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Microeconomics (Acemoglu/Laibson/List)
Chapter 7 Perfect Competition and the Invisible Hand
7.1 Perfect Competition and Efficiency
1) A ________ is the price at which a trading partner is indifferent between making the trade and not
doing so.
A) market value
B) reservation value
C) shadow value
D) discounted value
Answer: B
Difficulty: Easy
Topic: Perfect Competition and Efficiency
2) Reservation value of a buyer reflects her ________.

A) willingness to pay for a good or service
B) trade-off between buying various goods and services
C) total utility from a good or service
D) total income
Answer: A
Difficulty: Easy
3) A buyer is willing to buy 10 units of a good at a maximum price of $10 per unit. The reservation value
of the buyer in this case is:
A) $1.
B) $10.
C) $20.
D) $100.
Answer: B
Difficulty: Easy
AACSB: Application of Knowledge
4) Reservation value of a seller reflects her ________.

A) willingness to pay for using a resource
B) marginal cost
C) marginal revenue
D) total cost
Answer: B
Difficulty: Easy
1
Copyright © 2015 Pearson Education, Inc.
5) The marginal cost and total revenue of a firm are $5 and $275, respectively. The reservation value of the
seller in this case is ________.
A) $0
B) $5
C) $55
D) $275
Answer: B
Difficulty: Easy
6) A seller is willing to sell 5 units of a good at a minimum price of $1 per unit. The reservation value of
the seller in this case is:
A) $1.
B) $5.
C) $6.
D) $10.
Answer: A
Difficulty: Easy
7) The equilibrium price and quantity of a good under perfect competition are determined:
A) by the intersection of the market demand and total revenue curves.
B) by the intersection of the total revenue and total cost curves.
C) by the intersection of the market demand and market supply curves.
D) by the intersection of the market supply and total revenue curves.
Answer: C
Difficulty: Easy
2
The following table displays the reservation values of eight buyers and eight sellers where each
individual wants to buy or sell a calculator.
Reservation Value Reservation Value

Number of Buyers of Buyers ($) Number of Sellers of Sellers ($)
1 20 1 2
2 17 2 5
3 16 3 6
4 14 4 8
5 12 5 12
6 9 6 15
7 6 7 18
8 2 8 20
8) Refer to the table above. If the market is perfectly competitive, the equilibrium price of calculators is:
A) $2.
B) $6.
C) $12.
D) $20.
Answer: C
Difficulty: Medium
9) Refer to the table above. If the market is perfectly competitive, the equilibrium quantity of calculators
is:
A) 3 units.
B) 5 units.
C) 6 units.
D) 8 units.
Answer: B
Difficulty: Medium
10) Consumer surplus is the:

A) difference between the buyer's reservation value and the price he actually pays.
B) product of a buyer's reservation value and the price he actually pays.
C) sum of a buyer's reservation value and the price he actually pays.
D) ratio of a buyer's reservation value to the price he actually pays.
Answer: A
Difficulty: Easy
Topic: Social Surplus
3
11) Producer surplus is the:
A) sum of a seller's reservation values and the price he finally receives.
B) difference between a seller's reservation value and the price he finally receives.
C) product of a seller's reservation value and the price he finally receives.
D) ratio of a seller's reservation value to the price he finally receives.
Answer: B
Difficulty: Easy
12) If a seller's reservation value for a good is $10 and the price at which the good is sold is $15, his
producer surplus is:
A) $25.
B) $150.
C) $1.5.
D) $5.
Answer: D
Difficulty: Medium
13) If a seller's marginal cost is $25, and the price at which the good is sold is $15, the producer surplus is
________.
A) -$10
B) $10
C) $15
D) $25
Answer: A
Difficulty: Medium
14) If a seller enjoys a producer surplus of $30 when he sells a good for $79, his reservation value for the
good is ________.
A) $30
B) $49
C) $79
D) $109
Answer: B
Difficulty: Medium
4
15) If a buyer's reservation value for a good is $15 and the price at which he purchases the good is $8, his
consumer surplus is:
A) $7.
B) $1.8.
C) -$7.
D) $120.
Answer: A
Difficulty: Medium
16) If a buyer enjoys a consumer surplus of $25 when he purchases a good for $50, his willingness to pay
for the good is ________.
A) $2
B) $25
C) $50
D) $75
Answer: D
Difficulty: Medium
17) When buyers and sellers optimize in a perfectly competitive market, ________.
A) social surplus is maximized
B) social surplus is minimized
C) only consumer surplus is maximized
D) only consumer surplus is minimized
Answer: A
Difficulty: Easy
18) Social surplus is:

A) the product of consumer surplus and producer surplus.
B) the consumer surplus minus producer surplus.
C) the ratio of consumer surplus to producer surplus.
D) the sum of consumer surplus and producer surplus.
Answer: D
Difficulty: Easy
5
19) If the producer surplus in a market for a good is $36 and the consumer surplus in the market for the
same good is $9, the social surplus in the market is ________.
A) $4
B) $27
C) $45
D) $324
Answer: C
Difficulty: Easy
20) Suppose a market has only one seller and only one buyer of a good. The buyer has a reservation value
of $25 and the seller has a reservation value of $15. The market price of the good is determined at $20. If
they trade, the social surplus will be ________.
A) $10
B) $20
C) $40
D) $60
Answer: A
Difficulty: Medium
21) Suppose a market has only one seller and only one buyer of a good in the market. The buyer is willing
to pay $50 for the good and the seller is willing to accept $15. The market price of the good is determined
at $30. If they trade, the social surplus will be ________.
A) $15
B) $35
C) $45
D) $65
Answer: B
Difficulty: Medium
22) For social surplus to be maximized, the ________ buyers are actually making a purchase and the
________ sellers are selling the products.
A) lowest-value; highest-cost
B) highest-value; lowest-cost
C) highest-value; highest-cost
D) lowest-value; lowest-value
Answer: B
Difficulty: Easy
6
23) The total surplus in a market is represented by:
A) the area between the demand curve and the market price line.
B) the area between the supply curve and the market price line.
C) the area between the demand and supply curves and the price axis.
D) the area between the demand curve and the horizontal axis.
Answer: C
Difficulty: Medium
24) Jack is a prospective buyer of a commodity that Jill is offering to sell. Social surplus in this scenario
can be maximized:
A) when only Jack is optimizing.
B) when only Jill is optimizing.
C) when both Jack and Jill are optimizing.
D) when neither Jack nor Jill is optimizing.
Answer: C
Difficulty: Easy
The following table displays the reservation values of buyers and sellers in the market for notebooks,
where each one either wants to buy or sell one notebook.
Reservation Value Reservation Value

Buyers of Buyers ($) Sellers of Sellers ($)
1 7 1 1
2 6 2 2
3 5 3 3
4 4 4 4
5 3 5 5
6 2 6 6
7 1 7 7
25) Refer to the table above. If the market for notebooks is perfectly competitive, the equilibrium price is:
A) $2.
B) $3.
C) $4.
D) $5.
Answer: C
Difficulty: Medium
7
26) Refer to the table above. If the market for notebooks is perfectly competitive, the equilibrium quantity
is:
A) 2 units.
B) 3 units.
C) 4 units.
D) 5 units.
Answer: C
Difficulty: Medium
27) Refer to the table above. If the market is perfectly competitive, what is Buyer 3's consumer surplus?
A) $0
B) -$1
C) $1
D) $2
Answer: C
Difficulty: Medium
28) Refer to the table above. What is Seller 3's producer surplus?
A) $1
B) $2
C) $3
D) $4
Answer: A
Difficulty: Medium
29) Refer to the table above. If only the two highest-value buyers and the two least-cost sellers engage in
trade, what is the social surplus?
A) $6
B) $10
C) $12
D) $20
Answer: B
Difficulty: Medium
8
30) Refer to the table above. If the six highest-value buyers and the six least-cost sellers engage in trade,
what is the social surplus?
A) $6
B) $8
C) $10
D) $12
Answer: A
Difficulty: Medium
31) Refer to the table above. When the price is ________ and the quantity is ________, social surplus is
maximized.
A) $8; 5 units
B) $6; 4 units
C) $4; 4 units
D) $2; 8 units
Answer: C
Difficulty: Medium
32) Refer to the table above. Maximum social surplus is:

A) $10.
B) $12.
C) $14.
D) $16.
Answer: B
Difficulty: Medium
9
The following figure illustrates the demand and supply of decorative light bulbs in a perfectly
competitive market.
33) Refer to the figure above. What is the equilibrium price and quantity of the light bulbs?
A) Equilibrium price = $25, Equilibrium quantity = 0 units
B) Equilibrium price = $25, Equilibrium quantity = 15 units
C) Equilibrium price = $15, Equilibrium quantity = 15 units
D) Equilibrium price = $5, Equilibrium quantity = 15 units
Answer: C
Difficulty: Medium
34) Refer to the figure above. What is the consumer surplus in the market?
A) $50
B) $75
C) $100
D) $225
Answer: B
Difficulty: Medium
35) Refer to the figure above. What is the producer surplus in the market?
A) $50
B) $75
C) $150
D) $200
Answer: B
Difficulty: Medium
10
36) Refer to the figure above. What is the social surplus if the market is in equilibrium?
A) $50
B) $75
C) $100
D) $150
Answer: D
Difficulty: Medium
37) Refer to the figure above. What is the maximum possible social surplus?
A) $100
B) $150
C) $225
D) $375
Answer: B
Difficulty: Medium
38) The social surplus in a market is $50. If another economic agent enters the market such that the
marginal cost he incurs is $10 and the marginal benefit he receives from the trade is $5, then which of the
following statements is true?
A) The social surplus will remain the same.
B) The social surplus will increase by $5.
C) The social surplus will decrease by $5.
D) The social surplus will increase by $10.
Answer: C
Difficulty: Medium
39) Which of the following statements is true of competitive market equilibrium?

A) The determination of equilibrium price and quantity is independent of the demand for goods.
B) Social surplus is minimized at the competitive equilibrium.
C) At the competitive equilibrium, there are no unexploited gains from trade.
D) A competitive equilibrium is determined only by a few large sellers in the market.
Answer: C
Difficulty: Easy
Topic: Pareto Efficiency
11
40) In a competitive market equilibrium:
A) social surplus is minimized.
B) all the gains from trade are not realized.
C) there is Pareto efficiency.
D) all the firms earn positive economic profits.
Answer: C
Difficulty: Easy
41) An outcome is Pareto efficient if:

A) an individual can be made better off without making someone else worse off.
B) benefits of the outcome are equally distributed among all the participants.
C) no individual can be made better off without making someone else worse off.
D) costs of the outcome are equally shared by all the participants.
Answer: C
Difficulty: Easy
42) When an outcome is ________, social surplus is ________.

A) Pareto inefficient; maximized
B) Pareto efficient; maximized
C) Pareto efficient; minimized
D) Pareto inefficient; minimized
Answer: B
Difficulty: Easy
43) Which of the following statements is true of a perfectly competitive market?

A) At equilibrium, it is possible to make someone better off without making someone else worse off.
B) The equilibrium price in a competitive market efficiently allocates scarce resources to participants.
C) The equilibrium price is determined by a few large firms in the market.
D) The sum of consumer surplus and producer surplus is not maximized at the equilibrium.
Answer: B
Difficulty: Medium
44) The invisible hand suggests that:

A) individuals working for self-interest will eventually maximize the well-being of society.
B) equilibrium in a competitive market is determined independent of demand and supply.
C) government intervention is necessary to rectify market imperfections.
D) the price mechanism allocates resources only to the people with high income in the country.
Answer: A
Difficulty: Easy
12
45) $100 is to be divided among two individuals—Mary and Jenna. Which of the following allocations is
Pareto efficient?
A) Mary receives $45, and Jenna receives $45.
B) Mary receives $20, and Jenna receives $75.
C) Mary receives $1, and Jenna receives $99.
D) Mary receives $90, and Jenna receives $9.
Answer: C
Difficulty: Medium
46) $20 is to be divided among two individuals—Gary and Jamie. Which of the following allocations is
NOT Pareto efficient?
A) Gary receives $1, and Jamie receives $19.
B) Gary receives $19, and Jamie receives $1.
C) Gary receives $8, and Jamie receives $9.
D) Gary receives $15, and Jamie receives $5.
Answer: C
Difficulty: Medium
47) What does the concept of "invisible hand" imply?

Answer: The "invisible hand" is an idea in economics that suggests that when all assumptions of a
perfectly competitive market are in place, the pursuit of individual self-interest promotes the well-being
of society as a whole, almost as if the individual is led by an invisible hand to do so. Thus, under perfect
competition, when individuals are working to maximize personal profits, they end up promoting social
interests.
Difficulty: Easy
48) Define reservation values. If a buyer of a product has a reservation value of $10, the seller of the
product has a reservation value of $3, and the equilibrium price of the product is determined at $5,
calculate the consumer surplus and the producer surplus.
Answer: A reservation value is the price at which a trading partner is indifferent between making the
trade and not doing so. For a buyer, this is the highest price he is willing to pay for a good or service. For
a seller, it is the lowest price he is willing to accept for a good or service.
Consumer surplus = $10 - $5 = $5
Producer surplus = $5 - $3 = $2
Difficulty: Medium
13
49) The following figure shows the demand and supply of a good. Calculate the social surplus from the
following figure. What is the maximum possible social surplus in this market?
Answer: Social surplus refers to the sum of consumer surplus and producer surplus.
In this figure, consumer surplus = $(1/2 × 4 × 5) = $10.
Producer surplus = $(1/2 × 4 × 5) = $10.
Social surplus = $10 + $10 = $20.
Since, in the figure, market price is determined at the point of intersection of demand and supply, it is a
free market economy that is in equilibrium. Since social surplus is maximized when a market is in
equilibrium, the maximum possible social surplus is $20.
Difficulty: Medium
50) Define a Pareto efficient outcome. Does it ensure equity? Explain with an example.
Answer: An outcome is said to be Pareto efficient outcome if it is not possible to make someone better off
without making someone else worse off. Pareto efficiency does not ensure equity. For example, $100 is
divided between two individuals such that one individual receives $75 and the other individual receives
$25. This allocation is Pareto efficient as it is not possible to make an individual better off without making
the other worse off, but the allocation does not represent equity.
Difficulty: Medium
14
51) The following table displays the reservation values of 10 sellers and 10 buyers in a market for cameras
where each individual wants to buy or sell one camera.
Buyers Value ($) Sellers Value ($)

1 100 1 5
2 86 2 18
3 74 3 22
4 60 4 26
5 55 5 35
6 50 6 50
7 34 7 65
8 26 8 75
9 12 9 85
10 6 10 100
a) What is the equilibrium price and quantity of cameras?

b) What is the social surplus when four highest-value buyers trade with four lowest-value sellers?
c) What is the social surplus when eight highest-value buyers trade with eight lowest-value sellers?
d) What is the highest possible social surplus in the market? At what quantity does it occur?
Answer:
a) The equilibrium price is determined at $50 and the equilibrium quantity is 6 units. The equilibrium
quantity is 6 units since six buyers are willing to pay at least $50 for a camera, and six sellers are willing
to sell a camera for no less than $50.
b) Social surplus is the sum of consumer surplus and producer surplus. These can be calculated as
shown in the table below.
Consumer Producer
Buyers Value ($) Surplus ($) Sellers Value ($) Surplus ($)
1 100 50 1 5 45
2 86 36 2 18 32
3 74 24 3 22 28
4 60 10 4 26 24
5 55 5 5 35 15
6 50 0 6 50 0
7 34 -16 7 65 -15
8 26 -24 8 75 -25
9 12 -38 9 85 -35
10 6 -44 10 100 -50
Social surplus when the four highest value buyers trade with the four lowest value sellers:
= $(50 + 45 + 36 + 32 + 24 + 28 + 10 + 24) = $249.
c) The social surplus when the eight highest value buyers trade with the eight lowest value sellers:
= 50 + 45 + 36 + 32 + 24 + 28 + 10 + 24 + 5 + 15 - 16 - 15 - 24 - 25 = $189.
15
d) The highest possible social surplus will occur at a quantity of 6 units. The social surplus when six
highest value buyers trade with the six lowest value traders:
= 50 + 45 + 36 + 32 + 24 + 28 + 10 + 24 + 5 + 15 = $269
Difficulty: Hard
7.2 Extending the Reach of the Invisible Hand: From the Individual to the Firm
The following figure shows the marginal cost curves of two profit-maximizing firms—firm A and firm
B—in a perfectly competitive market.
1) Refer to the figure above. Which of the following statements is true?

A) Firm A produces at a lower marginal cost.
B) For a particular market price, firm A will enjoy a greater producer surplus.
C) Firm B will have a higher reservation value than firm A.
D) The profit-maximizing level of output of firm B will be greater than that of firm A at all prices.
Answer: D
Difficulty: Medium
Topic: Extending the Reach of the Invisible Hand: From the Individual to the Firm

A) Firm B produces at a higher marginal cost than firm A.
B) At a given market price, firm A will enjoy a greater producer surplus.
C) Firm A will have a higher reservation value for the good than firm B.
D) Firm B will produce a lower quantity than firm A at all prices.
Answer: C
Difficulty: Medium
16
3) If firms in a competitive industry independently operate to maximize profits, the ________ are
eventually equalized across the firms.
A) total costs
B) marginal costs
C) profits
D) revenues
Answer: B
Difficulty: Medium
4) When two firms in a perfectly competitive market seek to maximize profit in the long run, they
eventually end up:
A) producing at a suboptimal level.
B) minimizing total cost of production.
C) earning the same level of profits.
D) producing the same level of output.
Answer: B
Difficulty: Medium
5) If price is greater than the average variable cost, a profit-maximizing firm should:
A) contract production until price is equal to marginal cost.
B) expand production until price is equal to marginal cost.
C) contract production until total revenue is equal to total cost.
D) expand production until total revenue is equal to total cost.
Answer: B
Difficulty: Easy
6) If a firm faces an average total cost of $100 and sells its product for $115, how much profit does it make
when it sells 20 units of the product?
A) $200
B) $115
C) $300
D) $800
Answer: C
Difficulty: Medium
17
The following figure shows the marginal cost curve and the average total cost curve of a firm operating in
a perfectly competitive industry.
7) Refer to the figure above. What price does the firm face in the market?
A) $2
B) $4
C) $6
D) $8
Answer: D
Difficulty: Medium
8) Refer to the figure above. At what level of output does the firm maximize profits?
A) 0 units
B) 10 units
C) 20 units
D) 30 units
Answer: D
Difficulty: Medium
18
9) Refer to the figure above. What is the revenue of the firm when it sells the profit-maximizing level of
output?
A) $40
B) $160
C) $180
D) $240
Answer: D
Difficulty: Medium
10) Refer to the figure above. What is the total cost of the firm when it produces the profit-maximizing
level of output?
A) $60
B) $120
C) $180
D) $240
Answer: C
Difficulty: Medium
A) The firm maximizes profits if it produces 10 units of the good.
B) If the market price is $10, the firm will suffer losses.
C) If the market price is $2, the firm will make profits.
D) The firm makes maximum profits if it produces 30 units.
Answer: D
Difficulty: Medium
12) Refer to the figure above. What is the maximum profit that the firm can make?
A) $30
B) $60
C) $90
D) $180
Answer: B
Difficulty: Medium
19
Scenario: There are two firms producing ball point pens in a perfectly competitive industry. The market
price of one pen is $5. Firm A has a lower marginal cost than Firm B. The following graphs illustrate the
marginal cost curves of both the firms.
13) Refer to the scenario above. If both the firms are optimizing, which of the following statements will be
true?
A) Firm B will produce more than Firm A.
B) Firm A will produce more than Firm B.
C) Both firms will produce the same quantity.
D) The quantity produced by both firms will depend on the demand for pens and not the marginal costs.
Answer: B
Difficulty: Medium
14) Refer to the scenario above. The average total cost of Firm A when it produces 100 pens is $3, and the
average total cost of Firm B when it produces 50 pens is $7. At these levels of production, which of the
following statements is true?
A) Both firms incur losses.
B) Firm A incurs a loss but Firm B makes a profit.
C) Firm B incurs a loss but Firm A makes a profit.
D) Both firms make profits.
Answer: C
Difficulty: Medium
15) Refer to the scenario above. If the government enforces a ban on Firm B, and asks Firm A to carry out
all the production:
A) Firm A's marginal cost is likely to decrease, but its average cost is likely to increase.
B) Firm A's marginal cost and average cost are likely to decrease.
C) Firm A's marginal cost is likely to increase, but its average cost is likely to decrease.
D) Firm A's marginal cost and average cost are likely to increase.
Answer: D
Difficulty: Medium
20
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7.1 Perfect Competition and Efficiency

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18) Social surplus is:

Reservation Value Reservation Value

32) Refer to the table above. Maximum social surplus is:

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Buyers Value ($) Sellers Value ($)

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42) When an outcome is , social surplus is .