price of $10. We are therefore discussing a maximum-price law.
In a free market outcome (when there are no laws that determine selling price), the price adjusts to the level at which quantity supplied equals quantity demanded. When either a maximum-price law or a minimum-price law is in place, however, quantity supplied and quantity demanded have differing values. Remember that quantity demanded means "the amount that consumers wish to buy at a given price" and quantity supplied means "the amount that producers wish to produce and sell at a given price."
Any time that price is set at a level at which quantity supplied does not equal quantity demanded (this could be either because of a maximum-price law or because of a minimum-price law), the actual amount produced, sold and bought is the smaller of the quantity supplied and the quantity demanded.
In this question, at a price of $10, and with supply and demand curves having the "standard" slopes, the quantity supplied is less than the quantity demanded. Furthermore, since (P = 15, Q = 30) is the free market outcome, the fact that supply is upward-sloping tells us that the quantity supplied (which is the amount actually produced and sold) at a price of $10 must be less than 30 units.
Furthermore, we can be certain that the effect of this law cannot be to make better off every one of the 30 customers who have bought at a price of $15. First, since some amount less than 30 units will be produced, some people who would have been able to buy and consume the good in the absence of the law will not be able to do so when the law is in place. The law must make these people worse off than they would otherwise have been.
It may be possible that some consumers are made better off by the law. This will happen if some of the people who would have have bought at $15 really are able to buy the good for less than the $15 they would otherwise have been paying. [Call this outcome -- in which the law helps some consumers (they get the good cheap) and hurts others (they don't get the good at all) -- case A.]
However, it is also possible that the "effective price" of buying the good might rise above $15. This would happen if "standing-in-line" costs (as we called them is class) raised the effective price needed to buy the good (which counts both the monetary cost, which equals $10, and the the value of time spent waiting in line) to some amount above $15. In this case, the law would produce a fall in the number buying the good (the Q would be less than 30) and cause a rise in the effective price paid by those people who did buy it. In this situation, therefore, the law would make all consumers worse off. [Call this outcome -- in which the law means that some consumers don't get the good, and those who do pay a higher effective price than they would have paid in the absence of the law -- case B.]
Thus, we conclude that a law like the one described in the question may make some consumers better off while making others worse off (case A), or may make all consumers worse off (case B). The one outcome we can certainly rule out, however, is the one in which all consumers are helped.
Question 7 answer is: b. $9
Explanation: To answer this question, one needs to know the how the various measures of cost are related. Out of the cost definitions we covered, three are important for this question. First, Fixed Cost plus Variable Cost equals Total Cost. Second, Marginal Cost equals the change in Total Cost that results from producing one more unit of output. Third, Average Total Cost equals the Total Cost of producing a certain quantity of output divided by that Quantity.
The question tells us that when Quantity = 5, Fixed Cost = $30, and Variable Cost = $20. Also, the Marginal Cost of the 6th unit is $4. We begin by noting that the Total Cost of producing 5 units is $50. [This is true since TC = FC + VC.]
Using this result plus the information on the Marginal Cost of the 6th unit, we can figure out that the Total Cost of producing 6 units must be $54. [This is true because knowing that the Marginal Cost of producing the 6th unit is $4 tells that the Total Cost of producing 6 units must be $4 higher than the Total Cost of producing 5 units. Since TC of producing 5 was $50, and the TC of producing 6 is $4 higher, the TC of producing 6 must be $54.]
Finally, this result tells us that the Average Total Cost of producing 6 units is $9. [This is true because the Average Total Cost of producing a certain Quantity of units is the Total Cost of producing that quantity divided by that Quantity. Thus, ATC = TC/Q = $54/6 = $9.]
Question 8 answer is: b. Marginal Revenue equals its Marginal Cost ; Total Revenue exceeds its Total Cost by the largest possible amount
Explanation: This question shows the importance of understanding the meanings of Marginal Revenue and Marginal Cost as opposed to the meanings of Total Revenue and Total Cost.
Total Revenue and Total Cost tell us how much, in total, the firm has received from selling a certain number of units of its product, and how much, in total, it cost to produce that number of units. Since Profit equals Total Revenue minus Total Cost, a firm makes the largest profit it can possibly earn by selling the number of units for which Total Revenue exceeds Total Cost by the largest amount.
Marginal Revenue and Marginal Cost tell us how the VERY LAST unit sold (and produced) affects Total Revenue and Total Cost. More precisely, Marginal Revenue describes how Total Revenue changes when one more unit is sold, and Marginal Cost describes how Total Cost changes when one more unit is produced.
Because of the way profit is defined, saying that (producing and) selling one more unit increases a firm's profit is equivalent to saying that selling that unit increases the firm's Total Revenue by more than it increases its Total Cost.
Or, merely rephrasing the above, saying that selling one more unit increases a firm's profit is also equivalent to saying that selling that unit produces a Marginal Revenue that is larger than the Marginal Cost of producing it. Note that Profit rises whenever MR exceeds MC, even if the difference between the two is only $1 (or 1 cent).
Furthermore, note that if a firm wants to maximize its profit, it should take advantage of ANY opportunity to sell a unit for which MR exceeds MC. Here's an example. Suppose the MR of unit 3 is $10 and the MR of unit 4 is $8, while the MC of unit 3 is $6 and the MC of unit 4 is $7. Selling the 3rd unit increases the firm's profit (since MR exceeds MC), and selling the 4th unit also increases the firm's profit (since MR exceeds MC). The rise is profit is bigger for the 3rd unit than it is for the 4th (because the difference between MR and MC is bigger for unit 3 than it is for unit 4), but BOTH units produce a RISE in profit.
A firm that wishes to maximize its profit thus should NOT stop selling at the point where MR exceeds MC by the largest amount (which is what answer (d) implies). Doing so means that the firm has missed an opportunity to increase its profit. In the example above, a firm that stopped when MR exceeded MC by the most would miss the chance to increase its profit (by only $1, but a dollar's a dollar) by selling the 4th unit.
Rather, a firm maximizes its profit (makes the difference between TR and TC as big as it can be) by selling EVERY unit for which MR exceeds MC. This last statement is true regardless of whether MR exceeds MC by a lot, or only by a little.
Since the proper strategy for a firm that wants to maximize its profit is to sell every unit for which MR exceeds MC, the firm should continue to sell until the MR and MC of the last unit sold are equal (or as equal as possible) to each other.
Thus, by continuing to sell up to the point where MR equals MC, the firm guarantees that its TR exceeds it TC by the largest possible amount.
Question 9 answer is: c. 3
Explanation: There's more than one way to answer this question, but the method I'd suggest involves comparing Marginal Revenue and Marginal Cost. Remember from class (and from the answer to question 7) that a firm maximizes its profit by selling every unit for which Marginal Revenue exceeds Marginal Cost (even if it MR exceeds MC by just a little bit).
In this question, Marginal Revenue is always $8. We know this because the problem tells us that Betty can sells as many units of the output as she wishes at $8 per unit, which means that every time Betty sells one more unit her total revenue rises by $8.
The table in the question gives Betty's Total Cost of producing the first five units of output. Since Marginal Cost is defined as the change in Total Cost that results from producing the last unit, it's easy to compute the Marginal Cost of producing each output. For example, when Betty increases her production from 1 unit to 2 units, her Total Cost rises from $7 to $12. Thus, the Marginal Cost of producing the second unit is $5.
The accompanying table gives the Marginal Cost of producing units 2 through 5.
| Quantity | Total Cost | Marginal Cost |
|---|---|---|
| 1 | $7 | -- |
| 2 | $12 | $5 |
| 3 | $19 | $7 |
| 4 | $29 | $10 |
| 5 | $40 | $11 |
If Betty increased her sales from three units to four units, however, her revenue would rise by $8 while her cost rose by $10. Selling the fourth unit would thus decrease Betty's profit. Betty should thus sell three units, but no more.
Note: as a general rule in answering questions of this type, you should take whatever information is given, and convert that information into Marginal Revenue and Marginal Cost. MR and MC can be directly compared, but you'll always run into trouble if you try to compare Marginal Revenue with Total Cost (or Total Revenue with Marginal Cost).
Question 10 answer is: d. negative ; exit ; left
Explanation: The question states that the market is originally in long-run equilibrium, which implies that the firms in the market are earning zero economic profit (which means that they are doing as well in this industry as firms elsewhere in the economy are doing). A rise in the firms' cost of production thus means that that at the existing selling price the firms will be losing money. Firms will not be able to pass the entire cost increase along to consumers. [Since the market demand curve slopes downward, consumers will not pay a higher price and still continue to buy as many units as they did previously.] Thus the firms in the market will earn negative economic profits (which means that they will be doing worse in this market than firms elsewhere in the economy are doing).
Since the firms are earning negative profits, some of them will choose to leave; thus, firms will exit the market. A change in the number of firms active in a market alters the market equilibrium by shifting the supply curve. More specifically, since firms are leaving the market, the amount of output produced at given price will be reduced (since there are fewer active firms producing output). This means that there is a decrease in supply, which shifts the market supply curve to the left (towards lower amounts of quantity).
The leftward shift in supply causes the market equilibrium price to rise. Eventually, the market returns to a long-run equilibrium in which the firms are earning zero economic profit, the market price is higher than it was originally, and there are fewer firms active in the market than there were originally.
Question 11 answer is: e. both answers (b) -- decrease this firm's profit -- and (c) -- produce a net benefit for society; in other words, be efficient -- are correct.
Explanation: First, we need to compare the Marginal Revenue from selling the 9th unit with the Marginal Cost of producing it. The formula for Marginal Revenue says that MR of selling unit 9 = (P when 8 were sold) - (9) (drop in price needed to increase sales by one unit). In this case, MR = 10 - 9 (.50) = 5.50.
We can now compare Marginal Revenue (= $5.50) and Marginal Cost (= $7). Since MR is less than MC, we know that increasing sales from 8 units to 9 units will decrease the firm's profit (since the firm's revenue will rise by a smaller amount than its cost will rise).
Now, consider the "net benefit" part of the question. To answer this, we need to compare the value that a consumer places on the 9th unit with the cost of producing it. In this question, somebody would be willing to pay ($10 minus 50 cents =) $9.50 to buy the 9th unit. This tells us that the person who buys the 9th unit of the good must get $9.50 worth of value from consuming it. The marginal cost of producing that unit is only $7.
We conclude that producing and selling the 9th unit of the good would produce an increase in efficiency (a net benefit) for the overall society because the value that the customer would get from consuming that unit of the good exceeds the cost of producing it.
Question 12 answer is: d. All of (i), (ii), and (iii) are features of both markets.
Explanation: A monopolistically-competitive market has some features in common with a perfectly competitive market, and some features that are different from those in a perfectly-competitive market. All three of the features noted above are common to both markets.
Entry into the market is free in both a P-C and a M-C market. Thus, when existing firms are earning profits in either of the two markets, new firms will come into that industry in the hopes of sharing in those profits.
This entry of new firms affects the firms that were already in the market by either driving down the price at which they can sell their product or reducing the number of units they can sell at any given price. In both types types of markets, this change is illustrated by shifting down the demand curve facing an individual firm. The "real-world" event happening here is that the new firms have taken some customers away from the existing firms -- so the existing firms are selling at a lower price and/or selling a smaller quantity than they did previously.
Note, however, that the firm demand curves look different in the two markets. In a P-C market, the firm demand curve is horizontal; shifting it "down" means dropping a flat line to a lower price. In a M-C market, the firm demand curve is downward-sloping; shifting it "down" means moving it toward the origin (the point at which price = 0 and quantity = 0), which shows that (at any given price) the firm sells fewer units after the new firms have entered than it did before.
The lower price at which the existing firms can sell their product (caused by the new firms taking away some of their customers and illustrated by the demand curve shift just discussed), imply that the existing firms will make a smaller profit after the new firms have entered than they were making before.
Another similarity between a P-C market and a M-C market is that the above process of entry will stop when there is no longer any potential for a new firm to enter the market and make a positive economic profit. If all (current and potential) firms are identical, this means that entry stops when all firms are making zero economic profit.
As noted above, a P-C market and a M-C market also have some differences. One is whether costs of production are as low as they can possibly be in a long-run equilibrium. In a P-C market, entry pushes prices (and therefore costs) down to the lowest level at which any firm could still in business. In other words, costs of production are as low as they can be (given current technology). In a M-C market, costs are not driven down to the lowest possible level of ATC; in a long-run equilibrium, each firm produces a quantity that is on the downward-sloping part of the ATC curve. Thus, a M-C market has the "more variety" vs. "higher costs of production" tradeoff discussed in class.