Microeconomics Part L

Chapter 1 ➜ theory of consumers behavior and demand
Outcome ➜ understand the neoclassical theory of consumer behavior, how

each consumer makes decision to maximize her/his utility
1. The neoclassical theory of consumer behavior is based on the idea

that consumers are rational and seek to maximize their utility, or
satisfaction, from the goods and services they consume. According to
this theory, consumers make choices based on their preferences and
the constraints they face, such as their income and the prices of goods
and services.
The theory assumes that consumers have a set of preferences that

can be represented by a utility function, which assigns a level of
satisfaction to each possible combination of goods and services.
Consumers are assumed to choose the combination of goods and
services that maximizes their utility, subject to their budget
constraint.
The budget constraint is the set of all possible combinations of goods

and services that a consumer can afford, given their income and the
prices of goods and services. The budget constraint is represented by
a budget line, which shows all the combinations of two goods that a
consumer can afford at a given income and prices.
The theory also assumes that consumers have a diminishing marginal

utility of income and goods, which means that as they consume more
of a good or service, the additional satisfaction they receive from each
additional unit decreases. This leads to the law of demand, which
states that as the price of a good or service increases, the quantity
demanded of that good or service will decrease, ceteris paribus.
Overall, the neoclassical theory of consumer behavior provides a

framework for understanding how consumers make choices and how
their choices are influenced by their preferences and the constraints
they face. It is a fundamental concept in microeconomics and is used
to analyze a wide range of economic phenomena, from individual
consumer behavior to market outcomes and welfare analysis.
2. Consumers can make decisions to maximize their utility by

following the principle of rational choice. The principle of rational
choice states that consumers should choose the combination of goods
and services that maximizes their utility, subject to their budget
constraint.
To illustrate this principle, let's consider an example. Suppose a

consumer has $100 to spend on two goods: books and movies. The
price of a book is $10 and the price of a movie is $20. The consumer's
utility function for books and movies is given by the following table:
| Books | Movies | Total Utility |
|-------|--------|---------------|
|0 |0 |0 |
|1 |0 | 10 |
|2 |0 | 18 |
|3 |0 | 24 |
|4 |0 | 28 |
|4 |1 | 32 |
|4 |2 | 34 |
|4 |3 | 35 |
|4 |4 | 34 |
The table shows the total utility that the consumer receives from
different combinations of books and movies. For example, if the
consumer consumes 2 books and 0 movies, their total utility is 18.
To maximize their utility, the consumer should allocate their spending

in such a way that the marginal utility per dollar spent is equal for
books and movies. The marginal utility of a good is the additional
utility that the consumer receives from consuming one more unit of
that good, while holding the consumption of the other good constant.
Suppose the consumer has already consumed 2 books and 0 movies,

and is deciding how to allocate their remaining $80. The marginal
utility of a book is 8, while the marginal utility of a movie is 6.
Therefore, the consumer should spend their next dollar on a book,
since it provides a higher marginal utility per dollar spent. The
consumer should continue to allocate their spending in this way until
the marginal utility per dollar spent is equal for books and movies.
In this example, the consumer should consume 6 books and 2 movies,

since this combination provides the highest total utility given the
consumer's budget constraint. By following the principle of rational
choice, the consumer is able to make decisions that maximize their
utility, given their preferences and budget constraint.
Exercise
1. If the price of a good is $10 and the quantity demanded is 100 units,
and the price increases to $12, what is the new quantity demanded if
the price elasticity of demand is -2?
Answer: Using the formula for price elasticity of demand, we have:
E = (% change in quantity demanded) / (% change in price)
-2 = (% change in quantity demanded) / (20%)
% change in quantity demanded = -40%
The new quantity demanded is:
100 - (40% of 100) = 60 units

and the price decreases to $4, what is the new quantity demanded if
the price elasticity of demand is -1.5?
-1.5 = (% change in quantity demanded) / (-20%)
% change in quantity demanded = 30%
200 + (30% of 200) = 260 units

and the price increases to $25, what is the price elasticity of demand if
the new quantity demanded is 40 units?
E = (40 - 50) / ((40 + 50) / 2) / (25 - 20) / ((25 + 20) / 2)
E = -0.5
The price elasticity of demand is -0.5, which means that the good is
inelastic.
and the price elasticity of demand is -1.2, what is the new quantity
demanded if the price decreases to $8?
-1.2 = (% change in quantity demanded) / (20%)
% change in quantity demanded = -24%
100 + (-24% of 100) = 76 units

and the price elasticity of demand is -0.8, what is the new price if the
quantity demanded increases to 25 units?
-0.8 = (5 / 22.5) / (% change in price)
% change in price = -11.25%
The new price is:
$50 - (-11.25% of $50) = $44.38
Question
1. Which of the following is a fundamental concept in
microeconomics?
a. The law of gravity
b. The law of demand
c. The law of supply
d. The law of inertia
2. The neoclassical theory of consumer behavior assumes that

consumers are:
a. Irrational
b. Emotional
c. Rational
d. Impulsive
3. The budget constraint is the set of all possible combinations

of goods and services that a consumer can afford, given their:
a. Income and the prices of goods and services
b. Income and the weather
c. Age and gender
d. Education and occupation
4. The law of demand states that as the price of a good or

service increases, the quantity demanded of that good or
service will:
a. Increase
b. Stay the same
c. Decrease
d. Fluctuate
5. The principle of marginal utility states that consumers

should allocate their spending in such a way that the:
a. Marginal utility per dollar spent is equal across all goods
and services
b. Total utility per dollar spent is equal across all goods and
services
c. Marginal utility per dollar spent is highest for all goods and
services
d. Total utility per dollar spent is highest for all goods and
services
6. The marginal utility of a good is the additional utility that
the consumer receives from consuming:
a. One more unit of that good, while holding the consumption
of the other good constant
b. One more unit of that good, while holding the price of the
other good constant
c. One more unit of both goods, while holding the price of
both goods constant
d. One more unit of both goods, while holding the
consumption of both goods constant
7. The law of diminishing marginal utility states that as a

consumer consumes more of a good or service, the additional
satisfaction they receive from each additional unit:
a. Increases
b. Stays the same
c. Decreases
d. Fluctuates
8. The consumer's utility function assigns a level of
satisfaction to each possible combination of goods and
services, and is used to represent the consumer's:
a. Preferences
b. Income
c. Budget constraint
d. Marginal utility
9. The principle of rational choice states that consumers

should choose the combination of goods and services that
maximizes their utility, subject to their:
a. Income and the prices of goods and services
b. Age and gender
c. Education and occupation
d. Preferences and budget constraint
10. The budget line shows all the combinations of two goods
that a consumer can afford at a given:
a. Income and prices of goods and services
b. Age and gender
c. Education and occupation
d. Preferences and budget constraint
11. The marginal rate of substitution is the rate at which a

consumer is willing to trade one good for another, while
holding their:
a. Income and the prices of goods and services constant
b. Age and gender constant
c. Education and occupation constant
d. Preferences and budget constraint constant
12. The income effect of a price change refers to the change in

the quantity demanded of a good or service that results from
a change in the consumer's:
a. Income
b. Preferences
c. Budget constraint
d. Marginal utility
13. The substitution effect of a price change refers to the
change in the quantity demanded of a good or service that
results from a change in the:
a. Price of a substitute good or service
b. Price of a complementary good or service
c. Consumer's income
d. Consumer's preferences
14. The market demand curve is the horizontal sum of the

individual demand curves for all consumers in the market, and
shows the relationship between the:
a. Price of a good or service and the quantity demanded by all
consumers in the market
b. Price of a good or service and the quantity supplied by all
producers in the market
c. Income of all consumers in the market and the quantity
demanded of all goods and services in the market
d. Preferences of all consumers in the market and the quantity
demanded of all goods and services in the market
15. The law of supply states that as the price of a good or
service increases, the quantity supplied of that good or service
will:
a. Increase
b. Stay the same
c. Decrease
d. Fluctuate
Answers:
1. b
2. c
3. a
4. c
5. a
6. a
7. c
8. a
9. d
10. a
11. a
12. a
13. a
14. a
15. a
Reasons:
1. The law of demand is a fundamental concept in
microeconomics, as it explains the relationship between the
price of a good or service and the quantity demanded by
consumers.
2. The neoclassical theory of consumer behavior assumes that
consumers are rational and seek to maximize their utility from
the goods and services they consume.
3. The budget constraint is determined by the consumer's
income and the prices of goods and services, and represents
the set of all possible combinations of goods and services that
the consumer can afford.
4. The law of demand states that as the price of a good or
service increases, the quantity demanded of that good or
service will decrease, ceteris paribus.
5. The principle of marginal utility states that consumers
should allocate their spending in such a way that the marginal
utility per dollar spent is equal across all goods and services.
6. The marginal utility of a good is the additional utility that
the consumer receives from consuming one more unit of that
good, while holding the consumption of the other good
constant.
7. The law of diminishing marginal utility states that as a
consumer consumes more of a good or service, the additional
satisfaction they receive from each additional unit decreases.
8. The consumer's utility function assigns a level of
satisfaction to each possible combination of goods and
services, and is used to represent the consumer's preferences.
9. The principle of rational choice states that consumers
should choose the combination of goods and services that
maximizes their utility, subject to their budget constraint and
preferences.
10. The budget line shows all the combinations of two goods
that a consumer can afford at a given income and prices of
goods and services.
11. The marginal rate of substitution is the rate at which a
consumer is willing to trade one good for another, while
holding their income and the prices of goods and services
constant.
12. The income effect of a price change refers to the change in
the quantity demanded of a good or service that results from
a change in the consumer's income.
13. The substitution effect of a price change refers to the
change in the quantity demanded of a good or service that
results from a change in the price of a substitute good or
service.
14. The market demand curve shows the relationship between
the price of a good or service and the quantity demanded by
all consumers in the market, and is the horizontal sum of the
individual demand curves for all consumers in the market.
15. The law of supply states that as the price of a good or
service increases, the quantity supplied of that good or service
will increase, ceteris paribus.
Chapter two ➜ choice involving risk and uncertainty
Outcome ➜ Understand how to make rational decision under risk and
uncertanity
In microeconomics, decision-making under risk and

uncertainty involves making choices when the outcomes of
those choices are uncertain. In some cases, the outcomes of a
decision are certain, and the decision-maker can easily
determine the best course of action. However, in many
situations, the outcomes of a decision are uncertain, and the
decision-maker must consider the probabilities of different
outcomes in order to make a rational decision.
To make rational decisions under certainty, the decision-
maker must have complete information about the outcomes
of their choices. In this case, the decision-maker can simply
choose the option that provides the highest level of utility,
given their preferences and budget constraint.
To make rational decisions under risk, the decision-maker

must consider the probabilities of different outcomes. In this
case, the decision-maker can use expected utility theory to
determine the best course of action. Expected utility theory
assumes that decision-makers are risk-averse, meaning that
they prefer a certain outcome to an uncertain outcome with
the same expected value.
To illustrate this concept, let's consider an example. Suppose a

decision-maker is considering two investment options: Option
A and Option B. Option A has a 50% chance of providing a
return of $100, and a 50% chance of providing a return of $0.
Option B has a 100% chance of providing a return of $50. The
expected value of Option A is $50, while the expected value of
Option B is $50.
However, the decision-maker may prefer Option B, since it
provides a certain return of $50, while Option A provides an
uncertain return with a higher expected value. This preference
for certainty is captured by the concept of risk aversion.
To make rational decisions under uncertainty, the decision-

maker must consider the probabilities of different outcomes,
as well as their subjective beliefs about those probabilities. In
this case, the decision-maker can use subjective expected
utility theory to determine the best course of action.
Subjective expected utility theory assumes that decision-
makers have subjective beliefs about the probabilities of
different outcomes, and that these beliefs are reflected in
their utility function.
To illustrate this concept, let's consider an example. Suppose a

decision-maker is considering two investment options: Option
A and Option B. Option A has a 50% chance of providing a
return of $100, and a 50% chance of providing a return of $0.
Option B has a 50% chance of providing a return of $50, and a
50% chance of providing a return of $25. The decision-maker
believes that Option A is more likely to provide a return of
$100 than Option B, but is uncertain about the probabilities of
the other outcomes.
In this case, the decision-maker can use their subjective
beliefs to calculate the expected utility of each option. The
expected utility of Option A is 0.5U($100) + 0.5U($0), where U
is the decision-maker's utility function. The expected utility of
Option B is 0.5U($50) + 0.5U($25). The decision-maker can
then choose the option that provides the highest expected
utility, given their subjective beliefs about the probabilities of
different outcomes.
In summary, to make rational decisions under risk and

uncertainty, decision-makers must consider the probabilities
of different outcomes, as well as their preferences and
subjective beliefs about those probabilities. By using expected
utility theory or subjective expected utility theory, decision-
makers can make rational decisions that maximize their
expected utility, given the available information.
Exercise
1. A company has two investment options: Option
A has a 60% chance of earning a profit of $10,000
and a 40% chance of earning a profit of $5,000.
Option B has a 70% chance of earning a profit of
$8,000 and a 30% chance of earning a profit of
$2,000. Which option has the higher expected
value?
Answer: The expected value of Option A is:
(0.6 x $10,000) + (0.4 x $5,000) = $8,000
The expected value of Option B is:
(0.7 x $8,000) + (0.3 x $2,000) = $6,800
Therefore, Option A has the higher expected value.

$5,000. Which option has the higher coefficient of
variation?
Answer: The coefficient of variation for Option A
is:
(($20,000 - $15,000)^2 x 0.5) + (($10,000 -
$15,000)^2 x 0.5) / $15,000 = 0.33
The coefficient of variation for Option B is:
(($15,000 - $10,000)^2 x 0.6) + (($5,000 -
$10,000)^2 x 0.4) / $10,000 = 0.53
Therefore, Option B has the higher coefficient of
variation.

$6,000. Which option has the higher expected
utility if the decision maker has a risk aversion
coefficient of 2?
Answer: The expected utility of Option A is:
(0.7 x (12,000)^0.5) + (0.3 x (8,000)^0.5) = 109.54
The expected utility of Option B is:
(0.8 x (10,000)^0.5) + (0.2 x (6,000)^0.5) = 100
Therefore, Option A has the higher expected
utility.

$8,000. Which option has the higher risk premium
if the decision maker has a risk aversion coefficient
of 3?
(0.6 x (15,000)^0.5) + (0.4 x (5,000)^0.5) = 122.47
(0.7 x (12,000)^0.5) + (0.3 x (8,000)^0.5) = 109.54
The risk premium for Option A is:
(122.47)^3 - (109.54)^3 / 3 = $1,758.33
The risk premium for Option B is:
(109.54)^3 - (122.47)^3 / 3 = -$1,758.33
Therefore, Option A has the higher risk premium.

$5,000. Which option has the higher certainty
equivalent if the decision maker has a risk aversion
coefficient of 2?
(0.5 x (20,000)^0.5) + (0.5 x (10,000)^0.5) = 141.42
(0.6 x (15,000)^0.5) + (0.4 x (5,000)^0.5) = 122.47
The certainty equivalent for Option A is:
(141.42)^2 / (2 x 2) = $10,000
The certainty equivalent for Option B is:
(122.47)^2 / (2 x 2) = $7,500
Therefore, Option A has the higher certainty
equivalent.
Question
1. Which of the following is a characteristic of decision-
making under risk?
a. Complete information about the outcomes of a
decision
b. Uncertainty about the outcomes of a decision
c. Subjective beliefs about the probabilities of different
outcomes
d. Both b and c
2. Expected utility theory assumes that decision-makers
are:
a. Risk-neutral
b. Risk-averse
c. Risk-seeking
d. Indifferent to risk
3. The expected value of a decision is calculated by:

a. Multiplying the probability of each outcome by its
utility
b. Adding the utility of each outcome
c. Multiplying the probability of each outcome by its
monetary value
d. Adding the monetary value of each outcome
4. The concept of risk aversion refers to the idea that

decision-makers:
a. Prefer a certain outcome to an uncertain outcome
with the same expected value
b. Prefer an uncertain outcome to a certain outcome
with the same expected value
c. Are indifferent between a certain outcome and an
uncertain outcome with the same expected value
d. Do not consider risk when making decisions
5. The certainty equivalent of an uncertain outcome is

the:
a. Monetary value of the uncertain outcome
b. Monetary value of a certain outcome that provides
the same expected utility
c. Probability of the uncertain outcome
d. Expected value of the uncertain outcome
6. The risk premium is the:

a. Difference between the expected value of an
uncertain outcome and the expected value of a certain
outcome that provides the same expected utility
b. Difference between the expected value of an
uncertain outcome and the monetary value of the
uncertain outcome
c. Difference between the expected value of a certain
outcome and the monetary value of the certain
outcome
d. Difference between the probability of an uncertain
outcome and the probability of a certain outcome
7. The coefficient of absolute risk aversion measures

the:
a. Degree to which a decision-maker is risk-averse
b. Degree to which a decision-maker is risk-neutral
c. Degree to which a decision-maker is risk-seeking
d. Degree to which a decision-maker is indifferent to
risk
8. The coefficient of relative risk aversion measures the:
a. Degree to which a decision-maker is risk-averse
b. Degree to which a decision-maker is risk-neutral
c. Degree to which a decision-maker is risk-seeking
d. Degree to which a decision-maker is indifferent to
risk
9. The principle of diminishing marginal utility of wealth

states that as a decision-maker's wealth increases, the:
a. Marginal utility of wealth decreases
b. Marginal utility of wealth increases
c. Total utility of wealth decreases
d. Total utility of wealth increases
10. The Allais paradox is an example of:

a. Risk aversion
b. Risk neutrality
c. Risk-seeking behavior
d. Inconsistent preferences
11. The Ellsberg paradox is an example of:

a. Risk aversion
b. Risk neutrality
c. Risk-seeking behavior
d. Inconsistent preferences
12. The concept of ambiguity aversion refers to the idea

that decision-makers:
a. Prefer known risks to unknown risks
b. Prefer unknown risks to known risks
c. Are indifferent between known risks and unknown
risks
d. Do not consider ambiguity when making decisions
13. The Hurwicz criterion is a decision rule that:
a. Maximizes the expected value of a decision
b. Maximizes the expected utility of a decision
c. Minimizes the maximum regret of a decision
d. Minimizes the expected regret of a decision
14. The minimax regret criterion is a decision rule that:

d. Minimizes the expected regret of a decision
15. The maximin criterion is a decision rule that:

d. Maximizes the minimum outcome of a decision
Answers:
1. d
2. b
3. c
4. a
5. b
6. a
7. a
8. b
9. a
10. d
11. a
12. a
13. b
14. c
15. d
Reasons:
1. Decision-making under risk involves making choices

when the outcomes of those choices are uncertain, and
may involve subjective beliefs about the probabilities of
different outcomes.
2. Expected utility theory assumes that decision-makers
are risk-averse, meaning that they prefer a certain
outcome to an uncertain outcome with the same
expected value.
3. The expected value of a decision is calculated by
multiplying the probability of each outcome by its
monetary value, and adding up the results.
4. The concept of risk aversion refers to the idea that
decision-makers prefer a certain outcome to an
uncertain outcome with the same expected value, due
to their aversion to risk.
5. The certainty equivalent of an uncertain outcome is
the monetary value of a certain outcome that provides
the same expected utility as the uncertain outcome.
6. The risk premium is the difference between the
expected value of an uncertain outcome and the
expected value of a certain outcome that provides the
same expected utility.
7. The coefficient of absolute risk aversion measures the
degree to which a decision-maker is risk-averse, based
on the curvature of their utility function.
8. The coefficient of relative risk aversion measures the
degree to which a decision-maker is risk-averse, based
on the ratio of their marginal utility of wealth to their
total wealth.
9. The principle of diminishing marginal utility of wealth
states that as a decision-maker's wealth increases, the
marginal utility of wealth decreases.
10. The Allais paradox is an example of inconsistent
preferences, where decision-makers violate the
principle of transitivity in their choices.
11. The Ellsberg paradox is an example of ambiguity
aversion, where decision-makers prefer known risks to
unknown risks.
12. The concept of ambiguity aversion refers to the idea
that decision-makers prefer known risks to unknown
risks, due
Chapter three ➜ theory of production
Outcome ➜ Analyze theories of production and how firms optimize

production process
The theory of production is concerned with how firms

transform inputs into outputs. In microeconomics, the
production function is used to describe the relationship
between inputs and outputs. The production function can be
represented mathematically as Q = f(K, L), where Q is the
quantity of output produced, K is the quantity of capital input,
and L is the quantity of labor input.
There are several theories of production that explain how

firms optimize their production process. One of the most
important theories is the law of diminishing marginal returns.
This law states that as a firm increases the quantity of one
input while holding all other inputs constant, the marginal
product of that input will eventually decrease. This occurs
because the fixed inputs, such as capital, become less
productive as more of the variable input, such as labor, is
added.
Another important theory of production is the concept of

isoquants. Isoquants are curves that represent all the
combinations of inputs that can produce a given level of
output. Isoquants are similar to indifference curves in
consumer theory, and can be used to determine the optimal
combination of inputs that a firm should use to produce a
given level of output.
To optimize their production process, firms must choose the
combination of inputs that minimizes their total cost of
production. This is known as the cost-minimization problem.
The cost-minimization problem can be solved using the
concept of marginal rate of technical substitution (MRTS). The
MRTS is the rate at which a firm can substitute one input for
another while holding the level of output constant. The
optimal combination of inputs occurs where the MRTS is
equal to the ratio of input prices.
In addition to the cost-minimization problem, firms must also

consider the profit-maximization problem. The profit-
maximization problem involves choosing the level of output
that maximizes the firm's profit, given the prices of inputs and
outputs. The profit-maximizing level of output occurs where
the marginal revenue of the last unit produced is equal to the
marginal cost of production.
To summarize, the theories of production explain how firms

transform inputs into outputs, and how they optimize their
production process to minimize costs and maximize profits.
The law of diminishing marginal returns and the concept of
isoquants are important theories that help firms determine
the optimal combination of inputs to use. The cost-
minimization problem and the profit-maximization problem
are two important problems that firms must solve to optimize
their production process.
Exercise
1. A firm's total product (TP) is given by the equation TP
= Q^2 - 10Q + 25. What is the marginal product of labor
when Q = 5?
Answer: The marginal product of labor (MPL) is the

change in TP resulting from a one-unit increase in labor
input. To calculate MPL, we take the derivative of TP
with respect to labor (L):
MPL = d(TP)/dL
MPL = 2Q - 10
When Q = 5, MPL = (2 x 5) - 10 = -0. This means that the

addition of one more unit of labor would decrease
output.
2. A firm has a fixed capital stock of $100 and hires
workers at a wage rate of $10 per hour. The production
function is given by Q = L^2 + K, where L is the number
of workers and K is the amount of capital used. What is
the average variable cost (AVC) when output is 64 units
and there are 8 workers employed?
Answer: Average variable cost (AVC) is calculated as

total variable cost divided by output:
AVC = TVC/Q
Total variable cost (TVC) can be calculated as the sum of

wages paid to workers:
TVC = wL
TVC = ($10/hour)(8 hours/day)(1 day/unit)(64 units)
TVC = $5,120
Therefore, AVC = $5,120/64 = $80/unit.

3. A firm produces output using two inputs: capital (K)
and labor (L). The production function is given by Q =
K^(1/3)L^(2/3). If capital costs $16 per unit and labor
costs $8 per unit, what is the firm's cost-minimizing
combination of inputs when output is 64 units?
Answer: The cost-minimizing combination of inputs

occurs where the marginal rate of technical substitution
(MRTS) equals the ratio of input prices:
MRTS = w/r
The MRTS can be calculated as the ratio of the marginal

products of labor and capital:
MRTS = MPL/MPK
MRTS = (2/3)(K^(1/3))(L^(-1/3))/(1/3)(K^(-2/3))(L^(2/3))
MRTS = 2L/K
Therefore, 2L/K = w/r = 8/16 = 0.5.

When Q = 64, K^(1/3)L^(2/3) = 64. Solving for L in terms
of K using the MRTS equation gives L = (0.25K).
Substituting into the production function and solving for
K gives K = 32.
Therefore, L = (0.25 x 32) = 8.
The cost-minimizing combination of inputs is therefore

K = 32 units and L = 8 units.
4. A firm has a total fixed cost (TFC) of $200 and a

variable cost (VC) function given by VC=Q^2 -10Q +25.
What is average fixed cost (AFC) when output is 20
units?
Answer: Average fixed cost (AFC) is calculated as TFC

divided by output:
AFC=TFC/Q
When Q=20, TFC=$200, so AFC=$200/20=$10/unit.
5. A firm's total product (TP) function is given by

TP=50L-2L^2+0.05L^3, where L is the amount of labor
employed. What is the firm's marginal product of labor
(MPL) when L=20?
Answer: Marginal product of labor (MPL) is given by the

first derivative of TP with respect to L:
MPL=d(TP)/dL
MPL=50-4L+0.15L^2
When L=20, MPL=50-4(20)+0.15(20^2)=10.
Therefore, the firm's MPL when L=20 is 10 units of

output per unit of additional labor input.
Question
1. Which of the following is NOT a factor of production?
a) Land
b) Labor
c) Capital
d) Money
2. The production function shows the relationship

between:
a) Inputs and outputs
b) Costs and revenues
c) Demand and supply
d) Price and quantity
3. The law of diminishing marginal returns states that:

a) As output increases, marginal cost decreases
b) As input increases, output increases at a decreasing
rate
c) As input increases, output increases at an increasing
rate
d) As output increases, marginal revenue decreases
4. Which of the following is an example of a fixed cost?

a) Rent
b) Raw materials
c) Labor
d) Electricity
5. Marginal cost is:

a) The cost of producing one more unit of output
b) The total cost of producing all units of output
c) The average cost of producing one unit of output
d) The cost of producing the first unit of output
6. Average total cost is:

a) Total cost divided by output
b) Marginal cost divided by output
c) Total cost divided by variable cost
d) Total cost divided by fixed cost
7. Which of the following is an example of a variable

cost?
a) Rent
b) Raw materials
c) Property taxes
d) Insurance
8. The long run is a period of time in which:

a) All inputs are fixed
b) All inputs are variable
c) Some inputs are fixed and some are variable
d) None of the above
9. Economies of scale occur when:

a) Average total cost increases as output increases
b) Average total cost decreases as output increases
c) Marginal cost increases as output increases
d) Marginal cost decreases as output increases
10. Diseconomies of scale occur when:

11. Which of the following is an example of a long-run

decision?
a) Hiring an additional worker
b) Purchasing a new machine
c) Increasing advertising spending
d) All of the above
12. The short run is a period of time in which:
13. Which of the following is an example of a sunk cost?

a) Rent
b) Raw materials
c) Advertising
d) Depreciation
14. Which of the following is an example of a marginal

product?
a) The total output produced
b) The additional output produced by one more unit of
input
c) The average output produced per unit of input
d) The maximum output that can be produced with a
given set of inputs
15. Which of the following is an example of a fixed

input?
a) Raw materials
b) Labor
c) Machinery
d) Electricity

input?
a) Rent
b) Raw materials
c) Property taxes
d) Insurance
17. Which of the following is an example of a short-run

decision?
a) Building a new factory
b) Hiring a new CEO
c) Increasing production for the next year
d) All of the above

decision?
d) All of the above
19. Which of the following is an example of a total cost?

a) The cost of raw materials
b) The cost of labor
c) The cost of rent
d) The sum of all costs of production

cost?
a) Rent
b) Raw materials
c) Property taxes
d) Insurance
Answers:
1. d) Money
2. a) Inputs and outputs
3. b) As input increases, output increases at a
decreasing rate
4. a) Rent
5. a) The cost of producing one more unit of output
6. a) Total cost divided by output
7. b) Raw materials
8. b) All inputs are variable
9. b) Average total cost decreases as output increases
10. a) Average total cost increases as output increases
11. b) Purchasing a new machine
12. c) Some inputs are fixed and some are variable
13. d) Depreciation
14. b) The additional output produced by one more unit
of input
15. c) Machinery
16. b) Raw materials
17. c) Increasing production for the next year

19. d) The sum of all costs of production
Reasons:
1. Money is not a factor of production as it is not used
to produce goods and services.
2. The production function shows the relationship
between inputs and outputs, which is the basis of
production.
3. The law of diminishing marginal returns states that as
input increases, output increases at a decreasing rate,
which is a fundamental concept in production theory.
4. Rent is an example of a fixed cost as it does not vary
with the level of output.
5. Marginal cost is the cost of producing one more unit
of output, which is an important concept in production
theory.
6. Average total cost is the total cost of producing all
units of output divided by the total output, which is a
measure of the average cost of production.
7. Raw materials are an example of a variable cost as
they vary with the level of output.
8. The long run is a period of time in which all inputs are
variable, which allows firms to adjust their production
processes to achieve optimal efficiency.
9. Economies of scale occur when average total cost
decreases as output increases, which is a key concept in
production theory.
10. Diseconomies of scale occur when average total cost
increases as output increases, which is a key concept in
production theory.
11. Purchasing a new machine is an example of a long-
run decision as it involves a significant investment in
capital that cannot be easily reversed.
12. The short run is a period of time in which some
inputs are fixed and some are variable, which limits a
firm's ability to adjust its production processes.
13. Depreciation is an example of a sunk cost as it is a
cost that has already been incurred and cannot be
recovered.
14. The marginal product is the additional output
produced by one more unit of input, which is a key
concept in production theory.
15. Machinery is an example of a fixed input as it does
not vary with the level of output.
16. Raw materials are an example of a variable input as
17. Increasing production for the next year is an
example of a short-run decision as it involves adjusting
the level of output using existing resources.
19. The total cost is the sum of all costs of production,
which is a key concept in production theory.
Chapter 5 ➜ theory of cost
Outcome ➜ Analyze how firms decide to minimize costs
In order to minimize costs, firms need to understand
the relationship between inputs and outputs, and how
changes in input prices and output levels affect their
costs.
The first step in minimizing costs is to determine the

optimal level of output. This is the level of output at
which the firm can produce goods and services at the
lowest possible cost. The optimal level of output is
determined by comparing the marginal cost of
production to the marginal revenue of the product. The
firm will continue to produce until the marginal cost of
production equals the marginal revenue of the product.
Once the optimal level of output has been determined,

the firm needs to decide how to allocate its resources in
order to produce the desired output at the lowest
possible cost. This involves making decisions about the
mix of inputs to use in production, and how much of
each input to use.
The firm will choose the mix of inputs that minimizes its
total cost of production. This involves comparing the
marginal product of each input to its price. The marginal
product of an input is the additional output that is
produced by using one more unit of the input. The price
of an input is the cost of purchasing one unit of the
input.
The firm will continue to use an input as long as its

marginal product is greater than or equal to its price. If
the marginal product of an input is less than its price,
the firm will reduce its use of that input. This is because
the cost of using the input is greater than the additional
output that it produces.
In addition to choosing the optimal mix of inputs, the

firm also needs to decide how much of each input to
use. This involves comparing the marginal product of an
input to its price per unit. The firm will continue to use
an input as long as its marginal product is greater than
or equal to its price per unit. If the marginal product of
an input is less than its price per unit, the firm will
reduce its use of that input.
Overall, the goal of minimizing costs is to produce goods

and services at the lowest possible cost, while still
meeting the demand for the product. This involves
making decisions about the optimal level of output, the
mix of inputs to use in production, and how much of
each input to use. By making these decisions, firms can
minimize their costs and increase their profits.
Exercise
1. Suppose the total cost function for a firm is
given by TC = 100 + 5Q - 2Q^2. What are the fixed
costs, variable costs, and marginal cost when Q =
10?
Answer:
Fixed Costs (FC) = $100
Variable Costs (VC) = $5Q - $2Q^2 = $5(10) -
$2(10)^2 = $50 - $200 = -$150
Note that in this case, variable costs are negative
because the quadratic term dominates at this level
of output.
Total Costs (TC) = FC + VC = $100 - $150 = -$50
Marginal Cost (MC) is found by taking the
derivative of TC with respect to Q:
MC = dTC/dQ = 5 - 4Q
When Q=10, MC=5-4(10)= -$35
2. Suppose a firm's production function is given by

Q(L,K) = L^(1/3)K^(1/3). The wage rate is
w=$16/hour and the rental rate on capital is
r=$8/hour. What is the cost-minimizing
combination of inputs required to produce an
output of Q=64 units?
Answer:
The marginal rate of technical substitution (MRTS)
between labor and capital is defined as
MRTS=w/r=(MP_L)/(MP_K).
Taking partial derivatives of the production
function gives MP_L=(1/3)L^(-2/3)K^(1/3) and
MP_K=(1/3)L^(1/3)K^(-2/3).
Substituting these into the MRTS equation gives
MRTS=(1/3)(L/K)^(-1).
Setting MRTS equal to the ratio of factor prices

allows us to solve for the optimal combination of
inputs:
MRTS=w/r = 2/1
(1/3)(L/K)^(-1) = 2/1
(L/K)^(-1) = 6
L/K = 1/6
When Q=64, K^(1/3)L^(2/3) = 64. Solving for L in

terms of K using the MRTS equation gives
L=(0.25K). Substituting into the production
function and solving for K gives K=32.
Therefore, L=(0.25 x 32) = 8
The cost-minimizing combination of inputs is

therefore K=32 units and L=8 units.
3. A firm has a total cost function of

TC=100+5Q+0.02Q^2. What are the fixed costs,
variable costs, and marginal cost when Q=20?
Answer:
Variable Costs (VC) = $5Q + 0.02Q^2 =
$5(20)+0.02(20^2)=$100+$8=$108
Total Costs (TC)= FC + VC =$100+$108=$208
MC=dTC/dQ=5+0.04Q
When Q=20, MC=5+(0.04)(20)=6

Q=L^0.5K^0.5 and the price of labor is w=$10/hour
while the rental rate on capital is r=$15/hour. If
the firm wants to produce an output of Q=400
units, what are its optimal quantities of labor and
capital that it should use?
Answer:
The marginal product of labor (MPL) is given by
MPL=(dQ/dL)*K=0.5*L^(-0.5)K^(0.5).
The marginal product of capital (MPK) is given by
MPK=(dQ/dK)*L=0.5*K^(-0.5)L^(0.5).
The cost-minimizing combination of inputs can be
found using the following formula: MPL/w =
MPK/r.
Substituting in the production function and

simplifying we get:
0.5*(L/K)^0.5 = 2/3
(L/K)^0.5 = 4/3
L/K = (4/3)^2 = 1.77
When Q=400, K^(1/2)L^(1/2)= 400, substituting

L/K=1.77 into this equation yields K=142, L=251.
Therefore, the optimal quantities of labor and
capital are L=251 units and K=142 units.
5. A firm has a total cost function of

TC=50+6Q+3Q^2+Q^3. What are the fixed costs,
variable costs, and marginal cost when Q=10?
Answer:
Variable Costs (VC) = $
6Q + 3Q^2 + Q^3 = $6(10) + $3(10^2) + (10^3) = $60

+ $300 + $1000 = $1360
Total Costs (TC) = FC + VC = $50 + $1360 = $1410
MC = dTC/dQ = 6 + 6Q + 3Q^2
When Q=10, MC=6+(6)(10)+(3)(10^2)=336
6. A firm has a total cost function of TC=500+12Q-

Q^2+0.04Q^3. What are the fixed costs, variable
costs, and marginal cost when Q=25?
Answer:
Variable Costs (VC) = $12Q - $Q^2 + 0.04$Q^3 =
$12(25)-25^2+0.04(25)^3 =$300-$625+$156.25=$-
168.75
Total Costs (TC) = FC + VC = $500 - $168.75 =
$331.25
MC=dTC/dQ=12-2Q+0.12Q^2
When Q=25, MC=12-2(25)+0.12(25)^2=$-18.75

Q(L,K)= L^(1/4)K^(1/4). The wage rate is
w=$12/hour and the rental rate on capital is
r=$16/hour. What is the cost-minimizing
combination of inputs required to produce an
output of Q=81 units?
Answer:
The marginal rate of technical substitution (MRTS)
between labor and capital is defined as
MRTS=w/r=(MPL)/(MPK).
Taking partial derivatives of the production
function gives MPL=(1/4)L^(-3/4)K^(1/4) and
MPK=(1/4)L^(1/4)K^(-3/4).
Substituting these into the MRTS equation gives
MRTS=(1/4)(L/K)^(-1).
Setting MRTS equal to the ratio of factor prices
allows us to solve for the optimal combination of
inputs:
MRTS=w/r = 0.75
(1/4)(L/K)^(-1) = 0.75
(L/K)^(-1) = 3
When Q=81, K^(1/4)L^(1/4) = 81. Solving for L in

terms of K using the MRTS equation gives L=3K.
Substituting into the production function and
solving for K gives K=27.
Therefore, L=81/K=3(27)=81.
The cost-minimizing combination of inputs is

therefore K=27 units and L=81 units.
Question
1. Which of the following is NOT a factor of production?
a) Land
b) Labor
c) Capital
d) Money
2. The law of diminishing marginal returns states that:

a) As output increases, marginal cost decreases
b) As input increases, output increases at a decreasing
rate
c) As input increases, output increases at an increasing
rate
d) As output increases, marginal revenue decreases
a) Rent
b) Raw materials
c) Labor
d) Electricity
4. Marginal cost is:

a) The cost of producing one more unit of output
b) The total cost of producing all units of output
c) The average cost of producing one unit of output
d) The cost of producing the first unit of output
5. Average total cost is:

a) Total cost divided by output
b) Marginal cost divided by output
c) Total cost divided by variable cost
d) Total cost divided by fixed cost
cost?
a) Rent
b) Raw materials
c) Property taxes
d) Insurance
7. The long run is a period of time in which:

8. Economies of scale occur when:

9. Diseconomies of scale occur when:


decision?
d) All of the above
11. The short run is a period of time in which:

12. Which of the following is an example of a sunk cost?

a) Rent
b) Raw materials
c) Advertising
d) Depreciation
13. Which of the following is an example of a marginal

product?
a) The total output produced
b) The additional output produced by one more unit of
input
c) The average output produced per unit of input
d) The maximum output that can be produced with a
given set of inputs
14. Which of the following is an example of a fixed

input?
a) Raw materials
b) Labor
c) Machinery
d) Electricity

input?
a) Rent
b) Raw materials
c) Property taxes
d) Insurance
16. Which of the following is an example of a short-run
decision?
a) Building a new factory
b) Hiring a new CEO
c) Increasing production for the next year
d) All of the above

decision?
d) All of the above
18. Which of the following is an example of a total cost?

a) The cost of raw materials
b) The cost of labor
c) The cost of rent
d) The sum of all costs of production

cost?
a) Rent
b) Raw materials
c) Property taxes
d) Insurance

a) Rent
b) Raw materials
c) Property taxes
d) Insurance
Answers:
1. d) Money
2. b) As input increases, output increases at a
decreasing rate
3. a) Rent
4. a) The cost of producing one more unit of output
5. a) Total cost divided by output
6. b) Raw materials
7. b) All inputs are variable
8. b) Average total cost decreases as output increases
9. a) Average total cost increases as output increases
11. c) Some inputs are fixed and some are variable
12. d) Depreciation
13. b) The additional output produced by one more unit
of input
14. c) Machinery
16. c) Increasing production for the next year
18. d) The sum of all costs of production

20. a) Rent
Reasons:
1. Money is not a factor of production as it is not used
to produce goods and services.
2. The law of diminishing marginal returns states that as
input increases, output increases at a decreasing rate,
which is a fundamental concept in production theory.
4. Marginal cost is the cost of producing one more unit
of output, which is an important concept in production
theory.
5. Average total cost is the total cost of producing all
units of output divided by the total output, which is a
measure of the average cost of production.
7. The long run is a period of time in which all inputs are
variable, which allows firms to adjust their production
processes to achieve optimal efficiency.
8. Economies of scale occur when average total cost
decreases as output increases, which is a key concept in
production theory.
9. Diseconomies of scale occur when average total cost
increases as output increases, which is a key concept in
production theory.
11. The short run is a period of time in which some
inputs are fixed and some are variable, which limits a
firm's ability to adjust its production processes.
12. Depreciation is an example of a sunk cost as it is a
cost that has already been incurred and cannot be
recovered.
13. The marginal product is the additional output
produced by one more unit of input, which is a key
concept in production theory.
14. Machinery is an example of a fixed input as it does
not vary with the level of output.
15. Raw materials are an example of a variable input as
16. Increasing production for the next year is an
example of a short-run decision as it involves adjusting
the level of output using existing resources.
18. The total cost is the sum of all costs of production,
which is a key concept in production theory.
Chapter 6 ➜ perfect competition market

Outcome ➜ Understand and analyze perfectly competitive firms profit
maximazing behaviour
In a perfectly competitive market, there are many

buyers and sellers, and no single buyer or seller has any
control over the market price. This means that firms in a
perfectly competitive market are price takers, meaning
they have to accept the market price for their product.
In order to maximize profits, a perfectly competitive
firm needs to produce at the level of output where
marginal revenue equals marginal cost. Marginal
revenue is the additional revenue earned by selling one
more unit of output, while marginal cost is the
additional cost of producing one more unit of output.
The firm will continue to produce as long as the
marginal revenue is greater than or equal to the
marginal cost. In a perfectly competitive market, the
price is equal to the marginal revenue, so the firm will
produce at the level of output where the price equals
the marginal cost. This is because if the firm produces at
a lower level of output
Exercise
1. A perfectly competitive firm has a total cost
function of TC=Q^3-6Q^2+15Q+10. What is the
firm's marginal cost function?
Answer:
The marginal cost (MC) function is the
derivative of the total cost (TC) function with
respect to quantity (Q):
MC=dTC/dQ=3Q^2-12Q+15
2. A perfectly competitive market has a

demand curve given by P=80-4Q and a supply
curve given by P=20+2Q. What is the
equilibrium price and quantity in this market?
Answer:
At equilibrium, the quantity demanded equals
the quantity supplied, so we can set the
demand and supply equations equal to each
other:
80-4Q=20+2Q
Solving for Q, we get Q=12.
Substituting this value into either equation

gives us the equilibrium price:
P=80-4(12)=32.
Therefore, the equilibrium price is $32 and the
equilibrium quantity is 12 units.
3. In a perfectly competitive market, a firm has

a marginal revenue (MR) function of MR=30-
Q. If its marginal cost (MC) function is
MC=10+2Q, what is the profit-maximizing level
of output?
Answer:
A profit-maximizing firm produces where
marginal revenue equals marginal cost:
MR=MC
30-Q=10+2Q
Solving for Q, we get Q=7.
Therefore, the profit-maximizing level of

output is 7 units.
4. A perfectly competitive industry initially has

100 identical firms each producing 50 units at
an average total cost of $40 per unit. If market
demand decreases from 5,000 units to 4,900
units while costs remain constant, how many
firms will exit the industry in the long run?
Answer:
If all firms are identical, the market supply
curve is simply the sum of all individual firms'
supply curves. At a price of $40, each firm
earns zero economic profit:
P=ATC=$40
MC=$40
At a market quantity of 5,000 units, each firm

produces 50 units for a total industry output
of 5,000 units. If demand decreases to 4,900
units, the market price will fall and some firms
will exit the industry in the long run.
To find out how many firms exit, we need to

determine what happens to the market supply
curve as firms leave. Assuming that all firms
have identical cost structures and that they
exit simultaneously so that costs remain
constant, the new market supply curve will be:
Qs=(100-x)50
where x is the number of firms that exit.
Setting this equal to market demand gives us:
(100-x)50=4,900
x=10.
Therefore, in the long run 10 firms will exit the

industry.
5. A perfectly competitive firm has a fixed cost

(FC) of $200 and a variable cost (VC) function
given by VC=2Q^2-8Q+12. What is the firm's
average variable cost (AVC) function?
Answer:
The average variable cost (AVC) function is
defined as VC/Q:
AVC=VC/Q=(2Q^2-8Q+12)/Q
Simplifying gives us:
AVC=2Q-8+12/Q
6. In a perfectly competitive industry with free

entry and exit in the long run, what happens
to profits in response to an increase in
demand?
Answer:
In perfect competition with free entry and exit
in the long run, profits are driven to zero since
there are no barriers preventing new firms
from entering or existing firms from exiting in
response to changes in market conditions such
as increased demand. As new firms enter,
market supply increases, driving down the
market price and reducing profits for all firms
in the industry.
7. A perfectly competitive firm has a

production function of Q=5L^(1/2)K^(1/2). If
the wage rate is $4 per unit of labor and the
rental rate on capital is $16 per unit of capital,
what are the firm's short-run total cost (TC)
function and average variable cost (AVC)
function if it produces 100 units of output?
Answer:
The short-run total cost (TC) function can be
derived from the production function by
multiplying each input by its respective factor
price:
TC=wL+rK
=4L+16K.
Substituting in Q=5L^(1/2)K^(1/2)=100 gives

us:
100=5L^(1/2)K^(1/2)
=> LK=400
We can then solve for K in terms of L using the

production function:
Q=5L^(1/2)K^(1/2)
=> K=(Q/(5L))^(2)
Substituting this into our expression for TC

gives us:
TC=4L+16((Q/(5L
Question
1. In a perfectly competitive market, there are:
a) Many buyers and sellers
b) Few buyers and sellers
c) One buyer and many sellers
d) One seller and many buyers
2. A perfectly competitive firm is a:

a) Price maker
b) Price taker
c) Monopoly
d) Oligopoly
3. In a perfectly competitive market, the

demand curve for a firm is:
a) Vertical
b) Horizontal
c) Upward sloping
d) Downward sloping
4. In a perfectly competitive market, the price

is:
a) Set by the government
b) Set by the firm
c) Set by the market
d) Set by the buyers
5. In a perfectly competitive market, a firm's

marginal revenue is:
a) Equal to the price
b) Greater than the price
c) Less than the price
d) Unrelated to the price

marginal cost is:
7. A perfectly competitive firm will maximize

its profits by producing at the level of output
where:
a) Total revenue is maximized
b) Marginal revenue equals marginal cost
c) Average revenue equals average cost
d) Total cost is minimized

average revenue is:

average cost is:
10. In a perfectly competitive market, a firm

will shut down in the short run if:
a) Price is less than average total cost
b) Price is less than average variable cost
c) Price is less than marginal cost
d) Price is less than average fixed cost
11. In the long run, a perfectly competitive

firm will earn:
a) Economic profit
b) Normal profit
c) Abnormal profit
d) Losses
12. In the long run, a perfectly competitive

market will have:
a) Many firms earning economic profit
b) Many firms earning normal profit
c) Many firms earning abnormal profit
d) Many firms earning losses
13. In a perfectly competitive market, entry
and exit of firms will:
a) Increase the price
b) Decrease the price
c) Have no effect on the price
d) Increase the quantity supplied

long-run equilibrium occurs when:
a) Price equals marginal cost
b) Price equals average total cost
c) Price equals average variable cost
d) Price equals average fixed cost
long-run equilibrium price is:
a) Higher than the short-run equilibrium price
b) Lower than the short-run equilibrium price
c) The same as the short-run equilibrium price
d) Unrelated to the short-run equilibrium price

supply curve is:
a) Upward sloping
b) Downward sloping
c) Horizontal
d) Vertical
market supply curve is:
a) Upward sloping
b) Downward sloping
c) Horizontal
d) Vertical

market demand curve is:
a) Upward sloping
b) Downward sloping
c) Horizontal
d) Vertical
market equilibrium occurs when:
a) Quantity demanded equals quantity
supplied
b) Price equals marginal cost
c) Price equals average total cost
d) Price equals average variable cost

profit is:
a) Total revenue minus total cost
b) Total revenue minus variable cost
c) Total revenue minus fixed cost
d) Total revenue minus average cost
Answers:
1. a) Many buyers and sellers
2. b) Price taker
3. b) Horizontal
4. c) Set by the market
5. a) Equal to the price
7. b) Marginal revenue equals marginal cost
9. c) Less than the price
10. b) Price is less than average variable cost
11. b) Normal profit
12. b) Many firms earning normal profit
13. c) Have no effect on the price
14. b) Price equals average total cost
15. c) The same as the short-run equilibrium
price
16. c) Horizontal
17. c) Horizontal
18. d) Vertical
19. a) Quantity demanded equals quantity

supplied
20. a) Total revenue minus total cost
Reasons:
1. In a perfectly competitive market, there are
many buyers and sellers, which ensures that
no single buyer or seller has any control over
the market price.
2. A perfectly competitive firm is a price taker,
meaning it has to accept the market price for
its product.
demand curve for a firm is horizontal, meaning
that the firm can sell as much as it wants at
the market price.
4. In a perfectly competitive market, the price
is set by the market, which ensures that all
buyers and sellers have to accept the same
price.
marginal revenue is equal to the price, which
is a key concept in profit maximization.
marginal cost is equal to the price, which is a
key concept in profit maximization.
7. A perfectly competitive firm will maximize
its profits by producing at the level of output
where marginal revenue equals marginal cost,
which ensures that the firm is producing at the
most efficient level.
average revenue is equal to the price, which is
a key concept in profit maximization.
average cost is less than the price, which
Chapter seven ➜ pure monopoly
Outcome ➜ Understand and analyze monopoly's profit
maximazing behaviour
A pure monopoly is a market structure in which there is

only one seller of a particular product or service, and
there are no close substitutes available. This gives the
monopolist significant market power, as it can control
the price of its product or service.
In order to maximize profits, a monopolist needs to

produce at the level of output where marginal revenue
equals marginal cost. Marginal revenue is the additional
revenue earned by selling one more unit of output,
while marginal cost is the additional cost of producing
one more unit of output. The monopolist will continue
to produce as long as the marginal revenue is greater
than or equal to the marginal cost.
However, unlike in a perfectly competitive market, a

monopolist can charge a price higher than the marginal
cost, which allows it to earn economic profits. The
monopolist will charge the highest price that consumers
are willing to pay, which is determined by the demand
curve for its product or service.
In a pure monopoly, the demand curve is downward

sloping, which means that as the price increases, the
quantity demanded decreases. The monopolist will
choose the price and quantity that maximizes its profits,
which occurs where the marginal revenue equals the
marginal cost. However, the price charged will be higher
than the marginal cost, which means that the
monopolist will earn economic profits.
In addition to setting the price and quantity, a
monopolist can also engage in price discrimination,
which involves charging different prices to different
groups of consumers. This allows the monopolist to
capture more of the consumer surplus, which is the
difference between the price that consumers are willing
to pay and the price that they actually pay.
Overall, a monopolist's profit maximizing behavior

involves producing at the level of output where
marginal revenue equals marginal cost, and charging
the highest price that consumers are willing to pay. This
allows the monopolist to earn economic profits, which
is a key characteristic of a pure monopoly market
structure.
Exercise
1. A monopolist produces and sells 500 units of
output per year at a price of $10 per unit. Its total
cost function is given by TC = 2000 + 4Q, where Q is
the quantity produced. What is the monopolist's
profit?
Answer: The monopolist's total revenue is TR = P ×
Q = ($10/unit) × (500 units) = $5,000. Its total cost
is TC = $2,000 + ($4/unit) × (500 units) = $4,000.
Therefore, its profit is π = TR - TC = $5,000 - $4,000
= $1,000.
2. If the monopolist in question 1 were to produce

and sell an additional unit of output, what would
happen to its total revenue and marginal revenue?
Answer: If the monopolist were to produce and
sell an additional unit of output, its total revenue
would increase by the price of that unit, or $10. Its
marginal revenue would be equal to the change in
total revenue divided by the change in quantity
sold, which would also be $10 since each
additional unit sold earns a price of $10.
3. How can we determine the monopoly price and

quantity for a firm with a linear demand curve?
Answer: To determine the monopoly price and
quantity for a firm with a linear demand curve, we
need to find the point on the demand curve where
marginal revenue equals marginal cost. This occurs
where the slope of the demand curve is equal to
twice the slope of the cost curve (since MR = P(1 +
1/ε), where ε is the price elasticity of demand).
The quantity produced at this point gives us our
monopoly quantity, while plugging this into our
demand curve allows us to find our monopoly
price.
4. A monopolist has a fixed cost of $100 and faces

a linear demand curve given by P = 10 - Q. What is
the monopolist's profit-maximizing quantity and
price?
Answer: The monopolist's marginal revenue is
given by MR = 10 - 2Q, while its marginal cost is
constant at MC = 0 (since it only has fixed costs).
Setting MR equal to MC gives us 10 - 2Q = 0, or Q =
5. Plugging this into our demand curve gives us P =
5, so the monopolist's profit-maximizing output
level and price are Q = 5 and P = $5/unit.
5. If a monopolist faces a downward-sloping

demand curve, why does it have to lower its price
in order to sell more units of output?
Answer: A monopolist faces a downward-sloping
demand curve, which means that in order to sell
more units of output, it must lower the price for all
units sold (i.e., engage in price discrimination)
since each additional unit sold will earn less
revenue due to lower marginal revenue from
decreased prices.
6. How does a natural monopoly arise?

Answer: A natural monopoly arises when a single
firm can produce a good or service at a lower cost
than any potential competitor due to economies of
scale. This can occur when fixed costs are high
relative to variable costs, such that spreading
these fixed costs over larger levels of production
leads to lower average total costs.
7. Can a monopolist ever benefit consumers? If so,

how?
Answer: In some cases, a monopolist may be able
to benefit consumers if it uses its market power to
innovate and develop new products or
technologies that improve consumer welfare.
Additionally, a monopolist may be able to achieve
efficiencies through economies of scale that allow
it to reduce costs and pass on these savings to
consumers in the form of lower prices or better
quality products. However, such benefits are
relatively rare and often outweighed by the
negative effects of monopoly power on
competition and consumer welfare.
Question
AI GPT Assistant:
Sure, here are 20 multiple choice questions based
on Chapter 7 of Microeconomics:
1. A pure monopoly is a market structure in which

there is:
a) One buyer and many sellers
b) One seller and many buyers
c) Many buyers and sellers
d) Few buyers and sellers
2. In a pure monopoly, the monopolist has:

a) Significant market power
b) No market power
c) Limited market power
d) No control over the price
3. In a pure monopoly, the demand curve is:

a) Horizontal
b) Upward sloping
c) Downward sloping
d) Vertical
4. A monopolist will maximize its profits by

producing at the level of output where:
a) Total revenue is maximized
b) Marginal revenue equals marginal cost
c) Average revenue equals average cost
5. In a pure monopoly, the monopolist can charge
a price:
a) Equal to the marginal cost
b) Lower than the marginal cost
c) Higher than the marginal cost
d) Unrelated to the marginal cost
6. In a pure monopoly, the price charged by the

monopolist is determined by:
a) The government
b) The market
c) The monopolist
d) The buyers
7. In a pure monopoly, the monopolist will earn

economic profits because:
a) It produces at the most efficient level
b) It charges a price equal to the marginal cost
c) It charges a price higher than the marginal cost
d) It produces at the level of output where total
cost is minimized
8. In a pure monopoly, the monopolist's demand

curve is:
a) Horizontal
b) Upward sloping
c) Downward sloping
d) Vertical
9. In a pure monopoly, the monopolist's marginal

revenue curve is:
a) Horizontal
b) Upward sloping
c) Downward sloping
d) Vertical

cost curve is:
a) Horizontal
b) Upward sloping
c) Downward sloping
d) Vertical
11. In a pure monopoly, the monopolist will

produce at the level of output where:
a) Marginal revenue equals marginal cost
b) Average revenue equals average cost
c) Total revenue is maximized
12. In a pure monopoly, the monopolist's price

elasticity of demand is:
a) High
b) Low
c) Unrelated to the price
d) Unrelated to the quantity demanded
13. In a pure monopoly, the monopolist can

engage in:
a) Price discrimination
b) Price fixing
c) Collusion
d) Monopsony
14. Price discrimination involves:
a) Charging the same price to all consumers
b) Charging different prices to different groups of
consumers
c) Charging a price equal to the marginal cost
d) Charging a price higher than the marginal cost
15. In a pure monopoly, the monopolist's profit

maximizing behavior involves:
a) Producing at the level of output where marginal
revenue equals marginal cost
b) Charging the highest price that consumers are
willing to pay
c) Engaging in price discrimination
d) All of the above
16. In a pure monopoly, the monopolist's
economic profits will:
a) Be zero in the long run
b) Be positive in the long run
c) Be negative in the long run
d) Be unrelated to the long run
17. In a pure monopoly, the monopolist's market

power is due to:
a) Barriers to entry
b) Many close substitutes
c) Perfect information
d) Low production costs

deadweight loss is due to:
a) Underproduction
b) Overproduction
c) Perfect competition
d) Price discrimination
19. In a pure monopoly, the monopolist's social

welfare is:
a) Higher than in perfect competition
b) Lower than in perfect competition
c) The same as in perfect competition
d) Unrelated to perfect competition
20. In a pure monopoly, the monopolist's price and

quantity are:
a) Higher than in perfect competition
b) Lower than in perfect competition
c) The same as in perfect competition
d) Unrelated to perfect competition
Answers:
1. b) One seller and many buyers
2. a) Significant market power
3. c) Downward sloping
4. b) Marginal revenue equals marginal cost
5. c) Higher than the marginal cost
6. c) The monopolist
7. c) It charges a price higher than the marginal
cost
8. d) Vertical
9. c) Downward sloping
10. b) Upward sloping
11. a) Marginal revenue equals marginal cost
12. b) Low
13. a) Price discrimination
14. b) Charging different prices to different groups

of consumers
15. d) All of the above
16. a) Be zero in the long run
17. a) Barriers to entry
18. a) Underproduction
19. b) Lower than in perfect competition
20. a) Higher than in perfect competition
Reasons:
1. A pure monopoly is a market structure in which
there is only one seller of a particular product or
service, and there are no close substitutes
available.
2. In a pure monopoly, the monopolist has
significant market power, as it is the only seller in
the market.
3. In a pure monopoly, the demand curve is
downward sloping, which means that as the price
increases, the quantity demanded decreases.
4. A monopolist will maximize its profits by
producing at the level of output where marginal
revenue equals marginal cost, which ensures that
the firm is producing at the most efficient level.
5. In a pure monopoly, the monopolist can charge
a price higher than the marginal cost, which allows
it to earn economic profits.
6. In a pure monopoly, the monopolist determines
the price charged, which gives it significant market
power.
7. In a pure monopoly, the monopolist will earn
economic profits because it charges a price higher
than the marginal cost.
8. In a pure monopoly, the monopolist's demand
curve is vertical, which means that the monopolist
can charge a higher price for a lower quantity.
revenue curve is downward sloping, which means
that the monopolist has to lower the price to sell
more units.
cost curve is upward sloping, which means that the
cost of producing additional units increases.
11. In a pure monopoly, the monopolist will
produce at the level of output where marginal
revenue equals marginal cost, which ensures that
the firm is producing at the most efficient level.
12. In a pure monopoly, the monopolist's price
elasticity of demand is low, which means that a
change in price will not significantly affect the
quantity demanded.
13. In a pure monopoly, the monopolist can
engage in price discrimination, which involves
charging different prices to different groups of
consumers.
14. Price discrimination involves charging different
prices to different groups of consumers, which
allows the monopolist to capture more of the
consumer surplus.
15. In a pure monopoly, the monopolist's profit
maximizing behavior involves producing at the
level of output where marginal revenue equals
marginal cost, charging the highest price that
consumers are willing to pay, and engaging in price
discrimination.
economic profits will be zero in the long

Microeconomics Part L

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Microeconomics Part L

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Chapter 1 ➜ theory of consumers behavior and demand

Outcome ➜ understand the neoclassical theory of consumer behavior, how

1. The neoclassical theory of consumer behavior is based on the idea

The theory assumes that consumers have a set of preferences that

The budget constraint is the set of all possible combinations of goods

The theory also assumes that consumers have a diminishing marginal

Overall, the neoclassical theory of consumer behavior provides a

2. Consumers can make decisions to maximize their utility by

To illustrate this principle, let's consider an example. Suppose a

| Books | Movies | Total Utility |

To maximize their utility, the consumer should allocate their spending

Suppose the consumer has already consumed 2 books and 0 movies,

In this example, the consumer should consume 6 books and 2 movies,

Answer: Using the formula for price elasticity of demand, we have:

E = (% change in quantity demanded) / (% change in price)

-2 = (% change in quantity demanded) / (20%)

% change in quantity demanded = -40%

The new quantity demanded is:

100 - (40% of 100) = 60 units

Answer: Using the formula for price elasticity of demand, we have:

E = (% change in quantity demanded) / (% change in price)

-1.5 = (% change in quantity demanded) / (-20%)

% change in quantity demanded = 30%

The new quantity demanded is:

200 + (30% of 200) = 260 units

3. If the price of a good is $20 and the quantity demanded is 50 units,

Answer: Using the formula for price elasticity of demand, we have:

E = (% change in quantity demanded) / (% change in price)

E = (40 - 50) / ((40 + 50) / 2) / (25 - 20) / ((25 + 20) / 2)

Answer: Using the formula for price elasticity of demand, we have:

E = (% change in quantity demanded) / (% change in price)

-1.2 = (% change in quantity demanded) / (20%)

% change in quantity demanded = -24%

The new quantity demanded is:

100 + (-24% of 100) = 76 units

5. If the price of a good is $50 and the quantity demanded is 20 units,

Answer: Using the formula for price elasticity of demand, we have:

E = (% change in quantity demanded) / (% change in price)

-0.8 = (5 / 22.5) / (% change in price)

% change in price = -11.25%

The new price is:

$50 - (-11.25% of $50) = $44.38

2. The neoclassical theory of consumer behavior assumes that

3. The budget constraint is the set of all possible combinations

4. The law of demand states that as the price of a good or

5. The principle of marginal utility states that consumers

7. The law of diminishing marginal utility states that as a

9. The principle of rational choice states that consumers

11. The marginal rate of substitution is the rate at which a

12. The income effect of a price change refers to the change in

14. The market demand curve is the horizontal sum of the

In microeconomics, decision-making under risk and

To make rational decisions under risk, the decision-maker

To illustrate this concept, let's consider an example. Suppose a

To make rational decisions under uncertainty, the decision-

To illustrate this concept, let's consider an example. Suppose a

In summary, to make rational decisions under risk and

2. A company has two investment options: Option

3. A company has two investment options: Option

4. A company has two investment options: Option

5. A company has two investment options: Option

3. The expected value of a decision is calculated by: