Example

questions for the Business

Economics Test
The questions in the test will be structured in exactly the same way; i.e. 5 answer
options. Recall that you will get a quarter negative point for answering wrongly.

Question 1
If the government imposes a tax on producers in a competitive market this will

a. Reduce consumer surplus and increase producer surplus
b. Increase consumer surplus and reduce producer surplus
c. Reduce producer surplus and the consumer surplus may either go up or
down
d. Reduce consumer surplus and the producer surplus may go up or down
e. Reduce both, producer and consumer surplus

Solution: e.

Question 2
Suppose the government wants to regulate two CO2 emitting firms with a
pollution tax. The marginal benefit from emitting CO2 in firm 1 (measured in )
is
MB1=20-3E1

where E1 are emissions of tons of CO2 and for firm 2
MB2=10-2E2

What tax level should the government choose if it wants to make sure that total
emissions are equal to 10 tons of CO2?
a. 3
b. 2
c. 1
d. 0
e. There is not enough information to tell.

Solution: b.

We know that firms will adjust emissions so that marginal benefits from
emissions (also know as abatement costs of emissions) are equal to the tax. We
also know that E1+E2=10 or E1=10-E2. Hence the following equation has to hold

20-3xE1=10-2xE2
which we can write as
20-3x(10-E2)=10-2xE2

We can solve this for E2 as E2=4. Plugging into the marginal benefit curve for E2
yields that MB2=MB1=tax=2.

Question 3
A competitive firm is facing a price of P=10. The firm has two factories to
produce the same output with the following marginal cost functions:

Factory 1: MC1=2Q1
Factory 2: MC2=1+Q2

How much output is the firm going to produce if it maximizes profits as a price
taker?

a. 5
b. 6
c. 9
d. 10
e. 14


Solution: e)

Remarks: In either factory price has to be equal to marginal cost.
Hence
10 = 2! ! = 5
10 = 1 + ! ! = 9
Consequently, total output is Q=14.


Question 4
A monopolist has set her level of output to maximise profit. The firm's marginal
cost is 20, and the price elasticity of demand is -5.0. The firm's profit
maximising price is approximately:

a) 0
b) 25
c) 40
d) 10
e) there is not enough information to answer this question

Solution: b)

Use the markup pricing formula

Question 5
A competitive market is characterised by the demand function P=450-0.5Q and
the supply function P=2Q. Production of good Q leads to pollution costs (PC) of
the form = 10 . What is the socially efficient total amount of Q?

a.
b.
c.
d.
e.

176
50
100
60
450

Solution: a)

We have to add the marginal costs of pollution to the supply function. If total
pollution costs are PC=10Q then marginal costs are 10. Hence the socially
optimal amount of output is determined by
10+2Q=450-0.5Q
Solving for Q yields
Q=(450-10)/2.5=176


Question 6
The orange juice industry is perfectly competitive. Each producer has the long-
run total cost function = 31 6! + ! /3 where q is the output of an
individual producer. The market demand curve for orange juice is = 3100
100. What will be the output of an individual producer in the long run
competitive equilibrium?

a. 9
b. 4
c. 3
d. 2

e. 1

Solution: a)

We know that in the long run equilibrium MC=AC; i.e. in this case
!
31 12 + ! = 31 6 +
3
which we can re-write as

12 + = 6 +
3
and easily solve for q as q=9



Question 7
Suppose a monopoly is serving a market with the demand curve
P=100-Q
Also assume that production costs are 0. What is the elasticity of demand in the
market equilibrium?

a. 0
b. -0.5

c. -1
d. -2
e. -4

Solution: c.
Note that a monopoly will always produce in a point where the elasticity is
smaller than -1. This is because of what we discussed in the first lecture: if
demand is inelastic (i.e. between -1 and 0) a firm can increase its revenue by
increasing prices. Moreover, because they sell less their costs go down too when
reducing output so profits must increase. Hence, as a consequence the
monopolist would increase price until the elasticity turns elastic (note that for
instance with the linear demand curve the elasticity goes to infinity if you
increase the price high enough.)
Of course you might have a demand function whose elasticity never turns elastic.
That would in principle imply that the monopolist would sell a very small
amount (0 in the limit) for an infinitely high price. However, this is not
something we see in actual markets (although some prices particular house
prices in London might seem virtually equal to infinity to many of us) so those
kind of demand functions are not very realistic (at least for a monopoly, take into
account that this would mean that profits would be infite as well. But if profits
are infinite its likely that other firms will enter the market and so we dont have a
monopoly any more).


Question 8
Which of the following is a correct definition of the concept of market failure?

a. A situation where no sales are undertaken on a market
b. When there is excess demand; i.e. not all buyers will be served by the
sellers in the market
c. When there is excess supply; i.e. not sellers can find customers for their
goods.
d. A situation where no market equilibrium can be reached
e. When the market equilibrium is inefficient.

Solution: e)

Question 9
Suppose a market is characterised by the following demand and supply curves:
P=100-QD

P=100+QS

How much output is being produced in equilibrium if firms receive a subsidy of

10 for every unit of output produced?

a. 1
b. 2

c. 3
d. 4
e. 5


Question 10
The demand curve for a product is given by:
P = 28 - 0.005Q
The supply curve of the product is given by:
P = 10 + 0.004Q
What is the price elasticity of demand in the market equilibrium?
a. 1
b. -0.5
c. -1
d. -1.8
e. -2

Solution: d)

Remarks: We first have to figure out the market equilibrium by equating supply
and demand:
28 0.005 = 10 + 0.004
18 = 0.009 = 2000 = 18

Note that the demand function (inverse of the inverse) is
= 5600 200

Hence, using the elasticity formula we find


18
=
= 200
= 1.8

2000


Question 11
Antigone is a producer in a monopoly industry. Her demand curve, and total cost
curve are given as follows:
P=160-4Q
TC=4Q
If she is to maximize profit, how much profit will she make?
a. 72
b. 22
c. 1521
d. 1296
e. 1300

Solution: c)

Remarks: We can use MR=MC; i.e. 160-8Q=4 so that Q=19.5 and P=82
Hence profits become (82-4)x19.5=1521



Question 12
Tony and Jim are two consumers that have arranged their consumption for two
periods in an optimal way. Tony consumes more than his income today and
compensates by consuming less of his income tomorrow. For Jim it is the other
way round. Unexpectedly the interest rate declines compared to the rate they
used for their calculations. Which of the following statements is correct?
a. Both are worse off
b. Tony is better off and Jim is worse off
c. Jim is better off and Tony is worse off
d. They are both better off.
e. Tony is worse off and Jim might be better or worse off

Solution: b)


Remarks: Tony is a borrower and Jim a saver. So when the interest rate drops
that is good for Tony but bad for Jim.