Consumer Theory

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Where does a consumer reach equilibrium on a graph showing the budget line and
indifference curve?
A) At the point where the budget line is tangent to the indifference curve
B) At the point where the budget line intersects the indifference curve
C) At the point where the budget line is parallel to the indifference curve
D) At the point where the budget line is perpendicular to the indifference curve
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Answers:
1. D (Budget line becomes steeper means: Price of good X has increased resulting in

a lower quantity of good X. Hence the correct option is D.)

2. C (Since prices have fallen for good X, consumer will substitute more of their

income to purchase good X. Hence option C. Additional information: Point G to

Point H shows income effect.)

3. D (Every point on the indifference curve yields the same level of satisfaction.

Hence, all points are equally desirable.)

4. B (First chocolate bar because MU of chocolate bar is greater than MU of toffee

bars. Second chocolate bar because MU of second chocolate bar is greater than

MU of first toffee bar. Now, a toffee bar will be selected as MU Of toffee bar is

greater than MU of third chocolate bar. Hence, 2 chocolate bars and 1 toffee bar

will be selected.)

5. A (Fall in price of G has resulted in a pivotal shift in the budget line. Substitutional

effect = X to Y Income effect = Y to Z Consumer is now also consuming more of

good F, indicating that G is an inferior good.)

6. A (Price of good Y must have been fallen. Price of good C must have risen.)

7. C ($1 is giving 3 utils. So, $4 will be giving 12 utils. Let’s see till which quantity of

good will create 12 utils of marginal utility. From good 1 to good 2, MU is 16 utils,

from 2 to 3 unit, MU is 14 utils, then from 3 to 4 units, the MU is 12 utils. Beyond

this unit, the consumer would not be willing to go.)

8. A (By observing the total utility curve, we can determine the individual's marginal

utility curve, which is the slope of the total utility curve. The marginal utility curve

shows the change in utility the individual receives from consuming additional

units of the good.)

9. B (At S, consumer is consuming 20 units of X, exhausting his complete budget.

This means that the price of good X will be $120 / 20 units = $6. Similarly, at P,

only 12 units of Y are being consumed. So, $120 / 12 units = $10.)

10. A (As an individual consumes more units of a good, the marginal utility from each

additional unit tends to decrease. When the marginal utility of a good decreases,

the individual is willing to pay a lower price for an additional unit of the good, and

therefore their demand for the good decreases at higher prices. This relationship

between price and quantity demanded is reflected in the downward slope of the

demand curve.)

11. B (Since there is a change in good Y from M to N, the price for good Y have fallen.

And since, the quantities of good X have reduced from M to N, this means prices

of good X have increased. Since price of good Y have increased, the consumer

would want to increase the quantities of good Y. B is the only option on the new

budget line NN)

12. A (Since price of X has fallen, consumer income will rise. The consumer might

consume more of X. However, good X is a giffen good, an increase in income

won`t motivate consumers to allocate more of their money towards them and

they will be more likely to consume the other good. Hence, the correct answer is

Option A)

13. D (This is the formula that has been rearranged: MUx / Px = MUy / Py)

14. B (In case of perfect substitutes, the indifference curves are parallel straight

lines because the consumer equally prefers the two goods and is willing to

exchange one good for the other at a constant rate)

15. B (When the price of a good falls, ceteris paribus (assuming all other factors

remain the same), the consumer will have an increased incentive to buy more of

that good. This results in a movement along the consumer's demand curve rather

than a shift in the demand curve itself. The consumer's demand curve shows the

relationship between the price of a good and the quantity of that good that the

consumer is willing and able to purchase at each price. A fall in the price of the

good will result in a movement along the same demand curve, as the consumer

responds to the lower price by buying more of the good. Therefore, the correct

answer is B a movement along the consumer's demand curve)

16. C (F to G represents substitution effect)

17. B (A: The indifference curves for inferior goods slope downward from left to right,

meaning as the quantity of an inferior good increases, the total utility derived

from the good decreases. The curves do not show higher satisfaction on lower

curves.

B: The marginal rate of substitution (MRS) is the amount of one good a consumer

is willing to give up obtaining an additional unit of another good, while remaining

indifferent or achieving the same level of satisfaction. Indifference curves for

normal goods are convex to the origin, showing a diminishing marginal rate of

substitution, meaning the consumer is willing to give up fewer units of one good

as the quantity of that good increases.

 C: Indifference curves for perfect complements are shaped like L-shaped or right-

angled, and they do not go through the origin. These curves show that the goods

are always consumed in fixed proportions, with no substitution between them.

D: Indifference curves for perfect substitutes are straight lines, and they do not

form right angles)

18. B (Since the utility he gets from spending one dollar is 4 utils, he will get 40 utils if

he spends $10. See the number of kilos he will purchase when the utility is 40.

That is 5 kilos. Hence the answer is B)

19. A (A consumer wants to operate on a higher IC. So if he moves from point Q to R,

he is acting rationally meaning he is acting logically/sensibly)

20. C (A is wrong because for inferior goods income and substitution effect works in

opposite directions.

B is wrong because income effect does not outweigh substitution effect in case

of giffen good.
D is wrong because for normal goods income and substitution effect works in the

same direction. Hence C is the correct answer. This is graphically shown below:
21. D (In case of an inferior goods, even if the price of good X falls, the income effect

outweighs the substitution effect. You can refer to the graph above for inferior

goods for better idea)

22. D (Paradox of value concept. The observation that the amount of water

consumed is lower when a price per liter is used implies that as the price of water

increases, the additional satisfaction (utility) gained from consuming each

 additional liter decreases. This is a classic example of the law of diminishing

marginal utility, where the first units of a good consumed provide a high level of

satisfaction, but each subsequent unit provides less and less satisfaction. So,

when people must pay more for water, they are likely to use less of it, as the

marginal utility of each additional liter becomes smaller.)

23. D (the slope of the budget line represents the trade-off between the two goods,

and changes in the price of one of the goods affects this trade-off.)

24. D (The total amount of income that could be spent by the households is same at

all the points on the budget line)

25. A (Preferences are assumed to be constant while drawing the budget line)

26. A (In the case of the 'eat all you can' banquet, as a person eats more and more

food, the additional satisfaction or utility gained from each additional course will

eventually decline. By the time they reach the final course, they are likely to be

feeling full, and the additional satisfaction gained from the final course is likely to

be relatively low compared to the earlier courses. This illustrates the law of

diminishing marginal utility, as the additional satisfaction gained from each

additional course of food declines as more and more courses are consumed.

Option B, the last coin to complete an enthusiast's coin collection, may not be the

best example of the law of diminishing marginal utility because it is possible that
the satisfaction or utility gained from each additional coin added to the collection

remains constant or even increases. For example, the last coin may be

particularly rare or valuable, which could result in a high level of satisfaction or

utility for the collector.

Option C, the second of the two rolls of wallpaper needed to decorate a room,

may not be the best example of the law of diminishing marginal utility because it

assumes that the additional utility or satisfaction gained from each additional roll

of wallpaper is declining, which may not necessarily be the case. It is possible that

the second roll of wallpaper is just as important as the first roll in achieving the

desired outcome of a well-decorated room.

Option D, the tenth driving lesson needed to enable a learner to pass the driving

test, may not be the best example of the law of diminishing marginal utility

because it assumes that the additional utility or satisfaction gained from each

additional driving lesson is declining, which may not necessarily be the case. It is

possible that the tenth driving lesson is just as important as the first lesson in

preparing the learner for the driving test. Additionally, passing the driving test

may result in a significant increase in utility, which would not be consistent with

the law of diminishing marginal utility.)

27. B (Only if the price of X increase, the consumer will be consuming less of good X.

Whereas, if the price of good Y falls, the consumer will be willing to buy more of

good Y)

28. D (A consumer will be willing to operate on a higher indifference curve as it

shows more satisfaction)

29. A (In case of giffen goods, substitution effect is positive but income effect is

negative)
30. A (When total Utility increases by a decreasing rate, it shows the MU is

diminishing i.e., at 3)

31. C (When price of X rise, the quantities for good X will decrease from Q to R. There

is no change in price of good Y that results in a pivotal shift. Pivotal shifts are due

to a change in price and not due to changes in income)

32. C (Substitution effect is shown from X1 to X2. Income effect is from X2 to X4.

Hence C is the answer)

33. A (As the MU of the consumer is lower at Q1 than Q0, the consumer will naturally

be willing to pay more at Q0 than Q1)

34. B (Complete shifts are caused due to change in income whereas pivotal shifts are

caused due to changes in price. A successful advertising campaign for good Y will

persuade the consumer to buy more of good Y. Hence, the individual will allocate

more of his resources towards the consumption of good Y, reducing his

consumption of good X)

35. A (At the point where the budget line is tangent to the indifference curve)

36. B (As employment increases, the capital-labor ratio falls, which leads to

diminishing marginal returns to labor. The capital-labor ratio measures the

amount of capital available per worker, and as employment increases, the

amount of capital per worker decreases. This leads to diminishing marginal

returns because the workers are becoming less and less productive, as they must
 share a smaller and smaller amount of capital. So, as employment increases, the

capital-labor ratio falls, and the law of diminishing returns is observed.)

37. C (Average cost equals total costs divided by the number of units produced. At

unit 1, total cost is $60, avg cost is also $60. At unit 2, total cost is $50, avg cost is

$25. At unit 3, total cost is $30, avg cost is $10. At unit 4, total cost is $30, avg

cost is $7.5. At unit 4, total cost is $70, avg cost is $14. Hence, the level of output

that minimizes average total cost is 4)

38. B (In many industries, firms specialize in certain components or inputs that are

used in the final product. Larger firms may choose to outsource the production of

these components to smaller firms that specialize in them, rather than producing

everything in-house. This can lead to the coexistence of both large and small

firms in the same industry)

39. C (It is possible that the firm may not change its price or output if it changes its

objective from sales volume maximization to revenue maximization while

retaining the same minimum profit constraint. If the firm is already producing at

a point where its marginal revenue equals its marginal cost, then changing its

objective to revenue maximization may not require any changes in price or

output.)

40. D (This is the graph of MP and AP which we did in class!)

41. B (The firm will produce quantities OJ.)

42. B (Profit maximization is the standard assumption for the primary objective of a

firm in economics. However, in some cases, a firm's objective may deviate from

profit maximization, particularly if there are many shareholders and few paid

managers. In this case, the managers may have personal goals that are not

directly tied to profit, such as power, prestige, or personal enjoyment from

running the firm. They may also be motivated by non-financial incentives, such as

social responsibility, or a desire to provide a certain type of product or service.

These personal goals may take priority over profit maximization, leading to

different decisions and outcomes than if profit were the only objective.)

43. C (A firm is maximizing profit and producing at the minimum point on its AC, this

means the firm is not making normal profit.)

44. B (Price discrimination requires different price sensitivity (elasticity of demand)

among different consumer groups, so that a seller can charge different prices for

the same good or service to maximize revenue. The seller charges a higher price

to consumers with less price-sensitive demand, and a lower price to those with

more price-sensitive demand.)

45. C (To maximize total revenue, the firm should produce at the output level where

marginal revenue equals zero. This is because total revenue is maximized at the

output level where marginal revenue is zero and any further increase or decrease
 in output would result in a decline in total revenue. Therefore, the correct

answer is C - increase the firm's output to where marginal revenue is zero.

Decreasing the firm's output to where marginal revenue equals average revenue

(option A) or decreasing the product's price to where average revenue is zero

(option B) will not maximize total revenue, as these strategies do not take into

account the relationship between marginal revenue and total revenue.

Increasing the product's price to where marginal revenue equals average revenue

(option D) will not necessarily maximize total revenue either, as it depends on the

price elasticity of demand for the product. If the demand is relatively elastic, a

price increase may result in a decrease in total revenue. Therefore, option C is

the most effective strategy to maximize the total revenue of the firm)

46. B (JLN is the long run average cost curve as it envelops the other curve)

47. C (The kinked demand curve model of oligopoly attempts to explain why firms in

an oligopolistic market tend to maintain price stability despite fluctuations in

costs and demand. The model suggests that each firm faces a demand curve that

is relatively elastic above the current price and relatively inelastic below the

current price, creating a kink in the demand curve. This kink arises from the

assumption that firms expect their rivals to match any price reductions but not
 price increases. However, the model does not explicitly explain how the

equilibrium market price is determined. Instead, it focuses on how firms behave

and interact with each other in the market.)

48. C (At MR = M, profit maximization. At AR = AC; sales maximization. Hence the old

profit was P1HGF while the new profit will be P2KLF)

49. B (When demand is inelastic, a change in quantity demanded is proportionally

smaller than the change in price. This would cause the total revenue to decrease

when the output increases, as the increase in quantity demanded will not be

sufficient to compensate for the fall in price.)

50. A (The profit maximizing level of output is where MR = MC. Since P = ATC, the

monopoly is making normal profit.)

P
51. B (Risk bearing economies of scale refers to greater diversification as risks has

expanded)

52. C (One strategy a firm could use to eliminate competition and become a

monopoly is to engage in predatory pricing. This involves setting prices so low

that competitors are unable to compete, forcing them to exit the market. Once

the competitors are gone, the firm can raise prices to monopoly levels and

maintain its dominant market position. By reducing prices, the firm is able to

attract customers away from competitors, which can lead to increased market

share and eventually, a monopoly position.)

53. C (The principal-agent problem is a conflict of interest between a principal

(shareholders) and their agent (directors of the company), where the agent may

act in their own interests rather than the principal's interests. This can cause a

separation of ownership and control in a firm)

54. D (The kinked demand curve theory implies that there is a tendency towards

price stability. This is because firms are reluctant to raise their prices, due to the

fear of losing market share to their competitors. Therefore, the theory suggests

that firms operating in an oligopolistic market are likely to maintain their prices at

a stable level, rather than engage in price wars.)

55. D (Profit is maximized at MR = MC. The ATC are at K so JK multiplied by OQ)

56. A (While improving management control and co-ordination can be a potential

benefit of growth, it is not typically the primary motivation for a firm to seek

growth.)

57. C (Profit maximization occurs when marginal revenue (MR) equals marginal cost

(MC).

Sales maximization occurs when marginal cost equals marginal revenue, which

results in producing at a higher output level than the one that maximizes profits.

This can be a goal of a firm in some cases where it seeks to increase market share

and deter potential competitors.

Satisficing refers to a situation where a firm aims to achieve satisfactory

performance, rather than to maximize profit or output. It occurs when a firm sets

a target level of profit or output and seeks to achieve that level, rather than

trying to maximize beyond that level.

Sales revenue maximization occurs when marginal revenue is equal to zero,

meaning the firm produces the quantity of output where it earns the maximum

amount of total revenue. This can be a goal of a monopoly that seeks to

maximize revenue, rather than profit or output.)

58. A (The FC of this firm is 120. The average fixed cost of producing 6 units is 20.)

59. B (In a contestable market, the threat of potential competition can limit the

market power of existing firms. Therefore, a firm operating in a contestable

 market is likely to set its price based on the threat of entry from new

competitors.

Option B, "It will set a price to deter the entry of new firms," is the most accurate

answer. By setting a price that is too low, the existing firm risks attracting new

entrants who can compete on price, eroding the existing firm's profits. On the

other hand, by setting a high price, the existing firm can deter potential entrants

from entering the market, as it makes it less attractive to compete in the market.

Options A, C, and D are not necessarily true in a contestable market. In a

contestable market, the firm's goal is not necessarily to maximize revenue or

sales in the short run, but rather to maintain a sustainable profit margin while

deterring new entrants from entering the market. Therefore, the answer is B, "It

will set a price to deter the entry of new firms.")

60. D (The demand curve of oligopoly is like this because of the response of rival

firms that might come as the said firm changes its price. If one firm raises its

price, the other firms will not follow. They will stick to the prevailing price P1.

However, if the firm reduces its prices, this will result in price wars.)

61. C (The main difference is that products in monopolistic competition are

differentiated, while in perfect competition, they are identical.)

62. A (Regulation refers to the use of government policies to limit or control the

behavior of firms in a market. In the context of reducing the abuse of monopoly

 power, regulation typically involves imposing restrictions on the behavior of

monopolies to prevent them from charging excessive prices or engaging in

anticompetitive behavior.

Option A, legislation to forbid price fixing by cartels, is an example of regulation.

Price fixing occurs when a group of firms agrees to set prices at a certain level,

which can be anticompetitive and result in higher prices for consumers.

Legislation to forbid price fixing by cartels is an example of regulatory

intervention to prevent anticompetitive behavior by firms.

Option B, removal of import tariffs, is an example of a trade policy measure that

can increase competition in a market, but it is not a form of regulation.

Option C, subsidizing small firms, is a form of government intervention in the

market, but it is not a form of regulation to reduce the abuse of monopoly

power.

Option D, taxation of monopoly profits, is a form of government intervention in

the market, but it is not a form of regulation to reduce the abuse of monopoly

power.)

63. A (A contestable market is a market where there are low barriers to entry and

exit, which means that new firms can enter the market and compete with

existing firms easily. In this case, the market for souvenir products sold to people

walking to the sporting event is a contestable market because street traders are
 able to produce and sell cheaper, unofficial souvenirs without having to pay for

licenses or official approval to sell their products. This competition from street

traders keeps prices lower and makes the market more competitive, despite the

presence of official souvenir products from the organizers of the sporting event.)

64. C (The short-run production function is a relationship between the quantity of

inputs used and the quantity of output produced by a firm in the short run. It

assumes that at least one factor of production is fixed (usually capital), while the

other factors of production (usually labor) are variable. In addition to this

assumption, the state of technology is also assumed to be fixed in the short run.

In the short run, a firm can increase output only by varying the quantity of the

variable input(s), given that the fixed input(s) cannot be changed. Therefore, the

level of technology used to transform inputs into outputs is assumed to be fixed

in the short run.

Option A, "All factors of production are fixed," is incorrect because if all factors of

production were fixed, the firm would not be able to produce any output in the

short run.
 Option B, "All factors of production are variable," is incorrect because this

assumption applies to the long run, not the short run.

Option D, "The state of technology is variable," is also incorrect because changes

in technology are assumed to occur in the long run, not the short run.)

65. D
66. A (The fixed costs of this firm is $40. The variable cost for 1 unit of output is 15.

For the second and third unit its 5. For the fourth unit its 15 again. The total

variable cost is $40. The average variable cost for 4 units is $10.)

67. D (Perfectly contestable markets are characterized by zero barriers to entry and

exit, allowing firms to enter and exit the market easily and quickly. This means

that potential competitors can enter the market without incurring any additional

costs, and existing firms can leave the market without facing any significant costs.

This condition ensures that there is no market power held by any individual firm,

and that firms are forced to operate as if they are in a perfectly competitive

market, where price is equal to marginal cost.

The other options, such as A (all firms in the industry are price-takers), B (all firms

in the industry produce an identical product), and C (there are a large number of

firms in the industry) are characteristics of perfectly competitive markets, but

they are not sufficient conditions for a market to be perfectly contestable. For

example, a market may have a large number of firms producing identical

products and still have significant barriers to entry or exit.)

68. C (This is the graph of an oligopolistic firm. Refer to the class lecture if you have

any issues on how the graph look like.)

69. A (In the long run, both perfect competition and monopolistic competition result

in zero economic profit, where the price equals the average total cost of
production. However, the two market structures differ in terms of their efficiency

and the level of competition.

In perfect competition, firms are price takers, producing at the minimum point of

their average total cost curves, leading to productive efficiency. Furthermore,

due to the existence of numerous firms in the market, consumers are not willing

to pay a premium for differentiated products, leading to allocative efficiency.

In contrast, in monopolistic competition, firms produce differentiated products,

which can be perceived as substitutes but are not perfect substitutes, leading to

some market power. As a result, firms in monopolistic competition may produce

at a point of excess capacity, where their average total cost curve is not

minimized, leading to lower productive efficiency compared to perfect

competition.

Therefore, the most likely outcome when comparing the long-run equilibrium

outcome in monopolistic competition with that in perfect competition is a

greater degree of excess capacity in monopolistic competition. Option A is the

correct answer. Option B is incorrect because in the long run, economic profit is

zero in both market structures. Option C is also incorrect because monopolistic

competition generally has fewer firms than perfect competition. Option D is not

necessarily true, as the elasticity of demand depends on the specific

characteristics of the products and the market.)

70. B (This is an example of lateral integration)

71. C (In perfect competition, firms produce at the minimum point of their average

total cost curves, resulting in productive efficiency, where marginal cost (MC)

equals average total cost (ATC). In contrast, in imperfect competition, firms have

some degree of market power, which allows them to charge a price above

marginal cost.

In the long run, firms in imperfect competition adjust their output and price to

achieve zero economic profit, where price equals average total cost. However,

since the price is above the marginal cost, the marginal cost curve will be below

the average total cost curve at the profit-maximizing level of output. Thus, option

C is the correct answer.

Option A, supply is elastic, is a characteristic of perfect competition where firms

have no market power and can adjust their output easily in response to changes

in price. In imperfect competition, firms may have some market power and

therefore may not be able to adjust their output as easily.

Option B, demand is inelastic, is not a necessary condition for imperfect

competition, as the elasticity of demand depends on the specific characteristics

of the products and the market.

Option D, average revenue will be below marginal revenue, is true for all firms,

regardless of whether they are in perfect or imperfect competition. This is

 because, in order to sell more units, a firm must lower the price for all units sold,

which decreases the average revenue for all units sold. Therefore, marginal

revenue is always below average revenue.)

72. C (A firm is allocatively efficient at MC = AR).

73. D (Standardization of the industry's product means that all companies in the

industry produce the same product with little or no variation. This makes it

difficult for small firms to differentiate themselves and stand out from the

competition.)

74. A (When a firm operates at the maximum point on its average product curve, it is

producing at the most efficient level of output for the given level of variable

inputs. This means that the firm is able to produce more output with the same

level of variable inputs, resulting in a lower average variable cost. Therefore, the

average variable cost is at a minimum at the point where the firm is producing at

the maximum point on its average product curve.)

75. B (In this scenario, the dominant firm is setting up a research institute to carry

out new product development. This can be seen as an example of non-price

competition, as the firm is investing in research and development to create new

products and gain an advantage over its rivals.

At the same time, this project can also be seen as an example of creating barriers

to entry, as the research institute may require significant investment and

 expertise, making it more difficult for new firms to enter the market and compete

with the dominant firm.

Option A, collusion, refers to an illegal agreement between firms to fix prices or

reduce output to increase profits, which is not present in this scenario.

Option C, non-price competition and price leadership, does not fully capture the

feature of creating barriers to entry that is present in this scenario.

Option D, price leadership and collusion, is also incorrect, as there is no mention

of collusion in the scenario.)

76. D (Nudge theory uses the principles of behavioral psychology to persuade

individuals to make choices that are in their best interests or the interests of

society.)

77. D (The starting part of the demand curve is elastic, this means that as prices fall

and output increases, total revenue will rise. The second part of the demand

curve is inelastic, which means that when prices fall, there is a reduction in the

total revenue curve.)

78. D (Shortages of the good are often an undesirable side effect of imposing a

maximum price on certain goods that is below the free market price. When the

government sets a maximum price, it creates a situation where the quantity

demanded of the good exceeds the quantity supplied. This creates a shortage of

the good as consumers are willing to buy more of the good at the lower price,
 while producers are unwilling to supply as much of the good at the lower price

since it is less profitable. The shortage of the good can lead to long lines, black

markets, and other inefficiencies. Additionally, producers may shift their focus to

producing goods that are not subject to price controls, leading to a reduction in

the supply of the controlled good.)

79. A (In the long run, all inputs are variable, and firms can enter or exit the market

as needed. In a perfectly competitive market, this entry and exit of firms will

continue until each firm is operating at the minimum point on its average total

cost curve, where average costs are at a minimum. This means that each firm is

producing at the most efficient level possible, given the market conditions, and

cannot lower its costs any further. At this long-run equilibrium point, firms earn

only normal profits, which is the minimum amount of profit necessary to keep a

firm in business. Therefore, in the long-run equilibrium of a perfectly competitive

market, each firm produces at the output level where its average costs are at a

minimum.)

80. A (If a firm estimates that an increase in its output will result in an equal

proportionate increase in its revenue, this implies that the firm faces a perfectly

elastic demand curve. Therefore, option A is correct, i.e., the demand curve for

the firm's product is horizontal. A perfectly elastic demand curve means that the
 firm can sell as much output as it wants at the market price, and any increase in

production will not affect the market price.)

81. A (The increase in sales revenue maximization may lead to the firm lowering the

price of its products to increase demand, which may benefit consumers in the

short run. The shift from profit maximization to sales revenue maximization may

negatively affect shareholders in the short run. The focus on increasing sales

revenue may lead to lower profits, which could result in a decrease in

shareholder dividends or a lower stock price. Additionally, if the firm incurs

additional costs to increase sales revenue, such as advertising or offering

discounts, this could further reduce profits and negatively impact shareholder

value.)

82. A (The minimum efficient scale (MES) of production is the lowest level of output

at which a firm can produce goods at the lowest possible average cost in the long

run. If the MES is relatively low in an industry, then it is easier for small firms to

compete with larger firms. Small firms can take advantage of lower start-up

costs, lower overheads, and a greater ability to respond quickly to changes in

market conditions. This can allow them to be competitive with larger firms

despite their smaller size.

Option B, "greater scope for specialization and division of labor," is not as strong

a reason for the existence of small firms in various industries compared to a low
 minimum efficient scale of production (option A). While it is true that small firms

can benefit from specialization and division of labor, this advantage is not unique

to small firms. Large firms can also take advantage of specialization and division

of labor, often to a greater extent than small firms due to their larger size and

greater resources. In fact, larger firms often have the advantage of economies of

scale more.

However, option C (the need to diversify in order to reduce risk) and option D

(the principal-agent problem) are less likely to be reasons for the existence of

small firms in various industries. Diversification is often more feasible for larger

firms due to their greater resources and ability to spread risk over a wider range

of activities. The principal-agent problem, which refers to the potential conflict of

interest between managers and shareholders, can occur in both small and large

firms. Therefore, the correct answer is option A, a low minimum efficient scale of

production.)

83. D (In monopolistic competition, firms face a downward-sloping demand curve,

meaning they can increase their sales by lowering their price. This means that the

marginal revenue (MR) for the firm is always less than the price (P), so option C

and D are the possible answers. However, option C can be eliminated as the firm

is making a loss and its average total cost (ATC) exceeds the price, so it cannot be

the case that AR is greater than MR.

 Option D is correct because it states that the average revenue (AR) is greater

than the marginal revenue (MR), but the average variable cost (AVC) is less than

the AR. This condition ensures that the firm is covering its variable costs and

contributing to its fixed costs, even though it is making a loss in the short run. By

continuing to produce in the short run, the firm can hope to earn enough

revenue to cover both variable and fixed costs and eventually earn a profit in the

long run.)

84. C (When the demand is perfectly elastic, the total revenue curve is upward

sloping.)

85. A (This objective refers to the attempt by a firm to minimize its losses in the short

run. In the short run, a firm may be unable to avoid making a loss due to fixed

costs and other factors. Therefore, it may choose to produce at a level where the

marginal revenue is equal to the marginal cost to minimize its loss.)

86. C (While drawing the kinked demand curve, it is assumed that the action of one

firm will affect the other firms in the market (interdependence). If one firm raises

its price, the other firms will not follow (elastic segment of the demand curve)

However, if the firm reduces its prices, this will result in price wars (inelastic

segment of the demand curve).)

87. D (According to the law of variable proportions , as more units of the variable

factor are added to the fixed factor, the total product initially rises at an

increasing rate, then rises at a diminishing rate, and finally may start to decline.

Option A is incorrect because the marginal cost of production is not necessarily

related to the proportion of factors used but is instead related to the change in

total cost resulting from producing one more unit of output.

Option B is also incorrect because it describes the relationship between total

product and the proportion of all factors used, which is not what the law of

variable proportions refers to.

Option C is incorrect because it implies that the marginal cost of production

diminishes as more of a variable factor is added, which is not generally true in the

short run.)

88. C (External growth occurs from mergers and takeovers.)

89. B (The successful advertising campaign is likely to increase the demand for the

firm's product, which could shift the AR curve to the right. As a result, the MR

curve will also shift to the right, reflecting the increase in marginal revenue from

selling an additional unit of the product. The increase in MR will result in a higher

profit-maximizing output level.

 The successful advertising campaign may also affect the firm's cost structure. If

the advertising campaign increases the firm's sales, it could increase the firm's

total AC curve. Hence, the answer is B.)

90. C (When monopolies are prevented from dominating the market, it opens up

opportunities for smaller firms to compete and grow. By promoting greater

competition and preventing the dominance of a few large players, smaller firms

may have a better chance of survival and growth, ultimately leading to an

increase in their numbers.)

91. D (In the short run, if the firm reduces its emphasis on increasing sales revenue

and instead focuses on maximizing profits, it may lead to an increase in prices.

Hence, consumers will loose. Also, in order to maximize profits, firms may reduce

wages. Hence, workers may also loose.)

92. C (When there are low barriers to entry, new firms can easily enter the industry

and compete with existing firms. This makes it difficult for the colluding firms to

maintain high prices and market power. The threat of new entry can act as a

deterrent to collusion, as the colluding firms will not want to lose market share to

new competitors. Therefore, low barriers to entry increase the competition in the

market, which makes collusion less likely to succeed.)

93. A (The theory of contestable markets can be applied to all the market structures

mentioned in option A, which are monopolistic competition, monopoly, and

oligopoly.)

94. D (The law of diminishing returns, also known as the law of variable proportions,

states that as more of a variable input is added to a fixed input (in the short run),

the marginal product of the variable input will eventually decrease. This means

that the increase in output resulting from adding each additional unit of the

variable input will become progressively smaller, eventually reaching zero and

then becoming negative.

This occurs because, in the short run, at least one input is fixed, so as more of the

variable input is added, there will be a point at which the fixed input becomes a

constraint on further increases in output. This leads to a situation in which

additional units of the variable input will not be as productive as the previous

units, leading to the diminishing marginal returns.

Option D correctly states that the proportions in which the factors are combined

will eventually result in progressively smaller increases in output. Therefore, D is

the correct answer.)

95. C (The situation that the firm is facing is a prisoner's dilemma. In a prisoner's

dilemma, two individuals or entities have to make a decision without knowing

what the other will choose, and the outcome depends on the choices made by
 both parties. In this case, Firm X has to decide whether to co-operate with its

rival or not, without knowing what the rival will choose.

If both firms co-operate, they will both earn $2000 a month, for a total joint

profit of $4000. However, if only one firm co-operates, it will earn $0, while the

other earns $4000. If neither firm co-operates, they will both earn $1200 a

month.

Firm X's dominant strategy would be to not co-operate, as that would guarantee

it a profit of $2800 a month if it kept all its customers. However, if the rival

decides to undercut its price and take some of its customers, Firm X's profit

would drop to $1200 a month.

Thus, even though co-operating would be mutually beneficial for both firms, the

uncertainty and lack of trust between them makes it difficult to achieve a co-

operative outcome, leading to a prisoner's dilemma.)

96. A (Rent controls artificially limit the price that landlords can charge for rental

properties. This price ceiling may discourage landlords from investing in the

rental market, as the potential for profit is limited by the price ceiling. As a result,

there may be a decrease in the supply of rental properties over time, as landlords

exit the market or reduce the number of properties they own.

Option B, "The number of unoccupied privately rented houses will increase over

time," is not necessarily a direct consequence of rent controls. It is possible that

 landlords may keep rental properties unoccupied rather than renting them out at

the lower price ceiling, but it is also possible that landlords may choose to rent

out their properties despite the rent control, particularly if they do not have

other viable investment options.

Option C, "The price of owner-occupied houses will increase," is not directly

related to rent controls on rental properties. However, if there is a decrease in

the supply of rental properties, there may be an increase in demand for owner-

occupied housing, leading to an increase in the price of owner-occupied houses.

Option D, "There will be no effect on the supply of the rental housing," is unlikely

to be the case in the long run, as rent controls are likely to discourage investment

in the rental market and lead to a decrease in the supply of rental properties over

time.)

97. D (For a horizontal integration, the industry and stage of production should be

same.)

98. C (OP represents fixed costs. For average fixed costs, fixed costs should be

divided by the output. Hence, the correct answer is OP / OQ.)

99. C (A firm in a perfect competition have a perfectly elastic demand curve. For such

demand curves, total revenue curve is always upward sloping.)

100. A (A natural monopoly occurs when a single firm can provide a good or

service at a lower cost than any potential competitor. This situation arises when
 there are high fixed costs of production and economies of scale that result in

falling average costs over all outputs demanded. As a result, it becomes more

efficient for one firm to supply the entire market rather than having multiple

firms each producing a smaller quantity at a higher cost.

In contrast, legal restrictions on new entrants, a single firm controlling the supply

of raw materials, and a firm having a patent on an essential process are not

necessarily the factors that lead to a natural monopoly. These situations may

contribute to a monopoly or oligopoly, but they do not necessarily result in a

natural monopoly.)

101. B (In an imperfectly competitive industry, firms have some degree of

market power and can influence the market price by their actions. If one firm

increases its advertising spending, it can attract more customers and increase the

overall demand for the industry's product. However, if other firms respond by

increasing their advertising spending, the competition for customers intensifies,

and the market price may not increase enough to offset the increased advertising

costs for each firm.

As a result, the firm that initially increased its advertising spending may

experience a fall in profits despite the overall increase in demand for the

industry's product. This situation is known as the advertising war or the prisoner's
 dilemma in advertising, where each firm tries to gain an advantage over the

others by increasing advertising spending, but all firms end up worse off.

Production being subject to diseconomies of scale, the demand for the industry's

product being price-inelastic, or the increase in demand for the firm's output

being entirely at the expense of other firms may also contribute to the firm's fall

in profits. However, these factors alone do not fully explain the situation

described in the question.)

102. C (Marginal cost is equal to price is the statement about the profit-

maximizing output of the small firms that is correct in an industry consisting of a

dominant firm, which acts as a price leader, and a large number of small firms.

In such an industry, the dominant firm sets the market price, and the small firms

must choose their output levels based on this price. Since the small firms are

price takers, they cannot influence the market price and must produce at the

market price set by the dominant firm.

To maximize their profits, the small firms will produce where their marginal cost

(MC) equals the market price (P), which is also equal to the marginal revenue

(MR) since the small firms are in a perfectly competitive market. Therefore,

option C is correct.
 Option A, average cost being equal to average revenue, is not correct because in

a perfectly competitive market, the price is equal to both average revenue and

marginal revenue, but the average cost is not necessarily equal to either of these.

Option B, average cost being minimized, is not correct because the small firms

will not necessarily produce at the point where their average cost is minimized.

Instead, they will produce where their marginal cost equals the market price.

Option D, marginal revenue being zero, is not correct because in a perfectly

competitive market, the marginal revenue is equal to the market price, which is

positive.)

103. D (The situation that the firm is facing is a prisoner's dilemma. In a

prisoner's dilemma, two individuals or entities have to make a decision without

knowing what the other will choose, and the outcome depends on the choices

made by both parties.

If Firm X acts independently, it can earn either $900 or $400 per week, depending

on its rival's choice. On the other hand, if Firm X works with its rival, the joint

profit of both firms is $1400 per week, which is higher than what Firm X can earn

by acting independently. However, since Firm X does not know what its rival will

do, it must consider the possibility that the rival may choose to act
 independently, in which case Firm X would be better off also acting

independently.

This situation illustrates the prisoner's dilemma because both firms have a

dominant strategy of acting independently, regardless of what the other firm

does, even though they would both be better off if they cooperated. The

incentive to act independently arises because each firm is concerned about the

possibility of being worse off if it trusts the other firm to cooperate, and the

other firm takes advantage of this to act independently as well.

Option A, contestable market, refers to a market where entry and exit are easy

and potential competitors can enter and exit the market freely. Option B, kinked

demand curve, is a model of oligopoly behavior where firms face a demand curve

that is kinked at the current price and quantity level. Option C, principal-agent

problem, refers to a situation where one party (the principal) delegates decision-

making authority to another party (the agent) who may have different interests

and incentives from the principal.)

104. C (The kinked demand curve model assumes that firms in oligopoly expect

their competitors to match any price decreases but not price increases.

Therefore, a firm that raises its price will lose customers to its competitors, while

a firm that lowers its price will not gain many new customers.
 The result of this expectation is price rigidity, where firms tend to maintain the

current price rather than raise it. This is because they fear that a price increase

will cause a significant loss of customers to their competitors, while a price

decrease will not result in a significant gain in customers.

Option A, collusion between all firms in the industry in the setting of prices,

assumes that all firms in the industry cooperate to set prices, which is not

realistic in practice.

Option B, the assumption that a single firm acts as a price leader for all firms in

the industry, assumes that a single firm sets the price, and the other firms follow

suit. This is not necessarily true in oligopoly, where each firm may have some

market power and may act independently.

Option D, the presence of barriers to the entry of new firms into the industry,

may affect the behavior of firms in oligopoly but does not explain the kinked

demand curve model of price rigidity.)

105. C (Price discrimination is the practice of charging different prices to

different customers for the same product or service. For a firm to successfully

practice price discrimination, it must be able to identify and separate different

groups of buyers in the market and charge different prices to each group.

Option A, there are many buyers in the market, may be beneficial for a firm that

wants to practice price discrimination, but it is not necessary. A firm can practice
 price discrimination even if there are only a few buyers in the market, as long as

it can identify and separate them into different groups and charge different

prices to each group.

Option B, there are many firms in the market, is not necessary for a firm to

practice price discrimination. In fact, price discrimination is more likely to occur in

markets with only a few dominant firms, as they have more market power and

can charge different prices to different buyers.

Option D, the price elasticity of demand for the product is inelastic, may make it

easier for a firm to practice price discrimination, as it means that buyers are less

sensitive to changes in price. However, it is not necessary for price discrimination

to occur. In fact, firms may practice price discrimination even when the price

elasticity of demand is elastic, as long as they can separate the buyers into

different groups and charge different prices to each group.)

106. C (A backward vertical integration occurs when a company decides to

acquire or control the inputs or raw materials it needs to produce its products or

services.)

107. D (If an imperfectly competitive firm was making supernormal profits but

the following year made normal profit with no change in output, this suggests

that new firms have entered the market or existing firms have expanded their
 production, leading to a reduction in the price and the elimination of the

supernormal profits.

This situation can be shown on a diagram by an upward shift in the average cost

curve. The firm's average revenue and marginal revenue curves will remain

unchanged, but the price will have decreased, leading to a reduction in the firm's

profits. As a result, the firm's average cost curve will shift upward to intersect

with the new, lower price level, and the firm will earn only normal profit at the

new equilibrium.)

108. D (A contestable market is one where there are low barriers to entry and

exit, which makes it easy for new firms to enter and for existing firms to leave the

market. In such markets, existing firms cannot maintain their monopoly power or

earn abnormal profits in the long run because they are under constant threat of

entry by new firms. This competitive pressure can also prevent firms from

exploiting their market power and charging high prices, as they risk losing

customers to new entrants who may offer lower prices.

Therefore, the main implication of a contestable market is that monopoly power

is not necessarily exploited, as the presence of potential competition keeps prices

competitive and prevents firms from earning excessive profits.)

109. B (When a company pays a low proportion of its profits as dividends, it

retains more earnings to reinvest in the company. This can allow the company to
 finance new projects and expansions, which can lead to growth in the long run. In

contrast, if a company pays a high proportion of its profits as dividends, it leaves

less money for reinvestment, which can limit the company's growth potential.)

110. D (The least change in economic welfare would occur if the firm operates

in a market structure where it already produces at the allocatively efficient

output.

In a perfectly competitive market, firms are already producing at the allocatively

efficient output, which means that marginal cost equals price. Therefore, if the

firm changes its objective from profit maximization to producing at the

allocatively efficient output, there would be no change in economic welfare in

this market structure. Therefore, the correct answer is D) Perfect competition.)

111. D (The two features that a firm in an oligopoly market show are price

rigidity and interdependence.)

112. C (Fuel is a variable cost whereas the cost of purchasing an aircraft is a

fixed cost (one time investment).. A fall in price of fuel means variable cost have

decreased while a rise in price of aircraft means fixed costs have increased.)

113. C (The feature of production that would make it more likely that an

industry is a contestable market is (C) low fixed costs. Low fixed costs would

make it easier for new firms to enter the market because they would not have to
 invest a large amount of capital to start production. This means that new firms

can enter the market and start producing at a lower cost than existing firms.

In contrast, (A) advertising has established consumer loyalty would make it

harder for new entrants to compete because existing firms have already

established a loyal customer base. (B) all firms in the industry share research and

development would lead to less competition because all firms would have access

to the same technology and knowledge. (D) market rivals aim to reduce product

differentiation would also make it harder for new entrants to compete because

existing firms would have already differentiated their products, making it harder

for new firms to differentiate themselves.)

114. A (A backward vertical integration occurs when a company decides to

acquire or control the inputs or raw materials it needs to produce its products or

services.

While option C, a vineyard buying an apple orchard, could also be considered an

example of backward vertical integration, it may not be as clear-cut as option A.

The vineyard may be able to purchase apples from other sources or work with an

existing supplier, whereas the bakery relies heavily on wheat as a fundamental

ingredient.)

115. D (Profit maximizing level of output of a monopoly is when MR = MC. At

this point, the firm is making supernormal profits meaning P > AC. When the firm
 changed its aim to sales revenue maximization (MR = 0), the Price is still above

the AC, indicating supernormal profits again.)

116. A (Economic efficiency refers to the ability of an economy to produce

goods and services in the most optimal way, given the available resources. An

economy is considered economically efficient if it is not possible to make any

individual or group better off without making someone else worse off.

Option A reflects this definition because if it is possible to make some people

better off without making other people worse off, then the current allocation of

resources is not economically efficient. In this scenario, the economy could be

better off if resources were reallocated to produce more goods and services or if

policies were implemented to ensure a more equitable distribution of resources.

Options B, C, and D do not accurately reflect the concept of economic efficiency.

Option B refers to income distribution, which is a separate issue from economic

efficiency. Option C suggests that government growth is inherently inefficient,

which is not necessarily the case. Option D refers to a situation where wage rates

rise faster than production, which could indicate a problem with inflation, but

does not necessarily mean that the economy is inefficient.)

117. B (The quantity Q is before the equilibrium quantity. This means that the

good is being underproduced and under consumed. The dead weight loss in this

case will be v + w.)

118. D (A negative externality from consumption occurs when the consumption

of a good or service imposes costs on third parties who are not involved in the

transaction. In this case, smoking is a consumption activity that has negative

effects on the health of smokers and on the health service that has to treat

smoking-related illnesses. The cost of treating these illnesses is borne not only by

smokers themselves but also by taxpayers and the broader society. This is an

example of a negative externality from consumption.)

119. A (In order for the firm to achieve maximum efficiency, it must produce at

a level where the cost of producing the last extra unit is equal to the value the

consumers place on it. This is because if the cost of producing the last unit is

higher than the value that consumers place on it, the firm is not generating a

profit and is therefore not operating efficiently. If the cost is lower than the value

that consumers place on it, the firm could have increased its profits by producing

more.)

120. D (Cost-benefit analysis (CBA) is a tool used to evaluate the potential

benefits and costs of a project or policy. The key difference between the use of

CBA in public-sector investment projects compared with its use in private-sector

 investment projects is that the benefits in public-sector projects are often non-

market benefits that are difficult to quantify or value. This is because many

public-sector projects involve providing goods and services that do not have a

market price.

In contrast, private-sector investment projects typically involve market goods and

services, and therefore the benefits can be more easily measured and valued.

Additionally, private-sector investment projects may have less uncertainty and

risk compared to public-sector investment projects. However, private-sector

investment projects may still face challenges in accurately estimating costs, as

costs can be difficult to compute in certain contexts.

Therefore, the key difference between the use of cost-benefit analysis in public-

sector investment projects compared with its use in private-sector investment

projects is that the frequent absence of prices in public projects makes benefit

estimates more uncertain.)

121. D (Dynamic efficiency refers to a firm's ability to innovate and improve its

production processes, products, and services over time. It involves investing in

research and development, adopting new technologies, and continually

improving product quality and design. Therefore, the action by a firm that is most

likely to raise its dynamic efficiency is retaining its current profit for product

research and development.

 By investing in research and development, a firm can develop new products,

improve existing products, and find new and more efficient ways of producing

goods and services. This can help the firm to stay competitive, expand its market

share, and increase its long-term profitability. In contrast, distributing all its

current profit to existing shareholders, maximizing labor productivity, or

minimizing average cost may improve short-term profitability, but may not

necessarily improve the firm's ability to innovate and adapt to changing market

conditions over time.)

122. B (The Pareto criterion is also known as Pareto efficiency or Pareto

optimality. A situation is Pareto efficient if no individual or group can be made

better off without making someone else worse off. In other words, a situation is

Pareto efficient if it is impossible to reallocate resources or goods in a way that

would make at least one person better off without making someone else worse

off. Only in Option B, Samir is better off without Tariq being wore off.)

123. B (The concept of allocative efficiency assumes that resources are

allocated in a way that maximizes the satisfaction or utility of consumers, based

on their own preferences and judgments about their own economic welfare. This

implies that individuals are the best judges of their own welfare, and that

markets are efficient in allocating resources to meet their needs and preferences.
 However, some goods and services may have social benefits that are not fully

reflected in their market prices or demand. For example, merit goods such as

education, healthcare, and environmental conservation may provide benefits to

society as a whole, but individuals may not fully recognize these benefits when

making their consumption decisions. In such cases, government intervention in

form of providing subsidies may be necessary to ensure that these goods are

provided and consumed at socially optimal levels.)

124. A (Net External Benefit = External Benefit – External Cost)

125. A (The Pareto criterion is also known as Pareto efficiency or Pareto

optimality. A situation is Pareto efficient if no individual or group can be made

better off without making someone else worse off. In other words, a situation is

Pareto efficient if it is impossible to reallocate resources or goods in a way that

would make at least one person better off without making someone else worse

off. Only in Option A, both are being worse off. Hence, A is not the point where

allocative efficiency will increase.)

126. D (Productive inefficiency occurs when an economy is not able to produce

goods and services at the minimum possible cost. This can happen due to various

reasons, such as poor allocation of resources, technological inefficiency, or lack of

competition. If an economy is productively inefficient, it means that it is not able

 to produce the maximum possible output with the given resources and

technology.

Unemployment due to deficient aggregate demand is an indicator of productive

inefficiency because it implies that there is a shortfall in the level of output that

the economy could potentially produce. This can happen when there is

insufficient demand for goods and services in the economy, which results in firms

producing less than what they are capable of. As a result, some resources, such

as labor, remain idle, which is an indicator of inefficiency.)

127. C (Economic efficiency refers to the ability of an economy to produce

goods and services using the minimum possible amount of resources. It is

achieved when an economy produces the maximum possible output with the

given resources and technology. Economic efficiency is important because it

ensures that resources are used in the most optimal manner and are not wasted.

Achieving economic efficiency leads to several benefits, such as lower production

costs, increased output, and higher standards of living. It also allows an economy

to produce more goods and services while using fewer resources, which can help

to conserve resources and reduce the environmental impact of economic

activities.

Therefore, the purpose of achieving economic efficiency is not to achieve full

employment or to use as many resources as possible, but rather to ensure that

 resources are used in the most effective and sustainable manner possible, which

can ultimately benefit society as a whole.)

128. B (Economic efficiency refers to the ability of an economy to produce

goods and services using the minimum possible amount of resources. When a

firm increases its production, it can improve economic efficiency if it can produce

additional units at a cost that is lower than the price consumers are willing to pay

for those units.

Option A is incorrect because increasing production may not necessarily lead to

higher total revenue, especially if there is insufficient demand for the additional

units.

Option C is incorrect because average and marginal revenue are not necessarily

related to economic efficiency. The efficiency of a firm's production is

determined by the relationship between the cost of producing the last unit and

the value that consumers place on that unit.

Option D is also incorrect because if the firm can produce additional units at a

cost that is lower than the price consumers are willing to pay for those units, then

the marginal cost will not rise, and the total cost may even decrease as the firm

benefits from economies of scale.)

129. B (We are given that the private costs of the power station were $800m,

the private benefits were $900m, and the external benefits were $300m.
 To determine the external costs, we need to use the concept of net external

benefit, which is calculated as follows:

Net External Benefit = External Benefit - External Cost

We are given that the proposal for the power station was not socially beneficial,

which means that the net external benefit is negative. Therefore:

Net External Benefit = External Benefit - External Cost < 0

Substituting the values we have, we get:

$300m - External Cost < 0

Simplifying the inequality, we get:

External Cost > $300m

Therefore, we can conclude that option B is correct: External costs were greater

than $400m.)

130. B (Option B, income inequality, is not a source of market failure. Market

failure refers to situations where the allocation of goods and services by a free

market is not efficient, resulting in either under-allocation or over-allocation of

resources. Income inequality is a distributional issue, and while it can have social

and economic consequences, it is not directly related to market failure. On the

other hand, options A, C, and D are all sources of market failure.)

131. D (When the government regulates the consumption of a demerit good, it

aims to reduce the negative externalities associated with its consumption. This

can be achieved by imposing taxes or setting limits on consumption.

The net welfare of society will increase when the fall in the total social cost is

greater than the fall in the total social benefit. This is because the total social cost

represents the total cost to society of producing and consuming the good, while

the total social benefit represents the total benefit to society of consuming the

good. By reducing consumption, the negative externalities associated with the

production and consumption of the demerit good can be reduced, which leads to

a reduction in the total social cost. As a result, society's net welfare increases.)

132. B (Noise Pollution = Negative Externality = Market Failure)

133. D (The correct answer is D, the production of a good at minimum average

cost for a given output, is a necessary condition for the achievement of

productive efficiency. When firms produce at the minimum average cost, they

are producing in the most efficient way possible given the resources available to

them. This ensures that the economy is producing goods at the lowest possible

cost, leading to an efficient allocation of resources.)

134. A (The government will choose a project in which Social Benefits > Social

Costs. Only in Option A, this is possible.)

135. C (If the social benefits of the development outweigh the social costs, then

the government should allow the project to proceed. If the social costs outweigh

the benefits, then the government should reject the proposal. It is important to

note that the private costs and benefits may not always align with the social costs

and benefits, and thus, it is important to consider both when making a decision.)

136. A (Pollution = Negative Externality = Market Failure)

137. C (Social Cost = Private Cost + External Cost)

138. C (The policy of requiring firms to pay a minimum wage is primarily aimed

at improving income distribution and reducing poverty, rather than correcting

inefficiency in resource allocation.)

139. A (In order to see the government`s decision, we must compare the social

costs with social benefits. The social costs of the project are $525 (450 + 75)

whereas the social benefits are $525. This means that the government will be

willing to build the road as SB > SC.

In order to see the private firm`s decision, we must compare the private costs

with the private benefit. Here, the private benefit is $500 (Social Benefit -

External Benefit). Hence, both the parties would be willing to build it.)

140. B (SC > PC indicating negative externality.)

141. B (The transfer earnings of the fashion model are the amount he could

earn in his next best alternative job, which is $100000 a year.

 The economic rent of the fashion model is the difference between his current

income and his transfer earnings, which is:

$500000 - $100000 = $400000

Therefore, the transfer earnings of the fashion model are $100000 a year and his

economic rent is $400000 a year.)

142. D (A reduction in the price of the firm's product would decrease the

marginal revenue of the firm, which in turn would decrease the marginal product

of labor, and thus shift the MRP curve to the left.

An increase in labour productivity (A) would shift the MRP curve to the right, as

the worker is now able to produce more output per unit of time, and therefore,

their marginal revenue product would increase.

An increase in the wage rate (B) would also shift the MRP curve to the right, as

the worker would have a higher opportunity cost of their time, and therefore, the

firm would only hire them if they can generate a higher revenue.

A reduction in labour hours (C) would also shift the MRP curve to the right, as the

worker would have less time to produce output, and therefore, their marginal

revenue product would increase.)

143. A (Without the minimum wage, the firm would hire workers up to the

point where the marginal revenue product of labor (MRP) equals the marginal

factor cost (MFC) which is given by the MFCL curve. This happens at point J where
 the MRP curve intersects the MFCL curve. Currently the firm, the firm hires OK

workers and pays them a wage rate of OW.

Therefore, if the minimum wage is abolished, the firm will revert to hiring OJ

workers. Hence, the number of firms employed will decrease by JK.)

144. D (The situation described in the question is an example of the law of

diminishing returns. According to this law, as additional units of a variable input

(such as labor) are added to a fixed input (such as capital), the marginal product

of the variable input will eventually decrease. In this case, the fact that the new

worker adds less to output than the previous worker indicates that the firm has

reached a point where additional workers are becoming less productive,

reflecting the diminishing returns to labor.

Therefore, the correct answer is D, the law of diminishing returns. The other

options are not directly related to this concept. Decreasing marginal costs (option

A) refer to the reduction in the cost of producing each additional unit of output

as production increases, which is a result of economies of scale. Diseconomies of

scale (option B) occur when the cost of producing each additional unit of output

increases as production increases, often due to coordination and communication

difficulties within a larger organization. Increasing returns to scale (option C)

occur when the output of a firm increases more than proportionally to the
 increase in all inputs, meaning that as a firm gets larger, it becomes more

efficient and productive.)

145. B (To calculate the total cost of labor, we can use the formula:

Total cost of labor = (number of workers) x (hourly rate of pay)

Initially, the school has 10 cleaners who are paid an hourly rate of $8.00.

Therefore, the total cost of labor is:

Total cost of labor = 10 x $8.00 = $80.00

When the school hires one more cleaner and raises the hourly rate of pay to

$8.50, the total cost of labor becomes:

Total cost of labor = 11 x $8.50 = $93.50

The increase in total cost of labor is $93.50 - $80.00 = $13.50, which is the

marginal cost of labor per hour to the employer.

Therefore, the correct answer is $13.50.)

146. C (For a firm in imperfect competition, the marginal revenue product of

labor (MRP) at any given level of employment is equal to the marginal physical

product of labor (MPP) multiplied by the marginal revenue (MR) that the firm

earns from selling an additional unit of output. Mathematically, this relationship

can be expressed as:

MRP = MPP x MR
 Therefore, the correct answer is C, the marginal physical product of labor

multiplied by marginal revenue.)

147. C (Minimum wage policy can directly increase the wages of low-income

workers, which can help to reduce income inequality. By setting a minimum

wage, the government can ensure that workers receive a wage that is sufficient

to cover their basic needs, such as food, housing, and healthcare. This can also

provide an incentive for employers to invest in their workers' skills and

productivity, which can lead to higher wages in the long run.

Progressive income taxes (option D) are also an effective way to reduce income

inequality, as they tax higher-income households at a higher rate than lower-

income households. This can help to redistribute income from higher-income to

lower-income households, thereby reducing the gap between them. However,

progressive income taxes may not be sufficient on their own to address the root

causes of income inequality, such as differences in education, skills, and job

opportunities.

Government support for trade unions (option A) can help to increase the

bargaining power of workers and negotiate better wages and benefits. This can

help to reduce income inequality to some extent, but may not be sufficient to

address the broader structural factors that contribute to income inequality.

 Import duties on manufactured goods (option B) are not directly related to

reducing income inequality. While they may protect domestic industries and

promote job growth, they can also lead to higher prices for consumers and

reduce overall economic efficiency.

Therefore, of the options given, the most effective policy for achieving a more

equal distribution of disposable incomes between households is C, minimum

wage policy.)

148. B (Means-tested benefits take into account the size of the household or

family when determining the amount of benefit paid. A larger family or

household may receive a higher level of benefit to reflect the increased cost of

living associated with a larger family.

Option A, age, is not a determining factor for means-tested benefits, although

some benefits may have age-related eligibility criteria.

Option C, income, is a crucial factor in determining the amount of benefit paid, as

means-tested benefits are designed to assist those with low income.

Option D, qualifications, is not typically a determining factor for means-tested

benefits, although some benefits may have education or training-related

eligibility criteria.)

149. A (If the Lorenz curve shifts to the right, it means that income inequality

has increased. Therefore, the least likely cause for this shift would be option A,
 where capital gains tax has been reduced, as this measure could potentially

exacerbate income inequality by benefiting the wealthy who hold more capital

assets.

150. B (In a perfectly competitive market, a firm faces a horizontal demand

curve for its product. Therefore, the firm can sell all of its output at the market

price, but it cannot charge a higher price for its output by increasing the quantity

produced. As the firm hires more of a factor of production, the marginal physical

product of that factor will eventually diminish, as the firm adds units of the factor

to a fixed amount of other factors. As a result, the additional output generated by

each additional unit of the factor will decline, which leads to a fall in the marginal

physical product of the factor.)