Practice Multiple Choice Test

The University of Melbourne
Department of Economics
316-660: Managerial Economics
Semester 2, 2008
Practice Multiple Choice Test
Solutions
1. Computer hardware and software are complements. Both goods are traded in perfectly
competitive markets. An improvement in the efficiency of making microchips for computer
hardware will:
a) Increase in the equilibrium price of hardware, and decrease in equilibrium quantity of
software traded
b) A decrease in equilibrium price of hardware, and an increase in equilibrium price of software
c) An increase in equilibrium quantity of hardware traded, and a decrease in equilibrium
quantity of software traded
d) A decrease in equilibrium quantity of hardware traded, and a decrease in equilibrium
quantity of software traded
e) A decrease in equilibrium price of hardware, and a decrease in equilibrium quantity of
software traded
Solution: B
An improvement in the efficiency of making microchips will shift the supply curve for computer
hardware to the right. This will cause a fall in the equilibrium price of computer hardware. As
software is a complement to hardware, a fall in the price of hardware will cause the demand
curve for software to shift to the right. As a result the equilibrium price of software will increase.
Therefore only answer B is correct.
2. Suppose the market for rental housing accommodation is perfectly competitive. A temporary
shortage of rental housing accommodation is likely to cause:
a) An increase in rents, together with an increase in the quantity of rental housing demanded,
and a decrease in the quantity of rental housing supplied.
b) An increase in rents, together with a decrease in demand for rental housing, and an increase
in supply of rental housing.
c) A decrease in rents, together with a decrease in the quantity of rental housing demanded, and
an increase in the quantity of rental housing supplied.
d) A decrease in rents, together with an increase in demand for rental housing, and a decrease
in supply of rental housing.
e) An increase in rents, together with a decrease in the quantity of rental housing demanded,
and an increase in the quantity of rental housing supplied.
Solution: E
A shortage of rental housing corresponds to a situation of excess demand. Excess demand exists
where the price is below the equilibrium price in a market. Where excess demand exists, market
forces will tend to push the price up toward the equilibrium price. (For example, suppliers will
offer to supply a larger quantity at a higher price than the price at which the initial shortage
exists, and at that higher price – provided it is still below the equilibrium price – consumers will
be willing to buy the entire quantity being offered for sale. In other words, at a new price that is
still below the equilibrium price, quantity demanded is greater than quantity supplied.) As the
price increases, there will be a decrease in quantity of rental housing demanded (by the law of
demand), and an increase in the quantity of rental housing supplied (by the law of supply).
3: The apple market in Australia is perfectly competitive. The cross price elasticity of demand
for apples with regard to the price of oranges is 0.3. This means that:
a) A rise in the price of oranges will lead to an increase in the revenue of apple farmers
b) A rise in the price of oranges will lead to a decrease in the revenue of apple farmers
c) A rise in the price of oranges will not alter the revenue of apple farmers
d) A rise in the price of oranges will lead to an excess supply of apples in equilibrium
e) A rise in the price of oranges will lead to an excess demand for apples in equilibrium
Solution: A
The cross price elasticity of demand is positive, so apples and oranges are substitutes. An
increase in the price of oranges will cause an increase in the demand for apples. This will
increase the price of apples and quantity of apples traded. As both price and quantity traded
increases there must be an increase in revenue.
5. There is a drought in regions in Australia where oranges are grown. At the same time, there is
a decrease in the price of fertiliser used in mango growing. Finally, an increase in income of
Australian consumers occurs.
From the information provided, we can say that the following must occur:
a) An increase in demand for mangoes and oranges
b) An increase in demand and supply of mangoes
c) An increase in demand for mangoes and a decrease in supply of oranges
d) An increase in supply of mangoes and a decrease in supply of oranges
e) An increase in supply of mangoes and a decrease in demand for oranges
Solution: D
The drought will cause the supply of oranges to shift to the left (a decrease in supply) and a
reduction in the price of fertiliser (an input into mango growing) will cause the supply curve for
mangoes to shift to the right (increase supply)
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4: Consider the following perfectly competitive market for a good:
QS = 3P
QD = 200 – 2P
where QS = quantity supplied; QD = quantity demanded; and P = price.
Which of the following is correct?
a) At P=50 there will be excess demand for the good
b) Only at prices below P=30 will there be excess demand for good
c) At prices below P=40 there will be excess demand for the good, and the quantity traded will
be greater than 120
d) It is not possible to find an equilibrium price and quantity traded for the good
e) At prices below P=40 there will be excess demand for the good, and the quantity traded will
be less than 120
Solution: E
In equilibrium Qs=Qd so equating the two functions and solving for P finds P=40, then plugging
this value into either equation will result in Q=120. Therefore at prices below P=40 there will be
excess demand, and quantity traded will be less than 120.
6. Sunscreen lotion and sunhats can be considered as substitutes for protection from UV rays.
A new type of fabric is discovered that is cheaper to manufacture than existing fabrics that
provide UV protection. Markets for sunscreen lotion and sunhats can both be assumed to be
perfectly competitive. Which of the following is correct?
a) The quantity traded of sunhats will increase, and the quantity traded of sunscreen lotion will
decrease.
b) The price of sunhats will increase, and the price of sunscreen lotion will decrease.
c) The price of sunhats will decrease, and the quantity traded of sunscreen lotion will increase.
d) The quantity traded of sunhats will increase, and the price of sunscreen will increase.
e) None of the above.
Solution: A
The fabric is an input to production of sunhats. A new fabric that is cheaper to manufacture
therefore represents a decrease in the price of an input for making sunhats. This will cause an
increase in supply of sunhats. That increase in supply will cause an increase in equilibrium
quantity of sunhats traded, and a decrease in price. Sunhats and sunscreen lotion are substitutes.
Hence a decrease in the price of sunhats will cause a decrease in demand for sunscreen lotion.
That decrease in demand will cause a decrease in equilibrium quantity traded, and a decrease in
price of sunscreen lotion. The only answer that is consistent with the predicted changes in
equilibrium price and quantities of sunhats and sunscreen lotion is A.
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7. Suppose that a 20 per cent increase in the price of tomatoes causes a 10 per cent decline in
the quantity demanded of cucumbers. The coefficient of the cross elasticity of demand for
cucumbers is:
a) negative and, therefore, these goods are substitutes.
b) positive and, therefore, these goods are substitutes.
c) negative and, therefore, these goods are complements.
d) positive and, therefore, these goods are complements.
e) greater than one and, therefore they are substitutes.
Solution: C
Cross price elasticity of demand is the % change in quantity of cucumbers divided by the %
change in price of tomatoes. These two variables are given and the result is negative, thus they
are complements.
8. The price of a local cable TV service increased from $16.20 to $19.80 per month and resulted
in a fall in the number of cable subscribers from 224,000 to 176,000. In this price range, the
average (arc) own-price elasticity of demand is:
a) -0.8.
b) -1.2.
c) -1.6.
d) -8.0
e) -1.0
Solution: B
The formula for the average own-price elasticity of demand is: (change in quantity/change in
price) multiplied by (average price/average quantity or sum of the prices over the sum of the
quantities). Using this formula, one arrives at –1.2.
9. What would happen in the market for restaurant pizza if the price of flour, an important
ingredient in pizzas, increased and the price of Chinese restaurant meals increased? These
markets can be assumed to be perfectly competitive
a) The equilibrium price of pizza would increase, but the impact on the amount of pizza sold in
a market could be either positive or negative
b) The equilibrium price of pizza would decrease, but the impact on the amount of pizza sold in
a market could be either positive or negative
c) Both equilibrium price and quantity of pizza would definitely increase
d) Equilibrium quantity of pizza would increase, but the impact on the equilibrium price of
pizza would be uncertain
e) Equilibrium quantity of pizza would decrease, but the impact on the equilibrium price of
pizza would be uncertain
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Solution: A
As flour is an input into pizza, an increase in the price of flour will shift the supply curve for
pizza to the left. As Chinese meals are a substitute for pizza, an increase in their price will shift
the demand curve for pizza to the right. The overall effect will be to increase the price of pizza,
but the effect on quantity will be uncertain.
10. Suppose the market demand for medical care is summarised by the demand function;
Qd = 60-2p and the market supply is summarised by the supply function; Qs = 40+ 3p; where p
is the price of medical care. What is the equilibrium price and quantity in this market?
a) P = 6 and Q = 64 units
b) P = 3 and Q = 18 units
c) P = 12 and Q = 100 units
d) P = 4 and Q = 52 units
e) None of the above is correct
Solution: D
In equilibrium Qs=Qd so equating the two functions and solving for P finds P=4, then plugging
this value into either equation will result in Q=52.
11. If the government introduces a new law that imposes a maximum rent on Brisbane
apartments that is BELOW the current equilibrium rent. You would expect that:
a) the new law will have no economic impact.
b) the new law will create a surplus of apartments to rent.
c) renters will find that landlords start offering to furnish the apartments.
d) the new law will cause a shortage of apartments to rent.
e) the impact of the new law cannot be predicted without further information.
Solution D
If the government imposes a maximum rent below the equilibrium rent, this would bring about a
shortage of apartments for rent. This is because at this rent the quantity demanded will exceed
the quantity supplied.
12. Consumer surplus is:
a) The cost of producing a unit of a product.
b) The maximum that a consumer is willing to pay for a product.
c) The difference between the price charged for a product and the cost of producing that
product.
d) The difference between the maximum that a consumer is willing to pay for a product and the
cost of producing that product.
e) The difference between the maximum that a consumer is willing to pay for a product and the
price that is paid for that product.
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Solution: E
The consumer surplus is the area under the demand curve, above the price. As the demand curve
maps maximum willingness to pay, CS is the difference between WTP and price paid.
13. Suppose that the number of buyers in a given competitive market increases and there is also
a technological advancement in the production process for the suppliers in the same market.
What would we expect to happen in the market?
a) The equilibrium price would increase, but the impact on the amount sold in the market could
either be positive or negative
b) The equilibrium price would decrease, but the impact on the amount sold in the market could
either be positive or negative
c) Both equilibrium price and quantity would definitely increase
d) Equilibrium quantity would increase, but the impact on the equilibrium price would be
uncertain
e) Equilibrium quantity would decrease, but the impact on the equilibrium price would be
uncertain
Solution D
An increase in the number of buyers in a market will cause the demand curve to shift to the
right, and a technological advancement in the production process will cause the supply curve to
shift to the right. We can be certain in this situation that the equilibrium quantity traded will
increase, but the effect on equilibrium price will be uncertain. This will depend on the relative
magnitude of the shifts in the demand and supply curves.
14. As a result of a rise in the price of cinema tickets, we observe that total consumer spending
on cinema tickets falls. We can conclude that:
a) demand for cinema tickets is price elastic
b) demand for cinema tickets is price inelastic
c) consumers see going to the cinema as a “luxury”
d) consumers see going to the cinema as an inferior good
e) price elasticity of demand for cinema tickets is zero.
Solution A
There is an inverse relationship between price and total revenue (total consumer expenditure), so
the price elasticity of demand must be elastic.
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15. The Bureau of Agricultural Economics calculates that the own price elasticity of demand for
chicken is -0.6. Other things being equal, this implies that a 20 per cent increase in the price of
chicken will cause the quantity of chicken demanded to:
a) increase by approximately 12 per cent.
b) increase by approximately 26 per cent
c) decrease by approximately 32 per cent.
d) decrease by approximately 26 per cent.
e) decrease by approximately 12 per cent.
Solution: E
Price elasticity of demand = % change quantity demanded/% change in price. Or Price elasticity
of demand* % change in price = % change quantity demanded. So -0.06*20=-12 or a decrease
in demand of 12%.
Price ($)
Quantity Demanded
Quantity Supplied
0
1
2
3
4
5
6
60
50
40
30
20
10
0
0
10
20
30
40
50
60
16. Using the information in the table shown above, which of the following is correct?
a) If the price is equal to $4 then there is excess demand, and the quantity traded is equal to 20
b) If the price is equal to $2 then there is excess demand, and the quantity traded is equal to 20
c) Only at prices below $3 will there be an excess supply
d) It is not possible to find an equilibrium price from the information given in the Table
e) When the price equals $0 the amount of excess supply is exactly the same as when the price
equals $6
Solution B
At price of $2 quantity demanded is 40 and quantity supplied is 20, therefore there is an excess
demand of 20.
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17. Again using the same information, suppose the quantity demanded increases by 10 at each
price, and that quantity supplied at each price decreases by 10. Which of the following is
correct?
a) Both the equilibrium price and quantity traded remain unchanged
b) The equilibrium price decreases to $2, and the equilibrium quantity traded remains
unchanged
c) The equilibrium price remains unchanged, and the equilibrium quantity traded increases to
40
d) The equilibrium price remains unchanged, and the equilibrium quantity traded decreases to
20
e) The equilibrium price increases to $4, and the equilibrium quantity traded remains
unchanged
Solution E
As a result of shifting the demand curve to the right by 10 for every price and shifting the supply
curve to the left by 10 for every price, the new equilibrium price is $4 and the equilibrium
quantity is 30. Thus the price has increased and the quantity has remained unchanged.
18. The ABC Computer Company wants to increase the quantity of computers it sells by 5
percent. If the price elasticity of demand is -2.5 the company must:
a) Increase price by 2 percent
b) Decrease price by 2 percent
c) Decrease price by 0.5 percent
d) Increase price by 0.5 percent
e) Decrease price by 5 percent
Solution B
Elasticity of demand = % change in price / % change in quantity demanded. So % change in
price = % change in quantity demanded / elasticity of demand = 5/-2.5 = -2, i.e., a 2% decrease
in price.
19. Simon and Erica give up their jobs in the Economics Department to set up their own
consulting firm. To set up the business they must buy an office for $50,000. Should they choose
to cease operating their business at some future date they know they will be able to sell the
office for $40,000. If they did not buy the office they would have invested the money they spent
on the office and earned an annual rate of interest of 10 percent. They also hire a research
assistant. The salary cost of the research assistant is $50,000 per annum. In its first year of
operation Simon and Erica expect to earn revenue of $20,000.
What is the total opportunity cost to Simon and Erica of setting up their consulting firm for one
year?
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a) $65,000
b) $100,000
c) At least $65,000
d) At least $200,000
e) $55,000
Solution C
Total opportunity costs are at least $65,000 = $10,000 (office) + $5,000 (loss of interest earned
on $50,000) + $50,000 (salary of assistant) + wages of Simon and Erica in Economics
department (no amount specified).
20. The University of Melbourne is contemplating increasing course fees to enhance revenue. If
the University expects that raising course fees would enhance revenue:
a) It is ignoring the law of demand
b) It is assuming that the demand for university education is elastic
c) It is assuming that the supply of university education is elastic
d) It is assuming that the demand for university education is inelastic
e) None of the above answers is correct
Solution D
If there is a positive relationship between price (fees) and revenue then demand must be
inelastic.
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