Practice Questions, Answer Key
10 T/F questions.
1.
In the long run, a firm with a U-shaped average cost curve has increasing returns to scale
when quantity is very large.
True
False
2. The more elastic the demand curve, the larger is the Lerner Index
True
False
3. When wages increase, the short-run expansion path rotates to the left.
True
False
4. At any optimal consumption bundle, the marginal utility per dollar spent is the same for
each good.
True
False
5. A person’s willingness to pay for a mug can be lower than his willingness to accept for
the same mug.
True
False
6. A person with diminishing marginal utility is risk averse.
True
False
7. The monopolistic competitive firm has market power both in the short and long run.
True
False
8. Average revenue = demand is true for all firms.
True
False
9. When the supply curve is perfectly elastic, consumers’ tax incidence is 100%.
True
False
10. A consumer that is indifferent between consuming 2 goods can still be rational.
True
False
RT III – 3 Long-Answer Questions
1. Blue Mountains Coffee is a monopoly operating in Jamaica with a marginal cost curve of 2Q.
They face a demand curve that is P = 120 – Q.
a. Plot supply and demand. Find the monopoly’s output and respective price and mark it on
your graph.
Competitive equilibrium:
120-Q = 2Q -> Q = 40, p = 80
Monopoly equilibrium:
120-2Q = 2Q -> Q = 30, p = 90
b. Now let there be unlimited supply of coffee in the global market at price pw, where MR
and MC intersect.
Find the value of Pw and the quantity demanded if there is free trade. Mark the free trade
equilibrium on your graph.
MC at Q = 30 is 60. So Pw = 60.
The FT equilibrium:
120 – Q = 60 -> Q = 60
c. With a table and on your graph show what is the DWL if trade is not allowed (compare
the monopoly and free trade equilibriums). You can assume that the monopoly supplies
some quantity at the free trade equilibrium.
2. The marginal cost of producing a ton of paper is constant at $5. Each ton produced yields
$2 in pollution costs. Assume that market demand is downward sloping .
a. Draw this scenario and mark on your graph the competitive and socially optimal
prices and quantities.
b. Mark on your graph DWL from producing at the competitive equilibrium.
c. Mark on your graph government revenues if it imposes a $2 tax on a ton of paper
produced. Who is going to bear the incidence of tax in this case? Consumers bear
all incidence since supply is completely elastic.
3. Let there be a market with identical firms, free entry and exit and constant costs.
(a) Show the firm’s quantity, price and profit. In another graph show market supply and
demand. Indicate what is consumer surplus and producer surplus.
There is no profit or producer surplus in the long run in a competitive market.
(b) Let the government limit the number of firms in the market. Show the new market
supply curve in your graph what are CS, PS and deadweight loss.
CS before limit: A+B+C
CS after limit: A
DWL:C
PS:0
PS: B
(c) What is the effect of the government policy on the individual firm’s supply curve,
quantity produced and profits?