Mr. Beck

SUNY College at Oneonta

Recent Exam Questions from Chapter 10 & 11-Solutions

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Review Questions for Economics 111


1.
Graph question 1-2

The profit-maximizing rule is to increase quantity as long as marginal revenue (MR) is greater than marginal cost (MC) and to stop increasing quantity when MR = MC. This occurs at Qb on the graph. The correct choice is b.
Return to Question 1



2.    The price the firm charges is read off the demand curve. Since Qb is the profit-maximizing quantity, we bring the line up from Qb until it hits the demand curve at a point equivalent to a price of P1. This is the profit-maximizing price, the price the firm is able to charge to sell Qb units. The correct choice is b.
Return to Question 2


3.    As stated in the answer to question 1: The profit-maximizing rule is to increase quantity as long as marginal revenue (MR) is greater than marginal cost (MC) and to stop increasing quantity when MR = MC. Since an increase in total fixed costs (TFC) does not affect either MR or MC, it will result in no change in either price or quantity, choice f.
Note that total fixed costs are independent of quantity. Whatever the amount of total fixed costs, this amount does not change as quantity changes. Therefore, the level of total fixed costs does not affect the value of marginal costs because marginal cost is the additional cost of an additional unit of quantity. As such, MC = DTVC/DQ which is equivalent to DTC/DQ.
Return to Question 3


4.    Marginal revenue (MR) represents the DTR/DQ. The marginal revenue of the 10th unit of quantity is equal to the total revenue of 10 units of quantity minus the total revenue of 9 units of quantity.
    We can determine MR by setting up a table for total revenue (TR):
Price (P)
Quantity (Q)
Total Revenue (TR) = P x Q
$10,000
10
$100,000
$11,000
9
$99,000
The marginal revenue (MR) of the 10th unit of quantity (Q) per week is $100,000 - $99,000 = $1,000.
Return to Question 4


5.
Quantity (Q)
Price (P)
Total Cost (TC)
0
$22
$5
1
$20
$27
2
$18
$43
3
$16
$54
4
$14
$62
5
$12
$77
    Total profits = Total revenue (TR) - Total cost (TC).
    Multiplying P x Q yields TR:
Quantity (Q)
Price (P)
Total Revenue (TR) = P x Q
Total Cost (TC)
0
$22
$0
$5
1
$20
$20
$27
2
$18
$36
$43
3
$16
$48
$54
4
$14
$56
$62
5
$12
$60
$77
Subtracting TR - TC across each row yields a total profit column:
Quantity (Q)
Price (P)
Total Revenue (TR) = P x Q
Total Cost (TC)
Total Profit
0
$22
$0
$5
-$5
1
$20
$20
$27
-$7
2
$18
$36
$43
-$7
3
$16
$48
$54
-$6
4
$14
$56
$62
-$6
5
$12
$60
$77
-$17
    The profit-maximizing quantity is 0. Since all the total profit values are negative, 0 units produced (shutting down) results in the smallest negative profit (loss) of  $5.
    The correct choice is a.
Return to Question 5


6.    TR = P x Q.
The total revenue of 9 units = $500 x 9 = $4,500.
MR = DTR/DQ. If the marginal revenue of the 10th unit is $100, then this represents the additional total revenue the firm receives. Adding $100 to $4,500 yields a total revenue of $4,600 for 10 units.
Since Price = TR/Q, the price the firm can sell 10 units at is $4,600/10 = $460.
Return to Question 6


7.
Quantity (Q)
Price (P)
Marginal Cost (MC)
0
$11
  
1
$10
$10
2
$9
$3
3
$8
$5
4
$7
$7
5
$6
$9
The profit-maximizing rule is to increase quantity as long as marginal revenue (MR) is greater than marginal cost (MC).
Since MR = DTR/DQ, we first calculate total revenue. This is done below by multiplying price x quantity:
Quantity (Q)
Price (P)
Total Revenue (TR) = P x Q
Marginal Cost (MC)
0
$11
$0
  
1
$10
$10
$10
2
$9
$18
$3
3
$8
$24
$5
4
$7
$28
$7
5
$6
$30
$9
We can now calculate marginal revenue (MR):
Quantity (Q)
Price (P)
Total Revenue (TR) = P x Q
Marginal Revenue (MR)=DTR
Marginal Cost (MC)
0
$11
$0
  
1
$10
$10
$10 = $0 = $10
$10
2
$9
$18
$18 - $10 = $8
$3
3
$8
$24
$24 - $18 = $6
$5
4
$7
$28
$28 - $24 = $4
$7
5
$6
$30
$30 - $28 = $2
$9
For the first 3 units of quantity, MR is greater than MC. For all units beyond the 3rd unit, MR is less than MC.
The profit-maximizing quantity is 3 units, choice d.
Return to Question 7


8.    A perfectly competitive firm produces a homogeneous, standardized product. It cannot raise its price above those of its competitors and expect to sell any units of quantity. Its demand curve is horizontal.
A monopolistically competitive firm produces a slightly differentiated product from that produced by its competitors. If it raises its price above the price charged by its competitors, it will still be able to sell some (although a reduced) quantity because some of its customers will be willing to pay a premium for its products. Thus, it has a negatively sloped demand curve.
    The correct choice is d, a perfectly competitive firm has a horizontal demand curve while a monopolistically competitive firm has a negatively sloped demand curve.
Return to Question 8


9.    A profit-maximizing firm produces the quantity at which MR = MC (as shown on the graph in question 1).
Since the monopolist has a negatively sloped demand curve, price is greater than MR for all units of quantity greater than 1. Therefore, if price were to equal MC, then MR would have to be less than MC. It never makes sense to produce units of quantity whose additional (marginal) revenue are less than their additional (marginal) cost. Thus, a profit-maximizing monopolist will never produce at a quantity at which price = marginal cost (MC). The correct choice is b.
Note that a monopolist will produce even if its price is less than average cost (AC), choice e, as long as its price is greater than its average variable cost.
Return to Question 9


10.    If new firms enter the industry, the existing industry sales must be spread among more competing firms. Each existing firm will find a decrease in demand for its product. Now, if the firm wanted to sell the same quantity as before the increased competition, it would have to decrease its price. This is shown by a shift down and to the left in the firm's demand curve, choice a.
Return to Question 10


11.    TR = P x Q. The total revenue of 6 units is $100 x 6 = $600.
MR = DTR/DQ. Since the marginal revenue of the 7th unit is $30, this represents the additional revenue received by producing the 7th unit. Therefore, the total revenue of 7 units is $600 + $30 = $630.
P = TR/Q. The price it can sell each of the 7 units is $630/7 = $90 per unit.
Return to Question 11


12.    To enable it to raise price above the level a perfectly competitive industry would set, a monopolist has to move up and to the left along its demand curve. At a higher price, quantity demanded will decrease. Therefore, the monopolist can only set a higher price if it is willing to sell a smaller quantity than would the competitive industry.
    The correct choice is c.
Return to Question 12


13.    Monopolistic competition is similar to perfect competition in that both industry structures are typified by the existence of a large number of firms and no entry barriers, choice b. The major difference is that firms in perfect competition produce a homogeneous, standardized product whereas firms in monopolistic competition produce a slightly differentiated product.
Return to Question 13


14.    There are no barriers to entry in a monopolistically competitive industry. The typical small size of existing firms makes it easy for new firms to raise sufficient capital to enter and compete. Therefore, although monopolistically competitive firms may earn either pure profits, normal profits, or losses in the short run, the freedom of entry ensures that in the long run only normal profits can be expected to be earned. Any pure (positive) profits will be competed away in the long run by new firms entering the industry.
    The correct choice is b.
Return to Question 14


15.    As indicated in the answer to question 14 above, in the long run, monopolistically competitive firms will only be able to earn a normal profit. A normal (0) profit exists when total revenue = total cost or, equivalently, price = average cost (AC).
    However, the monopolistically competitive firm faces a negatively sloped demand curve in which price is greater than marginal revenue (MR). Since firms produce at the profit-maximizing quantity at which marginal revenue (MR) equals marginal cost (MC), this ensures that price will be greater than MC for the monopolistically competitive firm. (If P > MR and MR = MC, then P will be greater than MC.)
    The correct choice is b, price will be greater than marginal cost (MC), but equal to average cost (AC).
Return to Question 15


16.
Graph question 16
    The profit-maximizing rule is to increase quantity as long as marginal revenue (MR) is greater than marginal cost (MC) and to stop increasing quantity when MR = MC. This occurs at a quantity of 160 on the graph. The correct choice is b.
Return to Question 16


17.    The price the firm charges is read off the demand curve. Since 160 is the profit-maximizing quantity, we bring the line up from 160 until it hits the demand curve at a point equivalent to a price of $14. This is the profit-maximizing price, the price the firm is able to charge to sell 160 units. The correct choice is c.
Return to Question 17


18.     The firm's total profits = (P-AC) x Q in which (P-AC) represents the firm's per unit profits.
Since AC = $12 at a quantity of 160 units, Total profits = ($14 - $12) x 160 = $2 x 160 = $320. A positive profit is also referred to as a pure (above-normal) profit.
    The correct choice is a.
Return to Question 18


19.    The more close substitutes available the more elastic demand will be (the greater will be the absolute value of price elasticity of demand).
    A perfectly competitive firm faces many perfect substitutes for its product because it produces a homogeneous, standardized product. Therefore, if it attempted to raise its price above the market set equilibrium price, its quantity demanded would be reduced to 0.
    A monopoly is the other extreme. There are no close substitutes available for the firm's product.
    Monopolistic competition falls somewhere in the middle of these 2 extremes. There are many close, but not perfect, substitutes available for each firm's product. Each firm's product is slightly differentiated from that produced by its competitors. If one firm were to raise its price, it would expect to lose some, but not all, of its customers. Its quantity demanded would decrease, but unlike perfect competition, it would not be reduced to 0.
    Therefore, the demand curve of a monopolistically competitive firm is more elastic than that of a monopolist, but less elastic than that of a perfectly competitive firm, choice b.
Return to Question 19


20.    Long-run equilibrium occurs after the entry of new firms or the exit of existing firms adjusts profits to a normal level. This occurs because there are no barriers to entry or exit in a monopolistically competitive industry. A normal profit refers to a 0 economic profit in which price = average cost (AC). Total profits = (P-AC) x Q. If P = AC, then (P-AC) = 0 and total profits = 0.
    The profit-maximizing rule is to increase quantity as long as marginal revenue (MR) is greater than marginal cost (MC) and to stop increasing quantity when MR = MC.
    The correct choice is c, marginal revenue (MR) = marginal cost (MC) and price (P) = average cost (AC).
Return to Question 20


21.
Graph question 21 solution
 

    The profit-maximizing rule is to increase quantity as long as marginal revenue (MR) is greater than marginal cost (MC) and to stop increasing quantity when MR = MC. The graph above repeats the graph from question 1 illustrating a firm with a negatively sloped demand curve. The profit-maximizing quantity was Qb. Now with the new, higher MC curve, all units of quantity from Qa to Qb will not be produced because from Qa to Qb marginal revenue is now less than marginal cost. The firm will maximize its profits (or minimize its loss) by producing Qa.
    The price the firm charges is read off the demand curve. Since Qa is the profit-maximizing quantity, we bring the line up from Qa until it hits the demand curve at a point equivalent to a price of P0. This is the profit-maximizing price, the price the firm is able to charge to sell Qa units. P0 is higher than the price of P1 which the firm charged when it sold a quantity of Qb units.
    The increase in MC results in an increase in price and a decrease in quantity. By producing fewer units, the firm is able to charge a higher price. Quantity decreases from Qb to Qa and price increases from P1 to P0.
    The correct choice is c.
Note: The increase in marginal cost will also cause the entire average cost (AC) to shift up since the firm's labor costs have increased. The new, higher MC curve must intersect the new, higher AC curve at minimum AC.
Return to Question 21



22.    The monopolist faces a negatively sloped demand curve in which price is greater than marginal revenue (MR). Since firms produce at the profit-maximizing quantity at which marginal revenue (MR) equals marginal cost (MC), this ensures that price will be greater than MC for the profit-maximizing monopolist . (If P > MR and MR = MC, then P will be greater than MC.)
    The correct choice is b.
Return to Question 22


23.    If losses are incurring in a monopolistically competitive industry, some firms will exit the industry. The presence of fewer firms in the industry will reduce competition and increase the demand for each remaining firm's product. The shift up in the demand curve will be accompanied by a shift up in the firm's marginal revenue (MR) curve. Since marginal revenue has increased, the firm's profit maximizing quantity, at the intersection of MR and MC, will occur at a higher level of quantity.
    Although the exit of competitors will increase remaining firms' demand, it will have no effect on the marginal cost (MC) curve of these remaining firms. The exception is choice c, the firm's entire marginal cost (MC) curve will shift up. There is no reason to expect this to occur.
Return to Question 23


24.    Recognized mutual interdependence exists when each firm knows that the action of each firm in the industry will affect its competitors. This occurs when there are a small number of relatively large firms in the industry, a defined characteristic of an oligopoly, choice c.
Return to Question 24


25.    The prefix oligo means few. Thus, a small number of relatively large firms is a characteristic of an oligopoly. Because of the large size typical of firms in an oligopoly, such as steel and autos, it takes a large amount of capital to enter the industry and compete. The substantial capital requirements and attendant risks involved operate as substantial entry barriers preventing firms from easily entering into an oligopoly and competing.
    The correct answer is a. Oligopolies are characterized by a relatively small number of firms and substantial entry barriers.
Return to Question 25


26.    As stated in the answer to question 1: The profit-maximizing rule is to increase quantity as long as marginal revenue (MR) is greater than marginal cost (MC) and to stop increasing quantity when MR = MC. Since an increase in total fixed costs (TFC) does not affect either MR or MC, it will result in no change in either price or quantity.
    The firm's total revenue is price x quantity. TR = $200 x 10 = $2,000. Its total profits = TR - TC = $2,000 - $1.900 = $100. In this case, the $100 increase in total fixed costs will reduce the monopolist's profits by $100 from $100 to $0 because its total costs will increase from $1,900 to $2,000.
    As a result of the increase in total fixed costs, the monopolist will keep its price constant at $200, choice d. Any attempt to increase its price will just lower its total profits further as it will move the monopolist away from its profit-maximizing point.
Return to Question 26


27.    The smaller the number of firms in an industry, the easier it is to obtain agreement among all the firms. In addition, it is easiest to agree on a common pricing policy if the product produced by the small number of firms is a homogeneous, standardized product. If firms produced differentiated products than it would be more difficult to obtain agreement on the correct premium or discount some of the firms' higher (or lower) quality products would warrant.
    The correct choice is a, price collusion is easiest to achieve when there are very few firms in the industry all producing a homogeneous product.
Return to Question 27


28.    If the oligopolist's rivals ignore (do not match) a price increase, then the oligopolist increasing its price will lose much of its sales to the lower priced competitors' products.
    On the other hand, if the oligopolist's competitors match a price decrease, the oligopolist will be unable to attract sales away from its competitors. As a result of its price decrease, its quantity demanded will not increase by nearly as much as if its competitors kept their prices constant and allowed it to undercut their prices.
    The result is a kinked, or cornered, demand curve. By raising its price the oligopolist faces a relatively flat demand curve (the quantity demand falls greatly); by lowering its price, the oligopolist faces a relatively steep demand curve. Its quantity demanded does not increase by as much as it would if its competitors did not match its price decrease.
    The correct answer is b. The oligopolist's demand curve is kinked, being steeper below the existing price than above it.
Return to Question 28


29.    As indicated in the solution to question 28 above, the oligopolist faces a kinked (cornered) demand curve, which is steeper below the existing price than above it, only under a specific set of 2 assumptions. The first is that competitors will match a price cut (to protect their market share). The second is that competitors will not match a price increase because they will only be too glad to increase their sales at the expense of the oligopolist which raises its price.
    The correct answer is d. The kinked demand curve of an oligopolist is based on the assumption that competitors will match a price cut but will not match a price increase.
Return to Question 29

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