The following 28 questions cover some of the material that is relevant for the second exam.

The exact questions given below will not be on the exam. Questions that are similar to (at least) some of them will be. Understanding the answers to these questions will therefore help you prepare for the exam.

Answers and explanations for all 28 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 the questions before checking any answers.

Please note that studying for the second exam should entail more than merely reviewing this page. The exam itself has 17 questions, and while these sample questions cover much of what we've done in class, there will certainly be topics appearing on the exam that do not appear in these sample questions. Make sure to also study your class notes and the homework questions, and read the material on the (web-page) outside reading list.

1. Unit	Kate's WtoP	Emma's WtoP
   1st	$50	$40
   2nd	$30	$34
   3rd	$18	$28
   4th	$14	$22
   5th	$10	$16

   The accompanying table shows the willingnesses to pay of Kate Nash and Emma Pollock for various units of (the same kind of) shirt.
   Suppose that the market price of this shirt is $26 per unit. Given the above numbers, _____ chooses to buy more shirts than does the other person; as a result of buying shirts, _____ experiences more consumer surplus from buying shirts than does the other person.   [answer and explanation]
   
   1. Emma   ;   Kate
   2. Emma   ;   Emma
   3. Kate   ;   Kate
   4. Kate   ;   Emma

   

2. The accompanying figure shows the market demand curve for some good, as well as the market price that must be paid to purchase the good. When some consumer buys the 1000th unit of the good, what is the value of the surplus that he or she experiences as a result of (just) that purchase?   [answer and explanation]
   
   1. 30
   2. 20
   3. 10
   4. 0

3. An article in the February 14, 2007 issue of The New York Times ("Four Brands in Car Rental May Merge", by Andrew Ross Sorkin) explains that General Motors, Ford, and DaimlerChrysler "have tried to move away from providing discounted fleet vehicles to rental car companies [in order to instead] focus on higher-margin retail customers." As a result, the "average rental price of a midsize car has risen to about $57 a day this year, from $52 last year, according to ... [the] president of Abrams Consulting Group ... which follows the rental car business." Consider the following possible changes in the market for rental cars.
     I.   a change in the supply of rental cars
     II.   a change in the demand for rental cars
     III.   a change in the quantity demanded of rental cars (in the market equilibrium)
   In which way(s) do the events described above affect the rental-car market?   [answer and explanation]
   1. only I
   2. only I and III
   3. only II
   4. only II and III
   5. all of I, II, and III

4. Apple juice and orange juice are substitute goods. A freeze in Florida destroys half the orange crop, and thus substantially reduces the production of orange juice. As a result, _____.   [answer and explanation]
   1. the price of orange juice rises, and the price of apple juice falls
   2. the price of orange juice falls, and the price of apple juice rises
   3. the prices of both orange juice and apple juice rise
   4. the prices of both orange juice and apple juice fall
   5. the prices of both orange juice and apple juice remain unchanged

5. The following is a true statement. In July, 1996, the price of corn (actually, the price for a "futures contract" on a bushel of corn to be delivered in December '96, but don't worry about this) fell dramatically. A Wall Street Journal story (9/9/96) that noted this fact attributed the drop in price to the weather Conditions in July in the major corn-growing areas of the U.S.. Which of the following is the best explanation of how the weather could cause a large drop in the price of corn?   [answer and explanation]
   1. A beneficial rain storm caused a shift in supply.
   2. A beneficial rain storm caused a shift in demand.
   3. The continuation of a drought caused a shift in supply.
   4. The continuation of a drought caused a shift in demand.
   5. No weather event could ever cause supply or demand to shift.

6. Indicate what direction price change is implied by the situations described in these two newspaper articles. (i) According to a June 1, 2002 story ("Onion farmer's tears") in the Atlanta Journal-Constitution, "Georgia's ... Vidalia onion industry is reeling from its worst crop season in 15 years". As a result, the price charged by farmers changed from "_____" per 40 pounds. (ii) According to a July 8, 2002 story ("An Oversupply of Coffee Beans") in The Wall Street Journal, increased production of "robusta coffee from Vietnam and Brazil" has led to wholesale coffee prices that "currently hover around 50 cents a pound, _____ ... in May 1997."   [answer and explanation]
   1. $16 to $12   ;   up more than 80% from their brief bottom
   2. $12 to $16   ;   up more than 80% from their brief bottom
   3. $16 to $12   ;   down more than 80% from their brief peak
   4. $12 to $16   ;   down more than 80% from their brief peak

7. The following material is taken from a story that appeared in the Atlanta Journal-Constitution in January, 1997. [Note: propane gas is both used to provide heat and to dry grain.]
   "Propane gas customers ... are now paying $1.25 to $1.35 a gallon, compared with 85 cents this same time last year." Some people claim that the price increases are "due to `excessive profiteering by the major oil companies.' " Industry spokesmen, however, say that the price increase is due to "market forces" caused by the following factors: (i) "severely cold weather in Europe," (ii) "needs for propane gas in the Midwest, where flooding spawned needs to dry certain crops," and (iii) "a fire [in Chiapas, Mexico] ... at one of the largest exporters of propane gas."
   Accepting the "market forces" explanation for the price increase, how many of the three factors listed above would have contributed to a price increase by shifting the demand curve for propane?   [answer and explanation]
   1. 0
   2. 1
   3. 2
   4. 3
   5. There is no possible way that market forces could have lead to an increase in the price of propane gas.

8. An article by Mary Lou Pickel in the January 25th, 2006 Atlanta Journal-Constitution reports that "[i]n countries with outbreaks of bird flu, poultry consumption has dropped 20 percent to 30 percent" Ms. Pickel quotes a member of the poultry industry as saying that "the price of leg quarters has dropped from about 38 cents down to 24 cents in the last six months", a change he "attribute[s] ... in part to [concerns about] bird flu". In a supply-and-demand framework, what event must have caused these price and quantity (in non-U.S. markets) changes?   [answer and explanation]
   1. a decrease in demand
   2. an increase in demand
   3. a decrease in supply
   4. an increase in supply

9. Suppose that, for some reason, the price of wheat falls; wheat is the major ingredient used to produce bread. At the same time, a fungus reduces rice production; rice and bread are substitutes. With both of these events occurring simultaneously, we can be sure that the price of bread will rise _____.   [answer and explanation]
   1. if the shift of supply is more sizable than is the shift of demand
   2. if the shift of demand is more sizable than is the shift of supply
   3. no matter whether the supply shift is more or less sizable than is the demand shift

10. We know that there have been shifts of both the demand curve for and the supply curve of a good. We also know that one end result of the changes in this market was that the equilibrium price of the good rose. Given this information, which combination of supply and demand changes could not possibly have occurred?   [answer and explanation]
    1. an increase in supply and a decrease in demand
    2. a decrease in supply and an increase in demand
    3. an increase in both supply and demand
    4. a decrease in both supply and demand
    5. Knowing only that price rose does not allow us to rule out any of the above.

11. Assume that there has been a decrease in both the demand for and the supply of a product. The only way that we could be certain that the supply curve had shifted by relatively more than did the demand curve would be if the product's equilibrium market _____.   [answer and explanation]
    1. quantity rose
    2. quantity fell
    3. price rose
    4. price fell

12. Suppose that, for some reason, the price of raw cow milk falls. Milk is the major input used for butter production. At the same time, some people become increasingly concerned about harmful medical effects of eating margarine. Butter and margarine are substitutes. How do these two events affect the equilibrium outcome in the market for butter?   [answer and explanation]
    1. price increases, but we can't be certain about how quantity changes
    2. quantity increases, but we can't be certain about how price changes
    3. price and quantity both increase
    4. quantity increases and price decreases
    5. price and quantity likely change, but we can't be certain about the direction in which either moves

13. We know only that the per-unit price of a particular good is higher now than it was one year ago. From this fact alone we know it must be true that there has been _____.   [answer and explanation]
    1. a decrease in the quantity demanded of the product
    2. either a decrease in the supply of or an increase in the demand for the product
    3. either an increase in the supply of or a decrease in the demand for the product
    4. Both (a) and (b) are correct.
    5. Both (a) and (c) are correct.

14. People are buying fewer units of Product X than they bought previously. This fact tells us that ____.   [answer and explanation]
    1. there must have been a decrease in the demand for Product X
    2. there must have been an increase in the supply of Product X
    3. if there was an increase in the demand for Product X, then there must have been a decrease in the supply for Product X
    4. if there was an increase in the demand for Product X, then there must have been an increase in the supply of Product X

15. Suppose that at the current price being charged for a certain product, the quantity supplied by producers exceeds the quantity demanded by consumers. This situation exists (and can last) because a law prevents the market price of the product from changing. Such a situation could be best described by saying that a _______ law has created a _______ of the relevant product.   [answer and explanation]
    1. maximum-price law   ;   surplus
    2. maximum-price law   ;   shortage
    3. minimum-price law   ;   surplus
    4. minimum-price law   ;   shortage
    5. No law could have the effect described above.

16. Throughout this question, assume that supply slopes up and demand slopes down in the standard way. In the absence of any government regulation, the market price of this good would be $15 and 30 consumers would buy it. Suppose that a law requires that this good be sold at a price of $10 per unit. At this price, the amount of the good produced and bought would be _____. We can furthermore state that the effect of this law _____ to make better off every one of the 30 consumers who would have bought at a price of $15.   [answer and explanation]
    1. less than 30   ;   would be
    2. greater than 30   ;   would be
    3. less than 30   ;   would not be
    4. greater than 30   ;   would not be
    5. equal to 30   ;   would be

17. In the absence of any government action, Product X would sell for a price of $30 per unit. Suppose in fact that government legislation imposes an upper limit on the monetary price that can be charged for this good. In particular, suppose that the selling price of this good can legally be no higher than $20. In this case, the "effective" price of this good _____.   [answer and explanation]
    1. must be less than $20
    2. must equal $20
    3. may be higher than $20, but must be less than $30
    4. must equal $30
    5. could be greater than $30

18. Two ways in which the government could affect the monetary selling price of a good are by imposing either a "price ceiling" or a "price floor". [Throughout this question, assume that the laws actually do cause a good's selling price to differ from what it would have been in the absence of the law.] Which of these laws would result in consumers, in effect, paying more (combining their monetary and (if any) time (or other) costs) for the relevant good when the law is in force than they would have paid if the law hadn't been imposed?   [answer and explanation]
    1. a "price ceiling" definitely has this effect; a "price floor" definitely does not
    2. a "price floor" definitely has this effect; a "price ceiling" definitely does not
    3. a "price ceiling" definitely has this effect; a "price floor" might if the "effective price" rises high enough
    4. a "price floor" definitely has this effect; a "price ceiling" might if the "effective price" rises high enough

19. In the absence of any government intervention, a certain good would sell at a price of $20 per unit, and 1000 units would be produced and sold. A law sets the cash price that consumers pay for this item at $15. At this price, only 700 units of the item are produced; desired purchases at the $15 price, however, equal 1400. Which of the following correctly describes the ultimate outcome that results from the price-restriction law?   [answer and explanation]
    1. The law definitely makes better off (than they would have been without the law) each person who, with no law and at a price of $20, would have bought one of the 1000 units of the good.
    2. The law definitely makes better off (than they would have been without the law) each person who, with the law, actually buys one of the 700 units of the good.
    3. The law definitely makes worse off (than they would have been without the law) each person who, with no law and at a price of $20, would have bought one of the 1000 units of the good.
    4. Both (a) and (b) are definitely correct.
    5. None of (a), (b), or (c) is definitely correct.

20. Firm A		Firm B		Firm C
    Units of Input	Units of Output	Units of Input	Units of Output	Units of Input	Units of Output
    1	6	1	6	1	6
    2	10	2	14	2	14
    3	13	3	18	3	24
    4	15	4	21	4	36

    Consider the information about firm production levels shown in the accompanying table. Up through 4 units of the input, which of these firms has (have) hit the "region of diminishing marginal returns"?   [answer and explanation]
    1. only Firm A
    2. only Firms A and B
    3. only Firm C
    4. all of Firms A, B, and C
    5. none of Firms A, B, and C

21. Suppose that when a certain firm produces 5 units of output, its fixed cost of production is $30 and its variable cost of production is $20. If the firm were to produce a 6th unit, its marginal cost of producing that unit would be $4. Given this information, this firm's average total cost of producing 6 units would be   [answer and explanation]
    1. $4
    2. $9
    3. $10
    4. $54
    5. None of the above are correct.

22. Suppose that when a certain firm produces 7 units of output per day, its average total cost of production is $21. If the firm were to produce a 8th unit, its marginal cost of producing that unit would be $13. Given this information, this firm's average total cost of producing 8 units would be _____.   [answer and explanation]
    1. $8.25
    2. $13.00
    3. $16.50
    4. $18.00
    5. $20.00

23. When a certain firm produces two units (per day), its fixed cost of production is $50, and its variable cost is $30. If the firm was to raise its production to four units, its variable cost would rise to $70. If the firm did increase its production from two to four units, its average variable cost of production would _____ and its average total cost of production would _____.   [answer and explanation]
    1. fall   ;   fall
    2. fall   ;   rise
    3. rise   ;   fall
    4. rise   ;   rise
    5. not change   ;   not change

24. When a firm produces 31 units of output, its average total cost of production is lower than was its ATC when it produced only 30 units. In other words, production of the 31st unit pulled down the firm's ATC of production. This fact tells us that the following is true: the firm's marginal cost of producing its 31st unit must be _____.   [answer and explanation]
    1. higher than is its average total cost of producing 30 units
    2. lower than is its average total cost of producing 30 units
    3. higher than is its marginal cost of producing its 30th unit
    4. lower than is its marginal cost of producing its 30th unit
    5. equal to its marginal cost of producing its 30th unit

25. Complete the following statement. If a firm sells the quantity of output at which its marginal revenue _____, then that firm can be absolutely certain that its total revenue _____.   [answer and explanation]
    1. equals its marginal cost   ;   exceeds its total cost by the largest possible amount
    2. equals its marginal cost   ;   equals its total cost
    3. exceeds its marginal cost by the largest possible amount   ;   exceeds its total cost by the largest possible amount
    4. exceeds its marginal cost by the largest possible amount   ;   equals its total cost
    5. Both (a) and (d) are correct.

26. We know that when Firm XYZ produces and sells 20 units of its product, it earns a larger profit than it would earn if it produced and sold 19 units, or 21 units, or any other quantity. From this fact, we know that the following statement must also be true. The marginal revenue that Firm XYZ receives as a result of selling the 20th unit must _____.   [answer and explanation]
    1. exceed the marginal cost of producing the 20th unit by more than MR exceeds MC for any other unit that XYZ produces
    2. be less than the marginal cost of producing the 20th unit by a greater amount than MR is less than MC for any other unit that XYZ produces
    3. exceed (or be equal to) the marginal cost of producing the 20th unit, while the MR from the 21st unit must be less than the MC of that unit
    4. be less than (or be equal to) the marginal cost of producing the 20th unit, while the MR from the 21st unit must exceed the MC of that unit
    5. equal zero

27. Quantity	Total Cost
    1	$37
    2	$45
    3	$55
    4	$68
    5	$86
    6	$111
    7	$145

    Betty owns a firm, and that firm's total cost of producing various quantities of output are given in the table. If Betty can sell as many units of this output as she wishes at an unchanging price of $20 per unit, Betty would maximize her profits by selling _____ units.   [answer and explanation]
    1. 3
    2. 4
    3. 5
    4. 6
    5. 7

28. Regardless of the number of days on which he opens his store, Frank pays a set amount of $1200 per month (for an average cost of $40 per day) to rent the building in which his store is located. Frank is committed to making this payment. Frank doesn't actually work at the store, but he does decide what its hours of operation will be. For every day that Frank opens the store, he must both pay wages to his employees and pay for electricity. These costs add up to $100 per day. If Frank decides to open his store on Sunday, the store will collect $300 in revenue; the items it sells that day cost $180 to buy. Frank's business is generally profitable, but he is trying to decide whether to stay open or close down on Sunday. Assume that whether he opens or closes on Sunday has no effect on the store's sales on other days. Given the above numbers, if Frank decides to keep his store open on Sunday, the result will be that his store's total profit will _____.   [answer and explanation]
    1. rise
    2. fall
    3. remain unchanged
    4. definitely fall to zero

Question 1 answer is:   a.   Emma   ;   Kate

Explanation: To answer the first part of this question, remember that a person's willingness to pay for a certain unit of a good is the maximum amount he or she would be willing to pay (if she had to) for that unit. As a result, a person will buy a particular unit if her willingness to pay for that item exceeds the price she actually has to pay.

With a market price equal to $26, Kate's willingness to pay exceeds the price for the 1st and 2nd units. We conclude that Kate buys two units. At the same price, Emma's willingness to pay exceeds the price for the 1st, 2nd and 3rd units. Emma buys three unita, which is more than Kate buys.

To answer the second part of the question, remember that a consumer's surplus from a particular unit of a certain good is defined as the difference between two numbers: the maximum amount the consumer would have willing to pay for that item (her willingness to pay -- or her value --- for it) and the amount she actually pays for it. To find total consumer surplus, one can compute the total value from all units acquired, and then subtract off the total amount paid for them (in whatever form those payments are made). In some cases (including this question), one might also be able to find (overall) consumer surplus by computing the person's surplus from each individual unit bought and then adding up those figures. [Although it's not relevant to this question, consumer surplus can also often be measured as an area on a graph.]

The willingness to pay numbers in the tabel indicate that Kate experiences $80 (= $50 + $30) worth of value from consuming two units of the good. Since Kate spends $52 (2 × $26) purchasing those units, her (overall) consumer surplus equals $28 (= $80 - $52). Emma receives $102 (= $40 + $34 + $28) worth of value from consuming three units. Since Emma spends $78 (3 × $26) purchasing those units, her consumer surplus equals $24 (= $102 - $78). Therefore, Kate experiences more consumer surplus from buying shirts than does Emma.

Question 2 answer is:   c.   10

Explanation: The surplus experienced as a result of the purchase of a single unit of a good equals the value the relevant consumer expriences from that unit (which is also known as the consumer's willingness to pay for the unit), minus the consumer's amount paid for the unit.

In this particular example, the graph indicates that some consumer is willing to buy unit #1000 as long as the price that he or she has to pay doesn't exceed $30. The value of the unit to the person who consumes it thus equals $30. The figure also shows that the person who buys unit #1000 has to pay $20 to get it. [Since there is a constant market price for the good, the last statement applies for every other unit as well. In contrast, the value of unit #1000 differs from the value of unit #500 or #1500 or ...]

Combining the above two statments allows one to determine that the surplus from unit #1000 = (value of unit #1000) minus (price paid for unit #1000) = $30 - $20 = $10.

Note that the surplus resulting from the purchase and use of a single unit is represented graphically as a distance: value minus cost for just that unit. The (total) consumer surplus from all the units of a good purchased (for example: the consumer surplus resulting from the consumption of all the units bought at a market price of $20), in contrast, is represented as an area. [In this case, the area is that underneath the demand curve, above the market price, and out to the quantity purchased.]

Question 3 answer is:   b.   only I and III

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, the fact that automobile manufacturers have stopped selling as many discounted cars to rental-car companies has no direct effect on people's interest in renting cars -- the change in strategy by auto makers don't cause people to be more or less interested in renting cars than they would have otherwise. [People will end up renting fewer cars, but we'll get to that.] Thus, the demand curve for rental cars doesn't move.

The direct impact of the event described in the question is to make it more expenisve for the suppliers of rental cars to provide their product. At any given market price for rental cars, renting cars is --- because of the higher price that the rental cars comapnies must pay to get cars --- less profitable. Rental car companies will therefore bring fewer cars to market than they otherwise would. Thus, the market supply curve for rental cars shifts. In particular, there is a reduction in the supply of rental cars -- the supply curve shifts towards lower quantity levels, or (to put it another way) it shifts to the left.

As noted above, the various events do in the end cause people to rent fewer cars. In other words, the "quantity demanded of rental cars" does fall. This happens not because the demand for rental cars shifts, but rather because the leftward shift in supply causes the market price of a rental car to rise. This price increase in turn causes an upwards (higher price -- smaller quantity) movement along a stationary demand curve.

The situation can be summarized by saying that a decrease in the supply of rental cars (caused by a rise in seller costs) causes a rise in their equilibrium market price and a fall in equilibrium market quantity.

[Another way to say the above is: the reduction in supply led to a rise in the price, which reduced the quantity demanded, but didn't cause any change in demand itself.]

Question 4 answer is:   c.   the prices of both orange juice and apple juice rise

Explanation: Based on the information in the question, we can determine that there has been a decrease in the supply of orange juice. As a result, the market price of orange juice rises.

Because orange juice has become more expensive, and because the question tells us that orange juice and apple juice are substitutes, we know that the described events will cause people to become more interested in buying apple juice. In other words, there will be a shift to the right of the demand curve for apple juice (an increase in demand); as a result, apple juice's equilibrium price rises.

In the end, the freeze in Florida causes the prices of both orange and apple juice to rise. Note, though, that they rise for different reasons --- it is a decrease in supply that affects the orange juice market, and an increase in demand that affects the apple juice market.

Question 5 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 tell 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 beneficial rain that wet the growing fields and increased the corn supply.

Question 6 answer is:   d.   $12 to $16   ;   down more than 80% from their brief peak

Explanation: Don't let the fact that the answers to this question contain specific numbers -- and you have no information about specific numbers -- confuse you. A question like this is simply an attempt to use real-world situations as examples of supply or demand shifts. The key point in choosing from among the answers is to focus on the direction in which price (or quantity) changes.

The first half of this question describes a particularly bad growing season for onion farmers. The bad weather (due to a lack of rain) caused a bad crop; in other words, there was a reduction in the supply of onions. A reduction in supply causes the market price to rise. The correct answer must therefore entail an increase (specifically, from $12 to $16) in the price of onions.

The second half of the question describes an increase in production (or in the supply) of coffee. A rise in supply causes the market price to fall. The correct answer must therefore entail a decrease (specifically, an 80% decrease) in the price of coffee.

Question 7 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 propane. 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 propane. 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 8 answer is:   a.   a decrease in demand

Explanation: The question explicitly states that the equilibrium quantity ("poultry consumption") has fallen, and that the equilibrium price has also fallen. Of the four possible market changes -- increase in demand, decrease in demand, increase in supply, and decrease in supply -- the only one that will reduce both P and Q is a decrease in demand. This answer obviously makes sense, since concerns about bird flu would be expected to discourage people from consuming poultry (i.e., would cause a decrease in demand).

Question 9 answer is:   b.   if the shift of demand is more sizable than is the shift of supply

Explanation: The fall in the price of wheat means that the cost of producing bread has fallen. As a result, the supply of bread increases.

The drop in rice production means (because bread and rice are substitutes) that the demand for bread increases.

By itself, an increase in the supply of bread causes the equilibrium price of bread to fall. By itself, an increase in the demand for bread causes the equilibrium price of bread to rise. Combining these two effects, the market price of bread could rise or fall -- the ultimate impact depends on whether the supply curve shifts by more or less than does the demand curve.

In particular, the price of bread rises if the demand curve shifts out (to the right) by more than does the supply curve.

Question 10 answer is:   a.   an increase in supply and a decrease in demand

Explanation: The question states that, as a result of the changes in the market, the equilibrium price rose. Any combination of supply and demand shifts in which one (or, of course, both) shifts tend to drive up price could be consistent with a price rise.

The question asks for the combination of supply and demand shifts that could not possibly be consistent with a price rise. In other words, the questions asks for the two movements that both drive price down. These two shifts are are (i) an increase in supply (which by itself decreases price), and (ii) a decrease in demand (which by itself also decreases price).

Question 11 answer is:   c.   price rose

Explanation: The question states that there has been a decrease in both the demand for and the supply of a product. By itself, a decrease in demand causes a fall in both the equilibrium price and the equilibrium quantity. In turn, a decrease in supply, by itself, causes a fall in equilibrium quantity but a rise in equilibrium price.

Both the described changes, therefore, cause a fall in quantity. Knowing what happened to quantity thus doesn't tell us anything about which curve shifted more.

Knowing how price moved, however, can tell which curve shifted by a relatively greater amount. As already noted, a decrease in demand pushes price down; a decrease in supply pushes price up. Suppose that supply moves more than does demand. In this case, price will be pushed up. In contrast, suppose that demand moves more than does supply. In this case, price will be pushed down.

This particular question asks about the circumstances under which we'd know that supply decreased by relatively more than demand decreased. The description in the previous paragraph makes clear that this pattern of changes could occur only if the equilibrium market price rose.

[Note: It may be easier to understand this question (and understand the answer) if you draw two pictures. In the first, show demand decreasing by a lot, and supply decreasing by just a little. In the second, show supply decreasing by a lot, and demand decreasing by a little.]

Question 12 answer is:   b.   quantity increases, but we can't be certain about how price changes

Explanation: There are two events described in this question. The first is the fall in the price of milk. This is a reduction in the cost of producing butter (making such production more profitable), which creates an increase in the supply of butter. The supply curve for butter thus shifts out (to the right).

The ssecond event is a rise in concerns about the health effects of eating margarine. Since the question asks about the butetr market, the effect of this event (increased reluctance to consume a substitute for butter) creates an increase in the demand for butter. The demand curve for butter thus shifts out (to the right).

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 demand shifts more than supply, or vice versa.

One way to answer this question is to draw two sets of supply-and-demand diagrams. In one, show demand increasing by a large amount, and supply increasing by a small amount. The picture will show that the equilibrium price rises and that the equilibrium quantity rises.

In the other picture, show demand increasing just a little and supply increasing a lot. This picture will show that price falls but that quantity rises.

Since we don't have enough information to determine which of the two pictures just described is more accurate (since we don't know which curve shifted more), all we can say for sure is that the quantity definitely rises (since it rises in both pictures). In contrast, since price rises in one picture but falls in the other, we can't be certain about how the equilibrium market price changes.

This answer can also be obtained by considering the two shifts separately and adding together their effects. To do so, use a table such as the one shown.

Shift	Price	Quantity
Demand increases	rises	rises
Demand decreases	falls	falls
Supply increases	falls	rises
Supply decreases	rises	falls

The question describes a increase in demand and an increase in supply. As indicated in the table, these effects both cause quantity to rise, but they have opposing impacts on price.

If we knew how much the two curves shifted, we could say more about the change in price. Again you can obtain the answer using either pictures or the table. In the picture in which demand increased by more than supply increased, price rose. When supply increased more than demand increased, however, price fell. The same outcome can be derived from the table by putting more weight on the effect caused by the curve that shifted more.

On your own, consider what would happen to the equilibrium price and quantity of butter if the price of milk rose while people became worried about consuming margarine. Or, if milk prices fell while people learned that consuming margarine had health benefits. Or, if milk prices rose while people learned that consuming margarine had health benefits.

Question 13 answer is:   b.   either a decrease in the supply of or an increase in the demand for the product

Explanation: The question tells us that the price of a good has risen. Answer (a) states that such a rise in price must be associated with a decrease in the quantity demanded of the relevant good. With a downward-sloping demand curve, this relationship must indeed be true if the demand curve for the relevant product does not move. When a downward-sloping demand curve is stationary, a higher price will always reduce quantity demanded.

Nothing in this question, however, states that the demand curve remained stationary. [In fact, answers (b) and (c) explicitly describe situations in which demand shifted.] If the rise in the good's price was caused by an increase in demand, then (depending on what the supply curve was doing) it is very possible to have both a higher price and a higher quantity demanded. Answer (a), therefore, is not something that must be true. [This conclusion also, of course, rules out the final two possible answers -- "both (a) and (b)" and "both (a) and (c)".]

C hoosing between the remaining two answers is relatively easy. Answer (b) is correct: a rise in the price of a good can be caused either by a decrease in supply or by an increase in demand. The two shifts described in answer (c) -- increase in supply and decrease in demand -- would, in contrast, cause a good's price to fall.

Question 14 answer is:   c.   if there was an increase in the demand for Product X, then there must have been a decrease in the supply of Product X

Explanation: The question tells us that people are buying less Product X than they had previously.

One might be tempted to think that answer (a) -- "there must have been a decrease in the demand for Product X" -- might be right. Remember though that the fact that people are buying less of a good does not mean that their demand for the good decreased.

Even if the demand for a good hasn't decreased, people might buy less of the item as long as the supply of the good has decreased. [With unchanged demand, a fall in supply will raise the equilibrium price, which will lead to a decrease in quantity demanded.]

We therefore cannot conclude that knowing that people are buying less of a good menas that their demand for it must have decreased.

Instead, answer (c) is correct. Even if people's demand for a good has increased, it's possible that they could end up buying fewer units of it. Of course, the only way that could happen is if supply decreased (thus pushing up the equilibrium price) to such an extent that it more than offset the increase in demand.

[The other two answers would both lead people to increase the number of units of X purchased, so they can't possibly be the correct answer.]

Question 15 answer is:   c.   minimum-price law   ;   surplus

Explanation: The question describes a situation in which the quantity supplied by producers exceeds the quantity demanded by consumers. Drawing a standard supply-and-demand diagram makes clear that the price set by the law must be above the price at which the supply and demand curves cross. It is only when the price is above the intersection of supply and demand that quantity supplied exceeds quantity demanded.

Thus, the law described in the question is one that prevents the selling price of a good from falling to its free-market-equilibrium level. A law that places a lower limit on a selling price (in other words, that sets the minimum value at which the price can be), and thus keeps the price above its free-market-equilibrium level is a "minimum-price law". [Such a law can also be called a "price floor". To remember this, just recall that a floor stops an object from falling as far as it normally would, and a "price floor" prevents a good's selling price from dropping as low as it normally would go.]

[In contrast, note that a "maximum-price law" (or a "price ceiling") sets the maximum (or highest) value at which a price can be. In other words, such a law prevents a price from rising to the level it would be in the absence of the law. A "price ceiling", in other words, keeps a price below its free-market-equilibrium level, just as a ceiling stops a helium-filled balloon from rising as high as it normally would.]

Any situation in which quantity supplied exceeds quantity demanded is called a "surplus." [In contrast, a "shortage" exists when quantity demanded exceeds quantity supplied.] When a surplus exists, some of the producers who would like to sell their product at the price set by the law will be unable to find (private) buyers. The surplus either will remain unsold or will be purchased by some "outside" entity, such as the government.

Question 16 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 price ceiling.

In a free-market outcome (when there are no laws that control selling price), the price adjusts to the level at which quantity supplied equals quantity demanded. When either a price ceiling or a price floor 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 price ceiling or a price floor), the actual amount produced, sold and bought by private entities 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. If firms can only get $10 per unit when they sell this item, they'll produce fewer units than they would have produced if they could sell at a price of $15.

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 30 potential customers are helped.

[By the way, the highest possible value for the "effective price" (mentioned two paragraphs ago) is found by starting at the quantity that firms actually choose to produce (when they can sell at a price of only $10), and going up to the demand curve. This tells us the highest price at which the units that are actually produced would all be sold. Since that price can't (by law) be charged in money, it would require the combination of $10 in money plus the value of the time-spent-standing-in-line to raise the effective price to this level.]

Question 17 answer is:   e.   could be greater than $30

Explanation: This question emphasizes the difference between the "monetary" price of a good and the "effective" price of that same good. While the effective price includes the monetary price, it also includes the dollar value of everything a consumer has to do to acquire a good. If, for instance, a person has to stand in line for an hour (and then pay a monetary price) in order to obtain an item, the value of one hour of that person's time is added to the monetary price to make up his or her effective price of getting the item.

For the following material, assume that the market for the relevant item can be described with a standard upward-sloping supply curve and a standard downward-sloping demand curve.

When an item that would sell for $30 (in the absence of any government regulation) can be sold for a monetary price of only $20, the quantity of the good supplied will fall. [Dropping the selling price moves the quantity supplied down along the supply curve.] It also causes the quantity demanded to exceed the quantity supplied.

At a $20-per-unit price, more people will want to buy the good than there are units of the good available. As a result, a typical person might begin taking actions to try to ensure that he or she gets some of the good before the available quantity is sold. Our figurative description of these actions has been that the person might get to the store before it opens and "stand in line" to make sure that he's admitted to the store, and is able to buy the item, before all the available units are sold. Suppose that enough people do this so that those who don't stand in the line aren't able to get the good. As a result, "standing in line" becomes part of what a person must do in order to acquire the good. The value of the person's time spent standing in line must therefore be counted as part of the price that a person must, in effect, pay to acquire the item.

[In general, "standing-in-line costs" could include activities other than literally standing in line. To get a good, perhaps a potential buyer has to pay a bribe, or has to devote time to determining where the good will be available. or has to incur costs designed to hide her activities in the underground economy. Any of these costs would also be added to the "effective price" of buying an item.]

There's no guarantee that the effective price will rise to its highest possible level. That said, what is the highest-possible effective price? In a supply-and-demand diagram, this amount is found by starting at the quantity supplied at the (set-by-law) monetary price, and going up from that quantity until hitting the demand curve. The dollar value on demand at this quantity shows the highest price at which people will still choose to buy all the available units of the good. It's possible (but not guaranteed) that people who wish to acquire the good will have have to devote so much time to standing in line (or to engaging in some other activity) that they are effectively paying this price to buy the item.

If the effective price of the good does rise to this level, it will certainly be higher than the price at which the good would have sold in the absence of any legal restrictions. This is because the drop in the quantity supplied of the good (due to the price ceiling that led to this whole chain of events) means that the price on the demand curve at the quantity actually produced must be higher than the price at which the demand and supply curves intersect. That's why it's possible that the effective price in this question might rise above the $30 price that would have existed in the absence of any price regulation.

A numeric example of such an outcome follows. To buy a good, a person has to pay a monetary price of $20. There is, however, a shortage of this good, and some of the people who would like to buy it at a $20 price will not be able to obtain a unit. To make sure that he or she gets a unit, a person has to spend some time (let's say two hours) standing in line before the store opens. The effective price of this good includes the value to that person of the time spend standing in line. For example, if a person acts as though his or her time is worth $10/hour, then a two-hour wait would impose a $20 cost on the person. To get this item, therefore, a person must pay an effective price of $40 (= $20 in money + $20 worth of time).

While the question doesn't ask this, it may be worthwhile to point out the overall effect of this law on consumers. If the effective price does indeed rise above what the market-clearing price would have been, it's obvious that the price-ceiling law made all consumers worse off. Alternatively, it's also possible that, for some consumers, the effective price stays below what the free-market price would have been. In that case, those consumers (but not all consumers -- see the answer to question 2) gain from the price ceiling.

Question 18 answer is:   d.   a "price floor" definitely has this effect; a "price ceiling" might if the "effective price" rises high enough

Explanation: A "price floor" (if it has any effect at all) keeps the monetary price of a good above the level at which it would naturally lie. Such a law can also be called a "minimum-price law". [The "floor" terminology reminds us that the floor of a room prevents an object from dropping as far as would otherwise drop -- and therefore keeps the object higher than it would otherwise be.] A price floor thus always leads consumers to pay more than they would pay in the absence of the law.

A "price ceiling" (if it has any effect at all) keeps the monetary price of a good below the level at which it would naturally lie. Such a law can also be called a "maximum-price law". [The "ceiling" terminology reminds us that the ceiling of a room prevents an helium-filled balloon from rising as high as would otherwise rise -- and therefore keeps the object lower than it would otherwise be.]

A price-ceiling law also reduces the quantity of the good produced. Since there is less of the good available, some consumers who would like to be able to purchase the good won't be able to do so. To make sure that he or she actually gets the product, some consumers might incur other costs. For example, a potential customer might get to the store before it opens and stand in line in order to ensure that he or she gets the item. [A consumer might also ensure his access to the good by engaging in other "nonproductive activities" like paying a bribe.]

The value of the time that a person spends standing in line must be considered part of the price that she has to pay to get the item. The "effective price" she pays (which equals the monetary price plus the value of the time she spends standing line) is thus greater than the good's monetary price.

It is possible that the good's "effective price" will rise above what the good's price would have been in the absence of the price-ceiling law. [For a explanation of this possibility, see the answer to the previous question.] If this happens, a price-ceiling law will satisfy the condition stated in the question. [Note, though, that we can't be sure that the effective price will rise this high; for this reason the question states that a price ceiling "might" cause consumers to "pay" more for a good.]

Question 19 answer is:   e.   None of (a), (b), or (c) is definitely correct.

Explanation: This question obviously refers to a "price ceiling", which -- by keeping the monetary selling price of a good below what it would be otherwise ($15 rather than $20) -- decreases the quantity of a good produced (700 rather than 1000). Since fewer units of the good are available for purchase, some of the people who would have willingly bought the good at a $20 price won't be able to obtain the good -- as a result, they must be made worse off. Answer (a) -- all buyers of the 1000 units are definitely better off -- is therefore wrong.

Even the people who do buy the 700 units that are available might not be made better off. While the law means that they will be paying a $15 monetary price rather than $20, they may also have to undergo some other "hassle" in order to obtain the good. [The possible role of this "hassle" is to determine which of the 1400 potential buyers get the 700 units available -- only those willing to do something in addition to paying the $15 monetary price actually get the good.] This hassle could potentially cause the "effective price" to exceed the $20 price that would have existed in the absence of the law. Answer (b) -- all buyers of the 700 units are definitely better off -- is therefore wrong.

On the other hand, it's also possible that some consumers could actually gain from such a law. It's possible that some people might be "in the right place at the right time" and as a result might be able to obtain the good at the $15 price set by the law without having to undergo much (or any) additional hassle. [The reading about "rent control" laws in New York City certainly indicates that some individuals have gained from being able to rent apartments at an artifically-low price.] We can't therefore say with certainty that the price ceiling has made each person worse off. Answer (c) -- all buyers of the 700 units are definitely worse off -- is therefore wrong.

Another way to explain why (b) and (c) are incorrect is to consider what we've called the "most optimistic" and "most pessimistic" cases of a price ceiling. In the most optimistic case, the 700 units are purchased at a true price of $15 -- because this is a possible outcome, statement (c) needn't have to be correct. In the most pessimistic case, the 700 units are purchased at an effective price that exceeds $20 (the price that would have existed in the absence of the law) -- because this is a possible outcome, statement (b) needn't have to be correct.

Question 20 answer is:   b.   Firms A and B

Explanation: Marginal Return measures the amount by which a firm's output rises when it uses one additional unit of an input. A firm is in the "region of diminishing marginal returns" when using one more unit of an input increases output by less than was the case when the previous unit of the input was used. [In other words, the firm is in this situation when the marginal return from the input diminishes as additional units of the input are used.]

In this question, as Firm A increases its use of the input from 1 to 2 to 3 to 4 units, its production of the output rises from 6 to 10 to 13 to 15. This numbers indicate that using one additional unit of the input causes output to rise first by 4 units, then by 3 units, and finally by 2. The figures are Firm A's marginal return, and they are clearly continually diminishing.

As Firm B increases its use of the input, its output rises from 6 to 14 to 18 to 21. Firm B's marginal return is thus 8, then 4, and then 3. For all units of the input after the 2nd, therefore, Firm B's marginal return is diminishing.

As Firm C increases its use of the input, its output rises from 6 to 14 to 24 to 36. Firm C's marginal return is thus 8, then 10, and then 12. For at least the first four units of the input, therefore, Firm C's marginal return is growing, not diminishing. [This could be because Firm C is still in a situation in which using more workers allows those workers to specialize, thus increasing output rapidly.]

Question 21 answer is:   b.   $9

Explanation: To answer this question, one needs to know the how the various measures of cost are related. Out of all 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. The Total Cost of producing 5 units is therefore $50. [This is true since TC = FC + VC.]

Using this result, plus the fact that the Marginal Cost of the 6th unit is $4, allows us to 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 is $4 higher than is the Total Cost of producing 5 units. Since the TC of producing 5 units is $50, and the TC of producing 6 is $4 higher, the TC of producing 6 must be $54.]

Finally, our last step 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 22 answer is:   e.   $20.00

Explanation: The question tells us that when the firm produces seven units of output, its average total cost of production equals $21. Since ATC = TC/Q, the firm's total cost of producing seven units is $147.

The question also tells us the firm's marginal cost of producing an 8th unit would be $13. Since the marginal cost of producing a unit is defined as the rise in total cost that results from producing a unit, we can figure out that the total cost of producing eight units must be $147 + $13 = $160.

Since we now know that TC = $160 when Q=8, it's easy to determine that the firm's ATC of producing eight units must be $160/8 = $20.

Question 23 answer is:   c.   rise   ;   fall

Explanation: Again, to answer the question, one needs to know basic cost definitions. This question asks about Average Total Cost (which equals the Total Cost of producing a given Quantity divided by that Quantity) and Average Variable Cost (which equals the Variable Cost of producing a given Quantity divided by that Quantity).

Average Variable Cost can be computed directly from the figures given in the question: at Q = 2, VC = 30, while at Q = 4, VC = 70. At Q = 2, therefore, AVC = 30/2 = 15, while at Q = 4, AVC = 70/4 = 17.5. As output increases from 2 to 4, therefore, Average Variable Cost rises.

Total Cost equals Fixed Cost (which, according to the question, equals 50) plus Variable Cost. At Q = 2, therefore, TC = 50 + 30 = 80, while at Q = 4, TC = 50 + 70 = 120. At these levels of output, ATC equals 80/2 = 40 and 120/4 = 30. We see that as output increases from 2 to 4, Average Total Cost falls.

Question 24 answer is:   b.   lower than is its average total cost of producing 30 units

Explanation: This question concerns the relationship between average and marginal costs of production. Suppose first that the cost of producing the last unit of a good is less than was the average cost of producing all the units up to that point. In that case, when the new (lower) number is added in with the previous information, and the average total cost is recomputed, ATC will have fallen.

In contrast, suppose that the cost of producing the last unit of a good is greater than was the average cost of producing all the units up to that point. In that case, when the new (higher) number is added in with the previous information, and the average total cost is recomputed, ATC will have risen.

In this question, producing the 31st unit caused the firm's ATC to fall. This tells us that that 31st unit must have been relatively cheap to produce. In other words, the marginal cost of the 31st unit must have been less than the average total cost of producing the first 30 units.

To answer this question correctly, one needs to understand why we must compare the MC of producing the 31st unit to the ATC of producing 30 units, rather than to the MC of producing the 30th unit. The best way to see why this is true might be with a numeric example.

Quan.	Marg Cost	Total Cost	Avg Tot Cost
1		$14	$14
2	$2	16	8
3	2	18	6
4	3	21	5.25
5	4	25	5
6	6	31	5.17

Note that unit #4 has a larger marginal cost than did unit #3. Nonetheless, the average total cost of producing 4 units is lower than is the ATC of producing 3 units. This is because MC (Q=4) < ATC (Q=3). This product had, on average, cost $6 to make; the new unit cost only $3 to make. Producing this unit thus causes the average cost of production to fall. The fact that MC (Q=4) > MC (Q=3) does not matter.

Only when MC exceeds ATC (which first happens when unit #6 is produced) does ATC start to rise.

Whether average total cost is rising or falling depends only on whether marginal cost is above or below ATC. Whether MC itself is rising or falling is irrelevant to the direction in which ATC moves.

Question 25 answer is:   a.   equals its marginal cost   ;   exceeds its total cost by the largest possible amount

Explanation: This question shows the importance of understanding the difference between the meanings of marginal revenue and marginal cost and 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 total revenue and total cost change as a result of a change in the number of unit. 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 (c) 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 26 answer is:   c.   exceed (or be equal to) the marginal cost of producing the 20th unit, while the MR from the 21st unit must be less than the MC of that unit

Explanation: The question tells us that when the first sells 20 units, it earns a bigger profit than it would earn if it sold 19 units, or 21 units, or any other quantity. In other words, the firm maximizes its profit by selling 20 units.

The above information tells us that when Firm XYZ increases its sales from 19 units to 20 units, its profit must rise, but when the firm increases its sales from 20 units to 21 units, its profit must fall. The first of these facts tells us that the firm's marginal revenue from selling its 20th unit must exceed its marginal cost of producing that unit (which is why selling unit #20 raises its profit). The second fact tells us that the firm's marginal revenue from selling its 21st unit must be less than its marginal cost of producing that unit (which is why selling unit #21 lowers its profit).

Note that MR > MC for unit 20, and MR < MC for unit 21 is all the information in the question tells us. We are told only that selling unit 20 increases the firm's profit, but we are not told by how much profit rises. We therefore do not know by how much MR exceeds MC. Correspondingly, knowing only that selling unit 21 decreases the firm's profit does not tell us by how much MC exceeds MR.

As was the case for the last question, you may get into trouble if you misunderstand the relationships between profit, total revenue and total cost, and marginal revenue and marginal cost. The question tells us that Firm XYZ earns a bigger profit when it sells 20 units than it would earn if it sold 19 units or 21 units. This is equivalent to saying that the difference between the firm's total revenue and its total cost when it sells 20 units is bigger than is the difference between its TR and TC when it sells 19 or 21. Knowing something about profit tells us something about the gap between TR and TC. In contrast, knowing how profit is changing tells us something about MR compares with MC.

Answer (a) states that knowing that profit is maximized at 20 units tells us that the marginal revenue of the 20th unit exceeds its marginal cost by more than MR exceeds MC for any other unit. This is incorrect. Here are the statements that are correct. First, when the firm sells 20 units, its total revenue exceeds its total cost by more than TR exceeds TC for 19 or 21 or any other number of units. Second, the marginal revenue of selling the 20th unit exceeds the marginal cost of producing it by some amount (but perhaps by a fairly small amount).

Question 27 answer is:   c.   5

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 answers to earlier questions) 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 $20. We know this because the problem tells us that Betty can sells as many units of the output as she wishes at $20 per unit, which means that every time Betty sells one more unit her total revenue rises by $20.

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 $37 to $45. Thus, the marginal cost of producing the second unit is $8.

The accompanying table gives the marginal cost of producing units 2 through 7. It also shows (as noted above) that the marginal revenue of every unit equals $20.

Quantity	Total Cost	Marginal Cost	Marginal Revenue
1	$37	--	$20
2	$45	$8	$20
3	$55	$10	$20
4	$68	$13	$20
5	$86	$18	$20
6	$111	$25	$20
7	$145	$34	$20

Given these numbers, it is clearly in Betty's interest to sell the the second unit, the third unit, the fourth units, and the fifth . Consider unit number five, for instance. Selling that unit causes Betty's revenue to rise by $20, and her cost to rise by $18. Since MR exceeds MC by $2, selling this unit raises Betty's profit. Note that selling the fifth unit doesn't increase Betty's profit by as much as did selling the fourth unit, but the fifth unit does raise her profit.

If Betty increased her sales from five units to six units, however, her revenue would rise by $20 while her cost rose by $25. Selling the sixth unit would thus decrease Betty's profit. [Note that Betty's profit would still be positive; it just wouldn't be as large as it could be.] In order to maximize her profit. therefore, Betty should thus sell five 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 28 answer is:   a.   rise

Explanation: This is a question about whether a business should "open" or "close" in order to maximize its profit. The important point in this question is that the rent cost is not relevant to Frank's decision about whether or not to open on Sunday. Frank is committed to paying the same amount for rent regardless of his open-or-close-on-Sunday decision. His rent payment is thus independent of the decision on which we are focusing, and should therefore play no role in that decision.

In other words, from the point of view of the open-or-close-on-Sunday decision, all of Fred's rent payments are fixed and sunk.

The only costs that are directly related to Frank's Sunday decision are those that depend on that decision -- wages, electricity, and cost of the things that are sold. These are costs that Frank can avoid if he chooses to open the store. In other words, these are variable costs over which Frank has control (costs that depend on his decision).

If Frank's revenue from opening on Sunday exceeds his variable cost of so doing, then opening on Sundays will increase his profit. If Frank's revenue from opening on Sunday is less than his variable cost, then so doing will lower his profit.

In this question, if Frank opens the store on Sunday, he incurs $280 in variable cost (wages plus electricity plus his costs of the products sold) and collects $300 in revenue. Frank would therefore increase his profit by opening on Sunday. The "$40 daily rent" cost is irrelevant to this decision because Frank has to pay it regardless of whether he opens the store or not.