Microeconomics Questions and Answers

Q: In Pareto optimal or efficiency equilibrium :

Pareto optimality is a situation in which it is impossible to make anyone better off without making someone worse off.This is Vilfredo Pareto's criterion: an allocation is optimal if no reallocation can raise one person's welfare without lowering another's. Every possible gain for one person has already been exhausted.A situation where someone can be made better off without harm is exactly the opposite, a Pareto improvement still available. Supply equal to demand describes market equilibrium, which need not be Pareto optimal. Equality of MRS and MRTS mixes conditions for consumers and producers and is not by itself the definition.

Q: Consider the pair of goods X or Y. It is observed that when price of Y falls, the demand for X also falls. Which one of the following options would you choose regarding the nature of these goods ?

X and Y are substitute goods.When the price of Y falls, Y becomes cheaper relative to X, so consumers buy more Y in place of X and the demand for X falls. A fall in the price of one good reducing demand for the other is the mark of substitutes, such as tea and coffee; their cross elasticity of demand is positive.With complements, such as cars and petrol, a fall in Y's price would raise the demand for X, the opposite of what is observed. Inferior and Giffen goods describe how a good responds to income or its own price, not the relation between two goods.

Q: In the third stage of production, the total product is :

In the third stage, total product is falling but positive.Under the law of variable proportions, stage I has rising average product, stage II has falling but positive marginal product, and stage II ends where total product reaches its maximum and marginal product is zero. In stage III marginal product is negative, so each extra unit of the variable input reduces total product, though total product itself is still a positive amount.Total product is rising in stages I and II, is at its maximum only at the boundary between II and III, and is never constant across a stage. A rational producer avoids stage III.

Q: According to Kenneth Arrow people do not prefer :

The key gives flood insurance. I could not trace the attribution to Kenneth Arrow, so the answer rests on how the four kinds of cover differ.Arrow's work on uncertainty explains why insurance markets fail when risks are hard to pool: adverse selection and moral hazard, and risks that strike many policyholders at once. Flood damage is the standard case, because a single river flood hits a whole district together and the people most at risk are the ones most eager to buy, so insurers price it out or exclude it and many households go without.Flight, property and life insurance are the ordinary, widely bought kinds: their risks are mostly independent from one policyholder to the next, so they can be pooled and priced. The question as worded cannot be checked against an Arrow text, which a reviewer should know.

Q: The basic objective of applying the game theory is :

The key's answer is to arrive at the dominant strategy.Game theory studies situations in which each player's best choice depends on what the others do, as among oligopoly firms. Applying it means working out the best strategy for each player given the possible strategies of rivals; where a strategy is best whatever rivals do, it is a dominant strategy, and the analysis leads to an equilibrium such as the Nash equilibrium.Maximising profit or sales, or minimising marginal cost, are goals a firm may have, but they do not describe what game theory itself is used for, which is choosing strategies under strategic interdependence.

Q: Other things remaining constant, if a competitor of commodity X carries out a successful advertisement campaign, the demand curve for X shall ................... .

The demand curve for X shall shift to the left.A successful advertisement campaign by a competitor draws buyers towards the rival product, so at every price fewer units of X are demanded. A fall in demand at every price is shown by a leftward shift of the whole demand curve. Its own price has not changed, so this is not a movement along the curve.A rightward shift would mean higher demand for X. The demand curve does not become positively sloping or vertical because of a rival's advertising; its slope reflects the law of demand.

Q: The payment to the input is in fixed supply in the short-run is called :

The payment is called Quasi rent.Alfred Marshall used quasi rent for the earnings of factors, such as machines and equipment, that are fixed in supply in the short run but can be varied in the long run. In the short run their earnings are a surplus over variable cost, like rent; in the long run, as supply adjusts, the surplus disappears.Economic rent is the surplus earned by a factor in fixed supply over its transfer earnings, classically land, in the long run as well. Transfer earnings are the minimum payment needed to keep a factor in its present use. Producer's surplus is the excess of price over the minimum price sellers would accept.

Q: A necessary (but not sufficient) condition for the existence of a general equilibrium is .................. .

The necessary condition is that the number of independent equations and number of unknowns must be the same.Leon Walras represented the economy as a system of simultaneous equations for demand and supply in every market, with prices and quantities as unknowns. For a solution to exist, he argued, the number of independent equations must equal the number of unknowns. Later economists such as Abraham Wald showed that this counting condition is not sufficient: a solution may still not exist or may be economically meaningless, for example with negative prices.Equal prices for all goods, or equality between factor supply and goods prices, are not conditions of general equilibrium; the other options mix unrelated quantities.

Q: Walras argued that all .............. and ..................... in all markets are determined simultaneously through their interaction with one another.

Walras argued that all prices and quantities are determined simultaneously.In Walrasian general equilibrium, every market is linked to every other: the price of one good affects demand for others, factor prices affect costs and incomes, and so on. The equilibrium prices and the quantities bought and sold in all markets are therefore determined together, as the solution of one system of equations.Demand and supply are the functions that determine prices and quantities, not the outcomes themselves, and costs are derived from factor prices and quantities. The determined variables are prices and quantities.

Q: Suppose Anil and Sunil are at an allocation bundle where their marginal rates of substitution are not equal, then ............... .

If their marginal rates of substitution differ, there are gains from exchange.In the Edgeworth box, the contract curve is the set of allocations where the two consumers' indifference curves are tangent, so their MRS are equal. If Anil values good X more highly in terms of Y than Sunil does, each can trade what he values less for what he values more, and both can move to higher indifference curves. Such mutually beneficial trade remains possible until the MRS are equal.So the allocation is not an equilibrium (D), and trade would bring gains, not losses (A). Any allocation of the two goods between them lies inside the box, so C is wrong.

131.

In Pareto optimal or efficiency equilibrium :

A.Situation, it is impossible to make anyone better off without making someone worse-off
B.Situation in which it is possible to make someone better off
C.Situation where supply equals demand
D.Situation where marginal rate of substitution and marginal rate of technical substitution are equal

Exam Year(s)

MH SET - 2021, SET Exam - 2021,

Answer: A

Pareto optimality is a situation in which it is impossible to make anyone better off without making someone worse off.

This is Vilfredo Pareto's criterion: an allocation is optimal if no reallocation can raise one person's welfare without lowering another's. Every possible gain for one person has already been exhausted.

A situation where someone can be made better off without harm is exactly the opposite, a Pareto improvement still available. Supply equal to demand describes market equilibrium, which need not be Pareto optimal. Equality of MRS and MRTS mixes conditions for consumers and producers and is not by itself the definition.

Discuss in Forum

132.

Consider the pair of goods X or Y. It is observed that when price of Y falls, the demand for X also falls. Which one of the following options would you choose regarding the nature of these goods ?

A.They are complementary goods
B.They are substitute goods
C.They are inferior goods
D.They are giffen goods

Exam Year(s)

MH SET - 2023, SET Exam - 2023,

Answer: B

X and Y are substitute goods.

When the price of Y falls, Y becomes cheaper relative to X, so consumers buy more Y in place of X and the demand for X falls. A fall in the price of one good reducing demand for the other is the mark of substitutes, such as tea and coffee; their cross elasticity of demand is positive.

With complements, such as cars and petrol, a fall in Y's price would raise the demand for X, the opposite of what is observed. Inferior and Giffen goods describe how a good responds to income or its own price, not the relation between two goods.

Discuss in Forum

133.

In the third stage of production, the total product is :

A.Rising
B.Constant
C.Maximum
D.Falling but positive

Exam Year(s)

MH SET - 2023, SET Exam - 2023,

Answer: D

In the third stage, total product is falling but positive.

Under the law of variable proportions, stage I has rising average product, stage II has falling but positive marginal product, and stage II ends where total product reaches its maximum and marginal product is zero. In stage III marginal product is negative, so each extra unit of the variable input reduces total product, though total product itself is still a positive amount.

Total product is rising in stages I and II, is at its maximum only at the boundary between II and III, and is never constant across a stage. A rational producer avoids stage III.

Discuss in Forum

134.

According to Kenneth Arrow people do not prefer :

A.Flight insurance
B.Property insurance
C.Life insurance
D.Flood insurance

Exam Year(s)

MH SET - 2023, SET Exam - 2023,

Answer: D

The key gives flood insurance. I could not trace the attribution to Kenneth Arrow, so the answer rests on how the four kinds of cover differ.

Arrow's work on uncertainty explains why insurance markets fail when risks are hard to pool: adverse selection and moral hazard, and risks that strike many policyholders at once. Flood damage is the standard case, because a single river flood hits a whole district together and the people most at risk are the ones most eager to buy, so insurers price it out or exclude it and many households go without.

Flight, property and life insurance are the ordinary, widely bought kinds: their risks are mostly independent from one policyholder to the next, so they can be pooled and priced. The question as worded cannot be checked against an Arrow text, which a reviewer should know.

Discuss in Forum

135.

The basic objective of applying the game theory is :

A.To maximise profits
B.To maximise sale
C.To arrive at the dominant strategy
D.To minimize marginal cost

Exam Year(s)

MH SET - 2023, SET Exam - 2023,

Answer: C

The key's answer is to arrive at the dominant strategy.

Game theory studies situations in which each player's best choice depends on what the others do, as among oligopoly firms. Applying it means working out the best strategy for each player given the possible strategies of rivals; where a strategy is best whatever rivals do, it is a dominant strategy, and the analysis leads to an equilibrium such as the Nash equilibrium.

Maximising profit or sales, or minimising marginal cost, are goals a firm may have, but they do not describe what game theory itself is used for, which is choosing strategies under strategic interdependence.

Discuss in Forum

136.

Other things remaining constant, if a competitor of commodity X carries out a successful advertisement campaign, the demand curve for X shall ................... .

A.Shift to the left
B.Shift to the right
C.Become positively sloping
D.Become parallel to Y axis

Exam Year(s)

MH SET - 2023, SET Exam - 2023,

Answer: A

The demand curve for X shall shift to the left.

A successful advertisement campaign by a competitor draws buyers towards the rival product, so at every price fewer units of X are demanded. A fall in demand at every price is shown by a leftward shift of the whole demand curve. Its own price has not changed, so this is not a movement along the curve.

A rightward shift would mean higher demand for X. The demand curve does not become positively sloping or vertical because of a rival's advertising; its slope reflects the law of demand.

Discuss in Forum

137.

The payment to the input is in fixed supply in the short-run is called :

A.Economic rent
B.Quasi rent
C.Transfer earnings
D.Producer's surplus

Exam Year(s)

MH SET - 2023, SET Exam - 2023,

Answer: B

The payment is called Quasi rent.

Alfred Marshall used quasi rent for the earnings of factors, such as machines and equipment, that are fixed in supply in the short run but can be varied in the long run. In the short run their earnings are a surplus over variable cost, like rent; in the long run, as supply adjusts, the surplus disappears.

Economic rent is the surplus earned by a factor in fixed supply over its transfer earnings, classically land, in the long run as well. Transfer earnings are the minimum payment needed to keep a factor in its present use. Producer's surplus is the excess of price over the minimum price sellers would accept.

Discuss in Forum

138.

A necessary (but not sufficient) condition for the existence of a general equilibrium is .................. .

A.Number of independent equations and number of unknowns must be the same
B.Prices of all goods should be equal
C.Supply of factors and prices of goods must be equal
D.Demand for factors and supply of goods should be the same

Exam Year(s)

MH SET - 2023, SET Exam - 2023,

Answer: A

The necessary condition is that the number of independent equations and number of unknowns must be the same.

Leon Walras represented the economy as a system of simultaneous equations for demand and supply in every market, with prices and quantities as unknowns. For a solution to exist, he argued, the number of independent equations must equal the number of unknowns. Later economists such as Abraham Wald showed that this counting condition is not sufficient: a solution may still not exist or may be economically meaningless, for example with negative prices.

Equal prices for all goods, or equality between factor supply and goods prices, are not conditions of general equilibrium; the other options mix unrelated quantities.

Discuss in Forum

139.

Walras argued that all .............. and ..................... in all markets are determined simultaneously through their interaction with one another.

A.Prices, quantities
B.Demand, prices
C.Supply, prices
D.Prices, costs

Exam Year(s)

MH SET - 2023, SET Exam - 2023,

Answer: A

Walras argued that all prices and quantities are determined simultaneously.

In Walrasian general equilibrium, every market is linked to every other: the price of one good affects demand for others, factor prices affect costs and incomes, and so on. The equilibrium prices and the quantities bought and sold in all markets are therefore determined together, as the solution of one system of equations.

Demand and supply are the functions that determine prices and quantities, not the outcomes themselves, and costs are derived from factor prices and quantities. The determined variables are prices and quantities.

Discuss in Forum

140.

Suppose Anil and Sunil are at an allocation bundle where their marginal rates of substitution are not equal, then ............... .

A.There are losses from exchange
B.There are gains from exchange
C.They are outside the Edgeworth box
D.They are at an equilibrium

Exam Year(s)

MH SET - 2023, SET Exam - 2023,

Answer: B

If their marginal rates of substitution differ, there are gains from exchange.

In the Edgeworth box, the contract curve is the set of allocations where the two consumers' indifference curves are tangent, so their MRS are equal. If Anil values good X more highly in terms of Y than Sunil does, each can trade what he values less for what he values more, and both can move to higher indifference curves. Such mutually beneficial trade remains possible until the MRS are equal.

So the allocation is not an equilibrium (D), and trade would bring gains, not losses (A). Any allocation of the two goods between them lies inside the box, so C is wrong.

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