microeconomics examination questions

8/21/2019 Microeconomics Examination Questions

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EXAMINATION QUESTIONS

1. Microeconomics as a science, its methodology and methods.

2. Basic problem of the organization of economic activity.

3. Production possibilities curve and rational economic choice. Opportunity cost.

4. Positive and normative analysis.

5. The nature of the demand. Demand function. The determinants of demand.

6. Market demand versus ndividual demand.

7. The nature of the supply. !upply function. The determinants of supply.

8. Market supply versus individual supply.

9. Market e"uilibrium establishment and price of e"uilibrium.

10. #pplied aspects of the model of demand and supply. $onse"uences of the government

intervention in the market mechanism %by fi&ing the prices, ta&ation, subsidies'.

11. Preferences, prices and income as general determinants of consumer behavior. #ssumptions

of consumer(s preferences.12. )tility as the economic category. )tility functions.

13. Total and marginal utility. The la* of the diminishing of marginal utility.

14. The marginal rate of substitution of goods and the slope of indifference curves.

15. ndifference curve analysis.

16. Budget constraint of a consumer

17. Consumer eu!"!#r!um. In$er!or %n& 'orner so"u$!ons.

$onsumer e"uilibrium means that condition, *hich gives him+her ma&imum utility from full

use of income.

The consumption decision of a rational consumer is motivated by the desire to ma&imise

utility or satisfaction. But this decision is constrained by his limited purchasing po*er. iven

the assumptions about consumer-s preferences, *e can dra* the indifference curves sho*ing

different levels of satisfaction. Three such indifference curves, , /, 0 are dra*n in 1igure

2.03. The budget line #B contains commodity bundles *hich are purchasable. The

consumption bundles like a, b, c lying on the budget line #B are purchasable. The consumer

*ill choose that commodity bundle *hich lie on the highest indifference curve. The

consumption bundle b on indifference curve /is the obvious choice because the alternative

commodity bundles such as a and c are located on lo*er indifference curve . The

indifference curve lying above /, such as 0. consists of commodity bundles *hich are not

attainable *ith the given budget line #B.

The consumption choice of b from among alternative consumption bundles ma&imises the

utility sub4ect to purchasing po*er limitations specified by the budget line. The consumer is

in e"uilibrium at point b because he has no incentive to choose any other commodity bundle.

5ote that consumption choice at b contains O6amount of good 6 and 7amount of good


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7. #t the e"uilibrium consumption point b, budget line #B is tangent to the indifference

curve . !ince the negative of the slope of the indifference curve is called M8! &,yand the

negative of the slope of the budget line is %P&+Py', the condition for e"uilibrium consumption

choice is given by the e"uation *ritten belo* 9

M)6+M)7: P6+P7

18. In'ome ( 'onsum)$!on 'ur*es.

;e no*, consider the effect of a change in M on e"uilibrium consumption demand, if P, and P,

are held constant. $onsider a rise in M at fi&ed prices. ;e have earlier stated that the purchasing

po*er of money income in terms of good 6 is %MP6' and the purchasing po*er in the units of

good 7 is %MP7'. ;hen M rises, both MP6and MP7rises. n other *ords, the consumer can

purchase more of both 6 and 7 if M rises at fi&ed prices.


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n 1igure 2.2/, the budget line has a constant slope. The initial budget line as *ell as income

level is indicated by Mand the corresponding consumption choice by commodity bundle a. f

income rises to M/, the budget line have a parallel right*ard shift to M /and the ne*

consumption choice is sho*n by the commodity bundle b. The diagram sho*s that bundle b

contains more of both 6 and 7 than bundle a. Therefore, income rise leads to a rise in the

e"uilibrium consumption of both 6 and 7. f *e imagine many e"uilibrium consumption choices

like a. b starting from the origin and lying on an up*ard=sloping curve O>, *e have a complete

picture of ho* e"uilibrium consumption plan changes *ith the change in the level of income.

The up*ard=sloping line O> is the income=consumption curve %$$'.


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19. En+e" 'ur*es.

The >ngel curve sho*s the e"uilibrium consumption of one of the t*o goods as a function of

income, prices remaining unchanged.

f *e take dra*n in 1igure 2.2/, *e see that the consumption of 6 rises by the same proportion

as the rise in income. By plotting M on the horizontal a&is and 6 on the vertical a&is, *e dra*

the >ngel curve as a straight line through the origin in 1igure 2.2?.

The real life >ngel curve need not al*ays be straight line. n general, *hen income rises, the

consumption of a good may rise by a proportion greater than or less than the rise in income. The

>ngel curve in 1igure 2.2@, is conve& from belo*, implying that 6+M rises as M rises.

# lu&ury is defined as a good for *hich the proportion of income spent %>6M' rises *ith the rise

in income. # necessity is defined as a good for *hich %>6M' falls as income rises. On average,

the proportion of income spent on food decreases %i.e., the proportion of income spent on non=

food items increases' *ith the increase in income.

20. ,r!'e ( 'onsum)$!on 'ur*es %n& &er!*%$!on o- &em%n& 'ur*e.

21. ,r!'e e"%s$!'!$ o- &em%n&.

f *e denote the amount of -all, other goods- by A and price per unit of A by 8e. . e&penditure on

all other goods e"uals 8s. A. The budget e"uation can be *ritten as

M : P&6 A or A: =P&6 M


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22. In'ome e"%s$!'!$ o- &em%n&.

23. Cross /)r!'e e"%s$!'!$ o- &em%n&.

24. Su))" e"%s$!'!$.

Price elasticity of supply measures the degree of responsiveness of "uantity supplied of a

commodity to change in its o*n price.

The value of elasticity of supply can be calculated by the formula9

>&: Percentage change in the "uantity supplied + Percentage change in price

This may be e&pressed as9

>&:%C+' + %CP+P' : %C+ CP' & %P+ '

>lasticity of supply is positive since the supply curve slopes up*ards from left to right. &is

negative.

Types9

Periods of !upply >lasticity


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%a' Momentary9 n the momentary period or the very short run supply is fi&ed and >, is zero.

%b' !hort run9 n the short run supply can be varied *ith the limit of the present fi&ed assets

%buildings. machines. etc.'. Thus >, in the short run is generally lo*.

%c' Eong run9 n the long run all factors may be varied and firms may enter or leave the industry.

25. #pplied aspects of the theory of elasticity.

26. The production function.

27. so"uants and their characteristics.

28. Production *ith one variable input.

29. Total, average and marginal product of a variable input and the interdependence bet*een

them.

30. Production *ith t*o variable inputs. M8T!.31. 8eturns to scale. Determinants of increasing and decreasing returns to scale. $onstant returns

to scale.

32. The 5ature of production costs. >&plicit and implicit costs. #ccounting and >conomic costs.

33. The cost function.

34. socost lines and their characteristics.

35. !hort = run cost.

36. Optimal combination of input factors for a firm.

37. Eong = run cost.

38. >conomies and diseconomies of scale.

39. The nature and features of perfectly competitive markets. The competitive firm(s demand

curve.

40. Total revenue F total cost approach.

41. Total 8evenue and profit of the firm. #ccounting, economic and normal profit.

42. Marginal revenue F marginal cost approach9 profit ma&imization, losses minimization and

shut=do*n decisions.

43. # perfectly competitive firm and market supply curve in the short=run.

44. Eong=run e"uilibrium in perfectly competitive firm.


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45. Pure monopoly and its properties.

46. Monopoly demand. Monopoly total revenue and its ma&imization.

47. The demand for a monopolist product. Marginal revenue curve for a monopolist.

48. !hort=run profit ma&imization and losses minimization by monopoly firm.

49. !ocial price of monopoly.

50. Mono)o" )oer.

The monopoly po*er consist in the capacity of the firm to set the price of its products at a higher

level as marginal cost, modifying the supply "uantity. The po*er of the monopoly firm depends

on the available substituents of this good and on the market "uota of the firm. ;hen trying to

ma&imize the profit, the monopoly firm has to modify the production volume or the selling price,

and *hen he decide to modify the "uantity supplied, it has to minimize the price. !o the price is

higher than marginal revenue and higher than marginal cost. The difference bet*een selling price

and marginal cost can be used to evaluate the monopoly po*er. #nother coefficient used to

calculate the monopoly po*er is the elasticity coefficient of the demand in relation *ith the

price.

51. ,r!'e &!s'r!m!n%$!on un&er mono)o".

Price discrimination consists in firm application of different prices for different unities of the

same product, and this action hasn(t any link *ith the cost differences. Price discrimination in

possible only if the monopoly firm can divide buyers in dependence *ith their demand elasticityand if the reselling of its goods are impossible. There are 2 types of price discrimination9

= Perfect price discrimination %/stdegree' F suppose that for each particular buyer it *ill set

a particular price. Perfect price discrimination can be only if the monopoly firm kno*s

the consumer demand curve and sell each unit of good at the demand price %at the higher

price *hich the consumer is able to buy a certain "uantity of goods'. By kno*ing the

reservation price, the seller is able to sell the good or service to each consumer at the

ma&imum price he is *illing to pay, and thus transform the consumer surplus into

revenues. !o the profit is e"ual to the sum of consumer surplus and producer surplus. The

marginal consumer is the one *hose reservation price e"uals to the marginal cost of the

product. The seller produces more of his product than he *ould to achieve monopoly

profits *ith no price discrimination, *hich means that there is no dead*eight loss.

>&amples of *here this might be observed are in markets *here consumers bid for

tenders, though, in this case, the practice of collusive tendering could reduce the market

efficiency.

= 0nd degree price discrimination F consist in the setting of the same price for all

consumers, but differ in relation *ith the "uantity purchased. Earger "uantities are


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available at a lo*er unit price. This is particularly *idespread in sales to industrial

customers, *here bulk buyers en4oy higher discounts. #dditionally to second degree price

discrimination, sellers are not able to differentiate bet*een different types of consumers.

Thus, the suppliers *ill provide incentives for the consumers to differentiate themselves

according to preference. #s above, "uantity GdiscountsG, or non=linear pricing, is a means

by *hich suppliers use consumer preference to distinguish classes of consumers. This

allo*s the supplier to set different prices to the different groups and capture a larger

portion of the total market surplus.

= n third degree price discrimination, price varies by attributes such as location or by

customer segment, or in the most e&treme case, by the individual customer-s identityH

*here the attribute in "uestion is used as a pro&y for ability+*illingness to pay.

52. Mono)o"!s$!' 'om)e$!$!on %n& !$s )ro)er$!es.

Monopolistic competition is an intermediary type of market *hich combines elements of

monopoly market and those of the market *ith perfect competition as high competition and an

insignificant part of monopoly po*er. This type of market is distinctive for clothes, shoes

production, furniture, food production and others.

Monopolistically competitive markets have the follo*ing characteristics9

= There are many producers, and each of them has a small share on the market and a limited

control over the price.

= There are different products *hich don(t represent perfect substituents of goods offered by

other firms. >ach firm has a uni"ue role as a seller of a certain "uantity of goods, possessing a

certain market po*er, *ho o*n the monopoly in a narro* specialized field. The differentiation

of the goods can appear through its "uality, services, placement, package, and others.

= There are fe*barriers to entryand e&it. n the long run there are no entry and e&it costs. There

are numerous firms *aiting to enter the market, each *ith their o*n Guni"ueG product or in

pursuit of positive profits. #ny firm unable to cover its costs can leave the market *ithout

incurring li"uidation costs. This assumption implies that there are lo* start up costs, no sunk

costs and no e&it costs.

= 1irms don(t take care on the competitors( reactions. On the market there isn(t an

interdependence bet*een firms and *hen one of them decide something about the price and

production volume, it doesn(t mind about the competitors( reactions.

53. Sor$(run eu!"!#r!um un&er mono)o"!s$!' 'om)e$!$!on.

Monopolistic $ompetition is a market structure featuring fe* large and many small firms, fairlylo* entry barriers similar goods and relatively high competition. The short=run, is a time period
http://en.wikipedia.org/wiki/Barriers_to_entryhttp://en.wikipedia.org/wiki/Barriers_to_entryhttp://en.wikipedia.org/wiki/Barriers_to_entry


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in *hich at least one factor of production is fi&ed and firms can usually gain some abnormal

profit.

The firm *ill produce "uantity s at price Ps. The firm produces *here marginal cost %M$' and

marginal revenue %M8' curves meet, because M$ is the cost of producing an one more of the

good and M8 is the revenue of selling one more good and their meeting point is the most

efficient production. This means that the shaded area bet*een Ps, #$s %average cost of

producing one good at this "uantity' and the #8 curve %average revenue curve' is the abnormal

profit the firm makes. #8 is e"uivalent to the demand curve and is the average revenue the firm

makes per item sold. Producing at this point ensures the highest amount of profit. Thus,

e"uilibrium is created in the short run.

54. on+(run eu!"!#r!um un&er mono)o"!s$!' 'om)e$!$!on.

Monopolistic $ompetition is a market structure featuring fe* large and many small firms, fairly

lo* entry barriers similar goods and relatively high competition. The long=run period is *hen all

factors of production are variable. n the long run, there are no abnormal profits because of the

features of Monopolistic competition. There are a fe* large firms, but many small firms that *ill

compete for profit and thus drive the price do*n. #lso, lo* entry barriers mean ne* firms *ill

enter the market and further add competition. 1inally, the goods are similar enough to ensure that

competition *ill al*ays remain high.


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n this diagram, the firm produces *here the E8M$, or long run marginal cost curve, and the

marginal revenue curve meets. The E8M$ describes the cost of producing one more of the good

*hen no factors of production are fi&ed over the long run. That point is, in the long run,

e"uivalent to the E8#$, or long run average cost curve, *hich sho*s them average cost of

producing one good at this "uantity over the long run. Because the E8#$ curve is above the #8

curve, there is no abnormal profit, as the average cost of the good e"uals the average revenue of

the good. Thus, in the long run, e"uilibrium is ac"uired.

55. Mono)o"!s$!' 'om)e$!$!on %n& e'onom!' e--!'!en'. E'ess '%)%'!$.

Monopolistically competitive markets are less efficient than perfectly competitive markets. n

terms of economic efficiency, firms that are in monopolistically competitive markets behave

similarly as monopolistic firms. Both types of firms- profit ma&imizing production levels occur

*hen their marginal revenues e"uals their marginal costs. This "uantity is less than *hat *ould

be produced in a perfectly competitive market. t also means that producers *ill supply goods

belo* their manufacturing capacity. 1irms in a monopolistically competitive market are price

setters, meaning they get to unilaterally charge *hatever they *ant for their goods *ithout being

influenced by market forces. n these types of markets, the price that *ill ma&imize their profit is

set *here the profit ma&imizing production level falls on the demand curve.This price e&ceeds

the firm-s marginal costs and is higher than *hat the firm *ould charge if the market *as

perfectly competitive. 8egardless of *hether there is a decline in producer surplus, the loss in

consumer surplus due to monopolistic competition guarantees dead*eight loss and an overall

loss in economic surplus.

>&cess capacity. The difference bet*een the "uantity of products *hich correspond *ith the

minimum level of long=run average cost and the "uantity of products offered by the firm in

conditions of long=run e"uilibrium is called e&cess capacity of firm production


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56. Mono)o"!s$!' 'om)e$!$!on )ure mono)o" %n& )er-e'$ 'om)e$!$!on 'om)%r%$!*e

%n%"s!s.

n conditions of monopolistic competition, firms offer differentiable goods, in contradiction to

homogeneous ones offered by firms from perfect competition market, and uni"ue goods offered

by pure monopoly firms. n monopolistic competition industry, consumers are imposed to pay

higher prices for differentiate goods. n perfect competition market, economic profit become

e"ual *ith %zero' *hen the price is e"ual *ith minimum total average costs for long period

%P:E8#$min'. !o in case of e"uilibrium for long=run activity of perfect competition,

P:E8M$:E8#$min. $onsumers buy goods at the minimum possible level of price. The prices

reflect minimum average costs for one unit of production and marginal cost.

The firm modify the price until M8:M$. Because the price is al*ays bigger than marginal

revenue, in conditions of e"uilibrium the price *ill be higher than marginal cost. The e"uilibrium

of the firm from monopolistic competition resembles %se aseamana' *ith the e"uilibrium in the

monopoly situation through the idea that prices are higher than marginal costs. Because here

e&ist barriers to enter the market, in case of monopoly market, the price in long=run can be higher

than average costs. n conditions of monopolistic competition, free entrance on the market,

doesn(t permit the e&istence of economic profit for a long period of time. The profit gained by

firms attract in this field other firms and maintain the prices at a lo*er level than in case of

e&istence of a monopoly firm. !o, in conditions of monopolistic competition, prices are lo*er as

in case the products are offered by a monopoly firm, but the price level is higher as in case the

products are offered by firms from perfect competition.

57. Te ro"e o- %&*er$!!n+ !n $e mono)o"!s$!' 'om)e$!$!on

!ome of the arguments in favor of advertising are

= advertising is informative,

= advertising increases sales and permits economies of scale,


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= advertising increases sales and contributes to economic

gro*th,

= advertising supports the media,

= advertising increases competition and lo*ers prices.

!ome of the arguments against advertising are

= advertising is not informative but competitive,

= the economies of scale are illusory,

= advertising raises the cost curve,

= advertisers may use their influence to bias the media,

= advertising is used as an entry barrier, and

= advertising is not a productive activity.

58. O"!+o)o" %n& !$s )ro)er$!es.

Oligopoly is a situation on the market *here e&ist a limited number of producers %more than one'

and a big number of consumers. The main characteristics of oligopoly are9

A -e "%r+e )ro&u'ers. )sually three, four, or five firms occupy the market

omo+enous or &!--eren$!%$e& )ro&u'$s. !ome oligopolistic industries offer homogenous, or

standardized, products, e.g. those of steel, zinc, copper, lead, industrial alcohol. Other industries,

e.g. those of automobiles, tires, electronics, breakfast cereal, offer different products and place an

emphasis on nonprice competition, such as advertising.

,r!'e m%er #u$ s$!"" mu$u%"" !n$er&e)en&en$. The small number of firms let oligopolies to

set prices and output levels, to some e&tent. ntry barriers e&ist that allo* a handful of firms to achieve

economies of scales, but no more beyond that. #ny ne* firms *ould have too small a market

share and *ould have to produce at too high a price. !ometimes the cost of capital is too high

and other times, o*nership and control of the ra* materials is a factor. Patents and brand loyalty

are also barriers of entry into an oligopolistic market.

microeconomics examination questions

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