mock half term test 2014.pdf

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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=203×E1 where E1 are emissions of tons of CO2 and for firm 2 MB2=102×E2 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=10E2. Hence the following equation has to hold 203xE1=102xE2 which we can write as 203x(10E2)=102xE2

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Page 1: Mock Half Term Test 2014.pdf

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-­‐3×E1    where  E1  are  emissions  of  tons  of  CO2  and  for  firm  2  

 MB2=10-­‐2×E2    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    

Page 2: Mock Half Term Test 2014.pdf

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 = 2𝑄! ⇒ 𝑄! = 5  10 = 1+ 𝑄! ⟹ 𝑄! = 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  𝑃𝐶 = 10𝑄 .  What  is  the  socially  efficient  total  amount  of  Q?    

Page 3: Mock Half Term Test 2014.pdf

a. 176  b. 50  c. 100  d. 60  e. 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  𝐶 = 31𝑞 − 6𝑞! + 𝑞!/3  where  q  is  the  output  of  an  individual  producer.  The  market  demand  curve  for  orange  juice  is  𝑄 = 3100−100𝑃.  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− 12𝑞 + 𝑞! = 31− 6𝑞 +𝑞!

3  which  we  can  re-­‐write  as  

12+ 𝑞 = 6+𝑞3  

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  

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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  don’t  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  

Page 5: Mock Half Term Test 2014.pdf

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− 0.005𝑄 = 10+ 0.004𝑄  ⟹ 18 = 0.009𝑄⟹ 𝑄 = 2000⟹ 𝑃 = 18  

 Note  that  the  demand  function  (inverse  of  the  inverse)  is  

𝑄 = 5600− 200𝑃    Hence,  using  the  elasticity  formula  we  find    

𝐸 =𝜕𝑄𝜕𝑃

𝑃𝑄 = −200×

182000 = −1.8  

   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  

Page 6: Mock Half Term Test 2014.pdf

   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.