Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
William M. Boal
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QUIZ #8
“Economic Efficiency and Perfect Competition”
August 10, 2010
INSTRUCTIONS: This quiz is closed-book, closed-notes. Simple calculators are permitted, but graphing calculators or
calculators with alphabetical keyboards are NOT permitted. Numerical answers, if rounded, must be correct to at least 3
significant digits. Point values for each question are noted in brackets. Maximum total points are 100.
I. Multiple choice: Circle the one best answer to each question. [2 pts each: 18 pts total]
(1) Suppose there is a change in government policy
affecting the automobile industry. Which of the
following outcomes would be a Pareto improvement?
a. Producers gain $10 billion while consumers lose $20
billion.
b. Producers gain $20 billion while consumers lose $10
billion.
c. Producers gain $10 billion while consumers gain
$20 billion.
d. Both (b) and (c).
e. All of the above.
(2) Suppose there is a change in government policy
affecting the automobile industry. Which of the
following outcomes would pass the compensation test of
Kaldor and Hicks?
a. Producers gain $10 billion while consumers lose $20
billion.
b. Producers gain $20 billion while consumers lose $10
billion.
c. Producers gain $10 billion while consumers gain
$20 billion.
d. Both (b) and (c).
e. All of the above.
(3) Suppose that the bread industry is producing 3
million loaves of bread per month, for some reason, and
that at this level of output, the marginal benefit to
consumers of a loaf of bread is $3, but the marginal cost
of producing a loaf of bread is only $2. Society would
be better off if
a. fewer loaves of bread were produced.
b. more loaves of bread were produced.
c. Because marginal benefit exceeds marginal cost,
production is already optimal and society cannot be
made better off by increasing or decreasing
production.
d. Cannot be determined from information given.
(4) New firms enter an industry because they hope to
a. drive down the market price.
b. drive down the profits of existing firms.
c. enjoy economic profit.
d. increase consumer surplus.
(5) If any firms enter the mobile-phone industry, the
a. short-run supply curve of mobile phones will shift
right.
b. short-run supply curve of mobile phones will shift
left.
c. short-run demand curve for mobile phones will shift
right.
d. short-run demand curve for mobile phones will shift
left.
(6) The following graph shows the short-run and longrun supply curves for a typical industry. Which curve is
which?
a. Curve A is the short-run supply curve and curve B is
the long-run supply curve.
b. Curve A is the long-run supply curve and curve B is
the short-run supply curve.
c. Neither curve can be a supply curve because both
curves slope upward.
d. Cannot be determined from the information given.
Price
A
B
Quantity
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
(7) If an industry depends on a particular mineral in
scarce supply, then the long-run supply curve for the
industry
a. is shaped like a U.
b. is shaped like an inverted U.
c. is horizontal.
d. slopes down.
e. slopes up.
(8) Price equals average cost in a competitive industry in
long-run equilibrium because
a. business owners have a sense of fairness.
b. individual firms adjust their output levels using the
rule "price equals average cost" to maximize profit.
c. consumers refuse to pay more than what is
reasonable.
d. positive profits encourage entry of new firms while
negative profits encourage existing firms to leave
the industry.
e. the threat of government regulation causes firms to
hold prices down.
Quiz 8
Page 2 of 7
(9) Price equals marginal cost in a competitive industry
in both short-run and long-run equilibrium because
a. business owners have a sense of fairness.
b. individual firms adjust their output levels using the
rule "price equals marginal cost" to maximize profit.
c. consumers refuse to pay more than what is
reasonable.
d. positive profits encourage entry of new firms while
negative profits encourage existing firms to leave
the industry.
e. the threat of government regulation causes firms to
hold prices down.
II. Problems: Insert your answer to each question below in the box provided. Use the margins and graphs for scratch
work. Only the answers in the boxes will be graded. Work carefullypartial credit is not normally given for questions in
this section.
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 8
Page 3 of 7
Price per gallon
(1) [Welfare effects of price controls: 24 pts] The graph below shows the market for milk.
$13
$12
$11
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
$0
Demand
Supply
0
1
2
3 4 5 6 7 8 9 10 11 12
Quantity (millions of gallons)
Consider the market without government regulation.
a. Find the equilibrium quantity.
million
b. Find the equilibrium price.
$
c. Compute total consumer surplus.
$
million
d. Compute total producer surplus.
$
million
Then suppose a price ceiling (or legal maximum price) of $3 is imposed on the market for milk. No milk may be sold for
more than the price ceiling.
e. Compute the quantity traded with the price ceiling.
million
f. Does the price ceiling create excess demand, excess supply, or neither?
g. How much?
million
h. Does producer surplus increase or decrease because of the price ceiling, as
compared to the market without government intervention?
i. By how much?
$
million
j. Does consumer surplus increase or decrease because of the price ceiling, as
compared to the market without government intervention? (Assume
optimistically that milk is actually purchased by those buyers who value
milk the most.)
k. By how much?
$
million
l. Compute the deadweight social loss caused by the price ceiling.
$
million
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 8
Page 4 of 7
Price
(2) [Welfare effects of tax: 14 pts] The graph below shows the market for baseball caps.
$15
$14
$13
$12
$11
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
$0
Demand
Supply
0 1 2 3
4 5 6 7 8 9 10 11 12 13 14 15
Quantity (millions)
Suppose that the government imposes a tax of $3 per baseball cap on this market.
a. Compute the quantity traded with the tax.
million
b. Does producer surplus increase or decrease because of the tax, as compared
to the market without a tax?
c. By how much?
$
million
d. Does consumer surplus increase or decrease because of the tax, as
compared to the market without a tax?
e. By how much?
$
million
f. Compute the tax revenue collected by the government.
$
million
g. Compute the deadweight social loss caused by the tax.
$
million
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 8
Page 5 of 7
(3) [Welfare effects of international trade: 16 pts] Domestic supply and demand for disk drives are given by the following
diagram.
$100
$90
$80
Price
$70
$60
Demand
$50
Supply
$40
$30
$20
$10
$0
0
1
2
3
4
5
6
7
8
9
10
Quantity (millions)
Suppose this industry is opened to international trade and the world price of disk drives turns out to be $30.
a. Will this country now export or import disk drives?
b. How many?
million
c. Does consumer surplus in this country increase or decrease from
international trade in disk drives?
d. By how much?
$
million
e. Does producer surplus in this country increase or decrease from
international trade in disk drives?
f. By how much?
$
million
g. Does net social welfare in this country increase or decrease from
international trade in disk drives?
h. By how much?
$
million
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 8
Page 6 of 7
Price
(4) [Long-run competitive equilibrium: 24 pts] The graph below shows the market for bright orange socks, which is
competitive. Assume all producers and potential producers have the same costs as each other.
$15
$14
$13
$12
$11
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
$0
Old demand
New demand
Short-run supply
Long-run supply
0
1
2
3
4
5
6
7
8
9
10 11 12 13 14 15 16 17 18
Quantity (thousands of pairs)
Initially the market is in long-run equilibrium, with the demand curve given by “old demand” and the short-run supply
curve given by “short-run supply” as shown in the graph.
a. What is the initial equilibrium price?
$
per pair
b. What is the initial equilibrium quantity?
c. What is the average cost of production for firms in this industry?
thousands of pairs
$
Suddenly, bright orange socks become popular, and the demand shifts right to “new demand.” Consider the short-run
market response to this demand shift.
d. What is the new equilibrium price in the short run?
$
per pair
e. What is the new equilibrium quantity in the short run?
thousands of pairs
f. Are producers making economic profits, losses, or just breaking
even?
Now, consider the long-run market response to this demand shift.
g. Given your answer to (f) above, will existing firms try to exit the
industry or will new firms try to enter the industry?
h. What is the new equilibrium price in the long run?
$
i. What is the new equilibrium quantity in the long run?
j. What is the new long-run average cost of production for firms in
this industry?
k. Has the number of firms in this industry increased, decreased, or
remained constant?
l. Should this industry be called a constant-cost industry, an
increasing-cost industry, or a decreasing-cost industry?
$
per pair
thousands of pairs
per pair
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 8
Page 7 of 7
III. Critical thinking: Write a one-paragraph essay answering one question below (your choice). [4 pts]
(1) Consider the following statement: "When two countries begin international trade in some good, the price falls in one
country and rises in the other. So both countries cannot benefit from trade. Social welfare must decrease in one of the
countries." Do you agree or disagree? Justify your answer with supply-and-demand diagrams for both countries, using
the concepts of consumer and producer surplus.
(2) Why do producers want the government to impose quotas on them? Justify your answer with a single supply-anddemand diagram, using the concepts of consumer and producer surplus.
Please circle the question you are answering. Write your answer below. Full credit requires correct economic reasoning,
legible writing, good grammar including complete sentences, and accurate spelling.
[end of quiz]