ANSWER SHEET

Multiple-Choice

Time —1 hour and 10 minutes

60 questions

For the multiple-choice questions that follow, select the best answer and fill in the appropriate letter on the answer sheet.

1 . Land, labor, capital and entrepreneurial talent are often referred to as

(A) production possibilities.

(B) goods and services.

(C) unlimited human wants.

(D) opportunity costs.

(E) scarce economic resources.

2 . The law of increasing costs is useful in describing

(A) a demand curve.

(B) a marginal benefit curve.

(C) a linear production possibility frontier.

(D) a concave production possibility frontier.

(E) a total fixed costs curve.

3 . Which of the following is likely to have a demand curve that is the least elastic?

(A) Demand for the perfectly competitive firm’s output

(B) Demand for the oligopoly firm’s output with a homogenous product

(C) Demand for the oligopoly firm’s output with a differentiated product

(D) Demand for the monopolistically competitive firm’s output

(E) Demand for the monopoly firm’s output

4 . The figure above shows the production possibility frontiers (PPFs) for two nations that produce crabs and cakes. If these nations specialize and trade based on the principle of comparative advantage, which of the following trade agreements benefit both nations?

(A) Nation A trades three crabs to Nation B in exchange for two cakes.

(B) Nation A trades three cakes to Nation B in exchange for three crabs.

(C) Nation A trades one cake to Nation B in exchange for two crabs.

(D) Nation A trades one crab to Nation B in exchange for two cakes.

(E) Nation A trades four crabs to Nation B in exchange for six cakes.

5 . Which of the following scenarios would increase a nation’s production possibility frontier (PPF)?

(A) The nation’s system of higher education slowly declines in quality.

(B) The nation invests in research and development of new technology.

(C) The nation’s infant mortality rate increases.

(D) Environmental pollution severely damages the health of the population.

(E) Mineral reserves are exhausted.

6 . A rational consumer who is eating Girl Scout cookies stops eating when

(A) the total benefit equals the total cost of eating cookies.

(B) the marginal benefit equals the marginal cost of the next cookie.

(C) the marginal cost of eating cookies is maximized.

(D) the marginal benefit of eating cookies is minimized.

(E) the price of the cookie equals the total benefit of the next cookie.

7 . A competitive market for coffee, a normal good, is currently in equilibrium. Which of the following would most likely result in an increase in the demand for coffee?

(A) Consumer income falls.

(B) The price of tea rises.

(C) The wage of coffee plantation workers falls.

(D) Technology in the harvesting of coffee beans improves.

(E) The price of coffee brewing machines rises.

8 . Which of the following certainly lowers the equilibrium price of a good exchanged in a competitive market?

(A) The demand curve shifts to the right.

(B) The supply curve shifts to the left.

(C) The demand curve shifts to the left, and the supply curve shifts to the right.

(D) The demand curve shifts to the right, and the supply curve shifts to the left.

(E) Both the demand and supply curves shift to the left.

9 . An effective price ceiling in the market for good X likely results in

(A) a persistent surplus of good X.

(B) a persistent shortage of good X.

(C) an increase in the demand for good Y, a substitute for good X.

(D) a decrease in the demand for good Z, a complement with good X.

(E) a rightward shift in the supply curve of good X.

10 . Which of the following goods is likely to have the most elastic demand curve?

(A) Demand for white Ford minivans

(B) Demand for automobiles

(C) Demand for Ford automobiles

(D) Demand for American-made automobiles

(E) Demand for a Ford minivan

11 . Which of the following is a fundamental aspect of the free market system?

(A) A high degree of government involvement.

(B) Public ownership of resources.

(C) Private property.

(D) Central planners set wages and prices.

(E) Employers consult government agencies for guidance in hiring workers with appropriate job skills.

12 . The elasticity of supply is typically greater when

(A) producers have fewer alternative goods to produce.

(B) producers have less time to respond to price changes.

(C) producers are operating near the limits of their production.

(D) producers have less access to raw materials necessary for production.

(E) producers have more time to respond to price changes.

13 . Good X is exchanged in a competitive market. Which of the following is true if an excise tax is now imposed on the production of good X?

(A) If the demand curve is perfectly elastic, the price rises by the amount of the tax.

(B) The consumer’s burden of the tax rises as the demand curve is more elastic.

(C) Consumer surplus rises as a result of the tax.

(D) The consumer’s burden of the tax rises as the demand curve is less elastic.

(E) If the demand curve is perfectly inelastic, the price does not rise as a result of the tax.

14 . Which of the following is an implicit cost for the owner of a small store in your hometown?

(A) The wage that is paid to the assistant manager

(B) The cost of purchasing canned goods from a wholesale food distributor

(C) The value placed on the owner’s skills in an alternative career

(D) The cost of cooling the refrigerated meat display

(E) The price of placing an advertisement in the local newspaper

15 . Suppose a price floor is installed in the market for coffee. One result of this policy would be

(A) a decrease in the demand for coffee-brewing machines.

(B) a persistent shortage of coffee in the market.

(C) an increase in consumer surplus due to lower coffee prices.

(D) an increase in the demand for coffee.

(E) a decrease in the profits for the owners of coffee plantations.

Questions 16 to 17 refer to the table below, which describes employment and production of a firm that hires labor and produces output in competitive markets. The competitive price of the product is $.50.

16 . Which unit of labor has marginal revenue product equal to $1.50?

(A) 1st

(B) 2nd

(C) 3rd

(D) 4th

(E) 5th

17 . If the wage paid to all units of labor is $4.50, how many units of labor are hired?

(A) 1

(B) 2

(C) 3

(D) 4

(E) 5

18 . Which of the following is true of the perfectly competitive firm in the short run?

(A) The firm earns a normal profit.

(B) The firm shuts down if the price falls below average total cost.

(C) The firm earns positive economic profit.

(D) The firm maximizes profit by producing where the price equals marginal revenue.

(E) The firm may earn positive, negative, or normal profits.

Questions 19 to 21 refer to the figure below.

19 . If the current price is 0B, we would expect

(A) a surplus in the market to be eliminated by rising prices.

(B) a shortage in the market to be eliminated by falling prices.

(C) a surplus in the market to be eliminated by falling prices.

(D) quantity demanded to be equal to quantity supplied as the market is in equilibrium.

(E) a shortage in the market to be eliminated by rising prices.

20 . If the price were to fall from 0C to 0A, which of the following would be true?

(A) Dollars spent on this good would increase if demand for the good were price inelastic.

(B) Dollars spent on this good would decrease if demand for the good were price elastic.

(C) Dollars spent on this good would increase if demand for the good were price elastic.

(D) Dollars spent on this good would increase if demand for the good were unitary price elastic.

(E) Dollars spent on this good would decrease if demand for the good were unitary price elastic.

21 . If the market is in equilibrium, which of the following areas corresponds to producer surplus?

(A) BGD

(B) 0AHJ

(C) 0DGK

(D) 0BG

(E) 0BGK

22 . The downward-sloping demand curve is partially explained by which of the following?

(A) Substitution effects and income effects

(B) The law of increasing marginal costs

(C) The principle of comparative advantage

(D) The law of diminishing marginal returns to production

(E) The least-cost principle

23 . Dorothy has daily income of $20, each cup of coffee costs P _c = $1, and each scone costs P _s = $4. The table below provides us with Dorothy’s marginal utility (MU) received in the consumption of each good. As a utility-maximizing consumer, which combination of coffee and scones should Dorothy consume each day?

(A) 2 coffee and 2 scones

(B) 5 coffee and 6 scones

(C) 3 coffee and 2 scones

(D) 4 coffee and 4 scones

(E) 4 coffee and 16 scones

24 . You are told that the Gini coefficient of income inequality has risen from .35 to .85. Which of the following is a likely cause of this change?

(A) Market power in the factor and output markets has increased.

(B) Labor market discrimination has been eliminated.

(C) The distribution of wealth and property has become more equitable.

(D) The vast majority of adults have achieved at least a college degree.

(E) The tax system has become even more progressive.

25 . The figure above best represents which of the following functions?

(A) Total product of labor

(B) Total revenue

(C) Total cost

(D) Total utility

(E) Total short-run economic profits

26 . If it is true that bacon and eggs are complementary goods, then

(A) the income elasticity of bacon is positive and the income elasticity for eggs is negative.

(B) the price elasticity for eggs is greater than the price elasticity for bacon.

(C) the cross-price elasticity between bacon and eggs is negative.

(D) the income elasticity of bacon is negative and the income elasticity for eggs is positive.

(E) the cross-price elasticity between bacon and eggs is positive.

27 . A firm employs variable amounts of labor to a fixed amount of capital to produce output. If the daily wage paid to labor increases, how does this affect the firm’s costs?

28 . Diminishing marginal returns to short-run production begin when

(A) the average product of labor begins to fall.

(B) the total product of labor begins to fall.

(C) marginal product of labor becomes negative.

(D) average variable cost begins to rise.

(E) marginal product of labor begins to fall.

29 . Which of the following is a characteristic of perfect competition?

(A) Firms produce a homogeneous product.

(B) Barriers to entry exist.

(C) Firms are price-setting profit maximizers.

(D) The government regulates the price so that deadweight loss is eliminated.

(E) Long-run positive profits are available.

30 . The table above shows how hiring increasing amounts of labor to a fixed amount of capital affects the hourly output of Eli’s lemonade stand. Based on this table of production data, which of the following can be said?

(A) Diminishing marginal returns begins with the first worker hired.

(B) Marginal cost begins to rise at the sixth worker hired.

(C) Total product is maximized at the third worker hired.

(D) Average product begins to decline with the first worker hired.

(E) Diminishing marginal returns begins with the fourth worker hired.

31 . The figure above shows the long-run average cost curve of a competitive firm. Which of the following choices best describes Region B in the diagram?

(A) Economies of scale

(B) Diseconomies of scale

(C) Constant returns to scale

(D) Diminishing returns to scale

(E) Increasing returns to scale

32 . The market for good X is currently in equilibrium. Which of the following choices would not cause both a decrease in the equilibrium price of good X and a decrease in the equilibrium quantity of good X?

(A) A decrease in consumer income and good X is a normal good.

(B) An increase in consumer income and good X is an inferior good.

(C) An increase in the price of good Y, a complement for good X.

(D) A decrease in the price of good Y, a substitute for good X.

(E) An increase in the number of consumers in the market for good X.

Questions 33 to 34 refer to the figure below, which shows cost curves for a competitive firm.

33 . If average variable cost at a quantity of 10 is $25, what is the value of $Y in the figure above?

(A) $250

(B) $25

(C) $35

(D) $1,000

(E) $350

34 . At a quantity of 10, what is the value of $(Y – X )?

(A) $100

(B) $25

(C) $10

(D) $35

(E) $350

35 . The demand for labor falls if

(A) labor productivity falls.

(B) the price of the good produced by labor rises.

(C) the price of a complementary input falls.

(D) demand for the good produced by labor rises.

(E) a minimum wage is removed from the labor market.

Questions 36 to 37 refer to the graph below.

36 . The curve labeled 4 represents which of the following?

(A) Marginal cost

(B) Marginal product of labor

(C) Average total cost

(D) Average fixed cost

(E) Average variable cost

37 . Where is the shutdown point for this perfectly competitive firm?

(A) Any price below curve 4

(B) Any price below 0c

(C) Any price below curve 3

(D) Any price below curve 2

(E) Any quantity less than Q

38 . If a market for a good is producing a negative externality,

(A) at the market output the marginal costs to society exceed the private marginal costs of production.

(B) at the market output the marginal benefits to society exceed the private marginal costs of production.

(C) at the market output the marginal costs to society exceed the total benefits to society.

(D) at the market output the private marginal costs of production exceed the marginal costs to society.

(E) at the market output the marginal benefits to society exceed the marginal costs to society.

39 . Which of the following is a characteristic of a monopoly market?

(A) Firms produce a homogeneous product.

(B) Barriers to entry exist.

(C) Firms are price-taking profit maximizers.

(D) Deadweight loss is eliminated through entry of competing firms in the long run.

(E) In the long run the firm earns normal profits.

40 . A monopolist may be able to maintain long-run positive profit due to

(A) deadweight loss.

(B) economies of scale in production.

(C) a price that is set equal to average total cost.

(D) perfectly elastic demand for the product.

(E) entry of new firms that keep the price high.

Questions 41 and 42 refer to the graph below.

41 . If this firm were a profit-maximizing monopolist, the price, output, and profit would be

42 . Consumer surplus in the monopolist market is equal to the area

(A) abce.

(B) abcf.

(C) P 5cd.

(D) 0Q 1aP 1.

(E) P 1P 5ca.

43 . The top six firms in an oligopolistic industry have market shares of 25%, 25%, 15%, 10%, 6%, and 3%. Many smaller firms split the rest of the market. What is the value of the four-firm concentration ratio?

(A) 65%

(B) 54%

(C) 75%

(D) 34%

(E) 50%

44 . Which of the following statements is true of a consumer’s utility-maximizing behavior?

(A) As consumption of good X increases, total utility increases at an increasing rate.

(B) The consumer should stop consuming good X when marginal utility is maximized.

(C) The consumer has maximized utility between two goods X and Y when the quantities of the two goods are equalized.

(D) Utility maximization occurs when the marginal utilities per dollar for goods X and Y are equalized.

(E) As consumption of good X increases, the marginal utility per dollar spent on good X also increases.

45 . Oligopoly has at times been the subject of government antitrust regulation. Which of the following is a reason for this government regulation?

(A) Price is approximately equal to marginal cost.

(B) Price is approximately equal to average total cost.

(C) Deadweight loss lessens over time.

(D) Consumer surplus is lost as market power increases.

(E) Market efficiency is maximized.

46 . The production of chicken often results in offending odors that are picked up by the wind and blown over rural communities. This is an example of a ______ externality, the result of which are spillover ______ and an _______ of resources to chicken production.

(A) negative, costs, underallocation

(B) negative, benefits, overallocation

(C) negative, benefits, underallocation

(D) positive, costs, overallocation

(E) negative, costs, overallocation

47 . Which of the following choices is true of both perfectly competitive firms and monopolistically competitive firms?

(A) Barriers to entry

(B) Homogenous products

(C) Normal profits in the long run

(D) Excess capacity

(E) Price-setting behavior

48 . The monopolistically competitive price is above marginal revenue because

(A) firms have differentiated products.

(B) firms are price takers.

(C) firms produce a homogenous product.

(D) the market is allocatively efficient.

(E) profits are normal in the long run.

49 . Deadweight loss in industries with market power is a result of

(A) profit-maximizing output occurs where price equals marginal revenue.

(B) profit-maximizing output occurs where price exceeds marginal cost.

(C) profit-maximizing output occurs where price equals marginal cost.

(D) profit-maximizing output occurs where price exceeds average total cost.

(E) profit-maximizing output occurs where price equals average total cost.

50 . If the government wishes to regulate a natural monopoly so that it earns a normal profit, it sets

(A) Price = Marginal cost.

(B) Marginal revenue = Marginal cost.

(C) Price = Average total cost.

(D) Price = Marginal revenue.

(E) Marginal revenue = Average total cost.

51 . Which of the following would improve the efficiency of a monopoly market?

(A) The government regulates the monopolist to produce the output where marginal revenue equals marginal cost.

(B) The government provides additional legal barriers to entry.

(C) The government subsidizes the monopolist so that they achieve even greater economies of scale.

(D) The government eliminates trade barriers on potential foreign producers.

(E) The government regulates the monopolist to produce the output where monopoly profits are maximized.

52 . Which of the following increases the demand for interstate truck drivers?

(A) An increase in the wage of truck drivers

(B) An increase in the supply of truck drivers

(C) An increase in the price of diesel fuel, which is used to power semitrucks

(D) A decrease in the demand for interstate shipping

(E) A decrease in the price of semitrucks

53 . A monopsony employer hires labor up to the point where

(A) Wage = Marginal factor cost.

(B) Marginal factor cost = Marginal product of labor

(C) Marginal factor cost = Marginal revenue product of labor

(D) Wage = Marginal revenue product of labor

(E) Wage = Price of the good produced by the labor

54 . The price of labor is $5 and the price of capital is $10 per unit. Using the table below, what is the least-cost combination of labor and capital that should be hired to produce 18 units of output?

(A) 1 Labor and 2 Capital

(B) 4 Labor and 8 Capital

(C) 2 Labor and 1 Capital

(D) 5 Labor and 5 Capital

(E) 3 Labor and 2 Capital

55 . A cartel is often the result of

(A) perfectly competitive firms that agree to produce a homogenous product.

(B) oligopoly competitors that agree to restrict output to maximize joint profits.

(C) a monopoly that has been regulated by the government.

(D) a natural monopoly that has evolved into a perfectly competitive industry.

(E) monopolistically competitive firms that have agreed to earn normal profits in the long run.

56 . Suppose the state requires hairdressers and manicurists to pass a series of exams to be certified cosmetologists. How does this policy change the supply of cosmetologists, the equilibrium wage, and the price of a manicure?

57 . The local market for bankers is currently in equilibrium. Which of the following increases the local wage paid to bankers?

(A) Internet banking at home is becoming more popular.

(B) More college students are majoring in finance and economics, majors that make them attractive as bank employees.

(C) The price of banking software, a complementary resource to bankers, rises.

(D) Several banks in the local market merge and consolidate many operations.

(E) The price of automatic teller machines, a substitute for bankers, decreases and the output effect is greater than the substitution effect.

58 . The U.S. government collects tax revenue, buys military equipment from many private firms, and uses this equipment to provide national defense to all Americans. This is a good example of

(A) a natural monopoly.

(B) an excise tax on military equipment.

(C) a regressive tax.

(D) a public good.

(E) deadweight loss.

59 . Which of the following scenarios is the best example of a positive externality?

(A) Your neighbor has a swimming pool and throws loud late-night parties.

(B) Your neighbor has a swimming pool and allows you free access.

(C) Your neighbor has a swimming pool and the powerful chlorine odor blows into your open dining room window.

(D) Your neighbor has a swimming pool and allows you to use it in exchange for letting his kids use your swing.

(E) Your neighbor has a swimming pool that is conducive for the breeding of mosquitoes.

60 . Because of the free-rider effect, the private marketplace tends to

(A) provide the allocatively efficient amount of a public good.

(B) produce too much of a public good, requiring the government to intervene and tax the production of it.

(C) produce a public good in the amount where the marginal benefit to society equals the marginal cost to society.

(D) produce too little of the public good, requiring the government to intervene and provide it for all.

(E) produce too little of the public good, requiring the government to intervene and ban it.

1 . E— Know the four scarce economic resources.

2 . D— A concave PPF exhibits the law of increasing costs. As more of a good is produced, opportunity costs rise. This is because resources are not perfectly substitutable between the production of different goods.

3 . E— Demand is more elastic if there are more substitute goods. A monopolist has no close substitutes so is likely the least elastic demand.

4 . A— Nation A has comparative advantage in crab production, and Nation B has comparative advantage in cake production. Nation A specializes in crabs and Nation B specializes in cakes, so avoid any option suggesting the opposite. Choice A is the only one that allows both to consume beyond the PPF.

5 . B— Nations that invest in research and technology expect the PPF to expand; the key to economic growth.

6 . B— Rational decision makers consume right up to the point where the MB of the next cookie is exactly equal to the MC of the next cookie.

7 . B— Tea is a coffee substitute. Higher tea prices increase coffee demand.

8 . C— Leftward demand shifts coupled with rightward supply shifts put downward pressure on prices.

9 . B— Price ceilings are legal maximum prices set below the equilibrium price. A shortage results.

10 . A— The more narrowly a good is defined, the more elastic demand.

11 . C— Private property is fundamental to the free market economy.

12 . E— The supply curve is more elastic as more time elapses.

13 . D— If the demand curve is more inelastic (more vertical), a greater burden of an excise tax falls upon consumers and less upon producers.

14 . C— The opportunity cost of starting a small store is the salary given up in the next best alternative for the entrepreneur’s skills.

15 . A— A price floor is a legal minimum price set above the equilibrium price. Higher coffee prices decrease the demand for complementary goods like coffee machines.

16 . E— P × MP_L = MRP_L .

17 . B— At the second worker, wage = MRP_L .

18 . E— In perfect competition, short-run profits may be positive or negative, or normal, but long-run profits are always normal.

19 . D— This is the equilibrium price.

20 . C— When the price falls and quantity demanded rises, consumer spending on the good (P × Q ) can change in two directions. If E _d > 0, a percent decrease in price increases quantity demanded by a greater percent, increasing spending on the good.

21 . D— PS is the area under the price and above supply.

22 . A— Substitution and income effects explain the law of demand.

23 . D— Using the utility maximizing rule, set MU_c /$1 = MU_s /$4. There are three options where the MU_c is four times the MU_s , and only one of those options uses exactly $20 of daily income.

24 . A— The Gini coefficient measures income inequality. The closer it gets to one, the more unequal the income distribution. One explanation for inequality is more market power in product and input markets. This redistributes CS to monopoly producers and/or employers.

25 . B— Quickly look at the graph to eliminate some possibilities. With dollars on the y axis, this curve cannot represent TP_L (output on the y axis) or total utility (utility on the y axis). The other key is that this curve has a value of zero dollars at an output of zero. TC = TFC at zero output and short-run economic losses equal TFC at zero output.

26 . C— If the price of eggs rises, demand for bacon falls if they are complementary; E _xy < 0.

27 . D— Labor is a variable cost so there is no change in TFC, but an increase in TVC and TC.

28 . E— This defines diminishing marginal returns and is often missed by students, who make the mistake of identifying falling TP_L , rather than falling MP_L , with diminishing returns.

29 . A— Know the characteristics of all market structures.

30 . E— The fourth worker is the first to have lower MP_L than the worker before.

31 . C— Constant returns exist when a larger firm has constant LRAC.

32 . E— All other choices would produce a decrease in the demand for good X and would therefore decrease both the price and quantity. You are looking for the only choice that would not . More consumers for good X would increase demand and increase both the price and quantity

33 . E— Since you know that AVC is $25 at Q = 10, TVC is $250. Adding this to the given $100 of TFC produces $350 of total cost at Q = 10.

34 . A— The vertical distance between TC and TVC is TFC.

35 . A— Demand for labor is the MRP_L curve. Higher labor productivity increases labor demand.

36 . D— AFC declines as output rises.

37 . C— The shutdown point is at P < AVC.

38 . A— With no externality, MSB = MSC. With a negative externality, MSC > MPC = MSB for the good.

39 . B— Barriers to entry are a defining characteristic of monopoly.

40 . B— Economies of scale are a common barrier to entry; a key to maintaining long-run positive profits.

41 . A— Find the output level where MR = MC and locate the price from the demand curve. Profit is equal to Q × (P – ATC) at that output.

42 . C— CS is the area above price and under demand.

43 . C— A four-firm concentration ratio is the sum of the market share of the four largest firms in an industry.

44 . D— Utility-maximizing consumers do not equate the units of two goods, they equate MU/P for each good.

45 . D— As industries approach monopoly, prices rise, lowering CS.

46 . E— Negative externalities, like “fowl” odors, impose spillover costs upon third parties. These costs, ignored by the market, reflect an over-allocation of resources to chicken production.

47 . C— Know the characteristics of all market structures.

48 . A— Product differentiation results in a small degree of price-setting ability and downward-sloping demand curves for the firms. P = ATC and profits are normal in the long run, and this output level does not occur where ATC is minimized. This defines excess capacity.

49 . B— DWL emerges when output is moved away from where P = MC.

50 . C— If P = ATC, economic profit is zero, or normal.

51 . D— Allowing more foreign competition lessens market power of a monopolist and improves efficiency as the price falls closer to MC.

52 . E— Semitrucks are a complementary resource to the truck drivers. If the price falls, demand for the labor rises.

53 . C— The monopsony hiring decision.

54 . C— Use the least-cost rule of MP_L /$5 = MP_K /$10 to find the optimal combination of labor and capital. There are three combinations of labor and capital where the MP_K is twice the MP_L, but only one choice produces 18 units of output. Remember that adding the marginal products provides the total product.

55 . B— This describes a cartel.

56 . A— Certification exams decrease labor supply and raise the wage in the market. A higher wage increases the MC of producing the good, which raises the price of the good.

57 . E— If the price of a substitute resource falls, labor demand can increase if the output effect is greater than the substitution effect.

58 . D— Know your public goods.

59 . B— You are the recipient of a spillover benefit from your neighbor’s purchase of a pool.

60 . D— The private marketplace underprovides for a public good because free riders benefit from the good without paying for it. Government must provide the public good.

Free-Response Questions

Planning time —10 minutes

Writing time —50 minutes

At the conclusion of the planning time, you have 50 minutes to respond to the following three questions. Approximately half of your time should be given to the first question, and the second half should be divided evenly between the remaining two questions. Be careful to clearly explain your reasoning and to provide clear labels to all graph axes and curves.

1. The graph below shows a firm that has monopolized the market for gadgets.

(A) Using the values in the graph, identify the following:

i. The profit-maximizing quantity

ii. The price of a gadget when the monopolist has maximized profit

iii. The allocatively efficient output

(B) Using the values in the graph, calculate the following and show your work:

i. Monopoly profit

ii. Consumer surplus

(C) Suppose the government levies a lump-sum tax on the monopolist. How will this affect the following?

i. Output. Explain.

iii. Deadweight loss. Explain.

iii. Profit.

2. Assume the following about the market for gizmos:

• Gizmos are sold in a competitive market.

• Gizmos have no close substitute.

• The demand for gizmos is price inelastic but not perfectly inelastic

Suppose now that the government imposes a per unit excise tax on producers of gizmos.

(A) Using a correctly labeled graph, show the impact of the excise tax on each of the following in the gizmos market:

i. Price

ii. Output

iii. The area of tax revenue collected by the government

iv. Deadweight loss from the tax

(B) Given that demand for gizmos is price inelastic, will consumer spending on gizmos increase, decrease, or remain constant? How do you know?

3. Two rival firms operate in an oligopoly and, once a year, choose an advertising strategy. The firms can choose between an expensive television and radio advertising campaign (costly ads) or an inexpensive direct-mail advertising campaign (cheap ads). Television and radio cost more but reach more potential customers. Each firm decides their advertising strategy independently on January 1, 2007, and, once chosen, cannot alter the decision until January 1, 2008. The table below summarizes the profits each firm would earn given their own, and their rival’s strategy. Use this matrix to answer the following questions.

(A) Suppose Firm 1 chooses Costly Ads and Firm 2 chooses Cheap Ads .

i. Identify the profit for Firm 1.

ii. Identify the profit for Firm 2.

(B) It is now January 1, 2007, and each firm must independently make the advertising strategy decision. Is there a dominant strategy in this game? Explain how you know.

(C) If each firm chooses the advertising strategy independently without collusion, what is the outcome of this game?

(D) Is the outcome of this game an example of a “prisoners’ dilemma”? Explain your answer.

Note: Based on my experience, these point allocations roughly approximate the weighting on similar questions on the AP examinations. Be aware that every year the point allocations differ and partial credit is awarded differently.

Question 1 (10 points)

Part (A): 3 points

i. 1 point for identifying 6 as the profit maximizing output.

ii. 1 point for identifying $80 as the price.

iii. 1 point for identifying that 7 units would be allocatively efficient (where P = MC).

Part (B): 2 points

i. 1 point for calculating, with work shown, that π = 6 × ($80 – $70) = $60.

ii. 1 point for calculating, with work shown, that CS = ½ × 6 × $20 = $60

Part (C): 5 points

i. 1 point for stating that output will not change.

1 point for explaining that the lump-sum tax does not affect marginal revenue or marginal cost.

ii. 1 point for stating that deadweight loss doesn’t change.

1 point for explaining that because output doesn’t change, and the demand curve still intersects MC at 7 units, the difference between profit maximizing and allocatively efficient output levels is the same.

iii. 1 point for stating that profit decreases.

Question 2 (7 points)

Part (A): 5 points

These are all graphing points, so to get all five points, you must perfectly identify all curves, axes, and directional shifts.

1 point: A correctly labeled graph showing the supply curve shifting upward by the amount of a tax.

i. 1 point: Showing that the price increases after the tax.

ii. 1 point: Showing that the quantity decreases after the tax.

iii. 1 point: Tax revenue is the area of the rectangle yP ₂ DW.

iv. 1 point: Deadweight loss is the area of the triangle DWL shown above.

TIP: In a question like this, there are very few partial credit possibilities. You either get the graphing points or you do not.

Part (B): 2 points

1 point: Consumer spending increases.

1 point: Because the percent increase in the price is greater than the percent decrease in quantity. It is also accurate to refer to proportional changes.

TIP: The last point is the more difficult of the two and serves to differentiate students. In the past you might have also received credit for saying “a large increase in the price outweighs a small decrease in quantity.” It is much more accurate to refer to proportional or percentage changes, and in recent years, the rubric has been more stringent on this point.

Question 3: (7 points)

Part (A): 2 points

These are points for just being able to read the payoff matrix in this game. Since we know that Firm 1 is choosing Costly Ads , then you must focus on the top half of the matrix. If Firm 2 is choosing Cheap Ads , then the game ends in the top right square.

i. 1 point: $250

ii. 1 point: $75

Part (B): 2 points

The key here is obviously to know what it means to have a dominant strategy. A dominant strategy is one that is always superior to the other option, no matter what the rival firm is doing. For example, if Firm 2 plays Costly Ads , Firm 1 should do the same because $100 (Costly Ads ) beats $75 (Cheap Ads ). If Firm 2 were to play Cheap Ads , Firm 1 would play Costly Ads because $250 (Costly Ads ) beats $200 (Cheap Ads ). So Firm 1 would always play Costly Ads . The same is true of Firm 2.

i. 1 point: Yes, playing Costly Ads is a dominant strategy for both firms.

ii. 1 point: Because, no matter what the rival firm is doing, this strategy always beats Cheap Ads .

Part (C): 1 point

The outcome is that both firms earn $100 because, without collusion, both will play the dominant strategy, Costly Ads .

Part (D): 2 points

A prisoners’ dilemma is a situation where playing the dominant strategy produces an outcome that, in hindsight, could have been better for both if the firms could have colluded and coordinated their strategies.

1 point: Yes, it is an example of a prisoners’ dilemma.

1 point: Both firms could have improved profits ($200 each versus $100 each) by colluding with a selection of Cheap Ads .

AP Microeconomics Practice Exam 2

Multiple-Choice Questions:

Number of correct answers: ______

Number of incorrect answers: ______

Number of blank answers: ______

Did you complete this part of the test in the allotted time? Yes/No

Free-Response Questions:

1. ______/10

2. ______/7

3. ______/7

Did you complete this part of the test in the allotted time? Yes/No

Calculate Your Score:

Multiple-Choice Questions:

Free-Response Questions:

Add the raw scores from the multiple-choice and free-response sections to obtain your total raw score for the practice exam. Use the table below to determine your grade, remembering these are rough estimates using questions that are not actually from AP exams, so do not read too much into this conversion from raw score to AP score.