Econ 2113 Test #4 Honor Pledge: I have neither given nor received aid on this exam

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1 Econ 2113 Test #4 Dr. Rupp Fall 2004 Name Honor Pledge: I have neither given nor received aid on this exam Signature:_ Multiple Choice (40 questions) Identify the best answer. Turn cell phones off (if your phone rings during the test you will be ineligible to answer the extra credit question). 1. Angelo is a wholesale meatball distributor. He sells his meatballs to all the finest Italian restaurants in town. Nobody can make meatballs like Angelo. As a result, his is the only business in town that sells meatballs to restaurants. Assuming that Angelo is maximizing his profit, which of the following statements is true? a. Meatball prices will be less than marginal cost. b. Meatball prices will equal marginal cost. c. Meatball prices will exceed marginal cost. 2. Which of the following statements is (are) true of a monopoly? (i) A monopoly has the ability to set the price of its product at whatever level it desires. (ii) A monopoly's total revenue will always increase when it increases the price of its product. (iii) A monopoly can earn unlimited profits. a. (i) only b. (ii) only c. (i) and (ii) d. (ii) and (iii) e. None of the above are correct. 3. Which of the following is an example of a barrier to entry? (i) A key resource is owned by a single firm. (ii) The costs of production make a single producer more efficient than a large number of producers. (iii) The government has given the existing monopoly the exclusive right to produce the good. a. (i) and (ii) b. (ii) and (iii) c. (i) only d. All of the above are correct. e. None of the above are correct. 4. To define a monopoly, we cite the following characteristics: (i) The firm is the sole seller of its product. (ii) The firm's product does not have close substitutes. (iii) The firm generates a large economic profit. (iv) The firm is located in a small geographic market. a. (i) and (ii) b. (i) and (iii) c. (ii) and (iv) d. All of the above are correct. e. None of the above are correct.

2 5. Because monopoly firms do not have to compete with other firms, the outcome in a market with a monopoly is often a. not in the best interest of society. b. one that fails to maximize total economic well-being. c. inefficient. d. All of the above are correct. 6. When a natural monopoly exists, it is a. always cost effective for government-owned firms to produce the product. b. never cost effective for one firm to produce the product. c. always cost effective for two or more private firms to produce the product. d. never cost effective for two or more private firms to produce the product. 7. Encouraging firms to invest in research and development and individuals to engage in creative endeavors such as writing novels is one justification for a. resource monopolies. b. natural monopolies. c. government-created monopolies. d. breaking up monopolies into smaller firms. Use Scenario 15-1 to answer questions #8 & #9: Consider the market for water in a small town in the Old West. Assume that the only source of water is the underground aquifer that lies directly below the town. Wells are used to supply water to the entire town. 8. If dozens of residents have their own wells, which statement best describes the behavior of sellers of water? a. Since water is a necessity of life, there will be no decline in the quantity of water consumed, regardless of how high the price is raised. b. Sellers will be able to charge a premium for the water. c. The price of a gallon of water will exceed its marginal cost. d. The price of a gallon of water will be driven to equal its marginal cost. 9. Refer to Scenario Assume that Jack is the sole owner of all the wells in town. He decides to move to a more suitable climate and sells the wells to a couple of dozen different town residents. a. The town residents will likely be better off. b. The price of water is likely to fall. c. The individual water sellers will not have as much pricing power as Jack had. d. All of the above are correct. Figure 15-1 (Use this figure to answer question #10)

3 10. The shape of the average total cost curve (on previous page) reveals information about the nature of the barrier to entry that might exist in a monopoly market.which monopoly type best coincides with Figure 15-1? a. ownership of a key resource by a single firm b. natural monopoly c. government-created monopoly d. None of the above are correct. 11. The De Beers diamond monopoly is a classic example of a monopoly that a. is government-created. b. arises from the ownership of a key resource. c. results in very little advertising of the product that the monopolist produces. d. was broken up by the government a long time ago. 12. A profit-maximizing monopolist will produce the level of output at which a. average revenue is equal to average total cost. b. average revenue is equal to marginal cost. c. marginal revenue is equal to marginal cost. d. total revenue is equal to opportunity cost. 13. When a monopolist decreases the price of its good, consumers a. continue to buy the same amount. b. buy more. c. buy less. d. may buy more or less, depending on the price elasticity of demand. 14. When a monopolist increases the amount of output that it produces and sells, the price of its output a. stays the same. b. increases. c. decreases. d. may increase or decrease depending on the price elasticity of demand. Fill in the blanks in the table below.you ll use this table to answer questions #15-#18. Quantity Price Total Revenue Average Revenue Marginal Revenue If the monopolist sells 8 units of its product, how much total revenue will it receive from the sale? a. 40 b. 112 c. 128 d. 164 e. It cannot be determined from the information provided.

4 16. When 4 units of output are produced and sold, what is average revenue? a. 17 b. 21 c. 23 d. 26 e What is the marginal revenue for the monopolist for the sixth unit sold? a. 3 b. 5 c. 11 d. 17 e Assume this monopolist's marginal cost is constant at $11. What quantity of output (Q) will it produce and what price (P) will it charge? a. Q = 4, P = $27 b. Q = 4, P = $25 c. Q = 5, P = $23 d. Q = 7, P = $17 e. Q = 6, P = $20 Figure 15-5 (Use this to answer questions #19-#21) _ 19. What is the profit-maximizing price for this monopolist? a. Price = a b. Price = c c. Price = f d. None of the above, since this monopolist should be closed. _ 20. Which of the following areas in the Figure above represents the deadweight loss due to monopoly pricing? a. triangle bde b. triangle bge c. rectangle acdb d. rectangle cfgd e. None of the above since there is no deadweight loss for this monopolist.

5 21. Which of the following areas in the Figure on previous page represents producer surplus for the monopolist? a. triangle bde b. triangle bge c. rectangle acdb d. rectangle cfgd e. rectangle afgb 22. The practice of selling the identical good to different customers at different prices is known as a. price segregation. b. price discrimination. c. arbitrage. d. monopoly pricing. 23. Many movie theaters give senior citizens reduced ticket prices because a. senior-citizen laws mandate such discounts. b. efforts of goodwill show community respect and win loyal patrons. c. theaters are profit maximizers. d. senior citizens usually comprise a solid portion of those who voice their opinions. 24. Markets with only a few sellers, each offering a similar product are typically referred to as a. competitive markets. b. monopoly markets. c. monopolistically competitive markets. d. oligopoly markets. 25. Monopolistically competitive firms are typically characterized by a. many firms selling products that are similar, but not identical. b. many firms selling identical products. c. a few firms selling products that are similar, but not identical. d. a few firms selling highly different products. Imagine a small town in which only two residents, Tony and Jill, own wells that produce water for safe drinking. Each Saturday, Tony and Jill work together to decide how many gallons of water to pump, bring the water to town, and sell it at whatever price the market will bear. To keep things simple, suppose that Tony and Jill can pump as much water as they want without cost; therefore, the marginal cost of water equals zero. The weekly town demand schedule and total revenue schedule for water is reflected in the table below. Table 16-2 (Use this table to answer the next three questions) Weekly Quantity (in gallons) Price Weekly Total Revenue (and Total Profit) 0 $12 $

6 26. Refer to Table If the market for water was perfectly competitive, how many gallons of water would be produced and sold? a. 70 b. 90 c. 110 d Refer to Table If Tony and Jill operate as a profit-maximizing monopoly, how much total weekly revenue will their monopoly earn? a. $200 b. $270 c. $350 d. $ Refer to Table Suppose the town enacts new antitrust laws that prohibit Tony and Jill from operating as a monopolist. What will the new price of water end up being once the Nash equilibrium is reached? a. $3 b. $4 c. $5 d. $6 29. Once a cartel is formed, the market is in effect served by a. a monopoly. b. an oligopoly. c. imperfect competition. d. monopolistic competition. 30. A situation in which economic actors interacting with one another each choose their best strategy given the strategies the others have chosen is called a. a competitive equilibrium. b. an open market solution. c. a socially optimal solution. d. a Nash equilibrium. Each year the United States considers renewal of Most Favored Nation (MFN) trading status with China. Historically, legislators have made threats of not renewing MFN status because of human rights abuses in China. The non renewal of MFN trading status is likely to involve some retaliatory measures by China. The Game below reflects the potential economic gains associated with a two-outcome game in which China may impose trade sanctions against U.S. firms and the United States may not renew MFN status with China. The following table contains the dollar value of all trade flow benefits to the United States and China under two trade-relationship scenarios. Table 16-4 (Use this table to answer the next two questions) China Impose trade sanctions against U.S. firms United States Don't renew MFN status with China Renew MFN status with China U.S. trade value = $65 b China trade value = $75 b U.S. trade value = $35 b China trade value = $285 b Do not impose trade sanctions against U.S. firms U.S. trade value = $140 b China trade value = $5 b U.S. trade value = $130 b China trade value = $275 b

7 31. Refer to Table When this game reaches a Nash equilibrium, the value of trade flow benefits will be a. United States $35 b and China $285 b. b. United States $65 b and China $75 b. c. United States $140 b and China $5 b. d. United States $130 b and China $275 b. 32. Refer to Table If trade negotiators are able to communicate effectively about the consequences of various trade policies (i.e., enter into an agreement about the policy they should adopt), then we would expect the game outcome to be a. United States $35 b and China $285 b. b. United States $65 b and China $75 b. c. United States $140 b and China $5 b. d. United States $130 b and China $275 b. Scenario 16-4 (use this information to answer the next three questions) Consider two cigarette companies, PM Inc. and Brown Inc. If neither company advertises, the two companies split the market. If they both advertise, they again split the market, but profits are lower, since each company must bear the cost of advertising. Yet if one company advertises while the other does not, the one that advertises attracts customers from the other. 33. Refer to Scenario What will these two companies do if they behave as individual profit maximizers? a. Neither company will advertise. b. Both companies will advertise. c. One company will advertise, the other will not. d. None of the above are correct; there is no way of knowing without more information. 34. Refer to Scenario What is PM Inc.'s dominant strategy? a. to refrain from advertising, regardless of whether Brown Inc. advertises b. to advertise only if Brown Inc. advertises c. to advertise only if Brown Inc. does not advertise d. to advertise, regardless of whether Brown Inc. advertises 35. Refer to Scenario In 1971, Congress passed a law that banned cigarette advertising on television. If cigarette companies are profit maximizers, it is likely that a. neither company opposed the ban on advertising. b. Brown Inc. sued the federal government on grounds that the ban constitutes a civil rights violation. c. both companies sued the federal government on grounds that the ban constitutes a civil rights violation. d. both companies retaliated with black-market operations. 36. Perfect price discrimination describes a situation in which the monopolist a. knows the exact willingness to pay of each of its customers. b. charges exactly two different prices to exactly two different groups of customers. c. maximizes consumer surplus. d. experiences a zero economic profit. 37. In theory, perfect price discrimination a. decreases the monopolist's profits. b. decreases consumer surplus. c. increases deadweight loss. d. All of the above are correct.

8 _ 38. Deadweight loss is: a. The reduction in consumer surplus due to monopolist pricing. b. The reduction in producer surplus due to the monopolist producing an inefficient level of output. c. The reduction in profits due to monopolist pricing. d. The loss of trade due to excise taxes. e. The reduction in total surplus due to the monopolist producing an inefficient level of output. Use the following table to answer the next question: Nike High Price Nike Low Price Rebok High Price 60, 75 50, 95 Rebok Low Price 80, 40 45, 55 _39. What is the Nash Equilibrium for this game? a. Rebok High Price & Nike High Price. b. Rebok High Price & Nike Low Price. c. Rebok Low Price & Nike Low Price. d. Rebok Low Price & Nike High Price. e. No Nash Equilibrium exists. _40. Who is President George W. Bush s current chief Economic Advisor? a. Alan Greenspan b. Robert Rubin c. Larry Samuelson d. N. Gregory Mankiw e. John W. Snow Extra Credit (These all come from student presentations of Wall Street Journal articles) _41. The college board explains that which of the following is responsible for the recent rise in public tuition: a. Faculty salary increases b. New construction and renovations c. Drops in fund-raising and endowment returns d. Increasing cost of heating-oil e. Children of baby boomers are now attending college _42. Four recent hurricanes in Florida have caused the State of Florida to pass new laws that: a. Prohibit ocean-front houses from being rebuilt b. Allow illegal immigrants to be hired by construction companies c. Require mandatory evacuations for Category 4 or higher hurricanes d. Implement stricter building codes e. Require every resident purchase hurricane and flood insurance. 43. The following is an actual interview question that appeared in the Wall Street Journal. How many hair stylists are there in the United States? (Explain your reasoning and how your answer was calculated).

9 Exam Answer Section MULTIPLE CHOICE 1. ANS: C Meatball prices will exceed marginal cost. 2. ANS: A (i) only 3. ANS: D All of the above are correct. DIF: 1 REF: SECTION: 15.1 OBJ: TYPE: M 4. ANS: A (i) and (ii) 5. ANS: D All of the above are correct. 6. ANS: D never cost effective for two or more private firms to produce the product. 7. ANS: C government-created monopolies. DIF: 1 REF: SECTION: 15.1 OBJ: TYPE: M 8. ANS: D The price of a gallon of water will be driven to equal its marginal cost. 9. ANS: D All of the above are correct. 10. ANS: B natural monopoly 11. ANS: B arises from the ownership of a key resource.

10 12. ANS: C marginal revenue is equal to marginal cost. 13. ANS: B buy more. DIF: 1 REF: SECTION: 15.2 OBJ: TYPE: M 14. ANS: C decreases. 15. ANS: B ANS: D ANS: B ANS: C Q = 5, P = $ ANS: A Price = a DIF: 2 REF: SECTION: 15.3 OBJ: TYPE: M 20. ANS: B Triangle bge DIF: 2 REF: SECTION: 15.5 OBJ: TYPE: M 21. ANS: E (is the best answer, but this question was tossed out since producer surplus is the area above MC and below price. Hence the correct PS area is all the stuff below the dotted line ab and above MC). DIF: 2 REF: SECTION: 15.5 OBJ: TYPE: M 22. ANS: B Price discrimination DIF: 2 REF: SECTION: 15.5 OBJ: TYPE: M 23. ANS: C the theaters are profit maximizers. DIF: 2 REF: SECTION: 15.5 OBJ: TYPE: M 24. ANS: D oligopoly markets.

11 DIF: 1 REF: SECTION: 16.1 OBJ: TYPE: M 25. ANS: A many firms selling products that are similar, but not identical. DIF: 1 REF: SECTION: 16.1 OBJ: TYPE: M 26. ANS: D 120 DIF: 2 REF: SECTION: 16.2 OBJ: TYPE: M 27. ANS: D $360 DIF: 2 REF: SECTION: 16.2 OBJ: TYPE: M 28. ANS: B $4 DIF: 3 REF: SECTION: 16.2 OBJ: TYPE: M 29. ANS: A a monopoly. DIF: 2 REF: SECTION: 16.2 OBJ: TYPE: M 30. ANS: D a Nash equilibrium. DIF: 1 REF: SECTION: 16.2 OBJ: TYPE: M 31. ANS: B United States $65 b and China $75 b. DIF: 2 REF: SECTION: 16.3 OBJ: TYPE: M 32. ANS: D United States $130 b and China $275 b. DIF: 2 REF: SECTION: 16.3 OBJ: TYPE: M 33. ANS: B Both companies will advertise. DIF: 2 REF: SECTION: 16.3 OBJ: TYPE: M 34. ANS: D to advertise, regardless of whether Brown Inc. advertises DIF: 2 REF: SECTION: 16.3 OBJ: TYPE: M 35. ANS: A neither company opposed the ban on advertising. DIF: 2 REF: SECTION: 16.3 OBJ: TYPE: M 36. A 39. B 42. D 37. B 40. D 38. E 41. C