Microeconomics Questions and Answers

Answer: C

The production possibility curve is drawn on the assumptions that resources are fully employed, that the quantity of resources and the state of technology are given and fixed, and that the resources are efficiently used. Full employment of the economy is therefore one of the assumptions. A variable supply of factors and continuous up-gradation of technology are changes that would shift the curve, so they are not assumptions behind a given curve, and allocating factor inputs to a single use would make the curve a point rather than a trade off between two goods. The answer is full employment of the economy, option C.

Answer: C

Elasticity of demand is below one (inelastic demand) when the percentage change in quantity is smaller than the percentage change in price. Then total outlay moves in the same direction as price: when price rises the outlay on the good rises, and when price falls the outlay falls. So an outlay that increases with an increase in price signals elasticity below unity. Outlay that rises when the price falls, or falls when the price rises, signals elastic demand, and an unchanged outlay when the price falls signals unit elasticity. The answer is option C.

Answer: D

A leftward shift of the supply curve means that less is offered at every price, which happens when production becomes costlier or less profitable. An excise duty raises the cost of selling each unit, so the supply curve shifts to the left. A fall in the cost of production, a rise in the number of sellers and an improvement in technology all raise supply at each price and shift the curve to the right. The answer is the imposition of an excise duty on a commodity, option D.

Answer: B

A perfectly competitive firm in the short run covers its variable cost if the price (equal to average revenue) is at least the average variable cost. When AVC is greater than AR, the revenue does not even cover the variable cost, so each unit produced adds to the loss and the firm is better off shutting down, where it loses only its fixed cost. If AVC is less than AR the firm continues to produce. AVC = MC marks the minimum of the AVC curve, which is the shut down price, and AVC less than MC alone does not decide the matter. The answer is AVC greater than AR, option B.

Answer: A

A monopsony is a market in which there is a single buyer of a good or a factor, for example the only employer of a type of labour in a town. A monopoly is the opposite, with one seller, and an oligopsony has a few buyers, while an oligopoly has a few sellers. The prefix 'mono' means one and the suffix 'opsony' refers to buying. The answer is one buyer, option A. The word comes from the Greek for one buyer, in the way that monopoly comes from one seller.

Answer: B

Price skimming means setting a high price when a new product is introduced, to earn high margins from buyers who are keen to have it, and lowering the price later as the market widens. It is the most common strategy at the introduction stage of the product life cycle. Loss leader pricing sells some goods below cost to attract customers, perceived value pricing is based on the buyer's view of worth, and value pricing offers good quality at low prices, and none is specific to the introduction stage. The key gives price skimming, option B.

Answer: A

The law of demand was graphically illustrated by Alfred Marshall, who drew the demand curve on a diagram, with price on the vertical axis and quantity on the horizontal axis, and stated the law in his Principles of Economics. Adam Smith wrote about the division of labour and the invisible hand, Pigou worked on welfare economics, and Irving Fisher on money and interest. The answer is Marshall, option A. The curve slopes downward because quantity demanded rises when price falls, other things equal, which is the law itself.

Answer: A

A natural monopoly arises when a single firm can supply the whole market at a lower cost than two or more firms could, because the average cost keeps falling over the whole range of market demand, as with water supply or railway lines. Perfect competition has many firms, a duopoly has two, and an oligopoly has few. The answer is natural monopoly, option A. Examples are the supply of water or electricity through one network, where two sets of pipes or wires would waste resources.

Answer: C

Adam Smith used the phrase 'invisible hand' to describe how individuals who seek their own gain are led, by competition in markets, to produce outcomes that serve society as a whole. So the invisible hand refers to competition and the price system. Scarcity, greed and monopoly are not what he meant, and monopoly would work against the benefit of the market. The answer is competition, option C. The idea appears in his Wealth of Nations of 1776 and became the base of the case for free markets.

Answer: D

A Nash equilibrium is a situation in which each player is doing the best he can given the strategy of the other player, so no player gains by changing his strategy alone. So it is correct to say that no player has anything to gain by changing its strategy given the strategy of the other player. The statement that a player has an incentive to change unilaterally is the opposite, and a Nash equilibrium need not be collectively optimal or unique. The answer is option D.